slides

• Conventional bank intermediary


  Lender - Borrower (interest based)
• Islamic intermediary


  • Depositor - custodian
  • Lender - Borrower (interest free)
  • Investor - entrepreneur
• Current accounts in Islamic banking

  • Amanah 'Trust': the money is entrusted to the bank for safekeeping and should be returned in whole. The bank accepts responsibility for its safekeeping.
  • Wadia 'deposit': The bank promises to return the money to the depositors.
• The bank needs the explicit permission of the depositors to use these funds. Some scholars permit Islamic banks to offer gift or hiba in exchange for the right to invest the deposit, but this is not contractual.
• Current accounts in Islamic banking

  • Example 1: X deposits USD 1,000 in an Amanah account, receives no return but has the security of the bank guaranteeing the face value of the deposit. After 12 months, X has USD 12,000 and receives USD 12,000 only.
  • Example 2: X has GBP 1,000 in an Amanah account, pays out GBP 750 and GBP 300 cheques, exceeding the funds. The bank charges GBP 75.50 to cover the overdrawn amount, GBP 25 penalty, and GBP 10 cost, donating the remaining GBP 15 to charity.
• How funds are used by Islamic banks

  • Profit Area
  • Asset Finance
  • Equity
  • Services
• Mudaraba


  A contract of partnership in profit whereby one party provides capital (Rab Al Mal) and the other provides labour and management (Mudarib). Profit is shared based on an agreed ratio, but loss must be borne by the capital provider alone. Mudaraba is a type of equity finance.
• Mudaraba process


  1. Ali (Rab Al Mal) provides 40% of capital, Islamic Bank (Mudarib) provides 60% of capital and 60% of profit

  2. Ali (Rab Al Mal) receives 40% of profit

  3. If there is a loss, it is borne by Ali (Rab Al Mal) unless the Islamic Bank has been negligent
• Mudaraba al Muqayyada


  Restricted Mudaraba is for specific business or place and is contractually limited by time and place, partner and deal type.
• Mudaraba al Mutlaqa


  Unrestricted Mudaraba, the manager is free to invest the funds, as long as the investments and the investment process are shariah compliant.
• Application of Mudaraba


  • Deposits products
  • Trade finance
  • Structured finance
• Risks in Mudaraba


  • The performance of Mudarabah funds relates to the performance of the respective project or asset and hence is subject to business, credit, market and equity investment risk.
• Two-Tier Mudaraba structure


  1. Ali (Rab Al Mal) provides capital to Islamic Bank (Mudarib)

  2. Islamic Bank (Mudarib) invests in Shariah compliant investments with Mohd (Mudarib) who also has a 40% profit share
• Musharaka


  A partnership process in which several parties contribute to the financing and the management of a Shariah compliant project.
• Rules and Principles of Musharaka

  • It is not allowed to guarantee the capital
  • All partners can participate in the management
  • Profit distributed according to pre agreed profit sharing ratios
  • Loss distributed according to capital contribution
• Types of Musharaka


  • Permanent or continuous
  • Diminishing Musharaka
• Diminishing Musharaka or Musharaka Muntahiya bittamleek


  A type of Musharaka where the capital contribution of one party decreases gradually during the financing period, or one partner will purchase units in the Musharaka venture from the other partner at a pre-agreed unit price.
• Transfer of shares of the asset is based on market value and hence it might result in a gain or loss. As the share of the asset decreases for one of the partners, so does his loss exposure. The mode of redemption of the shares of the asset can be either by a single payment or progressively during the financing period.
• Structure of Diminishing Musharaka

  1. Ali (Partner) starts with 30% capital contribution, Islamic Bank (Partner) starts with 70% capital contribution. Profit sharing is 40% for Ali and 60% for the Islamic Bank.

  2. Over time, Ali's capital contribution increases to 90% and the Islamic Bank's decreases to 10%.

  3. Eventually, Ali becomes the sole 100% owner of the asset.
• Application of Musharaka


  • Deposits products
  • Trade finance
  • Structured finance
• Murabaha


  The sale of a commodity at cost price plus a known profit.
• Shari'a rules applicable to Murabaha

  • Disclosure: It is mandatory for the seller to disclose to the buyer the cost of asset and amount of profit charged, if not, the contract will be a Musawama (bargaining) contract.
  • Price: Once determined cannot be changed.
  • Payment: The payment can be in spot, in instalments or in lump sum after certain time. In Islamic finance it is always differed.
• Structure of Murabaha


  Ali (Customer/Buyer) purchases an asset from the Financial Institution (Seller) who may ask Ali to provide a down payment in the form of earnest money (Hamish Jeddiyah) or Arbun (non-returnable down payment).
• Practical issues in Murabaha include the customer wanting to pay the amount outstanding before the end of the financed term (the customer may or may not be granted a rebate), the customer not paying the instalment amount (the customer may be charged an amount to be donated to charity but the profit rate cannot be changed), and the timing and order of the Murabaha steps being crucial.
• Commodity Murabaha


  A deferred payment sale or instalment credit sale that uses a commodity, usually a base metal, as the underlying asset for the transaction. Commodities that were originally used as a means of exchange or money are not acceptable.
• Commodity Murabaha & Tawarruq Structure

  Party A (Islamic Bank) buys commodities at spot from the Seller for GBP 100, then sells them to Party B (Client) for deferred payment of GBP 110. Party B then sells the commodities at spot to the Buyer for GBP 100.
• Tawarruq


  A form of reverse Murabaha which is tolerated as it involves three sales contacts and three independent parties, frequently used to deliver money to a person wishing to avoid borrowing at interest. Considered objectionable by most Muslim scholars due to the intention behind the purchase of the commodities.
• Commodity Murabaha


  A deferred payment sale or instalment credit sale that uses a commodity, usually a base metal, as the underlying asset for the transaction
• Any commodities that were originally used as a mean of exchange or money - i.e., gold, silver, barley, dates, wheat and salt- are not acceptable for Commodity Murabaha
• Commodity Murabaha & Tawarruq Structure

  1. Seller

  2. Buyer

  3. Party A (Islamic Bank)

  4. Party B (Client)

  5. The bank buy commodities @ spot from the seller for GBP 100

  6. The bank Sell the commodities @ GBP 110 to the client for deferred payment

  7. The client Sell the commodities @ GBP 100 to the buyer for spot payment
• Tawarruq


  A form of reverse Murabaha which is tolerated as it involves three sales contacts and three independent parties, frequently used to deliver money to a person wishing to avoid borrowing at interest
• Tawarruq is considered objectionable by most Muslim scholars to the fact that the intention behind the purchase of the commodity is not to own and use the commodity
• AAOIFI has approved Tawarruq and has issued a separate standard to regulate this instrument
• Conditions for Tawarruq to be approved


  • Auditable ownership transfer of the commodity
  • Separation of the purchase and sale arrangements
  • Commodities that were originally used as a mean of exchange or money are not acceptable
• Arbun


  An advance or down payment which is accounted as a part of the purchase price if the buyer decides to complete the sale, or which becomes the property of the seller if the sale is not completed
• The Arbun cannot be traded or sold to a third party
• Arbun is typically exercised on a specific date rather than at will
• Selling the Arbun is similar to "short selling" which is a condition that would result in a void contract
• At the time of exercise the buyer only pays the difference between the price and the Arbun
• Ijarah


  A contract of lease in which the usage of an Asset is transferred to another party for consideration