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Islamic Financial Instruments
Najmul HassanGeneral Manager,
Corporate Banking & Business Development
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Islamic Shariah is the set of rules ®ulations which are to be followed byIslamic Banks.
Scholars study these laws and guide thebank on how to apply them on day today transactions.
Islamic Finance
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BASIC RULES OF SALE
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Since Murabaha is a sale transaction, rulesof Shariah regarding sale need to beunderstood.
Sale is defined in Shariah as
Exchange of a thing of value, by anotherthing of value, with mutual consent
Rules of Sale
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But Allah has permitted trade [2:275], But take witnesses whenever you make a
commercial contract [2:282], But let there be among you traffic and
trade by mutual good will [4:29], It is no crime for you to seek the bounty
of your Lord [2:198].
Legitimacy of sale
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Rule 1The subject of sale must exist at the time of sale
Rule 2The subject of sale must be in the ownership ofseller at the time of sale. Hence, what is notowned by the seller cannot be sold.
Rules of Sale
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Rule 3The subject of sale must be in the physical orconstructive ownership of seller at the time ofsale.
Constructive Possession means where thebuyer has not taken physical delivery of goods,
but the goods are under his control. And allrights and liabilities of the goods have passed tohim,i.e. the goods are at his risk.
Rules of Sale
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Rules of Sale
Rule 4The sale must be instant and absolute. Thus asale attributed to a future date or a salecontingent on a future event is void.
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Rule 5
The subject of sale should be an object of value.A thing having no value according to the usage oftrade cannot be sold.
Rule 6The subject of sale should not be a thing used for
a Haram purpose, e.g. pork, wine etc. Thesubject should be Maal-e-mutaqawwam
Rules of Sale
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Rule 7
The subject of sale should be specifically knownand identified to the buyer. The subject of salemust be identified by pointing out or by detailed
specification which can distinguish it from otherthings not sold.
Rule 8The delivery of the sold commodity to the buyershould be certain and should not depend on acontingency or chance.
Rules of Sale
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Rule 9
The certainty of price is a necessary condition forthe validity of sale.
Rule 10
The sale must be unconditional. A conditionalsale is invalid, unless the condition is recognized
as a usual practice of trade
Rules of Sale
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MURABAHA
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Murabaha is a particular kind of sale andnot a financing in its origin.
Where the transaction is done on a costplus profitbasis i.e. the seller discloses thecost to the buyer and adds a certain profit
to it to arrive at the final selling price.
Murabaha
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The distinguishing feature of Murabahafrom ordinary sale is:
- The seller discloses the cost to thebuyer.
- And a known profit is added.
Murabaha
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Payment of Murabaha price may be:
1) At spot2) In installments3) In lump sum after a certain time
Hence, Murabaha does not necessarilyimply the concept of deferred payment.
Murabaha
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TYPES OF MURABAHA
1) Direct where the financier himselfpurchases directly from the market or
3rd party.
2) Indirect where the financier appointsthe customer as an Agent to makepurchases from the market beforebuying it from the bank.
Murabaha
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The Holy Quran says And Allah has permitted trade(2:275)
It is further mentionedBut let there be among youtraffic and trade by mutual goodwill (4:29)
According to Imam Shafi in Al-Umm: If an individualshows another a good and says: buy this, and I willgive you this much profit in it; and then the second
man buys it then the purchase is valid. If the first partysaid: I will give you this much profit in it , but I retainan option, then he may conclude the sale or leaveit.(See Financial Transactions in Islamic Jurisprudence
Vol1 Pg 361)
Sharia Source
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As for making the promise to purchase the item oncethe bank acquires it binding on the ultimate buyer, wemay take a ruling by Ibn Shabramah from the Malikischool that any promise that does not result inpermitting that which is forbidden or forbidding thatwhich is permitted is binding.The Malikis use this principle to make the promisebinding, especially if the promise leads another entityto undertake a financial obligation.
Sharia Source
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In the first Conference in Dubai (1979), it was ruledthat: This type of promise is legally binding on bothparties based on the Maliki ruling, and religiouslybinding on both parties for all the other schools. In thisregard, what is religiously binding can be made legallybinding if this is beneficial and can be regulated legally.
Sharia Source
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The second Conference in Kuwait (1983) ruled thus:The conference determines that the mutual promisesinvolved in murabaha sales to the one who orders theinitial purchase is permitted after the bank owns andgains possession of the sold object, and then sells it tothe one who ordered its purchase with the promisedprofit margin.This sale is valid as long as the bank is exposed to therisk of destruction of the goods prior to delivering it to
the final buyer, as well as the obligation to accept thereturn of the goods if a concealed defect was found. .
Sharia Source
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Cost-plus, sale is a legally permissible contract bythe testimony of the majority of jurists andcompanions of the Prophet (pbuh).
This type of sale satisfies all the legal requirementsfor sale, and it provides a valuable service ineconomic markets since it allows thoseknowledgeable of market conditions to make a profitand those without such knowledge to obtain thegoods at a good price.
It was narrated that Ibn Masud (RA) ruled thatthere was no harm in declared lump-sum orpercentage profit margins.
Sharia Source
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The conditions ofmurabaha are as follows: Knowledge of the initial price: The second buyer
must know the price at which the seller obtained theobject of sale, since knowledge of the price is afundamental condition for the validity of sale.
Knowledge of the profit margin: Since the profitmargin is a component of the price at which thesecond buyer obtains the goods, knowledge of thatmargin is essential for knowledge of the price, which
is in turn a condition of validity for the sale.
Sharia Source
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The present day Murabaha transactions are
being practiced under the guidelines given
by Accounting & Auditing
Organization of Islamic FinancialInstitutions (AAOIFI) and Islamic Fiqh
Academy which have representation of
scholars of all Islamic Fiqhs.
Murabaha
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Basic rules for Murabaha financing:
Asset to be sold must exist.
Sale price should be determined.
Sale must be unconditional.
Assets to be sold:a) Cannot be used for un-Islamic purposes.b) Should be in ownership of the seller at the time
of sale; physical or constructive.
Murabaha
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Basic rules for Murabaha financing:
Re-negotiation of price after concluding thetransaction and roll over of Murabaha are not
permitted.
Discounting of Murabaha instrument is notpermitted.
Murabaha
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Step by step Murabaha financing
(under Agency arrangement)
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1.Client and bank sign an agreement to enterinto Murabaha (MMFA).
Agreement toMurabaha
Bank Client
Murabaha
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2. Client appointed as Agent to purchasegoods on banks behalf
Agency
Agreement
Agreement toMurabaha
Bank Client
Murabaha
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3. Bank gives money to Agent/supplier forpurchase of goods.
Disbursement to the agent or supplier
Agency
Agreement
Supplier
Agreement toMurabaha
Bank Client
Murabaha
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4. The agent takes possession of goods on banksbehalf.
Transfer of RiskDeliveryof goods
Vendor
Bank Agent
Murabaha
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5(a). Client makes an offer to purchase thegoods from bank through a declaration.
Offer topurchase
Bank Client
Murabaha
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5(b). Bank accepts the offer and sale isconcluded.
Murabaha Agreement+
Transfer of Title
Bank Client
Murabaha
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6. Client pays agreed price to bank according toan agreed schedule. Usually on a deferredpayment basis (Bai Muajjal)
Payment of Price
Bank Client
Murabaha
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MURABAHA DOCUMENTATION
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There are a number of documents involved in aMurabaha financing transaction. The mostessential of these documents are:
Master Murabaha Financing Agreement Agency Agreement
Order Form / Draw Down Notice
Declaration
Purchase Evidences
Demand Promissory Note
Payment Schedule
Murabaha Documentation
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Master Murabaha Financing Agreement (MMFA)
Its an agreement between the client and theBank whereby the client agrees to purchasegoods from the Bank from time to time as per
terms and conditions of this agreement. This is an over all facility agreement under
which various Sub-Murabahas may be executedfrom time to time.
Hence it needs to be signed once, i.e. at thetime the facility is sanctioned.
Murabaha Documentation
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Agency Agreement
Through this agreement, the Bank appointscustomer its agent to select and procure specifiedgoods for the Bank.
This agreement needs to be signed once,between the client and the bank to cover thespecified agency period.The disbursement offunds is done under this agreement.
The customer should define a comprehensive listof assets and commodities that he may procureduring the course of business from time to time.
Murabaha Documentation
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Order Form
This document is executed at the time of eachsub-Murabaha request i.e. each time whenthe customer requires funds for the purchaseof assets.
Through this document customer requests thebank to purchase the assets from the supplierand undertakes that it will purchase theassets from the bank once the bank acquires
them from the market.
The customer also undertakes to compensatefor the actual loss the bank may suffer in casehe fails to purchase the assets from the bank.
Murabaha Documentation
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Declaration
This is the most important part of the Murabahaprocess.
Declaration is to be signed by the customerimmediately after the purchase of goods asBanks agent but before the actual consumption.
This document establishes the actual saletransaction, i.e. transfer of ownership of goodsfrom the Bank to the customer
At this stage the specific details of the assetsmust be known i.e. quantity, quality, cost etc.
Murabaha Documentation
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Declaration
Purchase Evidences in the form of bills, saleinvoice, sales tax invoice must be furnishedalong with the Declaration, specifying the fulldetails of the goods purchased.
The cost of goods must be inclusive of all costincluding sales tax, transportation and handlingetc.
Proper timing of declaration is extremely
important especially in cases of perishable orimmediately consumable commodities.
Murabaha price (Cost of Goods + Profit) shouldbe determined at this stage and stated clearly in
the Declaration.
Murabaha Documentation
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Payment Schedule
The Payment Schedule specifies the amount thatthe Client will make from time to time or at oncetowards the payment of Murabaha price.
This shall be implemented after the execution ofDeclaration.
The dates mentioned in the schedulecorresponds to the day when the payment
becomes due on the client.
Murabaha Documentation
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Practical Issues in Murabaha
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1.Timing of Declaration
A Murabaha financing arrangement consists ofa series of documents to be executed at variousstages, the sequence and timing of which isextremely important.
Through declaration, the client and the bankexecute an important step of a valid Murabahasale i.e. Offer & Acceptance
Declaration is to be signed by the customer
when it has purchased and taken possession ofthe goods as the Banks agent.
Declaration must be signed while the goods arestill in existence and have not been used in the
production process or sold to some other entity.
Issues in Murabaha
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2. Rollover in Murabaha
Rollover in Murabaha is not possible since each
Murabaha transaction is for the purchase of aparticular asset. A new Murabaha can only beexecuted for the purchase of new assets.
It is advisable that there must be a gap of 1-2
days between maturity of the previous Murabahaand disbursement of the new one.
Issues in Murabaha
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3. Rebate on early payments
This is normally prohibited by Shariah Board
since it can make the Murabaha transactionsimilar to conventional debt.
Issues in Murabaha
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4. Penalty on late payments
As soon as the Murabaha is executed (declarationsigned) the Murabaha price becomes a receivable
(Dayn) for the Bank. As per the rules of Islamic fiqh any amount charged
over and above thedaynamount will be Riba.
Hence bank cannot charge any late payment
charges.
The bank may, however, ask the customer to pay aforced charity in case of overdues so as to create adisincentive for him to delay the payment
Issues in Murabaha
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5. Subject matter of Murabaha
Murabaha cannot be done in all commodities, e.g.Murabaha can not be done in currencies.
Murabaha cannot be used for paying utility bills,wages, overhead expenses, etc.
As per general rules of sale subject matter mustbe:- In existence- Having intrinsic utility
- Usable for a Halal purpose (buyer must intendto use it for the same purpose)- Capable of ownership/delivery- Specified and quantified at the time of sale- Must be in Banks ownership/possession at the
time of sale
Issues in Murabaha
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6. Purchase Evidence
In order to ensure that the customer actuallypurchased the assets as claimed, thecustomer is required to submit asset purchaseevidence along with declaration.
The purchase evidence must confirm that theasset purchase took place after the agencyagreement.
Asset purchase may be in the form ofInvoices, delivery orders, truck receipts etc.
Issues in Murabaha
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6. Purchase Evidence..(Contd) In some cases, however, it may be too
burdensome for the client to submit all theinvoices as the number of invoices may run into
hundreds.
For example, cotton purchases are generally insmall quantities from various sources andhence for each Sub-Murabaha there may be too
many invoices to submit. It is suggested tofurnish samples of invoices along with summaryof all purchases.
Issues in Murabaha
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7. Direct Payment in Murabaha
Currently in many cases the disbursement ismade to the customer as an agent.
In order to ensure transparency of theMurabaha it is better that the bank disbursesthe funds directly to the supplier.
Issues in Murabaha
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7. Direct Payment in Murabaha..(Contd)
Direct payment can be made in the followingways:
- The bank can pay the supplier directly viacash, cheque, pay-order etc.
- The bank may credit the Murabaha funds inthe customers account and only allow him to
issue pay orders/demand drafts from hisaccount in favor of the suppliers.
Issues in Murabaha
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Purchase of raw material; for meeting working
capital needs of trade and industry.
Medium to long term requirements for purchase
of land, building and equipment.
Trade finance products including imports,
exports and alternative to bill purchase.
Applications of Murabaha
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IJARAH
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Ijarah is a term of Islamic Fiqh Literally, it means To give something on
rent
The termIjarahis used in two situations:
1. It means To employ the services of a
person on wagese.g. Ahires a porter at
the airport to carry his luggage
2. Another type of Ijarah relates to payingrent for use of an asset or property defined
asLANDin Islamic Economics
Ijarah
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Leases, like sales, are among the contractsthat are explicitly discussed in Islamic Law
Leases differ from sales due to the time
limitation involved in leases, in contrast to
sales where no time limit is allowed.
The proof from the Sunnah is derived from the
Hadith:Pay the hired worker his wages before
his sweat dries off.
Ijarah: Sharia Source
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Narrated by Ahmad, Abu Dawud, and Al-Nasaiwith the wording: The farmers during the
time of the Prophet (pbuh) used to pay rent
for the land in water and seeds. He (pbuh)
forbade them from doing that, and orderedthem to use gold and silver (money) to pay
the rent
It is impermissible to charge a rental for gold
or silver coins, or for any consumable good
measurable by weight or volume.
Ijarah: Sharia Source
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Ijarah is an Islamic alternative of Leasing.
Leasing backed by an acceptable contract is an
acceptable transaction under Shariah.
The question of whether or not the transaction
of leasing is Shariah compliant depends on the
terms and conditions of the contract.
Several characteristics of conventionalagreements may not conform to Shariah thus
making the transaction un-Islamic and thereby
invoking a prohibition.
Ijarah as a mode of financing
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Risk and rewards of ownership lies with the
owner i.e. any loss to the asset beyond the
control of the lessee should be borne by the
Lessor.
Late payment penalty cannot be charged to the
income of the Lessor.
Lease and Sale agreement should be separate
and non contingent.
Key Differences
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Difference b/w Conventional Lease &Ijarah
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Difference b/w Conventional Lease & Ijarah1. The Lessor cannot increase the rent
unilaterally
2. Expenses to be borne by the parties:
Lessor- expenses relating to the corpusof the asset i.e. insurance, accidentalrepairs etc. will be borne by the lessor
Lessee- actual operating/overheadexpenses related to running the asset willbe borne by the lessee
Ijarah
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Difference b/w Conventional Lease & Ijarah
3. Two contracts into one contract is notpermissible in Shariah therefore, the bankcannot have the agreement of hire andpurchase into one agreement, only the bank
can undertake/promise to purchase theleased asset
4. Under conventional Lease, the Leaserental starts from the date of payment by
Lessor.Under Shariah, the correct way tocharge rent is after delivery of the asset tothe Lessee. Because rent is charged for useof the asset
Ijarah
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Process of Ijarah
Ij h
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CUSTOMER
MECHANICS
ISLAMIC BANK
The Bank makes payment to the vendor
The Bank purchases the item required forleasing and receives title of ownership from thevendor
The customer approaches the Bank with therequest for financing and enters into a promiseto lease agreement.
VENDOR . .Agreement-1
Ijarah
Ij h d f fi i
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CUSTOMER
MECHANICS
ISLAMIC BANK
The customer makes periodic payments as percontract
The Bank leases the asset to the customer afterexecution of lease agreement.
VENDOR
Title transfers to the customer
. .Agreement-2
Ijarah as a mode of financing
T f Ij h
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1. Direct where the bank purchases an asset
from a 3rd party and leases the same to the
customer.
2. Sale & Leaseback where the bank
purchases an asset already owned by the
customer and leases back to the same person.
This is permissible with certain conditions.
Types of Ijarah
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Rules of Ijarah
R l f Ij h
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Ownership of the leased asset remains with the
Lessor during the term of Ijarah.
Since ownership of the leased asset remains with
the Lessor, all rights and liabilities relating toownership are borne by the Lessor.
The period of Lease must be determined in clear
terms.
The Lessee is responsible for damage to the asset
caused by fraud or negligence.
Rules of Ijarah
R l f Ij h
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Any damage to the asset not caused by the
Lessees neglect, is to be borne by the Lessor.
Normal maintenance is Lessees responsibility
Lease rentals for the entire lease period must befixed;
a) Different amounts of rents can be fixed for
different periods, but they must be known.
b) The rent may be tied to a known benchmark,
acceptable to both the parties.
Rules of Ijarah
R l f Ij h
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The Lease period will start when the asset has
been delivered to the Lessee
- in a usable condition
- whether or not the Lessee has started using it
Insurance is a cost related to ownership of the
assets, and therefore should be borne by the
Lessor
Rules of Ijarah
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Ijarah Documentation
Ijarah Documentation
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Undertaking to Ijarah
Ijarah Agreement
Description of the Ijarah Asset
Schedule of of Ijarah Rentals
Receipt of Asset
Demand Promissory Note
Undertaking to Purchase Ijarah Asset
Sale Deed
Ijarah Documentation
Applications of Ijarah
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For long and medium term fixed assetfinancing
BMR
Retail products
Applications of Ijarah
Ijarah as a mode of financing
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Auto Finance Car Ijarah
First Islamic Car Financing Scheme
Free from Interest/Riba
It is not a Hire-Purchase agreement
Product Features
For all Locally manufactured new cars
Term 3, 4 and 5 years
No upfront Insurance Payment
No advance Rental
Ijarah as a mode of financing
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Diminishing Musharakah
Musharakah
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Musharakah is a form of partnership (Shirkat)
between two or more parties whereby eachparty contributes to the capital of the partnershipin equal or varying proportions either to establisha new venture or share in an existing one.
There are two types of Shirkah:
1. Shirkat-ul-Milk
2. Shirkat-ul-Aqd
Musharakah
Musharakah
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1. Shirkat-ul-Milk
Joint ownership of two or more persons in a
particular property.
2. Shirkat-ul-Aqd
A partnership affected by mutual contract. It canalso be translated as a joint commercial
enterprise.
Musharakah
Diminishing Musharakah
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In Diminishing Musharakah the bank and the client
participate either in joint ownership of
a property or an equipment,
or in a joint commercial enterprise
The share of the bank is divided into a number ofunits
The client purchases these units one by one
periodically until he is the sole owner of theproperty.
DiminishingMusharakah
Diminishing Musharakah
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Most commonly, Diminishing Musharakah is used
in cases of Shirkat-ul-Milk
This concept is based on Declining ownership ofthe financier
Three components involved :
1. Joint ownership of the Bank and the customer
2. Customer as a lessee uses the share of the
bank
3. Redemption of the share of the Bank by the
customer
DiminishingMusharakah
Diminishing Musharakah
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Concept of Musha
Musha means undivided ownership of the asset
Lease of Musha
It is allowed to lease Musha to other joint owner.
DiminishingMusharakah
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Shariah Principles
Shariah Principles
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To create joint ownership in property is calledShirkat-ul-Milk and is expressly allowed by allschools of Islamic Jurisprudence.
All Muslim Jurists agree on the permissibilityof the Financier leasing his share in propertyto client and charging him rent i.e. thepermissibility of leasing ones share to hispartner.
Promise of client to purchase units of share offinancier is also allowed.
Shariah Principles
Shariah Principles
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The Transactions cannot be combined in asingle agreement and they have to beexecuted independently. This is because it isa well settled rule of Islamic Jurisprudence
that one transaction cannot be made acondition for another.
Instead of making the transactions a pre-condition for one another there can be one-
sided promises from one party to another
Shariah Principles
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Basic Structure
Diminishing Musharaka
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CUSTOMER
The Bank enters into a Musharaka (Joint Ownership)agreement with the customer and both of them pay theirrespective shares to the seller of the asset.
Customer pays rent for the use of banks share in theproperty
The customer approaches the Bank with the request for
Project financing
MBL JointOwnershipMusharaka
Rent
Diminishing Musharaka
Diminishing Musharaka
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CUSTOMER
The Bank enters into a Musharaka (Joint Ownership)agreement with the customer and both of them pay theirrespective shares to the seller of the asset.
Ownership of the asset is gradually transferred to the customerupon payment of asset price.
Customer pays rent for the use of banks share in theproperty
The customer approaches the Bank with the request for
Project financing
MBL JointOwnershipMusharaka
Gradual Transfer of Ownership
Diminishing Musharaka
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Legal Documentation
Legal Documentation
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1. Musharakah Agreement
Purpose: This is the main agreement that establishes the Banks
share in the Musharakah Property.
Components:
- Both parties share
- Musharakah Property detail
2. Payment Agreement (Rent Agreement)
Purpose: This agreement is signed after Main Musharakah
Agreement. Bank gives its share to the customer via this
agreement.
Components:
- Rent Schedule
- Formula of calculation
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Legal Documentation
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3. Undertaking to Purchase Musharakah Units
Purpose: This is an undertaking by the customer to purchase
Banks Musharakah units.
Components:
- Normal Sale Price
- Additional Unit Purchase Price
4. Undertaking to Sell Musharakah Units
Purpose: This is an undertaking by the Bank to sell its
Musharakah units from time to time.
Components:
- Normal Sale Price
- Additional Unit Purchase Price
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APPLICATION
Application
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Application
Diminishing Musharakah is commonly used for the
purpose of financing of fixed assets by various
Islamic banks.
House financing Car Financing
Plant and machinery financing
Factory/Building financing
Agriculture land financing
All other fixed Assets
Application
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First complete Islamic Home Finance
facility in Pakistan!
Halal, Quick, Affordable & Hassle free
A Comprehensive solution with:
Easy Buyer - Buying a home is Easy & Halal
Easy Builder -Building a home is Easy & Halal
Easy Renovate - Renovating a home is Easy &Halal
Easy Replacement - Replacing your existingmortgage is Easy & Halal
EasyHome - Islamic Housing Finance
Application
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The Way Forward
The Way Forward
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Islamic banking is a viable alternative however it is
still in the development stage and has to go a longway
It needs to be supported in its mission to eliminateRiba from our business.
Islamic options were unavailable in the past. Its notthe case anymore. The onus is on us now.
Positive criticism is always welcome but one shouldnot be judgmental before having any knowledge.
Ulema, bankers and professionals need to coordinate
more frequently to help R&D.
e ay o a d
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Jazak Allah
&
Thank you