6th mode of financing

8/16/2019 6th Mode of Financing

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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 1

Islamic Modes of FinancingIslamic Modes of Financing

Essentials of Islamic Finance

IQRA University Gulshan Campus MBA Spring, 21!

Muhammad [email protected]


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Mode of nancing: " Mode of nancing means way of supplying funds to

those who need funds;

" Supply of fund from a nancial institution to acompany is called indirect nancing;

" on!entional ban"s supply funds under one andonly mode of nancing that is #$%&I%' of money;

" $!ery con!entional ban"ing product( whether it is acar loan( industry loan( in!estment loan( personalloan or a go!ernmental loan( is o)ered under thismode;

Mode of FinancingMode of Financing


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Essentials of Islamic Finance – IU Gulshan Campus, Slide #

Islamic modes of nancing: " Islamic modes of nancing mean the way of supplying funds

that is acceptable to Islam;

" *s we ha!e learned Islamic mode of nancing could not bebased on lending of money as lending of money is not a

remunerati!e way of nancing; " +rohibition of interest does not allow utili,ation of loan-lending

as mode of earning;

" herefore( there must be a way of funding that does notcontain element of interest;

" here are three type of nancing a!ailable under Islamicconcept of funds supply/Trade-based modes of nancing;

Rental-based mode of nancing; and

Participation-based of nancing;

Islamic Modes of FinancingIslamic Modes of Financing


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Financial *cti!itiesFinancial *cti!ities

Exchange of goods orservices

Murabahah 0costdisclosed sale1

Musawamah 0simplebargain sale1

Salam 0Future sale1

Istisnaa2 0ManufacturingSale1

I3arah 0ser!icesrendering1

+artnership

'ift#oan

Capitalprovisioning

emporary+ermanent

4emunerati!e 0partnership basednancing1

%on5remunerati!e


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rade56ased Modes of Financing rade56ased Modes of Financing

rade5based mode of Financing means a way of nancing inwhich Islamic ban"s pro!ide nancing through sale andpurchase of commodities and assets;

rade5based modes are secure modes because they create debt

and payables upon debtors-customers;

Islamic ban"s buy a commodity-asset 0directly or through itsagent1 from the mar"et and sells it to customers on deferredpayment basis 0instalments1;

he agent may be a an employee on Islamic ban"( a third partyor the customer himself as well;

*ll conditions should be obser!ed carefully in sale nancing.


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rade56ased Modes of Financing rade56ased Modes of Financing

here are four "inds of rade5based modes of nancing which are!ery common/

MR!"!#!#!;

ost 7prot transaction in which both are disclosed to the buyer;

M$!%!M!#; * simple sale transaction in which a price is quoted to customer

without any disclosure to the buyer;

$!&!M;

* "ind of sale in which price is paid in ad!ance for a speciccommodity to be deli!ered in future;

I$TI$'!!(;

* sale transaction for assets that require manufacturing.


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rade 6ased Modes of Financing rade 6ased Modes of Financing

he customer e8presses its wish to buy a certain thing from theban" and the ban" buys it from mar"et and sells it on instalments;

*ll modes follow laws and rules of Islamic Sale contract.

$ach mode has separate set of additional rules which needs to befollowed strictly; *ny error may lead to ma"e the transaction a !oidsale;

redit 4is" is lower in this "ind of nancing therefore Islamic 6an"sprefers it;

he rate once 8ed in these modes could not be changed;

Islamic ban"s earn money through cash purchase and credit sale;

+rot is di)erence between cash purchase and credit sale;


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rade 6ased Modes of Financing rade 6ased Modes of Financing

Sometimes it is argued that the time has e)ectson calculation of prot in case of credit sale;

9e will analyse this question in following slides;


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* common question to Islamic ban"s/ 9hy the price is highin case of credit sale: his e8cess is as good as charging ofinterest;

6ut the question is too simple to reply;

he main concept is that/ is there any room for time inpricing:

Meaning can a seller consider 2time2 as one of the decisi!efactor for pricing a commodity or asset:

he answer is yes( time is one of the main factor that playrole in determining the price;

he di)erence of rice between whole sale and retail is due

+rice &i)erence in redit and ash sale+rice &i)erence in redit and ash sale


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he fast mo!ing or perishable items are not charged high

prot and return;

Slow mo!ing and storable items are charged higher prots

and return;

he reason is 2IM$2;

So the time is not something that should always be

neglected in pricing or determining the !alue;

he generic !ale of interest is its lin"age with time and not

with real assets and commodity;

+rice &i)erence in redit and ash+rice &i)erence in redit and ashsalesale



%on58ation of price in a Sale transaction means no precisedetermination of price which is an essential element of

Islamic Sale ontract;

So non58ation in sale is not allowed;

9hile 8ation in partnership is as good as considering

something unconrmed as conrmed which is no doubt

in3ustice with one of the partners;So non58ation here is the acceptable way.

Fi8ation of 4eturn-+rot in rade56ased ModesFi8ation of 4eturn-+rot in rade56ased Modes



* repeated question is that the return-prot is 8ed intrade5based modes of nancing while Islam prohibits 8ingof prot;

So what about famous Islamic concept of non58ation ofthe prot rate:

he actual reason of prohibition is not FI*IFi8ing of 4eturn-+rot in rade56ased Modes>



Murabahah and MusawamahMurabahah and Musawamah


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 1$

Murabahah ? &enition andMurabahah ? &enition andonceptoncept

Murabahah is one of the "inds of sales; It comes under trade5based modes of nancing;

Murabahah means selling a commodity or asset on

disclosure of cost and protA basis( which means the seller

discloses the cost and the added prot to buyer;

So the distinguishing feature of Murabahah from ordinary

sale is that the seller is bound to discloses the cost andprot both to the buyer.

If he does not disclose the cost the sale will not be a

Murabahah sale;


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 1%

Murabahah ? &enition and onceptMurabahah ? &enition and oncept

!s an) other sale the pa)ment of Price inM*rabahah co*ld be in three +a)s:

" Spot payment 0*l56ai2 ul Mua33al 5 immediate deli!eryand payment1;

" &eferred for a specic future date 0*l56ai2 ul Muwa33al 5full payment at a future date1;

" &eferred for a period of time 0*l5bai2 ul Muwa33al 5 sale on

instalment basis ? payment in tranches( similar topurchase on instalments1;


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 1!

Murabahah ? &enition and onceptMurabahah ? &enition and oncept

$ome important feat*res of the M*rabahah are: *s 6an"ing Murabahah is a "ind of sale( there must be a seller 0ban"1

and a buyer 0customer1 and something that could be bought and sold;

In such transactions the 6an" is the seller( the customer is buyer and

a commodity-goods are e8changed between them;

In case there is nothing that could be sold and purchased Murrabahah

is not possible;

9 nance -

Murabahah since there is no sale and purchase.

6ecause it is a sale from ban" to customer the 6an" is required to

purchase the commodity directly from the mar"et-seller before selling

it to the customer;


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 1&

Step by Step Murabaha FinancingStep by Step Murabaha Financing


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 1'

1) lient and ban" sign an agreement to enter intoMurabaha 0MMF*1.

*greement toMurabaha

"an, Client


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 1(

2) lient appointed as agent to purchase goods onban"Bs behalf

*gency*greement

"an, Client


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) Cpon submission of


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$) he agent ta"es possession of goods on ban"Bsbehalf and informs ban" through a &eclarationform.

ransfer of4is"

&eli!eryof goodsendor

"an, !gent


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%*a+) lient ma"es an o)er to purchase the goodsfrom ban" through a Murabahaontract.


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%*+) 6an" accepts the o)er and sale is concluded.

Murabaha ontract 7

ransfer of itle

"an, Client


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 2$

!) lient pays agreed price to ban" according to anagreed schedule. Csually on a deferred paymentbasis 06ai Mua33al1

+ayment of +rice

"an, Client


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 2%

*pplication*pplication


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 2!

Murabahah can be used to nance the real purchase needs of

customer;

It could be used for assets which are acceptable to ShariBah and

has a tangible form.

herefore( Murabahah can be used to nance the purchase of/

- 4aw Material;

- $quipment;

- onsumer 'oods;

Murabahah cannot be used to Finance/

- +ersonal loans;

- redit cards.

M*rabahah .M*rabahah .!pplication!pplication


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 2&2&

Issues in MurabahaIssues in Murabaha


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 2'2'

1. Timing of Declaration

* Murabaha nancing arrangement consists of a seriesof documents to be e8ecuted at !arious stages( thesequence and timing of which is e8tremely important.

hrough declaration client and the ban" e8ecute animportant step of a !alid Murabaha sale i.e.


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # 2(2(

1. Timing of Declaration….(Cont..)&eclaration must be signed while the goods are still in

e8istence and ha!e not been used in the productionprocess or sold to some other entity.

*s a general rule of thumb declaration must berecei!ed within E month or E-th of the Murabahatenor( which e!er comes rst.

he importance of proper timing of declaration can beunderstood better by the e8ample of a %i"ah contract.

Iss*es inIss*es inM*rabahaM*rabaha


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2. Rollover in Murabaha

4ollo!er in Murabaha is not possible since each Murabahatransaction is for the purchase of a particular asset. * newMurabaha can only be e8ecuted for the purchase of new assets.

It is ad!isable that whene!er practicable there must be a gap ofE5G days between maturity of the pre!ious Murabaha anddisbursement of the new one.



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3. Rebate on early payment

hese are strictly prohibited by our Shariah6oard since they ma"e the Murabahatransaction similar to con!entional debt.



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2

!. "enalty on late payment

*s soon as the Murabaha is e8ecuted 0declaration signed1 theMurabaha price becomes a recei!able 0&ayn1 for the 6an".

*s per the rules of Islamic qh any amount charged o!er and abo!ethe daynA amount will be 4iba.

=ence we cannot charge any late payment charges.

9e may( howe!er( as" the customer to pay a forced charity in case

of o!erdues so as to create a disincenti!e for him to delay thepayment



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#. $ub%ect matter of Murabaha

Murabaha cannot be done in all commodities( e.g. Murabahacan not be done in currencies. *s per general rules of salesub3ect matter must be/

In e8istence

5 =a!ing intrinsic utility

5 Csable for a =alal purpose 0buyer must intend to use itfor the same purpose1

5 apable of ownership-deli!ery

5 Specied and quantied at the time of sale

5 Must be in 6an"Bs ownership-possession at the time ofsale



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Essentials of Islamic Finance – IU Gulshan Campus, Slide # $

$

&. "urchae 'vience

In order to ensure that the customer actuallypurchased the assets as claimed( the customer isrequired to submit asset purchase e!idence along with

declaration.

he purchase e!idence must conrm that the assetpurchase too" place after the agency agreement.

*sset purchase may be in the form of In!oices(deli!ery orders( truc" receipts etc.



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Essentials of Islamic Finance – IU Gulshan Campus, Slide # %

%

&. "urchae 'vience…..(Cont..)

In some cases( howe!er( it may be too burdensomefor the client to submit all the in!oices as thenumber of in!oices may run into hundreds.

For e.g. cotton or sugar purchases are generally insmall quantities from !arious sources and hencefor each Sub5Murabaha there may be too manyin!oices to submit.



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Essentials of Islamic Finance – IU Gulshan Campus, Slide # !

!

. Direct "ayment in Murabaha

urrently in almost all cases the disbursement ismade to the customer as an agent.

In order to ensure transparency of the Murabaha itis better that we disburse the funds directly to thecustomer.

Shariah board has also instructed us to increasethe percentage of direct payment Murabahas as aH of total Murabahas



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Essentials of Islamic Finance – IU Gulshan Campus, Slide # &

&

.Direct"ayment in Murabaha…..(Cont…)

&irect payment can be made in the following ways/

he ban" can pay the supplier directly !ia cash( cheque(

pay5order etc.

he ban" may credit the Murabaha funds in thecustomerBs account and only allow him to issue

payorders-demand drafts from his account fa!oring theasset suppliers.



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Essentials of Islamic Finance – IU Gulshan Campus, Slide # '

MusawamahMusawamah

Musawamah is also one "ind of sale; his is a simple sale we do in our daily routine life;

he di)erence is that the quoted price does not require

any brea"5up of cost and prot;

*ll other details are same as for Murabahah;

he process ow is also same and the payment method

may also be of same nature.


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Essentials of Islamic Finance – IU Gulshan Campus, Slide # (

Juestions:Juestions:

6th mode of financing

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