financial system and products
DESCRIPTION
i am student of BBA in IIUITRANSCRIPT
PRESENTATION: SECURITY ANALYSIS & PORTFOLIO
MANAGEMENT
TOPIC: ISLAMIC FINANCIAL SYSTEM AND PRODUCTS
CLASS – BBA(25)
AHMAD ALI 3499-FMS-BBA-S12
PRINCIPALES OF ISLAMIC FINANCIAL SYSTEM
Prohibition of Interest (RIBA)“An excess” Any unjustifiable increase of capital whether are loans or sales
in the central tenant of the system.
Islamic regulations encourage the earning of profit but forbid the charging
of interest.
Money as a potential capitalIt joins hands with other resources to undertake a productive activity.
Risk sharingWhen interest is prohibited, suppliers of fund become investors instead of
creditors.
Investors & financial intermediary relationship is based on profit & loss
sharing principals.
Prohibition of speculative behavior
Discouraging hoarding & prohibits transacting featuring extreme
uncertainties.
Sanctity of contracts
Upholding contractual obligations & the disclosure as a sacred duty to reduce
the risk of asymmetric information & moral hazard.
Sharing-approved activities
Only activities that don’t violate the rules of shariah qualify for investment.
Any business Dealing with alcohol, gambling or casinos is prohibited.
Social justice
In Principle , any transaction leads to injustice & exploitation is prohibited.
The concept of Shirkah & Musharakah
Terminology & Definition of Musharakah
“Musharakah ” means “Sharing” and in the terminology of Islamic Fiqh.
The word Musharakah has been derived from “Shirkah” which means
being a partner
Musharakah is basically a kind of partnership in which the partners join
together with different contributions, work or obligation for the common
objective of undertaking business and trade in accordance with the
principles of Shariah.
It is an ideal alternative for the interest based financing with far reaching
effects on the economy
Contract of Musharakah
The contract of Musharakah can take place between two or more persons
with the capital contributed by the partners/shareholders and the profit to
be distributed among them according to the rates agreed upon by the
shareholders.
SHIRKAH
SHIRKAT-UL-MILK SHIRKAT-UL-AQD
SHIRKAT-UL-WUJOOH
GAIR IKHTIARIIKHTIARI
SHIRKAT-UL-AAMAL
SHIRKAT-UL-AMWAL
Types of Musharakah
Rules of Musharakah
Musharakah means relationship established under a contract by the
mutual consent of the parties for sharing of profits and losses,arising
from a joint enterprise or venture.
Investments come from all partners / shareholders hereinafter
referred to as partners.
Profits shall be distributed in the proportion mutually agreed in the
contract.
The existence of Muta’aqideen(Partners):
Capability of Partners:
Must be sane & mature and be able of entering into a contract.
The contract must take place with free consent of the parties without
any fraud or misrepresentation.
Management of Musharakah
• Each partner has a right to take part in Musharakah
management.
• The partners may appoint a managing partner by mutual consent
• One or more of the partners may decide not to work for the Musharakah
and work as a sleeping partner.
• If one or more partners choose to become non-working or silent partners.
The ratio of their profit cannot exceed the ratio which their capital investment
bears so the total capital investment in Musharakah.
Asset of Musharakah
All assets of Musharakah are jointly owned in proportion to the capital of
each partner.
Rules of Musharakah
Rules of MusharakahCapital of Musharakah
All partners must contribute their capital in terms of money or species at an agreed
valuation.
Share capital in a Musharakah can be contributed either in cash or in the form of
commodities. In the latter case, the market value of the commodities shall determine
the share of the partner in the capital.
Distribution of Profit
• The ratio of profit distribution must be agreed at the time
of execution of the contract
• The ratio must be determined as a proportion of the actual
profit earned by the enterprise
- Not as percentage of partner’s investment
- Not in lump sum amount
• A sleeping partner cannot share the profit more than the percentage of his capital.
Profit Distribution
ILLUSTRATION
If A and B enter into a partnership and it is agreed between them that A
shall be given Rs. 10,000/- per month as his share in the profit, and the
rest will go to B, the partnership is invalid.
Similarly, if it is agreed between them that A will get 15% of his investment,
the contract is not valid.
The correct basis for distribution would be an agreed percentages of the
actual profit accrued to the business.
OBSERVATIONS
Profit Distribution
If a lump sum amount or a certain percentage of the investment has been agreed for any one of the partners, it must be expressly mentioned in the agreement that it will be subject to the final settlement at the end of the term, meaning thereby that any amount so drawn by any partner shall be treated as on account payment and will be adjusted to the actual profit he may deserve at the end of the term.
But if no profit is actually earned or is less than anticipated, the amount drawn by the partner shall have to be returned.
Rules for Loss
In the case of a loss, all the Muslim jurists are unanimous on the point that each partner shall suffer the loss exactly according to the ratio of investment.
There is a complete consensus of jurists on this principle.
Profit is based on the agreement of the parties, but loss is always subject to the ratio of investment.
Rules of Musharakah
Application
Musharakah can be successfully used to in the following areas:
• Project financing
• Working capital financing
• Import Financing
• Export Financing
• Running finance
• Saving/Deposit account
• Certificates of Investments
• Term finance certificates
• Inter bank financing
THE PROJECT
PARTNER BANK
1
Share in Capital Share in Capital
2
3
Accruing Profits
Share of profits
• In the case of project
financing, the
traditional method of
Musharaka can be
easily adopted.
Project Financing
Export Financing (Al Baraka Islamic
Bank)
Meezan Bank Musharaka
Product
Diminishing
Musharakah
In Diminishing Musharakah the financier and the client participate either in joint ownership of
a property or an equipment, or in a joint commercial enterprise
The share of the financier will be divided into a number of units
The client will purchase these units one by one periodically until he is the sole owner of the property
Diminishing Musharakah
Three components of Diminishing Musharaka
Joint ownership of the Bank and customer
Customer as a lessee uses the share of the
bank
Redemption of the share of the Bank by the
customer
Diminishing Musharakah
Mode of Fixed Asset Financing
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
All other fixed Assets
Diminishing Musharakah
CUSTOMER
The Bank enters into a Musharakah (Joint
Ownership) agreement with the customer and
both of them pay their respective shares to the
seller of the asset.
Client promises to purchase Bank’s share (units)
over the tenure of transaction with the help of
Undertaking to Purchase
The customer approaches the Bank with the
request for Project/Machinery/House financing
BANK
Joint
Ownership
Musharaka
Rent
CUSTOMERBANK
Joint
Ownership
Musharaka
Gradual Transfer of Ownership
Client promises to purchase Bank’s share (units)
over the tenure of transaction with the help of
Undertaking to Purchase
Customer pays rent for the use of banks share
in the property
Client purchases the units every month via a
separate offer & acceptance every month and
will eventually become the owner of the
property.
CUSTOMER
Ownership of the asset is gradually transferred
to the customer upon payment of asset price.
(with the help of a Sale transaction between
bank & customer at the end of each period)
BANK
Joint
Ownership
Musharaka
Gradual Transfer of Ownership
• To create joint ownership in property is called Shirkat-ul-Milk and is expressly allowed by all schools of Islamic Jurisprudence.
• All Muslim Jurists agree on the permissibility of the Financier leasing his share in property to client and charging him rent i.e. the permissibility of leasing one’s share to his partner.
• There is difference of opinion among leasing one’s share to a third part But there is no difference on permissibility on leasing to a partner.
Shariah Principles
• Promise of client to purchase units of share of financier is also allowed.
• The Transactions cannot be combined in a single arrangementsand they have to be executed independently.
• This is because it is a well settled rule of Islamic Jurisprudencethat one transaction cannot be made a condition 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
1. Customer request financing for a fixed Asset costing Rs. 300 million.
2. Islamic Bank agrees to provide financing up to 90% of the cost.
3. Joint Ownership Agreement is executed between the bank and the Customer.
4. Bank will purchase 90% share in the asset by paying Rs. 270 million to supplier.
5. Customers pays its share of Rs. 30 million.
Diminishing Musharaka - Illustration
6. Bank’s share is divided into five units.
7. Customer agrees to buyout Bank’s share (units) on yearly basis and the Undertaking is executed by the customer.
8. Customer pays the rent for the usage of the Bank’s units .
9. Rental reduces after purchase of each unit by the customer.
10.After five years ownership of the asset is completely transferred to the customer.
Diminishg Musharaka- Illustration
PRODUCT - Meezan Bank Easy Home
Albarak Islamic Bank
Diminishing Musharaka Products
Mudarabah
This is a kind of partnership where one partner gives money to another for investing in a commercial enterprise.
The investment comes from the first partner who is called “Rabb-ul-Maal” (Investor)
The management and work is an exclusive responsibility of the other, who is called “Mudarib” (Working Partner)
Profit is shared as per agreed ratio
In case of Mudarbah all losses are borne by Rabbul- Mal
Mudarabah
1. Al Mudarabah Al Muqayyadah
(Restricted Mudarabah)
2. Al Mudarabah Al Mutlaqah
(Unrestricted Mudarabah)
Types of Mudarabah
1. Al Mudarabah Al Muqayyadah
(Restricted Mudarabah)
Rabb-ul-Maal may specify a particular business or a particular place for the mudarib.
In which case he shall invest the money in that particular business or place.
Types of Mudarabah
2. Al Mudarabah Al Mutlaqah
(Unrestricted Mudarabah)
Rabb-ul-maal gives full freedom to Mudarib to undertake whatever business he deems fit.
Mudarib is authorized to do anything normally done in the
course of business
Types of Mudarabah
Rabb-ul-Maal has authority to:
a) Oversee the Mudarib’s activities and
b) Work with Mudarib if the Mudarib consents.
Rabb-ul-Maal
The capital in Mudarabah may be either cash or in kind.
If the capital is in kind, its valuation is necessary, without which Mudarabah becomes void.
Capital of Mudarabah
It is necessary for the validity of Mudarabah that the parties agree, right at the beginning, on a definite proportion of the actual profit to which each one of them is entitled.
They can share the profit at any ratio they agree upon.
However in case the parties have entered into Mudarabah without mentioning the exact proportions of the profit, it will be presumed that they will share the profit in equal ratios.
Some incentives my be given to the Mudarib.
Profit & Loss Distribution
Apart from the agreed proportion of the profit, the Mudarib cannot claim any periodical salary or a fee or remuneration for the work done by him for the Mudarabah.
The Mudarib & Rabb-ul-Maal cannot allocate a lump sum amount of profit for any party nor can they determine the
share of any party at a specific rate tied up with the capital.
Profit & Loss Distribution
EXAMPLE
If the capital is Rs.100,000/-, they cannot agree on a condition that Rs.10,000 out of the profit shall be the share of the Mudarib nor can they say that 20% of the capital shall be given to Rab-ul-Maal. However they can agree that 40% of the actual profit shall go to the Mudarib and 60% to the Rab-ul-Maal or vice versa.
Profit & Loss Distribution
If the business has incurred loss in some transactions and has gained profit in some others, the profit shall be used to offset the loss at the first instance, then the remainder profit, if any, shall be distributed between the parties according to the agreed ratio.
Profit & Loss Distribution
Musharakah
In Musharaka both of the partners invest
Both parties can work
Mudarabah
In Mudarabah one party invest (Rabbul- Mal) and other party work (Mudarib)
Profit is shared as per agreed ratio
In case of Mudarbah all losses are borne by Rabbul- Mal
Diff b/w Musharakah & Mudarabah
Mudarabah
• Medium/long - term financing
Project financing
Import financing
For Saving/mahana amdani/investment accounts (deposit giving Profit based on Mudarabah – with predetermined ratio )
Certificate of Investment
Inter- Bank lending / borrowing
Application
Mudarabah in Banking
Deposits - The Bank as Mudarib
• Profit from the Mudaraba activity is shared between the Bank (as Mudarib) and the investment account holder (as Rabb-ul-maal) in a pre-agreed ratio
• The Bank does not bear any loss but remains responsible for negligence
• The Bank may receive from its investors compensation (Mudarib fees) in return for management of their funds
• The Bank is bound to return the capital to the investors after deducting any losses or Mudarib fees at the time of winding up the contract
Mudarabah in Banking
Investments - The Bank as the Rabb-ul-maal
• Profit from the Mudaraba activity is shared between the Bank (as Rabb-ul-maal) and the Mudarib in a pre-agreed ratio
• The Bank will bear all the loss unless the Mudarib violates the agreement
• The Bank will pay to the Mudarib, compensation (Mudarib fees) in return for management of its funds
• The Mudarib is bound to return the capital to the Bank after deducting any losses or Mudarib fees at the time winding up of the contract
PRODUCT – Meezan Bank Karobari Munafa Account
Al Baraka Islamic Bank Mudaraba Products
Meezan Bank Mudaraba Products
Murabaha
• Murabaha is a particular kind of sale and not afinancing in its origin.
• Where the transaction is done on a “cost plusprofit” basis i.e. the seller discloses the cost to thebuyer and adds a certain profit to it to arrive at the
final selling price.
Definition of Murabaha
• The distinguishing feature of Murabaha fromordinary sale is:
- The seller discloses the cost to the buyer.
- And a known profit is added.
Murabaha
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) Should not be used for un-Islamic purpose.b) Should be in ownership of the seller at the timeof sale; physical or constructive.
Murabaha
Step by step Murabaha Financing
1. Client and bank sign an agreement to enterinto Murabaha (MMFA).
Agreement to Murabaha
Bank Client
Murabaha
2. Client appointed as agent to purchase goodson bank’s behalf
Agency
Agreement
Agreement to Murabaha
Bank Client
Murabaha
3. Bank gives money to agent/supplier forpurchase of goods.
Disbursement to the agent or supplier
Agency
Agreement
Supplier
Agreement to Murabaha
Bank Client
Murabaha
4. The agent takes possession of goods on bank’sbehalf.
Transfer of RiskDelivery of goods Vendor
Bank Agent
Murabaha
5(a). Client makes an offer to purchase thegoods from bank through a declaration.
Offer to purchase
Bank Client
Murabaha
5(b). Bank accepts the offer and sale isconcluded.
Murabaha Agreement+
Transfer of Title
Bank Client
Murabaha
6. Client pays agreed price to bank according toan agreed schedule. Usually on a deferredpayment basis (Bai Muajjal)
Payment of PriceBank Client
Murabaha
Application of Murabaha
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 bill purchase.
Applications of Murabaha
Meezan Bank Murabaha Products
Meezan Bank Murabaha Products
Ijarah
• Ijarah is a term of Islamic Fiqh
• Literally, it means “To give something on rent”
• The term “Ijarah” is used in two situations:
1. It means ‘To employ the services of a person on
wages’ e.g. “A” hires a porter at the airport to carry
his luggage
2. Another type of Ijarah relates to paying rent for use
of an asset or property defined as “LAND” in Islamic
Economics
Ijarah
• 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 conventional agreements may
not conform to Shariah thus making the transaction un-
Islamic and thereby invoking a prohibition.
Ijarah as a mode of financing
• 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.
Ijarah-Key Difference
Process of Ijarah
CUSTOMER
MECHANICS
ISLAMIC BANK
The Bank makes payment to the vendor
The Bank purchases the item required for leasing and receives title of ownership from the vendor
The customer approaches the Bank with the request for financing and enters into a promise to lease agreement.
VENDOR
. .Agreement-1
Ijarah
CUSTOMER
MECHANICS
ISLAMIC BANK
The customer makes periodic rental payments as per the contract
The Bank leases the asset to the customer after execution of lease agreement.
VENDOR
At the end of the tenure customer can purchase the asset from the bank with the help of separate Sale agreement.
. .Agreement-2
Ijarah as a mode of financing
Rules governing Ijarah
• Rules governing Ijarah are similar to the rules
governing sale.
• Because in both cases something is transferred from
one person to another
The only difference is:
• In case of sale, title of property is transferred to Buyer
• In case of Ijarah, title remain with the Lessor
• Only the use of the property is transferred to Lessee
Ijarah
Difference b/w Conventional Lease & Ijarah
1. In conventional lease the Lessor has the unilateral right to rescind the lease contract at his sole discretion, which is against the laws of Shariah,
2. Expenses under Ijarah are as follows:
• Lessor- expenses relating to the corpus of the asset i.e. insurance, accidental repairs etc. will be borne by the lessor
• Lessee- actual operating/overhead expenses related to running the asset will be borne by the lessee
Ijarah
Difference b/w Conventional Lease & Ijarah
3. Two contracts into one contract is not permissible in Shariah therefore, we cannot have the agreement of hire and purchase into one agreement, only we can undertake/promise to purchase the leased asset.
4. In conventional lease the lease starts even before the existence of assets, which is also not permissible in Shariah.
5. Penalty income is charged for late payments in Conventional lease.
Ijarah
APPLICATION
Unique Selling Proposition
• Pakistan’s first truly Shariah-compliant Car
Financing Scheme.
• Available in tenures of 3, 4 and 5 years.
• Available for locally assembled as well as
Imported cars.
• Also available for Used Cars
• No application Fee
MEEZAN BANK Car Ijarah
Application of Ijarah
For long and medium term fixed asset financing
Project Financing,Expansion
Retail products (Car Ijarah)
Applications of Ijarah
MEZAAN Bank - Ijara Products
MEZAAN Bank - Ijara Products
ISTISNA’
Istisna’a is a contract of sale of specified items to be
manufactured (or constructed), with an obligation on the part of
the manufacturer (or contractor) to deliver them to the Customer
upon completion.
Istisna’a is the second exception to the rules of sale where a sale
is allowed without immediate delivery of the goods sold .
ISTISNA’
ISTISNA’
If complete specifications (such as type, kind, quality and quantity) of the
subject matter have been given to the manufacturer along with the
contract price, then the manufacturer is bound to manufacture the Asset
and cannot terminate the contract unilaterally.
The ultimate purchaser cannot be regarded as the owner of the
materials in the possession of the manufacturer for the purpose of
producing the subject matter.
ISTISNA’
The time of delivery of goods does not necessarily have to be fixed in
Istisna’a however, a maximum time may be agreed upon between the
parties.
The delivery of the subject matter may take place through constructive
possession. At this point, the liability of the manufacturer in respect of
the subject matter comes to an end and the liability of the ultimate
purchaser begins.
ISTISNA’
It is necessary for the validity of Istisna’a that the price is fixed with the
consent of the parties.
The Istisna’a price can either be paid in advance, or in installments or at
the time of delivery of goods.
The price of Istisna’a transactions may vary in accordance with
variations in the delivery date.
ISTISNA’
It is permissible to amend the contract price of an Istisna’a contract
upwards or downwards, as a result of intervening contingencies (Force
Majeure).
It is permissible if it is agreed between the parties that in the case of
delay in delivery, the price shall be reduced by a specified amount per
day.
ISTISNA’
Unlike Murabaha where only raw material can be financed, Istisna’a’ can
be easily utilized to facilitate payment of overheads etc. in addition to the
purchase of raw material.
It is also to be noted that amount paid out as Istisna’a’ price to the
manufacturer can be used by the manufacturer anywhere he deems fit. It
doesn’t have to be utilized exclusively for the production process.
ISTISNA’
Sale on Cash Basis
1. After necessary credit and Shariah Approvals, MBL (Meezan Bank Limited) &
Customer will enter into a Master Istisna Agreement to manufacture goods
from time to time at an agreed price.
2. MBL would then enter into an Istisna transaction with the Customer for the
production of specific Goods. At this time quantity, price, specification and
delivery date of Goods will be agreed. The delivery of goods could be lump sum
or in trenches.
3. MBL could pay the Istisna price to the Customer either in full or in installments.
4. After manufacturing, the Customer will inform MBL and will request for
acceptance of delivery. A Bank representative will accept the delivery after
physical inspection of the goods at the site. This delivery could be through
identification and separate storage of MBL goods (so that they are not mixed
with Customer’s own goods). A Goods Receiving Note will be executed at this
moment to evidence the delivery of goods to MBL.
Prdouct Structure for ISTISNA’
5. MBL will also enter into a separate Agency Agreement with the
Customer for sale of goods on Cash basis to credible buyers on behalf
of MBL in a specified number of days. In this manner the Agent will be
responsible for recovery of Sale price and its payment to MBL.
6. MBL’s ownership and risk in goods remains until the Agent sells these
goods to the Buyer in the market. Takaful may be obtained to cover this
risk.
7. MBL Agent will sell the goods in the market and will pay the price to
MBL.
8. The Agent (Manufacturer) will be entitled to a specified Agency Fee for
providing such services. MBL may also give a certain incentive to its
Agent for timely selling and payment to MBL.
Prdouct Structure for ISTISNA’
In case of Credit Sale
The customer (as Agent of MBL) will sell the goods to Credible Buyers
on Credit (instead of Cash) and collect the sale proceeds in a specified
number of days.
At the time of entering into Agency Agreement, the Customer may be
asked to provide a separate / independent Guarantee to guarantee
payment obligations of the potential buyers.
Prdouct Structure for ISTISNA’
Manufacturer
1. Istisna’a Agreement
MBL2. Delivery of Goods
3. Agency Agreement
Local Buyer
4. Sale of
Goods
6. Sale Proceeds (net of Agency Fee)
5. Sale
Proceeds
Prdouct Structure for ISTISNA’
The package comprises of the following:
1. Master Istisna’a Agreement
1. Agency Agreement
1. Corporate Guarantee
Legal Documentation
1. Master Istisna’a Agreement
This agreement sets out the terms & conditions upon which the
Bank, from time to time, orders the Customer to manufacture the
Goods
Components :
A. Written Offer for Manufacture of Goods:
Description of Goods including quantity, quality, delivery date,
cost price, place of delivery etc.
B. Goods Receiving Note:
Legal Documentation in ISTISNA’
2. Agency Agreement
The Bank appoints the manufacturer (customer) its Agent to sell the
manufactured goods.
Components :
A. Notice of Appointment
The Bank authorizes the Agent to sell the Assets as its
undisclosed Agent details of which are mentioned.
B. Schedule of Agency Fee
Legal Documentation in ISTISNA’
3. Corporate Guarantee
The Customer guarantees payment obligation of the ultimate
purchasers if they default to make payment on time
Legal Documentation in ISTISNA’
RISKS MITIGANTS
1 Delivery RiskDelay in delivery of goods from the
manufacturer to MBL at maturity
Istisna’a price can be reduced on
daily basis to penalize the
manufacturer
2Non-
performance
The Manufacturer may not be able
to manufacture the goods during
assigned time and refuses to carry
on the responsibility further.
MBL can terminate the Istisna
agreement and demand the price
back from the manufacturer.
Alternatively, the price may be paid
by MBL in installments after being
satisfied with the performance.
3 Quality Risk
The Manufacturer delivers
defected/inferior goods, which is
realized by MBL only when the
ultimate purchaser points out to
that.
The manufacturer can be asked to
rectify the defect.
Risk Mitigation
4
Increased cost
of
Manufacturing
Cost incurred by manufacturer
turns out to be higher than
anticipated earlier causing
manufacturer to default on
performance
Increased cost will be borne by
manufacturer unless caused by
some force majeure events in
which case Istisna price may be
increased with mutual consent.
RISKS MITIGANTS
5 Storage Risk
The goods once delivered by
Manufacturer will be at MBL's risk
before the same are sold to the
ultimate purchaser
This may be covered through
Takaful of the goods and by
minimizing the time duration
between acceptance of delivery
under Istisna and delivery to the
ultimate purchaser. The Agent is
asked to procure Takaful as part of
his services
Risk Mitigation
6
Default by
ultimate
Purchaser
The ultimate purchaser
refuses to make payment on
time or goes bankrupt.
The Customer (in its
independent capacity) may be
asked to provide Corporate
Guarantee to guarantee
payment obligations of ultimate
buyers.
RISKS MITIGANTS
Risk Mitigation
Bank Islami Istisna Product
Al Baraka Islamic Bank Istisna Product
Islamic Mode of Financing Proportion in Pakistan