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Alhuda cibe-Why Islamic Finance
Basic Rules of Ijara Ø It is necessary for valid lease that the corpus of the leases property remains in the ownership of the lessor. Ø The period of lease must be determined in clear terms. Ø The lease period shall start from the date on which the leased asset has been delivered. * Liabilities of Parties Lessor Responsibilities: Ø Since corpus of leased property remains in the ownership of the lessor therefore all liabilities of ownership are borne by lessor. Expenses: Ø As the lessor is the owner of the asset he is liable to pay all the expenses incurred in the process of its purchase and its import to the country of the lessor example expenses of shipment and customs duty etc. * Lessee Responsibilities: Ø Being user of the lease asset lessee can be made liable to any normally occurring wear and tear. Ø The lessee cannot use the leased asset for any purpose other then the purpose specified in the lease agreement. Ø If no such purpose is not specified in the agreement, the lessee can use it for whatever purpose it is use in normal course. * Lessee as Ameen: Ø The lessee is liable to compensate the lessor for every harm caused to the leased asset by his misuse or negligence. * Rental Ø The rental must be determined at the time of contract for the whole period of lease. Ø It is permissible that different amount of rent are fixed for different phases provided that the amount of rent for each phase is specifically agreed upon at the time of affecting a lease. Ø The lessor cannot increase the rent unilaterally and any agreement to this effect is vied. * Rental Ø A lease contract can have a condition that the rent shall be increased according to a specified proportion (e.g. 5%) after a specified period (like one year). Ø The rent or any part thereof may be payable in advance before the delivery of the asset to the lessee, but that amount so collected by the lessor shall remain with him as Amana and shall be adjusted towards the rent after its being due. * In Case of Late Payment Ø The lessor cannot charge an additional amount in case the lessee delays payment of the rent. Ø Penalty of late payment is given to charity by lessee. * Termination: contractual Ø Lease is binding contract. Ø It cane be terminated by mutual consent. Ø The lessor may terminate it when the lessee doesn’t pay the rent or fails to pay it on time or because of violation of any other term and condition of the agreement. * Termination: contractual Ø With total destruction of the leased asset Ø Upon the expiry of term. Ø Two parties may terminate it before it begins to run. * Procedure of Banking Ijarah Undertaking to Ijarah Agency Agreement Purchase Payment of Purchase Price Lease Agreement Finance Lease (Ijarah) Manufacturer / Supplier Customer Bank 1. Customer buys the property as Bank’s agent. Cost: $100 2. Execution of Ijara Agreement 3. Disbursement of the Facility. Facility Amount: $100 4. Bank appoints the Customer as its agent to buy the property. 5. Under the Ijara Agreement the Bank will lease the property immediately. Lease Features: Floating rate financing possible Can be used for refinancing Uses: Financing Capital Expenditure Financing Big Ticket items like Aircraft, VLCCs, LNG Carriers, etc. Tenor: 5-7 years Risks: Credit Risk Performance Risk Cost Overruns Ownership Risk Diminishing Musharakah Diminishing Musharakah (DM is a type of Shirkah where one partner purchases the other partner’s share gradually FEATURES OF DIMINISHING MUSHARAKAHIN SHIRKAT-UL-MILK (JOINT OWNERSHIP) Two partners purchase any asset (machinery/property) and their intention is that one or both partners will use this asset or they rent out their share and one Shareek undertakes to purchase the share of other gradually. Diminishing Musharakah in Shirkat ul Milk – with Ijarah A and B invest their capital and purchase a joint asset e.g. a house. A separate Musharaka agreement is executed. B promises to sell his shares to A gradually or A promises to buy B’s shares in the jointly owned property. A and B enjoy their rights as partners as they share the risks and rewards in the ratio of their joint investment. Diminishing Musharakah in Shirkat ul Milk – with Ijarah A uses the asset while he pays rent to B in proportion of B’s ownership in the joint property according to the pre-agreed benchmark. Expenses incidental to ownership are shared in proportion of ownership, while expenses relating to use are borne by A who uses the property. A will keep buying B’s shares until he acquires the complete ownership. Diminishing Musharaka Ownership Transfer Diminishing Musharaka Monthly Rentals Rs Procedure of DM D M Agreement (Bank +Client) Undertaking to Ijarah (from the client) Sale Agreement (Client + owner of the house) Payment of Purchase Price (to the owner of the house) Lease Agreement (Bank + client) Diminishing Musharakah Bank enters into a participation (Shirkat-ul-Milk) arrangement with the Customer Bank provides the larger share of the purchase price of the vehicle Bank rents out its share of the vehicle to the customer The customer makes regular scheduled investments to increase its equity in the property over the life of the transaction The monthly/ periodic payments are structured to reflect a portion of rent and a portion of purchase price i.e. EMI = Rent + Purchase of Share Once the customer has purchased all of the Bank’s share the ownership will transfer to the customer with free and clear title to the vehicle ISLAMIC BANKING MODEL Current Deposit SBP Operational Expenses Income/ Loss from Investment Income from non fund business POOL OF FUNDS PLS Depositors Bank Equity Reserves Distributable Income Equity Depositors PLS Idle fund Investment Current Deposit Comparison of the Islamic and Conventional systems Conventional Banking Equation of Banks Failure Admn Exp + Interest Exp > Total Income + Reserves Equation of Banking System Failure Admn Exp + Interest Exp > Total Income + Reserves + Equity Islamic Banking Equation of Banks Failure Operational Losses > Reserves + PLS Deposits Equation of Banking System Failure Operational Losses > Reserves + PLS Deposits + Equity Operational Losses Operational Losses = Income (Losses) from Invest ± Admn Exp AlHuda CIBE FZ LLE - U.A.E P: + 971 56 9286664, + 971 55 938 99 00 AlHuda Center of Islamic Banking & Economics - Pakistan Ph: (92-42) 35913096 - 98, Fax: (92-42) 35913056 Email: firstname.lastname@example.org Website: www.alhudacibe.com * * * * * * * * * Capacities of Mudarib Mudarib has different capacities for which rules are different. Listed down are his roles: Ameen (trustee): Mudarib holds money and assets of Mudarabah as trustee; Therefore, he is responsible for management of assets honestly; In case of actual loss he is responsible for nothing; Wakeel (Agent): Mudarib manages Mudarabah as an agent of owner; Therefore his actions are considered as of Rabbul Maal; Actual loss is born by Rabbul Maal in case it happens; Shareek (partner): Mudarib becomes partner in the profit that Mudarabah generates; Mudaraba Introduction - profit & loss distribution Profit and Loss distribution: The Mudaraba contract should mention profit sharing ratio in defined and clear terms; The profit sharing ratio should be: specific; of the expected profit; 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 Moradabad. The Mudarib & Rab-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. Mudaraba Vs Musharaka . Mudaraba: The contribution comes from Rabbul Maal (the investor); The Rabbul Maal (investor) is not permitted to manage the business; The Mudarib manages the business only; The Mudarib can also invest in the capital of Mudarabah. Musharaka: The contribution comes from all partners in form of cash, commodities, services or liability in case of reputation partnership; The work, as a general rule, is to be done jointly by the parties; A partner or some partners may be sleeping; CATEGORIES OF DEPOSIT IN ISLMIC BANKING Investment Account Depositors Profit & Loss Sharing Saving Accounts Current Account Fixed Investment Accounts Security Deposit DIFFERENCE IN DEPOSITS & INVESTMENT ACCOUNTS Investment Account Deposits Account These are not guaranteed. These are guaranteed. Their nature is investment Investment account holders are in participatory modes. It is liability of the bank It is loan to the bank. Return paid to the account holders is their portion in profit of the bank. Interest paid to the depositors is treated as bank expenses. * COMPONENTS OF VALID SALE SALE CONTRACT SUBJECT MATTER PRICE POSSESSION Offer/Acceptance Buyer/Seller Existence Ownership Possession Valuable Halal Purpose Certain Physical Constructive Instant and absolute Unconditional Types of sale */25 A trust sale is a type of sale in which buyer and seller agree on disclosure of actual cost while General sale is a type where seller quote a price whit out disclosure of cost;In trust sales honest disclosure of cost by seller is necessary; There are three types of trust sale: Ba’y Tauolia Cost to cost sale; Ba’y Wa’dia Below the cost sale; Ba’y Murabaha Cost plus profit sale; * Musawamah Musawamah is a general kind of sale in which price of the commodity to be traded is stipulated between seller and the buyer without any reference to the price paid or cost incurred by the former. Thus it is different from Murabaha in respect of pricing formula. Unlike Murabaha, seller in Musawamah is not obliged to reveal his cost. Murabaha In literary terms, Ba’y Murabaha (بيع مرابحه ) means “sale on profit”. In Arabic, its origin is Rabah ) ربح ) which means profit. Technically, it is a contract of sale in which the seller declares his cost and profit. It may be on spot basis, or on deferred payment basis. * FEATURES OF BANKING MURABAHA Murabaha finance is not a loan given on interest, it is a sale of Asset(s) for cash/deferred price. It is the obligation of the Seller to disclose the Cost and Profit to the Buyer. * FEATURES OF BANKING MURABAHA Murabaha Transaction can either be a cash sale (Spot Payment Murabaha) or a credit sale (Deferred Payment Murabaha) or a combination of both. Payment of Murabaha Price can be made in lump sum or in installments. * FEATURES OF BANKING MURABAHA Murabaha Finance can only be used for the purchase of fresh Asset(s) only. Buy-Back arrangement is prohibited. This means that Murabaha transaction cannot be executed for the Asset(s) already purchased by the Customer. */25 Murabaha is a fixed price sale and is normally used for short term financing; Murabaha cannot be used as a substitute for cash advancing or pure cash based running finance facility; The transaction can be used in order to meet the working capital requirements however it cannot be used to meet liquidity requirements; Murabaha can be used for long term as well but it such a case it would be a fixed rate transaction and will not accept flexibility in rate of financing; Scope of Murabaha * VARIOUS MODELS OF MURABAHA FINANCE * MODEL - I TWO PARTY REALTIONSHIP Bank – Customer MODEL - II THREE PARTY RELATIONSHIP (Bank-Vendor) and Customer MODEL - III THREE PARTY RELATIONSHIP Bank and (Vendor-Customer) * MODEL - I The simplest possible Model emerges when the transaction involves two parties only, i.e Bank and the Customer. The Bank is also vendor and sells the Asset(s) to its Customers on deferred payment basis. From Shari’ah perspective it is an ideal Model and its profits are fully justified because Bank assumes all risks as Vendor/Trader. * Bank/Vendor Customer 1 2 3 MODEL I – GRAPHICAL PRESENTATION * MODEL I - PHASES Phase 1: The customer approaches Bank (Vendor) and identifies Asset(s) and collects relevant information including cost and profit. Phase 2: Bank sells Asset(s) to the Customer, transfer risk and ownership to the Customer at certain Murabaha Price. Phase 3: Customer pays Murabaha Price in lump sum or in installments on agreed dates. * MODEL - II In most cases Murabaha Transaction involves a third party (i.e. Vendor) because Bank is not expected to engage in sale of variety of products required for variety of Customers. The Bank directly deals with the Vendor and purchases the Asset(s). * MODEL II The Bank sells the purchased Asset(s) to the customer on cost plus basis. There are two distinct sale contracts at different point of times. First between Bank and Vendor and second between Bank and the Customer. * Customer Bank Vendor 1 2 3 4 6 5 MODEL II – GRAPHICAL PRESENTATION * MODEL II - PHASES Phase 1: Customer identifies and approaches the Vendor or Supplier of the Asset(s) and collects all relevant information. Phase 2: Customer approaches the Bank for Murabaha Financing and promises to buy the Asset(s). Phase 3: The Bank makes payment to vendor directly. * MODEL II – PHASES Phase 4: Vendor delivers the Asset(s) & transfers the ownership of Asset(s) to the Bank. Phase 5: Bank sells the Asset(s) to Customer on cost plus basis and transfers ownership. Phase 6: Customer pays Murabaha Price in lump sum or in installments on agreed dates. * MODEL III – BANKING MURABAHA This Murabaha Model is mostly practiced model in Banking now a days and therefore we will look at it in more detail. We will also look at the documentation required at different stages of the transaction. It is also a three-party structure but it is bit complicated than previous ones. * MODEL III – BANKING MURABAHA The product of Murabaha that is being used in Islamic Banking as a mode of finance is something different from the Murabaha used in normal trade . It is called Murabaha to the Purchase Orderer . * MODEL III – BANKING MURABAHA It is a bunch of contracts completed in steps and ultimately suffices the financial needs of the client. THE SEQUENCE OF THEIR EXECUTION IS EXTREMELY IMPORTANT TO MAKE THE TRANSACTION SHARIA’H COMPLIANT. * Bank Customer Vendor 4 3 MODEL III – GRAPHICAL PRESENTAION 2 1 5 5 6 Offer Acceptance 7 How Murabaha works in Islamic finance? How Murabaha works in Islamic finance? Steps Of Banking Murabaha MOU Order Form Agency Agreement Purchase Payment of Purchase Price Possession Offer and Acceptance (Declaration) Payment of Murabaha Price Ijarah Lexically, Ijarah means “to give something on rent or to provide some service for consideration”. In Islamic jurisprudence, there are two different types of Ijarah; The first one is an employment or service contract by virtue of which a person provides services to employer and against those services he gets Ujrah i.e. remuneration of services. Ijarah The second type of Ijarah which is more common in Islamic finance, is a contract in which: fifty the owner of an asset (other than consumables) transfers its usufructs to another person for an agreed period against an agreed consideration. In this case, the term Ijarah is synonym to the English term ‘leasing’. Religiosity and threshold effect in social and financial performance of microfinance institutions Mohammad Ashraful Mobin 2 Days Specialized Training Workshop on Islamic Micro Finance6th Global Islamic Microfinance - Kenya Why Islamic Finance? The body which is promoted by Hiram sources is bound to hellfire. On the Day of Judgment, a person will not be moved from the place where he stand until he is asked about the sources of his income and they way he spent it. Purifying of the needs of life (food, drink, clothes house etc) is one of the most important reason for the acceptance of prayers by Allah. Rulings In Islam These 5 primary objectives follow by Shariah can be observed though the Al Ahkam (rulings) upon which Fiqh (Islamic Jurisprudence) rotate around. The rulings are categorized as follows: a. Wajib (obligatory) e. Haram (unlawful) b. Mustahab (recommended) (Sunnat) c. Mubah (permissible) d. Makruh (disliked) Rulings Wajib- An obligatory action or something that shall be performed. Anyone who leave it is liable to gain the punishment of Allah s.w.t. in the Here after as well as a legal punishment in this world. Haram- An unlawful action or the one that shall not be performed and is strictly prohibited. Anyone who engages in it is liable to gain the punishment of Allah s.w.t. in the Here after as well as a legal punishment in this world. Mustahab- A recommended action or something that should be performed. Mubah- A permissible action or something that is neither encouraged nor discouraged. Makruh- A disliked action or something which is abominable and should be avoided but not in strictly prohibitory terms. Islam and Shariah Islam Aqidah (Faith & Belief) Shariah (Practices & Activities) Akhlaq (Morality & Ethics) IBADAT (Man to God Worship) Muamalat (Man to Man Activities) Political Activities Economic Activities Social Activities Banking & Financial Activities Human Financial Needs Fulfillment of Financial Needs Own Capital Others’ Capital Equity Financing Debt Financing External (Equity & Debt) Financing Equity Financing Debt Financing Al-Musharakah (Joint Venture Profit Sharing) Uqud al-Muawadhat (Deferred Contracts of Exchange) Al-Mudarabah (Trustee Profit Sharing) Al-Bai’ Bithaman (Mu)Ajil (Deferred Installment Sale) Others Bai’ al-Murabaha (Cost Plus Profit Sale) Al-Ijarah (Leasing) Bai’ al-Salam (Commodity Sale) Bai’ al-Istisna’ (Sale on Order) Equity Market Debt Market Most Important Islamic Teaching Related To Business Elimination of Interest (Raba) The prohibition of uncertainty (Gharar) The prohibition of Gambling (Qimar) The precipitation of games of chance (Maser) Honesty and Fair Trade (Ghishsh and Khilabah) Spending in the Good Cause Buy Back Two Mutually Conditional Contract Entitlement to profit depends on liability for risk WHAT IS ISLAMIC BANKING? WHAT IS BANK? The name bank derives from the Italian word banco "desk/bench. In practice, the word “Bank” means an institution which borrows money from people and lends money to people for interest or profit and provided other financial services. BANKS ENGAGE IN THE FOLLOWINNNG ACTIVITIES. Accepting money Processing of payments by way of telegraphic transfer, internet banking, or other means; Issuing bank drafts and bank cheques Lending money Providing documentary and standby letter of credit, guarantees, performance bonds, securities underwriting commitments and other forms of off balance sheet exposures Safekeeping of documents and other items in safe deposit boxes WHAT IS ISLAMIC BANKING? Islamic banking has been defined as banking in consonance with the ethos and value system of Islam and governed, in addition to the conventional good governance and rick management rules by the principle laid down by Islamic Shariah. Comparison of the Islamic and Conventional systems Conventional Banking Conventional Banks take deposit on interest basis and lend on the basis on interest. A part of interest is paid to the depositors and the remaining interest is left for the bank as its income. If this residual is more than its expenses, it will have Net Income otherwise it will have Net loss. Islamic Banking Islamic Banking accepts deposits on PLS basis and invest in Shariah based modes. Whatever is the profit, it is shared with depositors. If there is a loss it will also be shared. * OBJECTIVES OF ISLAMIC BANKING Shariah compliant banking, to enable Muslims to do their banking transaction – a Halal way. Achieving the goals and objectives of an Islamic economy. DEPOSITS A deposit is an account at a banking institution that allows money to be deposited and withdrawn by the account holder. These transactions are recorded on the bank's books. All deposit appears as liability on Balance Sheet of the Bank. CATEGORIES OF DEPOSIT IN ISLMIC BANKING The Shariah option for deposit mobilization can be worked out by respecting two principles: The aim of the exchange at hand must be recognizes in Shariah. The modalities to achieve the said must be Shariah Compliant. GENERAL MOODES OF ISLAMIC BANKING USED TO RAISE DEPOSITS Depositors Deposit can be accepted by islamic bank on basis of: Amanah Qarid Investment Accounts Islamic banks generally use Musharakah and Mudarabah based product for obtaining investment account. These deposits are based on the Shariah principles of profit and loss sharing, and the banks use them, along with its own funds in businesses which are Shariah compliant. Wakala model can also be used for Investment Account. Definition of Qard In Islamic Shariah, loans called Qard have only one concept as far as return thereon is concerned i.e. these are interest–free. These are repayable in exactly equal amounts in which these are paid. Definition of Amanah To give any commodity / asset to anybody for the sake of safety is called Amanah. Anything given as Amanah is considered to be something held in trust, and the same can not be used. Shirkah MEANING OF SHAIRKAT The literal meaning of Musharakah is sharing. The root of the word "Musharakah" in Arabic is Shirkah, which means being a partner. Under Islamic jurisprudence, Musharakah means a joint enterprise formed for conducting some business in which all partners share the profit according to a specific ratio while the loss is shared according to the ratio of the contribution. Shirkat-ul-Ammwal Definition: It is an agreement between two or more persons to invest a sum of money in a business and share its profits according to agreement. The investment of this partnership consists of capital contributed by the partners. SHIRKAT-UL- AMWAL: Capital of Musharakah It should be known, ascertained and available at the time of contract. The value should be agreed upon in case of kinds; Capital paid in different currencies should be valued into the currency of Shirkah; Capital advanced by the parties. Should be uniform (currency of partnership). Share capital in a Musharakah can be contributed either in cash or in the form of commodities In the letter case the market value of the commodities shall determine the share of the partner in the capital. Management of Musharakah Each partner has right to take part in Musharakah management. The partner may appoint a managing partner by mutual consent. One are more of the partners may decide not to work for the Musharakah and work as a sleeping partner. It is not allowed to specify a fixed remuneration to a partner Musharaka who manages funds or provides some form of other services, such as accounting; However, it is permissible to give him a greater share of profit than he would receive solely on the basis of his share in the partnership capital; Distribution of Profit The ratio of profit distribution must be agreed at the time of execution of the contract. It is not necessary for sharing profit according to proportionate capital contribution; It is not allowed to defer the determination of profit until realization of profit. The ratio must be determined as a proportion on the actual profit earned by the enterprise. Not as percentage of partner’s investment. Not in lump sum amount. It is not allowed to defer the determination of profit until realization of profit. A sleeping partner cannot share in the profit more than the percentage of his capital. Rules of Loss Determination/Distribution Sharing of Loss: As a matter of principle the loss has to be shared according to the ratio of capital contribution; Partners are not allowed to adopt any other mechanism except the mechanism that ensure distribution of loss among partners on pro rata basis; Any other arrangement, even agreed upon by partners, will be invalid and void. It is not allowed to hold one partner or group of partners liable for entire loss. MUDARABAH Mudaraba Introduction - Definition “Mudaraba” is a kind of partnership where one partner gives money to another for investing in profitable avenues. The investor (fund supplier) is called “Rabb-ul-Mal” ( رب اﻟﻤﺎﻝ ) while the person who utilizes this fund (the fund manager) is called “Mudarib” ( ﻣﻀﺎﺭﺏ ) who is exclusively responsible for management of the business. * * * * * * * * * TS Depositors Deposit can be accepted by islam