CIFE Study Notes             ™              A User’s Guide to the 
Certified Islamic Finance Executive™ Program    © 2012-2...
© 2012-2015                                                               Published by                                    ...
Table of Contents   1. Why Islamic Finance                               9 - 14   2. Understanding Musharakah 
           ...
Certified Islamic Finance Executive™IntroductionWinner of "Best Islamic Finance Qualification" at the Global         Ethica...
There are no prerequisites for the Ethica CIFE™ though some prior knowledge of finance does help. If you have no prior know...
Course                                                                                                                    ...
Course                                                                                                                    ...
Course                                                                                                                    ...
CIFE Study Notes  ™A User’s Guide to the 
Certified Islamic Finance Executive™ ProgramImportant Note: The following CIFE™ ...
CIFE01Why Islamic Finance?What makes Islamic finance different fromconventional finance? And what makes it better?We look at...
www.EthicaInstitute.com
CIFE01: Why Islamic Finance?                                                  The difference between Islamic finance and co...
Nick the Homebuyer – Example                                            It took him 25 years to pay off his loan and he en...
Islamic banking transaction must:1. Be Interest free2. Have risk sharing and asset and service backing: Based on   the Isl...
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CIFE02, 03, 04Understanding Musharakah – 
Islamic Business PartnershipsYouve heard of joint-stock companies. Now learn abo...
www.EthicaInstitute.com
CIFE02, 03, 04: Understanding Musharakah                                                  A Musharakah is a partnership th...
Differences between Shirkah tul Aqd and Shirkah tul Milk                 intention of terminating or concluding the busine...
Musharakah Management                                                  For instance, $1000 of profit cannot be stipulated a...
• Musharakah may only announce an expected return for the               3. The client’s contribution to the Musharakah is ...
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CIFE05, 06, 07 Understanding Mudarabah –
 Islamic Investment PartnershipsWhere Islamic banks meet conventional private equ...
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CIFE05, 06, 07: Understanding Mudarabah                                                  A Mudarabah is a partnership betw...
Investment of Mudarabah Capital                                            3. Rabb al Maal bears any loss to the business ...
Similarity between Mudarabah and Wakalah                              For the Arbaab al Maal, the ratios of capital contri...
may make an investment contribution and become a Rabb al                At termination, business assets in the form of cas...
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CIFE08, 09 Understanding Ijarah –
 Islamic LeasingWhats an Islamic lease? This modules helps you find out.We introduce Ijar...
www.EthicaInstitute.com
CIFE08, 09: Understanding Ijarah                                                  Ijarah is the lease of a specific asset o...
Usufruct lease categorized as:                                        Ijarah - Key Elements    • Specific Asset Lease: A pa...
Ijarah Rent and Remuneration                                                2. Lessor takes care of major maintenance expe...
benefit from the usufruct as provided in the contract and not        In this document the lessee undertakes to purchase the...
As a general rule, contracts cannot be terminated unilaterally butonly by mutual consent, however there are some condition...
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CIFE10, 11, 12 Understanding Murabaha –
 Cost Plus FinancingLearn about the most widely used Islamic finance product:buy an...
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CIFE10, 11, 12: Understanding Murabaha                                                  A Murabaha is a sale in which the ...
3. The asset’s price includes all direct expenses where the bank           3. The client’s unilateral promise to purchase ...
• Bank must also ensure that the Murabaha asset to be                   Mitigating Murabaha Risks      purchased is not al...
impermissible as the resulting amount of debt is analogous to riba    In case the client as agent is unable to purchase th...
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CIFE13, 14, 15 Understanding Salam and Istisna –
 Forward Sale and Manufacturing ContractsWhat makes a forward contract Is...
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CIFE13, 14, 15: Understanding Salam and Istisna                                                  Salam is a sale where the...
2. Salam price must be paid at spot. The price is fixed and          Salam Essentials       cannot be increased due to an i...
Ethica cife study_notes[1]
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The CIFE™ Study Notes are an accompaniment to the online training modules available at Ethica and are not meant to replace the blended learning experience of the complete Certified Islamic Finance Executive™ program. Read detailed program information here: http://www.ethicainstitute.com/certification.aspx

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  1. 1. CIFE Study Notes ™ A User’s Guide to the 
Certified Islamic Finance Executive™ Program © 2012-2015 Ethica Institute of Islamic Finance
  2. 2. © 2012-2015 Published by Ethica Institute of Islamic Finance
 1401, Boulevard Plaza, Tower 1
 Emaar Boulevard, Downtown Dubai
 P O Box 127150, Dubai, United Arab Emirates
 
 www.EthicaInstitute.com
 info@EthicaInstitute.comAll rights reserved. Aside from fair use, meaning a few pages or less for nonprofit educational purposes, review or academic citation, no part of this publication may be reproduced without the prior permission of the Copyright owner.Ethica grants all individuals and institutions permission to forward thisdocument for educational purposes to whomever they wish. You mayforward this PDF or share this link http://bit.ly/EthicaCIFEStudyNotes i
  3. 3. Table of Contents 1. Why Islamic Finance 9 - 14 2. Understanding Musharakah 
 15 - 21 Islamic Business Partnerships 3. Understanding Mudarabah
 22 - 28 Islamic Investment Partnerships 4. Understanding Ijarah
 29 - 36 Islamic Leasing 5. Understanding Murabaha
 37 - 43 Cost Plus Financing 6. Understanding Salam and Istisna
 44 - 52 Forward Sale and Manufacturing Contracts 7. Understanding Islamic Insurance 53 - 59 8. Understanding Sukuk
 60 - 66 Islamic Securitization 9. Liquidity Management In Islamic Finance 67 - 73 10. Risk Management In Islamic Finance 74 - 81 11. Glossary – Commonly Used Industry Terminology 82 - 104 12. Contact Ethica 105 2© 2012-2015 Ethica Institute of Islamic Finance
  4. 4. Certified Islamic Finance Executive™IntroductionWinner of "Best Islamic Finance Qualification" at the Global Ethicas 100% online delivery platform enables us to give youIslamic Finance Awards, Ethica is chosen by more professionals dynamic and up-to-date material 24 hours a day, rather thanand students for Islamic finance certification than any other waiting around for outdated guidebooks, CDs, and distanceorganization in the world. With over 20,000 paying users in 44 learning emails. Our training and certification is designed forcountries, the Dubai-based institute is accredited by leading maximum knowledge transfer without burdening you with morescholars and serves banks, universities, and professionals across information than you require. All the information, includingover 100 organizations. Ethica’s 4-month Certified Islamic spreadsheets, case studies, questions, exercises, and quizzes isFinance Executive (CIFE) program is delivered 100% online. contained in the training modules.Ethicas award winning CIFE™ is a streamlined training and Our experts are here to answer your questions over emailcertification program designed to take complete newcomers to (questions@ethicainstitute.com).an advanced level of understanding in Islamic finance in just 4 You get access to our entire inventory of training videos duringmonths. your study-period. You can play each video as many times asThe program fee is $1,495, which can be paid online or through you like - 24 hours a day.wire transfer and includes: One module consists of an approximately 20 minute training • 4 months access to self study videos video comprising a variety of exercises, case studies, and • 1 examination attempt quizzes, along which the student is expected to conduct his or her own self-study. Experience with hundreds of other learners • CIFE™ Certificate couriered to your home or office shows that the CIFE™ program is comfortably manageable in • Ethicas 1-on-1 Career Counseling™ about 1 to 3 months of training and about 1 month or less of studying for the examination, enabling most users to complete • Ethicas Recruiters Database™ the program in less than the 4 month access period. 3© 2012-2015 Ethica Institute of Islamic Finance
  5. 5. There are no prerequisites for the Ethica CIFE™ though some prior knowledge of finance does help. If you have no prior knowledge ofIslamic finance, youve come to the right place. We designed the material specifically for newcomers seeking a high level of proficiency inthe practical aspects of Islamic finance in a very short amount of time.There are no fixed dates for the program either. You can start whenever you like.The CIFE™ Examination: A 90 minute timed exam comprising 112 multiple choice questions. The pass mark is 70%.How to take the exam: Login, click on My Account and then click on Take CIFE™ Exam.Re-attempt: If you fail you can re-attempt the exam by paying a small fee.Once you understand the 22 core modules listed below that comprise the testable material, you are ready to take the 90-minute onlineCIFE™ examination. You can take the exam as soon as you are ready. For some thats 3 months, for others its more: you choose yourpace. The recommended study schedule shows you how to comfortably finish the program in the allotted 4-month period with aninvestment of as little as 1 hour per week. Course Recommended Course Name Course Description Code Study Schedule CIFE01 Why Islamic Finance? What makes Islamic finance different from conventional finance? And what Week 1 makes it better? We look at 3 real-world examples and find out. We also introduce you to the 4 principles that guide Islamic finance transactions. CIFE02 Understanding Musharakah I Youve heard of joint-stock companies. Now learn about the Islamic variation. Week 1 (Islamic Business Partnerships) We look at Musharakah, the Islamic business partnership where partners pool together capital, expertise or goodwill to conduct business or trade. We look at the basic features of a Musharakah and its types, their mode of operation, duration and the various forms of capital contribution. CIFE03 Understanding Musharakah II We discuss the management of the Musharakah business and take you Week 2 (Islamic Business Partnerships) through some practical applications of how Islamic banks use Musharakah. We also look at profit and loss sharing ahead of the subsequent modules profit calculation exercises. CIFE04 Understanding Musharakah III We complete our discussion on general aspects of Musharakah, including Week 2 (Islamic Business Partnerships) how banks handle negligence, termination, and constructive liquidation. We and Quiz round our discussion with some practical examples of Musharakah calculation, a quick review of financial statements and how exactly profit gets calculated. 4 © 2012-2015 Ethica Institute of Islamic Finance
  6. 6. Course Recommended Course Name Course Description Code Study Schedule CIFE05 Understanding Mudarabah I Where Islamic banks meet conventional private equity type investing. Here Week 3 (Islamic Investment Partnerships) you learn Mudarabahs, the Islamic business partnership where one partner supplies capital for the business and the other provides management expertise. We explain the Mudarabah structure and contrast it with Musharakah and Wakalah, explaining how they differ in banking practice. CIFE06 Understanding Mudarabah II How is an investment partnership different from an agency contract? We Week 3 (Islamic Investment Partnerships) discuss the relative merits of the Mudarabah and the Wakalah structure in different situations. We also describe the Mudaribs role, the duration of Mudarabahs and the forms of capital contribution by the investor and in some cases even the Mudarib. CIFE07 Understanding Mudarabah III We discuss the Mudarabahs management and the rules for sharing profit Week 4 (Islamic Investment Partnerships) and loss. We also look at some practical examples showing how Islamic and Quiz banks use Mudarabahs. CIFE08 Understanding Ijarah I (Islamic Whats an Islamic lease? This modules helps you find out. We introduce Week 5 Leasing) Ijarah, the Islamic lease, and look at pre- requisites for their execution, legal title, possession, maintenance, earnest money, default, and insurance. We begin answering the question "How does an Ijarah work?" with step-by-step practical explanations. CIFE09 Understanding Ijarah II (Islamic You learn the rights and obligations of the lessor and the lessee and focus Week 5 Leasing) and Quiz on defective assets, sub-leases, extensions and renewals, transfer of ownership, and termination. CIFE10 Understanding Murabaha I (Cost Learn about the most widely used Islamic finance product: buy an asset for Week 6 Plus Financing) the customer; sell the asset at a premium in installments to the customer. Thats a Murabaha. In these modules we introduce Murabahas and walk you through the first 5 of the 7 important steps necessary for a Murabahas valid execution. CIFE11 Understanding Murabaha II (Cost Wrap up the 7 steps to executing a Murabaha: we cover steps 6 and 7 and Week 6 Plus Financing) go on to discuss common mistakes bankers make when executing Murabahas and how to avoid them. We also look at risk management, default, early repayment, and profit calculation in Murabahas. CIFE12 Understanding Murabaha III (Cost So how does it work in the real world? We look at 6 practical examples of Week 7 Plus Financing) and Quiz Murabahas based on installment repayments, bullet repayments, advance payments, and credit and import Murabaha. 5© 2012-2015 Ethica Institute of Islamic Finance
  7. 7. Course Recommended Course Name Course Description Code Study Schedule CIFE13 Understanding Salam And Istisna I What makes a forward contract Islamic? Learn here. In this module on Week 7 (Forward Sales And Manufacturing Salam, the Islamic forward sale, and Istisna, the Islamic manufacturing Contracts) contract, we begin with Salam. We look at the goods for which a Salam may be executed, the pre-requisites, and the use of a Parallel Salam. CIFE14 Understanding Salam And Istisna II We discuss security, replacement, and default before explaining how its Week 8 (Forward Sales And Manufacturing pricing is calculated. We then look at Istisna and discuss the major Contracts) differences between it and the Salam. CIFE15 Understanding Salam And Istisna In this final module we discuss delivery, default, and termination an Istisna. Week 8 III (Forward Sales And We conclude the 3 module series with a practical product structuring Manufacturing Contracts) and Quiz exercise where you get to choose the appropriate financing tools in a given scenario. CIFE16 Understanding Islamic Insurance You learn the difference between Islamic and conventional insurance and the Week 9 and Quiz essentials that make Islamic insurance unique. You walk through a numerical example before taking the Self-Assessment Quiz. CIFE17 Understanding Sukuk I (Islamic Youve read about them. Now learn about them. Sukuks are Islamic shares Week 10 Securitization) and we show you the main features walking you through the 8 step structuring process concluding with a study of Ijarah Sukuk. CIFE18 Understanding Sukuk II (Islamic We continue our discussion on Sukuk with a look at Musharakah and Week 10 Securitization) and Quiz Mudarabah, Sukuk and the limitations of issuing using Murabaha, Salam and Istisna. We close with a case study of the IDB Sukuk. CIFE19 Liquidity Management In Islamic What do Islamic banks do with excess capital in the short- term? How do Week 11 Finance I they access capital for the long-term? You learn the answers to these and other questions in this module. We discuss how Islamic banks manage liquidity and begin by explaining an inter-bank Mudarabah, walking you through how a weightage table works; useful information for other Islamic banking products. We close the module with a look at the application of Sukuk in liquidity management. 6© 2012-2015 Ethica Institute of Islamic Finance
  8. 8. Course Recommended Course Name Course Description Code Study Schedule CIFE20 Liquidity Management In Islamic You look at filters for stocks, shares, Musharakah investment pools, and the Week 11 Finance II and Quiz use of agency contracts to manage liquidity. We also look at local and the foreign currency Commodity Murabahas and walk you through the steps for executing each quiz. CIFE21 Risk Management In Islamic Some have said "Banking is risk management." If you dont know anything Week 12 Finance I about risk management this is the module for you. You learn the basics about risk management in Islamic finance and discuss the most common risks facing Islamic banks and the mitigation techniques used to address them. CIFE22 Risk Management In Islamic Now you learn about how risk relates to each specific Islamic finance Week 12 Finance II and Quiz product. We go through each major Islamic banking product, namely Murabaha, Salam, Istisna, Ijarah, Musharakah and Mudarabah, and explain the specific risks associated with each quiz. Week 13 - 16• Review all modules• Reattempt all self-assessment quizzes• Examination 7© 2012-2015 Ethica Institute of Islamic Finance
  9. 9. CIFE Study Notes ™A User’s Guide to the 
Certified Islamic Finance Executive™ ProgramImportant Note: The following CIFE™ Study Notes are anaccompaniment to the online training modules available atEthica and are not meant to replace the blended learningexperience of the complete Certified Islamic FinanceExecutive™ program
  10. 10. CIFE01Why Islamic Finance?What makes Islamic finance different fromconventional finance? And what makes it better?We look at 3 real-world examples and find out. Wealso introduce you to the 4 principles that guideIslamic finance transactions.
  11. 11. www.EthicaInstitute.com
  12. 12. CIFE01: Why Islamic Finance? The difference between Islamic finance and conventional finance is the difference• The difference between buying and selling something real and borrowing and lending something fleeting.• Example: Nigerian President Obasanjo Conventional banking transactions are interest based.• Example: Nick the homebuyer Islamic bank transactions are asset or service backed.• Example: Faisal the college student An asset or service cannot be compounded like an interest based loan. An asset or service can only have one buyer or seller at any given time, whereas interest• Islamic finance essentials allows cash to circulate and grow into enormous sums. Interest creates an artificial money supply that isn’t backed by real assets resulting • Transactions in increased inflation, heightened volatility, richer getting rich, and poorer getting poor. • Salient features 
 Nigerian President Obasanjo – Example Nigeria took a $ 5 billion loan in 1985 and paid it off as $44 billion in 2000 as a result of compound interest. How would the Islamic bank manage such a developing country’s need? • An Islamic bank could have arranged for the $4 billion construction of a natural gas pipeline and delivered it to Nigeria for $5 billion using an Istisna. • Or taken an equity stake in a highway project and shared in profits and losses using Musharakah or Mudarabah. • Or purchased commodities and sold them at a premium using a Murabaha. • Or structured a project financing using an Ijarah Sukuk. 11© 2012-2015 Ethica Institute of Islamic Finance
  13. 13. Nick the Homebuyer – Example It took him 25 years to pay off his loan and he ended up paying over $400,000.In 2009 Nick lost his job, his house, and all the money he hadspent paying off his mortgage. How would an Islamic bank fulfill Faisal’s need?The property bubble that triggered the global financial meltdown An Islamic bank could structure a service-based Ijarah to leasecould not have happened if the properties had been financed out the university’s credit hours. Faisal ends up paying aboutIslamically because a conventional bank merely lends out cash. 20% or 30% more; but with the interest-based loan, he paysLegally, it can keep lending this cash over and over, well above its about 400% more.actual cash reserves. Islamic finance never can, and never will be able to grow Faisal’sAn Islamic bank, on the other hand, has to take direct ownership debt once it’s fixed.of an actual asset. Whether for a longer period in a lease or 
partnership, or a shorter period in a sale or trade, Islamic finance Islamic Finance Essentialsalways limits the institution to an actual asset. All banking products can largely be divided into the following 4How could Islamic finance have fulfilled Nick’s need for a home? categories:Based on a Diminishing Musharakah. 1. EquityMusharakah refers to partnership. In a Diminishing Musharakah, 2. Tradingthe bank’s equity keeps decreasing throughout the tenure of thefinancing, while the client’s ownership keeps increasing through a 3. Leasingseries of equity purchases. Eventually, the client becomes the 4. Debtsole owner.At no time does the homebuyer pay any interest and at no timedoes any payment compound. The homebuyer just pays for two Some important Islamic finance transactions:things: the house, in small payments, little by little. And the rent, • Equity based - Mudarabah, Musharakah, and Sukukfor the portion of the house he doesn’t yet own. • Trade based - Murabaha, Salam, and Istisna
 • Lease based - IjarahsFaisal the Student – ExampleFaisal took a student loan. His university cost him $120,000 for 
four years. He began borrowing $30,000 at the beginning of eachyear. Three years after graduation he began paying off his studentloans at the rate of $20,000 a year. 12 © 2012-2015 Ethica Institute of Islamic Finance
  14. 14. Islamic banking transaction must:1. Be Interest free2. Have risk sharing and asset and service backing: Based on the Islamic concept of “no return without risk”. An Islamic bank takes a direct equity position, or buys a particular asset and charges a premium through a trade or a lease. It uses risk mitigants, but not without first taking ownership risk.3. Have contractually certainty: Contracts play a central role in Islam and the uncertainty of whether a contractual condition will be fulfilled or not is unacceptable in the Shariah.4. Be ethical: There is no buying, selling, or trading in anything that is, in and of itself, impermissible according to the Shariah for instance dealing in conventional banking and insurance, alcohol, and tobacco. 13 © 2012-2015 Ethica Institute of Islamic Finance
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  16. 16. CIFE02, 03, 04Understanding Musharakah – 
Islamic Business PartnershipsYouve heard of joint-stock companies. Now learn about theIslamic variation. We look at Musharakah, the Islamicbusiness partnership where partners pool together capital,expertise or goodwill to conduct business or trade. We look atthe basic features of a Musharakah and its types, their modeof operation, duration and the various forms of capitalcontribution. We discuss the management of the Musharakahbusiness and take you through some practical applications ofhow Islamic banks use Musharakah. We also look at profitand loss sharing ahead of the subsequent modules profitcalculation exercises. We complete our discussion on generalaspects of Musharakah, including how banks handlenegligence, termination, and constructive liquidation. Weround our discussion with some practical examples ofMusharakah calculation, a quick review of financialstatements and how exactly profit gets calculated.
  17. 17. www.EthicaInstitute.com
  18. 18. CIFE02, 03, 04: Understanding Musharakah A Musharakah is a partnership that is set up between two or more parties usually• Definition to conduct business or trade. It is created by investing capital or pooling together expertise or goodwill.• Types of Musharakah Partners share profit based on ownership ratios and to the extent of their• Musharakah duration participation in the business and share loss in proportion to the capital they invest. Profit cannot not be fixed in absolute terms such as a number or percentage of• Musharakah capital invested capital or revenue.• Musharakah management 
 Types of Musharakah:• Musharakah profit and loss • Shirkah tul Aqd• Negligence in Musharakah • Shirkah tul Milk• Musharakah termination 
 Shirkah tul Aqd is a partnership to enter into a joint business venture and trade. Partners enter into a contract to engage in a defined profit seeking business activity. Shirkah tul Milk is a partnership in the ownership of property or assets for personal use. Every Shirkah tul Aqd has a Shirkah tul Milk imbedded in it, namely joint ownership of assets and property. 17© 2012-2015 Ethica Institute of Islamic Finance
  19. 19. Differences between Shirkah tul Aqd and Shirkah tul Milk intention of terminating or concluding the business venture at any point for instance equity participation. 1. Shirkah tul Aqd is a direct contract of partnership in a business or income generating activity whereas Shirkah tul Partners may exit the business at any point they want. This is Milk comes indirectly through contracts or arrangements usually done by the remaining partner(s) purchasing the share of unrelated to production or income generation. the individual exiting the Musharakah. 2. Shirkah tul Milk is a partnership of joint ownership as opposed Temporary Musharakah: Partnership created with the intention of to a commercial venture (Shirkah tul Aqd). It may serve as terminating it at a given time in the future at which point source of income for one party but not for both. Musharakah assets are sold and distributed along with any remaining profit on a pro-rata basis. 3. In a Shirkah tul Milk ownership proportions cannot be specified however a Shirkah tul Aqd cannot be formed unless It is used to meet working capital needs of businesses, other the respective capital contribution shares of the parties are examples being private equity followed by planned exit. specified. 

 Musharakah CapitalTypes of Shirkah tul Aqd: All Shariah–compliant items of material value may be used as • Shirkah tul Wujooh: Partnership where subject matter is capital in a Musharakah. bought on credit from the market based on a relationship of It may be in the form of cash or it may be in kind, for instance goodwill with the supplier. contributing assets to the business in which case it is necessary • Shirkah tul Aa’mal: Partnership in the business of providing to ensure the assets are valued at the time of Musharakah services. There is no capital investment, instead partners execution. enter into a joint venture to render services for a fee. Partners’ capital investment ratio must be determined at • Shirkah tul ‘Amwaal/Shirkah tul ‘Inaan: Partnership Musharakah inception or before the business generates profit. between two or parties to earn profit by investing in a joint In case of a Musharakah investment in different currencies, business venture. partners must agree upon the numeraire, i.e. one particular
 currency to serve as the standard of value in the business whichMusharakah Duration is usually the currency of the country where the business is located.Ongoing Musharakah: Most common form also referred to asopen-ended or permanent. Partnership where there is no Debt may not constitute Musharakah capital. 18 © 2012-2015 Ethica Institute of Islamic Finance
  20. 20. Musharakah Management For instance, $1000 of profit cannot be stipulated as a fixed number at the time of the contract’s execution because the profitAll partners possess the right to be involved in the administration itself is not yet known.of the business. Or, for instance, if a person invests $100,000 and their profit isPartners who opt for limited partnership are silent partners. Since guaranteed to be 10% of their investment amount. This wouldthey do not participate in the business unlike the working result in an absolute positive number, or $10,000, regardless ofpartners, according to Shariah, they cannot be allocated a profit whether the business gains or loses money.share greater than their capital contribution ratio. Similarly, profit rates cannot be set as a percentage of theThe working partner is responsible for running the Musharakah revenue either as if there’s no revenue; how can there be anybut cannot receive separate remuneration for his services profit? And what if the revenue is unexpectedly high; why shouldalthough he may receive an increased profit share as a reward for investors be denied higher profits.his management role. In a Musharakah:Unlike for the silent partner, the working partner’s profit share mayexceed his capital contribution ratio. • Profit may not be guaranteed or fixed in absolute terms for any of the Musharakah partners.In case an individual who is not a business partner serves asbusiness manager, he is paid a fixed wage for his services but • Profit may not be set as a percentage of capital.does not share business profit or loss. • Each partner whether minority or majority shareholder mustThe business manager is liable for loss in case of his proven be allocated a profit share.negligence. • One partner cannot guarantee any part of the profit or capitalIf the business manager invests in the Musharakah business by of another partner.means of a separate contract, his capacities of manager and • Silent partner’s profit ratio may not exceed his investmentpartner are independent of one another. He earns remuneration ratio.for his managerial role and shares profit and loss based on hisbusiness partnership. • During the Musharakah, a partner may surrender all or part of his profit share to another provided doing so is not agreed at
 the time of Musharakah execution.Musharakah Profit and Loss • Profit sharing mechanism and profit ratios must be clearlyIt is important to remember that profits are not fixed in absolute determined at Musharakah inception.terms, such as a number, or as a percentage of the investedcapital or the revenue. 19 © 2012-2015 Ethica Institute of Islamic Finance
  21. 21. • Musharakah may only announce an expected return for the 3. The client’s contribution to the Musharakah is the business he business, actual returns are declared only after they are owns, while the bank’s contribution to the Musharakah are the known. running facility funds.
 4. After a certain period, the client and the bank share theProfit Calculation business’s operating profit based on a predetermined ratio.Profit is calculated by subtracting costs and expenses from 5. Eventually, one partner, the bank, sells shares to the remainingrevenue. partner, the client, and exits the Musharakah.Loss can only be shared by capital contribution ratios. Unlike interest-based financing, where the bank is only interested in the repayment of a debt, in a running Musharakah, the bank
 has actual equity ownership in the client’s business.In Practice 
Many Islamic banks base profit and loss sharing investment or Negligence in Musharakahsavings accounts on Musharakah. The bank is the workingpartner and the account holders are silent partners. Negligence refers to loss resulting from the violation of contract conditions, willful or intentional damage to the Musharakah.Modern ijtihad has enabled a profit calculation system based on acombination of tiers of investment amounts, investment duration, 
minimum and average balance. Musharakah TerminationMany businesses need running finance, but are unwilling to opt If partners have not agreed on a Musharakah term, one of themfor finance on interest. In a conventional running finance facility may terminate his partnership unilaterally at any time.the bank offers credit to a client over a certain period and charges Alternatively a condition may be stipulated at contract executioninterest. To address this, the bank and its client enter into a that no partner can terminate the contract without the consent oftemporary Musharakah. the other partners.
 In case of Musharakah termination, if assets are realized as cash,In a Shariah-compliant running Musharakah facility: they are distributed based on partnership ratios. In case a profit 1. The bank and the client agree to a financing limit. has been earned, it is distributed based on predetermined profit ratios. 2. The bank opens a current account to hold the client’s sale proceeds and also to allow him to utilize the finance facility. Tangible assets may be liquidated by granting them to existing partners in exchange for the profit they have earned or they may be sold in the market and the income from them distributed. 20 © 2012-2015 Ethica Institute of Islamic Finance
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  23. 23. CIFE05, 06, 07 Understanding Mudarabah –
 Islamic Investment PartnershipsWhere Islamic banks meet conventional private equity typeinvesting. Here you learn Mudarabahs, the Islamic businesspartnership where one partner supplies capital for thebusiness and the other provides management expertise. Weexplain the Mudarabah structure and contrast it withMusharakah and Wakalah, explaining how they differ inbanking practice. How is an investment partnership differentfrom an agency contract? We discuss the relative merits ofthe Mudarabah and the Wakalah structure in differentsituations. We also describe the Mudaribs role, the durationof Mudarabahs and the forms of capital contribution by theinvestor and in some cases even the Mudarib. We discussthe Mudarabahs management and the rules for sharingprofit and loss. We also look at some practical examplesshowing how Islamic banks use Mudarabahs.
  24. 24. www.EthicaInstitute.com
  25. 25. CIFE05, 06, 07: Understanding Mudarabah A Mudarabah is a partnership between two or more parties usually to conduct• Definition business or trade. Typically, one of the parties supplies the capital for the business and the other provides the investment management expertise.• Types of Mudarabah The financier or the Rabb al Maal provides all the investment capital for the• Investment of Mudarabah capital business. The investment manager or the Mudarib is entrusted with the Rabb al Maal’s• Differences and similarities capital, invests it in a Shariah-compliant project and takes full management responsibility. • Mudarabah and Musharakah The Rabb al Maal and Mudarib share profit based on pre-agreed ratios. • Mudarabah and Wakalah 
 Types of Mudarabah• Mudarabah duration With respect to scope of business activity, Mudarabahs may be unrestricted or• Mudarabah capital restricted. Unrestricted Mudarabah• Mudarabah management The Mudarib is free to invest capital in any Shariah-compliant project of his choice.• Mudarabah profit sharing Restricted Mudarabah• Loss in a Mudarabah The Mudarib’s investment of capital is restricted to specific sectors and activities and/or geographical regions only. Here too all investments must be Shariah-• Mudarabah termination compliant.• Mudarabah - At the bank 24© 2012-2015 Ethica Institute of Islamic Finance
  26. 26. Investment of Mudarabah Capital 3. Rabb al Maal bears any loss to the business provided it is not due to the Mudarib’s negligence however in a Musharakah all 1. More than one Rabb al Maal partners bear loss pro-rata to their capital contributions. 2. Mudarib also contributes capital 4. Mudarabah costs that relate to tasks that pertain to the 3. Mudarib invests business capital in different project Mudarib’s domain are not billed to the Mudarabah business, only running costs are whereas in a Musharakah, partners
 bear all costs as they are subtracted from revenue prior toMore than one Rabb al Maal profit distribution.Multiple capital providers pool in their contributions to the same 5. The Mudarib may only receive amount of capital that heproject and hire an investment manager as Mudarib. requires to invest in the business whereas in a Musharakah,Mudarib also Contributes Capital when the business project concludes the partners retain the right to receive Musharakah capital according to capitalThe Mudarib is permitted to contribute capital to the Mudarabah contribution ratios.provided that the Rabb al Maal/Arbaab al Maal approve. 
Mudarib invests business capital in different project Similarity between Mudarabah and MusharakahThe Mudarib as business manager is responsible for investingand managing the Rabb al Maal’s funds however the Shariah 1. The Mudarib is permitted to surrender all or part of his profitpermits him to use the capital for parallel investment, i.e. receive to the Rabb al Maal provided it is not pre-agreed. Similarly incapital for Mudarabah and invest in a different venture. a Musharakah, a partner may give up his profit in favour of another on the strict condition that it is not predetermined.
Differences Between Mudarabah and Musharakah 
 Differences between Mudarabah and Wakalah 1. In a Mudarabah, the Mudarib is solely responsible for managing the business whereas in a Musharakah all partners 1. The Mudarib in a Mudarabah receives a share in profit have the right to participate in the business. whereas the Wakeel or agent in a Wakalah receives a fixed fee for services. 2. The Rabb al Maal provides the business capital and only on the condition that the Rabb al Maal agrees can the Mudarib 2. The Mudarib gets paid his profit share only if there is profit contribute capital to the Mudarabah whereas in a Musharakah whereas the Wakeel receives a fee in any case.
 all partners must contribute capital. 25 © 2012-2015 Ethica Institute of Islamic Finance
  27. 27. Similarity between Mudarabah and Wakalah For the Arbaab al Maal, the ratios of capital contribution may help them in developing their profit sharing ratios but in practice these 1. Both Mudarabah and Wakalah are principal-agent contracts profit sharing ratios differ from capital contributions ratios. and profit is not guaranteed in either case. Example:
Mudarabah Duration A furniture business is set up between one Mudarib and one Rabb al Maal.Ongoing: Partnerships where there is no intention of concludingthe business venture at any known point however partners have The Rabb al Maal contributes $5,000 cash. There are no otherthe option of exit provided they give prior notice to the other assets at this point.partners. The annual profit sharing ratios are agreed at 60% for the Rabb alTemporary: Partnerships created with the specific intention of Maal and 40% for the Mudarib.terminating them at a given future point in time. When the time is The profit in the first year is $10,000 which is distributed asover, the Mudarabah assets are sold and distributed with any $6,000 for the Rabb al Maal and $4,000 for the Mudarib.remaining profit on a pro-rata basis. 

 Mudarabah ManagementMudarabah Capital Only the Mudarib possesses the right to manage the business.All Shariah-compliant items of material value may serve asMudarabah capital. The capital may be cash or in kind. In case it The Rabb al Maal/Arbaab al Maal serve in the capacity of silentis kind it is important to ensure that the assets are valued at the partners.time of Mudarabah execution. While restricted Mudarabahs are permitted, no conditions thatPartners’ capital investment must be established at Mudarabah may restrict or impede the Mudarib’s management of businessexecution or at the latest before the business generates any are allowed.profit. If partners are investing in different currencies it is As business manager, the Mudarib receives a profit share for hisimportant to agree upon one particular currency or numeraire to effort however he is not entitled to a fixed remuneration for hisserve as a standard value for the business. services.Debt cannot serve as Mudarabah capital. If the manager wants to receive a fixed wage he must bePartners may agree on individual profit shares. employed under a Wakalah contract as Wakeel, in which case he does not receive a profit share. If the Mudarib is permitted by the Rabb al Maal/ Arbaab a Maal to invest in the business, then by means of a separate contract he 26 © 2012-2015 Ethica Institute of Islamic Finance
  28. 28. may make an investment contribution and become a Rabb al At termination, business assets in the form of cash are distributedMaal. It is important to remember that his roles as Mudarib and based on capital contribution for cash and profit sharing ratio forRabb al Maal are independent of one another. profit. If the business capital is in illiquid form, it is realized in cash. Next after calculating accrued profit, the cash and profit are
 distributed as per capital contribution and profit sharing ratios.Mudarabah Profit Sharing 
The profit sharing mechanism and mutually agreed profit ratios Mudarabah – Practical Applications at the Islamic Bankmust be clearly defined for all the partners at the Mudarabah’sinception or before profit or loss is generated. Islamic banks collect money from their depositors on a Mudarabah (or Musharakah) basis and then form a Mudarabah (orProfit amount cannot be guaranteed or fixed in absolute terms for Musharakah) pool.any of the Mudarabah partners and neither can it be a percentageof capital. The bank serves as Mudarib to manage the pool.A partner may voluntarily surrender all or part of his profit share to Based on its contractual agreement with its account holdinganother partner provided it is not pre-agreed at contract customers, the bank retains the right to invest in the Mudarabahexecution. (or Musharakah) pool if it wants to.
 The bank uses the capital to make a range of Shariah-compliantLoss in a Mudarabah investments.The Rabb al Maal/Arbaab al Maal bear(s) the entire loss based on Operationally there is one difference, where normally profit incapital contribution ratios. partnership based ventures like Mudarabah are shared after costs have been deducted from the revenue, since it is difficult forMudarib does not beat any loss except that caused by his proven Islamic banks to identify and allocate costs to different pools andnegligence. projects, they absorb the costs and instead share gross profit.
 Mudarabah accounts are usually offered through savings or termMudarabah Termination deposit accounts where normally a longer duration of depositA Mudarabah may be terminated by any party at any time corresponds to a higher expected profit rate.provided the terminating party gives prior notice however a ‘lock- Such accounts have ‘expected’ profit rates attached with them.in’ clause may be established for a certain period that the These are the rates the account holders can expect to receive.Mudarabah must remain in operation unless unexpectedcircumstances such as death or injury materialize. It is important to remember that the bank cannot guarantee its rates of return. 27 © 2012-2015 Ethica Institute of Islamic Finance
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  30. 30. CIFE08, 09 Understanding Ijarah –
 Islamic LeasingWhats an Islamic lease? This modules helps you find out.We introduce Ijarah, the Islamic lease, and look at pre-requisites for their execution, legal title, possession,maintenance, earnest money, default, and insurance. Webegin answering the question "How does an Ijarah work?"with step-by-step practical explanations. You learn the rightsand obligations of the lessor and the lessee and focus ondefective assets, sub-leases, extensions and renewals,transfer of ownership, and termination.
  31. 31. www.EthicaInstitute.com
  32. 32. CIFE08, 09: Understanding Ijarah Ijarah is the lease of a specific asset or service to a client for an agreed period of• Definition time in exchange for rent which at the end of the lease period may result in transferring the subject matter’s ownership to the lessee.• Types of Ijarah 
• Ijarah classification Types of Ijarah• Prerequisites • Ijarah tul Aamaal • Ijarah tul Manafaay• Subject matter 
• Rent and remuneration Ijarah tul Aamaal: A lease contract providing services in exchange for agreed rent.• Default For instance the services of a lawyer purchased by a client in return for a fee.• Rights and obligations of Lessor and 
 Lessee Ijarah tul Manafaay: A lease contract executed to transfer the benefits of an asset in exchange for an• Renewal agreed price.• Transfer of asset ownership For instance an apartment leased for a year in exchange for a monthly rent. A part of the year’s rent may be paid in advance and the remainder be paid as monthly• Negligence installments, mutually agreed upon between the lessor and lessee. 
• Termination 31© 2012-2015 Ethica Institute of Islamic Finance
  33. 33. Usufruct lease categorized as: Ijarah - Key Elements • Specific Asset Lease: A particular asset. For instance a car Subject Matter identified by the lessee, a red fully loaded, automatic sedan. All Shariah-compliant assets or services may be used as Ijarah • Lease of asset based on specifications: An asset not subject matter. specifically identified by the lessee but one required to meet Legal Title certain conditions. For instance any sedan. Generally the lessor owns the leased asset and it should be in his
 name however for regulatory reasons the asset may be registeredIjarah classification based on transfer of ownership to lessee in the lessee’s name.Standard Ijarah PossessionA lease contract where the lessee benefits from the asset for a Ijarah may only be executed for subject matter the lessor ownsspecific time period but it does not result in the eventual transfer and possesses.of ownership of the asset to the lessee. MaintenanceIjarah wa Iqtina Periodic Maintenance: The lessee is responsible for regularA lease contract conducted solely to transfer ownership of the maintenance of the leased asset.leased asset to the lessee at the end of the lease period. Major Maintenance: The lessor is responsible to meet all
 requirements to ensure the leased asset continues to provideIjarah prerequisites intended use.The client and lessor enter into a promise to execute an Ijarah for Earnest Moneythe usufruct of a particular asset or service. The institutionundertakes to provide the asset or service and the client A sum of money the lessee deposits with the lessor. The lessorundertakes to enter into a lease contract for it. maintains it as compensation for actual loss in case the client goes back on his word about executing an Ijarah.The asset or service must be owned by the lessor and madeavailable to the lessee before the Ijarah commences. The lease If the client fulfills his undertaking to lease and enters into anperiod commences once the subject matter of the lease is made Ijarah contract, the lessor returns him the earnest money.available to the lessee. Insurance The Ijarah asset can be insured by means of Shariah-compliant Takaful insurance. 32 © 2012-2015 Ethica Institute of Islamic Finance
  34. 34. Ijarah Rent and Remuneration 2. Lessor takes care of major maintenance expenses and insurance costs. The lessor may include insurance costs atRent the time rentals are determined however once rentals are 1. Rent must be clearly defined, it may in the form of cash or established, they may not be adjusted to accommodate a kind or an asset’s usufruct. change in expenses. Lessor may appoint client as agent to deal with the insurance company. 2. Different rentals may be established for different periods. 3. Lessor is obliged to deliver the asset and all associated 3. Rent for the initial Ijarah period must be established and leased items necessary to transfer usufruct to the lessee. The received in advance from the lessee and rent for the remaining lessor must rectify any problem that prevents the lessee from period may be linked to a well known benchmark. utilizing the usufruct. 4. Rent begins to accrue as soon as the subject matter of the 
 lease is made available to the lessee. Lessor’s RightsRemuneration 1. In case the lessee defaults on lease payments, the lessor isRemuneration for a service is established in relation to time. within his rights to reclaim the leased asset or grant respite for a time. He may also charge late payment fee which includes
 administrative charges that belong t the lessor and lateDefault in Ijarah payment penalty that is given to a designated charity.Default in an Ijarah is a failure on the lessee’s part to make a 2. In case of excessive damage to leased asset, the lessor mayrental payment. rescind the Ijarah.If the lessee defaults on lease payments, the lessor may reclaim 3. Lessor may contract an Ijarah with more than one lessee forthe asset or grant him respite until his financial condition the same asset for different time periods.improves. 4. Lessor may rescind contract if he becomes aware of the
 lessee’s intent to use Ijarah asset for unlawful purposes.Lessor’s Rights and Obligations 
Lessor’s Obligations Lessee’s Rights and Obligations 1. Lessor bears all the risks associated with the leased asset Lessee’s Obligations during the lease term. 1. Lessee must utilize the Ijarah asset according to customary practice by which similar assets are used. He must take necessary measures to preserve it from damage or defect and 33 © 2012-2015 Ethica Institute of Islamic Finance
  35. 35. benefit from the usufruct as provided in the contract and not In this document the lessee undertakes to purchase the Ijarah in any way beyond its scope. asset at the end of the Ijarah period for a mutually agreed amount at the time of Ijarah contract execution. 2. The lessee is obliged to pay rentals once the Ijarah’s subject matter is made accessible to him. If the Ijarah asset is The price may be the actual cost of the leased asset or any other available to the lessee only for a part of the contract’s nominal value. Alternatively the lessor may gift the leased asset to duration, the lessee in not obliged to pay rentals for the period the lessee at the end of the Ijarah period. the usufruct is not at his disposal In some cases, with the lessor’s consent, the lessee may even
 purchase the asset during the lease period by making completeLessee’s Rights payment of rentals due or paying for the market value of the asset at the time. 1. The lessee is within his rights to rescind the Ijarah contract if the lessor refuses to repair the Ijarah asset’s defects that The asset is sold to the client at the end of the lease period based occur after the contract date or exist on the contract date on a separate sale contract that represents the transfer of unbeknownst to the lessee. ownership.
 
Sublease Negligence in IjarahThe lessee may sublease the Ijarah asset to third party with the Negligence is the loss that results from the violation of contractlessor’s consent. conditions.
 If the Ijarah asset is damaged as a result of the lessee’sIjarah Renewal negligence, he must bear repair expenses. However the lessee is not liable for rent for the period the asset remains out of use.The Ijarah may be extended when it reaches maturity and thelessee still wants to continue benefitting from it. A new Ijarah is 
not required. Ijarah Termination
 The Ijarah is terminated:Transfer of Ijarah Asset Ownership • Based on contractual termsIn order to transfer the Ijarah asset’s ownership to the lessee at • One of the party’s rescissionthe end of the lease term, a separate document independent ofthe original Ijarah contract is prepared. • Due to the theft or destruction of the Ijarah asset’s usufruct. 34 © 2012-2015 Ethica Institute of Islamic Finance
  36. 36. As a general rule, contracts cannot be terminated unilaterally butonly by mutual consent, however there are some conditions as aresult of which contracts are automatically terminated: 1. If the lessee fails to meet lease terms 2. If the lessee loses his sanity during the lease period 3. If case of the lessee’s death
Lessee can terminate Ijarah:If the Ijarah asset contains or develops defects. He may returnasset to the lessor and demand compensation for the period ofdefect.The lessee may not rescind the contract if the defect does nothinder usufruct utilization or the lessor ensures its immediatereplacement.Remember that the lessee can exercise rights of rescission in anIjarah of a specific asset only. 35 © 2012-2015 Ethica Institute of Islamic Finance
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  38. 38. CIFE10, 11, 12 Understanding Murabaha –
 Cost Plus FinancingLearn about the most widely used Islamic finance product:buy an asset for the customer; sell the asset at a premium ininstallments to the customer. Thats a Murabaha. In thesemodules we introduce Murabahas and walk you through thefirst 5 of the 7 important steps necessary for a Murabahasvalid execution. Wrap up the 7 steps to executing aMurabaha: we cover steps 6 and 7 and go on to discusscommon mistakes bankers make when executingMurabahas and how to avoid them. We also look at riskmanagement, default, early repayment, and profit calculationin Murabahas. So how does it work in the real world? Welook at 6 practical examples of Murabahas based oninstallment repayments, bullet repayments, advancepayments, and credit and import Murabaha.
  39. 39. www.EthicaInstitute.com
  40. 40. CIFE10, 11, 12: Understanding Murabaha A Murabaha is a sale in which the seller’s cost of acquiring the asset and the profit• Definition earned from it are disclosed to the client or buyer.• Murabaha prerequisites Islamic banks offer the Murabaha to fulfill asset purchase requirements and not as a liquidity financing facility. • Subject matter 
 Murabaha Prerequisites • Price Subject Matter• Steps of Murabaha execution 1. Murabaha subject matter or the Murabaha asset must exist at the time of contract execution. For instance a Murabaha can be executed for a car that• Mitigating Murabaha risks exists not for one that is to be manufactured. 2. The bank must own the asset and have either physical or constructive• Default in a Murabaha possession. 3. The subject matter must be an item of value and Shariah-compliant.• Prohibitions in a Murabaha 4. The subject matter must be a tangible good, clearly identified and quantified.• Calculating profit in a Murabaha 
 For instance if the buyer wants to purchase rice, its exact quality and quantity in terms of weight must be clearly specified in the Murabaha contract to avoid gharar or uncertainty that leads to dispute between contracting parties. 
 Price 1. Murabaha asset cost must be declared to the client. 2. The cost refers to all expenses involved in the asset’s acquisition. 39© 2012-2015 Ethica Institute of Islamic Finance
  41. 41. 3. The asset’s price includes all direct expenses where the bank 3. The client’s unilateral promise to purchase the Murabaha pays for all indirect expenses. goods and the financial institution’s acceptance of collateral 4. Parties to the contract establish a profit rate by mutual At this stage the bank in order to safeguard its rights in case consent or in relation to a specific and known benchmark. the client backs out from entering into a Murabaha, requests the client to furnish a security or earnest money called 5. The Murabaha price may be charged at spot or be deferred Haamish Jiddiah. and paid as a lump sum at the end of the contract or in installments on fixed dates during the term. In case the client backs out from entering into a Murabaha, the bank makes up for the actual loss from it and returns the 6. The Murabaha profit must be disclosed as a specific amount. remainder to the client.
It is important to remember that Murabaha execution must adhereto a certain sequence of procedures in order to ensure Shariah- 4. The agency agreement between the financial institution andcompliance. the client or a third party
 Since banks do not possess the expertise or manpower to Steps of Murabaha Execution purchase the asset, they appoint the client as the agent to procure the asset from the supplier on their behalf. 1. The client’s submission of a purchase requisition for Murabaha goods Agency agreements are of two types: Based on the requisition the bank approves the credit facility Specific Agency Agreement: Agent is restricted to 
 before entering into an actual agreement.
 purchase a specific asset from a specific supplier Global Agency Agreement: Agent may purchase the asset 2. The master Murabaha facility agreement between the financial from any source of his choice. Such an agreement also lists institution and the client a number of assets which the agent may procure on the 
 bank’s behalf without executing a new agency agreement 
 It includes: each time.
 i. An approval of the client’s credit facility 
 Key point to remember about the agency
 ii. The terms and conditions of the Murabaha contract iii. Murabaha asset specification • During the agency stage, the bank’s exposure to asset risk is iv. Client’s undertaking to purchase the Murabaha asset highest and it is in the bank’s interest to shorten this period as once the bank acquires it (if not included in the MMFA, it much as possible. constitutes step 3) • Bank may also minimize risk by ensuring the supplier receives payment for the Murabaha asset. 40 © 2012-2015 Ethica Institute of Islamic Finance
  42. 42. • Bank must also ensure that the Murabaha asset to be Mitigating Murabaha Risks purchased is not already in the client’s possession. To maintain correct sequence, the bank must disburse the • Shariah validity of a Murabaha is strongly sensitive to money to the agent before the agent purchases the goods. following the designated steps in the correct sequence. • The agency agreement is not a prerequisite but motivated by • A deferred Murabaha may not be executed for mediums of logistical ease. exchange, i.e. commodities such as gold, silver and currencies, only a spot Murabaha may be executed for them. • Banks can procure Murabaha goods directly or establish a third party agency. • The bank must seek Shariah-compliant Takaful insurance for Murabaha goods to cover transit period risk, i.e. the risk posed to the bank once it purchases the goods from the supplier and has their possession and before it sells them to 5. The possession of the Murabaha goods by the agent on behalf of the financial institution the client.
 After the agency agreement the client completes the 
 purchase order form. The bank disburses the money to the 
 Default in a Murabaha client, who as agent pays it to the supplier and receives 
 There is no concept of a late payment penalty in a Murabaha possession of Murabaha goods. contract however a charity clause is established at contract execution to serve as a deterrent to default. In case of a default in payment, based on the charity clause, the 6. The exchange of an offer and acceptance between the client client is obliged to pay a predetermined amount to a designated and the financial institution to implement the Murabaha sale charity. Either party can make the offer; the client may offer to buy 
 
 the Murabaha goods or the bank may offer to sell them. The 
 Murabaha Prohibitions Murabaha sale is completed at the time of offer and 
 acceptance. A roll-over is the provision of an extension in return for an increase in the original payable amount and is impermissible in a Murabaha. 7. The transfer of possession of Murabaha goods from the It constitutes repricing and rescheduling: financial institution to the client Repricing is prohibited because the Shariah does not permit an The client is the owner of goods and all the associated risk increase in debt once it is fixed. and rewards however his obligation does not conclude until he makes complete payment of Murabaha price. Rescheduling is only permissible when the creditor provides an
 extension to ease the burden of a debtor, so a roll-over where the bank increases the debt in return for an extension is 41 © 2012-2015 Ethica Institute of Islamic Finance
  43. 43. impermissible as the resulting amount of debt is analogous to riba In case the client as agent is unable to purchase the asset on theor interest which is prohibited in Islam. 1st of June due to some unavoidable circumstances such as a supply shortage and the Murabaha is terminated, the bank is
 entitled to receive only the capital back and nothing more.Calculating Murabaha Profit This is the key difference between a loan on interest and aFrom an accounting perspective, there are two stages in a Murabaha.Murabaha:1st stage: The investment stage: Begins after the bank and clientsign the agency agreement. It is the time period where the bankhas disbursed money for the purchase of the asset from thesupplier but has not yet acquired possession in order to sell it.2nd stage: The financing stage: This stage begins when the bankreceives the good and goes ahead with the exchange of offer andacceptance with the client. It ends once the bank receives theMurabaha payment from the client. It is during this time that thebank has the right to accrue profit.
ExampleA bank extends an advance for Murabaha to the client on the 1stof March, knowing that he will not purchase the asset until the 1stof June.The client purchases the asset on the 1st of June and theMurabaha sale takes place between him and the bank on thesame day.If the tenure of the Murabaha is 4 months, it will commence onthe 1st of June and last until the 1st of October.The bank will begin calculating profit on the 1st of June and notthe 1st of March so that no income accrues to the bank between1st of March and 1st of June. 42 © 2012-2015 Ethica Institute of Islamic Finance
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  45. 45. CIFE13, 14, 15 Understanding Salam and Istisna –
 Forward Sale and Manufacturing ContractsWhat makes a forward contract Islamic? Learn here. In thismodule on Salam, the Islamic forward sale, and Istisna, theIslamic manufacturing contract, we begin with Salam. Welook at the goods for which a Salam may be executed, thepre-requisites, and the use of a Parallel Salam. We discusssecurity, replacement, and default before explaining how itspricing is calculated. We then look at Istisna and discuss themajor differences between it and the Salam. We also discussdelivery, default, and termination an Istisna. We conclude the3 module series with a practical product structuring exercisewhere you get to choose the appropriate financing tools in agiven scenario.
  46. 46. www.EthicaInstitute.com
  47. 47. CIFE13, 14, 15: Understanding Salam and Istisna Salam is a sale where the price of the subject matter is paid in full at the time of• Salam definition the contract’s execution while the delivery of the subject matter is deferred to a future date.• Salam prerequisites and essentials It is not necessary that the subject matter exist, and be owned and possessed by• Salam term and termination the seller at the time of the Salam’s execution as is the customary requirement of a standard sale, provided it meets the other criteria specific to it.• Security in a Salam Salam is a mode of finance that helps the seller generate and utilize liquidity and at the same time allows the buyer to purchase commodities for a price lower than the• Replacement of subject matter spot market price.• Delay in delivery and default in a Salam A Salam may be executed for homogeneous commodities but not for specific commodities and mediums of exchange.• Istisna definition Homogeneous commodities, also termed fungible, are similar to one another and are sold as units. The difference between them is negligible. Since they are• Istisna essentials homogeneous, in case of loss, one unit may be replaced by another.• Istisna term 
 Salam Prerequisites• Parallel Istisna 1. The quantity and quality of Salam goods must be specified in order to avoid any ambiguity that may lead to dispute between contracting parties.• Delay in delivery and default in an Istisna Salam goods must be readily available in the market so that at the time of 
• Rebate, Prohibition of buy-back delivery if they do not meet specifications the seller can procure them easily and supply them to the buyer.• Istisna termination 46© 2012-2015 Ethica Institute of Islamic Finance
  48. 48. 2. Salam price must be paid at spot. The price is fixed and Salam Essentials cannot be increased due to an increase in the price of Salam goods in the market during the contract’s term. Price The seller must deliver the goods without demanding any 
 Most things established as the price for an ordinary sale may also excess money as the Salam goods become the property of be established as Salam price, i.e. cash, goods and usufruct. the purchaser once the contract is signed. It is important to remember that goods may serve as the Salam 3. The place of delivery of Salam goods must be specified and price provided they do not fall into the Amwaal e Ribawiya they must be delivered in their entirety on a fixed future date category. or in installments on predetermined dates. Usufruct refers to the benefits received from a particular asset. 4. Salam goods cannot be sold to a third party before receiving The buyer in a Salam may offer the seller an asset’s usufruct for a possession however a parallel Salam may be executed for specific time period as the Salam price. them. The Salam price is determined based on the number of days the
 bank’s funds remain invested in the Salam transaction.Parallel Salam 
A transaction executed simultaneously with the original Salam. Subject MatterThe buyer of goods in the first Salam is the seller of goods in the 1. Salam subject matter must fall into the category ofsecond or parallel Salam. homogeneous goods and be easily available in the marketFor instance, a buyer makes a payment for the subject matter to throughout the contract’s term or at the time of delivery.be delivered at a date, three months in the future. 2. The Salam subject matter must be clearly specified in terms ofAt the same time, as a seller, he executes another Salam for a quantity and quality.higher price with a third party for the same goods to be received 3. The subject matter must not be a commodity for which valueby him in the future. This way the money disbursed to purchase cannot be established. For instance precious stones.goods in the first Salam is retrieved as price payment and profitfrom the parallel Salam. Once the goods of the original 4. The Khayar al Aib (option of defect) may be exercised fortransaction are delivered they are transferred to the buyer in the Salam subject matter however not the Khayar al Rooyatparallel Salam. (option of refusal).A parallel Salam is permitted with a third party only. 47 © 2012-2015 Ethica Institute of Islamic Finance

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