Alhuda CIBE - Islamic Finance principles

1. Islamic Finance – Principles
Principles of Islamic Finance
Hhadith – Sahih Muslim:
…gold for gold, silver for silver, dates for dates,wheat for
wheat, salt for salt, barley for barley,….like for like,
equal for equal, hand to hand, ….
Two permissions follow two prohibitions:
1. Sales within single type, unequal exchange, with or
without delay: Riba al fadl. Money should be used as
medium of exchange
2. Exchange among listed goods, with or without
equality, but with delay: Riba al nasia [wheat and rice
so that wheat now and rice later OR gold now or silver
late]. Goods can be sold on credit for gold and silver.
CREDIT SALE IS ALLOWED IF GOODS EXCHANGE
WITH MONEY

2. Theory & Practice of Murabahah
Murabahah – Concept and Historical perspective
• Introduced as new form of sale in second half of first
Hijrah century as a sale with necessary condition of a
profit margin agreed by both the seller and purchaser
[Al Mutta, Imam Malik] and without the order of
purchaser [cost includes direct expenses]
• Modifications were made by Imam Shafi’, including an
order of the purchaser, who could subsequently
exercise the option not to purchase the same, and
also included credit transaction
• Therefore, he clearly bifurcated two sale transactions,
one from supplier (or vendor) to the seller and other
from seller to the purchaser

3. Theory & Practice of Murabahah
Murabahah – Concept and Historical perspective
• The contemporary banking also takes into account the cash and
credit prices different from each other, as justified by Usmani
• The banks are also required to fulfill regulatory compliance
relating to credit transactions, maximum exposure to risk,
classification of credit transactions, international supervision,
etc.
• In addition, the banks are also emphasized to follow the Shariah,
and accounting standards issued by AAOIFI relating to Murabaha
transactions. In Pakistan, the Islamic Financial Accounting
Standard-1 issued by ICAP vide SECP Notification dated 24th
August, 2005 is also required to be followed.
• Since the operation of Murabaha transaction resembles Riba
based practice of lending, the preconditions prescribed by
Shariah advisors are to be met in letter and spirit

4. 100% 75% OB
50%
75%25%
50%
100%25%OA
M
R
N
A’s Capital
B’s Capital
A’s Share of Profit B’s Share of Profit
90%
10%
MUSHARAKAH P&L DISTRIBUTION

5. Bank arranges pool of funds
Islamic Modes – Agricultural Financing
ISLAMIC
BANK
Special
Purpose
Mudarabah
I
N
V
E
S
T
O
R
S
Investment
Units purchased
6
m
onths
W
hole
sale
Purchases
Retail Sales
Lined up
Profits Accrued

6. Financing of crop production
Liquidity requirements (hiring of tractor & implements,
sowing, purchase of water, hiring of labour for preparation of
land and harvesting, marketing)
Input requirements (seed, fertilizer, pesticides)
Islamic Modes – Agricultural Financing
Liquidity
Hiring for
land prep.
Inputs in kind
Sale of fertilizers, seed, pesticides
Liquidity
Hiring for
Harvest +
Marketing Exp.
S
A
L
A
M
S
A
L
A
M
M
U
R
A
B
Liquidity
Hiring for
land prep.
Inputs in kind
Delivery
Payment
Delivery

7. Islamic Modes/Instruments - Sale Contracts:
Parallel Salam: Procedural Details:
The disposal of commodity at the end of Bank can
be through:
– Parallel Salam: Bank may sell commodity, before
the date of delivery, to some other
purchaser for the date of
original delivery. The period in
second contract will be shorter than
the original contract, but price
higher than the original contract.
– Unilateral Promise: Promise of purchase can be
obtained from third party for delivery
on the date of original contract.
Price in this promise is set
higher than parallel salam
because the promisor has to pay
nothing.

8. Islamic Modes/Instruments - Sale Contracts:
Risks involved in Salam Transaction:
Risks Mitigants
Counterparty delivery risk
•Client defaults after receiving
price
•There could be dispute in
quality, quantity, time of delivery,
etc. in case of commodity
•Defective goods could be
supplied
•Goods may be delivered late
Commodity price risk
•The market price at delivery
time could be lower than the
price expected at the time of
contract
•Liquidate security & purchase
same goods from market
•MoU should clearly specify to
avoid any dispute
•Collateral or security can be
obtained
•Penalty clause – charity
•Parallel salam or promise to
purchase

9. Islamic Modes/Instruments - Sale Contracts:
Risks involved in Salam Transaction:
Risks Mitigants
Commodity marketing risk
•Bank is not able to market the
goods timely resulting into
blocking of funds
Asset holding risk
•Bank bears holding cost till
disposal of commodity
Early termination chances
•Clint refuse to supply the goods
Parallel Salam
•Original seller might not supply
goods in time. The buyer in
parallel salam may sue the
bank.
•Select appropriate commodities
for salam, take promise with
Hamish Jiddiyah or appoint
client as agent
•Cost can be recovered in
parallel transaction
•Salam is a binding contract.
Penalty clause can be inserted –
charity
•Bank may purchase the similar
asset from market. But no such
loss can be recovered from
original seller

10. Principles of Islamic Finance
1. Prohibition of Riba: Prohibition in Shariah:
B. Ahadith
Riba al fadl: [Traditions]
1. ….exchange of radi with burny dates…..
2. Gold for gold, silver…..,……, like for like, equal for equal,
and hand to hand. If the commodities differ, you may sell
as you wish, provided the exchange is hand to hand.
1. When illa is different, shortfall/excess and delay both
are permissible
2. When commodities of exchange are similar, excess
and delay both are prohibited
3. When commodities are heterogenous but illa is the
same, then excess/deficiency is allowed but delay not
allowed
Principles of Islamic Finance

11. REFERENCE SLIDES FOR
PARTICIPANTS FROM BANKS
Work on Murabahah

12. Practice of Murabahah
Pricing of Murabahah [Example]:
• Purchase of poultry feed stock
• Murabahah Facility: 180 Days
• Payment: Six monthly installments
• Rate of Profit: Six months KIBOR+2%
• Murabahah transaction: Rs. 500,000
• Securities: Pledge of feed stock,
equitable mortgage, lien
on deposit, post dated
cheques, etc.

13. Practice of Murabahah
Pricing of Murabahah [Example]:
Particulars Amount (Rs.)
Cost of goods Rs. 500,000
Rate of Profit Kibor + 2% (Floor 11.5%)
Six monthly KIBOR 10% p.a.
Freight & insurance 5% of cost
Total cost 500000 x 5% 500000 + 25000
=525000
Risk premium 2%
Profit 10%+2%+2% = 14% p.a. 525000 x 14% x
180/365 =
36247
Murabahah Price 525000+36247= 561247
Amount of
Installment
561247/6 = 93541 Cost = 87500
Profit= 6041

14. Training Workshop – Islamic Microfinance
Accounting of Murabahah [Example]:
Advance Payment
Advance Payment (Against Murabahah
purchases)
F&I charges
To Pay order
(Payment made in advance for purchase
of goods)
500000
25000
525000
Arrival of Goods
Murabahah purchases A/C
To Advance Payment (Against Murabahah
purchases)
(Goods received on account of
purchases)
500000
500000

15. Training Workshop – Islamic Microfinance
Accounting of Murabahah [Example]:
Murabahah Contract/Sale
Murabahah Facility A/C
Murabahah Profit Receivable A/C
To Murabahah Sale A/C
(To amount of goods sold)
5250000
36247
561247
Recovery of Murabahah Price
Client’s A/C
To Murabahah Facility A/C
To Murabahah Profit Receivable A/C
(Payment received on maturity by
debiting client’s A/C on 1st
installment)
93541
87500
6041

16. Training Workshop – Islamic Microfinance
Accounting of Murabahah [Example]:
Recovery of Murabahah Price
Client’s A/C
To Murabahah Facility A/C
To Murabahah Profit Receivable A/C
(Payment received on maturity – 2nd
installment)
93541
87500
6041
Client’s A/C
To Murabahah Facility A/C
To Murabahah Profit Receivable A/C
(Payment received on maturity – 3rd
installment)
93541
87500
6041
Client’s A/C
To Murabahah Facility A/C
To Murabahah Profit Receivable A/C
(Payment received on maturity – 4th
installment)
93541
87500
6041
Client’s A/C
To Murabahah Facility A/C
To Murabahah Profit Receivable A/C
(Payment received on maturity – 5th
installment)
93541
87500
6041
Client’s A/C
To Murabahah Facility A/C
To Murabahah Profit Receivable A/C
(Payment received on maturity – 6th
installment)
93541
87500
6041

17. Accounting of Murabahah
[Example]:
Profit and Loss Account Statement
Murabahah Sales
Less COGS
Purchases
F&I
Profit
561247
500000
25000 525000
36247

18. Sale Defined:
Exchange of a thing of value with another thing of
value with mutual consent OR the sale of a commodity
in exchange of cash.
Elements of a valid sale:
• Contract ( Aqd )
• Subject matter ( Mabe’e)
• Price ( Thaman )
• Possession or delivery ( Qabza )