Alhuda CIBE -Why islamic finance

Religiosity and threshold effect in social and financial
performance of microfinance institutions
Mohammad Ashraful Mobin

2 Days Specialized
Training Workshop on
Islamic Micro Finance
6th
Global Islamic
Microfinance - Kenya

Why Islamic Finance?Why Islamic Finance?
 The body which is promoted by HiramThe body which is promoted by Hiram
sources is bound to hellfire.sources is bound to hellfire.
 On the Day of Judgment, a person will not beOn the Day of Judgment, a person will not be
moved from the place where he stand until hemoved from the place where he stand until he
is asked about the sources of his income andis asked about the sources of his income and
they way he spent it.they way he spent it.
 Purifying of the needs of life (food, drink,Purifying of the needs of life (food, drink,
clothes house etc) is one of the mostclothes house etc) is one of the most
important reason for the acceptance ofimportant reason for the acceptance of
prayers by Allah.prayers by Allah.

Rulings In IslamRulings In Islam
 These 5 primary objectives follow byThese 5 primary objectives follow by ShariahShariah
can be observed though thecan be observed though the Al AhkamAl Ahkam
(rulings) upon which(rulings) upon which FiqhFiqh (Islamic(Islamic
Jurisprudence) rotate around. The rulingsJurisprudence) rotate around. The rulings
are categorized as follows:are categorized as follows:
 a. Wajib (obligatory)a. Wajib (obligatory)
 e. Haram (unlawful)e. Haram (unlawful)
 b. Mustahab (recommended) (Sunnat)b. Mustahab (recommended) (Sunnat)
 c. Mubah (permissible)c. Mubah (permissible)
 d. Makruh (disliked)d. Makruh (disliked)

RulingsRulings
 Wajib- An obligatory action or something that shallWajib- An obligatory action or something that shall
be performed. Anyone who leave it is liable to gainbe performed. Anyone who leave it is liable to gain
the punishment of Allah s.w.t. in the Here after asthe punishment of Allah s.w.t. in the Here after as
well as a legal punishment in this world.well as a legal punishment in this world.
 Haram- An unlawful action or the one that shall notHaram- An unlawful action or the one that shall not
be performed and is strictly prohibited. Anyone whobe performed and is strictly prohibited. Anyone who
engages in it is liable to gain the punishment ofengages in it is liable to gain the punishment of
Allah s.w.t. in the Here after as well as a legalAllah s.w.t. in the Here after as well as a legal
punishment in this world.punishment in this world.
 Mustahab- A recommended action or something thatMustahab- A recommended action or something that
should be performed.should be performed.
 Mubah- A permissible action or something that isMubah- A permissible action or something that is
neither encouraged nor discouraged.neither encouraged nor discouraged.
 Makruh- A disliked action or something which isMakruh- A disliked action or something which is
abominable and should be avoided but not in strictlyabominable and should be avoided but not in strictly
prohibitory terms.prohibitory terms.

Islam and ShariahIslam 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 NeedsHuman Financial Needs
Fulfillment of Financial Needs
Own Capital Others’ Capital
Equity Financing Debt Financing

External (Equity & Debt) FinancingExternal (Equity & Debt) Financing
Equity FinancingEquity Financing Debt FinancingDebt Financing
Al-MusharakahAl-Musharakah (Joint(Joint
Venture Profit Sharing)Venture Profit Sharing)
Uqud al-MuawadhatUqud al-Muawadhat
(Deferred Contracts of Exchange)(Deferred Contracts of Exchange)
Al-MudarabahAl-Mudarabah
(Trustee Profit Sharing)(Trustee Profit Sharing)
Al-Bai’ Bithaman (Mu)AjilAl-Bai’ Bithaman (Mu)Ajil (Deferred(Deferred
Installment Sale)Installment Sale)
OthersOthers Bai’ al-MurabahaBai’ al-Murabaha
(Cost Plus Profit Sale)(Cost Plus Profit Sale)
Al-IjarahAl-Ijarah (Leasing)(Leasing)
Bai’ al-SalamBai’ al-Salam (Commodity Sale)(Commodity Sale)
Bai’ al-Istisna’Bai’ al-Istisna’ (Sale on Order)(Sale on Order)
Equity MarketEquity Market Debt MarketDebt Market

Most Important Islamic TeachingMost Important Islamic Teaching
Related To BusinessRelated To Business
1.1. Elimination of Interest (Elimination of Interest (RabaRaba))
2.2. The prohibition of uncertainty (The prohibition of uncertainty (GhararGharar))
3.3. The prohibition of Gambling (The prohibition of Gambling (QimarQimar))
4.4. The precipitation of games of chance (The precipitation of games of chance (MaserMaser))
5.5. Honesty and Fair Trade (Honesty and Fair Trade (GhishshGhishsh andand KhilabahKhilabah))
6.6. Spending in the Good CauseSpending in the Good Cause
7.7. Buy BackBuy Back
8.8. Two MutuallyTwo Mutually Conditional ContractConditional Contract
9.9. Entitlement to profit depends on liability for riskEntitlement to profit depends on liability for risk

WHAT ISWHAT IS ISLAMICISLAMIC
BANKING?BANKING?

WHAT IS BANK?WHAT IS BANK?
 The nameThe name bankbank derives from thederives from the ItalianItalian
wordword bancobanco "desk/bench."desk/bench.
 In practice, the word “Bank” means anIn practice, the word “Bank” means an
institution which borrows money frominstitution which borrows money from
people and lends money to people forpeople and lends money to people for
interest or profit and provided other financialinterest or profit and provided other financial
services.services.

BANKS ENGAGE IN THEBANKS ENGAGE IN THE
FOLLOWINNNG ACTIVITIES.FOLLOWINNNG ACTIVITIES.
 Accepting moneyAccepting money
 Processing of payments by way ofProcessing of payments by way of telegraphictelegraphic
transfertransfer,, internet bankinginternet banking,, or other meansor other means;;
 IssuingIssuing bank draftsbank drafts andand bank chequesbank cheques
 Lending moneyLending money
 Providing documentary and standbyProviding documentary and standby
letter of creditletter of credit, guarantees,, guarantees, performanceperformance bondsbonds,,
securities underwriting commitments and othersecurities underwriting commitments and other
forms of off balance sheet exposuresforms of off balance sheet exposures
 Safekeeping of documents and other items inSafekeeping of documents and other items in
safe deposit boxessafe deposit boxes

WHAT ISWHAT IS ISLAMICISLAMIC BANKING?BANKING?
Islamic banking has been defined asIslamic banking has been defined as
banking in consonancebanking in consonance with the ethoswith the ethos
andand value systemvalue system ofof Islam andIslam and
governedgoverned, in addition to the conventional, in addition to the conventional
good governance and rick managementgood governance and rick management
rulesrules by the principleby the principle laid down bylaid down by
Islamic Shariah.Islamic Shariah.

Comparison of the Islamic and ConventionalComparison of the Islamic and Conventional
systemssystems
Conventional BankingConventional Banking
 Conventional Banks take deposit on interestConventional Banks take deposit on interest
basis and lend on the basis on interest. A part ofbasis and lend on the basis on interest. A part of
interest is paid to the depositors and theinterest is paid to the depositors and the
remaining interest is left for the bank as itsremaining interest is left for the bank as its
income. If this residual is more than itsincome. If this residual is more than its
expenses, it will have Net Income otherwise itexpenses, it will have Net Income otherwise it
will have Net loss.will have Net loss.
Islamic BankingIslamic Banking
 Islamic Banking accepts deposits on PLS basisIslamic Banking accepts deposits on PLS basis
and invest in Shariah based modes. Whatever isand invest in Shariah based modes. Whatever is
the profit, it is shared with depositors. If there isthe profit, it is shared with depositors. If there is
a loss it will also be shared.a loss it will also be shared.
1414

OBJECTIVES OF ISLAMICOBJECTIVES OF ISLAMIC
BANKINGBANKING
 Shariah compliant banking, to enableShariah compliant banking, to enable
MuslimsMuslims to do theirto do their banking transactionbanking transaction – a– a
Halal way.Halal way.
 Achieving theAchieving the goalsgoals andand objectivesobjectives of anof an
IslamicIslamic economy.economy.

DEPOSITSDEPOSITS
 AA depositdeposit is an account at ais an account at a bankingbanking
institution that allowsinstitution that allows moneymoney to beto be
deposited and withdrawn by the accountdeposited and withdrawn by the account
holder. These transactions are recordedholder. These transactions are recorded
on the bank's books.on the bank's books.
 All deposit appears as liability on BalanceAll deposit appears as liability on Balance
Sheet of the Bank.Sheet of the Bank.

CATEGORIES OF DEPOSIT INCATEGORIES OF DEPOSIT IN
ISLMIC BANKINGISLMIC BANKING
The ShariahThe Shariah optionoption for deposit mobilizationfor deposit mobilization
can becan be workedworked out by respecting twoout by respecting two
principles:principles:
 The aim of the exchange at hand must beThe aim of the exchange at hand must be
recognizes in Shariah.recognizes in Shariah.
 The modalities to achieve the saidThe modalities to achieve the said must bemust be
ShariahShariah CompliantCompliant..

GENERAL MOODES OF ISLAMIC BANKINGGENERAL MOODES OF ISLAMIC BANKING
USED TO RAISE DEPOSITSUSED TO RAISE DEPOSITS
DepositorsDepositors
 Deposit can be accepted by islamic bank on basis of:Deposit can be accepted by islamic bank on basis of:
1.1. AmanahAmanah
2.2. QaridQarid
Investment AccountsInvestment Accounts
 Islamic banks generally use Musharakah and MudarabahIslamic banks generally use Musharakah and Mudarabah
based product for obtaining investment account.based product for obtaining investment account.
 These deposits are based on the Shariah principles of profitThese deposits are based on the Shariah principles of profit
and loss sharing, and the banks use them, along with itsand loss sharing, and the banks use them, along with its
own funds in businesses which are Shariah compliant.own funds in businesses which are Shariah compliant.
 Wakala model can also be used for Investment Account.Wakala model can also be used for Investment Account.

Definition of QardDefinition of Qard
 In Islamic Shariah, loans called QardIn Islamic Shariah, loans called Qard
have only one concept as far as returnhave only one concept as far as return
thereon is concerned i.e. these arethereon is concerned i.e. these are
interest–free.interest–free.
 These are repayable in exactly equalThese are repayable in exactly equal
amounts in which these are paid.amounts in which these are paid.

Definition of AmanahDefinition of Amanah
 To give any commodity / asset toTo give any commodity / asset to
anybody for the sake of safety is calledanybody for the sake of safety is called
Amanah.Amanah.
 Anything given as Amanah is consideredAnything given as Amanah is considered
to be something held in trust, and theto be something held in trust, and the
same can not be used.same can not be used.

MEANING OF SHAIRKATMEANING OF SHAIRKAT
 The literal meaning of Musharakah is sharing.The literal meaning of Musharakah is sharing.
The root of the word "Musharakah" in Arabic isThe root of the word "Musharakah" in Arabic is
Shirkah, which means being a partner.Shirkah, which means being a partner.
 Under Islamic jurisprudence, MusharakahUnder Islamic jurisprudence, Musharakah
means a joint enterprise formed for conductingmeans a joint enterprise formed for conducting
some business in which all partners share thesome business in which all partners share the
profit according to a specific ratio while the lossprofit according to a specific ratio while the loss
is shared according to the ratio of theis shared according to the ratio of the
contribution.contribution.

Shirkat-ul-AmmwalShirkat-ul-Ammwal
Definition: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:SHIRKAT-UL- AMWAL:
Capital of MusharakahCapital of Musharakah
 It should be known, ascertained and available at the
time of contract.
 The value should be agreed upon in case of kinds;The value should be agreed upon in case of kinds;
 Capital paid in different currencies should be valued into theCapital paid in different currencies should be valued into the
currency of Shirkah;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 MusharakahManagement of Musharakah
 Each partner has right to take part in MusharakahEach partner has right to take part in Musharakah
management.management.
 The partner may appoint a managing partner by mutualThe partner may appoint a managing partner by mutual
consent.consent.
 One are more of the partners may decide not to work forOne are more of the partners may decide not to work for
the Musharakah and work as a sleeping partner.the Musharakah and work as a sleeping partner.
 It is not allowed to specify a fixed remuneration to aIt is not allowed to specify a fixed remuneration to a
partner Musharaka who manages funds or providespartner Musharaka who manages funds or provides
some form of other services, such as accounting;some form of other services, such as accounting;
 However, it is permissible to give him a greater share ofHowever, it is permissible to give him a greater share of
profit than he would receive solely on the basis of hisprofit than he would receive solely on the basis of his
share in the partnership capital;share in the partnership capital;

Distribution of ProfitDistribution of Profit
 The ratio of profit distribution must be agreed atThe ratio of profit distribution must be agreed at
the time of execution of the contract.the time of execution of the contract.
 It is not necessary for sharing profit according toIt is not necessary for sharing profit according to
proportionate capital contribution;proportionate capital contribution;
 It is not allowed to defer the determination of
profit until realization of profit.
 The ratio must be determined as a proportionThe ratio must be determined as a proportion
on the actual profit earned by the enterprise.on the actual profit earned by the enterprise.
 Not as percentage of partner’s investment.Not as percentage of partner’s investment.
 Not in lump sum amount.Not in lump sum amount.
1. It is not allowed to defer the determination of profit
until realization of profit.
2.2. A sleeping partner cannot share in the profit more thanA sleeping partner cannot share in the profit more than
the percentage of his capital.the percentage of his capital.

Rules of Loss
Determination/Distribution
 Sharing of Loss:Sharing of Loss:
 As a matter of principle the loss has to be shared according toAs a matter of principle the loss has to be shared according to
the ratio of capital contribution;the ratio of capital contribution;
 Partners are not allowed to adopt any other mechanism exceptPartners are not allowed to adopt any other mechanism except
the mechanism that ensure distribution of loss among partnersthe mechanism that ensure distribution of loss among partners
on pro rata basis;on pro rata basis;
 Any other arrangement, even agreed upon by partners, will beAny other arrangement, even agreed upon by partners, will be
invalid and void.invalid and void.
 It is not allowed to hold one partner or group of partners liable
for entire loss.

Mudaraba Introduction - DefinitionMudaraba Introduction - Definition
““Mudaraba” is a kind of partnership whereMudaraba” is a kind of partnership where
one partner gives money to another forone partner gives money to another for
investing in profitable avenues.investing in profitable avenues.
 The investor (fund supplier) is calledThe investor (fund supplier) is called
“Rabb-ul-Mal” (“Rabb-ul-Mal” ( ) while the person who) while the person who
utilizes this fund (the fund manager) isutilizes this fund (the fund manager) is
called “Mudarib” (called “Mudarib” ( ) who is exclusively) who is exclusively
responsible for management of theresponsible for management of the
business.business.

Capacities of MudaribCapacities of Mudarib
Mudarib has different capacities for whichMudarib has different capacities for which
rules are different. Listed down are hisrules are different. Listed down are his
roles:roles:
 Ameen (trustee):Ameen (trustee):
 Mudarib holds money and assets of Mudarabah as trustee;Mudarib holds money and assets of Mudarabah as trustee;
 Therefore, he is responsible for management of assets honestly;Therefore, he is responsible for management of assets honestly;
 In case of actual loss he is responsible for nothing;In case of actual loss he is responsible for nothing;
 Wakeel (Agent):Wakeel (Agent):
 Mudarib manages Mudarabah as an agent of owner;Mudarib manages Mudarabah as an agent of owner;
 Therefore his actions are considered as of Rabbul Maal;Therefore his actions are considered as of Rabbul Maal;
 Actual loss is born by Rabbul Maal in case it happens;Actual loss is born by Rabbul Maal in case it happens;
 Shareek (partner):Shareek (partner):
 Mudarib becomes partner in the profit that Mudarabah generates;Mudarib becomes partner in the profit that Mudarabah generates;

Mudaraba Introduction - profit &Mudaraba Introduction - profit &
loss distributionloss distribution
 Profit and Loss distribution:Profit and Loss distribution:
 The Mudaraba contract should mention profit sharing ratio inThe Mudaraba contract should mention profit sharing ratio in
defined and clear terms;defined and clear terms;
 The profit sharing ratio should be:The profit sharing ratio should be:
 specific;specific;
 of the expected profit;of the expected profit;
 Apart from the agreed proportion of the profit, the Mudarib cannotApart from the agreed proportion of the profit, the Mudarib cannot
claim any periodical salary or a fee or remuneration for the workclaim any periodical salary or a fee or remuneration for the work
done by him for the Moradabad.done by him for the Moradabad.
 The Mudarib & Rab-ul-Maal cannot allocate a lump sum amountThe Mudarib & Rab-ul-Maal cannot allocate a lump sum amount
of profit for any party nor can they determine the share of anyof profit for any party nor can they determine the share of any
party at a specific rate tied up with the capital.party at a specific rate tied up with the capital.

Mudaraba Vs MusharakaMudaraba Vs Musharaka
.. Mudaraba:Mudaraba:
1.1. The contribution comesThe contribution comes
from Rabbul Maal (thefrom Rabbul Maal (the
investor);investor);
2.2. The Rabbul MaalThe Rabbul Maal
(investor) is not permitted(investor) is not permitted
to manage the business;to manage the business;
3.3. The Mudarib managesThe Mudarib manages
the business only;the business only;
4.4. The Mudarib can alsoThe Mudarib can also
invest in the capital ofinvest in the capital of
Mudarabah.Mudarabah.
Musharaka:Musharaka:
1.1. The contribution comesThe contribution comes
from all partners in form offrom all partners in form of
cash, commodities,cash, commodities,
services or liability in caseservices or liability in case
of reputation partnership;of reputation partnership;
2.2. The work, as a generalThe work, as a general
rule, is to be done jointlyrule, is to be done jointly
by the parties;by the parties;
3.3. A partner or someA partner or some
partners may be sleeping;partners may be sleeping;

CATEGORIES OF DEPOSIT INCATEGORIES OF DEPOSIT IN
ISLMIC BANKINGISLMIC BANKING
Investment AccountInvestment Account DepositorsDepositors
Profit & Loss SharingProfit & Loss Sharing
Saving AccountsSaving Accounts
Current AccountCurrent Account
Fixed InvestmentFixed Investment
AccountsAccounts
Security DepositSecurity Deposit

DIFFERENCE IN DEPOSITS &DIFFERENCE IN DEPOSITS &
INVESTMENT ACCOUNTSINVESTMENT ACCOUNTS
Investment AccountInvestment Account Deposits AccountDeposits Account
These areThese are notnot
guaranteed.guaranteed.
These areThese are guaranteed.guaranteed.
TheirTheir naturenature is investmentis investment
Investment accountInvestment account
holdersholders are inare in
participatoryparticipatory modes.modes.
It isIt is liabilityliability of the bankof the bank
It isIt is loanloan to the bank.to the bank.
ReturnReturn paid to thepaid to the
account holders is theiraccount holders is their
portion in profitportion in profit of theof the
bank.bank.
InterestInterest paid to thepaid to the
depositors is treated asdepositors is treated as
bank expensesbank expenses..

3535
COMPONENTS OF VALIDCOMPONENTS OF VALID
SALESALE
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 saleTypes of sale
3636
//2525
ν
 A trust sale is a type of sale in which buyer and seller agreeA trust sale is a type of sale in which buyer and seller agree
on disclosure of actual cost while General sale is a typeon disclosure of actual cost while General sale is a type
where seller quote a price whit out disclosure of cost;In trustwhere seller quote a price whit out disclosure of cost;In trust
sales honest disclosure of cost by seller is necessary; Theresales honest disclosure of cost by seller is necessary; There
areare threethree typestypes of trust sale:of trust sale:
Ba’yBa’y TauoliaTauoliaν
Cost to cost sale;
Ba’yBa’y Wa’diaWa’diaν
Below the cost sale;
Ba’y MurabahaBa’y Murabahaν
Cost plus profit sale;

3737
MusawamahMusawamah
Musawamah is a general kind of sale inMusawamah is a general kind of sale in
which price of the commodity to be tradedwhich price of the commodity to be traded
is stipulated between seller and the buyeris stipulated between seller and the buyer
without any reference to the price paid orwithout any reference to the price paid or
cost incurred by the former. Thus it iscost incurred by the former. Thus it is
different from Murabaha in respect ofdifferent from Murabaha in respect of
pricing formula.pricing formula.
Unlike Murabaha, seller in Musawamah isUnlike Murabaha, seller in Musawamah is
not obliged to reveal his cost.not obliged to reveal his cost.

MurabahaMurabaha
 In literary terms, Ba’y MurabahaIn literary terms, Ba’y Murabaha (())
means “sale on profit”.means “sale on profit”.
 In Arabic, its origin is RabahIn Arabic, its origin is Rabah )) ))
which means profit.which means profit.
 Technically, it is a contract of saleTechnically, it is a contract of sale
in which the seller declares hisin which the seller declares his
cost and profit.cost and profit.
 It may be on spot basis, or onIt may be on spot basis, or on
deferred payment basis.deferred payment basis.

3939
FEATURES OF BANKINGFEATURES OF BANKING
MURABAHAMURABAHA
Murabaha finance is not aMurabaha finance is not a loanloan givengiven
on interest, it is a sale of Asset(s) foron interest, it is a sale of Asset(s) for
cash/deferred price.cash/deferred price.
It is the obligation of the Seller toIt is the obligation of the Seller to
disclose the Cost and Profit to thedisclose the Cost and Profit to the
Buyer.Buyer.

4040
MURABAHAMURABAHA
Murabaha Transaction can either be aMurabaha Transaction can either be a
cash salecash sale (Spot Payment Murabaha)(Spot Payment Murabaha)
or a credit saleor a credit sale (Deferred Payment(Deferred Payment
Murabaha)Murabaha) or a combination of both.or a combination of both.
Payment of Murabaha Price can bePayment of Murabaha Price can be
made in lump sum or in installments.made in lump sum or in installments.

4141
MURABAHAMURABAHA
Murabaha Finance can only be used forMurabaha Finance can only be used for
the purchase ofthe purchase of fresh Asset(s)fresh Asset(s) onlyonly..
Buy-Back arrangementBuy-Back arrangement is prohibited.is prohibited.
This means that Murabaha transactionThis means that Murabaha transaction
cannot be executed for the Asset(s)cannot be executed for the Asset(s)
already purchased by the Customer.already purchased by the Customer.

4242
//2525
• Murabaha is a fixed price sale and is normally usedMurabaha is a fixed price sale and is normally used
for short term financing;for short term financing;
•Murabaha cannot be used as a substitute for cashMurabaha cannot be used as a substitute for cash
advancing or pure cash based running finance facility;advancing or pure cash based running finance facility;
•The transaction can be used in order to meet theThe transaction can be used in order to meet the
working capital requirements however it cannot be usedworking capital requirements however it cannot be used
to meet liquidity requirements;to meet liquidity requirements;
•Murabaha can be used for long term as well but it suchMurabaha can be used for long term as well but it such
a case it would be a fixed rate transaction and will nota case it would be a fixed rate transaction and will not
accept flexibility in rate of financingaccept flexibility in rate of financing;
Scope of MurabahaScope of Murabaha

4343
VARIOUSVARIOUS
MODELS OFMODELS OF
MURABAHAMURABAHA
FINANCEFINANCE

4444
MODEL - IMODEL - I
TWO PARTY REALTIONSHIPTWO PARTY REALTIONSHIP
 Bank – CustomerBank – Customer
MODEL - IIMODEL - II
THREE PARTY RELATIONSHIPTHREE PARTY RELATIONSHIP
 (Bank-Vendor) and Customer(Bank-Vendor) and Customer
MODEL - IIIMODEL - III
THREE PARTY RELATIONSHIPTHREE PARTY RELATIONSHIP
 Bank and (Vendor-Customer)Bank and (Vendor-Customer)

4545
MODEL - IMODEL - I
 The simplest possible Model emergesThe simplest possible Model emerges
when the transaction involves twowhen the transaction involves two
parties only, i.e Bank and theparties only, i.e Bank and the
Customer.Customer.
 The Bank is also vendor and sells theThe Bank is also vendor and sells the
Asset(s) to its Customers on deferredAsset(s) to its Customers on deferred
payment basis.payment basis.
 FromFrom Shari’ahShari’ah perspective it is anperspective it is an
ideal Model and its profits are fullyideal Model and its profits are fully
justified because Bank assumes alljustified because Bank assumes all
risks as Vendor/Trader.risks as Vendor/Trader.

4646
Bank/VendorCustomer
1
2
3
MODEL I – GRAPHICALMODEL I – GRAPHICAL
PRESENTATIONPRESENTATION

4747
MODEL I - PHASESMODEL I - PHASES
Phase 1:Phase 1:
The customer approaches Bank (Vendor) andThe customer approaches Bank (Vendor) and
identifies Asset(s) and collects relevantidentifies Asset(s) and collects relevant
information including cost and profit.information including cost and profit.
Phase 2:Phase 2:
Bank sells Asset(s) to the Customer, transferBank sells Asset(s) to the Customer, transfer
risk and ownership to the Customer at certainrisk and ownership to the Customer at certain
Murabaha Price.Murabaha Price.
Phase 3:Phase 3:
Customer pays Murabaha Price in lump sumCustomer pays Murabaha Price in lump sum
or in installments on agreed dates.or in installments on agreed dates.

4848
MODEL - IIMODEL - II
 In most cases Murabaha TransactionIn most cases Murabaha Transaction
involves a third party (i.e. Vendor)involves a third party (i.e. Vendor)
because Bank is not expected to engagebecause Bank is not expected to engage
in sale of variety of products requiredin sale of variety of products required
for variety of Customers.for variety of Customers.
 The Bank directly deals with the VendorThe Bank directly deals with the Vendor
and purchases the Asset(s).and purchases the Asset(s).

4949
MODEL IIMODEL II
 The Bank sells the purchasedThe Bank sells the purchased
Asset(s) to the customer on costAsset(s) to the customer on cost
plus basis.plus basis.
 There are two distinct sale contractsThere are two distinct sale contracts
at different point of times. Firstat different point of times. First
between Bank and Vendor andbetween Bank and Vendor and
second between Bank and thesecond between Bank and the
Customer.Customer.

5050
Customer Bank
Vendor1
2
3
4
6
5
MODEL II – GRAPHICALMODEL II – GRAPHICAL
PRESENTATIONPRESENTATION

5151
MODEL II - PHASESMODEL II - PHASES
Phase 1:Phase 1:
Customer identifies and approaches theCustomer identifies and approaches the
Vendor or Supplier of the Asset(s) andVendor or Supplier of the Asset(s) and
collects all relevant information.collects all relevant information.
Phase 2:Phase 2:
Customer approaches the Bank forCustomer approaches the Bank for
Murabaha Financing and promises to buyMurabaha Financing and promises to buy
the Asset(s).the Asset(s).
Phase 3:Phase 3:
The Bank makes payment to vendorThe Bank makes payment to vendor
directly.directly.

5252
MODEL II – PHASESMODEL II – PHASES
Phase 4:Phase 4:
Vendor delivers the Asset(s) & transfers theVendor delivers the Asset(s) & transfers the
ownership of Asset(s) to the Bank.ownership of Asset(s) to the Bank.
Phase 5:Phase 5:
Bank sells the Asset(s) to Customer on costBank sells the Asset(s) to Customer on cost
plus basis and transfers ownership.plus basis and transfers ownership.
Phase 6:Phase 6:
Customer pays Murabaha Price in lumpCustomer pays Murabaha Price in lump
sum or in installments on agreed dates.sum or in installments on agreed dates.

5353
MODEL III – BANKINGMODEL III – BANKING
MURABAHAMURABAHA
 This Murabaha Model is mostlyThis Murabaha Model is mostly
practiced model in Banking now a dayspracticed model in Banking now a days
and therefore we will look at it in moreand therefore we will look at it in more
detail.detail.
We will also look at the documentationWe will also look at the documentation
required at different stages of therequired at different stages of the
transaction.transaction.
 It is also a three-party structure but it isIt is also a three-party structure but it is
bit complicated than previous ones.bit complicated than previous ones.

5454
MURABAHAMURABAHA
 The product of Murabaha that is beingThe product of Murabaha that is being
used in Islamic Banking as a mode ofused in Islamic Banking as a mode of
finance is something different from thefinance is something different from the
Murabaha used in normal trade .Murabaha used in normal trade .
 It is calledIt is called Murabaha to the PurchaseMurabaha to the Purchase
Orderer .Orderer .

5555
MURABAHAMURABAHA
 It is a bunch of contracts completed in stepsIt is a bunch of contracts completed in steps
and ultimately suffices the financial needs ofand ultimately suffices the financial needs of
the client.the client.
 THE SEQUENCE OF THEIR EXECUTIONTHE SEQUENCE OF THEIR EXECUTION
IS EXTREMELY IMPORTANT TO MAKEIS EXTREMELY IMPORTANT TO MAKE
THE TRANSACTION SHARIA’HTHE TRANSACTION SHARIA’H
COMPLIANTCOMPLIANT..

5656
BankCustomer
Vendor
4
3
MODEL III – GRAPHICALMODEL III – GRAPHICAL
PRESENTAIONPRESENTAION
2
1
5
5
6
Offer Acceptance
7

How Murabaha works in IslamicHow Murabaha works in Islamic
financefinance??

How Murabaha works in IslamicHow Murabaha works in Islamic
finance?finance?

Steps Of Banking MurabahaSteps Of Banking Murabaha
MOU
↓
Order Form
↓
Agency Agreement
↓
Purchase
↓
Payment of Purchase Price‌
↓
Possession
↓
Offer and Acceptance
(Declaration)
↓
Payment of Murabaha Price

IjarahIjarah
 Lexically, Ijarah means “to giveLexically, Ijarah means “to give
something on rent or to providesomething on rent or to provide
some service for consideration”.some service for consideration”.
 In Islamic jurisprudence, there areIn Islamic jurisprudence, there are
two different types of Ijarah;two different types of Ijarah;
 The first one is an employment orThe first one is an employment or
service contract by virtue of whichservice contract by virtue of which
a person provides services toa person provides services to
employer and against thoseemployer and against those
services he gets Ujrah i.e.services he gets Ujrah i.e.
remuneration of services.remuneration of services.

IjarahIjarah
 The second type of Ijarah which isThe second type of Ijarah which is
more common in Islamic finance,more common in Islamic finance,
is a contract in which: fiftyis a contract in which: fifty
 the owner of an asset (other thanthe owner of an asset (other than
consumables) transfers its usufructsconsumables) transfers its usufructs
 to another personto another person
 for an agreed periodfor an agreed period
 against an agreed consideration.against an agreed consideration.
 In this case, the term Ijarah isIn this case, the term Ijarah is
synonym to the English termsynonym to the English term
‘leasing’.‘leasing’.

Basic Rules of IjaraBasic Rules of Ijara
  It is necessary for valid lease that theIt is necessary for valid lease that the
corpus of the leases property remains incorpus of the leases property remains in
the ownership of the lessor.the ownership of the lessor.
  The period of lease must be determinedThe period of lease must be determined
in clear terms.in clear terms.
 The lease period shall start from theThe lease period shall start from the
date on which the leased asset has beendate on which the leased asset has been
delivered.delivered.
6262

Liabilities of PartiesLiabilities of Parties

 Lessor Responsibilities:Lessor Responsibilities:
            Since corpus of leased property remains inSince corpus of leased property remains in
the ownership of the lessor therefore all liabilitiesthe ownership of the lessor therefore all liabilities
of ownership are borne by lessor.of ownership are borne by lessor.
 Expenses:Expenses:
            As the lessor is the owner of the asset heAs the lessor is the owner of the asset he
is liable to pay all the expenses incurred in theis liable to pay all the expenses incurred in the
process of its purchase and its import to theprocess of its purchase and its import to the
country of the lessor example expenses ofcountry of the lessor example expenses of
shipment and customs duty etc.shipment and customs duty etc.
6363

Lessee Responsibilities:Lessee Responsibilities:
         Being user of the lease asset lesseeBeing user of the lease asset lessee
can be made liable to any normallycan be made liable to any normally
occurring wear and tear.occurring wear and tear.
       The lessee cannot use the leasedThe lessee cannot use the leased
asset for any purpose other then theasset for any purpose other then the
purpose specified in the leasepurpose specified in the lease
agreement.agreement.
           If no such purpose is not specified inIf no such purpose is not specified in
the agreement, the lessee can use it forthe agreement, the lessee can use it for
whatever purpose it is use in normalwhatever purpose it is use in normal
course.course. 6464

Lessee as Ameen:Lessee as Ameen:
  The lessee is liable to compensateThe lessee is liable to compensate
the lessor for every harm caused to thethe lessor for every harm caused to the
leased asset by his misuse or negligence.leased asset by his misuse or negligence.
6565

RentalRental
  The rental must be determined atThe rental must be determined at
the time of contract for the wholethe time of contract for the whole
period of lease.period of lease.
  It is permissible that differentIt is permissible that different
amount of rent are fixed for differentamount of rent are fixed for different
phases provided that the amount ofphases provided that the amount of
rent for each phase is specificallyrent for each phase is specifically
agreed upon at the time of affecting aagreed upon at the time of affecting a
lease.lease.
  The lessor cannot increase theThe lessor cannot increase the
rent unilaterally and any agreementrent unilaterally and any agreement
to this effect is vied.to this effect is vied. 6666

RentalRental
  A lease contract can have a condition that theA lease contract can have a condition that the
rent shall be increased according to a specifiedrent shall be increased according to a specified
proportion (e.g. 5%) after a specified period (likeproportion (e.g. 5%) after a specified period (like
one year).one year).
  The rent or any part thereof may be payableThe rent or any part thereof may be payable
in advance before the delivery of the asset to thein advance before the delivery of the asset to the
lessee, but that amount so collected by thelessee, but that amount so collected by the
lessor shall remain with him as Amana and shalllessor shall remain with him as Amana and shall
be adjusted towards the rent after its being due.be adjusted towards the rent after its being due.
6767

In Case of Late PaymentIn Case of Late Payment
  The lessor cannot charge an additionalThe lessor cannot charge an additional
amount in case the lessee delays paymentamount in case the lessee delays payment
of the rent.of the rent.
  Penalty of late payment is given toPenalty of late payment is given to
charity by lessee.charity by lessee.
6868

Termination: contractualTermination: contractual

      Lease is binding contract.Lease is binding contract.
   It cane be terminated by mutualIt cane be terminated by mutual
consent.consent.
   The lessor may terminate it when theThe lessor may terminate it when the
lessee doesn’t pay the rent or fails to paylessee doesn’t pay the rent or fails to pay
it on time or because of violation of anyit on time or because of violation of any
other term and condition of the agreement.other term and condition of the agreement.
6969

Termination: contractualTermination: contractual
     With total destruction of the leasedWith total destruction of the leased
assetasset
       Upon the expiry of term.Upon the expiry of term.
     Two parties may terminate it before itTwo parties may terminate it before it
begins to run.begins to run.
7070

Procedure of Banking IjarahProcedure of Banking Ijarah
Undertaking to IjarahUndertaking to Ijarah
↓↓
Agency AgreementAgency Agreement
↓↓
PurchasePurchase
↓↓
Payment of Purchase PricePayment of Purchase Price
↓↓
Lease AgreementLease Agreement

Finance Lease (Ijarah)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 MusharakahDiminishing Musharakah
(DM(DM is a type of Shirkah where oneis a type of Shirkah where one
partner purchases the other partner’spartner purchases the other partner’s
share graduallyshare gradually

FEATURES OF DIMINISHINGFEATURES OF DIMINISHING
MUSHARAKAHMUSHARAKAH
IN SHIRKAT-UL-MILK (JOINT OWNERSHIP)IN SHIRKAT-UL-MILK (JOINT OWNERSHIP)
Two partners purchase any assetTwo partners purchase any asset
(machinery/property) and(machinery/property) and their intentiontheir intention
is that one or both partners will useis that one or both partners will use
this asset or they rent out theirthis asset or they rent out their
shareshare and one Shareek undertakes toand one Shareek undertakes to
purchase the share of other gradually.purchase the share of other gradually.

Diminishing Musharakah in ShirkatDiminishing Musharakah in Shirkat
ul Milk – with Ijarahul Milk – with Ijarah
 A and B invest their capital andA and B invest their capital and
purchase a joint asset e.g. apurchase a joint asset e.g. a
house.house.
 A separate MusharakaA separate Musharaka
agreement is executed.agreement is executed.
 B promises to sell his shares to AB promises to sell his shares to A
gradually or A promises to buygradually or A promises to buy
B’s shares in the jointly ownedB’s shares in the jointly owned
property.property.
 A and B enjoy their rights asA and B enjoy their rights as
partners as they share the riskspartners as they share the risks
and rewards in the ratio of theirand rewards in the ratio of their
joint investment.joint investment.

Diminishing Musharakah in ShirkatDiminishing Musharakah in Shirkat
ul Milk – with Ijarahul Milk – with Ijarah
 A uses the asset while he pays rentA uses the asset while he pays rent
to B in proportion of B’s ownership into B in proportion of B’s ownership in
the joint property according to thethe joint property according to the
pre-agreed benchmark.pre-agreed benchmark.
 Expenses incidental to ownership areExpenses incidental to ownership are
shared in proportion of ownership,shared in proportion of ownership,
while expenses relating to use arewhile expenses relating to use are
borne by A who uses the property.borne by A who uses the property.
 A will keep buying B’s shares until heA will keep buying B’s shares until he
acquires the complete ownership.acquires the complete ownership.

Diminishing MusharakaDiminishing Musharaka
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Customer Bank
----------Time------->
Ownership Transfer

Diminishing MusharakaDiminishing Musharaka
Monthly Rentals
----------Time------->
Rs

Procedure of DMProcedure of DM
D M AgreementD M Agreement (Bank +Client)(Bank +Client)
↓↓
Undertaking to IjarahUndertaking to Ijarah (from the client)(from the client)
↓↓
Sale AgreementSale Agreement (Client + owner of the house)(Client + owner of the house)
↓↓
Payment of Purchase PricePayment of Purchase Price (to the owner of the(to the owner of the
house)house)
↓↓
Lease AgreementLease Agreement (Bank + client)(Bank + client)

 Bank enters into a participation (Shirkat-ul-Milk) arrangement with theBank enters into a participation (Shirkat-ul-Milk) arrangement with the
CustomerCustomer
 Bank provides the larger share of the purchase price of the vehicleBank provides the larger share of the purchase price of the vehicle
 Bank rents out its share of the vehicle to the customerBank rents out its share of the vehicle to the customer
 The customer makes regular scheduled investments to increase itsThe customer makes regular scheduled investments to increase its
equity in the property over the life of the transactionequity in the property over the life of the transaction
 The monthly/ periodic payments are structured to reflect a portion ofThe monthly/ periodic payments are structured to reflect a portion of
rent and a portion of purchase price i.e. EMI = Rent + Purchase ofrent and a portion of purchase price i.e. EMI = Rent + Purchase of
ShareShare
 Once the customer has purchased all of the Bank’s share theOnce the customer has purchased all of the Bank’s share the
ownership will transfer to the customer with free and clear title to theownership will transfer to the customer with free and clear title to the
vehiclevehicle

ISLAMIC BANKING MODELISLAMIC BANKING MODEL
Current
Deposit
SBP
Operational Expenses
Income/
Loss from
Investment
Income from
non fund
business
POOL OF
FUND
S
PLS
Depositors
Bank
Equity
Reserves
Distributable
Income
EquityDepositor
s
PLS
Idle fund
Investment
Current
Deposit

Comparison of the Islamic and ConventionalComparison of the Islamic and Conventional
systemssystems
Conventional BankingConventional Banking
 Equation of Banks FailureEquation of Banks Failure
Admn Exp + Interest Exp > Total Income + ReservesAdmn Exp + Interest Exp > Total Income + Reserves
 Equation of Banking System FailureEquation of Banking System Failure
Admn Exp + Interest Exp > Total Income + Reserves + EquityAdmn Exp + Interest Exp > Total Income + Reserves + Equity
Islamic BankingIslamic Banking
 Equation of Banks FailureEquation of Banks Failure
Operational Losses > Reserves + PLS DepositsOperational Losses > Reserves + PLS Deposits
 Equation of Banking System FailureEquation of Banking System Failure
Operational Losses > Reserves + PLS Deposits + EquityOperational Losses > Reserves + PLS Deposits + Equity
 Operational LossesOperational Losses
Operational Losses = Income (Losses) from Invest ± Admn ExpOperational 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: info@alhudacibe.com Website: www.alhudacibe.com

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