Modes of islamic finance


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Modes of islamic finance

  1. 1. Basic principles of Islamic finance : 1- Prohibition of Riba: The practice of charging financial interest or a premium in excess of the principal amount of the loan. 2-Risk sharing: Interest is prohibited and owner of funds become investors instead of creditors.The provider of capital and entrepreneur shares business risks and shares profits and loss according to the ratio of investment and participation by way of their Capital or Skill. 3-Prohibition of speculative behavior: An Islamic financial system discourages exhibition of wealth and prohibits transactions featuring extreme uncertainties, gambling, and risks 4-Transparency of contracts: Disclose all obligations and information regarding the contracts undertake
  2. 2. Basic principles of Islamic financial : 5-Shariah Approved Activities Sharia’h qualifies businesses are allowed (alcohol, gambling and casinos) are not allowed 6- Prohibition of Gharar Gharar is variously defined in English as 'uncertainty' or 'deceptive uncertainty'.The Qur'an uses the word "al-gharūr" to mean "deceptive". A Gharar transaction occurs where one party can only benefit by the other's loss, under conditions of uncertainty. Commercial insurance is given as an example of this, since either the insured pays a premium and receives no counter value, or the insurer pays out much more on a claim than was received by way of premium. Example Of Gharar: 1-Selling goods that the seller is unable to deliver 2-Selling known or unknown goods against an unknown price 3-Selling goods without proper description 4-Selling goods without specifying the price
  3. 3. ExampleOf Gharar: 5- Making a contract conditional on an unknown event 6-Selling goods on the basis of false description 7-Selling goods without allowing buyer to properly examine the goods 8-Gambling is a form of Gharar because the gambler is ignorant of the result of his gamble
  4. 4. Towards achieving the objectives of Shari’ah (Maqasid al-Shari’ah)  High ethical values - justice, fairness, trust, honesty and integrity  Protection of religion, life, lineage, intellect and wealth More equitable distribution of wealth 1-Materiality andValidity ofTransactions Economically productive underlying activities Avoidance of interest-based transactions No involvement in illegal and unethical activities Genuine trade and business transactions Avoidance of speculative transactions EmbeddedGovernance 2-Mutuality of Risk Sharing Entitlement of protitcontingent upon risk taking Honouring both substance and form of contract Disclosure &Transparency
  5. 5. 1- Modarba (Riba Free Mode Of Financing) 2-Mosharika(Trade Financing) 3-Morabha (Equity Participation orVenture Financing 4-Ijarah (Asset Financing)
  6. 6. 3-Morabha (Equity Participation orVenture Financing : Definition: Morabaha is a contract of sale in which a commodity is sold on profit.The seller tells the buyer his cost price as well as his profit he is adding to the cost.
  7. 7. Parties Of Murabaha Contract: 1-Finacial Institution (Rab-Ul-Maal) i.e Meezan Bank etc. 2-Murahib (who influences the Rab-Ul-Maal to buy the goods) 3- Muqqddam (The agent may be hired by the Rab-Ul-Maal) 4-The Supplier (who is directly approached by the Rab-Ul-Maal)
  8. 8. 3-Morabha (Equity Participation orVenture Financing : 1- Morabaha is a financing technique that involves a request by the Morahib (Worker) to the financier (Rab-ul-Maal) for the purchase of a certain goods or equipment or Asset for him and adds up the declared profit in the cost(COST+PROFIT) which is agreed by the Murahib.
  9. 9. 3-Morabha (Equity Participation orVenture Financing : 2- The financer (Rab_ul_Maal) approaches to the supplier by himself or through Muqqddam (Agent) for the purchase of machines and add up the all expenses or less the financing amount invested by Murahib (ARBOON)
  10. 10. 3-Morabha (Equity Participation orVenture Financing :  The seller discloses the cost to the buyer  Disclosed profit is added  Normal Sale  The seller does not disclose the cost to the buyer  Hidden profit  Murabaha Sale
  11. 11. 3-Morabha (Equity Participation orVenture Financing : • As per the rules of Shariah the seller cannot sell the goods unless they come into his ownership. • The goods are need to be identified and purchased. • The bank(Rab-Ul-Maal) , being a financial institution does not have the expertise to identify the goods and negotiate an efficient price. • The customer, however, being in the industry, can do this. The Bank therefore appoint him(Maqqaddam), in the first step of the transaction, to identify and procure the goods on the bank’s behalf.
  12. 12. • Once the customer purchase the goods the risk of the goods transfers to the Bank. Bank can now sell these goods to the customer. • The customer play two different roles in this transaction. On that of Bank’s agent and other of purchaser. These roles should be clearly segregated to make the transaction halal. • This process is explained in detail in next slides. 3-Morabha (Equity Participation orVenture Financing :3-Morabha (Equity Participation orVenture Financing :
  13. 13. 3-Morabha (Equity Participation orVenture Financing :3-Morabha (Equity Participation orVenture Financing : Agreement to Murabaha Bank Client Murabha Financing Step By Step 1- Client and bank sign an agreement to enter into Murabaha
  14. 14. 3-Morabha (Equity Participation orVenture Financing :3-Morabha (Equity Participation orVenture Financing : Murabha Financing Step By Step 2- Client appoints as an agent to purchase asset on behalf of Bank Agency Agreement Bank Client Agreement to Murabaha
  15. 15. 3-Morabha (Equity Participation orVenture Financing :3-Morabha (Equity Participation orVenture Financing : Murabha Financing Step By Step 3- Bank gives money to client to buy an asset Agreement to Murabaha Agency Agreement Disbursement to the client Bank Client
  16. 16. 3-Morabha (Equity Participation orVenture Financing :3-Morabha (Equity Participation orVenture Financing : Murabha Financing Step By Step 4- Client purchases the asset on behalf of Bank Client purchases goods and takes possession Transfer of Risk Vendor Bank Client
  17. 17. 3-Morabha (Equity Participation orVenture Financing :3-Morabha (Equity Participation orVenture Financing : Murabha Financing Step By Step 5. Client makes an offer to purchase the goods from bank. Offer to purchase Bank Client
  18. 18. 3-Morabha (Equity Participation orVenture Financing :3-Morabha (Equity Participation orVenture Financing : Murabha Financing Step By Step 6. Bank accepts the offer and sale is concluded. Murabaha Agreement + Transfer of Title Bank Client
  19. 19. 3-Morabha (Equity Participation orVenture Financing : Murabaha financing and risk diversion In a conventional transaction the bank transfer the risk on the client, however in a Murabaha transaction the Bank takes the following risks: 1. Asset Risk •Since for a short period of time the risk of Asset is transferred to the bank. 2. Credit Risk •Since once money is receivable from the customer, the risk of non-payment does exist
  20. 20. 3-Morabha (Equity Participation orVenture Financing : • Murabaha transaction is the simplest from of an Islamic Financial Transaction. • Murabaha can be used to finance the purchase of any assets which is recognized as Mal-e-Mutaqawam (Valuable) under Shariah. • A wide range of customer needs can be catered through financing purchase of different assets by the customers. Conclusion
  21. 21. 3-Morabha (Equity Participation orVenture Financing : Calculation Under Murabaha Contract with Modarba