FINANCIAL SYSTEM AND PRODUCTS

PRESENTATION: SECURITY ANALYSIS & PORTFOLIO
MANAGEMENT
TOPIC: ISLAMIC FINANCIAL SYSTEM AND PRODUCTS
CLASS – BBA(25)
AHMAD ALI 3499-FMS-BBA-S12

PRINCIPALES OF ISLAMIC FINANCIAL SYSTEM
Prohibition of Interest (RIBA)
“An excess” Any unjustifiable increase of capital whether are loans or sales
in the central tenant of the system.
Islamic regulations encourage the earning of profit but forbid the charging
of interest.
Money as a potential capital
It joins hands with other resources to undertake a productive activity.
Risk sharing
When interest is prohibited, suppliers of fund become investors instead of
creditors.
Investors & financial intermediary relationship is based on profit & loss
sharing principals.

Prohibition of speculative behavior
Discouraging hoarding & prohibits transacting featuring extreme
uncertainties.
Sanctity of contracts
Upholding contractual obligations & the disclosure as a sacred duty to reduce
the risk of asymmetric information & moral hazard.
Sharing-approved activities
Only activities that don’t violate the rules of shariah qualify for investment.
Any business Dealing with alcohol, gambling or casinos is prohibited.
Social justice
In Principle , any transaction leads to injustice & exploitation is prohibited.

The concept of Shirkah &
Musharakah

Terminology & Definition of Musharakah
 “Musharakah ” means “Sharing” and in the terminology of Islamic Fiqh.
 The word Musharakah has been derived from “Shirkah” which means
being a partner
 Musharakah is basically a kind of partnership in which the partners join
together with different contributions, work or obligation for the common
objective of undertaking business and trade in accordance with the
principles of Shariah.
It is an ideal alternative for the interest based financing with far reaching
effects on the economy
Contract of Musharakah
The contract of Musharakah can take place between two or more persons
with the capital contributed by the partners/shareholders and the profit to
be distributed among them according to the rates agreed upon by the
shareholders.

SHIRKAH
SHIRKAT-UL-MILK SHIRKAT-UL-AQD
SHIRKAT-
UL-WUJOOH
GAIR IKHTIARIIKHTIARI
SHIRKAT-
UL-AAMAL
SHIRKAT-
UL-AMWAL
Types of Musharakah

Rules of Musharakah
 Musharakah means relationship established under a contract by the
mutual consent of the parties for sharing of profits and losses,arising
from a joint enterprise or venture.
 Investments come from all partners / shareholders hereinafter
referred to as partners.
 Profits shall be distributed in the proportion mutually agreed in the
contract.
The existence of Muta’aqideen(Partners):
Capability of Partners:
 Must be sane & mature and be able of entering into a contract.
 The contract must take place with free consent of the parties without
any fraud or misrepresentation.

Management of Musharakah
• Each partner has a right to take part in Musharakah
management.
• The partners may appoint a managing partner by mutual consent
• One or more of the partners may decide not to work for the Musharakah
and work as a sleeping partner.
• If one or more partners choose to become non-working or silent partners.
The ratio of their profit cannot exceed the ratio which their capital investment
bears so the total capital investment in Musharakah.
Asset of Musharakah
 All assets of Musharakah are jointly owned in proportion to the capital of
each partner.
Rules of Musharakah

Rules of Musharakah
Capital of Musharakah
 All partners must contribute their capital in terms of money or species at an agreed
valuation.
 Share capital in a Musharakah can be contributed either in cash or in the form of
commodities. In the latter case, the market value of the commodities shall determine
the share of the partner in the capital.
Distribution of Profit
• The ratio of profit distribution must be agreed at the time
of execution of the contract
• The ratio must be determined as a proportion of the actual
profit earned by the enterprise
- Not as percentage of partner’s investment
- Not in lump sum amount
• A sleeping partner cannot share the profit more than the percentage of his capital.

Profit Distribution
ILLUSTRATION
If A and B enter into a partnership and it is agreed between them that A
shall be given Rs. 10,000/- per month as his share in the profit, and the
rest will go to B, the partnership is invalid.
Similarly, if it is agreed between them that A will get 15% of his investment,
the contract is not valid.
The correct basis for distribution would be an agreed percentages of the
actual profit accrued to the business.

OBSERVATIONS
Profit Distribution
If a lump sum amount or a certain percentage of the investment has been
agreed for any one of the partners, it must be expressly mentioned in the
agreement that it will be subject to the final settlement at the end of the
term, meaning thereby that any amount so drawn by any partner shall be
treated as on account payment and will be adjusted to the actual profit he
may deserve at the end of the term.
But if no profit is actually earned or is less than anticipated, the amount
drawn by the partner shall have to be returned.

Rules for Loss
In the case of a loss, all the Muslim jurists are unanimous on the point that
each partner shall suffer the loss exactly according to the ratio of
investment.
There is a complete consensus of jurists on this principle.
Profit is based on the agreement of the parties, but loss is always subject
to the ratio of investment.
Rules of Musharakah

Application
Musharakah can be successfully used to in the following areas:
• Project financing
• Working capital financing
• Import Financing
• Export Financing
• Running finance
• Saving/Deposit account
• Certificates of Investments
• Term finance certificates
• Inter bank financing

THE PROJECT
PARTNER BANK
1
Share in Capital Share in Capital
2
3
Accruing Profits
Share of profits
• In the case of project
financing, the
traditional method of
Musharaka can be
easily adopted.
Project Financing

Export Financing (Al Baraka Islamic
Bank)

 In Diminishing Musharakah the financier and the
client participate either in joint ownership of
 a property or an equipment, or in a joint
commercial enterprise
 The share of the financier will be divided into a
number of units
 The client will purchase these units one by one
periodically until he is the sole owner of the
property
Diminishing Musharakah

Three components of Diminishing Musharaka
 Joint ownership of the Bank and customer
 Customer as a lessee uses the share of the
bank
 Redemption of the share of the Bank by the
customer

Mode of Fixed Asset Financing
Diminishing Musharakah is commonly used for the
purpose of financing of fixed assets by various Islamic
banks.
 House financing
 Car Financing
 Plant and machinery financing
 All other fixed Assets

CUSTOMER
 The Bank enters into a Musharakah (Joint
Ownership) agreement with the customer and
both of them pay their respective shares to the
seller of the asset.
 Client promises to purchase Bank’s share (units)
over the tenure of transaction with the help of
Undertaking to Purchase
 The customer approaches the Bank with the
request for Project/Machinery/House financing
BANK
Joint
Ownership
Musharaka
Rent

CUSTOMERBANK
Joint
Ownership
Musharaka
Gradual Transfer of Ownership
 Client promises to purchase Bank’s share (units)
over the tenure of transaction with the help of
Undertaking to Purchase
 Customer pays rent for the use of banks share
in the property
 Client purchases the units every month via a
separate offer & acceptance every month and
will eventually become the owner of the
property.

CUSTOMER
 Ownership of the asset is gradually transferred
to the customer upon payment of asset price.
(with the help of a Sale transaction between
bank & customer at the end of each period)
BANK
Joint
Ownership
Musharaka
Gradual Transfer of Ownership

• To create joint ownership in property is called Shirkat-ul-Milk
and is expressly allowed by all schools of Islamic Jurisprudence.
• All Muslim Jurists agree on the permissibility of the Financier
leasing his share in property to client and charging him rent i.e.
the permissibility of leasing one’s share to his partner.
• There is difference of opinion among leasing one’s share to a
third part But there is no difference on permissibility on leasing
to a partner.
Shariah Principles

• Promise of client to purchase units of share of financier is also
allowed.
• The Transactions cannot be combined in a single arrangements
and they have to be executed independently.
• This is because it is a well settled rule of Islamic Jurisprudence
that one transaction cannot be made a condition for another.
• Instead of making the transactions a pre-condition for one
another there can be one-sided promises from one party to
another
Shariah Principles

1. Customer request financing for a fixed Asset costing Rs. 300
million.
2. Islamic Bank agrees to provide financing up to 90% of the
cost.
3. Joint Ownership Agreement is executed between the bank
and the Customer.
4. Bank will purchase 90% share in the asset by paying Rs.
270 million to supplier.
5. Customers pays its share of Rs. 30 million.
Diminishing Musharaka - Illustration

6. Bank’s share is divided into five units.
7. Customer agrees to buyout Bank’s share (units) on yearly
basis and the Undertaking is executed by the customer.
8. Customer pays the rent for the usage of the Bank’s units .
9. Rental reduces after purchase of each unit by the customer.
10. After five years ownership of the asset is completely
transferred to the customer.
Diminishg Musharaka- Illustration

PRODUCT - Meezan Bank Easy Home

Albarak Islamic Bank
Diminishing Musharaka Products

 This is a kind of partnership where one partner gives
money to another for investing in a commercial
enterprise.
 The investment comes from the first partner who is called
“Rabb-ul-Maal” (Investor)
 The management and work is an exclusive responsibility
of the other, who is called “Mudarib” (Working Partner)
 Profit is shared as per agreed ratio
 In case of Mudarbah all losses are borne by Rabbul- Mal
Mudarabah

1. Al Mudarabah Al Muqayyadah
(Restricted Mudarabah)
2. Al Mudarabah Al Mutlaqah
(Unrestricted Mudarabah)
Types of Mudarabah

1. Al Mudarabah Al Muqayyadah
(Restricted Mudarabah)
Rabb-ul-Maal may specify a particular business or a
particular place for the mudarib.
In which case he shall invest the money in that particular
business or place.
Types of Mudarabah

2. Al Mudarabah Al Mutlaqah
(Unrestricted Mudarabah)
Rabb-ul-maal gives full freedom to Mudarib to undertake
whatever business he deems fit.
Mudarib is authorized to do anything normally done in the
course of business
Types of Mudarabah

Rabb-ul-Maal has authority to:
a) Oversee the Mudarib’s activities and
b) Work with Mudarib if the Mudarib consents.
Rabb-ul-Maal

The capital in Mudarabah may be either cash or in kind.
If the capital is in kind, its valuation is necessary, without
which Mudarabah becomes void.
Capital of Mudarabah

It is necessary for the validity of Mudarabah that the
parties agree, right at the beginning, on a definite
proportion of the actual profit to which each one of them is
entitled.
They can share the profit at any ratio they agree upon.
However in case the parties have entered into Mudarabah
without mentioning the exact proportions of the profit, it
will be presumed that they will share the profit in equal
ratios.
Some incentives my be given to the Mudarib.
Profit & Loss Distribution

Apart from the agreed proportion of the profit, the Mudarib
cannot claim any periodical salary or a fee or remuneration
for the work done by him for the Mudarabah.
The Mudarib & Rabb-ul-Maal cannot allocate a lump sum
amount of profit for any party nor can they determine the
share of any party at a specific rate tied up with the capital.

EXAMPLE
If the capital is Rs.100,000/-, they cannot agree on a
condition that Rs.10,000 out of the profit shall be the share
of the Mudarib nor can they say that 20% of the capital shall
be given to Rab-ul-Maal. However they can agree that 40%
of the actual profit shall go to the Mudarib and 60% to the
Rab-ul-Maal or vice versa.

If the business has incurred loss in some transactions and
has gained profit in some others, the profit shall be used to
offset the loss at the first instance, then the remainder profit,
if any, shall be distributed between the parties according to
the agreed ratio.

Musharakah
 In Musharaka both of the partners invest
 Both parties can work
Mudarabah
 In Mudarabah one party invest (Rabbul- Mal) and other
party work (Mudarib)
 Profit is shared as per agreed ratio
 In case of Mudarbah all losses are borne by Rabbul- Mal
Diff b/w Musharakah & Mudarabah
Mudarabah

• Medium/long - term financing
 Project financing
 Import financing
 For Saving/mahana amdani/investment accounts
(deposit giving Profit based on Mudarabah – with
predetermined ratio )
 Certificate of Investment
Inter- Bank lending / borrowing
Application

Mudarabah in Banking
Deposits - The Bank as Mudarib
• Profit from the Mudaraba activity is shared between the
Bank (as Mudarib) and the investment account holder
(as Rabb-ul-maal) in a pre-agreed ratio
• The Bank does not bear any loss but remains
responsible for negligence
• The Bank may receive from its investors compensation
(Mudarib fees) in return for management of their funds
• The Bank is bound to return the capital to the investors
after deducting any losses or Mudarib fees at the time of
winding up the contract

Mudarabah in Banking
Investments - The Bank as the Rabb-ul-maal
• Profit from the Mudaraba activity is shared between the
Bank (as Rabb-ul-maal) and the Mudarib in a pre-agreed
ratio
• The Bank will bear all the loss unless the Mudarib
violates the agreement
• The Bank will pay to the Mudarib, compensation
(Mudarib fees) in return for management of its funds
• The Mudarib is bound to return the capital to the Bank
after deducting any losses or Mudarib fees at the time
winding up of the contract

PRODUCT – Meezan Bank Karobari Munafa Account

Al Baraka Islamic Bank Mudaraba Products

• Murabaha is a particular kind of sale and not a
financing in its origin.
• Where the transaction is done on a “cost plus
profit” basis i.e. the seller discloses the cost to the
buyer and adds a certain profit to it to arrive at the
final selling price.
Definition of Murabaha

• The distinguishing feature of Murabaha from
ordinary sale is:
- The seller discloses the cost to the buyer.
- And a known profit is added.
Murabaha

Basic rules for Murabaha financing:
 Asset to be sold must exist.
 Sale price should be determined.
 Sale must be unconditional.
 Assets to be sold:
a) Should not be used for un-Islamic purpose.
b) Should be in ownership of the seller at the time
of sale; physical or constructive.
Murabaha

Step by step Murabaha Financing

1. Client and bank sign an agreement to enter
into Murabaha (MMFA).
Agreement to
Murabaha
Bank Client
Murabaha

2. Client appointed as agent to purchase goods
on bank’s behalf
Agency
Agreement
Agreement to
Murabaha
Bank Client
Murabaha

3. Bank gives money to agent/supplier for
purchase of goods.
Disbursement to the agent or supplier
Agency
Agreement
Supplier
Agreement to
Murabaha
Bank Client
Murabaha

4. The agent takes possession of goods on bank’s
behalf.
Transfer of Risk
Delivery
of goodsVendor
Bank Agent
Murabaha

5(a). Client makes an offer to purchase the
goods from bank through a declaration.
Offer to
purchase
Bank Client
Murabaha

5(b). Bank accepts the offer and sale is
concluded.
Murabaha Agreement
+
Transfer of Title
Bank Client
Murabaha

6. Client pays agreed price to bank according to
an agreed schedule. Usually on a deferred
payment basis (Bai Muajjal)
Payment of Price
Bank Client
Murabaha

 Purchase of raw material; for meeting
working capital needs of trade and industry.
 Medium to long term requirements for
purchase of land, building and equipment.
 Trade finance products including imports,
exports and bill purchase.
Applications of Murabaha

• Ijarah is a term of Islamic Fiqh
• Literally, it means “To give something on rent”
• The term “Ijarah” is used in two situations:
1. It means ‘To employ the services of a person on
wages’ e.g. “A” hires a porter at the airport to carry
his luggage
2. Another type of Ijarah relates to paying rent for use
of an asset or property defined as “LAND” in Islamic
Economics
Ijarah

• Ijarah is an Islamic alternative of Leasing.
• Leasing backed by an acceptable contract is an acceptable
transaction under Shariah.
• The question of whether or not the transaction of leasing
is Shariah compliant depends on the terms and conditions
of the contract.
• Several characteristics of conventional agreements may
not conform to Shariah thus making the transaction un-
Islamic and thereby invoking a prohibition.
Ijarah as a mode of financing

• Risk and rewards of ownership lies with the owner i.e. any
loss to the asset beyond the control of the lessee should be
borne by the Lessor.
• Late payment penalty cannot be charged to the income of
the Lessor.
• Lease and Sale agreement should be separate and non
contingent.
Ijarah-Key Difference

CUSTOMER
MECHANICS
ISLAMIC BANK
 The Bank makes payment to the vendor
 The Bank purchases the item required for
leasing and receives title of ownership from the
vendor
 The customer approaches the Bank with the
request for financing and enters into a promise
to lease agreement.
VENDOR
. .
Agreement-1
Ijarah

CUSTOMER
MECHANICS
ISLAMIC BANK
 The customer makes periodic rental payments
as per the contract
 The Bank leases the asset to the customer after
execution of lease agreement.
VENDOR
 At the end of the tenure customer can purchase
the asset from the bank with the help of
separate Sale agreement.
. .
Agreement-2
Ijarah as a mode of financing

• Rules governing Ijarah are similar to the rules
governing sale.
• Because in both cases something is transferred from
one person to another
The only difference is:
• In case of sale, title of property is transferred to Buyer
• In case of Ijarah, title remain with the Lessor
• Only the use of the property is transferred to Lessee
Ijarah

Difference b/w Conventional Lease & Ijarah
1. In conventional lease the Lessor has the unilateral
right to rescind the lease contract at his sole
discretion, which is against the laws of Shariah,
2. Expenses under Ijarah are as follows:
• Lessor- expenses relating to the corpus of the
asset i.e. insurance, accidental repairs etc. will be
borne by the lessor
• Lessee- actual operating/overhead expenses
related to running the asset will be borne by the
lessee
Ijarah

Difference b/w Conventional Lease & Ijarah
3. Two contracts into one contract is not permissible in
Shariah therefore, we cannot have the agreement of
hire and purchase into one agreement, only we can
undertake/promise to purchase the leased asset.
4. In conventional lease the lease starts even before the
existence of assets, which is also not permissible in
Shariah.
5. Penalty income is charged for late payments in
Conventional lease.
Ijarah

Unique Selling Proposition
• Pakistan’s first truly Shariah-compliant Car
Financing Scheme.
• Available in tenures of 3, 4 and 5 years.
• Available for locally assembled as well as
Imported cars.
• Also available for Used Cars
• No application Fee
MEEZAN BANK Car Ijarah
Application of Ijarah

 For long and medium term fixed asset
financing
 Project Financing,Expansion
 Retail products (Car Ijarah)
Applications of Ijarah

 Istisna’a is a contract of sale of specified items to be
manufactured (or constructed), with an obligation on the part of
the manufacturer (or contractor) to deliver them to the Customer
upon completion.
 Istisna’a is the second exception to the rules of sale where a sale
is allowed without immediate delivery of the goods sold .
ISTISNA’

 If complete specifications (such as type, kind, quality and quantity) of the
subject matter have been given to the manufacturer along with the
contract price, then the manufacturer is bound to manufacture the Asset
and cannot terminate the contract unilaterally.
 The ultimate purchaser cannot be regarded as the owner of the
materials in the possession of the manufacturer for the purpose of
producing the subject matter.
ISTISNA’

 The time of delivery of goods does not necessarily have to be fixed in
Istisna’a however, a maximum time may be agreed upon between the
parties.
 The delivery of the subject matter may take place through constructive
possession. At this point, the liability of the manufacturer in respect of
the subject matter comes to an end and the liability of the ultimate
purchaser begins.
ISTISNA’

 It is necessary for the validity of Istisna’a that the price is fixed with the
consent of the parties.
 The Istisna’a price can either be paid in advance, or in installments or at
the time of delivery of goods.
 The price of Istisna’a transactions may vary in accordance with
variations in the delivery date.
ISTISNA’

 It is permissible to amend the contract price of an Istisna’a contract
upwards or downwards, as a result of intervening contingencies (Force
Majeure).
 It is permissible if it is agreed between the parties that in the case of
delay in delivery, the price shall be reduced by a specified amount per
day.
ISTISNA’

 Unlike Murabaha where only raw material can be financed, Istisna’a’ can
be easily utilized to facilitate payment of overheads etc. in addition to the
purchase of raw material.
 It is also to be noted that amount paid out as Istisna’a’ price to the
manufacturer can be used by the manufacturer anywhere he deems fit. It
doesn’t have to be utilized exclusively for the production process.
ISTISNA’

Sale on Cash Basis
1. After necessary credit and Shariah Approvals, MBL (Meezan Bank Limited) &
Customer will enter into a Master Istisna Agreement to manufacture goods
from time to time at an agreed price.
2. MBL would then enter into an Istisna transaction with the Customer for the
production of specific Goods. At this time quantity, price, specification and
delivery date of Goods will be agreed. The delivery of goods could be lump sum
or in trenches.
3. MBL could pay the Istisna price to the Customer either in full or in installments.
4. After manufacturing, the Customer will inform MBL and will request for
acceptance of delivery. A Bank representative will accept the delivery after
physical inspection of the goods at the site. This delivery could be through
identification and separate storage of MBL goods (so that they are not mixed
with Customer’s own goods). A Goods Receiving Note will be executed at this
moment to evidence the delivery of goods to MBL.
Prdouct Structure for ISTISNA’

5. MBL will also enter into a separate Agency Agreement with the
Customer for sale of goods on Cash basis to credible buyers on behalf
of MBL in a specified number of days. In this manner the Agent will be
responsible for recovery of Sale price and its payment to MBL.
6. MBL’s ownership and risk in goods remains until the Agent sells these
goods to the Buyer in the market. Takaful may be obtained to cover this
risk.
7. MBL Agent will sell the goods in the market and will pay the price to
MBL.
8. The Agent (Manufacturer) will be entitled to a specified Agency Fee for
providing such services. MBL may also give a certain incentive to its
Agent for timely selling and payment to MBL.

In case of Credit Sale
 The customer (as Agent of MBL) will sell the goods to Credible Buyers
on Credit (instead of Cash) and collect the sale proceeds in a specified
number of days.
 At the time of entering into Agency Agreement, the Customer may be
asked to provide a separate / independent Guarantee to guarantee
payment obligations of the potential buyers.

Manufacturer
1. Istisna’a Agreement
MBL2. Delivery of Goods
3. Agency Agreement
Local Buyer
4. Sale of
Goods
6. Sale Proceeds (net of Agency Fee)
5. Sale
Proceeds

The package comprises of the following:
1. Master Istisna’a Agreement
1. Agency Agreement
1. Corporate Guarantee
Legal Documentation

1. Master Istisna’a Agreement
This agreement sets out the terms & conditions upon which the
Bank, from time to time, orders the Customer to manufacture the
Goods
Components :
A. Written Offer for Manufacture of Goods:
Description of Goods including quantity, quality, delivery date,
cost price, place of delivery etc.
B. Goods Receiving Note:
Legal Documentation in ISTISNA’

2. Agency Agreement
The Bank appoints the manufacturer (customer) its Agent to sell the
manufactured goods.
Components :
A. Notice of Appointment
The Bank authorizes the Agent to sell the Assets as its
undisclosed Agent details of which are mentioned.
B. Schedule of Agency Fee

3. Corporate Guarantee
The Customer guarantees payment obligation of the ultimate
purchasers if they default to make payment on time

RISKS MITIGANTS
1 Delivery Risk
Delay in delivery of goods from the
manufacturer to MBL at maturity
Istisna’a price can be reduced on
daily basis to penalize the
manufacturer
2
Non-
performance
The Manufacturer may not be able
to manufacture the goods during
assigned time and refuses to carry
on the responsibility further.
MBL can terminate the Istisna
agreement and demand the price
back from the manufacturer.
Alternatively, the price may be paid
by MBL in installments after being
satisfied with the performance.
3 Quality Risk
The Manufacturer delivers
defected/inferior goods, which is
realized by MBL only when the
ultimate purchaser points out to
that.
The manufacturer can be asked to
rectify the defect.
Risk Mitigation

4
Increased cost
of
Manufacturing
Cost incurred by manufacturer
turns out to be higher than
anticipated earlier causing
manufacturer to default on
performance
Increased cost will be borne by
manufacturer unless caused by
some force majeure events in
which case Istisna price may be
increased with mutual consent.
RISKS MITIGANTS
5 Storage Risk
The goods once delivered by
Manufacturer will be at MBL's risk
before the same are sold to the
ultimate purchaser
This may be covered through
Takaful of the goods and by
minimizing the time duration
between acceptance of delivery
under Istisna and delivery to the
ultimate purchaser. The Agent is
asked to procure Takaful as part of
his services
Risk Mitigation

6
Default by
ultimate
Purchaser
The ultimate purchaser
refuses to make payment on
time or goes bankrupt.
The Customer (in its
independent capacity) may be
asked to provide Corporate
Guarantee to guarantee
payment obligations of ultimate
buyers.
RISKS MITIGANTS
Risk Mitigation

Al Baraka Islamic Bank Istisna Product

Islamic Mode of Financing Proportion in Pakistan

FINANCIAL SYSTEM AND PRODUCTS

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