application of funds - financing facilities and the underlying shariah concepts

7/27/2019 Application of Funds - Financing Facilities and the Underlying Shariah Concepts

1/40

ISLAMICBANKING AND

FINANCE

Mahyuddin Khalid emk a y @

s al am. ui t m. e d u.m

y

APPLICATION OF FUNDS-

FINANCING FACILITIES AND THE UNDERLYING SHARIAHCONCEPT


2/40

C

CONTENT

HOME/PROPERTY FINANCING (BAI BITHAMAN AJIL /BBA)HOME/PROPERTY FINANCING(MUSHARAKAH)(MUSHARAKAH MUTANAQISAH)MOTOR VEHICLE FINANCING (AL-IJARAH) (AL-IJARAHTHUMMA AL- BAI) PERSONAL FINANCING (BAI AL -INAH)CREDIT CARDS (AL- WADIAH)( BAI AL-INAH)(QARD AL-HASAN)PROJECT FINANCING (AL-MUDARABAH) (AL-MUSHARAKAH)WORKING CAPITAL FINANCING (AL-MURABAHAH )LETTER OF CREDIT (WAKALAH) (MUSHARAKAH)(MURABAHAH)ISLAMIC ACCEPTED BILLS (BAI` AL-DAYN)ISLAMIC EXPORT CREDIT REFINANCING (IECR)

2


3/40

PROPERTY FINANCING BASED ON BAI BITHAMAN AJIL

Definition of Bai' Bithaman Ajil (BBA) A normal sale with the payment of the selling pricedeferred to an agreed later date or installment payment.

PracticeThe item to be sold exists at the time of contract.

The shariah does not require that the cost price be knownto the buyer.Objectives of BBA:

To provide financing for potential buyers who could notafford to pay cash in advance and enable them to perform

daily responsibilities and obligations without any financialhardship or difficulties.To facilitate and support the smooth flow of transaction inthe business society by providing flexible modes of payment especially through credit payment.

3


4/40


5/40

PROPERTY FINANCING BASED ONMUSHARAKAH

Definition of Musharakah: A form of partnership where two or more personscombine either capital or labor or creditworthinesstogether to carry on a business venture on condition thatthey will share the profits, enjoying similar rights andliabilities.

It is basically a profit and loss sharing partnershipwhereby the ratio for the distribution of profits mustbe determined and specified in advance.Pillars of musharakah:

Shuraka (Shareholders ) Rasul Mal (Capital) Mashru (Project or business venture)Ribh (Pre-determined profit allocation)Sighah (Ijab (Offer) and Qabul (Acceptance ))

5


6/40

PROPERTY FINANCING BASED ON MUSHARAKAHMUTANAQISAH

Definition of Musharakah Mutanaqisah:Form of partnership in which one of the partners promises(wad) to buy the equity share of other partner gradually untilthe title of the equity is completely transferred to him.

A form of Musharakah where the financier and the clientparticipate in a joint commercial enterprise or property. This

enterprise is converted into undivided ownership of both thefinancier and the client. Over certain period the equity of financier, divided into equal value units, is purchased by theclient. And ultimately the client becomes the sole owner of the enterprise

Application of Musharakah Mutanaqisah:Home financing

Agriculture Machinery and implements financingStorage facility construction/shedsTransport vehicles, etc.

6


7/40

PROPERTY FINANCING BASED ON MUSHARAKAHMUTANAQISAH

Customer

Provides most of financinge.g. 90%

Provides least of financinge.g. 10%

Both financier + customer become partners in the

ownership of asset (Shirkah al Milk)

90%Financiers Share Decreasing0%

100%Customers share

Increasing10%

Pay monthly installment partlyas rental and partly as gradual

purchase price of part of financiers share in Asset

1

2

3

7


8/40

VEHICLE FINANCING BASED ON AL-IJARAH

Definition of Ijarah: A contract of proposed and known usufruct with a specified and lawfulreturn or compensation for the effort or work which has beenexpended. It is used to express the sale (bai') of a known benefit inreturn for its known equivalent.

Under this concept, the bank makes available to the customer theuse of service of assets/equipment such as plant, officeautomation, motor vehicle for a fixed period and price.Practice

The property to be leased belongs to the lessor.The lessor has the right to repossess the property on a default of thelessee

Pillars of Ijarah:Muajjir (A person who give something for hire Lessor, landlord,owner etc.)Mustajir (A person who takes on hire Lessee, tenant, renter etc.)Majur (A thing given for rent)

Al-Manfaah (The benefit from a thing usufruct, services etc.)

Ujrah (Price or fee given for the payment of rent or lease)Sighah (Offer (Ijab) and Acceptance (Qabul))

8


9/40

VEHICLE FINANCING BASED ON AL-IJARAHTHUMMA AL- BAI

Definition of Al-Ijarah Thumma al-Bai' (AITAB)Simple leasing for leasing period with an option for the lesseeto purchase the property at the end of the leasing periodthrough a contract of purchase.

In AITAB, the contract of al-ijarah runs separately from thecontract of al-bai'. These stages are:

Stage 1: Executing the contract of true leasing (al- ijarah ain) Stage 2: Executing the contract of sale (al-bai') at a nominalvalue agreed upon by both parties.

Condition In Al-Ijarah Thumma Al-Bai':3 party

Not a loan but a hiring arrangementOwnership does not pass to lessee until all installments paidLessee has right to return asset.Lessee has a right to early termination or early settlement of hiring arrangement.

9


10/40

VEHICLE FINANCING BASED ON AL-IJARAHTHUMMA AL- BAI

FINANCIER CUSTOMERVEHICLE

1)Lease Agreement

2) Rental Payment

3) Sale Agreement

4) Sale Price

1st: Contract of al-ijarah

2nd : Contract of al- bai''

10


11/40

PERSONAL FINANCING BASED ON BAI AL -INAH

Definition of Bai' al-Inah:The selling of an asset with a mark up price on deferredpayment, with the intention to sell the same asset to thedebtor with lower cash price, which is meant to settle hisdebt.

It is a bargaining (musawamah) sale and purchasecontract i.e. without disclosing or referring to whatthe cost price is.Bai al -Inah conceptually refers to a sale of an asset,which is later repurchased at a different price,whereby the deferred price is higher than the cashprice.Pillars of Bai' al-Inah:

Seller and buyer Merchandise/goods

PriceSighah

11


12/40

PERSONAL FINANCING BASED ON BAI AL -INAH

B A

Asset

1) Sell Asset indeferredpayment

2) Buy back Assetin cash

Price

3)Pay cash moneyfor personalFinancing

12


13/40

CREDIT CARDS

A credit card is a system of payment named after the small plastic card issued to users of asystem.The difference between Islamic credit card and aconventional credit card:-

In Islamic Banking, the profit rate is non-compounding as compared to a conventional creditcardIt cannot be used for transactions prohibited byShariah such as gambling, liquor, etc.

The Credit Card is formulated based on theShariah concepts of:

Bai' al-InahQardhul Hassan

Al-Wadiah

13


14/40

CREDIT CARDS BASED ON BAI AL-INAH

CUSTOMER

WADIAH

(Safe keeping)

1

2

3

4

Sells a price od land on deferred paymentbasis(profit 18%,RM10,000+RM1800=RM18,000)

Resells the land to BANK for cash at the principal price

=RM10,000

Disburse RM10,000 to customersICC (Islamic Credit Card) Wadiahaccount

(QARDHUL HASSAN)/Benevolent Loan

Allow customer to use more than available balance in ICC Wadiahaccount

14


15/40

CREDIT CARDS BASED ON BAI AL -TAWARRUQ

BROKER A BROKER B

CUSTOMERCREDITCARD

ACCOUNT

1

2

4 5

3

The Bank purchase the commodity for a Purchase Price(Principal)

Customer sell the commodity and receivescash)

The Bank sell the commodity for a Sale Price (Principal+Profit)

Customer deposit the proceeds into the creditcard account as its credit limit

Manage the facility

15


16/40

MODES OF OPERATION OF ISLAMIC CREDITCARDS

Periodic service chargeThe card issuer charges the card holder a monthly or annual charge (fixed feeperiod)

Additional charges for any forward credit balance.Deferred payment sale

The card issuer allows the customer to use his card to pay for a good or serviceunder murabahah type transaction.

Lease purchase agreementThe card provider is the owner of the asset until the card holder makes the finalpayment.The client can be charged a rental fee.

Pre paid credit cardThe client deposits an amount of money on their card to pay for goods and

services.Due to the nature of the card, client can not pay for goods in excess of their debit balance and credit balances do not occur.Thus, any type of interest charges are easily avoided.The card issuer can invest the excess balances to generate a return and mustbe in shariah compliant.

16


17/40

PROJECT FINANCING

Definition:The financing of long-term infrastructure, industrial projects andpublic services based upon a non-recourse or limited recoursefinancial structure where project debt and equity used tofinance the project are paid back from the cash flow generatedby the project..

Characteristic of Project Financing:Project cash flowsNormally higher levels of debtVariety of contractual obligations and undertakings to manageand reduce risk

A variety of funding sources

Technique and instruments must comply with shariahprinciples:ConceptuallyStructurallyDocumentaries

Modus operandi execution and implementation.

17


18/40

PROJECT FINANCING BASED ONMUDHARABAH

Financier (Rabb al Mal)

Company(Amil/

Mudarib)

Capital

Contract of Mudharabahprofit sharing ratio (X:Y)

Projectrevenue

Invest inproject

Y: to rabb almal

Profit sharedin accordanceto pre-agreedproportions(X:Y) X% to mudarib

Loss borne totally by rabb almal

E.g.: real estate

18


19/40

PROJECT FINANCING BASED ONMUSHARAKAH

Financier (Rabb al Mal)

Company(Amil/

Mudarib)

Capital

Contract of Mudharabah

Capital Contribution(X:Y)

Projectrevenue

Invest inproject

Y%

X%

Profit shared according to agreed ratio. To ratio of capital contribution. Loss shared according to ratio of capital contribution.

E.g.: real estate

19


20/40

WORKING CAPITAL FINANCING BASED ONMURABAHAH

Definition of Murabahah:Sale in which the mark up is disclosed to thepurchaser as per the sellers purchase price for atrust-sale for a certain specific asset.

Allows customer:

To take delivery of the goods immediatelySettle deferred payment agreement with Bank

Pillars of MurabahahSeller

Buyer Merchandise/goodsPrice (mark-up)Sighah : Offer (Ijab) and Acceptance (qabul)

20


21/40


Murabahah can be applied:Ordinary Murabahah SaleInvolve 2 parties seller & buyer The seller is an ordinary so trader who buys a commoditywithout depending on a prior promise of purchase, then he

display it for Murabahah sale for a price and a profit to beagreed upon.Murabahah based on Order & Promise

Widely applicable because used as one of financing toolsby Islamic banks worldwide

Murabahah to the purchase orderer for a pre-agreedselling price, this having been specified in the customerspromise to purchase. The payment is payable within afixed future date in lump sum of by fixed installments.

21


22/40


SUPPLIER OF GOODSCUSTOMER

ACTS AS AN AGENT FOR THEBANK

1) Purchase order

2) Supplier goods to customer

3) Settles thepurchase price oncash basis

5) Settles the Banks selling price on maturity

4) Sells goods ondeferred payment basis

22

FINANCING BASED ON BAI' AL


23/40

FINANCING BASED ON BAI' AL-SALAM

Definition of Bai' al-Salam:Sale contract over prescribed commodity sold as a deferredliability on one party, in exchange for a price that is receivedduring the contract session

The wisdom of making Bai' al-Salam permissible lies in thefact that Bai' al-Salam facilitates a types of financing for

people in need of it.By using Bai' al-Salam contract, the buyer may benefit fromits permissibility as well, by acquiring the commodity at aprice below the market price.Pillars of Bai' al-Salam:

Rabb as-salam/ Musallim (The Buyer)Muslam Ilaihi (The Seller)Ras al -Mal (The Price)

Al-Musallim Fih (The Product)Sighah (Ijab (Offer) and Qabul (Acceptance))

23



24/40


To meet the need of small farmers who needmoney to grow their crops and to feed their family up to the time of harvestTo meet the need of traders for import and exportbusinessThe financial institution can sell the bai' al-salamcommodity through a parallel bai' al-salamcontract and earn profits provided that:

There must be 2 different and independent contractsCannot be used as a buy back facility

The financial institution can obtained a promiseto purchase from a 3rd party

24



25/40


25



26/40

FINANCING BASED ON BAI' AL-ISTISNA

Definition of bai' al- istisna: Bai' al- istisna is defined as a contractual agreement with manufacturer to produce items with specified description at a determined price, andmanufactured from his own materials with his own effort.

It is an order to producer to manufacture a specific commodity for the purchaser.Upon delivery, the IFI sells it to the customer at a prevailing marketprice comprising original acquisition price and a margin of profit.The customer repays by installments within a period and in themanner agreed between the IFI and the customer.Pillars of bai'' al- istisna:

Mustasni (Customer)

Sani (Manufacturer) Ras al -Mal (The Price)Masnu (The Product) Sighah (Ijab (Offer) and Qabul (Acceptance))

26



27/40

FINANCING BASED ON BAI' AL-ISTISNA

The buyer (mustasni ) places an order to purchase an asset(e.g. building, house) to be delivered in the future.The buyer (mustasni) requires the seller (sani) to constructthe asset based on the specification stipulated in thecontract agreed by both of parties. These specificationsinclude the nature, type, quantity of the asset and also

delivery date.Then, both of the parties decide and agreed with the saleand purchase price and any changes cannot be makingafter that.The payment can be made either spot cash or installment.Its no required for the buyer (mustasni ) to pay the full priceat the time of contract.Lastly at the delivery date, the seller (sani) will deliver theorder to the buyer ( mustasni).

27

DIFFERENCES BETWEEN ISTISNA AND


28/40

DIFFERENCES BETWEEN ISTISNA ANDSALAM

SALAM ITEM ISTISNA

Can be anything thatneed manufacturing or not.

SUBJECT MATTER Is always a thing whichneeds to bemanufactured.

Has to be paid in full inadvance.

PRICE Does not necessarilyneed to be paid in full inadvance.Not even necessary topay the full price atdelivery.Can be deferred to any

time agreed upon by bothparties.May be made ininstallments.

It is an essential part of the contract

TIME OF DELIVERY Does not have to be fixed

Cannot be cancelled CANCELLATION OF Can be cancelled before

28

DIFFERENCES BETWEEN ISTISNA AND


29/40

DIFFERENCES BETWEEN ISTISNA ANDIJARAH

IJARAH ITEM ISTISNA

Provided by thecustomer.

MATERIAL Provided by themanufacturer.

Right of rejection of goods after inspection does notexist.

RIGHT OF

REJECTION The customer has aright to reject thegoods after inspection.

29


30/40

LETTER OF CREDIT

Letter of Credit is a letter from a bankguaranteeing that a buyer's payment to a seller will be received on time and for the correctamount.

In the event that the buyer is unable to makepayment on the purchase, the bank will berequired to cover the full or remaining amount of the purchase.The Letter of Credit is formulated based on theShariah concepts of :

Wakalah

Musharakah

30

LETTER OF CREDIT BASED ON


31/40

LETTER OF CREDIT BASED ONWAKALAH

Under this concept, the Bank acts as agent on behalf of the Buyer/Applicant. Customers have to pay for fee and commissions under the concept of Ujr-wal-Umulah.Refers to any agency relationship where a Bank actsan agent on behalf company/individual.Procedures:

The Buyer/customer informs the Bank of their LCrequirements and request the Bank to provide facility.Buyer/Applicant will place deposit to the full amount of goods to be purchased/imported which Banks acceptsunder the contract of Wadiah.Bank Islam establishes the LC and remits the payment tothe Seller/Beneficiary utilizing the customers deposit andreleases the documents to the customer.

31



32/40

LETTER OF CREDIT BASED ONMUSHARAKAH

A partnership agreement between two or more individuals or bodies.Each contributing capital.Profit or loss is shared between the partners according to theratios.Procedures:

Customers who interested have to admit the LC requirement andnegotiates the term of Musharakah financing, following the projectfinancing under the contract of Musharakah.

A deposit required for his share of the costs of goods to be purchasedor imported.Banks established the LC and pays the proceeds to the negotiatingbank utilizing the customers deposits as well as its own share of financing and releases the documents to the customer.Customers takes possession and dispose these off in the manner agreed in the agreement.

Bank together with customer share the profit from the venture asprovided for in the agreement.

32



33/40

LETTER OF CREDIT BASED ONMURABAHAH

Refers to the sale of goods at a price, which includes costplus as agreed by both seller and the buyer. This is acontract where the commodity exchanged for is deliveredimmediately and the price is paid in lump sum at late date.Procedures:

The customer/buyer require the LC together with financing over

a certain period of time.The Bank will establish the LC and remit the payment to theSeller/Beneficiary utilizing its own funds.The banks appoints the customer as its agent to purchase therequired goods on its behalf.The banks will sell the goods to the Buyer/Applicant at a saleprice comprising its cost and a profit margin (cost plus basis -al-Murabahah)Buyer/Applicant is given a deferred payment term for thesettlement the purchases.

33


34/40

ISLAMIC ACCEPTED BILLS (AB-i)

Islamic Accepted Bills is an order to a bank by itscustomer obliging it to pay a certain amountof money to the holder of the acceptances bill.The bank makes payment in lump sum for the goodspurchased by its customer on its behalf and sellsthose goods to the customer on the deferredpayment basis.There are two types of financing under the AB-ifacility:

Imports and local purchases; andExports and local sales.

The AB-i is formulated based on the Shariahconcepts of:

Bay al-DaynMurabahah

34

ISLAMIC ACCEPTED BILLS BASED ON BAI'


35/40

ISLAMIC ACCEPTED BILLS BASED ON BAI' AL-DAYN

Definition of bai' al-dayn: An exchange between A payable right upon the person and Aproperty on the basis of ownership of the price and the right

Sale of debt which can be either against a debt or other thana debt , to the debtor or other than a debtor, on a cash basisor a deferred payment basis.

Sale contract in which the creditor sells his payable rightupon the debtor either to the debtor himself or to A thirdparty at discount price or at cost price on the spot paymentbasis.Pillars of bai' al-dayn:

Seller and buyer Merchandise/goodsPriceSighah

35

ISLAMIC ACCEPTED BILLS BASED ON BAI'


36/40

ISLAMIC ACCEPTED BILLS BASED ON BAI' AL-DAYN

The Sale of Debt to a Third Party (Bai al -dayn lighayr al madin)

According to Hanafis, some Shafiis, Hanbalis and Zahiris the sale of confirmed or non confirmed debt is notallowed to be sold to the third party based on:

A sale of un possessed item (bai' ma la tamlik)

A sale of undeliverable itemIt may create a conflict between the debtor and the buyer of the debt

Some Shafiis and Hanbalis (Ibn Qayyim) the sale of confirmed debt to the third party is allowed based on:

There is no authentic nas that prohibits such saleThe debt is a right in the possession of the creditor. So hehas the full right to sell it to the debtor or the third partyBased on legal maxim: All transactions are permissible untilthey are proven non permissible by an authentic source

36


37/40

AB-i - IMPORT

Financing facility using the Bai' Dayn contract, granted tothe seller or exporter to finance their sales or export of goods on credit terms that includes raw materials, semi-finished and finished goods.Bai' Dayn or debt trading is a short-term, financing facilitywhereby Bank Islam purchases the customers right to thedebt, which is normally securitized in the form of AcceptedBills.The previous working capital financing under al-Murabahahwhich gives rise to debt or al-Dayn may indeed besecuritized.The Bank drawn a Bill of Exchange to be accepted by thecustomer.This bill will be drawn for full amount of the Banks sellingprice on the maturity date of the financing.

37


38/40

AB-i - EXPORT

The Bank finance exports and sales on the concept of bai'al-Dayn.Bai' al-Dayn or debt purchase is short-term financing facilitywhereby the bank purchases the customers rights to thedebt which is normally securitizes in the form of BillExchange.

Under this facility, an exporter who wishes to avail himself of this facility. Prepares export documents as required under the sales contract or letter of credit.He presents this documents to the bank to be purchased. Asthe exports documents have to be sent to buyer overseas,the bank request the exporter to drawn another Bill of exchange drawn on the Bank, known as AB-i Exports.The AB-i Exports may subsequently be sold in thesecondary market.

38

ISLAMIC EXPORT CREDIT


39/40

ISLAMIC EXPORT CREDITREFINANCING (ECR-i)

Export Credit Refinancing (ECR) provides an alternativeshort term pre- and post-shipment financing to direct/indirectexporters to promote export of manufactured products,agricultural products and primary commodities.It is available to a manufacturer or trading company withECR credit line duly established with any participatingIslamic bank.Classification:

ECR-i Pre-ShipmentPre-Shipment ECR-i is a financing facility based on Murabahahcontract granted to customer as direct or indirect exporter for preparing goods prior to shipment.

ECR-i Post-ShipmentPost-Shipment ECR-i is a financing facility based on Bai' Dayncontract granted to customer as a direct exporter who exportseligible products on sight or usance terms.For sight term, financing period shall not exceed 60 days.

39


40/40

END OF CHAPTER40

application of funds - financing facilities and the underlying shariah concepts

Documents