Islamic Finance – Principles
Principles of Islamic Finance
Hhadith – Sahih Muslim:
…gold for gold, silver for silver, dates for dates,wheat for
wheat, salt for salt, barley for barley,….like for like,
equal for equal, hand to hand, ….
Two permissions follow two prohibitions:
1. Sales within single type, unequal exchange, with or
without delay: Riba al fadl. Money should be used as
medium of exchange
2. Exchange among listed goods, with or without equality,
but with delay: Riba al nasia [wheat and rice so that
wheat now and rice later OR gold now or silver late].
Goods can be sold on credit for gold and silver.
CREDIT SALE IS ALLOWED IF GOODS EXCHANGE
WITH MONEY
Theory & Practice of Murabahah
Murabahah – Concept and Historical perspective
• Introduced as new form of sale in second half of first
Hijrah century as a sale with necessary condition of a
profit margin agreed by both the seller and purchaser
[Al Mutta, Imam Malik] and without the order of
purchaser [cost includes direct expenses]
• Modifications were made by Imam Shafi’, including an
order of the purchaser, who could subsequently
exercise the option not to purchase the same, and
also included credit transaction
• Therefore, he clearly bifurcated two sale transactions,
one from supplier (or vendor) to the seller and other
from seller to the purchaser
Theory & Practice of Murabahah
Murabahah – Concept and Historical perspective
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The contemporary banking also takes into account the cash and
credit prices different from each other, as justified by Usmani
The banks are also required to fulfill regulatory compliance
relating to credit transactions, maximum exposure to risk,
classification of credit transactions, international supervision,
etc.
In addition, the banks are also emphasized to follow the Shariah,
and accounting standards issued by AAOIFI relating to Murabaha
transactions. In Pakistan, the Islamic Financial Accounting
Standard-1 issued by ICAP vide SECP Notification dated 24th
August, 2005 is also required to be followed.
Since the operation of Murabaha transaction resembles Riba
based practice of lending, the preconditions prescribed by
Shariah advisors are to be met in letter and spirit
B’s Capital
MUSHARAKAH
100%
75%
P&L DISTRIBUTION
OB
A’s Share of Profit
B’s Share of Profit
50%
50%
N
25%
75%
R
90%
10%
OA
M
25%
100%
A’s Capital
Islamic Modes – Agricultural Financing
Bank arranges pool of funds
ISLAMIC
BANK
Special
Purpose
Mudarabah
Investment
Units purchased
Profits Accrued
Retail Sales
Lined up
Islamic Modes – Agricultural Financing
Financing of crop production
Liquidity requirements (hiring of tractor & implements,
sowing, purchase of water, hiring of labour for preparation of
land and harvesting, marketing)
Input requirements (seed, fertilizer, pesticides)
Liquidity
Hiring for
land prep.
S
A
L
A
M
M
U
R
A
B
Inputs in kind
Liquidity
Sale of fertilizers, seed, pesticides
Hiring for
Harvest +
Marketing Exp.
S
A
L
A
M
Delivery
Payment
Delivery
Islamic Modes/Instruments - Sale Contracts:
Parallel Salam: Procedural Details:
The disposal of commodity at the end of Bank can
be through:
–
Parallel Salam:
the
original
second contract
the original
higher than the
–
Bank may sell commodity, before
date of delivery, to some other
purchaser for the date of
delivery. The period in
will be shorter than
contract, but price
original contract.
Unilateral Promise: Promise of purchase can be
obtained
from third party for delivery
on the
date of original contract.
Price in this
promise is set
higher than parallel
salam
because the promisor has to pay
nothing.
Islamic Modes/Instruments - Sale Contracts:
Risks involved in Salam Transaction:
Risks
Counterparty delivery risk
•Client defaults after receiving
price
Mitigants
•There could be dispute in
quality, quantity, time of delivery,
etc. in case of commodity
•MoU should clearly specify to
avoid any dispute
•Defective goods could be
supplied
•Collateral or security can be
obtained
•Goods may be delivered late
•Penalty clause – charity
Commodity price risk
•The market price at delivery
time could be lower than the
price expected at the time of
contract
•Parallel salam or promise to
purchase
•Liquidate security & purchase
same goods from market
Islamic Modes/Instruments - Sale Contracts:
Risks involved in Salam Transaction:
Risks
Commodity marketing risk
•Bank is not able to market the
goods timely resulting into
blocking of funds
Asset holding risk
•Bank bears holding cost till
disposal of commodity
Mitigants
•Select appropriate commodities
for salam, take promise with
Hamish Jiddiyah or appoint
client as agent
•Cost can be recovered in
parallel transaction
Early termination chances
•Clint refuse to supply the goods •Salam is a binding contract.
Penalty clause can be inserted –
charity
Parallel Salam
•Original seller might not supply •Bank may purchase the similar
asset from market. But no such
goods in time. The buyer in
loss can be recovered from
parallel salam may sue the
original seller
bank.
Principles of Islamic Finance
Principles of Islamic Finance
1. Prohibition of Riba: Prohibition in Shariah:
B. Ahadith
Riba al fadl: [Traditions]
1. ….exchange of radi with burny dates…..
2. Gold for gold, silver…..,……, like for like, equal for equal,
and hand to hand. If the commodities differ, you may sell
as you wish, provided the exchange is hand to hand.
1. When illa is different, shortfall/excess and delay both
are permissible
2. When commodities of exchange are similar, excess
and delay both are prohibited
3. When commodities are heterogenous but illa is the
same, then excess/deficiency is allowed but delay not
allowed
REFERENCE SLIDES FOR
PARTICIPANTS FROM BANKS
Work on Murabahah
Practice of Murabahah
Pricing of Murabahah [Example]:
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Purchase of poultry feed stock
Murabahah Facility:
180 Days
Payment:
Six monthly installments
Rate of Profit:
Six months KIBOR+2%
Murabahah transaction: Rs. 500,000
Securities:
Pledge of feed stock,
equitable mortgage, lien
on deposit, post dated
cheques, etc.
Practice of Murabahah
Pricing of Murabahah [Example]:
Particulars
Amount (Rs.)
Cost of goods
Rs. 500,000
Rate of Profit
Kibor + 2% (Floor 11.5%)
Six monthly KIBOR
10% p.a.
Freight & insurance
5% of cost
Total cost
500000 x 5%
Risk premium
2%
Profit
10%+2%+2% = 14% p.a.
Murabahah Price
525000+36247= 561247
Amount of
Installment
561247/6 = 93541
500000 + 25000
=525000
525000 x 14% x
180/365 =
36247
Cost = 87500
Training Workshop – Islamic Microfinance
Accounting of Murabahah [Example]:
Advance Payment
Advance Payment (Against Murabahah
purchases)
500000
25000
F&I charges
525000
To Pay order
(Payment made in advance for purchase
of goods)
Arrival of Goods
Murabahah purchases A/C
500000
To Advance Payment (Against Murabahah
purchases)
(Goods received on account of
purchases)
500000
Training Workshop – Islamic Microfinance
Accounting of Murabahah [Example]:
Murabahah Contract/Sale
Murabahah Facility A/C
5250000
Murabahah Profit Receivable A/C
36247
To Murabahah Sale A/C
561247
(To amount of goods sold)
Recovery of Murabahah Price
Client’s A/C
To Murabahah Facility A/C
To Murabahah Profit Receivable A/C
(Payment received on maturity by
debiting client’s A/C on 1st installment)
93541
87500
6041
Training Workshop – Islamic Microfinance
Accounting of Murabahah [Example]:
Recovery of Murabahah Price
Client’s A/C
93541
To Murabahah Facility A/C
To Murabahah Profit Receivable A/C
(Payment received on maturity – 2nd installment)
Client’s A/C
87500
6041
93541
To Murabahah Facility A/C
To Murabahah Profit Receivable A/C
(Payment received on maturity – 3rd installment)
Client’s A/C
87500
6041
93541
To Murabahah Facility A/C
To Murabahah Profit Receivable A/C
(Payment received on maturity – 4th installment)
Client’s A/C
87500
6041
93541
To Murabahah Facility A/C
To Murabahah Profit Receivable A/C
(Payment received on maturity – 5th installment)
Client’s A/C
To Murabahah Facility A/C
To Murabahah Profit Receivable A/C
(Payment received on maturity – 6th installment)
87500
6041
93541
87500
6041
Accounting of Murabahah
[Example]:
Profit and Loss Account Statement
Murabahah Sales
Less COGS
Purchases
F&I
Profit
561247
500000
25000 525000
36247
Sale Defined:
Exchange of a thing of value with another thing of
value with mutual consent OR the sale of a commodity
in exchange of cash.
Elements of a valid sale:
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Contract ( Aqd )
Subject matter ( Mabe’e)
Price ( Thaman )
Possession or delivery ( Qabza )