Islamic Modes of Financing
PRODUCTS – Murabahah, Salam
and Istisna
Mirpur, Azad Kashmir
11 – 12 June, 2008
Al – Huda Training Programme
Muhammad Khaleequzzaman
Head Islamic banking Department
Int’l Islamic University Islamabad
Islamic Modes –
Sale Modes:
1. Murabahah to the purchase orderer
2. Salam as financing mode of Islamic banks
3. Istisna’ and parallel Istisna’
Participatory Modes:
1. Mudarabah (asset and liabilities side)
2. Musharakah as a mode for house finance
Rent based Modes:
1. Operating lease (Ijarah)
2. Ijarah wa Iqtina’
Islamic Modes – Murabahah
Contents:
1. Murabahah – Historical perspective
2. Spot and Deferred Murabahah
3. Banking Murabahah/Murabahah to the
Purchase Orderer
4. Why Unilateral Promise?
5. Why Security Deposit?
6. Why Agency?
7. Issue of default / penalty
8. Pricing of Murabahah
Islamic Modes – Murabahah
Murabahah:
Murabahah is simply a sale contract which fixes
the price in terms of the sellers cost plus a
specified percentage markup. The seller must
disclose all items of expense which are included
in the cost ie. All direct expenses incurred in
acquiring that goods – trust relationship
between bank and the clkient.
Uses of Murabaha
•
•
•
•
Sale of raw material
Sale of equipment
Sale of agricultural inputs
Sale of real estate and vehicles
Islamic Modes – Murabahah
Process Flow:
Approval of Credit Facility
– Negotiation/Approval of overall limit
– MOU/Murabahah Facility Agreement
– Requisition + Undertaking + Security Deposit
2
Bank
MOU/Facility
Agreement
Approval of Limit
Client
1
Requisition, Undertaking, Sec. Dep.
3
Islamic Modes – Murabahah
Process Flow:
Agency/Payment to Supplier
– Client appointed as agent [Optional] – When the
option to be used?
– Payment to the Supplier – Direct
Bank
Bank
Client
Agency Agreement
2
1
Supplier
Payment
3
2
Islamic Modes – Murabahah
Process Flow:
Acquiring / Possession /First sale
– Physical Possession / Constructive Possession
•
•
•
•
Payment to supplier
Discount of supplier
Title of goods
Transfer of risk and responsibilites
Bank
Title
Supplier
Goods
Agent
(Client)
Islamic Modes – Murabahah
Process Flow:
Execution of Murabahah / second Sale
–
–
–
–
–
–
Receipt / Possession report / Offer of client
Acceptance of offer by the bank
Return of security deposit
Delivery of goods / Transfer of Risk & responsibility
Ownership changes
Payment of earnest money (Urboun)
Payment of Murabahah Price
– Client pays Murabaha price as per agreed schedule
– Collateral released
– Murabahah terminates
Islamic Modes – Murabahah
• Execution of Murabahah
Urboun/Securities
Offer to Purchase
2
Client
IB
Acceptance of Offer
3
Receipt , Possession Report
1
Hamish jiddiyah

4
3
Payment of Murabahah Price
Murabahah Price
1
Client
IB
Murabahah Terminates
2
Islamic Modes – Murabahah
Purchase of poultry feed stock
•
•
•
•
Murabahah transaction: Rs. 100,000
Murabahah Facility:
90 Days
Payment:
Lump sum
Rate of Profit:
Six months
KIBOR+2%
• Freight:
5% of cost of goods
• Securities:
Pledge of feed stock,
post dated cheques
Islamic Modes – Murabahah
Pricing of Murabahah [Example]:
Particulars
Amount (Rs.)
Cost of goods
Rs. 100,000
Rate of Profit
Kibor + 2%
Six monthly KIBOR
10% p.a.
Freight
5% of cost
Total cost
100000 x 5%
100000 + 5000
=105000
Profit
10%+2% = 12% p.a.
105000 x 12% x
90/365 = 3107
Murabahah Price
105000+3107= 108107
Islamic Modes – Murabahah
Book Keeping of Murabahah:
 Funds are advanced to supplier for purchase
of goods and F&I paid
 On arrival of goods Murabahah purchase
account effected [bank becomes owner]
 Murabahah Facility A/C and Murabahah Profit
Receivable A/C are effected against
Murabahah Sale A/C [goods sold]
 Client’s A/C is effected against Murabahah
Facility A/C and Murabahah Profit Receivable
A/C (Murabahah price recovered]
Islamic Modes – Agricultural Financing
BLANK SLIDE
Salam
Islamic Modes – Salam
Salam: Forward Purchase
A salam transaction is the purchase of a
commodity for deferred delivery in exchange for
immediate payment. It is a type of sale in which
the price, known as the salam capital, is paid at
the time of contracting while delivery of the item
to be sold, known as subject matter of salam, is
deferred. Salam is also known as Salaf (lit:
borrowing)
Uses:
– Purchase of commodities (financing for
production of agricultural commodities/
minerals)
– Liquidity requirements of sugar mills, etc.
Islamic Modes – Salam
Salam: Shariah Legitimacy


Allh says “O ye who believe when you deal with
each other, in transactions involving future
obligations in a fixed period time, reduce them to
writing” [Al Baqara Verse 282]
Ibn Abbas reported, the Prophet (PBUH) came to
Medina and found that people were selling dates
for deferred delivery (salam) after a duration of
one or two years. The Prophet (PBUH) said:
“whoever pays for dates on a deferred delivery
basis (salam) should do so on the basis of
specified scale and weight” [Bukhari and Muslim]
Islamic Modes – Salam


Wisdom of allowing Salam
Beneficial for both seller and
purchaser
Three major problems
1. Risk of default by seller
2. Bank’s need to liquidate goods
after delivery
3. Seller’s inabillity to produce or
procure commodity
Islamic Modes – Salam
Principles/conditions

An exception to the possession

A contract opposite to Murabahah

Payment of full price at spot - otherwise selling
debt for debt

Allowed in fungible commodities

Product of a particular origin cannot be specified

Quality and quantity decided in un ambiguous
terms

Allowed in fungible commodities

Product of a particular origin cannot be specified

Quality and quantity decided in un ambiguous
terms
Islamic Modes – Salam
Principles/conditions

Allowed in fungible commodities

Product of a particular origin cannot be specified

Quality and quantity decided in un ambiguous terms

Certain date and place of delivery

The commodity should remain in the market throughout the
period of contract [Different opinions]

The time of delivery should be sufficient to allow use of
salam capital conveniently and effect prices, preferably be
at least 15-30 days from the date of contract [Different
opinions]

A security/guarantee or is preferred as safeguard to the risk
of default

Only commodity is delivered and not the money
Islamic Modes – Salam
Parallel Salam:
The disposal of commodity at the end of Bank
can be through:
–
Parallel Salam:
–
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.
MFI may sell commodity, before the
date of delivery, to some other
purchaser for the date of original
delivery. The period in second
contract will be shorter than the
original contract, but price higher
than the original contract.
Islamic Modes – Salam
Rules of Parallel Salam and Third party
promise



Both the contracts viz. salam and parallel
salam must be independent of each other
Parallel salam is allowed only with third
parties [Agency allowed]
The third party giving unilateral promise
should not pay the price as this is not
allowed in Shariah
Islamic Modes – Salam – Example
Bank transacts purchase of wheat

Contract against payment of certain price

Commodity to be delivered in six months

Bank apprehends trend of depressed prices
in the prospect OR requires liquidity

Bank’s position at disadvantage as compared
to other purchasers contracting lower spot
price but cannot undo the contractual
obligation –

Bank can keep the original contract and enter
another salam contract with a buyer
expecting trend otherwise… can lower the
price risk
Islamic Modes – Salam
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