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Ordinarily transaction will take on the
following elements:
(i) borrower and lender enter into a
purchase contract to buy asset that is the subject of the financing;
(ii) borrower and lender enter into a
lease contract under the terms of which borrower agrees to lease asset that is
the subject of the financing;
(iii) on completion of the lease term,
borrow can either make a balloon payment to purchase asset or, alternative, if
the rental has included part principal payments, can pay a small sum to the
lender in exchange for ownership of asset.
This type of Islamic financing structure
is very similar to hire purchase contracts. As such, assets that are commonly
the subject of this type of Islamic financing include motor cars, home
appliance, electronic goods, etc.
Murabaha - Cost-plus financing /
buy-sell arrangement
Essentially works by borrower asking
lender to purchase asset on the understanding that after lender has purchased
asset, borrower will purchase asset from lender.
Agreement is made that lender on-sells
asset to borrower at an increased price.
Repayment can either be in one balloon
payment or by way of installments over a period of time. If repayment is a
balloon payment, more commonly known as a Bai’ Bithaman Ajil – or deferred
payment sale agreement.
Popular structure for purchasing real
estate property. It should be noted, however, that as lender on-sells property
to borrower, all land title deeds, etc. vest with the borrower. Thus, security
provisions of such an arrangement need to be considered carefully so that the
lender can adequately protect themselves.
Components of this type of Islamic
financing include:
(i) on-sell
arrangement;
(ii) agreed mark-up
on on-sell price;
(iii) asset must be
Shari compliant;
(iv) asset must exist
at the time of the transaction; thus, this cannot be utilized in futures trading
transactions;
(v) all terms and
conditions of the arrangement must be known by all parties at the time of
entering into the arrangement;
(vi) reoccurring
expenses cannot be passed on to the borrower.
Bai’ al-Inah – Sale and buy-back
Similar concept to Murabaha. However,
due to security concerns on default, structure is changed slightly. Lender
purchases asset on behalf of borrower. Borrower purchases asset from lender on
deferred payment basis. Asset is immediately resold to lender for cash at
discount.
Preferred financing mechanism if there
is any danger that lender will become insolvent.
Musharakah - Partnership or joint
venture financing
An arrangement between a lender and a
borrower where both parties agree to make a capital contribution towards
financing a commercial operation.
Parties agree to share profits from the
arrangement at a pre-agreed ratio.
Losses from the arrangement need to be
shared pro-rata to the capital contributions of each of the parties.
Tawarroq finance - Monetary finance
Lender agrees to purchase a commodity on
behalf of the borrower.
Lender sells commodity to the borrower.
Borrower sells commodity to a third
party buyer.
Cash payment from third party buyer acts
as monetary financing element of the transaction.
Borrower repays lender in installments.
Qardul Hassan – Benevolent loan
Consists of a loan given to a borrower
on a “goodwill” basis, i.e. no interest or fees are charged
Borrower may, at their discretion, repay
more than they borrowed
Seen as being the only “pure” form of
Islamic financing loan as, unlike all the other financing structures, it makes
no attempt to charge riba (interest), which is prohibited under Islam.
Mudharabah - Profit sharing
Islamic investors agree that a Mudhareb
(trustee) will provide skill and expertise.
Mudhareb agrees to hold and manage the
assts for Islamic investors.
In return for providing services,
Mudhareb earns an agreed share of profits from the assets managed on behalf of
Islamic investors.
Mudhareb cannot claim any right to the
assets - merely acts as manager and trustee of assets.
II. Commodities financing
Salam – Advance payment
Under this Islamic financing structure,
purchaser agrees to make advance payment for asset/goods to be delivered at a
future date.
It is essential that purchase price be
paid at the time of making the agreement, and not on delivery of the asset/goods
- failure to comply with this requirement would alter the nature of the
agreement to that of a sale of debt against debt, which is prohibited under
Shari law.
As Shari law stipulates that items must
exist at time of contract, i.e. no futures contract, asset to be purchased must
be clearly stated in the purchase agreement and the quantity and quality of the
purchased asset must be capable of being specified exactly – there can be no
room for dispute.
Assets must be goods and cannot not
include commodities; such as gold, silver or money.
The exact date and place of delivery of
the asset/goods must be specified in the agreement.
Istisna’a is another Islamic financing
structure that follows almost exactly the same concept as found here
III. Deposit taking functions
Wadiah - Safe-keeping
Agreement between two parties where on
agrees to look after the property of another.
Concept is used to take deposits of
money, where bank acts as custodian of money deposited by customer.
Bank agrees they will refund sums
deposited “on call”, i.e. on demand.
Hibah - Gift
Hibah literally means a ‘gift’. This is
used by banks to compensate depositors for lost earnings (interest) on their
deposits. It can also be used by borrowers who have been granted Qardul Hassan
loan mention above.
No agreement to provide Hibah can be
made – it’s an arbitrary payment made at the discretion of the person making it.
IV. Bonds
Fixed-term, fixed-income,
interest-bearing securities cannot be issued under Shari law.
Sukuk – Islamic bonds
Although fixed-income, interest-bearing
bonds cannot be issued under Shari law, it is estimated that over $500 billion
in corporate and government bonds issues have been made using Sukuk (Islamic
bonds) mechanism.
Essentially, Sukuk bonds are long-term
bond issues made by SPVs where the bond sale proceeds are used to purchase
assets that are then leased back to the issuer in return for rent. Rental
payments constitute part repayment of the principal and part profit revenue to
the bondholders.
Salam bonds
In certain circumstances, short-term
bond issues can be made using the same mechanism concepts found in Salam
transactions. It should be noted, however, that due to the precise nature of
the assets/goods that are the subject of a Salam transaction, these types of
bond issues are rare and for very short-term periods.
Conclusion
The growth of Islamic financing in the
past decade has been stellar. Given the large amounts of cash available in the
oil rich Middle-East, it is likely that the growth of Islamic financing will
continue. Moreover, as investors in the Middle-east look to break-out an invest
elsewhere, it is certain that governments around the world will need to
familiarize themselves with the principal concepts of Islamic financing, and to
regulate for such, if they wish to take advantage of this growth industry.
Excellent Books on Muslim
Business Financing
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