Islamic Financial Services

Top 20 FREQUENT WORDS

islamic 866 financial 448 price 384 funds 340 risk 317 investment 311 client 294 contract 287 financing 281 project 266 services 257 takaful 257 products 246 based 245 ijara 236 fund 234 debt 207 insurance 202 conventional 201 sale 194

DOCUMENT KEY POINTS

one of the key impediments to the growth of islamic finance is lack of awareness among muslims about the islamic alternative models of banking insurance and investments
islamic financial institutions have generally been recruiting from the pool of conventional bankers and financial professionals who often find it too comfortable to camouflage conventional products and services as islamic ones

insurance professionals financial analysts regulators and policy makers need to be told the full story why conventional financial products and services are not acceptable in shariah what are the specific elements and features that are unacceptable what are the islamic alternative products and services that fulfill similar needs and address similar concerns and finally whether the alternatives are efficient as well
i am sure the text would address a long felt need serve as a useful guide and be of immense help to students researchers teachers finance professionals regulators and policy makers in the area of islamic finance

the text covers products and services relating to commercial banking insurance investment banking financial engineering fund management and project finance and is therefore neatly divided into five parts a each part devoted to one of the relevant sectors in addition to the introductory part
the distinctive feature of this book is presentation of the products and services in the form of flow charts and blue prints that facilitate conceptual clarity and greatly simplify the learning process

chapter three sets the tone with a discussion of how conventional commercial banking is practiced and undertakes an assessment of the same from the standpoint of shariah compliance
it includes all debt based financing products that are widely perceived to be shariah compliant in form only and not in spirit

chapter twelve initiates the discussion with how conventional investment banking is practiced and undertakes an assessment of the same from the standpoint of shariah compliance

references are neatly divided into five parts that correspond to the structure of the contents and are presented at the end of the book
in most cases the consensus view of mainstream contemporary scholars is presented and all controversial issues are presented as they are a labeled as controversial and relegated wherever possible to a separate chapter

islamic financial system an overview financial system efficiency financial products services financial markets financial system ethics norms of ethics in an islamic financial system islamic financial system a blueprint chapter
major norms of islamic finance norms relating to riba norms relating to gharar norms relating to ta wun part ii commercial banking chapter

financing products equity based trustee partnership mudaraba facility joint venture musharaka facility issues in product management declining partnership musharaka facility issues in product management areas of application chapter
financing products debt based a iii repurchase bai al einah credit card based on bai al einah bill discounting bai al dayn tripartite resale tawarruq issues in product management areas of application chapter

financial engineering conventional financial engineering islamic appraisal of conventional financial engineering forwards futures islamic alternative s options islamic alternative s swaps islamic alternative s xiii
insurance products tabarru based takaful mudaraba based takaful wakala based takaful issues in product management areas of application part iv investment banking financial engineering chapter

project finance conventional project finance islamic appraisal of conventional project finance islamic alternative s issues in product management suggested further readings index xiv

ijara financing structure ii exhibit
direct structuring of sukuk al murabaha exhibit

bahrain monetary authority ijara leasing certificates issue www dot bma
pewani savings account at bank islam

criteria set by the shariah advisory council sac of malaysian securities commission for approved list of securities www dot sc
share trading shareholder s affairs unit at al rajhi

households typically receive income in the form of wages and salaries and make frequent expenditures on durable and non durable consumer goods and services and for real estate in the form of home mortgage payments or rents
for a given time period any unit within a group can have one of three possible budget positions i a balanced position where income and expenditures are equal ii a surplus position where income for the period exceeds current expenditures or iii a deficit position where expenditures for the period exceed receipts

financial system efficiency is measured in terms of efficiency achieved in mobilizing savings from the savings surplus units in the economy and in allocating these funds among savings deficit units in the economy

from the above it is clear that any move that reduces transaction costs simplifies transaction system increases the availability and accuracy of information improves information processing by participants is a step towards improving the allocational efficiency of the system
instantaneous and accurate price adjustment also presupposes that intense competitive pressures force all participants to react without any lag and that the system is dominated by rational investors who would not over react or under react

these may be in the nature of various deposit products offered by an intermediary where the process is indirect and financial securities offered by sdus where the process is direct
given these multiple needs if a product is less attractive along one dimension say more risky then it must be more attractive with respect to the second dimension or should promise more returns

the products are in the nature of various financing products offered by intermediaries where the process is indirect and financial securities offered by sdus where the process is direct

spot market and futures market the spot market is the market in which products such as stocks commodities or foreign currencies are traded for immediate delivery and payment
a recent study by shefrin and statman identifies seven classes of fairness relevant to a financial system freedom from coercion freedom from misrepresentation right to equal information right to

right to equal information processing power this right entitles all investors not only to equal access to a common set of information but also to a competency floor of information processing ability and protection against a cognitive errors
this right may take the form of compulsory disclosure of information in a processed form or prohibition of certain transactions where certain groups of investors may be at an informationprocessing disadvantage

the question of riba has been addressed in a large body of literature and there is a general consensus about the meaning and implications of riba
freedom from al qimar gambling and al maysir unearned income contracting under excessive uncertainty gharar is akin to gambling al qimar

the concealment of vital information ghish also violates the norms of islamic ethics and according to the traditions of the prophet pbuh the informational disadvantaged party at the time of the entering into the contract has the option to annul the contract
entitlement to transact at fair prices prices that are an outcome of free play of forces of demand and supply without any intervention or manipulation are believed to be fair

in case of a commodity transaction the commodity in question is subject to inspection and both the parties can be reasonably sure about the benefits that are going to flow from future possession of the commodity
this pre emptive right may be extended by analogy to a situation where existing minority shareholders are being adversely affected by any decision of the controlling shareholders such as to sell additional stocks to the public to effect a change in management asset sale mergers and acquisitions etc

what should be the guiding principle for the regulator in establishing a system of priorities in these areas for example if the regulator believes that majority of investors are naive and irrational can it take a paternal approach and protect them just as parents protect their children it is quite possible that investors may lack information processing ability and even if all relevant information were made available to them they would not be in a position to assimilate and interpret such information and take rational investment decisions

islamic financial system a blueprint an islamic financial system by definition provides a linkage between ssus and sdus through an array of financial products and services that do not violate the above norms of islamic ethics

range of islamic banking products and services

islamic debt based financing products comprise cost plus sale murabaha with deferred payment bai bithaman ajil facility leasing ijara facility deferred delivery sale salam facility manufacture sale istisna facility recurring sale istijrar facility benevolent loan qard facility and the like

blueprint of islamic financial system

islamic financial system an overview murabaha funds or commodity funds ijara funds equity funds real estate funds and the like
these banks also provide after market services such as stock broking and advisory services relating to project appraisal mergers and acquisitions corporate restructuring and the like

chapter major norms of islamic finance in an islamic financial system by definition concerns about conformity to norms of islamic ethics dominate all other concerns
while islam provides a basic freedom to enter into transactions this basic norm does not imply unbridled freedom to contract and is constrained by other norms such as the prohibition of riba and gharar

o the prophet pbuh is reported to have said sell gold for gold silver for silver wheat for wheat barley for barley date for date salt for salt in same quantities on the spot and when the commodities are different sell as it suits you but on the spot muslim o bilal visited the messenger of allah pbuh with some high quality dates and the prophet pbuh inquired about their source

riba in exchange sell gold for gold silver for silver wheat for wheat barley for barley date for date salt for salt in same quantities on the spot and when the commodities are different sell as it suits you but on the spot muslim the above hadith explains riba with regard to six defined things

however any violation of the hadith will result in one of two forms of forbidden riba a riba al fadl where money is exchanged for money hand to hand but in different quantities or b riba al nasiah where money is exchanged for money with deferment
therefore it follows i when a debt is exchanged for money it must be at par and ii when a debt is exchanged for debt it must also be at par

in such case adequate precautions need be taken to ensure that riba does not enter through the back door in the shape of fee or u junior in fact fee or service charge or ujr remains the single most abused mechanism that can potentially permit riba through the back door unless adequate precautions are taken
first a cash flow of sr now to an individual implies that he she can purchase and consume goods and services worth the amount now while sr tomorrow would mean that he has to wait till tomorrow before he may consume

in addition to the various justifications provided in favor of positive time value of money in the context of debt one important argument relates to inflation and the consequent decrease in the value of money
needless to say when the buyer in the above deferred payment sale decides to defer his payment beyond the due date for payment neither he nor the seller is allowed to increase the price

another example is the requirement that the lessor in an ijara contract who is entitled to receive the rentals must bear the losses arising out of destruction of the asset
you may note here that existing literature on islamic financial contracting deals with the risk return relationship in a broad sense and does not necessarily require a risk return parity

c want of knowledge jahl with regard to the characteristics of the price or of the subject matter such as the vendor saying to the potential buyer i sell you a piece of cloth which is in my home
f two sales in one transaction such as selling one article at two different prices one for cash and one for credit or selling two different articles at one price one for immediate remittance and one for a deferred one

the reason for the prohibition of gharar is the risk or uncertainty which casts a shadow on the delivery of subject matter and settlement of the contract rather than the non existence of the subjectmatter
this line of reasoning was questioned by others who argued that gharar is present when the seller is not in a position to hand over the subject matter to the buyer irrespective of whether this is in existence or not

sale of a bird in the air the sale of a bird in the air or of one which after having been caught is again set at liberty is null because in the one case it is not property and in the other the delivery is rendered impractical
as far as mulamasah transaction is concerned it is that when a man can feel a garment but is not allowed to unfold it or examine what is in it or he buys by night and does not know what is in it and munabadhah is that a man throws his garment to another and the other throws his garments without either or them making any inspection

it is this concern that perhaps underlies the hadith that prohibits a sale whereby a townsman meets a tribesman outside the market place and buys the tribesman s goods at a price cheaper than the price prevailing in the market thus taking advantage of the seller s ignorance of the market price or the hadith under which the informationally disadvantaged party gets an option to rescind the contract subsequent to the time to contracting
a two sales in one means that a single contract relates to two sales whether in the form that one of them is concluded by the seller saying i sold you this item at a hundred in cash today and at a hundred and ten a year hence and the buyer says i accept without

such a sale is forbidden because of gharar in the contract the person who sells the item at a hundred in cash and at a hundred and ten a year hence does not know which of the two sales will take place and he who sells his house provided the other would sell him his car does not know whether this contract will be accomplished or not since the fulfillment of the first sale is conditional upon the fulfillment of the second
o satan s plan is but to excite enmity and hatred between you with intoxicants and gambling and hinder you from the remembrance of allah and from prayer will ye not then abstain o they ask thee concerning wine and gambling

norms relating to mutual cooperation ta awun while the above norms relating to riba and gharar are in the nature of prohibition the norms relating to mutual co operation solidarity and brotherhood are in the nature of exhortations to act in the desired manner

the guardian of the lady who was fined said o allah s apostle shall i be fined for a creature that has neither drunk nor eaten neither spoke nor cried a case like that should be nullified on that the prophet pbuh said this is one of the brothers of soothsayers

in the absence of intermediaries like commercial banks the flow of funds would have to be direct from the lenders to the borrowers
term to maturity denomination from savers or fundproviders and transform them into indirect claims with a different set of characteristics which they sell to the fund users

in producing financial commodities intermediaries such as commercial banks perform four basic services i they are able to produce a wide range of denominations by pooling the funds of many individuals and investing them in direct securities of varying sizes ii they are able to create securities with a wide range of maturities iii they are able to spread risk by investing in a wide range of assets and iv they are able to provide liquidity by lowering the transaction costs associated with converting financial assets into money

repurchase agreements repurchase agreements are a form of loan in which the bank sells securities usually government securities to the lender but simultaneously contracts to repurchase the same securities either on call or on a specified date at a price that will produce an agreed yield

if a borrower fails to meet the terms and conditions of his or her promissory note the bank may sell the collateralized assets to recover the loan loss
although loans are very profitable to banks they take time to arrange are subject to greater default risk and have less liquidity than most bank investments

however in the event of subsequent default by the client the liability may fall on the bank as the guarantor and the bank may be required to pay up the amount guaranteed

the return at times is not fixed as in case of floating rate deposits where the interest rate is linked to some other benchmark such as the london inter bank offering rate libor and varies over time depending upon the value of the benchmark
islamic financial services islamic appraisal of conventional commercial banking modern banking operations involve debt related riba prohibited by the holy qur an in that they borrow and lend against a certain specified paid or received revenue

bill discounting in any bill discounting operation as discussed above the creditor may wait till maturity to receive the amount from the debtor or get the instrument discounted at any bank and receive the discounted value from the bank anytime before the maturity period

islamic alternative s in the foregoing sections we examined some major commercial banking products and services and sought to evaluate these in the light of the norms of islamic ethics primarily focusing on the need to avoid riba and gharar
islamic financial services letters of guarantee acceptances conventional letters of guarantees and acceptances have no clear parallels in fiqh and combine features of classical contracts of kafala wakala and qard

but where there is no loan involved the fee would be based on the benefit to the customer on one hand and the efforts exerted by the bank or work done on the other
fee based services may be enumerated as under i opening of bank accounts ii safe keeping of negotiable instruments including shares and bonds and collection of payments iii internal domestic and external transfer operations iv hiring strong boxes coffers v administration of property estates and wills and the like

the difference between the profit share received from the entrepreneurs mudarib under the first contract and the profit share paid to the depositors rabb al maal under the second contract constitute the source of profits for the islamic commercial bank
if you take a look at the balance sheet of an islamic commercial bank you would find that the liabilities or sources of funds in addition to capital provided by shareholders and owners are in the nature of current deposits savings deposits investment deposits and some other variants

islamic banks are engaged in mobilizing savings from this unique group of savers by offering shariah compliant products that also vary with respect to other dimensions of return risk liquidity maturity safety stability and the like
while needs related to returns liquidity maturity safety stability and the like are important for him her the muslim saver has a unique concern shariah compliance

these debit cards and charge cards cater to the fundamental need behind possession of a credit card ie convenience by doing away with the need to carry cash to the point of purchase
according to one view the only islamic alternative to a credit card is a debit card or a charge card that is essentially a mechanism of withdrawal of one s own funds deposited with an islamic bank

the product requires the islamic bank a c to accept deposits from its clients looking for safe custody and a degree of convenience in the use of their funds a c to request permission from such depositors to make use of their funds so long as the funds remain with the bank a c to claim ownership over all profits derived from the use of such funds a c to reward the customers by returning a portion of the profits if any from time to time at its absolute discretion a c to guarantee withdrawal or refund of a part or the whole of their balances wherever they so desire

depending upon the degree of freedom accorded to the bank as the mudarib intended end use of funds or eligibility of depositors there are several types of investment deposits

profits if negative are absorbed by depositor effectively bringing down the value of the asset created with its investments and the value of the deposit
deposit products bank customerdepositor investment asset profit positive negative activity depositor and bank discuss terms of mudaraba depositor provides funds to bank

the product provides the bank with specific authorization to invest in a particular project or trade and the profits of this particular project only are distributed between the bank and its customers according to mutually agreed terms and conditions
issues in product management gifts in wadiah and qard when deposit products are modeled after wadiah or qard the customer does not participate in any way in risk

can these be justified simply as withdrawal mechanisms that provide for the right of the lender to seek partial or full redemption of his loan or that of the depositor to seek withdrawal of his her deposits any time guaranteed return in mudaraba investment deposits are modeled after the classical contract of mudaraba

hsbc interest free services hsbc interestfree checking with an hsbc interest free checking account and a combined balance of or more one can enjoy i a free hsbc s mastermoney debit card ii no monthly maintenance fee iii no atm fees iv free internet banking v internet bill pay service vi no issuance fee for money orders official checks and travelers cheques vii discount on small safe deposit box annual fee

the bank called rabb al mal is the owner of the capital and the customer entrepreneur called mudarib is responsible for the management of the business and provides professional managerial and technical expertise for initiating and operating the business enterprise or project
chapter financing products equity based in this section we discuss various equity based financing products such as mudaraba and musharaka

mudaraba may also be an unrestricted one mudaraba al mutlaqa in which case the mudarib may invest the capital provided in any business he deems fit
client bank investment asset profit positive negative dotted line indicates flow of funds activity bank and client discuss business plan bank provides funds to client towards capital investment

it is an agreement whereby the customer and the bank agree to combine financial resources to undertake any type of business venture and agree to manage the same according to the terms of the agreement

in musharaka however both the bank and the client share in the losses in the ratio of their investment in the project
liquidation a feature of the classical mudaraba and musharaka is that either of the parties to the agreement have an option to terminate the agreement or withdraw from the venture any time they deem fit

the catch here is the ratio of profit share for a pure financier who does not participate in the management and operations of the business is capped at or cannot exceed the ratio of its contribution to capital of the venture
issues in product management forward commitment a major issue in design of products based on declining musharaka is related to the forward nature of some activities that are part of the mechanism

profits if positive are shared between client and bank as per a preagreed ratio the profit share of client flows into bank too towards partial redemption of the latter s capital contribution
profits if negative are shared between client and bank in proportion to their respective capital contributions effectively bringing down the asset value while keeping their respective shares in it unchanged

this structure is similar to ijara in that the customer agrees to pay the cost price over a time period to the bank in return for acquiring the bank s share in the property and paying rent in the meantime for living in the property
financing products equity based it is not without reason that the housing sector has witnessed greater use of declining musharaka than any other sector since the expected profits from this business would be sourced from rentals that are predictable to a considerable degree

the ratio of profit sharing may be tilted in favor of the islamic bank being the sole financier of the project cost and in some instances also the project sourcing party
areas of application project finance mudaraba facility is observed to be a useful mode for financing projects such as real estate and housing development construction of public roads ports markets buildings corporate plants warehouses and other infrastructural concerns

musharaka based letter of credit at al amanah philippines an islamic letter of credit at al amanah involves the following steps a c the customer informs the bank of his letter of credit requirements and negotiates the terms and conditions of joint venture financing

chapter financing products debt based a i as you are aware by now early models of islamic banks are based on a two tier mudaraba or partnership structure
the list also includes debt products that involve bai aldayn bai al einah and tawarruq that are either rejected or at best deemed controversial by mainstream islamic scholars

islamic financial services deferred payment facility bai bithaman ajil with cost plus sale murabaha bai bithaman ajil bba or simply bai mu ajjal is a sale where payment of price is deferred to a future date

this mechanism where the client acts as the agent of the bank for the first sale transaction may be ideal when the client requires a specialized equipment and is better informed than the bank about the product s and source s of supply
bba murabaha financing structure i in most cases however the mechanism involves a third party a the vendor or supplier since the bank cannot be expected to engage in sale of a variety of products from multiple sectors

islamic financial services it is interesting to note in the structure how the relationship between the bank and its client changes from one phase to other
client approaches bank for bba murabaha finance and promises to buy the commodity from the bank upon resale at the marked up price

there is an agreement of mutual promise between bank and client whereby the bank promises to sell and the client promises to buy the commodity at the marked up price the promise covers agreed profitrate or mark up to be added to the cost which is already known to the client and fixed date s of repayment
vendor makes physical delivery of commodity to agent client of bank trained staff from bank oversee the process of client taking physical possession of goods

depending upon how price moves between the time of first contract between the bank and the vendor and the second contract between the bank and the client either of the parties would have an incentive to default
risk and return in line with the shariah maxim of al kharaj bi al daman or revenue goes with liability the bank must bear a certain amount of risk associated with ownership such as price risk risk of destruction of asset etc

can a university sell the offer of enrollment to a bank that would be resold to the student does a bank qualify to be a student of the university in the first instance can anyone transfer its right to enrollment in an academic institution as it is supposed to take place in the second instance can a right be the subject matter of a sale or murabaha specification of price a requirement of a valid sale is knowledge and specification of price and payment ter miss the price is fixed at the time of contracting as is the exact mode of payment e
we have in fact not only witnessed murabaha financing of cars trucks and buildings but also some innovative and controversial murabaha products involving education umrah packages and even foreign currencies murabaha financing of education see concepts in practice

does this mean that the deferred price in bba murabaha is the same as cash or spot price according to majority of scholars the deferred price may be more than the cash price but it must be fixed at the time of sale
a c purpose of financing to finance a full time or part time course approved by the relevant authorities which is being offered by a local as well as overseas colleges universities other institutions of higher learning

it is natural for rates on both islamic and conventional products to align with each other especially in an integrated market comprising both types of products
as a consequence it is also natural and legal for an islamic bank to benchmark its murabaha rates against lending rates charged by conventional banks

a customer may be exempted from providing a guarantor if a bank guarantee is brought to cover the full loan during the installment period or a reservation is provided on invested amounts or accounts with the corporation equivalent to the loan amount or stocks from saudi companies equivalent to of the loan value are presented signed to sell
considering the case of discounts first some scholars do not object to granting of rebate by a lender or the bank in case of early repayment or prepayment by its client as an act of kindness and virtue

in case of default in the payment of price at the due date the bank may have recourse to the guarantor who will be liable to pay the amount guaranteed by him
according to this view clients who default in payment deliberately may be made liable to pay compensation to the bank for the loss at a rate equal to its profit rate on deposits

the letter of credit under murabaha is provided as follows a c the client informs the bank of his letter of credit requirements and requests the bank to purchase import the goods indicating thereby that he would purchase the goods from the bank on their arrival under the principle of murabaha
working capital financing bba murabaha is suitable for manufacturers who need working capital on a relatively short term basis to finance acquisition of raw materials and consumables or for traders who need working capital for financing acquisition of merchandize

in ijara the bank continues to be the owner throughout the ijara period while the client receives the benefits of ownership or the benefits of using the asset
bba murabaha is also suitable for financing purchase of fixed assets such as land building machinery and equipments automobiles computers furniture and the like

ijara financing structures the simplest form of ijara involves the bank as the owner of an asset leasing out the same to its client against predetermined rentals for an agreed period of time
in case of ijara however the rentals could be flexible and be made to reflect the changing economic and business conditions as we shall see later

in the first instance the client is an agent of the bank in respect of purchase of the asset on behalf of the bank
the second stage begins from the date when the client takes delivery from the supplier

since in ijara ownership of the asset remains with the bank the asset reverts back to the bank at the end of the lease period
vendor makes physical delivery of asset to agent client of bank trained staff from bank oversee the process of client taking physical possession of asset

what happens when there is a significant residual value at end of the ijara period since it is much shorter than the economic life of the asset one alternative for the bank is to sell the asset to the client at the end of ijara period at a predetermined price
this may accrue to the bank either through the periodic lease rentals plus the sale price of the asset as in lease sale or simply through the lease rentals adjusted upwards in case of a lease gift structure

the customer has an option to purchase the property from the bank at any time at a predetermined price which depends upon the time at which the customer exercises the purchase option
ae another method of ijara ending with transfer of ownership to the client is provided by a combination of ijara with partnership based on musharaka or mudaraba

the total stream of cash inflows to the spv is distributed between all the co lessors or investors according to the proportion of their respective shares in the leased assets
note that sub ijara or ijara of a leased asset is permissible if it is provided in the ijara or an express permission is obtained from the lessor

bank forms a partnership with the client based on musharaka client promises to take on lease the property to be purchased by the musharaka against predetermined rentals for a definite time period bank may appoint itself as agent manager of the partnership subsequent activities are undertaken in this capacity
another portion a the share of the client in rental income is used to redeem part of bank s stake in partnership bank transfers ownership of asset to client when its stake is reduced to zero

debt and equity may be provided to the pool of financing through islamically permissible modes such as murabaha ijara musharaka or mudaraba bank appoints itself as agent manager of spv subsequent activities are undertaken in this capacity
financing products debt based i lead lessor co lessor i co lessor ii spv pool of properties rental income residual value activity

spv leases the asset on the basis of the agreement of mutual promise transfers possession and right of specified use to client client pays known rentals over future known time period s

thus the leased asset remains in the risk of the lessor throughout the ijara period in the sense that any loss damage or loss caused by the factors beyond the control of the lessee shall be borne by the lessor
financing products debt based i issues in product management risk and return as discussed earlier in the context of murabaha it is very important for the bank to bear a certain amount of asset risk in order that its profits are deemed legitimate in the eyes of shariah

note that in some conventional financial lease agreements specifically where the lessee purchases the asset on behalf of the lessor who pays its price to the supplier the lease commences on the very day on which the agreement is made or disbursement is made by the lessor irrespective of whether the lessee has taken delivery of the asset or not

the rate adjustment may be in the nature of a specified rent escalation at the end of an interval of say six months or one year or may be indexed to a macroeconomic indicator such as consumer prince index cpi or even a benchmark interest rate such as the london inter bank offering rate libor

the model calls for the financing entity to purchase the equipment jointly with the client and in a back to back agreement the client purchases the shares of the financing entity at cost
return on capital r on c pronounced a ronsee it represents the property s lease value as explained in item above and is calculated based on a declining equity model based on the property s economic value utility

if the termination has been affected due to the misuse or negligence on the part of the lessee he may also be asked to compensate the lessor for the loss caused by such misuse or negligence
bba murabaha is suitable for financing purchase of fixed assets such as land building machinery and equipments automobiles computers furniture and the like

chapter financing products debt based ii in the previous chapter we covered the debt based financing products such as murabaha bba and ijara that account for a major chunk of total financing activities of islamic banks
under a salam agreement a trader in need of short term funds sells merchandize to the bank on a deferred delivery basis

since the spot price that the bank pays is pegged lower than the expected future price the transaction should result in a profit for the bank
if the bank does not want to commit its funds for the given time period it may enter into a parallel or back to back salam contract with a third party

in case of the latter both the client and the bank would experience difficulties during activities and as they need to purchase from or sell in the market the commodity
if a third party makes a unilateral promise to buy the commodity at a predetermined price at time period t then the bank need not participate in the market

if a bank wishes to release salam funds to a borrower according to the latter s production schedule the bank should sign more than one separate salam contracts with the borrower one for each stage of ending

the difference between the price received from the client and the price paid to the manufacturer constitutes profit for the bank
like other financing mechanisms istisna involves risk of default and delinquencies and a bank can take various measures such as mortgage on land on which the asset is being built any other property or personal or third party guarantee to mitigate such risk

upon completion the bank hands over the building at the specified time and the client pays in installments as per his agreement with the bank
istisna financing of property at abu dhabi islamic bank adib s istisna facility arranges to finance your specific requirements over a period of time giving you easy payment options that can be made immediately or on a deferred basis

the contract adopted for the ar rahnu scheme is as follows the bank grants a benevolent loan qardhul hassan to the applicant
since istijrar involves repeat purchases from a single seller some scholars see a room for flexibility in the matter of fixation and payment of price

istisna is used to finance the construction of houses and development of properties construction of factories roads and other capital assets or to finance the manufacture of a specific product
qard financing structure areas of application as we have discussed above salam may be used as it was originally used in early days for financing agriculture

a murabaha can change into bai al einah if the identity of the vendor is not different from its client when the bank purchases a commodity from its client on a spot basis and sells it back to the client at a cost plus price and on a deferred basis
repurchase bai al einah the first and a very popular mechanism used by islamic banks in south east asian countries is based on repurchase or bai al einah

the net result of the above two activities are similar to the conventional loan transaction you may further note that under bai al einah the market price of the commodity need not bear any relationship with the amount effectively borrowed
client in need of an amount c sells commodity x to bank for a price of c on a cash basis

and when bba bai al einah mechanisms may be renewed any number of times and may be executed without any reference to the fair market value of the underlying asset the effect is similar to conventional loans with compounding of interest needless to say there is no difference between conventional credit line and the cash line facility of bank muamalat see concepts in practice

some questions that naturally arise are how large is the portfolio of plots of land owned by bank islam is it a separate plot of land for each customer does the sale value of land hold any relationship with fair market value or with the credit card limit sanctioned to the customer are stamp duties and other levies usually associated with land deals levied here concepts in practice
cash withdrawal fee at bank islam atm machines cash withdrawal fee for bic is rm for every rm or below for withdrawal made at bank islam atm while conventional credit card is or rm whichever lower of the withdrawal amount

the discount is determined by the rate of interest and the time between date of purchase of the instrument by the bank and the date of maturity
mainstream islamic scholars have put a plug on the possibility of earning interest by insisting that any sale of debt bai al dayn or transfer of debt hawalat al dayn must be at par

as the export documents have to be sent to the buyer overseas the bank requests the exporter to draw another bill of exchange drawn on the bank
islamic financial services client client bank dotted line indicates flow of funds activity supplier draws a bill of exchange on customer for a specific maturity value say m maturing after time period t which the latter accepts

an individual in need of funds purchases a commodity on a deferred payment basis from a seller and then sells the same in the market in order to realize cash
financing products debt based iii tripartite sale tawarruq facility tawarruq is another financing product that is cited as a classic case of hiyal or legal stratagem but has been permitted by mainstream scholars under certain conditions

more important than this however is the requirement that there must be a time gap between activities and ie between the sale by the bank to client and sale by the client in the market
bank as agent of client sells x back to vendor for p on cash basis note that bank would be able to sell back x to vendor at p if price of the commodity x is unchanged between activities and

on the contrary the deferred sale to client activity may be for the loan amount plus interest while the cash purchase from vendor activity and cash sale to vendor activity may be for the amount that the client needs to borrow

areas of application a survey of the above controversial mechanisms in use at various islamic banks across the globe reveals the following major areas of application

while a conventional letter of credit may involve a temporary loan based on interest an islamic bank may extend such a facility in the following manner using the mechanism of wakala agency
while islamic banks are currently offering a wide range of such products and services we discuss a few that are more popular and commonplace

however in the event of subsequent default by the client the liability may fall on the bank as the guarantor and the bank may be required to pay up the amount guaranteed
a c the bank charges the client fees and commissions for its services under the principle of agency fee or u junior letter of guarantee as discussed earlier a customer often requires the bank to act as an intermediary in certain kinds of transactions in order to ensure an atmosphere of security and confidence for both parties

other fee based services as discussed in chapter islamic banks like their conventional counterparts provide fee based services such as i safe keeping of negotiable instruments including shares and bonds and collection of payments based on an agreement of wakala under which the islamic bank acts as the wakil or agent of its client ii internal domestic and external transfer operations based on an agreement of wakala under which the islamic bank acts as the wakil or agent of its client iii hiring strong boxes coffers based on an agreement of amana or ijara iv administration of property estates and wills etc
needless to say guarantee has become a necessity especially in international trade where the sellers and the buyers do not know each other and the payment of the price by the purchaser cannot be simultaneous with the supply of the goods

location advisory site and plot assessment as well as advice on the suitability of a particular type of construction project management services may include the range of activities that make up the pre development stage of construction such as project planning cost planning and contract procurement

examples of pure risk include the risk of one s meeting with a fatal accident the risk of one s house getting burgled the risk to a business that goods being shipped would be destroyed in transit the risk to a business that the warehouse would catch fire and the like
insurance is an economic device by which individuals and organizations can transfer pure risks that is uncertainty about financial losses to others

of course for the law of large numbers to work the exposure units used to predict losses must be homogeneous and the losses that occur must be fortuitous meaning that the loss is unexpected and happens as a result of chance
for example traders may not set up businesses in crime prone localities importers may avoid importing goods from distant regions if the possibility of goods being lost in transit is high physicians in certain high risk specialties may not practice if the cost of a liability suit could bring financial ruin

estimate investment income when pricing insurance the insurer also takes into consideration the investment income that will be earned on the premium paid thus if interest rates are expected to be high and investment income is expected to be large a

the objective of this type of organization is to minimize the cost of the insurance product to the policyholders
maisir gambling qimar and maisir is clearly forbidden to musli miss as far as insurance for profit is concerned it is argued that the insurer effectively bets that the contingencies insured against will not occur

while this avoids the possibility of using insurance as a device for gambling in the conventional sense the scope of maisir and qimar in shariah is much broader and includes any form of unjust enrichment of one party at the cost of another
the insurer s obligation under the contract is not limited to paying claims but includes holding the assured covered which commences when the policy period begins or when the subject matter comes on risk

the fiqh council of the muslim world league ruled in favor of what it called the cooperative insurance which visualizes a group of people working in the same type of business establishing a joint fund to which everyone of them contributes
rather it is an arrangement by a group of people with common interests to guarantee or protect each other from a certain defined misfortune or mishap through the creation of a defined pool contributed out of their common resources

in view of the fact that the defined fund belongs to the participants the practice does not aim at deriving undue advantage at the expense of other individuals

for instance in conventional insurance the insured or policyholder may decide between original cost or replacement cost as the basis of valuation and claim accordingly whether or not they chose to rebuild property

under the arrangement any participant who suffers such loss is compensated in the form of financial assistance from a common fund established for this purpose
chapter insurance products from the operational standpoint takaful implies an agreement among a group of members known as participants who collectively agree to guarantee each member against potential loss or damage

profits flow and expenses are charged to the two funds representing two parties a the policyholders and the takaful operator or shareholders of the takaful company according to set principles
such ventures are often in the nature of small self help groups who may seek the help of a professional manager to oversee day to day operations of the venture

insurance products mudaraba based takaful in this model a clear distinction is made between the business of takaful or insurance and the business of investing funds mobilized from policyholders and or the shareholders
t policyholders takaful company policyholders shareholders investments fund fund profits investment expenses takaful benefits takaful beneficiaries surplus exhibit

in line with the rules of mudaraba operational expenses relating to the investments are charged to the mudarib the takaful operator company and hence to the shareholders fund
at periodic intervals the net insurance or takaful surplus that is the difference between premium received and claims paid is computed policyholders receive full refund of insurance surplus if any and are required to make additional payment of deficit if any

insurance products t policyholders takaful company policyholders investment shareholders fund fund profits from investment takaful benefits takaful beneficiaries operational expenses agency fee profits surplus exhibit
flowchart for wakala based takaful

the takaful operator company assumes the role of an agent or wakil of the policyholders its shareholders contribute to a fund called shareholder s fund that is maintained separately from the policyholders fund
at periodic intervals the insurance or takaful surplus that is the difference between premium received and claims paid is computed policyholders receive full refund of insurance surplus if any and are required to make additional payment of deficit if any

profit is defined as underwriting surplus plus returns on the investment of the general takaful fund which is then subject to profit sharing between the participants and the operator under the mudaraba contract

together with the overall returns on the investment of the general takaful fund the surplus is declared as the profit of the general business which is then subject to profit sharing between the participants and the operator under the mudaraba contract
general takaful schemes at mni takaful syarikat takaful structure general takaful schemes are risk only contracts of joint guarantee as compared to investment oriented nature of family takaful plans

the surplus is defined as the excess of contributions over clai miss this additional fee will provide an incentive for bank aljazira to ensure that prudent underwriting is carried out at all times optimize investment performance of the takaful funds minimize direct expenses related to the takaful fund such as issue cost stamp duty legal fees reinsurance cost etc minimize claims amount payable ie control fraud without sacrificing the objectives of takaful ensure that contributions for participation in takaful is set at a reasonable level to ensure adequacy equity and fairness among participants

in case of mni takaful the policyholders fund is debited with all the expenses incurred in managing the family takaful account with the exception of the expenses relating to investment of the family takaful account
family takaful plan at mni takaful syarikat takaful family takaful plans have the triple objectives of facilitating long term savings investment of savings for shariah compliant wealth creation and provision of takaful benefits to heirs of participants in case of death or disablement

the total amount of the takaful installments paid by the participant from the date of inception of his takaful plan to the due date of the installment payment prior to his death and his share of profits from the investment of the installments which have been credited into his participant s account ii

for some the takaful participants would be eligible to participate in the distributable surplus provided that they have not made any claims or received any takaful benefits from the takaful companies or if the participant has
in this case as in line with the shari ah legal maxim the agent appointed by the main agent has now become the de facto agent for the participants

the general assembly of the insurance company may on the recommendation of the board allocate the whole or a part of the surplus to policyholders reserves
commingling of funds it is pertinent to note here that a mudarib or wakil can commingle its own funds with policyholders funds for investment purposes

the wakala model is perhaps better suited than the mudaraba for managing the takaful business as the agency fee cost of insurance is more transparent and is free from the controversial charging of expenses including marketing commissions to the policyholders fund
according to traditional reinsurance practice the insurance company passes the premiums it receives from the insured to the reinsurance company and in return receives a commission from the reinsurer towards its management expenses

insurance products areas of application family takaful products basically family takaful plans can be divided into individual plans group plans mortgage plans and credit plans individual plan these are essentially long term financial programs to facilitate the creation of one s personal savings fund that can serve as a family endowment in case of untimely death of participant before the maturity period

money takaful this takaful covers loss destruction or damage of money by any cause while in transit or in the charge of the participant s messenger and or employee or burglary from locked safe or strong room or by hold up while in the premises
workmen compensation takaful it provides cover for liabilities of an employer who is legally required to compensate an employee in case of personal injury by accident or disease to the employee in the participant s immediate service arising out of and in the course of his employment

in order to correctly appreciate the role of an investment banker as a provider of a range of services it is important to appreciate the factors that govern the needs of its clients

in the after market that is after the company s stocks are freely and publicly traded on stock exchanges an investment banker provides services of a broker arbitrageur and various corporate advisory services such as relating to mergers and acquisition m a activities corporate restructuring and the like
we therefore discuss the services provided by investment bankers in two broad classes a i services rendered during initial stages of formation of a company that is still private and when the company goes public iii services rendered in the after market

a strategic vc on the other hand is typically a small division of a large technology company that is set up with the objective of helping and financing companies whose success may spur revenue growth of the parent
venture capitalists vcs are generally observed to focus on technology heavy companies such as relating to computer and network technology telecommunications technology biotechnology and the like

origination during this phase the investment banker can help the issuer analyze the feasibility of the project and determine the amount and type of financing needed design the characteristics of securities to be issued such as maturity coupon rate and the presence of additional features such as call or put or convertibility options
islamic financial services initial public offerings ipos when companies reach a stage where they have a track record of profitability and are in further need of funds to finance their expansion plans they may decide to go public with an ipo

these services include i providing investment advice and a host of relevant information to the investor ii storage of securities iii margin credit which allows the investor to borrow part of the money from the brokerage firm to pay for the security purchased iv cash management services for instance one that allows investors to write checks against credit balances and the value of securities they hold in their brokerage account
the market maker is willing to buy the security at one price known as the bid price and sells it at a higher price the ask price

islamic financial services mergers and acquisitions such as valuation of synergies or of the individual and combined firms negotiation between companies involved or providing advice to the acquiring or target firm to choose appropriate offensive or defensive strategies and the like
islamic appraisal of conventional investment banking in this section we undertake an assessment of the various investment banking services highlighted above from an islamic point of view

the scheme of preference for one group of shareholders owners of preferred stock over another owners of common stock in the matter of payment of dividend or in sharing of residual value upon liquidation of a company that is inherent to preference stocks is considered unacceptable in an islamic framework

another method of offer and sale is underwriting of securities in which the investment banker i makes a wholesale purchase of all the securities to resell them to retail investors at a later date at a profit or ii brings together the potential buyers and sellers together in consideration for a fee or commission also called best efforts underwriting or iii bears the risk of under subscription by the investors

most of the other activities of investment bankers that are in the nature of rendering value adding expert service for a fee do not transgress the norms of islamic ethics and at the same time enhance the efficiency of the system
brokerage services should therefore not permit borrowing and or lending on interest or margin trading and trading activities must not involve borrowing and or lending on interest or margin trading

in the matter of offering corporate advisory services such as relating to mergers and acquisitions islamic investment banking offers exciting possibilities that take into consideration ethical concerns in hostile takeovers
islamic financial services bank can create islamic debt securities that are backed by murabahah bba ijara salam and istisna contracts

venture finance to many contemporary scholars of all modern financial products venture capital finance is closest to classical islamic finance conforming to the islamic ideals of cooperation partnership mutual help and social solidarity
chapter investment banking products in chapter we discussed in detail the role of an investment banker in the resource generating process as also in the after market

as indicated before venture capital financing is mostly targeted at small and technology heavy sectors that are pure from an islamic point of view unlike islamic equity funds that have to screen out a large number of companies because of their being engaged in manufacture of forbidden products and activities

while an islamic vc differs from a conventional vc in the matter of charging interest to client companies and use of specific financial instruments most other activities of an islamic vc would be similar to a

the services can be grouped under the following main areas of activity corporate finance it is through our corporate finance capability that tii is able to meet the needs of clients seeking to raise various innovative forms of islamic debt and equity for a wide range of issuers based in the region and beyond
venture capital tii has built up an extensive network which through strategic alliances with renowned financial institutions and institutional investors will assist new and growth oriented companies raise venture capital by means of private placements or initial public offerings

the former is a process under which securities are issued first funds raised through the issue are then invested in creation of specific types of assets projects with the client company and subsequently the income generated from the assets projects is distributed among securityholders
for example some typical rights demanded by vcs in order to protect their investment such as the right of first refusal on sale of shares tag along rights follow founder sale on pro rata basis are quite similar in essence to the right to shufa granted by shariah to co owner of a joint property

the spv mudaraba is entrusted with the task of issuing securities to the investing public raising funds and investing the same in specific types of assets projects in order to meet the requirements of the company
now each murabaha instrument would involve an initial cash outflow of x n would have a maturity of t months and periodic cash inflows of x p tn over a period of t months

murabaha receivables x p in the above example are in the nature of pure debt and hence the instrument that is an evidence of such debt shahada aldayn can be transferred only at its face value
company purchases assets from spv on deferred payment basis and makes payment of installments to spv

the ijara rentals when received by spvmudaraba from the company as per the terms are passed through to the holders of the instruments
it has been rightly asserted that sale of debt at a negotiated price price that is different from the face value of debt or at a discount opens the floodgates of riba based transactions

direct structuring of sukuk al ijara amount of rent given in the contractual relationship represented by the instrument represents a maximum return subject to deduction of this kind of maintenance and insurance expenditure

all standard shariah requirements that apply to bai salam also apply to sukuk al salam such as full payment by the buyer at the time of effecting the sale fungibility or standardized nature of underlying asset clear enumeration of quantity quality date and place of delivery of the asset and the like

at the same time the buyer appoints the government of bahrain as an agent to market the appropriate quantity at the time of delivery through its channels of distribution
the government of bahrain provides an additional undertaking to the representative bib to market the aluminum at a price which will provide a return to al salam security holders equivalent returns to those available through other conventional short term money market instruments

such securities are to be known as muqarada bonds unless the use of the funds is known before hand such as in murabaha ijara salam or istisna operations in which case the sukuk are known by the nature of investment
however it is permissible to sell these instruments if mixed with other assets such as commodities services and cash provided that real assets and services overwhelm debt and cash

muqarada sukuk bonds on the expiry of the specified time period of the subscription the bondholder is given the right to transfer the ownership by sale or trade the bonds in the securities market at his discretion considering that this right has been agreed by the mudarib while the investor entering into the contract of muqarada bonds
if the muqarada capital after the subscription period is over and before the operation of the specific project still in the form of money therefore the trading of bonds would be based on the exchange of money for money and it must satisfy the rules of sarf

it is not permissible for the issuer to guarantee the capital of the mudaraba the investor would not bear any loss in the value of the bonds or to guarantee the investor a fixed amount paid as profit
this process is reverse and involves pooling of existing assets of a company and then issuing of securities against these assets

it involves transfer of ownership and consequently all risks and rewards of ownership of existing assets of the company to the spv representing investors
the end outcome of such practice is the emergence of a vibrant market in bonds that is islamic in name but conventional in every other sense

islamic financial services investment bank asset s company spv sukuk investors dotted line indicates the flow of funds activity company seeks advice from investment bank regarding securitization assets are identified and pooled together

since all commodities which may be subject matter of sale with profit can be subject matter of murabaha the shares of a lawful company may be sold or purchased on murabaha basis because shares of a company represent the holder s proportionate ownership in the assets of the company and the assets of a company can be sold with profit

share trading shareholder s affairs unit at al rajhi al rajhi banking investment corporation is distinguished by its geographical presence its large network of branches in the kingdom of saudi arabia making it popular for providing a wide range of services to its clients

risk management products that are an outcome of a sophisticated process of financial engineering enable companies to share transfer and avoid partially or fully unwanted risks
they make it possible to transfer risks to other participants who would like to bear them

a put option on the other hand entitles the holder the right but not the obligation to sell the underlying asset at a predetermined exercise price at or before maturity
futures are believed to add more to the efficiency of the system by getting rid of the problem of doublecoincidence of needs and counterparty default risk

if the buyer had purchased the stock itself say at a price of instead of the call on the stock in order to benefit from expected price rise then he would have made a profit of on an investment of
and given the complexity of modern business requiring advance planning and the many risks arising out of fluctuations in prices and rates in markets for commodities currencies and other financial assets the maslahah seems to be real and substantial

the possibility of risk and returns are magnified the gains of the buyer being equal to the losses of the seller and vice versa
islamic financial services stock falls below on the maturity date say to the buyer would allow the option to expire without exercising it since he can buy from the market at a lower price

even in this case the scholars have insisted that one end of the contract must be settled on the spot that is the buyer must give delivery of the thaman or price at the time of contracting to the seller
since both the buyer and seller enter into an obligation to deliver the price and object of exchange respectively on a future date the transaction essentially boils down to exchange of a debt for another debt or bai al dayn bi al dayn or bai al kali bi al kali

in this case a is able to hedge his position and at the same time forgoes the opportunity of making a gain if his expectations do not materialize and us dollar appreciates against indian rupee say to which implies that he would have realized rs and not rs which he would realize now
this perhaps explains why scholars insist on full payment of price at the time of contracting in case of bai salam and not in case of bai istisna or bai istijrar

the difference from the earlier scenario is that the counterparty would be more restrained in trading because of the investment required and such trading is unlikely to take the shape of rampant speculation
innovative financial engineering however seems to have an answer to such proble miss for example a currency forward can be developed synthetically from some basic shariah nominate contracts

islamic financial services t investment importer banker investor exporter foreign domestic murabaha murabaha rd rf investment importer banker investor exporter tt activity

ft amount in foreign currency that needs to be hedged t now tt specific future date sfx spot exchange rate and ffx forward exchange rate f amount in foreign currency required at t to hedge a future amount in foreign currency ft l f in local currency rf murabaha rate in foreign market rd rate in domestic market the key to developing the synthetic forward is as follows f or the amount in foreign currency required at t to hedge ft should be equal to the value of a murabaha at time t such that the terminal value of the murabaha in foreign market is equal to ft
financial engineering let us consider the case of an importer in an islamic country who is supposed to pay an amount f say us in foreign currency after time period t say months

a call option is similar to bai al urbun in the sense that the seller does not return the premium or advance payment to the buyer in case the latter does not exercise the purchase option and does not confirm the contract
islamic financial services thus the forward exchange rate is determined such that forward discount premium on currency is equal to differential of expected rates of return on murabah contracts of equal risk in domestic and foreign financial markets

currency options currency options provide a right without obligation to the purchaser of the option to exchange currency with a counter party at a predetermined exchange rate within or at the end of a stipulated time period
in this case a is able to hedge his position and at the same time does not forgo the opportunity of making a gain if his fears do not materialize and us dollar appreciates against indian rupee say to which implies that he would now realize rs

of the various types of options some are created by mutual consent of the parties to the contract while others are in the nature of rights existing for either or both parties because of the very operation of the law
broadly the classical fiqh literature classifies options into the following categories though minor variations in the classification scheme have been reported by some scholars khiyar al shart option by stipulation khiyar altayeen option of determination or choice khiyar al ayb option for defect khiyar al ruyat option after inspection and khiyar al majlis option of session

what is clear from the discussion undertaken in a large body of literature devoted to the subject is that the primary considerations underlying the prescriptions of various jurists are benefit of both parties to the contract and avoidance of any potential conflict or litigation between them
however there is some divergence of opinion among jurists on whether options and other contractual stipulations are valid as a matter of principle or these are merely tolerated by way of exception

the process involves a risk that subsequent to purchase by the islamic bank from the original supplier it may not be in the interest of the client any longer to buy the same from the bank
ijara seems to be a popular mode of financing with islamic banks for financing of long term assets such as land building plant and machinery

what if the rates turn out to be different from x y percent another problem could be due to the fact that the expectations of the lessee may be diametrically opposite to that of the lessor ie if the lessee expects rates to go down in the second period in which case no contracting is perhaps feasible
instead of committing itself for an ijara with two period maturity at the current x percent and be exposed to risk of loss it may opt for two one period ijara contracts the first for ijara at x percent beginning from now but with a maturity of one period only and the second beginning from one period hence through the second period at x y percent

at the end of three months if price of stock x moves up down then it can confirm the contract of purchase sale at the known contractual price and thus be immune from price risk

in the presence of such uncertainty about the future prospects and expected price performance of the financials the bank may sell the shares along with options for the buyer to rescind the contract in case the expectations do not materialize
under this arrangement volatile prices of the raw materials would not constitute a source of risk for the bank though the client company would be exposed to such risk as its cash outflows due to raw material purchases would now be volatile

for example if the seller holds the option then it would not rescind the contract if it expects the contractual price to be higher than value which would perhaps closely approximate the average of daily market prices assuming that the clientcompany goes for daily purchases and possession of the raw materials from the islamic bank
the bank s option would get activated if price pierces an upper bound and the client s option would get activated if the price pierces a lower bound

the sale price is taken as the average of the market prices during the financing period relating to the particular commodities goods involved in the transaction determined by authentic and undisputed sources
istijrar financing by muslim commercial bank mcb istijrar is an islamic mode of financing for transactions relating to various commodities raw materials and goods such as cotton edible oils pharmaceuticals including a range of other products which does not charge a profit on the basis of time

price fixation under istijrar the actual settlement price ps at t would be as follows i ps pavg if the underlying asset price remained within the bounds or ii ps p if the underlying asset exceeds the bounds and one of the parties chooses to exercise its options and use p as the price at which to settle at maturity
islamic financial services pt pub pub client exercises ps p plb pt pub ps pavg pt p p pt plb bank exercises plb ps p exhibit

this option has the benefit of widening the domain of choice for the parties to the contract and may be stipulated and held by the seller or the buyer
financial engineering khiyar al tayeen option of determination khiyar al tayeen is similar to khiyar al shart in many respects

this contract is similar to the conventional repo with the difference that in case of bai bil wafa the repurchase price is same as the initial sale price
investors may be offered to subscribe to an equity fund concentrating on a geographic region or market or sector but with an option to switch between a growth growth cum income and income portfolio

one common risk factor associated with ijara financing for the lessor is the risk of finding an alternative use of the asset of locating a new client where the lease period is shorter than the economic life of the asset
such a combination of bai bil wafa and ijara termed as bai bil istighlal is not only permissible in the islamic framework but also being extensively used in modern markets for project finance

a close look at the nature of contracting reveals that the same essentially involves an exchange of two interest free loans qard in different currencies which are repaid by both parties at the end of a stipulated time period
for example bank a in india has liquid funds denominated in us dollars and currently it expects the us dollar to weaken against indian rupee over the next six months

domestic bank a pays back x sfx in domestic currency to foreign bank b at time period tt
we may now consider an example today a lends million us dollars b borrows and a borrows million indian rupees b lends after six months a repays million indian rupees to b and a is repaid million us dollars by b

with rupee being the reporting currency and with continued fall in the value of dollar against rupee the bank would have faced a loss due to the currency rate changes
assume now that individual a is an exporter from india to us who has already sold some commodities to a us importer and anticipates a cash flow of which at the current market rate of mean rs to him after one month

when a and b contract to exchange rs and at the rate of at a future date say months then it can be easily seen that a s debt of rs payable to b after months is being exchanged for b s debt of us payable to a after months

in the context of islamic finance conventional derivatives options and futures as independent contracts are not quite acceptable since the so called public benefits or maslahah appear to be trivial in view of the strong quranic condemnation of al qimar and al maysir
this chapter shows that hedging is quite in conformity with islamic rationality but hedging with derivatives is fraught with grave dangers since large scale speculation is now made possible with derivatives

in addition investment funds offer economies of scale in investment management and transaction costs by spreading the costs of security evaluation over a large number of investors and by taking advantage of reduced rates on large scale transactions
they issue instruments called units in a wide variety of denominations and they provide marketability by either issuing units for which a ready market exists or repurchasing the units at their current asset value

o professional management few investors have the time or expertise to manage their personal investments every day to efficiently reinvest interest or dividend income or to investigate the thousands of securities available in the financial markets

open end and closed end funds the commonest form of mutual fund is the open end investment fund
fund management into a fund from its bank account or one can arrange automatic transfers from a fund to its bank account to meet expenses

there are also various types of money market funds based on the type of securities they buy but the most important distinction is whether the dividends to the investor are taxable or tax free
some funds specialize in investing in large cap stocks others in small cap stocks and still others invest in what s left mid cap stocks

the manager of a stock index fund doesn t have to worry about which stocks to buy or sell he or she only has to buy the stocks that are included in the fund s chosen index
accordingly one finds funds such as emerging market funds asia pacific funds and the like

real estate investment trusts reits real estate investment trusts reits are an efficient way for many investors to invest in commercial and residential real estate businesses

there are three typical types of private reits reits targeted to institutional investors that take large financial positions reits that are syndicated to investors as part of a package of services offered by a financial consultant and incubator reits that are funded by venture capitalists with the expectation that the reit will develop a sufficient track record to launch a public offering in the future
for their respective interests in the operating partnership units the partners contribute the properties from the existing partnership and the reit contributes the cash

all types of debt funds a bond funds short term intermediate term or long term money market funds muni bond funds junk bond funds and the like are excluded from the domain of the islamic fund manager
islamic financial services after a period of time often one year the partners may enjoy the same liquidity of the reit shareholders by tendering their units for either cash or reit shares at the option of the reit or operating partnership

after deducting a certain portion as fee for the mudarib towards covering management related expenses the net income for the fund can be estimated with a reasonable degree of certainty and hence the units or certificates of investments can promise an assured return to the investor s

the reason is that in the in the case of bba or murabahah as undertaken by the present financial institutions the commodities are sold to the clients immediately after their purchase from the original supplier while the price being on deferred payment basis becomes a debt payable by the client
additional benefits to investors in the certificates include personalized cheque books no restriction on withdrawals call center facilities monthly profit payment to investor s current or saving account with meezan free bank balance certificates personal financial consultancy services and access to priority desk source commodity murabaha fund a possible type of islamic fund may be a commodity fund going for bba or murabaha operations

since these sukuk represent the pro rated ownership of their holders in the tangible assets of the fund and not the liquid amounts or debts they are fully negotiable and can be sold and purchased in the secondary market
by implication if a company is engaged in a halal business however it keeps its surplus money in an interest bearing account wherefrom a small incidental income of interest is received it does not render all the business of the company unlawful

for instance the saudi economic development company sedco is in the process of developing an islamic hedge fund product that would basically use the bai salam contract to synthesize forwards and futures based on stocks where the price of the shares is determined and paid up front and the shares are to be delivered at an agreed future date

equity reits are particularly attractive for islamic fund managers as compared to investment in real estate companies since the former acquires and develops its properties primarily to operate them as part of its own portfolio rather than to resell them once they are developed
skeptics note that islamic financiers must be aware of the dangers of creative accounting creative structuring and of overengineering contracts for the sake of raising margins rather than efficiency gains

there is greater transparency not only about the types of contracts and products but also about the specific sectors utilities or housing or metals etc and markets domestic or international etc where the investments would be made
chapter fund management products next only to islamic commercial banks islamic investment funds have become extremely popular as alternative financial institutions that conform to norms of islamic financial ethics

islamic financial services issues in product management investment objective s all equity funds are required to state their investment objectives in clear ter miss most of the islamic funds state that their fund objective is to provide medium to long term capital appreciation through investment in islamically acceptable or shariah compliant equities

one of the financial criteria initially was exclude a company if interest income is more than of their operating income this was subsequently changed to exclude a company if non operating interest income revenue or apparently this was called for considering the anomaly that if a company has non operating interest income but the net income is negative it is excluded
note total debt short term debt current portion of long term debt long term debt a c the sum of cash and interest bearing securities divided by trailing month average market capitalization is greater than or equal to

the following fiqhi rule is also cited in its support whether a commodity that is part gold and part brass qualifies as gold for purposes of applying the rules of riba is resolved by the percentage of gold in the commodity ie if greater than a third it is gold

the screen uses criteria such as good public perception or the image of the company importance and maslahah of the company s core activities to the muslim ummah and the country very small haram element uruf or customs and the rights of the non muslim community see concepts in practice
criteria set by the shariah advisory council sac of malaysian securities commission for approved list of securities the council excluded stocks from the approved list based on the following criteria

some scholars are of the view that even in the case of capital gains the process of purification is necessary because the market price of the share may reflect an element of interest included in the assets of the company
therefore a question arises as to whether this is a convenient solution to a major fiqhi problem needless to say there must be no interest income by intention

while the former is an international banking institution with over offices in countries the latter is part of one of the largest financial groups in the world the dar al maal al islami dmi group
while the gulf bank is entrusted with distribution and administrative functions ie sales collection of investment amounts investing those monies with tii maintaining an investor register and processing redemption requests tii assumes all managerial responsibilities regarding al deema and has authority over the asset allocation of the products in each portfolio

its ibn majid emerging markets fund as the name suggests has exposure to emerging markets from around the globe while its aldar eastern european fund has exposure to eastern european markets in russia czech republic poland croatia hungary and others

in malaysia the rhb unit trust management berhad has been a pioneer in developing islamic indices for the malaysian and indonesian markets a the rhb islamic index rhbii launched in and the rhb indonesian islamic index rhbiin launched in
fund management products complexity of product s complexity of a product in terms of financial characteristics and how well it is understood may at times be a deciding factor for the future success or failure of a fund

the latest in the series of global indices are the five tii ftse indices launched by the kuwait based the international investor tii with ftse international ftse global ftse americas ftse asia pacific ftse europe and ftse south africa
for instance amanah saham wanita offers value added benefits like insurance ration of one to one up to rm without medical check up scholarship for eligible children of unit holders after a year in operation and direct investment for petty traders after a year in operation funeral expenses up to rm

fund management products as the united sates and the united kingdom due to compliance considerations an offshore fund may seem to be an ideal alternative
besides there are the onshore malaysian funds like tabung ittikal fund amanah saham bank islam and the us based funds like amana funds by saturna

investments in highways airports power generation and distribution telecommunications networks oil and gas pipelines in developing muslim economies is believed to accelerate the process of economic development and to create value and wealth in these societies

in general terms under the bot structure a government or government entity enters into an agreement with a private sector company under which the company agrees to finance design and build a facility at its own cost and is given a concession usually for a fixed period to operate that facility and collect tolls or other revenues from its operation before transferring the facility back to the government at the end of the concession period
islamic financial services implementation of privately designed and developed projects since there is an incentive to generate revenues as early as possible ii lower project costs because of a quicker schedule in an inflationary environment iii greater efficiency in responding to the demands of the market because of availability of price signals leading to introduction of innovative products and services and iv economies of scale scope experience and benefits of diversification with involvement of multinational companies in the process

one type is project sponsors whose participation in the project is not restricted to their role as investor such as a construction company that intends to undertake or participate in the construction of the project an operating company that intends to operate the completed project a bank providing debt for the project and the host government

the government lenders and investors may prefer the operator to be one of the project sponsors and to be committed as a shareholder to the project for a certain minimum time period
publicprivate partnerships substitute government investments in infrastructure with private capital these also replace taxation with privately collected user fees or other forms of remuneration to pay for use of infrastructure

obviously some cost factors clearly have potential ethical consequences and hence are of legitimate concern to musli miss though there is generally a consensus among scholars regarding the permissibility of the basic idea of private participation in the process of infrastructure development a comparison of the macro level benefits and costs needs to be undertaken in the fiqhi framework of maslahah mursalah before a particular project is found acceptable

the partnership between the government and the private parties with the provision that the government or the state company having a degree of autonomy from government ultimately becomes the sole owner of the project may indeed be modeled as a diminishing musharaka musharaka yantahi bi al tamlik contract between the parties

the various private parties that may come together to from the mudaraba include the project sponsors as mudarib such as the construction company the government the operating or utility company and the parties that are entrusted with managerial or monitoring responsibilities
like many other products of financial engineering or innovation this too is not free from divergence of views the major objections from some scholars relate to the shariah basis of forward commitments involved in the contract and when the musharaka contract is seen to contain several contracts of forward sale

indeed various alternative financing structures are possible with combinations of the above contracts because of the fact that various parties involved in the process the project company the construction company the supplier the operating or utility company and the islamic financiers may not be different entities and may also act as agents of each other
the islamic financiers would purchase the original contract s to supply goods and services to the project company from the supplier s and agree to the subsequent sale of the goods arising from this contract to the project company at a fixed profit mark up

with the ijara contract the project company transfers all the rights of collection of revenues in the form of tolls or other user fees in favor of the lessee that is the utility company in lieu of the rental payment in future

the underlying rationale seems to be that with multiple interdependent contracts forming part of one contract the possibility that the rights and obligations of the parties to the contract would not be honored in future greatly increases since default in one component of the structure may lead to defaults in others
issues in product management agency problems and their resolution as stated earlier various contracts forming part of a financial structure must be independent though these may be executed in parallel fashion in spite of their interrelated nature in order to avoid the possibility of gharar

whilst the long term investors would appreciate that the contractor must obtain reasonable payments under the construction contract to ensure that the project is actually built on time their obvious concern is that these payments should not be overly generous as the sums paid are part of the overall development cost of the project which the shareholders are financing through their injection of funds into the project company

indeed if such a claim is contemplated by or against the project company against or by any shareholder such a shareholder or any director appointed by it may well be disenfranchised by the terms of the shareholders agreement from voting in determining whether such a claim should be brought or the terms of settlement thereof the approval of entry by the project company into a contract with a subsidiary or associate company of any shareholder

this may be the preferred situation as it mitigates a possible conflict of interest in that the investment bank would only have the interests of its client the project company in mind in negotiating the financial ter miss another view is that this bank as financial adviser in negotiating and putting together the finance package and in having perhaps the best overview of the project in total should itself take up a portion of the third party finance
the presence of a large number of parties in the financial structures with many parties performing multiple roles is certain to raise many moral and ethical proble miss these potential areas of conflict of interest need more exhaustive investigation and must be minimized through appropriate stipulations in the mudaraba and musharaka structures used for the purpose

there is a need therefore to examine the allocation of the risk factors among various parties under these alternative mechanis miss considering the case of istisna first as discussed earlier a contract between the islamic bank as the seller and the project company as the buyer will provide for the manufacturing or construction of the facility or equipment s conforming to the specifications required by the latter and the delivery thereof within the stipulated time for an agreed price to be paid by the latter normally on deferred basis
constructionrelated risks risk factors during the design construction and commissioning of the project include inter alia the unexpected and adverse topographic and geotechnical conditions weather conditions and labor relations that may adversely affect the project budget and schedule adherence risk in application and absorption of a new technology resulting in construction and operational defects cost overruns due to increase in financing costs and or increase in prices of inputs during inflation these are in practice the major risks environmental damage and force majeure events

a possible variation in the istisna contract between the islamic bank and the project company in addition to providing for the manufacturing of the facility or equipment s conforming to the specifications within a certain time for an agreed price may also provide that the project company agrees to take delivery from the construction company and to supervise through a consultant or other expert the execution of the contract with the construction company in a manner that will ensure that no progress payment under the contract will be effected unless the project company s consultant certified that the work for

islamic financial services which payment is sought has been carried out in conformity with the contract and that the issuing by the project company s consultant of the final payment certificate under the contract with the construction company will ipso facto operate as acceptance of the goods under the first contract

the process involves a risk that subsequent to purchase by the islamic bank from the original supplier it may not be in the interest of the client any longer to buy the same from the bank
another alternative contractual mechanism used for financing the construction phase is bai bithman ajil under which an islamic bank purchases a facility or equipment s as required and specified by the project company from the construction company or the manufacturer and sells the same to the project company at a higher price on a deferred basis

since the lessor is the owner of the asset it is supposed to bear the above risk even in a long term ijara often with a purchase option resulting in ultimate transfer of ownership in favor of the client except when the loss is due to misuse or negligence on the part of the lessee
when the contract is joala for an absolute fee the risk of revenue fluctuation is borne by the project company and the operators or the utility company receives a reward which is known and unaffected by the risk factors

other risk factors relevant during the operation phase may be the risk of insolvency of the operator risk of incurring liabilities in a litigious society fluctuations in revenues caused by service interruptions due to accidents weather conditions equipment failure natural disasters etc here too as discussed in the context of construction related risks the risk for the parties may be mitigated transferred or shared through the mechanism of liquidated damages specific stipulations in ijara agreements or passed on to the takaful company
interest rate increases are also caused by inflation to the extent the same is anticipated by the market and adversely affect the bottom line by increasing the financing costs

instead of committing itself for an ijara with two period maturity at the current a x percent and be exposed to risk of loss it may opt for two one period ijara contracts the first for ijara at a x percent beginning from now but with a maturity of one period only and the second beginning from one period hence through the second period at a x y percent the forward commitment to lease involved in such contracting is permissible

in a contract between the power producer and the utility in a power purchase agreement the producer which is likely to be adversely affected with inflation may retain an option for itself it is also possible to make it conditional upon extreme movements that is the option would get activated only when inflation rate exceeds a certain rate to fix the price at a normal level as against the level initially set by the contract

the advantages are in the form of greater efficiency in planning and implementation of privately designed and developed projects lower project costs greater efficiency in responding the demands of the market because of availability of price signals economies of scale scope experiences and benefits of diversification and most importantly the reduced capital and investment demands on the governments for provision of the goods and services
there are however few other dimensions of such securitization process such as sale of receivables or debt bai al dayn in the secondary market at price lower than the nominal value of the debt and repurchase bai al einah of assets which have generated a lot of controversy and divergence of opinion regarding their acceptability

various contracts that form part of the structures and lead to risk allocation among the parties include the concession agreement the construction agreement the operations agreement the credit agreement the shareholders agreement the off take agreement the tariff agreement the agreements relating to insurance guarantees and derivatives for managing currency risk
this chapter identifies some shariah based contractual structures that would result in allocation of risk among the parties concerned but in an islamically acceptable manner that is free from riba and gharar

othman the role and responsibilities of the shari ah supervisory council the islamic banking finance forum dubai
othman takaful a suitable alternative for contemporary economy a paper presented at labuan international summit on takaful islamic insurance held at hotel sheraton labuan june

sadiq chaudhuri mohammad islamic insurance takaful concept and practice encyclopaedia of islamic banking and insurance institue of islamic banking and insurance london pp
quantum of damages in takaful the possibilities of adaptation of the doctrines of al diyah and al daman a reappraisal journal of islamic banking and finance iaib vol

strategies in islamic funds industry an exploratory analysis co author zafar sareshwala proceedings of the th harvard forum on islamic finance usa designing islamic contracts for project finance proceedings of the rd harvard forum on islamic finance usa
legal issues in restructuring islamic project financing paper presented at conference on restructuring islamic project financing organized by the asia business forum kuala lumpur malaysia

Please note, This is an auto generated summary based on sentances position in the document and other factors

DOCUMENT WORD ANALYSIS

Main Category

AlHuda Material\islamic banking

KeyWords

contract price sale asset financing lease client purchase ijarah payment profit musharakah lessee amount commodity housing agreement contracts ownership project

DOCUMENT REFERENCES

Number of Pages

270

Published Date

2005-09-12 09:35:18

Full Document

Read the Full Document

Islamic Financial Services

Contents

Top 20 FREQUENT WORDS

DOCUMENT KEY POINTS

DOCUMENT WORD ANALYSIS

Main Category

KeyWords

RELATED DOCUMENTS

DOCUMENT REFERENCES

Number of Pages

Published Date

Full Document

Navigation menu

Personal tools

Namespaces

Variants

Views

More

Search

Navigation

Tools

Categories