Islamic Financial Instruments

1. Islamic Financial Instruments IPIEF 3rd Week

2. Activities in the IFS • Funding Activities • Collect fund from fund surplus parties (saver, investor) • Financing Activities • Distributing fund to the fund minus parties (entrepreneur, lender) • Consists of two: • Equity Financing • Debt Financing • Exchange goods for money • Exchange money for goods • Exchange money for money • Service Activities

3. Islamic financial instruments • Depository (wadiah) • Profit-sharing agreement (mudharabah) • Equity participation (musyarakah) • Trade with mark up or cost-plus sale (murabahah and BBA) • Leasing (ijarah) • Sales contracts (salam, istishna) • Money lending (sharf) • Al Qardhul Hasan

4. Al Wadiah • Depository • IFI is deemed as a keeper and trustee of funds or other asset. • A person deposits funds or other assets in the IFI • The IFI guarantees refund of the entire amount of the deposit when the depositor demands it • The IFI only keeps the asset and has no permission to utilize the asset  idle capacity of the asset • IFI is benefited from cash incurred from safety keeping services • Customers are benefited because their assets are safe • Consists of: • Al Wadiah • Al Wadiah yad Dhomanah

5. Al Wadiah yad Dhomanah • Modified depository, to avoid idle capacity • IFIs can utilize the asset as Islam encourages productive activities by transfer the assets especially funds to the fund minus parties through financing activities • The depositor, at the IFI's discretion, may be rewarded with Hibah (bonus/gift) as a form of appreciation for the use of funds by the bank

6. Al Murabahah • The sale of goods at a price, which includes a profit margin agreed to by both parties • Commonly used for short-term financing is based on the traditional notion of purchase finance • The investor undertakes to supply specific goods or commodities • Incorporating a mutually agreed contract for resale to the client and a mutually negotiated margin • Around 75 percent of Islamic financial transactions are cost-plus sales

7. (1) Penerimaan Modal Istishna (2) Penyerahan Modal Istishna I F I S Pembeli Subkontrak (4) Menyerahkan barang pesanan (3) Menyerahkan barang pesanan

8. (1) Memesan barang dan memberi uang muka (2) Memesan barang sesuai pesanan nasabah dan memberi uang muka I F I s Pembeli Supplier (3) Menerima barang pesanan (4) Menyerahkan barang pesanan

9. Bay’ Bitsaman Ajil (BBA) • A deferred-payment sale • Sale of goods on a deferred payment basis at a price, which includes a profit margin agreed to by both parties • Similar to Murabahah, except that the debtor makes the payment on installments basis.

10. Al Ijarah • Lease, rent or wage • Selling the benefit of use or service for a fixed price or wage • The IFI makes available to the customer the use of service of assets/equipments such as hous, plant, office automation, motor vehicle for a fixed period and price • 10 percent of Islamic financial transactions • Consists of two types: • Ijarah (operating lease) • Ijarah Muntahiya Bittamlik (financial lease)

11. The Advantages of Ijarah for the Lessee • Conserve the Lessee‘s capital since it allows up to 100% financing • Gives the Lessee the right to access the equipment on payment of the first installment • Ijarah arrangements aid corporate planning and budgeting by allowing the negotiation of flexible terms • Not considered Debt Financing so it does not appear on the Lessee' Balance Sheet as a Liability • Not included in the Debt Ratios used by bankers to determine financing limits so lessee • All payments towards Ijarah contracts are treated as operating expenses, thus it’s fully tax-deductible

12. Al Ijarah Muntahiya Bittamlik • Leases where a portion of the installment payment goes toward the final purchase • Ended by transfer of ownership of the assets to the lessee. • Transfer of ownership methods: • As a gift (hibah), • Sale before the contract period due • Sale after the contract period • Gradually sale (gradually transfer of ownership)

13. Al Mudharabah • One party acts as shohibul maal (investor, the fund owner) and another party acts as mudharib (entrepreneur/manager, lack of fund) • Identical to an investment fund in which managers handle a pool of funds • The agent-manager has relatively limited liability while having sufficient incentives to perform. • The capital is invested in broadly defined activities, and the terms of profit and risk sharing are customized for each investment • The maturity structure ranges from short to medium term and is more suitable for trade activities • Profit earned from the activities is shared to both parties with the predetermined nisbah (proportion)

14. Al Musyarakah • Analogous to a classical joint venture • Both entrepreneur and investor contribute to the capital of the operation in varying degrees and agree to share the returns (as well as the risks) in proportions agreed to in advance. • Capital may include assets, technical and managerial expertise, working capital, etc) • Traditionally, it has been used for financing fixed assets and working capital of medium- and long-term duration.

15. Bay’salam • An advance payment or in front payment • A deferred-delivery sale • Similar to a forward contract • Delivery of the product is in the future in exchange for payment on the spot market • The quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute • The objects of this sale are goods and cannot be gold, silver, or currencies based on these metals cause the exchange of good, silver, currencies and other ribawi commodity must be done simultaneously.

16. Bay’ al istishna’ • Purchase by order or manufacture • Made-to-order sale contract in which payment can be made in advance of delivery. • The manufacturer designs and manufactures the item in accordance with the buyer's wishes.

17. (1) Penerimaan Modal Istishna (2) Penyerahan Modal Istishna I FI s Pembeli Subkontrak (4) Menyerahkan barang pesanan (3) Menyerahkan barang pesanan

18. The Differences between Salam & Istishna’

19. Sharf • Sale of money for money. • This form of transaction is strictly regulated under shariah in order to prevent the occurrence of riba

20. Al Qard Hasan/Al Qard • interest-free loan

21. Service Activities • Wakalah (agent, delegation of duty) • Hiwalah (transfer of debt) • Joalah (reward based contract) • Kafalah (guarantor) • Rahn (pawn shop)