What is Islamic Microfinance ?

2. What is Islamic Microfinance ? • Abdul Samad • Shariah Advisor • The Bank of Khyber

3. Why Islamic Banking? • The body which is promoted by Hiram sources is bound to hellfire. • On the Day of Judgment, a person will not be moved from the place where he stand until he is asked about the sources of his income and they way he spent it. • Purifying of the needs of life (food, drink, clothes house etc) is one of the most important reason for the acceptance of prayers by Allah.

4. Rulings In Islam • These 5 primary objectives follow by Shariah can be observed though the Al Ahkam(rulings) upon which Fiqh (Islamic Jurisprudence) rotate around. The rulings are categorized as follows: • a. Wajib (obligatory) • e. Haram (unlawful) • b. Mustahab (recommended) (Sunnat) • c. Mubah (permissible) • d. Makruh (disliked)

5. Rulings • Wajib- An obligatory action or something that shall be performed. Anyone who leave it is liable to gain the punishment of Allah s.w.t. in the Here after as well as a legal punishment in this world. • Haram- An unlawful action or the one that shall not be performed and is strictly prohibited. Anyone who engages in it is liable to gain the punishment of Allah s.w.t. in the Here after as well as a legal punishment in this world. • Mustahab- A recommended action or something that should be performed. • Mubah- A permissible action or something that is neither encouraged nor discouraged. • Makruh- A disliked action or something which is abominable and should be avoided but not in strictly prohibitory terms.

6. Islam and Shariah

7. Human Financial Needs

8. External (Equity & Debt) Financing

9. Most Important Islamic Teaching Related To Business • Elimination of Interest (Raba) • The prohibition of uncertainty (Gharar) • The prohibition of Gambling (Qimar) • The precipitation of games of chance (Maser) • Honesty and Fair Trade (Ghishshand Khilabah) • Spending in the Good Cause • Buy Back • Two Mutually Conditional Contract • Entitlement to profit depends on liability for risk

10. Interest • Interest, Usury, or Riba is forbidden in almost all major religions of the world e.g. • Judaism • Christianity • Islam

11. Riba in Quran • God has permitted trade and forbidden interest….” (The Cow – Sura Al-Baqara 2:275) • Obelievers, fear Allah, and give up what is still due to your from the interest (usury), IF [indeed] you are true believers[!!!]. If you do not do so, then take Notice of War from Allah and his Messenger. • But, if you repent, you can have your principal. Neither should you commit injustice, nor should you be subjected to it.” (The Cow – Sura Al-Baqara 2:278-9)

12. Riba in Quran (Related in context to 2:278) The only reward of those Who make War upon Allah & his Messenger, and strive after corruption in the land, will be that they will be • Killed • Or, Crucified, • Or, have their Hands and Feet on alternate sides Cutoff, • Or, will be Expelled out of the land. • Such will be their degradation in the world, and • in the hereafter, theirs will be an terrible doom.” (Quran: The Table Spread - Al-Maida Chapter 5: Verse 33)

13. Riba in Hadith The Prophet cursed • the receiver and • the payer of interest, • the one who records it and • the witnesses to the transaction • and said: “They are all alike (in guilt).” (Sources: Jabir Ibn Abdullah, Muslim, Tirmidhi, Musnad Ahmed

14. RIBA

15. The prohibition of uncertainty (Gharar) • There are strict rules in Islamic finance against transactions that are highly uncertain or may cause any injustice or dishonesty against any of the parties.  • The concept of Gharar has been broadly defined by the scholars in two ways. • First, Gharar implies uncertainty. • Second, it implies dishonesty.

16. Classical Examples of Gharar • Selling goods that the seller is unable to deliver • Selling known or unknown goods against an unknown price, such as selling the contents of a sealed box   • Selling goods without proper description, such as shop owner selling clothes with unspecified sizes   • Selling goods without specifying the price, such as selling at the 'going price'   • Making a contract conditional on an unknown event, such as when my friend arrives if the time is not specified   • Selling goods on the basis of false description • Selling goods without allowing the buyer the properly examine the goods • The Prophet (pbuh) prohibited the pebble sale and the Gharar sale.

17. Qimar • Qimar includes every form of gain or money, the achievement of which depends purely on luck and chance. • All Lotteries and Prize schemes based purely on luck come under this prohibition. • O ye who believe! Intoxicants and gambling, sacrificing to stones, and (divination by) arrows, are an abomination, of Satan’s handiwork…..:(5:90-91) • He who played Qimar has disobeyed Allah and His Messenger.” (IbnMajah )

18. Honesty and Fair Trade (Ghishshand Khilabah) • Thus Manipulations and Mismanagement like Hoardings • Black marketing • Cheating • Profiteering • Short weighting • Hiding the defective quality of the goods are prohibited in Islamic Financial System. • The prophet (PBUH) said: the truthful honest merchants are with the prophets In the Day of Judgment.

19. Spending in the Good Cause • The Islamic economic approach is one, which is directed towards the achievement and actualization of justice in human relations. • The result of this effort is falah or success and salvation, and hayahtayyibah or good life in this world and the hereafter. • So Islamic banks don’t permute to establish any relation with commodities, services and individuals whose moral practices are doubtful • Some people spend Allah’s wealth (i.e. Muslim’s Wealth) in an unjust manner, such people will be put in the (Hell) fire on the day of resurrection” (Bukhari and Ahmad)

20. Buy Back • The financier sells an asset to the customer on a deferred-payment basis, and then the asset is immediately repurchased by the financier for cash at a discount.

21. Two Mutually Conditional Contract • Two mutually contingent contract have been prohibited by the holy prohibited by the holy Prophet (pbuh). • The sale of two item in such a way that one who intends to purchase good is obliged to purchase the other also at any given price. • One sale transaction with tow prices. • Combining sale and lending in one contract.

22. WHAT IS ISLAMIC BANKING?

23. WHAT IS BANK? • The name bank derives from the Italian word banco "desk/bench. • In practice, the word “Bank” means an institution which borrows money from people and lends money to people for interest or profit and provided other financial services.

24. BANKS ENGAGE IN THE FOLLOWINNNG ACTIVITIES. • Accepting money • Processing of payments by way oftelegraphic transfer, internet banking, or other means; • Issuingbank draftsand bank cheques • Lending money • Providing documentary and standbyletter of credit, guarantees, performance bonds, securities underwriting commitments and other forms of off balance sheet exposures • Safekeeping of documents and other items insafe deposit boxes

25. WHAT IS ISLAMIC BANKING? Islamic banking has been defined as banking in consonancewith the ethos and value system of Islam and governed, in addition to the conventional good governance and rick management rules by the principle laid down by Islamic Shariah.

26. Comparison of the Islamic and Conventional systems Conventional Banking • Conventional Banks take deposit on interest basis and lend on the basis on interest. A part of interest is paid to the depositors and the remaining interest is left for the bank as its income. If this residual is more than its expenses, it will have Net Income otherwise it will have Net loss. Islamic Banking • Islamic Banking accepts deposits on PLS basis and invest in Shariah based modes. Whatever is the profit, it is shared with depositors. If there is a loss it will also be shared.

27. OBJECTIVES OF ISLAMIC BANKING • Shariah compliant banking, to enableMuslimsto do theirbanking transaction– a Halal way. • Achieving the goals and objectives of an Islamic economy.

28. Types of contract CONTRACT Non Compensatory / Social Contract Compensatory / Financial Contract Gift Trade Nikah Leasing Moneylending Employment Guarantee (Damanat) Partnership Non-paid agency Paid agency Rights transfer (Hawalah) Services against fee

29. COMPONENTS OF VALID SALE SALE CONTRACT SUBJECT MATTER PRICE POSSESSION • Offer/Acceptance • Buyer/Seller • Certain • Physical • Constructive • Existence • Ownership • Possession • Valuable • Halal Purpose • Instant and absolute • Unconditional

30. DERIVATION OF MURABAHA The word “Murabaha” has been derived from the Arabic word “Ribah”, which has literary meaning of profit. The Murabaha can be denoted as “Sale With Profit”.

31. DEFINITION OF MURABAHA Murabaha is a particular kind of sale where Seller expressly mentions the cost it has incurred on purchase of the Asset(s) to be sold and sells it to another person by adding some profit, which is known to Buyer.

32. Musawamah Musawamah is a general kind of sale in which price of the commodity to be traded is stipulated between seller and the buyer without any reference to the price paid or cost incurred by the former. Thus it is different from Murabaha in respect of pricing formula. Unlike Murabaha, seller in Musawamah is not obliged to reveal his cost.

33. VARIOUS MODELS OF MURABAHA FINANCE

34. MODEL - I TWO PARTY REALTIONSHIP • Bank – Customer MODEL - II THREE PARTY RELATIONSHIP • (Bank-Vendor) and Customer MODEL - III THREE PARTY RELATIONSHIP • Bank and (Vendor-Customer)

35. MODEL - I • The simplest possible Model emerges when the transaction involves two parties only, i.e Bank and the Customer. • The Bank is also vendor and sells the Asset(s) to its Customers on deferred payment basis. • From Shari’ah perspective it is an ideal Model and its profits are fully justified because Bank assumes all risks as Vendor/Trader.

36. MODEL I – GRAPHICAL PRESENTATION 2 Customer Bank/Vendor 1 3

37. MODEL I - PHASES Phase 1: The customer approaches Bank (Vendor) and identifies Asset(s) and collects relevant information including cost and profit. Phase 2: Bank sells Asset(s) to the Customer, transfer risk and ownership to the Customer at certain Murabaha Price. Phase 3: Customer pays Murabaha Price in lump sum or in installments on agreed dates.

38. MODEL - II • In most cases Murabaha Transaction involves a third party (i.e. Vendor) because Bank is not expected to engage in sale of variety of products required for variety of Customers. • The Bank directly deals with the Vendor and purchases the Asset(s).

39. MODEL II • The Bank sells the purchased Asset(s) to the customer on cost plus basis. • There are two distinct sale contracts at different point of times. First between Bank and Vendor and second between Bank and the Customer.

40. MODEL II – GRAPHICAL PRESENTATION Vendor 3 1 4 Customer Bank 5 2 6

41. MODEL II - PHASES Phase 1: Customer identifies and approaches the Vendor or Supplier of the Asset(s) and collects all relevant information. Phase 2: Customer approaches the Bank for Murabaha Financing and promises to buy the Asset(s). Phase 3: The Bank makes payment to vendor directly.

42. MODEL II – PHASES Phase 4: Vendor delivers the Asset(s) & transfers the ownership of Asset(s) to the Bank. Phase 5: Bank sells the Asset(s) to Customer on cost plus basis and transfers ownership. Phase 6: Customer pays Murabaha Price in lump sum or in installments on agreed dates.

43. MODEL III – BANKING MURABAHA • This Murabaha Model is mostly practiced model in Banking now a days and therefore we will look at it in more detail. We will also look at the documentation required at different stages of the transaction. • It is also a three-party structure but it is bit complicated than previous ones.

44. MODEL III – BANKING MURABAHA • The product of Murabaha that is being used in Islamic Banking as a mode of finance is something different from the Murabaha used in normal trade . • It is called Murabaha to the Purchase Orderer .

45. MODEL III – BANKING MURABAHA • It is a bunch of contracts completed in steps and ultimately suffices the financial needs of the client. • THE SEQUENCE OF THEIR EXECUTION IS EXTREMELY IMPORTANT TO MAKE THE TRANSACTION SHARIA’H COMPLIANT.

46. MODEL III – GRAPHICAL PRESENTAION Vendor 3 4 5 5 Bank Customer 2 6 Offer Acceptance 1 7

47. PHASE I – PROMISE TO PURCHASE AND SELL • The Customer approaches the Bank for Murabaha Finance and promises to purchase the Asset(s) from the Bank which, the Customer will purchase as an Agent of the Bank. • Master Murabaha Finance Agreement (MMFA) shall be signed by the Bank and the Customer at this stage. This is basically a Memorandum of Understanding between two parties.

48. PHASE II – APPOINTMENT OF AGENT • In the absence of expertise required to purchase particular kind of Asset(s), the Bank appoints Customer as its Agent to buy Asset(s) on its behalf • Types of Agency Agreement ON ASSET BASIS ON TIME BASIS • Global Agency • Specific Agency • Limited Period • Open Ended

49. PHASE III & IV – PURCHAHSE OF ASSETS BY AGENT • The Customer identifies the Vendor, selects the Asset(s) on behalf of the Bank and advice its particulars, including the Vendor’s name and purchase price to the Bank. • If the supplier is nominated by the Customer itself, guarantee for good performance can be demanded from the Customer.

50. PHASE III & IV – PURCHAHSE OF ASSETS BY AGENT • The Customer takes possession of the Asset(s) as an Agent of the Bank. • It is the obligation of the Customer(Agent) to ensure, at this stage, that Asset(s) supplied is in accordance with the given specifications. • To ensure that a fresh Asset(s) are purchased by the Agent, Bank’s staff should verify actual purchase of Asset(s).