Muhammad Khaleequzzaman Head Islamic banking Department Int’l Islamic University Islamabad

1. Islamic Modes of FinancingPRODUCTS – Murabahah, Salamand IstisnaMirpur, Azad Kashmir 11 – 12 June, 2008Al – Huda Training Programme Muhammad Khaleequzzaman Head Islamic banking Department Int’l Islamic University Islamabad

2. Islamic Modes – Sale Modes: • Murabahah to the purchase orderer • Salam as financing mode of Islamic banks • Istisna’ and parallel Istisna’ Participatory Modes: • Mudarabah (asset and liabilities side) • Musharakah as a mode for house finance Rent based Modes: • Operating lease (Ijarah) • Ijarah wa Iqtina’

3. Contents: Murabahah – Historical perspective Spot and Deferred Murabahah Banking Murabahah/Murabahah to the Purchase Orderer Why Unilateral Promise? Why Security Deposit? Why Agency? Issue of default / penalty Pricing of Murabahah Islamic Modes – Murabahah

4. Islamic Modes – Murabahah Murabahah: Murabahah is simply a sale contract which fixes the price in terms of the sellers cost plus a specified percentage markup. The seller must disclose all items of expense which are included in the cost ie. All direct expenses incurred in acquiring that goods – trust relationship between bank and the clkient. Uses of Murabaha • Sale of raw material • Sale of equipment • Sale of agricultural inputs • Sale of real estate and vehicles

5. Process Flow:Approval of Credit Facility Negotiation/Approval of overall limit MOU/Murabahah Facility Agreement Requisition + Undertaking + Security Deposit Islamic Modes – Murabahah 2 MOU/Facility Agreement Bank Client Approval of Limit 1 Requisition, Undertaking, Sec. Dep. 3

6. Process Flow:Agency/Payment to Supplier Client appointed as agent [Optional] – When the option to be used? Payment to the Supplier – Direct Bank Client 1 Agency Agreement Supplier 2 Payment Islamic Modes – Murabahah Bank Client 2 Agency Agreement Supplier Supplier 3 Payment

7. Process Flow: Acquiring / Possession /First sale Physical Possession / Constructive Possession Payment to supplier Discount of supplier Title of goods Transfer of risk and responsibilites Goods Bank Supplier Agent (Client) Title Islamic Modes – Murabahah

8. Process Flow: Execution of Murabahah / second Sale Receipt / Possession report / Offer of client Acceptance of offer by the bank Return of security deposit Delivery of goods / Transfer of Risk & responsibility Ownership changes Payment of earnest money (Urboun) Payment of Murabahah Price Client pays Murabaha price as per agreed schedule Collateral released Murabahah terminates Islamic Modes – Murabahah

9. Execution of Murabahah 1 Murabahah Price IB Client Murabahah Terminates 2 Islamic Modes – Murabahah Urboun/Securities 4 2 Offer to Purchase IB Client Acceptance of Offer 3 Receipt , Possession Report 1 Hamish jiddiyah 3 • Payment of Murabahah Price

10. Purchase of poultry feed stock Murabahah transaction: Rs. 100,000 Murabahah Facility: 90 Days Payment: Lump sum Rate of Profit: Six months KIBOR+2% Freight: 5% of cost of goods Securities: Pledge of feed stock, post dated cheques Islamic Modes – Murabahah

11. Islamic Modes – Murabahah Pricing of Murabahah [Example]:

12. Book Keeping of Murabahah: Funds are advanced to supplier for purchase of goods and F&I paid On arrival of goods Murabahah purchase account effected [bank becomes owner] Murabahah Facility A/C and Murabahah Profit Receivable A/C are effected against Murabahah Sale A/C [goods sold] Client’s A/C is effected against Murabahah Facility A/C and Murabahah Profit Receivable A/C (Murabahah price recovered] Islamic Modes – Murabahah

13. Islamic Modes – Agricultural Financing BLANK SLIDE

14. Salam

15. Islamic Modes – Salam Salam: Forward Purchase A salam transaction is the purchase of a commodity for deferred delivery in exchange for immediate payment. It is a type of sale in which the price, known as the salam capital, is paid at the time of contracting while delivery of the item to be sold, known as subject matter of salam, is deferred. Salam is also known as Salaf (lit: borrowing) Uses: • Purchase of commodities (financing for production of agricultural commodities/ minerals) • Liquidity requirements of sugar mills, etc.

16. Islamic Modes – Salam Salam: Shariah Legitimacy • Allh says “O ye who believe when you deal with each other, in transactions involving future obligations in a fixed period time, reduce them to writing” [Al Baqara Verse 282] • Ibn Abbas reported, the Prophet (PBUH) came to Medina and found that people were selling dates for deferred delivery (salam) after a duration of one or two years. The Prophet (PBUH) said: “whoever pays for dates on a deferred delivery basis (salam) should do so on the basis of specified scale and weight” [Bukhari and Muslim]

17. Islamic Modes – Salam • Wisdom of allowing Salam • Beneficial for both seller and purchaser Three major problems • Risk of default by seller • Bank’s need to liquidate goods after delivery • Seller’s inabillity to produce or procure commodity

18. Islamic Modes – Salam Principles/conditions • An exception to the possession • A contract opposite to Murabahah • Payment of full price at spot - otherwise selling debt for debt • Allowed in fungible commodities • Product of a particular origin cannot be specified • Quality and quantity decided in un ambiguous terms • Allowed in fungible commodities • Product of a particular origin cannot be specified • Quality and quantity decided in un ambiguous terms

19. Islamic Modes – Salam Principles/conditions • Allowed in fungible commodities • Product of a particular origin cannot be specified • Quality and quantity decided in un ambiguous terms • Certain date and place of delivery • The commodity should remain in the market throughout the period of contract [Different opinions] • The time of delivery should be sufficient to allow use of salam capital conveniently and effect prices, preferably be at least 15-30 days from the date of contract [Different opinions] • A security/guarantee or is preferred as safeguard to the risk of default • Only commodity is delivered and not the money

20. Islamic Modes – Salam Parallel Salam: The disposal of commodity at the end of Bank can be through: • Parallel Salam: MFI may sell commodity, before the date of delivery, to some other purchaser for the date of original delivery. The period in second contract will be shorter than the original contract, but price higher than the original contract. • Unilateral Promise: Promise of purchase can be obtained from third party for delivery on the date of original contract. Price in this promise is set higher than parallel salam because the promisor has to pay nothing.

21. Islamic Modes – Salam Rules of Parallel Salam and Third party promise • Both the contracts viz. salam and parallel salam must be independent of each other • Parallel salam is allowed only with third parties [Agency allowed] • The third party giving unilateral promise should not pay the price as this is not allowed in Shariah

22. Islamic Modes – Salam – Example Bank transacts purchase of wheat • Contract against payment of certain price • Commodity to be delivered in six months • Bank apprehends trend of depressed prices in the prospect OR requires liquidity • Bank’s position at disadvantage as compared to other purchasers contracting lower spot price but cannot undo the contractual obligation – • Bank can keep the original contract and enter another salam contract with a buyer expecting trend otherwise… can lower the price risk

23. Islamic Modes – Salam BLANK SLIDE LAST SLIDE