Islamic Modes:

1

Islamic Modes Murabaha and Salam Islamic
Microfinance Workshop CIBE Training
Program Muhammad Khaleequzzaman Head Islamic
MFIing Finance IIU Islamabad
2
Training Workshop Islamic Microfinance

• ISLAMIC MODES/INSTRUMENTS
• Sale Contracts
• Murabaha/Murabahah to the Purchase Orderer
• Salam/Parallel Salam
• Istisna/Parallel istisna
• Participatory Modes
• Mudarabah/Resource Mobilization
• Musharakah/Diminishing Musharakah
• Rent based Modes
• Operating ijarah
• Ijarah wa iqtina

3
Training Workshop Islamic Microfinance

• Sale Defined
• Exchange of a thing of value with another thing
  of value with mutual consent OR the sale of a
  commodity in exchange of cash.
• Elements of a valid sale
• Contract ( Aqd )
• Subject matter ( Mabee)
• Price ( Thaman )
• Possession or delivery ( Qabza )

4
Training Workshop Islamic Microfinance

• Rules of Sale Sale Defined and Elements of
  Sale
• Subject must exist at the time of sale
• Subject must be in the ownership of seller
  Physical or constructive
• Sale must be instant and absolute
• exception of above rules in Salam and Istisna
• 4. Subject should be halal
• 5. Subject must be known and identified
• 6. Sale must be unconditional
• 7. Delivery of sold item must be certain
• Price of subject must be certain
• Risks and responsibilities attached with the
  subject must transfer from seller to the
  purchaser as a result of sale

5
Training Workshop Islamic Microfinance

• Types of Islamic Sale
• Bai muajjal
• Murabaha
• Musawama
• Salam
• Istisna
• Murabaha
• Uses of Murabaha
• Sale of raw material
• Sale of cart
• Sale of equipment
• Sale of agricultural inputs
• Sale of consumer goods
• House material financing

6

Theory Practice of Murabahah

• Outline
• Murabahah Brief Historical Perspective
• MFIing Murabahah/Murabahah to the Purchase
  Orderer
• Procedural details of Murabahah as practiced by
  Islamic MFIs
• Issues in Murabahah
• Documentation

M. Khaleequzzaman IBF, IIUI
7
Theory Practice of Murabahah

• Murabahah Concept and Shariah Legitimacy
• Murabahah defined
• Selling a commodity as per cost with a defined
  and agreed margin of profit (Ribh)
• Profit may be a percentage of the selling price
  or a lump sum.
• The transaction may be concluded with or without
  any promise to purchase by the client Ordinary
  Murabahah / MFIing Murabahah or Murabahah to the
  Purchase Orderer.
• Shariah Legitimacy of Murabahah
• Quraan It is no crime for you to seek the
  bounty of your Lord Surah Ale Imran 198
• Allah has permitted trading and
  forbidden Riba Surah Al-Baqarah 275
• Sunnah The Prophet (PBUH) purchased a she camel
  from Abu Bakr (RAA) for use as transportation
  from Medinah...

M. Khaleequzzaman IBF, IIUI
8
Theory Practice of Murabahah

• Murabahah Historical perspective
• Introduced as new form of sale in second half of
  First Hijrah century as a sale with necessary
  condition of declaring cost by the seller and
  agreeing on profit margin by both the seller and
  the purchaser Al- Muwatta, Imam Malik
• Modifications were made by Imam Shafii,
  including an order of the purchaser, who could
  subsequently exercise the option not to purchase
  the same, and also included credit transaction
• He clearly bifurcated two sales transactions

M. Khaleequzzaman IBF, IIUI
9
Theory Practice of Murabahah

• Process Flow
• Negotiation/Approval of overall limit
• MOU/Master Murabahah Facility Agreement
• Requisition Undertaking Security Deposit
  (Hamish jiddiyah - Optional) Invoice

2
MOU/Master MFA
MFI
Client
Approval of Limit
1
Requisition, Undertaking, Sec. Dep.
2
M. Khaleequzzaman IBF, IIUI
10
Theory Practice of Murabahah

• Third party appointed as agent Optional
• Clint can be appointed agent case of dire need
• Payment to the Supplier Direct

Invoice
M. Khaleequzzaman IBF, IIUI
11
Theory Practice of Murabahah

• Possession
• Payment to supplier
• Discount of supplier/benefit to client
• Title of goods
• Transfer of risk and responsibilites

M. Khaleequzzaman IBF, IIUI
12
Theory Practice of Murabahah

• Conclusion of Murabahah

Personal/group sec.
4
2
Offer to Purchase
Client
MFI
Acceptance of Offer
3
Receipt , Possession Report
1
Sec. Deposit/Hamish jiddiyah
3
DP Note

• Payment of Murabahah Price

M. Khaleequzzaman IBF, IIUI
13
Theory Practice of Murabahah

• Purchase of poultry feed stock
• Murabahah transaction Rs. 30,000
• Murabahah Facility 90 Days
• Payment Each month
• Rate of Profit 15 p.a.
• Freight 5 of cost of goods
• Security Personal/group guarantee

M. Khaleequzzaman IBF, IIUI
14
Theory Practice of Murabahah
Pricing of Murabahah Example
Particulars Amount (Rs.) Amount (Rs.)
Cost of goods Rs. 30,000
Rate of Profit 15 p.a.
Freight/Insurance 5 of cost
Total cost 30000 x 5 30000 1500 31500
Profit 31500 x 15 x 90/365 1165 31500 x 15 x 90/365 1165
Murabahah Price 315001165 32665 315001165 32665
Installment 31500/31165/3 10888 31500/31165/3 10888
M. Khaleequzzaman IBF, IIUI
15
Theory Practice of Murabahah

• Issues in Murabahah
• Unilateral promise/undertaking
• Invoice in the name of MFI
• Prior contractual relationship (customer and
  supplier)
• Vendor being third party/blood relation/wholly
  owned institution of customer Buy back (Inah)
• Commitment or credit facility fee
• Documentation charges
• Hamish Jiddiyah/treatment/timing
• Timing of promissory note
• Rollover/Default in payment of price
• Rebate on early payment

M. Khaleequzzaman IBF, IIUI
16
Theory Practice of Murabahah

• Documentation
• Murabahah Agreement and Allied Documents
• Parties to the Murabahah
• Subject matter
• Cost price
• Profit Margin
• Value Date Disbursement date of Cost Price
• Contract price
• Default clause/penalty
• Right of set off i.r.o clients credit balance
• Agency agreement as separate contract
• Purchase Requisition
• Invoice
• Receipt of payment to the supplier

M. Khaleequzzaman IBF, IIUI
17
Theory Practice of Murabahah

• Documentation
• Declaration
• Securities as per security documents
• Demand Promissory Note
• Schedule of payment

M. Khaleequzzaman IBF, IIUI
18
Theory Practice of Murabahah

• Risks in Murabahah

Risks Mitigants
Customer refuses to purchase while holding as agent Promise, HJ,
Customer already purchased from supplier/wants liquidity/Inah Direct payment to supplier, date of invoice to be after date of agency agreement, obtain other documents gate pass, truck receipts, physical inspection, etc.
Overdue installments Penalty to go to charity
Default risk Collateral/securities
Market (price) risk Immediately supply the item
M. Khaleequzzaman IBF, IIUI
19
Theory Practice of Murabahah Some Applicable
Guidelines from AAOIFI

• A. Measurement of asset value
• At acquisition Measured and recorded at
  historical cost.
• After acquisition
• Asset available for sale to client shall be
  measured at historical cost
• In case of default in payment of Murabahah price,
  the asset shall be measured at cash equivalent
  value (ie. Net realizable value).
• A provision to be created for decline in the
  asset value (ie. Difference between acquisition
  cost and the cash equivalent value).

M. Khaleequzzaman IBF, IIUI
20
Theory Practice of Murabahah Some Applicable
Guidelines from AAOIFI

• B. Potential discount after acquisition
• The discount shall not be considered as revenue
• However it should reduce the cost of goods.
• C. Profit recognition
• Profit shall be recognized at the time of
  executing contract if the term does not exceed
  the current financial period.
• Profits of credit sale whose payment is due after
  the current financial period shall be recognized
  as per following
• Proportionate allocation of profits
• Profit may also be recognized as and when
  received.

M. Khaleequzzaman IBF, IIUI
21
Theory Practice of Murabahah Some Applicable
Guidelines from AAOIFI

• D. Failure to fulfill promise having paid Hamish
  Jiddiyah
• Hamish Jiddiyah to be treated as liability on
  Islamic MFI.
• Treatment
• The amount of actual loss to be deducted from
  Hamish Jiddiyah
• E. Penalty Deposited in Charitable A/C on
  realization

M. Khaleequzzaman IBF, IIUI
22

• Salam

23
Islamic Modes Agricultural Financing

• Salam Defined
• 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 the delivery of the
  item to be sold known as subject matter of salam
  (al Muslam fihi) is deferred. Salam is also known
  as Salaf (lit borrowing)
• Salam Purposes
• Liquidity needs of farm production
• Working capital/Running Finance
• Project finance (partial requirements)

24
Islamic Modes Agricultural Financing

• 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

25
Islamic Modes Agricultural Financing

• Wisdom of allowing Salam
• Farmers, orchard owners, merchants can fulfill
  their working capital and liquidity needs before
  the commodity is ready to be sold
• Three major problems and solutions
• Risk of default by seller personal/group
  guarantee/ hypothecation
• MFIs need to liquidate goods after delivery
  parallel salam
• Sellers inabillity to produce or procure
  commodity receive back the same price

26
Islamic Modes Agricultural Financing

• Salam
• An exception to the possession
• A purchase contract opposite to Murabahah
• Benefits both the seller and purchaser
• Payment of full price at spot - otherwise selling
  debt for debt
• Allowed in commodities satisfying condition of
  Dhawatul Amthal - quality and quantity can be
  specified exactly
• Product of a particular field or farm cannot be
  sold
• Quality and quantity decided in un ambiguous
  terms
• Quantity should be agreed in specific terms (by
  weight, volume or measure)

27
Islamic Modes Agricultural Financing

• Salam
• 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

28
Islamic Modes Agricultural Financing

• Salam Alternatives Available to MFIs of
  Taking Delivery of Commodity
• By establishing a subsidiary
• By appointing the third party or client its agent
  to sell the commodity
• The agency agreement should be separate from the
  salam agreement
• If agent has been able to sell the commodity at a
  price more than the one agreed in agency
  agreement, agent gets the difference
• 3. By opting for Parallel Salam or Third party
  sales

29
(No Transcript)
30
(No Transcript)
31
(No Transcript)
32
Islamic Modes Agricultural Financing

• 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. Therefore the original seller cannot be
  entered into the parallel salam
• The third party giving unilateral promise should
  not pay the price as this is not allowed in
  Shariah
• Examples of Products

33
THANKS