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 ﺑﺴﻢ ﺍﻟﻠﻪ ﺍﻟﺮﺣﻤﻦ ﺍﻟﺮﺣﻴﻢ The Principles of Islamic Finance ﺑﺴﻢ ﺍﻟﻠﻪ ﺍﻟﺮﺣﻤﻦ ﺍﻟﺮﺣﻴﻢ The Principles of Islamic Finance

The Principles of Islamic Finance Islamic Banking (IB) Definition: Islamic banking can be defined The Principles of Islamic Finance Islamic Banking (IB) Definition: Islamic banking can be defined as: a form of modern banking based on Islamic legal concepts using risk- sharing as its main method excluding financing based on fixed pre- determined return.

The Principles of Islamic Finance The purpose of the Islamic financial system: The purpose The Principles of Islamic Finance The purpose of the Islamic financial system: The purpose of the Islamic financial system is, as with conventional finance, to mobilize global resources to promote and sustain global and regional development. Islamic Finance taps the vast pool of savings held by Muslims, and puts these savings to productive use for the benefit of Islamic and other societies.

The Principles of Islamic Finance Principles that underlie the methodology of Islamic finance: 1 The Principles of Islamic Finance Principles that underlie the methodology of Islamic finance: 1 - Prohibition of Riba 2 - Prohibition of Gharar

The Principles of Islamic Finance Riba is understandable given that the payment and receipt The Principles of Islamic Finance Riba is understandable given that the payment and receipt of interest are central to all conventional banking. v Riba literally means increase, addition, expansion or growth. It is a typical increase or growth , which has been prohibited by Islam. v Riba technically refers to the premium that must be paid by the borrower to he lender along with the principle amount as a condition for the loan or for an extension in its maturity. in this case Riba obviously means interest. v Islam made a clear distinction between trade and Riba. Trading is encouraged but Riba is prohibited.

The Principles of Islamic Finance v Islam does not consider money as a commodity The Principles of Islamic Finance v Islam does not consider money as a commodity so that there should be a price for its use. v Money is a medium of exchange i. e. Haman in asset-oriented economy , and a store of value. v The prohibition can be expressed in more technical terms by saying that while money is recognised in Islam as a means of exchange it may not lawfully be Regarded as a commodity for exchange. v The important difference between trade and Riba is that the business risk in trading is allocated more evenly among all the parties involved, whereas in Riba operations the business risk lies heavily, if not solely, on the borrower.

The Principles of Islamic Finance The prohibition of Riba implies that: The fixing in The Principles of Islamic Finance The prohibition of Riba implies that: The fixing in advance of a positive return on a loan as a reward for waiting is not permitted by Islam. It makes no difference whether the return is : • a fixed or variable percent of the principle • or an absolute amount to be paid in advance or on. maturity, • or a gift or service as a condition for the loan.

The Principles of Islamic Finance Gharar is a type of exchange in which one The Principles of Islamic Finance Gharar is a type of exchange in which one or both parties stand to be deceived through ignorance of an essential element of the exchange - Ignorance of the goods or price, - or false description of the goods. - selling of goods that the seller is not in a position to deliver. The element of speculation inherent in derivatives trading means that such transactions fall into the category of Gharar and are therefore prohibited.

The Principles of Islamic Finance Sources of Funds in Islamic Banks - Current Accounts The Principles of Islamic Finance Sources of Funds in Islamic Banks - Current Accounts - All Islamic banks operate current accounts on behalf of their clients: individuals and business firms. - These accounts are operated for the safe custody of deposits and for the convenience of customers. The bank guarantees the full return of these deposits on demand the depositor does not gain any share of the profit or any other return in any form.

The Principles of Islamic Finance There are two dominant views about current accounts: 1 The Principles of Islamic Finance There are two dominant views about current accounts: 1 - To treat demand deposits as Amanah. A "Trust Account" instead of a current account In such case the bank does not have the authority to use them without first obtaining the specific permission of the owner of the funds.

The Principles of Islamic Finance 2 - The other view is to treat demand The Principles of Islamic Finance 2 - The other view is to treat demand deposits as Qard Hasan (or interest free loan). According to this view the bank is free to utilize these funds at its own risk without return to, or authorization from, the depositors.

The Principles of Islamic Finance INVESTMENT ACCOUNTS In Islamic banks, Investment accounts (Profit and The Principles of Islamic Finance INVESTMENT ACCOUNTS In Islamic banks, Investment accounts (Profit and Loss Sharing (PLS) Accounts) play the same role as term deposits or time deposits in the conventional system. The two differ in the following manner: Investment accounts Fixed time accounts Interest Profit Income pre-determined determination expected return percentage Principle and return are guaranteed no guarantee except in cases of misconduct or mismanagement Maturity maturity as well as on the basis of purpose

The Principles of Islamic Finance The main characteristics of investment deposits can be described The Principles of Islamic Finance The main characteristics of investment deposits can be described as follow: Different Kinds of Investment Deposits: 1. 2. 3. 4. Joint/ General Investment Accounts Limited Period Investment Accounts Unlimited Period Investment Accounts Specified Investment Accounts

The Principles of Islamic Finance Uses of Funds in Islamic Banking Islamic banks use The Principles of Islamic Finance Uses of Funds in Islamic Banking Islamic banks use many techniques to utilize the raised funds. Such techniques, called modes of finance, are used as alternatives to interestbased financing.

The Principles of Islamic Finance Bai'salam This is a sale of goods whose specifications The Principles of Islamic Finance Bai'salam This is a sale of goods whose specifications are determined at the time of the contract, for a cash price paid in advance, and whose delivery will be at a future date. The seller of the goods must make delivery of the goods of determined specification on a definite future due date. The goods need not be already manufactured at the time of the sale contract. Bai’salam Finance Industrial sector Agriculture sector

The Principles of Islamic Finance Istisna Definition: Istisna is an agreement meeting the Client's The Principles of Islamic Finance Istisna Definition: Istisna is an agreement meeting the Client's need for an item, equipment, building, or project, which needs to be constructed, manufactured, fabricated, or assembled. Istisna Manufacturing good House under construction Securitization

The Principles of Islamic Finance Musharakah Definition: A Musharakah is a joint venture where The Principles of Islamic Finance Musharakah Definition: A Musharakah is a joint venture where by all partners (BANK /CLIENT) participate in providing the financial resources for the business. the Client to start and/or operate a business or industry, or undertake any other type of business venture. The bank and the Client agree to manage the business enterprise according to the terms of the agreement. Musharakah Permanent Musharakah inequity Diminishing Musharakah Financing working capital One of Musharakah transaction Substitute for overdraft

The Principles of Islamic Finance Basic Principles Of Musharakah: Ø Financing through Musharakah means The Principles of Islamic Finance Basic Principles Of Musharakah: Ø Financing through Musharakah means participation in the business. Ø An investor/financier must share the loss incurred by the business to the extent of his financing. Ø The partners are at liberty to determine, with mutual consent, the Ratio of profit allocated to each one of them, which may differ from the ratio of investment. Ø The loss suffered by each partner must be exactly in the proportion of his investment.

The usage of Musharakah in financing business : Musharaka Securitization of Musharakah Project financing The usage of Musharakah in financing business : Musharaka Securitization of Musharakah Project financing Financing of a single transaction Financing of Working Capital

Murabaha Definition: Murabaha is a sale contract between the Bank as seller of goods Murabaha Definition: Murabaha is a sale contract between the Bank as seller of goods and Client as purchaser, based on the disclosure of initial price to client. Bank purchases Goods on spot at the request of the Client, and then sells same to him on credit at a mutually agreed marked-up price.

Murabaha Financing Process Customer 1 Promise to Purchase Bank (Buyer) 2 Sale Contract (Musawama) Murabaha Financing Process Customer 1 Promise to Purchase Bank (Buyer) 2 Sale Contract (Musawama) Supplier (Seller) 3 Price 4 Goods Sale Contract (Murabaha) Customer (Buyer) Installments Goods Price Bank (Seller) 6 7 5

The Principles of Islamic Finance Any Murabaha transaction will typically involve a number of The Principles of Islamic Finance Any Murabaha transaction will typically involve a number of steps, which are broadly as follows: 1. The purchaser/ client submits an order to the bank to purchase the goods they require. 2. The bank agrees to finance the purchase of proposed goods. 3. The bank prepares and sends an offer to the purchaser /client. 4. The purchaser accepts the offer, which binds it contractually to purchase the goods.

5. the bank pays the supplier and purchases the goods using spot payment. 6. 5. the bank pays the supplier and purchases the goods using spot payment. 6. The purchaser, acting for himself, enters into a contract to buy the goods from the bank. 7. the purchaser purchases the goods from the bank for immediate delivery with deferred payment. 8. On the due date, the purchase price plus the mark-up is due.

Murabaha can be used to finance various needs of clients: Murabaha Personal Murabaha Commercial Murabaha can be used to finance various needs of clients: Murabaha Personal Murabaha Commercial Murabaha Liquidation of Musharaka Contracts Murabaha LC’s Utilization Assets of investment funds & Portfolio

The Principles of Islamic Finance Mudarabah Definition: Mudarabah is a mode of financing in The Principles of Islamic Finance Mudarabah Definition: Mudarabah is a mode of financing in which the bank provides the needed finance, while the Client provides the professional, managerial, and technical know-how for starting and/or operating a business enterprise or project. The profit is shared in a pre-agreed ratio.

Characteristics that distinguish Mudarabah from Musharakah : a. The investment in a Mudarabah is Characteristics that distinguish Mudarabah from Musharakah : a. The investment in a Mudarabah is provided by one partner only, whereas in a Musharakah it is supplied by all the partners. b. In a Mudarabah the management of the investment is the sole responsibility of the mudarib, while in a Musharakah the partners all participate in the management of the business. c. The loss in a Mudarabah is carried by the Rab'ul Mal alone, as the Mudarib has nothing to lose. In a Musharakah the proportion of loss is determined by the size of the investment.

d. A Mudarabah is a limited liability investment, whereas a Musharakah is not. e. d. A Mudarabah is a limited liability investment, whereas a Musharakah is not. e. The assets acquired by a mudarib for the rab'ul mal are the sole possession of the latter, and the former can only profit by shrewd disposal of the assets. In a Musharakah the assets acquired are the joint possessions of all the partners in the deal. Structuring investment funds Raising funds from clients Mudarabah uses in Islamic Banking Finance Clients Structuring investment portfolios

Ijara Under the terms of an Ijara transaction the investor, or lessor, would purchase Ijara Under the terms of an Ijara transaction the investor, or lessor, would purchase equipment from a manufacturer and lease it on to the company, or lessee, for an Agreed period of time. During this pre-determined period, the title to the underlying assets will remain in the hands of the lessor, whereas the actual possession and usage of the asset would be for the benefit of the lessee.

Ijara Financing Offer & Acceptance Lessee Lessor Ijara (Lease) Rental Payments Leased Asset Ijara Financing Offer & Acceptance Lessee Lessor Ijara (Lease) Rental Payments Leased Asset

Over the life of the asset, the lessee will pay pre-agreed rentals to the Over the life of the asset, the lessee will pay pre-agreed rentals to the lessor at a frequency mutually agreed upon by the two parties. During the life of the asset the risk of ownership remains with the lessor, while the lessee is responsible for use of the asset.

Important differences between a conventional lease and Ijara : • In a conventional lease Important differences between a conventional lease and Ijara : • In a conventional lease arrangement penalties will be incurred for late payment of an installment, which are stated as a percentage of the total. As this equates to an interest payment, it is prohibited under Shariah. • Under shari'ah, original agreements can not be altered to reflect rescheduling. This can be done only in cases of mutual agreement to cancel the old agreement and to draw up a new one. • Under conventional lease contract the lessee is responsible to insure the leased asset, where in an Islamic lease contract, the lessor holds the responsibility of paying the insurance since he owns the leased asset.

Ijara Financing Process Customer Promise to Lease 1 Bank Sale Contract 2 Landlord (Seller) Ijara Financing Process Customer Promise to Lease 1 Bank Sale Contract 2 Landlord (Seller) (Buyer) 3 Price 4 Buildings Lease contract Customer 5 (Lessee) (Lessor) Rental Payments 6 7 Bank Buildings

Salam is a sale whereby the seller undertakes to supply some specific goods to Salam is a sale whereby the seller undertakes to supply some specific goods to the Buyer at a future date in exchange for an advanced price fully paid on the spot. The permissibility of Salam was an exception to the general rule that prohibits forward sales. For that, it was subjected to some strict conditions.

These conditions are as follows: 1. The payment of the price by the buyer These conditions are as follows: 1. The payment of the price by the buyer should be at the time of effecting the sale. 2. Such sale is permissible only in the commodities whose quality and quantity can be specified exactly. For example, precious stones cannot be sold on the basis of Salam, because every piece of precious stone is normally different from the other. 3. It cannot be effected on a commodity whose supply is not certain. For example, if the seller undertakes to supply rice or wheat of a particular field, or the fruit of a particular tree, the Salam will not be valid.

4. The quality and quantity of the commodity sought to be sold by Salam 4. The quality and quantity of the commodity sought to be sold by Salam must be fully specified. The exact date and place of delivery must be specified in the contract 5. It is not permissible for the buyer of a Salam commodity to sell it before receiving it because that is similar to the prohibited sale of debts before holding.

Usage of Salam: Salam sale has been found suitable for the finance of agricultural Usage of Salam: Salam sale has been found suitable for the finance of agricultural operations. It is also used to finance commercial and industrial activities, especially phases prior to production and export of commodities and that is by purchasing them on Salam and marketing them at a profit.

 The Salam sale is also used by banks in financing craftsmen and small The Salam sale is also used by banks in financing craftsmen and small producers by supplying them with inputs of production as a Salam capital in exchange for some of their commodities to remarket. The scope of Salam sale is large enough to cover the needs of various people such as farmers, industrialists, contractors or traders. It can cover the finance of operational costs and capital goods.

Istisna’a is the second kind of sale where a commodity is transacted before it Istisna’a is the second kind of sale where a commodity is transacted before it comes into existence. It entails ordering a manufacturer to manufacture specific goods for the purchaser. If the manufacturer undertakes to manufacture the goods for him, the transaction of Istisna’a comes into existence. It is necessary for the validity of Istisna’a that: A. The price is fixed with the consent of both parties. B. The specification of the commodity intended to be manufactured is fully settled between them.

 The contract of Istisna’a creates a moral obligation on the manufacturer to manufacture The contract of Istisna’a creates a moral obligation on the manufacturer to manufacture the goods, but before he starts the work , any one of the parties may cancel the contract after giving notice to the other. However, after the manufacturer has started the work, the contract cannot be cancelled unilaterally. In Istisna’a, the party placing the order has the right to retract if the commodity does not conform to the specification demanded. In Istisna’a the price could be in advance or in installments or deferred but the time of payment should be fixed.

Istisna’a Financing Manufacturer Bank Client Istisna’a Financing Manufacturer Bank Client

Usage Of Istisna: Istisna can be used for providing the facility of financing in Usage Of Istisna: Istisna can be used for providing the facility of financing in certain transactions, especially in the housing finance. It is not necessary that the financier himself constructs the house. He can enter into a parallel contract of Istisna with a third party, or may hire the services of a contractor. In order to secure the payments of installments, the bank , as a security, may keep the title deeds of the house or land, or any other property , until the client pays the last installment. The instrument of Istisna may also be used for project financing on similar lines.

The Principles of Islamic Finance TAWAROQ Tawaroq is a financial product to satisfy customer The Principles of Islamic Finance TAWAROQ Tawaroq is a financial product to satisfy customer cash needs compliant with Shariah rules. Under such program the bank purchases certain goods on spot basis either from local or international markets and sells them to customers on credit. The customer in his turn resells the goods to a third party to obtain cash.

Tawaroq Financing Definition: Tawaroq means converting an asset into “wareq” or money. Offer & Tawaroq Financing Definition: Tawaroq means converting an asset into “wareq” or money. Offer & Acceptance Supplier (Seller) Offer & Acceptance Tawaroq Structure Customer (Buyer) Customer (Seller) 3 rd Party (Buyer) Sale Deferred payment (Ex. 110) Sale Spot payment (Ex. 100) Goods Inah Sale (Prohibited) Offer & Acceptance Supplier (Seller) Customer (Buyer) Offer & Acceptance Customer (Seller) Sale Deferred payment (Ex. 110) 15/03/2018 Goods Supplier (Buyer) Sale Goods Spot payment (Ex. 100) Goods 43

Tawaroq Financing Inah Sale (Prohibited) Purchase Contract (Deferred Payment Ex. SR 110) Supplier (2 Tawaroq Financing Inah Sale (Prohibited) Purchase Contract (Deferred Payment Ex. SR 110) Supplier (2 nd Party) Customer (1 st Party) Sale Contract (Cash Payment Ex. SR 100) End Result: SR 110 – SR 100 = SR 10 (Interest) 15/03/2018 44

Tawaroq Financing Tawaroq Structure (international Commodity) Purchase Contract Promise to Purchase Customer (1 st Tawaroq Financing Tawaroq Structure (international Commodity) Purchase Contract Promise to Purchase Customer (1 st Party) Sale Contract (Murabaha) Bank (2 nd Party) Agency Agreement Sale Contract Deferred Installment Payments Broker 1 (3 rd Party) Broker 2 (4 th Party) 15/03/2018 45

Tawaroq Financing Tawaroq Structure (Local Commodity) Purchase Contract Promise to Purchase Customer (1 st Tawaroq Financing Tawaroq Structure (Local Commodity) Purchase Contract Promise to Purchase Customer (1 st Party) Sale Contract (Murabaha) Bank (2 nd Party) Agency Agreement Sale Contract Deferred Installment Payments Local Supplier (3 rd Party) Broker 2 (4 th Party) 15/03/2018 46

The Principles of Islamic Finance Thank You The Principles of Islamic Finance Thank You