Islamic Banking Products &

Services
Developed & Copyrighted by
Emirates Institute for Banking & Financial
Studies
Moin Rahman (CTP)
Moin has over 15 years of experience in Training, Banking, and
Insurance and as Consultant to various financial institutions in region.
His rich and varied cross functional exposures includes assignments in
Islamic banking operation, due diligence, product structuring,
managing projects of shari’ah advisory, consultation, auditing, review,
business development (takaful & conventional insurance) as well as
technology related projects such as smart card solutions and
management of banking software among others.
He has led and managed various assignments in these functions
across markets in gulf and South East Asia with reputed companies
such EmiratesNBD, Citi Islamic, Maritime Management Company
(MMC) and Arya Insurance Brokerage LLC (Bayzaat) among others. He
was part of the team that was responsible for launching chip card
solutions by Network international (EmiratesNBD) and was key person
for ensuring Shari’ah compliance requirements for various sukuk
offering by Citibank as consultant. He also developed comprehensive
Islamic banking training module for Citibank staff. He was also
recognized and awarded by Arya insurance for consistently meeting
team goals.
He holds Masters in Islamic banking and finance from prestigious
International Islamic University Malaysia (IIUM) and another Master’s
in Computer Application (MCA) from Pune University. He is accredited
by FAA as Certified Training Professional (CTP)
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 Training Timings: 8:30 AM – 2:30 PM
Breaks : Two breaks in between for around 15min

Course Material
Available on the Moodle LMS for download

GROUND RULES:
Attendance Policy:
 Attendance will be marked in 3 sessions
 Attendance will be marked within 15 min from start of the
session.

Denial of Certificate (EIBFS Policy agreed with Banks)

 Being late more than 15min in a 1 day program
 Absent for more than 1 session in a 2/3 days program

Assessment & Evaluation

 At the end of the program trainer will conduct an
assessment and feedback will be shared with the Banks
 Participants need to research about Islamic retail products
 Online quizzies

Any Support/Issues
3
Any issues regarding Registration, Attendance please contact
 LEARNING OUTCOMES:

• After the completion of this course, the learners would be able to understand:
• Demonstrate clear understanding of Islamic Financing concepts and legal and sharia framework of
Islamic banking operations
• Discuss the structure and mechanism of Islamic financing techniques and suggest suitable
Shari’ah contracts to suit customer financing needs
• To understand the structuring of Islamic retail banking products and the operational functions &
process of offering Islamic finance products
• Explain the types of Islamic Banks deposits and highlight the process of fund management in
Islamic banks in contrast to conventional banks

LEARNING METHODOLOGY:
Lectures, discussions, case studies, assessments

ASSESSMENT STRATEGY:
• Summative – End of course exam / Case studies/ online quizzies
• Formative - Group Discussion/participation / feed back/ Class observation rubrics

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Please introduce yourself here:
https://padlet.com/rahman_moin/ppud5ajeumxf

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What is Islamic Finance?

Islamic Finance
An ethical and equitable mode of finance that derives
its principles from the Islamic law. (the shari’ah).
Faith-Based

Ethical Equitable

Islamic
Finance

Islamic Bank
Islamic banks are business, which aim to make profit within the
constraints of Islamic law; by undertaking profit-sharing
projects, trade-financing, lease financing and providing fee-
based services.

6
Course topics

Shariah Contracts
Islamic Finance Compliance and used in financial
Concepts Regulation Transaction

Islamic Finance Deposit

Deposit and Fund
&Fund
Fund
Islamic Finance
Evolution Islamic Products Deposit and
Management
Management
Management
Evolution
How Islamic Finance work

8
Basic Principles

 Money is regarded as a measure of value rather than as asset itself

 Interest on loans (referred to as “riba”) is not allowed
 However profiting from the trade of assets within the parameters of Shari’a (i.e., Islamic law) is permitted
Basic principles of
Islamic Finance  Islamic financial transactions are structured so as to be underpinned some Shari’a compliant asset
transaction where the return to the financier comes from rent or profit from that underlying transaction
 Conventional benchmarks (e.g. LIBOR) may be used to benchmark profit/ rent in Islamic financial
transactions

 Tangible assets (real property, moveable property)

What are assets?  Intangible assets (e.g. minutes of mobile airtime, electricity, contractual rights, other intangibles with an
measurable economic value)

 Asset purchase, sale or leasing transactions

What is Permissible?  Trading of goods (e.g. commodities)
 Investment in Shari’a compliant equities, real estate or other assets

 Receipt of interest – making money from money

What is not  Investment in certain prohibited industries (e.g. gambling, alcohol, tobacco)
Permissible?
 Contracts purely of a speculative nature

Removing speculation and creating value-enhancing and sustainable activity

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Islamic Finance – General Instructions

Lawful
Lawful
investments
investments

Asset
Asset
Trading
Trading

Lawful Profit and

Investment Loss
s Sharing
Sanctity
Sanctity
Key Principles – of
of
Islamic Finance Contracts
Contracts

Asset Sanctity of
Trading Contracts

Profit/Loss
Profit/Loss
Sharing
Sharing

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Islamic Finance – General Prohibitions

Elimination
Elimination of
of
Uncertainty
Uncertainty &&
Speculation
Speculation
(Gharar)
(Gharar)
Prohibition
Prohibition
of
of Money
Money Elimination
Trading
Trading
Prohibition of
of Interest Uncertainty
and
(Riba) Speculation
(Gharar)
Prohibition
Prohibition
Key Principles – of
of Interest
Interest
Islamic Finance (Riba)
(Riba)
Prohibition
Prohibition
of Chance
of Money
Game
Trading
(Maysir)

Prohibition
Prohibition
of
of Chance
Chance
Game
Game
(Maysir)
(Maysir)

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Islamic Finance is the outcome of CSR derived from religion and applied to banking

Co esp
rp on
R
e

or si
at ce

at bi
Accountability to God r
o

e S lit
orp rnan “More-than-profit”

oc y
C ve Ethical mentality

ial
go
profits
(rather than “profits-at-
any-costs”)

Business ethics

Shari`a “code of ethics”

Islamic Finance is capitalism with a moral compass

Fajr Capital | 12
Course topics

Islamic Finance Shariah Contracts used

Shariah Compliance in financial Transaction
Concepts & Regulation

Islamic Banking Islamic Finance Islamic Retail Deposit & Fund

Model Evolution Products Management
The industry has developed a comprehensive product offering over
its young history

Development of industry Evolving richness in products

− Development of theoretical framework

1950s
1950s − Muslim-majority nation independence structured
products Debt issues
− Egypt and Malaysia pioneering institutions
60s
60s − Establishment of OIC (1969)
insurance
− Islamic Development Bank (1974) and DIB 2000s 1970s
70s
70s − One country-one bank setup
− Advancement of Islamic products
private
− Institutions like Shamil & Baraka. Growth of equity
80s
80s 1990s 1980s
commercial banking with concentration on on syndications
Murabaha+ Ijarah and Istisna transactions
90s
90s − Entry of global institutions e.g. HSBC Amanah project
−
finance structured
Tipping point reached in some markets
00s
00s − Development of industry-building institutions
equity and trade finance

Industry has near like-for-like parity with conventional offering

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In all, the Islamic finance industry is developing a global reach…

Growth Engine

Awakening

Ripe for Growth

Future Markets Source: Standard and Poor’s “The Globalization of Islamic Finance”

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The development of the Islamic finance industry has been fueled by
pioneering institutions and industry building organizations

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Course topics

Shariah Contracts
Islamic Finance Shariah Compliance used in financial
Concepts & Regulation Transaction

Islamic Banking Islamic Finance Deposit & Fund Practical

Evolution Management Implications
Model
 AAOFI

IIFM IFSB

Shari’ah
Board

EIBFS/Islamic Banking 18
 Guidance and Regulation of Islamic Finance

• AAOIFI: The Accounting and Auditing Organization for Islamic Financial Institutions is
an Islamic international autonomous non-for-profit corporate body that prepares
accounting, auditing, governance, ethics and Shari'ah standards for Islamic financial
institutions and the industry.
• http://www.aaoifi.com/
• IFSB: The Islamic Financial Services Board is an international standard-setting
organization that promotes and enhances the soundness and stability of the Islamic
financial services industry by issuing global prudential standards and guiding principles
for the industry, broadly defined to include banking, capital markets and insurance
sectors.
• http://www.ifsb.org/
• IIFM: International Islamic Financial Market is a standard-setting body of the Islamic
Financial Services Industry (IFSI) focusing on standardization of Islamic financial
contracts and product templates relating to the Capital & Money Market, Corporate
Finance and Trade Finance segments of the IFSI.
• http://www.iifm.net/

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 Islamic Banking Regulation- The UAE Legal Framework

 Islamic banks in the UAE are subject to Federal Law No. 6 of 1985 regarding
Islamic Banks, Financial Institutions and Investment Companies.
 All banking institutions including the Islamic ones are subject to the same
monitoring and compliance criteria by the UAE Central Bank.
 In addition to this, Islamic financial institutions are subject to Shari’ah Supervision
and Monitoring by Shari’ah Supervision Authority of minimum three scholars
established by the institution and approved by a government authority.
 UAE Federal Law No. 5 of 1985 Concerning Civil Transactions (the ‘Civil Code’),
has a strong Shari’ah foundation which supports the proper regulation of Islamic
financial mechanisms.

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Role of Religious Supervisory Board in Islamic Finance

• The Religious Supervisory Board, or “Shari’ah Board” consist of scholars

of the Islamic law, who fulfill the function of independent consultants in
advising Islamic banks on whether their transactions are in accordance
with shari’ah rules. The role of the Board includes but not limited to the
following:
Supervise the shari'ah compliance of all the transactions in the bank.
Analyze, advise and direct the bank on day-to-day emerging situations
reported by different departments, branches or customers to ensure shari'ah
compliance.
Supervise and approve the development of shari’ah compliant procedures.
Certify shari'ah compliance of bank's product documents, contracts and
agreements.
Prepare an annual report on the bank's shari'ah compliance.

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Course topics

Shariah Shariah Contracts

Islamic Finance Compliance & used in financial
Concepts Regulation Transaction

Islamic Banking Islamic Finance Practical

Islamic Banking Deposit & Fund
Model Evolution Implications
Model Management
 Islamic Banking Model

Islamic Banks
Avoid dealing in prohibited interest

Direct all their activities towards lawful ventures

Disallow lending money to money

Generate wealth through legitimate trade and investment

Advance funds to fund takers on the basis of partnership, sales or lease contracts

EIBFS/Islamic Banking 23
 Islamic VS Conventional Banking Model

• Sources of Funds • Sources of Funds

• Current Accounts; deposits are • The bank takes all the risks and
guaranteed by the bank but earn no guarantees the deposits and a pre-
income. specified return.
• Profit Sharing Accounts: Depositors
share the risk and return with the • Uses of Funds:
bank. • Financing is debt-based.
• Returns are not guaranteed; • Borrowers are required to pay
depends on the bank’s performance. interest on loans, independent of the
• Uses of Funds: return on their project.
• The bank shares the earning risk in • The Bank transfers or otherwise,
equity-based contracts and take mitigate the credit risk through
credit and transaction risks on other securitization or hedging.
contracts, without the use of
conventional hedging instruments.

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 Sources of Income for an Islamic Bank

Profit sharing from partnership Profit margin from sales contract

contracts
Sources of Income
for an Islamic Bank

Rental income from ijarah Service charges

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Course topics

Shariah
Islamic Finance Compliance & Shariah Contracts
Concepts Regulation Used in Financial
Transaction

Islamic Banking
Islamic Banking Islamic Finance Deposit & Fund Practical Implications
Model Evolution Management
Model
 Parameters for Shari'ah-compliance Contracts

Sanctity of Contract Elements of Contract Purpose of Contract

No Unlawful Products
Mutual Consent No Interest
Lawful objectives/purpose
 No coercion, fraud, misrepresentation No Gambling
No Speculation

To be shari'ah compliant a contract must be permissible and valid in terms of

FORM and SUBSTANCE

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 Islamic Financing
Techniques

Partnership Lease Contract

Sales Contract Services
Contracts (Ijarah)

Musharakah
Mudarabah Murabahah Lease for Ready wakalah
Profit and loss good/service
Profit sharing Cost plus Sale Agency
sharing

Salam Kafalah
Restricted Permanent Forward Lease
Pre-poduction Sale Guarantee

Istisna’a
Sale and Lease
Unrestricted Diminishing Pre-construction Back
Sale

Lease end with

ownership

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Elements of Valid Sale
DEFINITION OF SALE

• Exchange of a thing of value with another thing of value with mutual consent.
• The sale of a commodity in exchange of cash

VALID SALE
 A sale is valid if all elements together with their conditions are present
 Contracting Parties (Buyer and seller): must be Sane and Mature
 Offer and Acceptance: Present, Sale must be non-contingent / Sale must be
immediate
 Subject matter: Existing, Valuable, Usable, Capable of ownership / title,
 Capable of delivery / possession, Specific & Quantified, Seller must have title
& risk
 Price: Quantified , Specified & certain

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 Murabahah

 The word Murabahah is derived from the Arabic word Ribh which means profit.

 Murabaha is a Shariah-compliant Islamic Finance structure that involves a kind

of sale, where the seller honestly declares the cost he has incurred on the
commodity, and sells it to the buyer at a cost-plus-profit rate.

1.Sale of 3. Sale of assets

assets to the to the customer
bank

Seller Islamic Bank Client

Rem: payment is often

2. Payment of 4.Payment of purchase made on a deferred
purchase price price plus margin lump sum basis or an
installment basis

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Murabahah, cont’d
• Murabahah is a kind of asset sale recognized in Islamic finance
• The Purchaser requires financing for the purchase of some asset
• The Financier acquires the asset from the supplier and on-sells to the
Concept Purchaser on a cost-plus-profit basis
• The profit component must be determined up-front – Murabahah is
therefore not suited to floating rate financings
• Payment is deferred
• Has value
• Exists at the time of sale
Characteristics • Is not prohibited
• Is owned and is in physical or constructive possession of the seller at the
time of sale
• Murabahah is generally used for equipment finance, consumer finance
and working capital finance.
• In south-eastern countries Murabahah is also used in Islamic bonds and
Applications Islamic fund management.
• Murabahah is also extensively used in treasury placements and
financings and it is also used in Sharia compliant hedging

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Murabaha, cont’d

• Late payment fees are permissible to collect, but once collected must be
donated to charity
• Rescheduling of payments is not allowed if it results in extra charge to the
customer; however, rescheduling can be agreed upon keeping the
outstanding payment constant.
After the Sale • Once total sales price is fixed, it cannot be changed
• A discount may be given for early payment, but such is voluntary by the
seller
• Deferred payments may be accelerated upon default

• The profit amount is agreed upon up-front as a fixed amount – it may be

Notes
quantified in absolute terms or as a percentage

• Goods Murabaha
Types of • Commodity Murabaha
Murabahah

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Goods Murabaha
• The Bank appoints the Purchaser as its disclosed/undisclosed agent to
purchase Goods from a third party vendor and subsequently will issue an
Offer to the Purchaser so that the purchased Goods can be sold to the
Description Purchaser.
• Notice should be taken that the Goods should not be already in ownership
of the Purchaser as a sale and sale back will not be acceptable from
Shariah perspective (mostly from the middle – eastern shariah scholars)
from the same entity.

• Banks use this financing method to finance manufacturers by facilitating

them in purchasing raw materials.
Application • Banks generally also use it for the import finance wherein the Bank
purchases the Goods from the exporter and sells the same to the
importer.

1. Appointment of Purchaser as
Third Party
his agent and issuance of
Purchaser 2
purchase offer
2. Purchaser gets the goods from
third party in exchange for
Diagram 1 purchase amount.
3
3. Bank sells the goods to
purchaser as customer in return
for deferred payment.
Financier 33
Goods Murabahah - video presentation

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Commodity Murabaha ( Personal Finance mechanism)

• Commodity Murabahah is a particular kind of Murabahah transaction

where the asset being transacted is generally a commodity with an
Concept exchange or trade value (e.g. palladium)
• It is used where the client requires cash financing or where floating rate
financing is required in the Murabahah context

Commodity Client
Broker 1

3. Sale of
commodities
on spot basis
1. purchase 2. Sale of
of commodities
Diagram commodities on deferred
basis Commodity
Broker 2

Financier

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Commodity Murabaha

• Financier purchases commodities from the Broker 1

• Financier sells the commodities to the Client on a deferred payment basis
Description
• Client sells the commodities to the Commodity Broker 2 on a spot basis
and applies the cash to its requirements

• Banks use this financing method to purchase assets by using metals

(such as copper)that they sell to their clients on a cost-plus basis.
• It is also used in working capital finance, personal finance, Islamic credit
cards etc.
Application
• It is also used as a liquidity management scheme by many banks (dealing
with overnight and short-term deposits), which use commodities like crude
palm oil as the underlying commodity traded for investment.

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Ijara

Definition of Ijara (Leasing)

The term Ijarah (Leasing) in Arabic literally means to give something on

rent.
 Ijarah contract is an agreement wherein a lessor leases physical asset
or property to a lessee who receives the benefits associated with
ownership of the asset against payment of predetermined rentals .
Ijara is for a known time period called ijarah period.
Ijarah is comparable (but not identical) to conventional leasing contract.

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Ijarah video presentation

38
 SALIENT FEATURES OF THE IJARA CONTRACT

1. Asset to be leased must have a valuable use that is compliant with Shari’a.
2. Asset to be leased must not be consumable. That is, it can be returned to the lessor in its
original form at the end of the lease period. Normal wear and tear is accepted.
3. Ownership of the asset remains with the lessor and only the usufruct is transferred to the
lessee. Usufruct means the right of using another’s property for profit, without spoiling its
substance.
4. Liabilities and risks incidental to ownership will reside with the lessor.
5. Period of the ijarah arrangement must be clearly specified
6. Purpose and mode of usage should be agreed upfront
7. Lessee is liable for damage to leased asset only to the extent of the lessee’s negligence.
8. Lessee does not guarantee the safeguarding of the leased asset nor indemnifies the lessor
of damages
9. Rental payment must commence after the delivery of the leased asset either actually or
constructively (e.g. give keys to house)
10.Upon loss or non-existence of usufruct, the ijarah contract is terminated

39
Ijara (Lease)
• “Ijara” means “lease” and refers to financing where the return to the
Financier comes from rentals on some asset owned – legally or
Concept beneficially - by it.
• Ijara refers to sale of the usufruct
6 1.Promise to Lease
2. Purchase Offer
3. Acquisition of the
property through
2 purchase agreement.
Diagram Client 1
Financier
3
Vendor 4. Purchase Price
5. Lease of the
Property to the
customer through
Lease Agreement
4
5 6. Lease Rental

• Financier purchases some asset from a Vendor (e.g. for $100)

• Financier leases that asset to the Client in exchange for rentals
payments. The rental payments can be fixed or benchmarked to some
reference rate (e.g. LIBOR)
Description
• Client provides a unilateral Purchase Undertaking, under which it
undertakes to purchase the asset back from the Financier at par (i.e.,
$100) upon maturity
• Upon maturity, Client purchases asset from Financier
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Basic Rules of Leasing
• If the asset is destroyed ijara stands terminated.
Description • Late payments incur penalty which the Lessor must donate to charity

• Operating Lease (Simple Ijarah) ,

Types of • Lease to Own (Ijarah muntahiyah bittamleek) ,
Lease:
• Forward Lease (Ijara bi thimma)

• Transferring of benefits associated with the ownership of assets not

ownership
• To another person for an agreed price.
• Subject of lease: Valuable, Identified and Quantified. Consumable things
cannot be leased out
• All liabilities of ownership are borne by lessor (e.g., Insurance)
Rules of • Period of lease must be determined in clear terms at the time of contract
Leasing • Lease for specific purpose only: If no specific purpose is identified in the
agreement, then it can be used for any purpose for which it is used in
normal course.

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Basic Rules of Leasing and Application

• Ijara is generally used for Home finance, Car finance and Equipment
finance.
Application • Islamic leasing is a major activity for banks. Banks primarily use the Ijara
concept to finance high-valued equipment such as aircrafts; however, it is
also used to finance smaller items of equipment such as medical
equipment.

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Forward Ijara ( property under – construction mechanism)
• It is a leasing facility which allows bank to enter into an agreement to lease an
asset to the customer in the future even before the said assets is acquired or
Concept constructed
•The relationship between the bank and customer is of Lessor and Lessee

Description:
Customer 1.Customer enters into forward ijara agreement with
the specification of the asset included in the contract.

2.Customer shall be appointed as an agent to ensure

that all periodic major maintenance are done and
1 expenses pertaining to the ownership are paid
6
4 2 accordingly

3.The Bank will appoint a Contractor to construct the

asset under the Istisna Agreement.

Diagram 4.During the Construction period term, Customer

shall pay rental(advance rental) as per the agreed
terms
Islamic Bank
5.Upon completion of the asset, the Contractor will
deliver the Asset to the Bank
3
5 6.The Bank will then deliver the asset to the
Customer

•Upon expiry of the lease term and fulfillment of all its

Contractor obligations under the lease agreement, the Bank 43
shall transfer the ownership of the Asset to Customer
Istisna ( Construction / Manufacturing contract)
Literally, the Arabic word ‘Istisna’ means ‘asking someone to manufacture.
Istisna is a contract of exchange with deferred delivery and is applied to specified
made-to-order items.
Basic characteristics of Istisna is as follows:
a) the nature and quality of the item to be delivered must be specified.
b) the manufacturer must make a commitment to produce the item as described.
c) the delivery date is not fixed. The item is deliverable upon completion by the
manufacturer.
d) the contract is irrevocable after the commencement of manufacture except
where delivered goods do not meet the contracted terms.
e) payment can be made in one lump sum or in installments and at any time up
to or after the time of delivery.
f) the manufacturer is responsible for the sourcing of inputs to the production
process.

44
Istisna video

45
Istisna (Construction/ Manufacturing Contract)

• An Istisna contract is a construction and/or manufacturing contract,

whereby one party funds another to procure/ construct some asset
for it . This is the purchase of an item or equipment which is part of
Concept a project by an Islamic bank, accompanied by the sale-on of said
item to the customer on deferred payment basis. This structure –
typically combined with an Ijara – is often used in the project
finance context

Purchase price Purchase price plus

premium (deferred)

Diagram DEVELOPER/CONTRACTOR/
FINANCIER CUSTOMER
MANUFACTURER

Sale of developed Sale of developed

equipment/construction equipment/construction
46
Istisna (Construction/ Manufacturing Contract)

 Islamic banks can use Istisna for financing high-technology goods such as
ships, highways, etc.
 The Istisna contract can also be used to finance the manufacture of goods
Application or construction of houses, plants, projects, bridges, roads, and so forth.
The contract can also be drawn-up for real estate developments or on land
in which either the purchaser or the contractor owns the usufruct.
 Other applications of Istisna include housing finance schemes.

47
Salam ( Islamic Forward contract)
Salam In Islamic Finance means a contract in which advance payment is made for
goods to be delivered later on.
It is necessary that 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. Barring this, Salam covers almost everything that is capable of being
definitely described as to quantity, quality, and workmanship.

Purchase price Purchase price

(discounted) (plus premium)

SUPPLIER FINANCIER CUSTOMER

Sale of asset Sale of asset (delivery

(delivery deferred) deferred)
48
Salam, cont’d

• Salam is a sale whereby the Seller undertakes to sell some goods whose
specification is known to the Purchaser at a future date in consideration
of full payment on a spot basis.
Concept • Islamically acceptable forward contract.
• A key difference between Salam and Istisna (though not the only
difference) is that the object of a Salam contract is typically fungible (such
as commodities), whereas the object of an Istisna is something that needs
manufacturing/ construction.
• Salam sale is used for the finance of agriculture operations, where the
transaction occurs between the banks and the farmer, who is expected to
have the commodity in plenty during harvest.
Application • Salam sale is also used to finance commercial and industrial activities.
• Banks use Salam as a method to finance craftsmen and small producers
by providing them with production inputs.

49
Salam video

50
Difference between Istisna’ & Salam

Istisna Salam
• The subject on which transaction of • Subject can be non manufacturing
Istisna’ is based is always a thing things.
which needs to be manufactured. • Price has to be paid in full in
• Price must be fixed, but need not to advance
be paid in advance • Time of delivery is an essential part
• Time of Delivery does not have to be of the sale
fixed • The contract cannot be cancelled
• The contract can be cancelled before unilaterally post execution.
the manufacturer starts working.

51
 Wakalah (Agency)
• Wakalah is a contract of agency that performs work or a service(s) on the behalf of
another.
• The contract brings together an agent, a principal and a third party, wherein the
Concept agent serves as the intermediary.
• The agency establishes the relationship between the principal and third party for a
fixed fee.
• Wakalah is used by some Islamic Banks to manage funds on an off-balance sheet
basis.
• The contract is also more commonly used by Islamic mutual funds and finance
companies.
• Some Takaful contracts are based on the principles of Wakalah in order to maintain
Application the virtues of cooperation, solidarity and brotherhood, promoted in Islam.
• Wakalah is also used in syndication financing where one financial institution acts as
an investment agent for another participating financial institution, and enters into a
financing agreement with the customers

Investment Amount
Diagram
Agency fee Investment Amount
Principal Agency Third Party
Incentive
Agency Agreement

52
Musharaka ( Joint venture contract )

• Musharakah is a form of partnership(Shirkah).In Islamic Finance, it refers to

a joint enterprise between two partners with the profit/loss sharing method as
the basis for the partnership (as opposed to interest-bearing means).
• Partnership concept where both partners contribute capital and co-own the
assets of the partnership.
• Partners may share profits in any pre-agreed ratio, but must share losses in
proportion to capital contribution.

There are two types of Shirkah(Partnership):

1.Shirkat-ul-Milk
- Joint ownership of two or more persons in a particular property
2. Shirkat-ul-Aqd
- A partnership affected by mutual contract. It can also be translated as a
joint
commercial enterprise

53
Musharaka ( Joint venture contract )

• Musharakah is generally used for home financing

• Client can agree to buy the financiers’ shares in the Musharakah at pre-
agreed intervals and at a pre-agreed price
Applications
• Musharakah has also been used in Sukuk to co-own the underlying
property
• Musharakah is also used in import-export finance and infrastructure
project financing.

FINANCIER CUSTOMER

Diagram Share in Share in

Cash profits profits and Contribution in
contribution and losses kind (at least
losses 30%)

Musharakah

54
 Diminishing Musharakah

Another form of Musharakah developed in near past is ‘diminishing

Musharakah’. According to this concept a financier and his client participate
either in the joint ownership of a property or an equipment, or in a joint
commercial enterprise.
The share of the financier is further divided into number of units and its
understood that the client will purchase the units of the share of the
financier one by one periodically, thus increasing his own share till all the
Concept units of the financier are purchased by him so as to make him the sole
owner of the property or the commercial enterprise.
Three components of Diminishing Musharakah
 Joint ownership of the Bank and customer
 Customer as a lessee uses the share of the bank
 Redemption of the share of the Bank by the customer

Diminishing Musharakah is commonly used for the purpose of financing

of fixed assets by
various Islamic banks
Application  House financing
 Plant and machinery financing
 All other fixed Assets
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Mudarabah

Mudarabah is derived from the word ‘dharaba’ which means ‘traveling for trade’.
Mudarabah is a contract which involves one partner, the Rab-ul-Mal, investing in
an enterprise managed and run by another partner, the Mudarib. Unlike
Musharakah, the capital is only invested by one partner, while the enterprise is
run by the Mudarib, but losses are only borne by the Rab-ul-Mal.

Partner 1 Partner 2
(‘Rab al-mal’) Share in profits Fee (‘Mudarib’)
& losses (based on share profits)

Provides capital Mudaraba Provides expertise and

manages the capital

Project/Assets

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Mudaraba

• Partnership concept where one partner contributes capital and other

partner manages that capital
• Partners may share profits in any pre-agreed ratio, but losses must be
Concept borne by the partner who has contributed capital
• Mudarib only shares in profits and has no right to receive a fee/salary
• There are two types of Mudarabah, restricted and unrestricted

• Savings account is developed using the Mudarabah structure

• Some of the Islamic funds are also structured using Mudarabah.
Applications • It is also used in takaful and Sukuk structures.

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Questions: ‘Shariah Contracts Used in Financial Transactions’
• In order for a sale to be valid, the price of the item should be:
(a) Low and affordable
(b) Quantified and certain
(c) Variable and subject to change
• An Islamic financing technique that involves the financier acquiring an asset and selling it to the
purchaser at a cost-plus-profit basis is known as:
(a) Musharakah
(b) Salam
(c) Murabaha
• Khalid gave USD100,000/- to Ahmed to invest, in real estate. He also advised him that his
compensation will be 5% of the net investment amount. This contract can be classified as:
(a) Musharaka
(b) Mudaraba
(c) Wakalah
• In the Islamic Sharia, it is permissible to:
(a) Charge a person for the amount of cash credit extended to the customer
(b) Charge a person for the credit extended to the customer through a commodity
(c) Sell an asset, which a person is going to purchase tomorrow
• ‘Ijara in Islamic Finance refers to:
(a) The financier making returns on renting or leasing an owned asset
(b) Contributing a certain sum of money towards a common pool
(c) An islamically acceptable forward contract
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Course topics

Shariah
Islamic Finance Compliance & Shariah Contracts
Regulation Used in Financial
Concepts Transaction

Islamic Banking
Islamic Banking Islamic Finance Deposit & Fund Practical
Model Evolution Management Implications
Model
 Case Example: A Vehicle Murabahah

Vehicle Murabahah — Profit Calculation

Cost of the Car AED 150,000
Down payment AED 30,000
Murabahah Cost AED 120,000
Profit Rate 4%
Financing Period 5 Years
Profit Calculation 120,000 x .04 x5= 24,000
Murabahah Selling price (Total Financing Amount) 120,000 + 24000= 144,000
Murabaha Profit 144,000 –120,000 = 24,000
Monthly Installment 144,000/60 = 2,400

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Early Settlement

• Monthly installment of AED 2,400.

• Cost Settlement: 2,000 (120,000/60)
• Profit Settlement: AED 400 (24,000/60)
• After 3 years:
• Total profit payment of (400x36) AED 14,400
• Remaining Profit: (24,000–14,400) AED 9,600
• Bank offered 80% early settlement rebate, (9,600 x 0.80) = 7,680.
• Customer will pay to the bank (9,600–7,680) = AED 1,920.
• Remaining portion of the cost (2000 x 24) = AED 48,000.00

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Case Study – Calculation of Istisna profit by bank

• On January 1 2009 XYZ Islamic bank agreed to construct on an

istisna’a contract term, a factory building for its client.
• The total contract price is US$ 1,700,000 and is estimated to be
completed in 24 months with a contract cost estimated at US$
800,000.
• The cumulative costs incurred by end of year 1 were US$300,00
including pre-contract costs of US$45,000.
• Assuming all of these costs were paid off by cash record the journal
entries at end of year 1.

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Journal entries at end of year 1:

    DR. CR.

  Istisna’a work in progress 300,000  

  Cash   255,000

  Deferred Cost (being entry for cost for year1)   45,000

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Journal entries to reflect the profit for year 1:

    DR. CR.

 
Istisna’a accounts receivable 337,500  

 
Istisna’a revenue (being entry for revenue-profit   337,500
portion

1.Percentage completion = 300’000 / 800000 = 0.375

2.Profit for the year = 1700000 – 800000 = 900000 x 0.375 = 337,500

64
Course topics

Shariah
Islamic Finance Compliance & Shariah Contracts
Regulation Used in Financial
Concepts Transaction

Islamic Finance Practical

Islamic Banking
Islamic Banking Deposit and Fund Implication
Model Evolution Managements
Model
Islamic Banks Deposits

Current Account:
Saving Account:
Investment Deposits
• Mudaraba Fixed Deposit
• Murabaha Fixed Deposit
• Wakalah Fixed Deposit

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Qard ( Current account mechanism)

Definition:
Qard is an interest-free loan, used as a current-account arrangement
by Islamic Financial Institutions (IFIs).
Application:
 It allows the bank to use its customers’ current account as a loan for
investment or other purposes.
 The repayment of these deposits is guaranteed by the IFI to its
customer.
 Unlike the ‘Salaf’( a loan/deposit on a fixed-time basis) a Qard is
basically a demand deposit, that needs to be returned by the IFI to its
customer upon demand by the customer.

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Saving & Investment Deposits

• For the safekeeping of one’s surplus funds while providing a modest

return.
• The depositor (fund owner or rabb al maal) authorizes the bank (mudarib/
investor) to invest his/her funds according to the unrestricted mudarabah
contract.
• The bank as mudarib is entitled to a percentage of the realized net profit. It
has to bear any loss attributable to negligence or violation of mudarabah
terms.
• Investment deposit in an Islamic bank allows depositors to make
fixed deposits throughout the year at intervals of one, three, six,
nine, twelve months or more.
• Invest Deposits Types
 Mudarabah Fixed Deposit
 Murabaha Fixed Deposit
 Wakalah Fixed Deposit

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Steps in Fund Management

• The bank creates an investment pool.

• The depositors’ funds go to investment pool.
• The bank enters into a mudarabah agreement with the pool.
• The pool acts as capital provider (rabb al mal) and the bank as
mudarib.
• The bank as mudarib invests these funds into shari’ah
compliant assets / investments and the resulting profit is
distributed between the bank and the pool.
• The share of the pool is then distributed among the depositors
according to pre-defined ratios and weightages.
• Note: Use of weightage system for the distribution of profit

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 Investment Account in an Islamic Bank

Customer as Equity Holder Bank – Investment Manager

Profit

Pre-agreed profit
Islamic Accounting sharing ratio
Standards/EIBFS 70
 Case Study

Mudaraba Profit Distribution (Deposit Accounts - Liabilities for Islamic Banks)

Let us assume that an Islamic Bank receives a total of AED 20M from different categories of depositors. Fort he
calculation of profit each category is assigned a specific weightage.

A. Deposit Type Deposit Amount Weightage B. PROFIT DISTRIBUTION AED

Savings Account 5,000,000 0.2 Total Deposit   20,000,000
Term Deposit (1 Profit
month) 2,000,000 0.4 Distribution (Customer:
Term Deposit (3- Ratio (Mudaraba) 80:20 Bank)
month) 3,000,000 0.5
Term Deposit (6 Net Profit   500,000 (Annualized)
month) 4,000,000 0.6
Islamic Bank's Share (IBP) 100,000
Term Deposit (1 year) 6,000,000 0.7 Pool of
Depositors Share (PPr) ? 400,000
TOTAL 20,000,000  

a. Calculate pool of depositor's share (profit share )

b. Profit amount & rate based on account type / tenor
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