Moreover, Islamic financing prohibits engaging in contractual agreements with uncertainty. The law demands that all parties entering into any contract must be fully aware of the true nature of such a transaction. Furthermore, business transactions that depend on speculation are forbidden by Shariah. Consequently, according to the Sharia, returns from a business venture should only be derived from the efforts of the parties involved in the transaction. Shariah prohibits guarantee of a fixed return on an investment, the parties must assume some risk in a transaction.
Islamic financing structures
Ijarah is a lease agreement where the lessor assumes ownership of an asset for a specific time period and pays the agreed fee for the duration. The leased item must retain constant value over the lease duration the term of the lease. Consumable items are therefore not permissible in such transactions. The lessor covers maintenance and insurance costs of the assets throughout the period of the agreement.
The lessor may also exercise their right to purchase the asset at the end of the lease period (Ijarah muntahiya bi-tamlik). This type of Islamic financing structure is similar to conventional hire purchase contracts. Assets that may be used in this mode of financing include capital assets such as vehicles and land.
Murabaha - Cost-plus financing / buy-sell arrangement
In this transaction the borrower asks the lender to purchase an asset on the premise that the borrower will eventually purchase the asset at a higher price. Repayment can be done in a lump sum or by instalments. The lump repayment is known as Bai' Bithaman Ajil - or deferred payment sale agreement. On completion of such a transaction all land titles are transferred to the borrower. For such a transaction to be valid all parties must have been fully aware of the conditions and the asset in question must not be haram.
Bai' al-Inah - Sale and buy-back
Under this transaction the borrower purchases an asset from the lender on a deferred payment basis. The asset is then resold immediately to a lender for cash at a discount. This mode of financing is normally used to mitigate against insolvency of the lender after the transaction.
Commission to manufacture (Istisna)
An Istisna is an agreement for the sale of assets that are to be manufactured in accordance with an agreed specification. The sale price must be fixed in advanced, but payments can be made in a single lump sum or in instalments. Until the assets or title to them are delivered to the purchaser at completion, risk in the assets remain with the seller. Islamic project financing deals often employ single Istisna or parallel Istisna structures. In a single Istisna structure, the financier commissions the customer to build the asset. Upon delivery, the customer enters into a lease and purchase arrangement with the financier whereby the financier receives its return of principle and profit.In a parallel Istisna structure, the first Istisna involves the customer commissioning the financier to build the asset for a price set above the market price. The customer makes a downpayment and the remaining finance amount is usually deferred. The financier then enters into a second (parallel) Istisna with a contractor for the market price and provides the finance until completion. Upon delivery under the second Istisna, the financier in turn delivers the same asset to the customer under the first Istisna. The customer may continue to make instalment payments to the financier for an agreed period. The difference
Different rental amounts may be fixed for different rental periods. 6 in price between the first Istisna and the second Istisna represents the financier's profit.
Spot payment for future delivery (Bai Salam) Bai Salam is an upfront payment by the purchaser for Shariah compliant assets that the seller undertakes to supply to the purchaser at a date in the future. Although Istisna and Bai Salam appear similar, a key feature of Bai Salam is that the purchase price must be paid in full at the outset and the date for delivery must also be fixed. These are not requirements under an Istisna.
Musharakah - Partnership or joint venture financing
In this arrangement, a lender and a borrower agree to make a capital contribution towards the financing of an asset. The Parties further agree to share profits from the transaction at an agreed ratio before the actual transaction. Similarly any losses are shared at a proportionoal ratio to their initial contributions.
Tawarroq finance - Monetary finance
A Lender may also agree to purchase an asset on behalf of the borrower then sell it back to the former. The Borrower may later sell the asset to a third party buyer while repaying the lender in instalments.
Benevolent loan
A loan given ON goodwill basis is referred to as Qardul Hassan and attracts no interest. However the borrower may repay more than they actually borrowed.
Mudharabah - Profit sharing
Under Mudharabah a trustee who provides skill and expertise in managing assets for Islamic investors earn an agreed share of the profits. However, they cannot claim any right to the assets since they merely act as managers.
Salam or advance payment allows the purchaser agrees to make advance payment for asset/goods to be delivered at a future date. Such a payment must be made at the time of the agreement so as not to violate the sharia laws on debt accumulation. The assets must not include money. The exact date and place of delivery of the asset/goods must be specified in the agreement.
Conclusion & implications of shift to sharia banking
Islamic finance
Apr 10th 2012, 18:40 by The Economist online
THE global market for Islamic finance at the end of last year was worth around $1.3 trillion, according to the UK Islamic Finance Secretariat, part of the CityUK lobby group. The total value of sharia-compliant assets has grown by 150% since 2006. Globally, banks hold over 90% of Islamic assets, and together with funds are big investors in sukuk, a type of bond. According to the latest quarterly report from Zawya, a business information firm, global sukuk issuance in the first quarter of this year was $43.3 billion, almost half the total for the whole of 2011. The withdrawal of European banks lending to the Gulf Co-operation Council (GCC) region is thought to have contributed to this rise. Total issuance could reach $126 billion this year, continuing the growth trend (aside from a brief decline in 2008 associated with the global economic slowdown). Malaysia, which dominates the global sukuk issuance market, is over 60% Muslim, and Islamic banking assets make up around a quarter of the country's total. Globally, perhaps 12% of Muslims use Islamic financial products, but with other countries (predominately Muslim or with large Muslim populations) expressing interest in increasing services, the market seems likely to continue to grow.
Conclusion
The growth of Islamic financing in the past decade has been stellar. Given the large amounts of cash available in the oil rich Middle-East, it is likely that the growth of Islamic financing will continue. Moreover, as investors in the Middle-east look to break-out an invest elsewhere; it is certain that governments around the world will need to familiarize themselves with the principal concepts of Islamic financing, and to regulate for such, if they wish to take advantage of this growth industry.
