In an Islamic mortgage transaction, instead of lending the purchaser an amount of money to buy a certain product, a bank could buy the item itself from the seller, and re-sell it to the buyer, but with profit of course, while giving the buyer the chance to pay the bank in installments. The bank's profit cannot be made explicit and therefore there are no additional penalties for late payment. In order for the bank to protect itself against default the goods or land is registered to the name of the buyer from the start of the transaction. This is what is known as Murabaha.
Murabaha, sometimes referred to as mark-up or cost plus financing. The financial institution purchases the goods for the customer, and re-sells them to the customer on a deferred basis, adding an agreed profit margin.
http://www.hmrc.gov.uk/ria/4-alternative-finance-products.pdf
Ijarah concept in general means selling the benefit of use or service for a fixed price or wage. Under this concept, the Bank makes available to the customer the use of service of assets or equipments such as plant, office automation, motor vehicle for a fixed period and price.
EIjara wa EIqtina, is similar to real estate leasing. Islamic banks handle loans for vehicles in a similar way (selling the vehicle at a higher-than-market price to the debtor and then retaining ownership of the vehicle until the loan is paid).
Ijara, is the Islamic equivalent of a conventional lease. There are several variations on this structure, one important form being ijara wa'iqtina. Ijara wa'iqtina is similar to a hire purchase agreement; the financial institution buys goods, rents them to the customer and transfers the goods to the customer in exchange for a defined terminal payment.
http://www.hmrc.gov.uk/ria/4-alternative-finance-products.pdf
Advantages of Ijarah
Ijarah provides the following advantages to the Lessee:
Ijarah conserves the Lessee' capital since it allows up to 100% financing.
Ijarah gives the Lessee the right to access the equipment on payment of the first installment. This is important as it is the access and use (and not ownership) of equipment that generates income.
Ijarah arrangements aid corporate planning and budgeting by allowing the negotiation of flexible terms.
Ijarah is not considered Debt Financing so it does not appear on the Lessee' Balance Sheet as a Liability. This method of "off-balance-sheet" financing means that it is not included in the Debt Ratios used by bankers to determine financing limits. This allows the Lessee to enter into other lease financing arrangements without impacting his overall debt rating.
All payments towards Ijarah contracts are treated as operating expenses and are therefore fully tax-deductible. Leasing thus offers tax-advantages to for-profit operations.
Many types of equipment (i.e computers) become obsolete before the end of their actual economic life. Ijarah contracts allow the transfer of risk from the Lesse to the Lessor in exchange for a higher lease rate. This higher rate can be viewed as insurance against obsolescence.
If the equipment is used for a relatively short period of time, it may be more profitable to lease than to buy.
If the equipment is used for a short period but has a very poor resale value, leasing avoids having to account for and depreciate the equipment under normal accounting principles
Ijarah thumma al bai' (hire purchase)
Parties enter into contracts that come into effect serially, to form a complete lease/ buyback transaction. The first contract is an Ijarah that outlines the terms for leasing or renting over a fixed period, and the second contract is a Bai that triggers a sale or purchase once the term of the Ijarah is complete. For example, in a car financing facility, a customer enters into the first contract and leases the car from the owner (bank) at an agreed amount over a specific period. When the lease period expires, the second contract comes into effect, which enables the customer to purchase the car at an agreed to price.
The bank generates a profit by determining in advance the cost of the item, its residual value at the end of the term and the time value or profit margin for the money being invested in purchasing the product to be leased for the intended term. The combining of these three figures becomes the basis for the contract between the Bank and the client for the initial lease contract.
This type of transaction is similar to the contractum trinius, a legal maneuver used by European bankers and merchants during the Middle Ages to sidestep the Church's prohibition on interest bearing loans. In a contractum, two parties would enter into three concurrent and interrelated legal contracts, the net effect being the paying of a fee for the use of money for the term of the loan. The use of concurrent interrelated contracts is also prohibited under Shariah Law.
Ijarah-wal-iqtina
A contract under which an Islamic bank provides equipment, building, or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the promise does not become an integral part of the lease contract to make it conditional. The rentals as well as the purchase price are fixed in such manner that the bank gets back its principal sum along with profit over the period of lease.
There are several other approaches used in business transactions. Islamic banks lend their money to companies by issuing floating rate interest loans. The floating rate of interest is pegged to the company's individual rate of return. The bank's profit on the loan is equal to a certain percentage of the company's profits. Once the principal amount of the loan is repaid, the profit-sharing arrangement is concluded. This practice is called Musharaka an innovative approach applied by some banks for home loans, called Musharaka al-Mutanaqisa, allow for a floating rate in the form of rental. The bank and borrower form a partnership entity, both providing capital at an agreed percentage to purchase the property. The partnership entity then rents out the property to the borrower and charges rent. The bank and the borrower will then share the proceeds from this rent based on the current equity share of the partnership. At the same time, the borrower in the partnership entity also buys the bank's share of the property at agreed installments until the full equity is transferred to the borrower and the partnership is ended. If default occurs, both the bank and the borrower receive a proportion of the proceeds from the sale of the property based on each party's current equity. This method allows for floating rates according to the current market rate such as the BLR (base lending rate), especially in a dual-banking system like in Malaysia.
Musharaka financing, a partnership agreement. A common form is diminishing musharaka where the partners jointly acquire an asset. The financier's share of the asset decreases through periodic payment containing elements of capital repayment and rent from the other partner, who eventually becomes the sole owner.
http://www.hmrc.gov.uk/ria/4-alternative-finance-products.pdf
Mudaraba is venture capital funding of an entrepreneur who provides labor when the bank provides financing so that profit and risk are both shared.Similar arrangements between capital and labor show well the Islamic view that the borrower must not take alone all the risk and cost of a failure, resulting in a balanced distribution of income and forbidding lender to monopolize the economy. Mudaraba is a contract that has no time limits, so that the borrower could use cash whenever he was in need for it. This contract consists of lending an amount of money for a person to work with, and then give him in return certain percentages of profit. If the business failed, the money owner bears the consequences (Basics of Islamic banking systems chp. 2-p 55, dr, Sadek Rashed Al Shamry).
Bai' al-inah (sale and buy-back agreement)
The bank would be selling an asset to the customer on a deferred-payment basis, and then the asset is immediately re-bought by the financier for cash at a discount. The buying back agreement allows the bank to assume ownership over the asset in order to protect against default without explicitly charging interest in the event of late payments or insolvency.
http://www.azmilaw.com/Article/Article_8_&_9/Article_9_Tawarruq_00093603_.pdf
Nomani, Farhad; Rahnema, Ali. (1994). Islamic Economic Systems. New Jersey: Zed books limited. pp. 99-101. ISBN 1-85649-058-0.
Bai' bithaman ajil (deferred payment sale)
This concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit margin agreed to by both parties. This is similar to Murabahah, except that the debtor makes only a single installment on the maturity date of the loan. By the application of a discount rate, an Islamic bank can collect the market rate of interest
Bai muajjal (credit sale)
Literally bai muajjal means a credit sale. Technically, it is a financing technique adopted by Islamic banks that takes the form of murabaha muajjal. It is a contract in which the bank earns a profit margin on the purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in installments. It has to expressly mention cost of the commodity and the margin of profit is mutually agreed. The price fixed for the commodity in such a transaction can be the same as the spot price or higher or lower than the spot price. (Deferred-payment sale)
Musawamah
Musawamah is the negotiation of a selling price between two parties without reference by the seller to either costs or asking price. While the seller may or may not have full knowledge of the cost of the item being negotiated, they are under no obligation to reveal these costs as part of the negotiation process. This difference in obligation by the seller is the key distinction between Murabaha and Musawamah with all other rules as described in Murabaha remaining the same. Musawamah is the most common type of trading negotiation seen in Islamic commerce.
Bai salam
Bai salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. 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, Bai Salam covers almost everything that is capable of being definitely described as to quantity, quality, and workmanship.
Hibah
This is a token given voluntarily by a debtor to a creditor in return for a loan. Hibah usually arises in practice when Islamic banks voluntarily pay their customers a 'gift' on savings account balances, representing a portion of the profit made by using those savings account balances in other activities.
It is important to note that while it appears similar to interest, and may, in effect, have the same outcome, Hibah is a voluntary payment made (or not made) at the bank's discretion, and cannot be 'guaranteed.' However, the opportunity of receiving high Hibah will draw in customers' savings, providing the bank with capital necessary to create its profits; if the ventures are profitable, then some of those profits may be gifted back to its customers as Hibah
"Learn more about Islamic Banking - Returns on deposits are competitive". RHB Banking Group. 2006-05-17. http://www.rhbislamicbank.com.my/index.asp?fuseaction=learning.details&recID=77. Retrieved 2009-03-26.
Qard hassan/ Qardul hassan (good loan/benevolent loan)
This is a loan extended on a goodwill basis, and the debtor is only required to repay the amount borrowed. However, the debtor may, at his or her discretion, pay an extra amount beyond the principal amount of the loan (without promising it) as a token of appreciation to the creditor. In the case that the debtor does not pay an extra amount to the creditor, this transaction is a true interest-free loan. Some Muslims consider this to be the only type of loan that does not violate the prohibition on riba, since it is the one type of loan that truly does not compensate the creditor for the time value of money.
http://www.irfi.org/articles/articles_301_350/is_islamic_banking_islamic.htm
2. AL-WADIAH (Current/Saving Account)
Al Wadiah refers to funds deposited with a depository (the Bank) for safekeeping. Wadiah is a "trust", whereby the depository becomes the guarantor or custodian and guarantees the repayment of the entire deposit upon demand. Deposits are placed in trusteeship with the Bank. You appoint a Bank as the trustee and guarantor for the safekeeping of your deposit. While your money is under the Bank's responsibility, the funds will be placed in investments that are within the Syrian guidelines. The Bank will guarantee the full payment of such funds or part thereof whenever needed.
http://www.managementlinks.com.my/finance_workshop.htm
Sukuk (Islamic bonds)
Sukuk is the Arabic name for a financial certificate but can be seen as an Islamic equivalent of bond. However, fixed-income, interest-bearing bonds are not permissible in Islam. Hence, Sukuk are securities that comply with the Islamic law (Shariah) and its investment principles, which prohibit the charging or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and non-tradability in the secondary markets.
Sukuk, which is at its simplest a certificate (sakh) that evidences a share in the beneficial ownership of particular assets. The holder of the certificate is paid a return that is their share of the income generated by the assets. The issue of the sukuk obtains funding and can 'securitise' assets
http://www.irfi.org/articles/articles_301_350/is_islamic_banking_islamic.htm
Takaful (Islamic insurance)
Takaful is an alternative form of cover that a Muslim can avail himself against the risk of loss due to misfortunes. Takaful is based on the idea that what is uncertain with respect to an individual may cease to be uncertain with respect to a very large number of similar individuals. Insurance by combining the risks of many people enables each individual to enjoy the advantage provided by the law of large numbers.
Wakalah (power of attorney)
This occurs when a person appoints a representative to undertake transactions on his/her behalf, similar to a power of attorney.
Wakala, a form of agency agreement. The financial institution promises a return to the investor. The financial institution keeps any return over and above that which has been promised to the investor as their agency fee.
http://www.hmrc.gov.uk/ria/4-alternative-finance-products.pdf
