Concepts of Sharia’a

Objectives of Islamic Bank: to deploy public’s savings and direct it towards Sharia’a compliant investments, to contribute in comprehensive development of societies, i.e. and before that addition to its economic role, Islamic banking shall also take the charge as to social partnership enhancement.

In terms of its functionality, the Islamic banks, like conventional banks, deliver banking services against commissions and fees, and they also act as an intermediary for transferring funds from Savings Surplus Units (SSU) to Savings Deficit Units (SDU) aiming at generating income.

CONCEPT OF ISLAMIC BANKING:

Important concepts need to be considered in Islamic Bank:

• Islamic bank is neither a lender nor a borrower, and its income is not from funds mobilization by borrowing and lending.

• Islamic bank is a trader, a landlord or a lessor/lessee, a manufacturer, a manager, carrying asset-backed transactions for asset the acquisition, selling and leasing such assets and services.

THE DIFFERENCE BETWEEN ISLAMIC BANKING AND CONVENTIONAL BANKING:

The difference between the two concepts is substantial and significant. The difference lies in the contract structure through which funds are moved from SSU to SDU. The tools in conventional banks are the interest-bearing-loan contracts. i.e. lending and borrowing, taking and giving interest. So, Principal and Return are secured. 

• The mobilization of funds in Islamic Banks is underpinned by Sharia’a contract.
  • The subject of contract must be a commodity, a property or a service permissible in itself and permissible to be disposed of for Sharia perspective.
  • and consequently risk-sharing and profit sharing, to justify the entitlement of profit.

CONVENTIONAL BANK

1. Conventional bank borrows funds from depositors and lends to clients at predetermined interest rates, secured along with the finance amount.
2. Bank holds sole authority to increase lending rates or decrease the borrowing rates without reference to the borrowers or lenders.
3. Conventional banks not permitted to trade with depositors’ funds but are only allowed to lend them.

ISLAMIC BANKS 

1. Islamic bank is not a lender or borrower, however, it’s a buyer, seller, lessor, lessee, and agent
2. Islamic Banks receives funds based on contracts of Qard (Current Account), Mudarabah (Savings Accounts) and Wakalah (Investments) basis or Musharakah
3. Islamic banks provide financing facilities to their client based on their business needs under Sharia compliance contracts
   
4. Islamic Bank Finance featured with:
   1. Profit and Loss Sharing
   2. Prohibit interest based lending
   3. Late payment charges does not become the part on Banks income, customer undertake to donate the late payment amount as charity.
   4. Funds collected by the Islamic Bank are invested on Shariah permissible contracts
5. Islamic bank cannot pre-advise rate of return to Depositors, it can only indicate a certain range based on its past performance.

ISLAMIC FINANCING AND INVESTMENT CONTRACTS

1. MUDARABA DEFINITION

• A contract between two parties.
• based on profit sharing (Musharaka in profit)
• One Party  provides Capital – Rabulmal.
• Other manages the venture – Mudarib.
• Loss is borne by the Rab ul Maal (Fund Provider, unless in case of Mudarib negligence
  

ELEMENTS OF MUDARABA

• Contracting parties: bank as Mudarib (Funds Manager) Customer as (Rubul Mal)
• Capital: the funds placed by the customer under a Fixed Deposit (a Mudarabah based Investment )
• Work: bank investing such funds in its Sharia Compliant activities.
• Profit and loss clauses: agreement on sharing the achieved profit whilst Loss will be borne by the customer, unless in the case of bank’s negligence, default, or failing to abide by terms and condition of the Mudarabah contract.

MUDARABA PROFIT AND LOSS RULES

• Profit is the amount earned in access of Capital.
• Distributed based on pre-agreed ratios.
• Ratios may be changed on agreement, and new ratios apply to future periods.
• Loss borne by Rub-ulmal, unless caused by Mudarib gross negligence or willful misconduct. or violates the conditions of the agreement.

2. MURABAHA CONCEPTS AND MECHANISMS

• Murabaha, a “cost-plus sale”, i.e. selling a commodity against the cost plus on a defined and agreed profit mark-up.  The seller has to disclose the cost-incurred by him for acquisition of the goods and provide all cost-related information to the buyer
• The distinguishing features of Murabaha from ordinary sale are:

1. The seller discloses the cost to the buyer
2. And a known profit is added

• The following is the mechanism for Murabaha:

1. Client approaches the bank for the Murabaha facility by filling the application and the “promise to purchase”
2. Bank, after receiving the quotation, purchases the Asset subject of the deal.
3. Bank receives the goods and sells to the customer under a Murabaha Sale Contract.
4. Customer receives the goods.
5. Deal to be booked by the Bank.

BASIC RULE FOR MURABAHA

1. Asset to be sold:
   1. Must be Sharia permissible
   2. Must exist at the time of contracting
   3. Should be in ownership of the seller at the time of sale
   4. Should be in physical or constructive possession of the seller
   5. Should be deliverable
2. Sale price should be determined at contract session
3. Forward sale is not permissible
4. Offer and acceptance to be exchanged then follows exchange of counter-considerations (Al badalain), i.e. sold item and price

3. IJARAH CONCEPTS AND MECHANISMS

• Ijarah as a contract refers to hiring or renting any asset/service to benefit from its usufruct
• It also encompasses the hiring of labour and any contract of work for anyone against a return (wage)
• It provides the usufruct rights for a consideration, which is rent in the case of hiring land, building, equipment, etc. and wages in the case of hiring people  
• Therefore, it can be said that Ijarah in Islamic law is a contract for a specific or described benefit in the conscience in return for a specified fee for a specified period

RULES OF IJARAH

1. Ownership of the leased asset remains with the Lessor throughout lease period
2. All rights and liabilities relating to ownership are borne by the Lessor
3. Subject matter of Lease should be Valuable and Identified
4. The period of Lease and rentals must be determined in clear terms
5. The Lessor cannot increase the rent unilaterally
6. The Lessee is not responsible for any damage except in case of its default, negligence or breaching agreement terms and conditions
7. Normal maintenance is Lessee’s responsibility
8. The Lease Agreement will be terminated in case of total loss of leased asset
9. In leasing/hiring, forward contract is permissible