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Concepts of Sharia’a

Objective 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. in addition to its economic role, Islamic banking shall also take the charge as to social partnership enhancement.

Concept of Islamic Banking vs. Conventional Banking

1- Banks, being Islamic, or conventional deliver banking services against commissions and charges.

2- Banks, whether Islamic or non-Islamic, are mediators to mobilize funds from Savings Surplus Units (SSU) to Savings Deficit Units (SDU) aiming at generating income.

Concept of Islamic banking:

Important concepts that need to be considered in Islamic Banks:

• Islamic bank is not a lender or borrower, so ascertaining return should not be subject to funds disbursement.

• Islamic bank is a trader, a landlord or a lessor, a manufacturer, a manager, That is to say, the basis of its transactions is the acquisition, resale, and leasing of assets and services.

What is the difference then?

It is substantial and significant between the two concepts. The difference lies in the TOOLS 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, Return assured upon disbursement.

- The mobilization of funds in Islamic Banks is underpinned by Sharia’a contract.

i.e. asset-backed business,
and consequently risk-sharing and profit sharing transactions to justify the entitlement of profit.
As per the governing Sharia'a precepts: Not to sell whatever you do not own & possess.

Conventional bank

1. Conventional bank borrows funds from depositors and lends to clients at predetermined interest rates

2. By virtue of borrowing, the bank becomes liable to return the funds with interest to depositors, even if bank’s lending goes sour

3. Depositors having ‘sold’ their money on deferred basis, are waiting to be paid the sale price upon completion of deferred sale period

4. Interest paid by the bank to depositors is considerably lower than interest it charges to borrowers. Difference being bank's profit

5. Bank holds sole authority to increase lending rates but, depositors who lend to bank do not have such authority

6. Conventional banks not permitted to trade with depositors’ funds but are only allowed to lend them.

Islamic Banks

Islamic bank does not borrow funds from depositors, nor lends the funds to clients
It accepts funds from clients on fund management basis and invests them on their behalf and at their risk and responsibility
Islamic bank is fund manager, client is fund provider and contract is fund management
Islamic banks are permitted to trade with depositors’ funds and barred from lending them
Islamic bank cannot pre-advise rate of return to Depositors
It can only indicate a certain range based on its past performance
Islamic bank has full discretion to manage funds as it deems fit but within Sharia parameters.
Islamic bank plays dual role of a fund manager and an investor with entrepreneurs
Islamic bank receives deposits through fund management contract and earns profit by investing in different types of investment contracts and sale contracts
Islamic bank shares profit with depositors at pre-agreed ratio of ascertained return
Only the distribution ratio is pre-agreed, not the return
Islamic bank invests funds at depositors’ risk BUT being trustee, is accountable to depositors in case of its negligence.
In case of negligence by Islamic bank, as per Sharia, the trusteeship gets automatically converted into debtor-creditor aspect.

Islamic Financing and Investment contracts

Mudaraba Definition

A contract between two parties based on profit sharing (Musharaka in profit)
One Party provides Capital – Rabulmal.
Other manages the venture – Mudarib.

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 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 Mudarib commits a mistake, is careless, or violates the conditions of the agreement.

Murabaha Concepts and mechanism

Murabaha, a “cost-plus sale”, i.e. selling a commodity against the cost plus an 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 feature of Murabaha from ordinary sale is

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

The following is the mechanism for Murabaha:

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

Basic Rule for Murabaha

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.
Sale price should be determined at contract session.
Forward sale is not permissible.
Offer and acceptance to be exchanged then follows exchange of counter-considerations (Al badalain), i.e. sold item and price.

Ijarah Concepts and mechanism

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 is the transfer of usufruct for a consideration, which is rent in the case of hiring land, building, equipment, etc. and wages in the case of hiring people

So it can be said that, in Islamic law, Ijarah is a contract of:

a known and proposed usufruct of specified assets for a specified period, against a specified and lawful return. Or,
a consideration for the service, or for the effort or work proposed to be extended.

Rules of Ijarah

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