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Even
though, the Islamic finance market has matured to $200
billion in assets, and Islamic Banks are expanding throughout
the Muslim world and beyond, the market still represents
a very small percentage of the overall financing activity.
We
believe that a lack of understanding on available options,
less competitively priced products, and most importantly,
the continuing debates on the religious viability of
some Islamic financing practices, are the causes for
much confusion and apathy.
Islamic
Finance represents an area that already has a huge amount
of interest and constant innovation - albeit some of
which is vigorously debated. Indeed, there are a number
of scholars critical of the way Islamic finance in particular
has developed in the modern banking sector.
All
this debate and lack of information makes it increasingly
difficult for a business to understand the financing
options he/she has while trying to conform to the principles
of the higher
authority.
This
article is intended as an introduction to some of the
key types of Islamic contracts and how they are applied
to provide alternative Islamic financing options. Our
hope is that this will prove a useful launch pad for
Muslim business owners who are looking for ideas on
how to use Islamically permissible alternatives to conventional
financial products.
We
will highlight the salient features of murabaha,
Ijara, and musharakah/mudarabah. These contract
types form the basis of a variety of Shari'a compliant
substitutes to conventional corporate and trade financing
solutions today. The following table provides information
on the conventional financial needs that the above mentioned
contract types apply to.
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Shari'a
Compliant Conventional Financing Options
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Key
Financial
Needs
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Islamic
Contracts Applied
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Sample
Bank
Offering
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Trade
Financing
|
|
|
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Letter
of Credit
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|
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Financing
Working Capital
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|
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Corporate Financing
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|
|
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Asset
Financing
(Raw Material, Equipment)
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|
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Advance
on Commodity to
be delivered later
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Salam
Finance
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Construction
/
Project Financing
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Istisna'a
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Leasing
Equipment/ Heavy Machinery
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| Joint
Ventures/ Business Partnerships |
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Despite
the amount of discord sometimes encountered on the specifics
of these instruments, there is a good amount of agreement
on what the religious drivers of Islamic finance are.
Most, if not all, scholars will concur that the basic
premise of Islamic finance lies in the need to eliminate
both interest (Riba) and uncertainty (Gharar) from financial
transactions.
Still,
intricacies of Islamic fiqh are constantly invoked in
understanding the precise logic behind contract and
transaction types. This leaves the common business person
at a loss for the actual type of instrument needed to
satisfy their requirements.
The
following sections define key types of Islamic contracts
applied today. It should be noted that there might be
some degree of ikhtilaf (Disagreement) on the
specific modalities of the instruments mentioned here.
These
are only the most basic outlines of these contract types.
Murabaha
Murabahah
is often referred to as 'cost-plus financing' and frequently
appears as a form of trade finance based upon letters
of credit. In its simplest form, this contract involves
the sale of an item on a deferred basis. The item is
delivered immediately and the price to be paid for the
item includes a mutually agreed margin of profit payable
to the seller. In this contract, the market cost price
(true cost) of the item is shared with the buyer at
the time of concluding the sale.
According
to Tarek al-Diwany (Islamic-finance.com), Murabahah
is a form of 'trust sale' since the buyer must trust
that the seller is disclosing his true costs. After
discussing the true costs, a profit margin may be agreed
either on a percentage of cost basis or as a fixed amount.
It is very important to remember that the amount of
profit earned in this transaction is not a reward for
the use of the financier's money. In other words, a
financier cannot take money if he/she does not perform
any service other than the use of his/her money for
the transaction. Such an occurrence would cause this
type of deal to resemble the charging of interest. Today,
Murabahah is used most to assist short-term trade transactions.
Ijara
The
use of leasing is represented by the Ijara contract
in Islamic law. The contract represents a transaction
in which a known benefit (usufruct) associated with
a specified asset is sold for a payment. In the course
of this sale of usufruct, ownership of the asset is
not transferred - the bank maintains ownership of the
asset. The Ijara contract can be designed to return
the fixed assets to the lessor at the end of the lease
period, in which case the lease takes on the features
of an operating lease in which the bank takes title
of the asset at the end of the lease term. The other
mechanism would be to allow the lessee to agree, at
the outset, to buy the assets in question at the end
of the lease period. The lease here takes on the nature
of a hire purchase known as ijara wa iqtina (literally,
lease and ownership). In simple terms, this means that
the asset can be sold to the lessor at the end of the
lease.
Mudarabah
and Musharakah
Since
the inception of Islamic economic theory and its outgrowth
into Islamic finance, scholars have lauded Mudarabah
and Musharakah as the ideal forms of permissible contract
in Islamic thought. The basic reasoning is that these
contracts pool resources and expertise as well as spread
the inherent risk in a project among the various parties
involved. Here we present some salient features of both
contract types.
In
the Mudarabah model, a mudarib or entrepreneur usually
provides management expertise which is treated as a
form of capital. The investor is known as the rabb al-mal.
The share of expected future profits between the mudarib(s)
and the investor(s) is agreed at the outset in any ratio
mutually agreed to by the parties involved. The rabb
al-mal bears all losses of invested assets (be they
cash or other forms of capital). In the case there is
more than one investor losses are to be shared according
to the investment share of each investor. The entrepreneur
must not bear any of the loss(es) attributable to invested
capital. The entrepreneur is not allowed to take any
form of remuneration other than profit-share. Technically,
the entrepreneur has no recompense for his efforts unless
the project is profitable; unless there is a guaranteed
wage.
The
Musharakah model is essentially a sharing model. Parties
involved in a partnership arrangement contribute funds
to and have the right to exercise executive powers in
that project in accordance with an agreed formula. All
partners are obligated to contribute capital to the
venture. These contributions can be subject to profit
sharing in a ratio mutually agreeable to all the investing
parties. Just as with mudarabah, a fixed amount of payment
can not be agreed at the outset. As with most joint
ventures partners must receive regular accounting information
as well as other information on business activities.
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