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Jeff (Jaafer) Gareau,
B.A., I.R.Econ.

Financial Advisor/Dealing Representative,
NO INTEREST Investments
Global Maxfin Investments Inc.

 
 
 
   
   

About Halal Finance

CONCEPTS IN ISLAMIC DEBT BANKING

Bai' al-Inah (Sale and Buy Back Agreement)

The financier sells an asset to the customer on a deferred-payment basis, and then the asset is immediately repurchased 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.


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

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.


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. Barring this, Bai Salam covers almost everything, which is capable of being definitely described as to quantity, quality, and workmanship.

BASIC FEATURES AND CONDITIONS OF SALAM

First of all, it is necessary for the validity of Salam that the buyer pays the price in full to the seller at the time of effecting the sale. It is necessary because in the absence of full payment by the buyer, it will be tantamount to sale of a debt against a debt, which is prohibited, as the basic wisdom behind the permissibility of salam is to fulfill the instant needs of the seller. If the price is not paid to him in full, the basic purpose of the transaction will be defeated. Therefore, all the Muslim jurists are unanimous on the point that full payment of the price is necessary in Salam. However, Imam Malik is of the view that the seller may give a concession of two or three days to the buyers, but this concession should not form part of the agreement.
Salam can be effected in those commodities only the quality and quantity of which can be specified exactly. The things whose quality or quantity is not determined by specification cannot be sold through the contract of salam. For example, precious stones cannot be sold on the basis of salam, because every piece of precious stones is normally different from the other either in its quality or in its size or weight and their exact specification is not generally possible.

Salam cannot be effected on a particular commodity or on a product of a particular field or farm. For example, if the seller undertakes to supply the wheat of a particular field, or the fruit of a particular tree, the salam will not be valid, because there is a possibility that the crop of that particular field or the fruit of that tree is destroyed before delivery, and, given such possibility, the delivery remains uncertain. The same rule is applicable to every commodity the supply of which is not certain.
It is necessary that the quality of the commodity (intended to be purchased through salam) is fully specified leaving no ambiguity which may lead to a dispute. All the possible details in this respect must be expressly mentioned.

It is also necessary that the quantity of the commodity is agreed upon in unequivocal terms. If the commodity is quantified in weights according to the usage of its traders, its weight must be determined, and if it is quantified through measures, its exact measure should be known. What is normally weighed cannot be quantified in measures and vice versa.
The exact date and place of delivery must be specified in the contract.

Salam cannot be effected in respect of things which must be delivered at spot. For example, if gold is purchased in exchange of silver, it is necessary, according to Shari‘ah, that the delivery of both be simultaneous. Here, salam cannot work. Similarly, if wheat is bartered for barley, the simultaneous delivery of both is necessary for the validity of sale. Therefore the contract of salam in this case is not allowed.

Hibah (Gift)

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 interest on savings account balances.


Ijarah

Ijarah is a contract of a known and proposed usufruct against a specified and lawful return or consideration for the service or return for the benefit proposed to be taken, or for the effort or work proposed to be expended. In other words, Ijarah or leasing is the transfer of usufruct for a consideration that is rent in case of hiring of assets or things and wage in case of hiring of persons.

the literal meaning of usufruct is the right to enjoy the use of another’s property short of the destruction or waste of its substance.

Ijarah Thumma Al Bai' (Hire Purchase)

These are variations on a theme of purchase and lease back transactions. There are two contracts involved in this concept. The first contract, an Ijarah contract (leasing/renting), and the second contract, a Bai contract (purchase) are undertaken one after the other. 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 rental 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 price.

In effect, the bank sells the product to the debtor, at an above market-price profit margin, in return for agreeing to receive the payment over a period of time; the profit margin on the lease is equivalent to interest earned at a fixed rate of return.

This type of transaction is particularly reminiscent of contractum trinius, a complicated legal trick used by European bankers and merchants during the Middle Ages, which involved combining three individually legal contracts in order to produce a transaction of an interest bearing loan (something that the Church made illegal).

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.

Istisna'a

Istisna'a is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and future delivery or a future payment, and future delivery. Istisna’a can be used for providing the facility of financing the manufacture or construction of houses, plants, projects, and building of bridges, roads, and highways.

Mudarabah (Profit Loss Sharing)

Mudarabah is an arrangement or agreement between a capital provider and an entrepreneur, whereby the entrepreneur can mobilize funds for its business activity. The entrepreneur provides expertise and management and is referred to as the Mudarib. Any profits made will be shared between the capital provider and the entrepreneur according to an agreed ratio, where both parties share in profits and only capital provider bears all the losses if occurred. The profit-sharing continues until the loan is repaid. The bank is compensated for the time value of its money in the form of a floating interest rate that is pegged to the debtor's profits.

Murabahah (Cost Plus)
Main article: Murabaha

This concept refers to the sale of goods at a price, which includes a profit margin agreed to by both parties. The purchase and selling price, other costs, and the profit margin must be clearly stated at the time of the sale agreement. The bank is compensated for the time value of its money in the form of the profit margin. This is a fixed-income loan for the purchase of a real asset (such as real estate or a vehicle), with a fixed rate of interest determined by the profit margin. The bank is not compensated for the time value of money outside of the contracted term (i.e., the bank cannot charge additional interest on late payments); however, the asset remains in the ownership of the bank until the loan is paid in full.

This type of transaction is similar to rent-to-own arrangements for furniture or appliances that are very common in North American stores.

Musawamah

Musawamah is a general and regular kind of sale in which price of the commodity to be traded is bargained between seller and the buyer without any reference to the price paid or cost incurred by the former. Thus, it is different from Murabaha in respect of pricing formula. Unlike Murabaha, however, the seller in Musawamah is not obliged to reveal his cost. Both the parties negotiate on the price. All other conditions relevant to Murabaha are valid for Musawamah as well. Musawamah can be used where the seller is not in a position to ascertain precisely the costs of commodities that he is offering to sell.

Musharakah (Joint Venture)

Musharakah is a relationship established under a contract by the mutual consent of the parties for sharing of profits and losses in the joint business. It is an agreement under which the Islamic bank provides funds, which are mixed with the funds of the business enterprise, and others. All providers of capital are entitled to participate in management, but not necessarily required to do so. The profit is distributed among the partners in pre-agreed ratios, while the loss is borne by each partner strictly in proportion to respective capital contributions. This concept is distinct from fixed-income investing (i.e. issuance of loans).

Qardul Hassan (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 [4].

Sukuk (Islamic Bonds)
Main article: Sukuk

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 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.

Conservative estimates suggest that over US$500 billion of assets are managed according to Islamic investment principles. Such principles form part of Shariah, which is often understood to be Islamic law, but it is actually broader than this in that it also encompasses the general body of spiritual and moral obligations and duties in Islam.

Takaful (Islamic Insurance)
Main article: Takaful

Takaful is an alternative form of cover that a Muslim can avail himself against the risk of loss due to misfortunes. The concept of takaful is not a new concept; in fact, it had been practiced by the Muhajrin of Mecca and the Ansar of Medina following the hijra of the Prophet over 1,400 years ago. 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.

In modern business, one of the ways to reduce the risk of loss due to misfortunes is through insurance which spreads the risk among many people. The concept of insurance where resources are pooled to help the needy does not contradict Shariah. However, conventional insurance involves the elements of uncertainty (Al-gharar) in the contract of insurance, gambling (Al-maisir) as the consequences of the presence of uncertainty and interest (Al-riba) in the investment activities of the conventional insurance companies that contravene the rules of Shariah. It is generally accepted by Muslim jurists that the operation of conventional insurance does not conform to the rules and requirements of Shariah.

Wadiah (Safekeeping)

In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the entire amount of the deposit, or any part of the outstanding amount, when the depositor demands it. The depositor, at the bank's discretion, may be rewarded with a hibah (gift) as a form of appreciation for the use of funds by the bank. In this case, the bank compensates depositors for the time-value of their money (i.e. pays interest) but refers to it as a gift because it does not officially guarantee payment of the gift.

Wakalah (Agency)

This occurs when a person appoints a representative to undertake transactions on his/her behalf, similar to a power of attorney.

Thanks go to Shariah-Investment in Europe for the information posted.