Islamic Finance – Principles

1. Islamic Finance – Principles Principles of Islamic Finance Hhadith – Sahih Muslim: …gold for gold, silver for silver, dates for dates,wheat for wheat, salt for salt, barley for barley,….like for like, equal for equal, hand to hand, …. Two permissions follow two prohibitions: 1. Sales within single type, unequal exchange, with or without delay: Riba al fadl.Money should be used as medium of exchange 2. Exchange among listed goods, with or without equality, but with delay: Riba al nasia [wheat and rice so that wheat now and rice later OR gold now or silver late]. Goods can be sold on credit for gold and silver. CREDIT SALE IS ALLOWED IF GOODS EXCHANGE WITH MONEY

2. Theory & Practice of Murabahah Murabahah – Concept and Historical perspective • Introduced as new form of sale in second half of first Hijrah century as a sale with necessary condition of a profit margin agreed by both the seller and purchaser [Al Mutta, Imam Malik] and without the order of purchaser [cost includes direct expenses] • Modifications were made by Imam Shafi’, including an order of the purchaser, who could subsequently exercise the option not to purchase the same, and also included credit transaction • Therefore, he clearly bifurcated two sale transactions, one from supplier (or vendor) to the seller and other from seller to the purchaser

3. Theory & Practice of Murabahah Murabahah – Concept and Historical perspective • The contemporary banking also takes into account the cash and credit prices different from each other, as justified by Usmani • The banks are also required to fulfill regulatory compliance relating to credit transactions, maximum exposure to risk, classification of credit transactions, international supervision, etc. • In addition, the banks are also emphasized to follow the Shariah, and accounting standards issued by AAOIFI relating to Murabaha transactions. In Pakistan, the Islamic Financial Accounting Standard-1 issued by ICAP vide SECP Notification dated 24th August, 2005 is also required to be followed. • Since the operation of Murabaha transaction resembles Riba based practice of lending, the preconditions prescribed by Shariah advisors are to be met in letter and spirit

4. MUSHARAKAH P&L DISTRIBUTION B’s Capital 100% 75% OB A’s Share of Profit B’s Share of Profit 50% 50% N 25% 75% R 90% 10% M OA 25% 100% A’s Capital

5. ISLAMIC BANK INVESTORS Investment Units purchased Special Purpose Mudarabah 6 months Whole sale Purchases Profits Accrued Retail Sales Lined up Islamic Modes – Agricultural Financing Bank arranges pool of funds

6. Liquidity Liquidity Inputs in kind Inputs in kind Liquidity Hiring for land prep. Hiring for land prep. Sale of fertilizers, seed, pesticides Hiring for Harvest + Marketing Exp. S A L A M M U R A B S A L A M Delivery Payment Delivery Islamic Modes – Agricultural Financing Financing of crop production Liquidity requirements (hiring of tractor & implements, sowing, purchase of water, hiring of labour for preparation of land and harvesting, marketing) Input requirements (seed, fertilizer, pesticides)

7. Islamic Modes/Instruments - Sale Contracts: Parallel Salam: Procedural Details: The disposal of commodity at the end of Bank can be through: • Parallel Salam: Bank may sell commodity, before the date of delivery, to some other purchaser for the date of original delivery. The period in second contract will be shorter than the original contract, but price higher than the original contract. • Unilateral Promise: Promise of purchase can be obtained from third party for delivery on the date of original contract. Price in this promise is set higher than parallel salam because the promisor has to pay nothing.

8. Islamic Modes/Instruments - Sale Contracts: Risks involved in Salam Transaction:

9. Islamic Modes/Instruments - Sale Contracts: Risks involved in Salam Transaction:

10. Principles of Islamic Finance Principles of Islamic Finance 1. Prohibition of Riba: Prohibition in Shariah: B. Ahadith Riba al fadl: [Traditions] • ….exchange of radi with burny dates….. • Gold for gold, silver…..,……, like for like, equal for equal, and hand to hand. If the commodities differ, you may sell as you wish, provided the exchange is hand to hand. • When illa is different, shortfall/excess and delay both are permissible • When commodities of exchange are similar, excess and delay both are prohibited • When commodities are heterogenous but illa is the same, then excess/deficiency is allowed but delay not allowed

11. REFERENCE SLIDES FOR PARTICIPANTS FROM BANKS Work on Murabahah

12. Purchase of poultry feed stock Murabahah Facility: 180 Days Payment: Six monthly installments Rate of Profit: Six months KIBOR+2% Murabahah transaction: Rs. 500,000 Securities: Pledge of feed stock, equitable mortgage, lien on deposit, post dated cheques, etc. Practice of MurabahahPricing of Murabahah [Example]:

13. Practice of MurabahahPricing of Murabahah [Example]:

14. Training Workshop – Islamic MicrofinanceAccounting of Murabahah [Example]:

15. Training Workshop – Islamic MicrofinanceAccounting of Murabahah [Example]:

16. Training Workshop – Islamic MicrofinanceAccounting of Murabahah [Example]:

17. Training Workshop – Islamic MicrofinanceAccounting of Murabahah [Example]:

18. Sale Defined: Exchange of a thing of value with another thing of value with mutual consent OR the sale of a commodity in exchange of cash. Elements of a valid sale: Contract ( Aqd ) Subject matter ( Mabe’e) Price ( Thaman ) Possession or delivery ( Qabza )