Sharia'h Contracts and Usage
Ijarah
Ijarah is an agreement whereby Bank leases moveable or immovable property to the Customer with an option to purchase the item at the end or during the Ijara period at a pre-agreed price. Ijarah can also be a contract involving Sale of Usufructs of tangible property (land, real estate, equipment etc). Ijarah can be either Operating Ijarah (operating lease) or Ijarah wa Iqtina (lease with a purchase option/finance lease).
Areas of Application:
The Ijara transactions are suitable for financing of expensive assets such as ships, aircraft, and heavy-duty industrial and agricultural equipment. The Ijarah wa Iqtina is widely used in real estate, vehicle, machinery, project, computers, equipment financing etc. that require medium to long term financing.
Istisna
Istisna is a sale contract between two parties whereby the underlying project requires construction financing. The Istisna contract will establish the sale price of the underlying project /asset, date of delivery and modes of payments to the seller.
Areas of Application:
Istisna can be useful in the case of contractor financing and project finance. Istisna contracts are used to offer finance for companies operating in asset - intensive industries like aircraft, locomotive, ship building industry, real estate and similar industries. The Istisna contract is also applied in the construction of residential buildings, schools, hospitals and other areas that support the development of society. Istisna is often exited through a used in combination with longer-term Islamic modes such as Ijarah or parallel Istisna to recover the entire financing and profits.
Mudaraba
Mudaraba is a mode of financing through which Bank provides capital finance for a specific venture indicated by a Customer and Bank act as Trustee / Manager for the Customers for any such venture. It is also commonly used to facilitate investing surplus cash with the bank in the case of saving / fixed deposits. In both of cases Mudaraba Contract is a profit sharing arrangement wherein capital provider bears the risk and the Mudarib / Manager contributes expertise and management skills.
Areas of Application:
Mudaraba is suitable for financing any kind of business venture, manufacturing, trading, and others where Bank is willing to act as capital contributor. Mudaraba is pure private equity type venture and hence financial institutions will usually only provide Mudaraba facility based on merit for very few and selected group of Customer. Customers can use Mudaraba financing for their running finance requirements, short term financing and even bridge or project financing needs. Islamic banks also use Mudaraba to attract saving and fixed deposits on profit sharing basis.
Murabaha
Murabaha is a sale contract between two parties-seller and buyer. Customers can avail Murabaha for purchase of any Tangible Asset like, Real Estate, Stocks, Machines, Equipments (both import and local), Goods (perishable and un-perishable), Furniture, Raw Materials, Vehicles or any other identifiable tangible or intangible assets or goods, including shares of companies which are Sharia'h complaint. Bank will first procure the goods and then sell the same goods for a price which is cost plus a fixed mark-up per annum taking into account the facility tenor.
Areas of Application:
Murabaha can be used to provide all type of short term corporate facilities if they are backed by tangible assets. It is also used in trade finance (L/Cs) and consumer finance. It can be used as a substitute for Short Term Financing and Medium Term Financing. Trust Receipts, LC / TR facilities, Share Finance, Financing of working capital/ inventory, vehicle finance, etc. can also be financed under Murabaha financing.
Musharaka
Musharaka is an agreement whereby the Customer and Bank agree to combine financial resources to undertake any type of business venture, and agree to manage the joint venture / transaction according to the terms of the agreement. In Permanent Musharaka (equity participation) Bank invests in partnership with the customer and continues to be invested as long as the Musharaka continues. In Diminishing Musharaka (long term financing) Bank’s share in the equity is diminished each year through partial return of capital. In Diminishing Musharaka (working capital financing) a form of working capital financing, Bank invests for a short specific period of time, and receives it’s invested capital plus profits thereon at the end of an agreed period.
Areas of Application:
Musharaka financing is very flexible and can be used to finance domestic industry, working capital finance and trade financing - imports and exports. Musharaka is good substitute for short term corporate facilities as provided by conventional banking in addition to overdrafts or running finance, short-term financing, bridge financing and/or project financing.
Salam
Salam is a deferred delivery sale; where delivery occurs at a future date in exchange for spot payment of price. This mode of financing is ideally suited where the end product is to be manufactured, produced or grown.
Areas of Application:
Salam contract is an excellent substitute for conventional short term corporate facilities especially in a situation where Customers require pre-funding for manufacturing, trading or producing any tangible goods, conventional banking overdraft facilities, pre-shipment financing against letters of credit, production of commodities for onward selling by farmers, manufacturing units looking to finance their tangible and un-perishable goods, all types of white-goods manufacturers, etc. where the manufacturer / producer and even trader require financing against the inventory of goods that does not exist at the time of financing can avail Salam facilities.
Commodity Murabaha
Commodity Murabaha is a product designed to facilitate financing to a Customer who needs cash to pay for various corporate needs. Bank sells the Customer commodities on deferred payment basis. Subsequently the Customer can sell these commodities to a third party on spot basis to receive cash.
Areas of Application:
Commodity Murabaha can be helpful instrument for bridge financing, working capital financing, general funding purposes and all types of short term and long term financing for corporate customers where cash disbursement is a must. Bank prefers to use Commodity Murabaha in a restricted manner - only when alternative Islamic financing modes cannot be used to serve the needs of the Customer.