Overview of Financial Institutions and Products 193 5. The bank will charge a pre-agreed Mudarib fee as a percentage of the realized profit; the bank can pay additional profit from its own share. 6. The investor will bear a loss unless it arises from misconduct or negligence of the Mudarib. Islamic banks may also agree to an arrangement with the central bank serving as a lender of last resort. One option is financing on a Mudarabah basis; the central bank may agree to provide liquidity for, say, a three day grace period with ceilings, followed by a Mudarabah with profit-sharing ratio heavily favouring the central bank to discourage the Islamic bank from resorting to the central bank’s funds for longer periods. Another option is the sale and purchase of Shar ¯ ı´ah-compliant certificates/Sukuk. Sukuk are important for liquidity management. In Sukuk, an investor gets returns on the basis of ownership rather than interest. Ijarah Sukuk are more common instruments in this regard and are issued against assets for rental. To generate liquidity, Sukuk can be sold/purchased in the secondary market. If the regulatory structure allows, Islamic banks can sell the Sukuk to the central bank to generate liquidity. Sukuk can be structured on an amortizing or bullet maturity basis. Foreign Exchange Operations Exchange of currencies and monetary units has to be subjected to the rules of Bai‘ al Sarf, i.e. it must be simultaneous. Accordingly, spot purchase and sale of one currency against another currency is allowed; forward purchase and sale is not allowed. However, IFIs can enter into a promise to purchase and sell agreement. On this principle, foreign currency forward cover is allowed with certain conditions, as discussed in Chapter 14. In order to ensure that the transaction actually goes through, parties may stipulate any earnest money. Negotiation of export documents is partially allowed. Government/Public Sector Financing Government and public sector enterprises can obtain finance by way of Mudarabah or Musharakah certificates, which can be issued to purchase equipment or utility-generating assets in order to lease them to public sector corporations. Ijarah and Istisna‘a are best suited for infrastructure projects in the public sector. Recently, Ijarah Sukuk have emerged as the most crucial instruments for financing of the public sector. Through syndication arrangements, Islamic banks can supply goods/assets of enormous value to government entities or corporations on a Murabaha basis by setting up joint Murabaha funds. In such cases, ownership of Murabaha funds can also be securitized to offer equity-based investment opportunities to the investors and the banks themselves. Returns on these funds would be distributed among Sukuk/certificate holders on a pro rata basis. Alternatives to Foreign Loans For the inflow of foreign resources, the instruments of portfolio investment through stock markets, flotation of various categories of Sukuk and direct investment by foreigners can be used. 194 Understanding Islamic Finance Public as well as private enterprises can issue Musharakah and Ijarah Sukuk to finance projects, especially development projects. Sukuk can be denominated in foreign as well as domestic currencies and carry a predetermined proportion of the profit earned by their respective projects. The Sukuk issued can be restricted to a particular project or earmarked to a group of projects. Various funds can be established to finance the economic activities of public and private enterprises on equity, partnership, leasing, Salam and mixed asset pool bases. Funds can be established to finance a specific sector, for example, agriculture, industry or infrastructure; a particular industry, for example textiles, household durables, etc.; or general types of projects. Box 8.2: Islamic Banking Products and Services Nature of Product/Service Modes and Basis I. Deposits – fund mobilization Current deposits Am ¯ anah – Qard to bank; no return payable Savings deposits Mudarabah General investment term deposits Mudarabah Special investment deposits Mudarabah, closed-and open-ended mutual funds, Wakalatul Istism ¯ ar Individual portfolios Mudarabah, Wakalatul Istism ¯ ar Liquidity generation Tawarruq – reverse Murabaha, sale to any 3rd party II. Trade finance, corporate finance Project finance Musharakah, Mudarabah-based TFCs, syndication through Mudarabah, Murabaha, Istisna‘a, Ijarah/Ujrah Working capital finance Murabaha, Salam, Musharakah in single transactions Export finance – preshipment Salam/Istisna‘a plus Murabaha and Wakalah, Murabaha, Musharakah Import finance Murabaha, Musharakah Cash finance Salam, Istisna‘a, Tawarruq (sale to 3rd party) Export finance – post shipment (bill discounting) Qardal Hasan in local currency (spot rate) and promise to sell foreign exchange in future market – exchange rate differential bank’s income; Murabaha if funds needed for next consignment Letter of credit Commission, Ujrah along with Murabaha, etc. Letter of guarantee Kafalah, service charge III. Agriculture, forestry and fisheries Production finance for input and pesticides Murabaha, Salam Overview of Financial Institutions and Products 195 Tubewells, tractors, trailers, farm machinery and transport (including fishing boats) Ijarah Munahia-bi-Tamleek, Salam, Murabaha Plough cattle, milk cattle and other livestock; dairy and poultry Murabaha, Salam Storage and other farm construction (sheds for animals, fencing, etc.) Diminishing Musharakah or rent-sharing Land development Operating Ijarah, Salam Orchards, nurseries, forestry Salam, Musaqat IV. Treasury Money market – inter-bank Mudarabah with or without allocation of assets Liquidity management Sale/purchase of permissible securities, Parallel Salam, Tawarruq Fund management Mudarabah, Wakalatul Istism ¯ ar, trading in permissible stocks and Sukuk Trading in Sukuk, stocks Depending upon the nature of instruments Forex operations Unilateral promise to buy/sell foreign exchange simultaneously at pre-agreed rate V. Personal advances (including consumer durables and housing) Consumer durables Murabaha/instalments sale Automobiles Ijarah Munahia-bi-Tamleek, Murabaha Housing finance Diminishing Musharakah, Murabaha Providing cash for personal needs Salam if possible, Tawarruq 8.6 THE ISSUE OF MODE PREFERENCE According to the majority of scholars, the main instrument by which the interest-based system has to be replaced is profit/loss sharing, encompassing Musharakah, Mudarabah and their variants. The idea of replacing interest by profit sharing in the depositor–bank and bank–business relationships, first mooted during the 1940s to 1960s, gained considerable acceptance in the 1980s and 1990s. However, there are slight differences in approach and priorities. While S.M. Hasanuz Zaman is not in favour of using Mudarabah 9 (on the assets side) for non-trade operations 10 , a vast majority of scholars have recommended its extensive use. Nejatullah Siddiqi has discussed thoroughly the extended scope of Mudarabah. 11 To him, it does not involve traits like Riba, Qim ¯ ar, fraud, coercion, exploitation of needs, hazard and uncertainty that could make it unlawful. He hints that although in practice the role of profit-sharing and partnership is very small at present, they continue to dominate the 9 Alternatively, he recommends the use of Musharakah. As the combination of Mudarabah and Musharakah is also accepted by Shar ¯ ı´ah scholars, the bank could use profit/loss sharing as a technique encompassing both modes, subject to the fulfilment of relevant conditions. 10 Hasanuz Zaman, 1990 (1410 AH), pp. 69–88. 11 Siddiqi, 1991, pp. 21–34. 196 Understanding Islamic Finance theory of Islamic banking. They are regarded as the norm towards which practice should, and will, eventually gravitate. Like him, a large group of Islamic economists insist that Islamic banking and finance will have to rely on profit-sharing contracts if the objectives of socio-economic justice, efficiency and stability of the economic system are to be achieved. Similarly, according to Umer Chapra, the most important and unanimously agreed upon form of financing provided by Islamic banks would be on the basis of Mudarabah, Shirkah or acquisition of shares of joint stock companies. Chapra has given its rationale in the following words: “The general principle, which is beyond dispute as being the criterion for determining the permis- sibility or otherwise of any method of financing, is that the financier cannot avert the taking of at least some risk if he wishes to derive an income. To put this in the form of an adage, one could state with respect to all financing operations: no risk, no gain”. 12 On the other hand, as pointed out by Abdul Halim Ismail, the approach of Islamic banks’ practitioners is different from the general approach adopted by Islamic economists. He considers that the contracts of exchange, both for instant and deferred prices, are more relevant to Islamic financial institutions and equally legitimate as per Qur’ ¯ anic injunctions. Giving more importance to PLS modes according to the popular theory of Islamic finance has been formulated incorrectly. He has divided the writers on Islamic finance into the categories of “Islamic economists” and “Islamic bankers”. While the economists group is in favour of replacing interest with a PLS system as a main policy tool, bankers have tended to give equal importance to debt-based modes involving both trade and leasing. Islamic bankers are remarkably uniform in their application of exchange contracts, including both trade and leasing. He blames Islamic economists for not deriving their theory of PLS preference from the Holy Qur’ ¯ an and considers the contracts of exchange on a par with the contracts of profit-sharing. He argues that the current practice of Islamic finance, in contrast to the general perception of Islamic finance theory, is largely based on trade/exchange-based transactions. However, the point is that Islamic economists have not prohibited debt-creating modes; the issue is of preference only and that, too, on account of the possible impact of risk-based versus risk-free capital in an economy. As exchange-based modes also involve risk-sharing, Islamic economists have allowed them subject to the fulfilment of relevant conditions. Their stress on profit-sharing modes is for their better socio-economic impact and to avoid any back doors to interest. Analysing the issue from another angle, the replacement of the interest-based system by an alternative profit-sharing system raises a number of fundamental theoretical, practical and policy questions. The questions being discussed in the emerging literature include, among others, the following: • What is the theoretical framework underlying Islamic banking and finance? • Will the Islamic system be more or less stable than the traditional interest-based system? • What will be the effect of the adoption of an interest-free Islamic system on important macroeconomic variables like saving and investment? • Will monetary policy have a role to play in such a system? 12 Chapra, 1985. Overview of Financial Institutions and Products 197 As regards the first two questions above, Mohsin S. Khan takes the view that the replace- ment of interest by some type of profit-sharing arrangement makes the Islamic system an equity-based system, as opposed to a traditional debt-based system. Using the concept of equity participation, he has developed a theoretical model to examine the working of the Islamic banking system. He has shown that the Islamic system may well turn out to be better suited than the interest-based banking system to adjust to shocks that can lead to banking crises. In an equity-based system, shocks to the assets position of banks are immediately absorbed by changes in the nominal values of shares (deposits) held by the public in banks. Therefore, the real value of assets and liabilities would be equal at all points in time. In the conventional banking system, since the nominal value of deposits is guaranteed, such shocks can cause a divergence between real assets and real liabilities, and it is not clear how this disequilibrium can be corrected and how long the process of adjustment would take. 13 On the basis of this analysis, Mohsin Khan has had an important insight that from an economic standpoint, the principal difference between the Islamic and traditional banking systems is not that one allows interest payments and the other does not. The more relevant distinction is that the Islamic system treats deposits as shares and accordingly does not guarantee their nominal value, whereas in the traditional system, such deposits are guaranteed either by the banks or by the government. As regards the impact of adoption of the Islamic system (the third question above), Waqar Masood concludes that in a full Islamic system, the costs of monitoring would be insignificant and the equity participation arrangement would be superior to the interest- based system. Honesty and faithfulness to the terms of one’s contract are an indispensable ingredient of Islamic behaviour. The driving force of a truly Islamic society is the existence of a strong ideological consensus that the success of the society and its members depends on how closely the rules of the Shar ¯ ı´ah are followed. 14 Nadeem ul Haque and Mirakhor are of the view that the adoption of a profit-sharing arrangement between the lender and investor may raise monitoring costs that could have an adverse effect on the supply of credit, and thus on investment. They are of the view that individual contracts can be designed to take into account the moral hazard problem. Avoiding an adverse effect on investment would require implementation of a legal and institutional framework that facilitates contracting. The Islamic law of contracts provides for such a framework, but it has not yet been fully adopted in countries where an Islamic banking system is being established. In the absence of this framework, monitoring costs could be prohibitive and investment could consequently be discouraged. On the other hand, if legal measures are present to safeguard the terms of contracts, the level of investment may increase. 15 Shahrukh Rafi Khan, while discussing the implications of introducing a PLS system, has concluded that: 16 1. Expectation-based profit-sharing ratios can serve as a pricing mechanism to bring the loanable funds market into equilibrium. 2. The elimination of risk-free assets with positive returns will leave lenders worse off. 13 Khan and Mirakhor, 1987, pp. 15–36. 14 Khan and Mirakhor, 1987, pp. 75–105. 15 Khan and Mirakhor, 1987, pp. 125–161. 16 Khan and Mirakhor, 1987, pp. 107–124. 198 Understanding Islamic Finance 3. Profit-sharing ratios are relatively inefficient instruments of monetary policy. 4. The introduction of interest-free banking does not necessarily lead to a situation where all profitable projects will be financed irrespective of their rate of return. However, Mohsin Khan and Mirakhor do not feel convinced by these conclusions because they are conditional on the model and the specific assumptions under which the results are obtained. The traditional welfare comparisons made by Rafi Khan are incorrect because the welfare function itself will change with Islamization of the economy. Regarding the impact on savings, Nadeem ul Haque and Abbas Mirakhor have concluded that the rate of return also increases as risk increases, and then savings may, in fact, rise. The structural changes accompanying the implementation of an Islamic financial system may produce favourable effects on the rate of return on financial assets. As such, there is no a priori reason for believing that savings in an Islamic system will necessarily be lower than in an interest-based system. The above discussion implies that all Islamic modes have potential for development. The institution of Mudarabah serves as a basis of business to be conducted by combining funds and the expertise of different groups of people. Shirkah-based (PLS) modes that provide the much-needed risk-based funds can be used for short-, medium- and long-term project financing, import financing, preshipment export financing, working capital financing and financing of all single transactions. Mudarabah Sukuk can be issued to mobilize funds and strengthen trading and industrial activities. SPVs can manage such assets as trusts/funds for conducting business for their benefit as well as the Sukuk holders. This could generate higher rates of return for the investors relative to the return realizable on any interest-based investment. As visualized by Homoud, if the profit rate in Mudarabah-based businesses is as low as 10 % and the annual turnover is 3, the realized profits may reach 30 % per annum. “These profits may be distributed at an equal sharing ratio or at the rate 1/3 to 2/3 between Mudarabah certificate holders and the management of the institution. The idea has the potential to alleviate the hardships of low income people in many countries.” 17 In the case of big projects, the IFIs may form a consortium to issue certificates to the public for subscription. Similarly, they can carry out work on infrastructure and socio-economic projects in coordination and partnership with the engineering firms. The non-PLS techniques not only complement the PLS modes but also provide flexibility of choice to meet the needs of different sectors and economic agents in society. Murabaha with less risk has several advantages vis-à-vis other techniques and can be helpful in employment generation and alleviation of poverty. Leasing can be very much conducive to the formation of fixed assets and medium- and long-term investments. Salam has a vast potential in financing the productive activities in crucial sectors, partic- ularly agriculture, agro-based industries and the rural economy as a whole. It provides an incentive to enhance production and leads to the creation of a stable commodities market with stability in prices. To realize this potential, IFIs could organize a forward commodity trade market on the basis of Salam. This would provide not only a nonspeculative forward market for resource mobilization and investment but would also be a powerful vehicle for rural finance. 17 Homoud, 1998. Overview of Financial Institutions and Products 199 8.7 ISLAMIC INVESTMENT BANKING Islamic investment banking can be easily understood in the light of conventional investment banking. An Islamic investment bank provides exactly the same products and services as a con- ventional bank does. The distinguishing factor, however, is that their products and services are tailored in a Shar ¯ ı´ah-compliant manner while meeting the clients’ requirements.Islamicinvest- ment banks manage portfolios for institutions, corporate clients and high net worth individuals, as well as pooled investment vehicles such as unit trusts and mutual funds. Asset management companies managing conventional funds are now gearing up for Islamic funds. The following are the opportunities for Islamic asset management: • open and closed-end mutual funds; • equity benchmarks; • leasing companies involved in asset-backed financing. Islamic investment banks provide venture capital financing to small, medium and big companies in a number of sectors. They avoid involvement in prohibited and unlawful activities and offer services to all projects except those manufacturing or dealing with forbidden products and services, such as alcohol, pork, entertainment, interest-based financial services and the like. Their services relate to venture capital and corporate finance, including syndication finance, project finance and transactions in the capital markets. Asset management or management of funds includes equity funds, real estate funds as well as alternative investments in Ijarah and other Sukuk. They engage in treasury operations for managing the asset–liability mismatch created by different tenors of investment opportunities and different return profiles. Islamic corporate finance activities of investment institutions are similar to conventional corporate finance except that the products and services offered are Shar ¯ ı´ah-compliant. These services include: • equity issues such as IPOs, offers for sale, rights issues; • private placements; • strategic reviews; • financial restructurings; • acquisitions, divestments, mergers; • joint ventures, alliance searches and studies. Islamic investment banks also undertake syndicate financing, which is usually a large financing facility granted to a key industrial or trading organization and lead-managed by a bank of strong base. Since the amount involved is large, a number of financial institutions par- ticipate in the financing. An Islamic syndication facility can be provided through Murabaha, Mudarabah, Musharakah, Ijarah or leasing (detailed processes are given in relevant chapters of the book). 8.8 ISLAMIC FINANCIAL MARKETS AND INSTRUMENTS Islamic financial markets, like their conventional counterparts, comprise money and capital markets, but the instruments and the procedures of functioning are different. An Islamic 200 Understanding Islamic Finance financial market would be free of interest and would work on a different set of principles. 18 The Islamic Fiqh Council of the OIC has observed: “Although the original concept of financial markets is sound and its application is very much needed in the present-day context, yet their existing structure does not present an example to carry out the objective of investment and growth of capital within the Islamic framework. This situation requires serious academic efforts to be undertaken in collaboration between the jurists and the economists, so that it may be possible to review the existing system with its procedure and instruments and to amend what needs amendment in the light of the recognized principles of Shar ¯ ı´ah”. The major instruments of Islamic financial markets are equity related. Besides equity instruments in the form of shares in any company, the Islamic financial system has other redeemable short-, medium- and long-term participating instruments representing ownership in the assets, and hence entitled to participate in the profit/loss resulting from the operations on the assets. Various types of participatory instruments can be based on (i) profit/loss sharing (Mudarabah/Musharakah), like instruments issued by Mudarabah and asset management companies and participation term certificates (PTCs), and (ii) rent-sharing in the form of Diminishing Musharakah or otherwise. A pure debt or bonds market is not an active part of the Islamic financial markets because debt liabilities have to be paid at the nominal value subject to observance of the rules of Hawalah (recourse to the original debtor if the assignor is not able to pay the liability). The instruments on the basis of which the Islamic market has to function need to be backed by or represent real asset transactions. A debt security would result from a transaction based on any trading or Ijarah mode that can implicitly include time value of money at the stage of pricing of the underlying commodities or usufruct of the assets. These instruments may be of either a variable or quasi-fixed/fixed return nature. Equity instruments having a claim to share in the net income and the assets of a business give a variable return, while debt-related instruments can be issued in respect of trade or leasing- based transactions subject to the observation of the principles of the underlying Islamic modes. Backing by real assets according to the rules of the relevant modes is a must and mere replacement of one paper transaction with another kind of similar paper transaction will not serve the real purpose. Islamic financial market instruments can be of two types in terms of their nature and flow of return: 1. Fixed/quasi-fixed (stable) income securities. A bank can securitize or sell a pool of assets or offer certificates of deposit (CODs) against a fund composed of pooled Ijarah and some Murabaha and Istisna‘a contracts. It will offer the investors/depositors a defined stream of cash flow constituting the return on the pooled assets. Such securities would accommodate risk-averse investors like widows, retired people, etc. and generate new resources for additional intermediation and income flow to the banks. 2. Variable income (Shirkah-based) securities. For such securities, banks can securitize a pool of Musharakah and Mudarabah contracts that are part of their asset portfolio. Such securities will offer the investors a stream of variable income with potential for growth, based on the strength of the underlying projects – profit and risk both would be higher than 18 For details see Ahmad, Ausaf, 1997. Overview of Financial Institutions and Products 201 in the case of stable income securities. These would accommodate risk-taking investors with the commensurate possibility of a higher income. 8.8.1 Islamic Funds Fund management can be conducted both by commercial and investment banks, but presently, mostly investment banks are involved. Due to the asset-based nature of Islamic finance, this type of business is more suitable for IFIs than short-term commercial banking. Fund management refers to investors pooling their resources to purchase a larger num- ber of shares through any manager collectively, which otherwise they could not purchase individually. About 150 mutual funds of various categories are providing low risk/moderate return, balanced risk/return and high risk/high return Shar ¯ ı´ah-compliant investment facilities to investors in various parts of the world. While presently Islamic mutual funds are operating mainly in Saudi Arabia, UAE, Bahrain, Kuwait, Qatar, Pakistan, Malaysia, Brunei, Singa- pore, Germany, Ireland, the UK, the USA, Canada, Switzerland and South Africa, efforts are underway to provide investment facilities through mutual funds in all parts of the world to capture the emerging demand. Most of these funds are equity funds while a number of hybrid funds are managing leasing, real estate, Takaful and other funds. Management of the funds can be carried out on Mudarabah or agency basis. In the case of Mudarabah, the fund manager would get any pre-agreed percentage of the realized profit, while in the case of an agency arrangement, the manager would get a fee on agreed terms that may be any specified amount or percentage of the net asset value of the fund. Shaikh Taqi Usmani has indicated the following categories of Islamic investment fund: 1. Equity funds, the proceeds of which are invested in shares of joint stock companies, and returns in the form of capital gains and dividends are distributed on a pro rata basis among the investors. 2. Ijarah funds. The amounts of such funds are used to purchase the assets for the purpose of leasing. Rentals received from the user are distributed among subscribers of the fund. Ijarah Sukuk can be traded in the secondary market on the basis of market forces. Anyone who purchases these Sukuk replaces the sellers in the pro rata ownership of the relevant assets and all the rights and obligations of the original subscriber are passed on to him. 3. Commodity funds, in which the subscription amounts are used to purchase different commodities for the purpose of resale. The profits generated by the sales are distributed among the subscribers. 4. Murabaha funds. Any fund created for Murabaha sale should be a closed-end fund; its units cannot be negotiable in a secondary market as an Islamic bank’s portfolio of Murabaha does not own any tangible assets. 5. Mixed funds, the subscription amounts of which are employed in different types of invest- ments like equities, leasing, commodities, etc. For trading of mixedfunds, the tangible assets should be more than 51 %, while the liquid assets and debts less than 50 %. 19 Asset Management Through Equity Funds As compared to a conventional equity fund, in which a fixed return is tied up with its face value, an Islamic equity fund must carry a pro rata profit actually earned by the fund. 19 Usmani, 2000a, pp. 203–218. 202 Understanding Islamic Finance Therefore, neither the principal nor a rate of profit (tied up with the principal) can be guaranteed. On the basis of the risk profiles of the investors and the investment strategy of the asset management companies, equity funds can be divided into four categories: 1. Regular income funds: the objective of these funds is to earn profit through dividends of investee companies. Such funds provide a regular income stream by way of dividends to their investors who are mostly risk-averse, like old and retired people. 2. Capital gain funds: the objective of these funds is to earn profit through capital gain from frequent sale and purchase of Shar ¯ ı´ah-compliant stocks. These funds can provide a better return to moderate risk-taker investors by proper management and risk diversification. 3. Aggressive funds: these funds invest in high-risk securities to generate abnormal profits for their investors. They do not allow every investor to invest and limit the portfolio to high-risk investors as chances of loss are greater. 4. Balanced funds: such funds invest in high quality securities with less risk and give to the investors a regular income stream based on dividends and capital gain. These funds adopt a “capital proactive” approach. Screening and Purification Criteria Equity stocks included in the funds need to be compliant with Shar ¯ ı´ah guidelines. Shar ¯ ı´ah boards of IFIs develop a tolerance level in respect of investments in stocks. The selection of stocks goes through a strict screening process decided by the respective Shar ¯ ı´ah boards. Keeping in mind the scenario in the markets, this tolerance level might be different in different financial institutions and markets. Generally, the screening criteria tend to ensure that: 1. Theinvesteecompany’scapitalstructureispredominantlyequitybased(debtless than 33 %). 2. Prohibited activities such as gambling, interest-based financial institutions, alcohol pro- duction, etc. are excluded. 3. Only a negligible portion of the income of an investee company is derived from interest on securities. (In the case of Al Meezan Islamic funds, for example, the income of an investee company from nonpermissible income should not exceed 5 % of total income.) 4. The value of share should not be less than the value of the net liquid assets of the company. The most widely known are the Dow Jones Islamic Market Index Criteria, encompassing the following: 1. The basic business of the investee company should be Halal. 2. Debt to market capitalization: total debt divided by 12-month average market capitaliza- tion should be less than 33 %. 3. Cash and interest-bearing securities: the sum of the company’s cash and interest-bearing securities divided by the trailing 12-month average market capitalization should be less than 33 %. 4. Accounts receivable: accounts receivable divided by the trailing 12-month average market capitalization should be less than 33 %. Further, Islamic asset management companies have to purify their income by deducting from the returns on the investments the earnings emanating from any unacceptable source from the Shar ¯ ı´ah point of view. It is obligatory to dole away the prohibited income that is mixed up with the earnings of the company, and this obligation is on the one who is the owner of the shares or Sukuk – the investor. Purification is not obligatory for the [...]... be added and expenses which represent the services that the seller could have 13 14 15 16 Udovitch, 1970, p 220 Al-Jaziri, 1973, p 56 4; AAOIFI, 2004–5a, p 128 Al-Marghinani, 1 957 , p 282; Shaybani, 1 953 , pp 155 , 156 Al-Jaziri, 1973, pp 56 4, 56 5; Saleh, 1986, p 96 218 5 6 7 8 9 17 18 19 20 21 22 Understanding Islamic Finance provided himself but did not provide, such as packing charges, sales commission,... After basing the sale price on the original cost of the goods to the seller, the 4 5 6 7 8 9 10 11 12 Al-Marghinani, 1 957 , p 282 Ibn Qudama, 1 958 , 4, p 179; Al Jaziri, 1973, pp 55 9 56 4 Malik, 19 85, pp 424, 4 25 Al Jaziri, 1973, p 55 9 Al-Hilli, 1389 AH, p 40 Al-Kasani, 1993, 5, p 223, cf Hassan, 1993, p 95 Al-Marghinani, 1 957 , p 282 Ibn Qudama, 1367 AH, p 187 Al-Kulayni, 1278 AH, p 197 Murabaha and Musawamah... financier for a deferred price.42 39 40 41 42 AAOIFI, 2004–5a, p 113 AAOIFI, 2004–5a, Standard on Murabaha, clause 2 /5/ 1, p 116 AAOIFI, 2004–5a, Standard on Murabaha, pp 113, 114, 116, 128; clauses 2/2/1 to 2/2 /5 and 2 /5 Usmani, 2000a, p 106; for principal’s ownership during agency, see Zuhayli, 2003, p 674 224 9.8.1 Understanding Islamic Finance MPO – A Bunch of Contracts Modern Murabaha also involves... clause 4/2, pp 119, 131; see also Vogel and Hayes, 1998, p 126 47 AAOIFI, 2004–5a, pp 114, 1 15, 127, 128 48 AAOIFI, 2004–5a, pp 116, 129; clause 2/3 /5 of Standard on Murabaha 49 AAOIFI, 2004–5a, Standard on Murabaha, clause 4/1 226 Understanding Islamic Finance The above structure involves the following stages/steps: pre-promise understanding; promise stage; agency stage; acquiring possession; execution... include the opportunity cost”. 45 43 44 45 AAOIFI, 2004–5a, Standard on Murabaha, p 130 This is the view of Imam Abu Hanifa, Imam Shafi‘e, Imam Ahmad and of some Maliki jurists, cf Usmani, 2000a, pp 121, 122 Usmani, 2000a, pp 1 25, 126; Resolution Nos 2 and 3, 5th session of the Islamic Fiqh Academy Murabaha and Musawamah 2 25 This aspect has been discussed in detail in Chapter 5, with the conclusion that... deduction from the price according to Imam Abu Hanifa and his disciple Muhammad, because the commodity against which he has to practise his right of option does not exist Ibn Rushd, 1 950 , 2, p 217 See Saleh, 1986, p 96 AAOIFI, 2004–5a, clause 4 /5, p 120; See also Saleh, 1986, p 96 Al-Marghinani, 1 957 , p 2 85 Ibn Rushd, 1 950 , 2, p 218; cf Ray, 19 95, p 44 Ibn Qudama, 1369 AH, 13, p 78 Murabaha and Musawamah 219... be financed on a Murabaha–Mu’ajjal basis 26 Majallah al Ahkam refers to Bai‘ al Mujjal as Bai‘ bil Nasiah or bi al T’ajil wa al Taqsit (Al-Atasi, 1403 AH, Articles 2 45 251 ) 27 Al-Marghinani, 1 957 , p 242 24 25 220 Understanding Islamic Finance right of the seller It is, therefore, within his discretion to postpone it for the convenience and ease of the purchaser The fact is that he is empowered even... Tradability • Islamic money market instruments can either be tradable or nontradable in the secondary market; • instruments representing ownership in business, real physical assets and usufructs are negotiable at market prices; • instruments representing ownership of debt are not tradable in the secondary market, as sale of debt is not permissible in Islamic law; 25 Khan, 19 95 208 Understanding Islamic Finance. .. made to the supplier, and in this ı case, the bank would charge a higher profit margin than the case of post-supply payment 53 54 AAOIFI, 2004–5a, Standard on Murabaha, clause 2/2/6, pp 114, 128 AAOIFI, 2004–5a, Standard on Murabaha, clause 4/2, p 119 228 Understanding Islamic Finance Agency Stage An agency agreement can be signed side by side with the signing of an MoU But it should invariably be... http://www.ruf.rice.edu/∼ elgamal The Economist, London, 15th March, 2003 212 Understanding Islamic Finance The markets that can function in the Islamic financial framework include both money and capital markets, equity markets, limited forex markets, forward markets and investment Sukuk markets, representing a variety of instruments for fund and investment management by Islamic financial institutions Providing Shar¯´ah-compliant . Mirakhor, 1987, pp. 15 36. 14 Khan and Mirakhor, 1987, pp. 75 1 05. 15 Khan and Mirakhor, 1987, pp. 1 25 161. 16 Khan and Mirakhor, 1987, pp. 107–124. 198 Understanding Islamic Finance 3. Profit-sharing. tradable in the secondary market, as sale of debt is not permissible in Islamic law; 25 Khan, 19 95. 208 Understanding Islamic Finance Box 8.3: (Continued) • instruments representing a combination. 21–34. 196 Understanding Islamic Finance theory of Islamic banking. They are regarded as the norm towards which practice should, and will, eventually gravitate. Like him, a large group of Islamic