Where the mode of financing is under and pursuant to Islamic terms and in particular a Murabaha, where the Bank retains ownership and title in the Goods till the time of repayment, the Field Warehousing / Collateral Management agreement would have to be amended accordingly.
Islamic Financing Briefly Explained
It is of standard practice that Islamic banks and banking institutions that offer Islamic banking products and services are required to establish a Shariah Supervisory Board to advise them and to ensure that the operations and activities of the bank comply with Shariah principles. An essential ingredient is a regulatory framework that can accommodate Islamic finance principles and a regulator that is prepared to work with Islamic institutions to overcome technical hurdles. There must also be a tax regime that enables Islamic financing structures and products to be treated in an equivalent manner to their conventional counterparts.
Islamic finance has always been known and seen as a form of socially responsible investing whereby Shariah law requires that investments made have to be based on tangible assets and that lenders and borrowers in a business transaction share profits and losses.
With the adoption of stringent Shariah principles, Islamic finance offers a huge alternative economic opportunity to the conventional methods that investors have become accustomed to. Many countries globally from Europe, Middle East, Asia, Australia and even the United States have realized the importance of Islamic finance.
The principal instruments take the following forms: (i) Mudarabah, the provision of capital in a partialequity partnership; (ii) Musharakah, full equity partnerships, (iii) Murabaha, an instrument used for financing the purchase of goods; (iv) Bai muajjall, deferred payments on products;(v) Bai Salam, advance sale contracts; (vi) Istisna, or manufacturing contracts; (vii) Ijarah, lease financing; and (viii) Quard Hassan, a system of benevolent loans.
Mudarabah (capital trusts)
The Mudarabah (or capital trust) is a form of profit or loss (equity-based) sharing used by tradesmen. In other words, Mudarabah is a contract between two parties: an investor (individual or bank) who provides a second party, the entrepreneur, with financial resources to finance a particular enterprise. Profits are then shared between the two parties (rabb-al-mal and mudarib) according to some pre-agreed ratio, but if there are losses the investor bears all financial losses and the entrepreneur the operating losses; principally the opportunity cost of their own efforts.
Musharakah (full partnerships)
Musharakah (or full partnership) is an arrangement where two or more parties establish a joint commercial enterprise and all contribute capital as well as labour and management as a general rule. The profits and losses that flow from the Musharakah are again shared among the parties on a pre-agreed ratio.
Murabaha (mark-ups on sale)
The fundamental principles attached to Murabaha can be summarised as follows: (i) goods must be classified, clearly identified according to commonly accepted standards and must exist at the time of sale; (ii) goods for sale must be in the ownership of the bank at the time of sale; (iii) the cost price must be known at the time of sale and this should be declared to the client. This is especially the case when the bank succeeds in obtaining a discount where the profit margin is calculated on the net purchase price (this means discounts also provide benefits to the client); and (iv) the time of delivery of the goods and the time of payment must be specified.
In fact, the Murabaha contract is merely a two-party buying and selling contract between bank and customer involving no financial intermediation or financing. In other words, the bank offers this service to clients who should pay the cost of the goods plus a profit margin to the bank immediately following receipt.
Istisna (manufacturing contracts)
Istisna is a relatively new method in Islamic banking, defined as a manufacturing contract which allows one party to obtain industrial goods with either an upfront cash payment and deferred delivery or deferred payment and delivery.
Ijarah (lease financing)
Ijarah is the reward or recompense that proceeds from a rental contract between two parties, where the lessor (the owner of the asset) leases capital asset to the lessee (the user of the asset). Ijarah literally means “to give something on rent.
In Islamic finance, there are two forms of leasing: (1) direct leasing finance (Ijarah), whereby the lessor (either an individual or a firm) allows the lessee to use capital assets owned by the lessor for a specified period of time ranging from a few days to years depending on the type of asset. In return, the lessee pays the rental fee monthly or annually. However, the ownership of the capital assets cannot transfer to the lessee in this type of leasing (as in finance leases) and insurance on the capital assets remains the responsibility of the lessor.
In contemporary Islamic banking, Ijarah has been adapted to provide a form of hirepurchase whereby an institution or individual customer requests the bank to purchase equipment with the intention of leasing it to the customer. In turn, the Islamic bank rents the asset to the client who pays a certain fixed rent and promises to purchase the asset within a specified period to transfer ownership from the bank to the. Furthermore, this could be transformed as a decreasing-value lease that allows the client to pay an instalment of the value of the asset plus its rent each period to reduce the lessor’s share of ownership until the lessee becomes the owner.