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ShariahContractfor Islamic FinancInstrumentsChap 3 (Part 2)

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ESSENTIAL ELEMENTS (rukun) ANDCONDITIONS OF SHARIAH CONTRA

In order to make a contract valid, each type of contract usehave essential element and each essential element required bcontract must meet the necessary conditions outlined.

For the purpose of identifying the essential element, the typcontracts used in the Islamic finance have been categorized ifollowing:

Trading contracts

Participating contracts

Supporting contracts

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Trading contrac

Contract of sale

Contract of IjarahContract of Bay InahContract of Bay Dayn

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1. Contract of sale (Bay Bithaman AjMurabahah)

The most popular type of financing by almost every Ibank in Malaysia is Bay Bithaman Ajil (BBA)

In 1997, BIMB used BBA and Murabahah as its mainincome-generating products of up to 90.5 per cent oassets

Definition a sale contract in which the payment ofselling price is deferred to an agreed later date. Themerchandise exists at the time of contract.

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Modus operandi of BBA Contract

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The illustration above shows that how BBA works;

1. You pick an asset you would like to buy.

2. You then ask the bank for BBA and promise to buy the asset from t

through a resale at a mark-up price.

3. Bank buys the asset from the owner on cash basis.

4. Ownership of the goods passes to the bank.

5. Bank sells the goods, passes ownership to you at the mark-up pric

6. You pay the bank the mark-up price in instalments over a period of

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Essential elements of BBA/ Muraba

seller

Buyer

Item soldPrice

Contract

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Essential elements of BBA Contra

Essential element Conditions of essential element

a) seller There are 3 necessary conditions of se

buyer, as follows:1. Capable of taking responsibility2. Not prohibited from dealing with t3. No coercion is exerted on either of

b) buyer

c)Item sold (underlying asset) There are 6 conditions required underas follows:1. It must exist

2. It must be pure (halal) according to3. It must have use according to the S4. It must be owned by the seller5. It must be capable of being delivere

free from encumbrances6. It must be known and specific by a

description or specification

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Essential elements of BBA Contra

Essential element Conditions of essential element

d) Price There are 2 necessary conditions of pri1. Known currency2. Absolute amount

e) Contract (offer and acceptance) There are 3 necessary conditions of confollows;1. The offer and acceptance must be ab

definite and decisive language

2. The acceptance must agree with the 3. The offer and acceptance must be mand the same meeting

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Bay al Murabahah

As in BBA, a Murabahah transaction involves the sale of ga price which includes a profit margin agreed by both par

However, in Murabahah, the seller must let the buyer knoactual cost for the asset and the profit margin at the timsale agreement.

Usually, islamic banks used to apply BBA altogether withmurabahah in asset financing

The Islamic banking practice in Malaysia tends to confine long term asset financing and Murabahah to short & medterm financing

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Bay al-Salam Definition

Postponed/deferred

delivery sale

The sale of a

deferred item in

an exchange for

an immediate

price

Literally

A sale with an

immediate

payment to thseller while del

of the goods so

delayed until a

specified date i

future

Technically

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Essential elements in Bay al-Sala

Price

Must be fully paid in

cash during the time of

contract

Must be fully specified in

term of currency

In an absolute amount

Goods

The quality of

commodity must be

expressly specified

The quantity of the

commodity is agreed

upon in absolute terms

Cannot be effected on a

particular commodity or

on a product of a

particular field

D

The exact

of deliver

specified

Cannot b

specific c

respect o

which m

at spot

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Types of Bay al-Salam

Ordinary Salam contract It involves only two

transacting parties which isthe buyer (musallim) andthe seller (musallam ilayh)

Parallel Salam Contrac It is a contractual

arrangement that coof two different andindependent contrac

in which the bank is And the other in wh

bank is a seller

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Application of Salam Contract inContemporary Islamic Finance

Is typically used in short-term financing and also could beemployed for a longer term financing

The salam and parallel salam are among the most effectivfinancing tools available for IFIs, particularly in providing financing services for small and needy farmers

May lies benefit for both contracting parties: the bank (buand the farmers (sellers)

The bank can bargain with the farmers for price less thanprice whereas the seller will have funds to enable him to pthe commodities according to specified quantity and qualit

M d di f B l S l

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Modus operandi of Bay al-SalamAgricultural Financing

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2. Contract of Ijarah

Ijarah contract is a form of exchange contract (`aqd mu`awadah) usufruct vs rent.

Ijarah is a contract that results in the transfer of theto use (usufruct).

The ownership of the asset remains with the owner c

lessor. In practice, ijarah can be used as operating lease or le

contract with an option to purchase al ijarah thumbay` (AITAB)

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Modus operandi of Ijarah

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Modus operandi of AITAB

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Modus operandi of AITAB Ijarah Thumma Bai is normally used in financing consumer goods especially m

There are two separate contracts involved: Ijarah contract (leasing/renting) an(purchase).

The contracts are made one after the other as shown in the diagram above:

Here is how it works:

1. You pick a car you would like to have.

2. You ask the bank for Ijarah of the car, pay the deposit for the car and promfrom the bank after the bank has bought the car.

3. Bank pays the seller for the car.

4. Seller passes ownership of the car to the bank.

5. Bank leases the car to you.

6. You pay Ijarah rentals over a period.

7. At end of the leasing period, the bank sells the car to you at the agreed sale

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Essential element of Ijarah

Ijarah

lessor

lessee

property

benefit

Rental

amount

contract

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Essential element of Ijarah

Essential element Conditions of essential element

a) Lessor There are 3 necessary conditions of lessor anas follows:1. Capable of taking responsibility2. Not prohibited from dealing with their pro3. No coercion is exerted on either of them

b) Lessee

c) Property There are 4 necessary conditions of the propfollows:

1. It must be owned by the lessor2. It must be ready for use3. It must be delivered to the lessee4. It must be specific by address, description

specification

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Essential element of Ijarah

Essential element Conditions of Essential element

d) Benefit There are 5 necessary conditions of benefitare;1. It must be permissible2. It can be fixed in value3. The lessor has the power and capability

the benefit and allow the lessee to use thproperty

4. It must be specified5. The benefit must not be a material part

property

e) Rental amount There are 2 necessary conditions of price 1. Known currency2. Absolute amount

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Essential element of IjarahEssential element Conditions of Essential element

f) Contract (offer and acceptance) There are 3 necessary conditiocontract as follows:1. The offer & acceptance mus

absolute and in definite andlanguage

2. The acceptance must agree offer

3. The offer & acceptance musat the one and the same m

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Shariah contracts involved in AITAB con

1. Ijarah contracta contract whereby the lessor (Islam

bank) will rent the asset to the lessee (customer) ovecertain period and at a monthly rental amount as aby both parties

2. Al-bay contract upon completion of the rental peupon early settlement, the lessor will then enter into

sale contract with the lessee to sell the asset at a preselling price

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Issues/challenges in operation of AITA(Oct 10 Q5(a)(iii))

1) Customer awareness

- customers do not really understand the differences between Aand conventional hire purchase. Customers also do not aware on thdistinction of AITAB as a Shariahcompliant product

2) Lack of experiences among bank officers

- many of them proclaim that both Ijarah and AITAB is similaespecially with regards to its document, procedure and governance

3) Competition in the market

- how to penetrate the market. As a new product, AITAB facedchallenge on how it can be offer at a lower cost compared to itscounterpart since AITAB require more paper documents and papethat have to be filled

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Contd..

4) ShariahFramework

- the basic operation of AITAB in effect is similar toconventional hire purchase, the only differences is the isinterest (riba) and issuance of acceptance (aqad) letter. regards to determination of fixed rate, standarddocumentation, and formation of agreement, AITAB

transactions follows the same spirit of Hire Purchase Ac

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3. Contract of Bay al-Inah Bay Inah conceptually refers to a sale of an asset, which i

repurchased at a different price, whereby the deferred prhigher than cash price

Is permissible based on analogy, the contract is similar to sale and purchase contract i.e transfer of ownership is tak

the majority view that such a sale is forbidden. They are HMalikis, Hambalis and some Shafiis.

Imam ShafiI, Abu Yusuf, Abu Daud, and Abu Thur, are ofview that this contract of sale is not contrary to Shariahprinciples.

SAC of BNM resolved the Bay al-Inah is still necessary inMalaysian context.

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Essential elements of Bay al-Ina

Seller

Buyer

goodsSighah

Price

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Conditions required for Bay al-In

Bai al-inah is permissible subject to the following condition:

i. There must be two separate contracts properly executed

ii. The transacted item must not be a ribawi material in the medium

iii. Payments of the price in the banks purchase contract must be on

iv. There must be real and valid taking possession of subject matter i

contractv. Allocation of the property as the subject matter of the contract m

and reasonable according to market price

vi. The first contract must be executed at the start before entering incontract

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Application.

Bay al-Inah has been used to construct numerous fin

product offered by the bank in Malaysia:a. Personal financing

b. Working capital financing

c. Istisna between 2 parties

d. Islamic credit card

e. BBA financing products

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Contract of Bay al-Dayn (Debt trad

A sale contract in which the creditor sells his payable

upon the debtor either to the debtor himself or to a party at discount or at cost price on the spot payme

The legality of bay al-dayn depends on its types whidetermined by the number of parties involved (whethor three), the party to whom the debt is sold (wheth

debtor or non-debtor) and the modes of delivery (onbasis or credit basis)

S l f d bt t th d bt d

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Sale of debt to the debtor and nondebtor

Illustration of the sale of debt

to the debtor Ahmad owes Muhammad

RM1000 and Muhammadsells the debt to Ahmad fora portion of the land ownedby Ahmad.

Illustration of the sale

to the non-debtor Yusuf owes Ahmad

RM5,000. Ahmad ththe debt (RM5,000)for a motorbike on abasis.

Th i t f Sh i h

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The requirement of Shariah concernBay al-Dayn

1. A debt must have been created through a contract o

deferred payment sale of goods or service.2. The goods must have been delivered or the service m

have been rendered.

3. The trading of debt must be on cash term

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Bay al-Sarf

Transactions of exchanging one currency with a simil

another currency For example, to buy 100 Ringgit Malaysia with an ex

of 1000 Thai Baht

Bay al-Sarf is applicable to modern spot forex whichbased on the spot rate in which the deal settlement iexpected to be completed within two business days afcontract has been executed

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Basic rules and conditions of Bay al Since trading currency involves ribawi items, it is always

to the Islamic rules in order to avoid occurrence of riba There are basic rules and conditions that needs to follow:

1. If the exchange is between the same type of currency, forexample gold for gold, it follows:

- equal quantity or weight regardless of quality

- must be on the spot basis2. If the exchange is between the two different types of curr

for example gold for silver, RM with IDR,

- the exchange must be on the spot basis

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Qardul Hassan A contract where a creditor (lender) transfers a specified property

borrower (debtor) and the debtor would have to return the similaback to its owner (creditor) when it is due with no additional amoimposed.

The word qardh is derived from Arabic qirad means to cut

Also called as qard, as it cuts certain part of the lenders propertyloan to the borrower.

Hassan is derived from the word ihsan means kindness to oth

The term Qard al-Hassan means beneficial loan or benevolent loanloan, interest free loan.

This loan is normally given for charity purposes or for short term requirements.

Therefore, the borrower is obliged to pay only the amount borrow

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Objective of Qardul Hassan

To help the needy fellow

people.

To establish better

relationship among poor

and the rich.

The mobiliz

among al

s

To perform a good deed

that is encouraged and

appreciated by the

Almighty Allah and His

Messenger.

To facilitate the poor to

create new jobs market and

business ventures by using

their merits, skills and

expertise.

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Conditions that need to be fulfille

Both contracts should

be legally capable to

enter into the qard

contract

Ijab and qabul of the

qard must be clearly

made before entering

into the loan contract

Both parti

provide w

Both of the partiesinvolve must not

hesitate to document

all details

The lender must notimpose any extra

payment in the

contract

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Individual assignment 2

Jan 2013: i) Q1 (b),

ii) Q2 (b)

iii) Q5 (b)

Jun 2012: i) Q1 (b), (d)

ii) Q2 (c) Jan 2012: Q5 (a) and (c)

Oct 2010: Q1

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End of chap 3 partAny questions?