1

FINANCING MECHANISM OF ISLAMIC BANKING

Taudlikhul Afkar

Ph.D Student (Economics Science) at Airlangga University

Lecturer at An-Najah Islamic Institute, Department of Islamic Economics

Abstract

Some previous articles gives more of an overview of Islamic Banking by exploring and

explaining one, two, or more types of Islamic banks financing, while this article provides

a simple overview of the existing financing mechanism in Islamic Banking as a whole.

The presentation is classified into four sections; first, financing mechanism based on the

principle of sharing, second, financing mechanism based on selling (Ba'i), third,

financing mechanism based on lease, and the fourth is a financing mechanism that is

based on benevolent loans.

Keywords : Financing, Mechanism, Islamic Contract, Islamic Banking

JEL : G00, G21, N20, Z12

1. INTRODUCTION

Islamic banks are banks that conduct

business based on Sharia principles (Islamic

law) which rules are based on the agreement

between the bank and other party that involves

storage of funds and/or funding for business

activities or other activities stated in accordance

to the Islamic law. The differences between

Islamic banks and conventional banks can be

seen from its operational bases. Conventional

banks bases its operation on interest while

Islamic banks„ is based on the principle of

Islamic law.

In an Islamic financial system, all

transactions must be governed by norms of

Islamic ethics as enunciated by the Sharia

(Islamic law). While entering into commercial

transactions is not prohibited, the freedom to

contract is proscribed by other norms, such as

the prohibition of riba and gharar (Ashurst,

2009).

In the view of Islam, the system of

interest occupy an element of injustice because

the owner of the funds requires the borrower to

pay more by returning principal plus interest

regardless their situation, whether they are

making a profit or a loss. In contrast, the Islamic

principles used by Islamic banks is the system

where the borrower and the lender share the risks

and benefits with the division according to the

agreement, so that there is no injured party

disadvantaged by the other partaker.

Furthermore, when being seen from an

economic perspective, Islamic banks can also be

defined as an intermediary institution of public

investment that flows optimally (with the

obligation of zakah and the prohibition of

interest) that is productive (with the prohibition

of gambling), and executed according to values,

ethics, morals, and the principles of Islam.

Financing is one product of the Islamic

banking from its type of funds distribution. It is

based on the principles of Islamic Law. In

distributing the funds to the client, an outline of

Islamic financing products are divided into four

categories which are distinguished based on their

intended use; first, financing with the principle

of selling, second, financing based on lease,

third, financing based on profit sharing, and

fourth, contract financing with complementary or

better known by services or benevolent loans.

2

Figure 1 Financing in Islamic Banking

2. LITERATURE REVIEW

2.1 Financing based on Profit-Loss Sharing

Profit-Loss Sharing system is an

agreement or mutual bond in conducting

business. In the business activities, profits are

shared together. Profit-Loss Sharing is a special

feature offered to the people, and in the Shari'ah

rules the distribution of net income is to be

determined at the beginning of the contract.

Determining the magnitude of the portion of the

Profits and Loss between the two sides are

determined according to mutual agreement, and

must occur in the presence of willingness (An-

Tarodhin) on each side without coercion.

2.1.1 Mudharabah Financing Mechanism

Mudharabah is a kind of cooperation

between two or more parties in which one party

entrusts a number of capital to other parties who

act as managers (mudharib) with a profit-loss

sharing agreement. In mudharabah, the presence

of representatives of the owners of capital

(shahib al-maal) is not required to manage some

project. This kind of system can be applied to the

financing of working capital.

Mudharabah are longterm instruments

that Islamic banks use, on the basis of profit and

losssharing to manage or participate in mutual

funds companies or to finance business

enterprises in the fields of industry, commerce

and agriculture (Al-Zaabi, 2011). Mudharabah is

a special type of partnership between at least two

types of partners, one partner provides the capital

who is or as Shahib al-Maal or the investor and

the second is term as Mudharib or amil or

worker who is responsible for the working and

management of business (Saleh,1986).

In this case under which partnership

should be based on a agreement between finance

and worker for a particular business. In this event

prophet did not give the permission to do any

business to the shahib (owners of capital) (Aziz

et al, 2013). Whereas the distribution of profit–

loss is concern in case of profit it will be

distributed in a pre-decided ratio

(Siddiqui,1969). It is also seen that use of a

stable unit of account that will result in sharing

of real profits makes mudharabah a very just and

equitable mode of finance (Rab, 2004).So,

Mudharib is completely responsible for all the

affairs of the business entity (Chapra, 2005).

Two types of mudarabah are, first

Mudharabah Muqayyadah and Mudharabah

Mutlaqah. In mudharabah muqayyadah, rab-ul-

maal (owners of capital) may specify a particular

business or a particular place for the mudharib,

in which case shall invest the money in that

particular business or place. In mudharabah

mutlaqah, rab-ul-maal (owners of capital) gives

full freedom to mudarib to undertake whatever

business he deems fit. However mudharib

cannot, without the consent of rab-ul-maal

(owners of capital), lend money to anyone.

Mudharib is authorized to do anything, which is

normally done in the course of business.

However if they want to hane an extraordinary

work, which is beyond the normal routine of the

traders, he cannot do so without express

permission form rab-ul-maal (Usmani,2002).

Pillars in mudharabah contract are; 1) the

presence of the perpetrator. It means that in the

mudharabah agreement there must be a

minimum of two perpetrators. The first party acts

as shahib al-maal (owners of capital) and the

second party as mudharib (a business executive)

2) The presence of objects. As a logical

consequence of mudharaba contract, there

Mudharabah

Musharakah

Profit Sharing

Salam

Istishna

Ijarah

Murabahah

Selling

Financing

Lease

Benevolent Loans

Qardh

3

should be objects which are capital and labor.

Capital owners submit their capital as

mudharabah object in the money or goods, and

mudharib in expertise or skill. 3) an agreement.

It means that in the agreement both parties must

be willing and sincerely agree to bind themselves

in mudharabah contract. The owners of capital

agree with its role to contribute funds or goods

while the business executors agree with the role

to manage the business. 4) Ratio of profit. This

ratio reflects the benefits entitled to by both

parties. Capital owners get rewarded for their

capital investments while business managers

(mudharib) get compensated for their work. To

prevent disputes, the amount of remuneration

must see the initial approval for profits

percentage that has been agreed upon and

implemented in mudharaba contract. It happens

likewise if a loss is also borne jointly.

Mudharabah is based on the Holy Qur'an

4: 29 that means “O You who have believed, do

not consume one another's wealth unjustly but

only (in lawful) business by mutual consent And

do not kill yourselves (or one another). Indeed,

Allah is to you ever Merciful”.

Figure 2 Mudharabah Financing Mechanism

Figure 2 describes the mechanisms of financing

that is initiated with the customer or the bank

discussing cooperation negotiations about the

business activities that will be performed without

violating Islamic principles. After agreeing the

types and forms of business activities, the

customer and the bank talk further on profit-loss

sharing which would then be included into

mudharabah contract as a binding agreement

between the two parties. Having agreed on the

whole concept, in this case the bank as owners of

capital (Shahibul maal) melts venture capital

financing as agreed by 100% and the customers

in this case who acts as the manager of venture

capital (mudharib) provide the ability or

expertise to manage the business. Furthermore, if

the business activities is providing benefit, the

bank and the customer will get a share in

accordance to what has been agreed in

mudharabah contract as well as also at the time

of loss. Furthermore, customers in addition to

getting the share of profit, they still have to

return the lent capital back into the banks.

2.1.2 Musharakah Financing Mechanism

Musharakah transactions are types of

business that involves two or more parties in

which they jointly integrate all forms of

resources both tangible and intangible.

Specifically, the type of contribution from the

parties can be in the form of funds, goods trade,

entrepreneurship, intelligence or skill, property,

equipment or intangible assets such as patents or

good will, trust or reputation and other goods

that can be valued in money. Literally the word

Musharakah means sharing or mingling. In

Arabic language, the root words of Musharakah

are shirkah or shirk which means partnership

(Farooq and Ahmed,2013). Musharakah refers to

the act or contract of making a partnership

between two or more parties. It is a participatory

mode of finance which basically involves direct

participation of the parties in profits as well as

losses, if any (Ayub,2007).

Musharakah transaction is based on the

willingness from both parties or more who work

Islamic Bank Customers

Operation

Equity

Profit

Profit-loss Sharing

Agreement

Capital Loan

100%

Equity 100%

Part of profit

X

Skill

Part of profit

Y

Cooperation

4

together to bind the value of the assets owned.

General provisions in musharakah financing are

all united capital used for projects that are

managed together. Each other are entitled to

participate in decisions about the business. The

costs incurred in the implementation of projects

and the projects should be shared while profits

are divided according to the initial agreement,

yet the losses are divided according to the capital

contribution of each party. Project or business

carried on should be mentioned in the contract, it

must be in accordance with Islamic principles.

After its completion the customer returns the

fund in conjunction with the results that have

been agreed upon.

The basis for entitlement to the profits of

a Musharakah is capital, active participation in

the Musharakah business and responsibility.

Profits are to be distributed among the partners

in business on the basis of proportions settled by

them in advance. The share of every party in

profit must be determined as a proportion or

percentage. No fixed amount can be settled for

any party (Sidiqqi, 1985). According to the

diminishing musharakah, a financier and his

client participate either in the joint ownership of

property or an equipment, or in a joint

commercial enterprise (Usmani, 2002).

In a musharakah contract, the parties

share profit or loss according to their share in the

capital or as otherwise specified in the contract.

In the event of the project being profitable, the

profit is distributed according to the proportion

specified before hand in the contract (Al-Zaabi,

2011). Musharakah is run and managed by the

will and equal rights of participation of all the

partners (Ahmed, 2014). The term Musharakah

can be defined as a joint enterprise formed for

conducting some business in which all partners

share the profit according to a specific agreed

ratio while loss is shared according to the ratio of

their contributions (Ibid). Assigning partners to

God (Allah) is also referred to as shirk (Usmani,

2002).

Musharakah are longterm instruments that

Islamic banks use, on the basis of profit and loss

sharing to manage or participate in mutual funds

companies or to finance business enterprises (Al-

Zaabi, 2011). During the execution of the agreed

project, the parties should not commit acts that

violate the contract such as combining assets

with private property, running the project with

other parties without permission from the owners

of capital listed in Musharakah contract, giving

loans to other parties, and the owners of capital

are considered to end the collaboration if

withdrawing from the agreed cooperation with

certain rational reasons, or passing away.

Musharakah contract is based on

Qur‟an 38:24 that means “(Dawud) said, "He

has certainly wronged you in demanding your

ewe (in addition) to his ewes. And indeed, many

associates oppress one another, except for those

who believe and do righteous deeds - and few

are they." And Dawud became certain that We

had tried him, and he asked forgiveness of his

Lord and fell down bowing (in prostration) and

turned in repentance (to Allah).

Figure 3 Musharakah Financing Mechanism

Figure 3 describes the musharakah financing

mechanism, it begins with the customer in need

Part of profit X

Islamic Bank Customers

Operation

Equity

Profit

Profit-loss sharing

agreement

Capital Loan

Part of capital X

Skill and Equity

Part of profit Y

Cooperation

Part of capital Y

5

of funds to accommodate businesses and then

apply to the bank by negotiation and after the

banks understand the intention of customers then

there was cooperation with the profit and loss

sharing agreement. Almost the same as

mudharabah, both parties submit owned

property so that the bank can finance in whole or

in part for the business activities in loans, while

the customers can participate by embedding

partly owned capital and provide skills to

manage the business activities. Furthermore, if

the benefit of business management, the profits

will be divided according to the agreed portion

of the initial agreement. If the financing is

entirely financed by the bank, the customer must

return the entire loan capital to the bank,

however if the business activity is partly a

customer capital, the customer will also get the

most return on capital.

2.2 Financing based on Selling (Ba’i)

Financing which is based on Selling

principle in Arabic is called Ba'i or al-Ba'i. Bai

is the exchange transaction between (real assets)

“ayn” in the form of goods and (financial assets)

“dayn” in the form of money, commonly referred

as a transaction. In this transaction, the gain on

sale is already included in the price so that the

seller does not have to notify the desired profit

level.

Al-Ba'i can be divided into three parts, the

first, Al-Bai 'Naqdan which means that in the

contract of sale of an item or service, the

payment and delivery of goods or services are

made in cash or in the immediate time. Second,

Al-Bai 'muajjal means that in the contract of sale

of an item or service the payment is not made in

cash or will be done in the future (debt) but the

goods or services is received earlier. Third, Al-

Bai 'Taqsith which means that in the contract of

sale of an item or service, the payment is made

in installments over a period of debt while the

goods or services is received at the beginning of

the period.

Al-Ba’i agreement is based on (Qur‟an

2:275) that means “Those who consume interest

cannot stand (on the Day of Resurrection) except

as one stands who is being beaten by Satan into

insanity. That is because they say, "Trade is

(just) like interest." But Allah has permitted

trade and has forbidden interest. So whoever has

received an admonition from his Lord and

desists may have what is past, and his affair rests

with Allah. But whoever returns to (dealing in

interest or usury) - those are the companions of

the Fire; they will abide eternally therein”.

And in (Qur‟an 2:198)”There is no

blame upon you for seeking bounty from your

Lord (during Hajj). But when you depart from

'Arafat, remember Allah at al- Mash'ar al-

Haram. And remember Him, as He has guided

you, for indeed, you were before that among

those astray”.

2.2.1 Murabahah Financing Mechanism

Murabahah is a transaction in which the

bank acts as the seller while the customer as a

buyer. The selling price is the banks‟ purchasing

price from the supplier plus other certain

advantages. Both parties must agree on the price

and payment terms. The sale price is included in

the sale and purchase agreement and if it had

been agreed upon, it is not to change during the

lifespan of the contract. In general, murabaha is

conducted by paying repayments. In this

transaction the goods are delivered right away

after the contract is agreed while the payment is

done later.

Murabahah is a particular kind of sale

where the seller expressly mentions the cost of

the sold commodity he has incurred, and sells it

to another person by adding some profit thereon.

Thus, murabahah is not a loan ginven on interest

it is a sale of commodity for cash or deferred

price (Usmani,2002).

Murabahah is a sale contract between two

or more parties one of them is the Islamic bank,

in this case the Islamic bank is selling goods to

the second part who is the customer opposite

profit margin adds to the price that bought it the

first from the market provided that known the

second part with goods original price, after the

6

second part received goods can repaid what is

due on him forthwith or during enough time

according to the agreement (Almsafir &

Alsmadi, 2013). Murabahah is a short-term

instrument where banks buy the goods on the

market to customer specification then sell the

same to him at a price based on cost plus profit

margin (Al-Zaabi,2011). Murabahah can be

done by order or no order. If it is based on order,

bank make purchases after there are orders from

customers that can be both binding or non-

binding for customers to buy goods ordered (the

bank may ask for advance purchases to

customers). While in murabahah that is based on

binding order, the buyer or customer can not

cancel the order. Murabahah which is not based

on the purchase order means that the bank buys

from the owner which later it will be saved as an

asset.

Characteristic of murabahah is that the

bank must inform the buyer about the purchase

price of traded goods and stating the amount of

profit that is added so that the buyers or

customers know about it and there will be

bargains to be eventually agreed upon price

which is in accordance with the bank where the

bank still can gain benefit. In Murabahah

transaction, the price is fixed so any savings on

prepayment of the deferred sale price may not be

possible. There is, however, a difference of

opinion among scholars in relation to rebates on

voluntary prepayment (Ashurst,2009).

Figure 4 Murabahah Financing Mechanism

Figure 4 describes the murabahah financing

mechanism that begins with the customer to

apply for financing with the negotiation of the

items to be purchased and various kinds of

requirements. When they are agree with it the

murabahah contract are signed by both parties.

Next, the banks will look for suppliers to

purchase goods desired by the customer. After

the banks buy the goods, the goods will be

handed over to the bank and then delivered to the

customer by regarding the suitability of the

goods ordered by the customer. Customers

receive the ordered goods if it is in accordance

with the specification of customers. The next

stage is that the customer began to make a

payment by installments until they are paid off.

2.2.2 Salam (As-Salam) Financing

Mechanism

Salam is a sale and purchase transactions

in which there are no goods to be traded yet, but

the quantity, quality, price, and time of delivery

of the goods is to be determined at exact time.

Bank pays in cash to the supplier and the goods

are delivered later. When goods are delivered to

the bank, the bank will sell it to a partner or

client itself in cash or in installments. Selling

price set is the purchase price plus profit.

Examples of this financing system is financing

for the purchase of agricultural or plantation.

General provisions in the Salam financing

is; 1) Purchase of production must clearly know

the specifications type, kind/shape, size, quality

and quantity, 2) When the production received

does not match, then the customer should be

responsible, among others, to restore funds that

has been accepted or replace the goods to order,

3) when the Bank does not make goods

purchased or ordered as inventory, it is possible

to perform the Salam contract to third parties.

The mechanism is called the Salam parallel. In

other words, the bank can do Salam contract with

another agency or other buyer where the goods

can be sold, for example the Main Market

Dealer, or Wholesale.

In salam contract, the seller undertakes to

supplay specific goods to the buyer at a future

date in exchange of an advance price fully pait at

Islamic

bank

Customers

1. Negotiation

4 delivery

5. Installment

Payment

Suplier

2. Cash

Purchasing

3. delivery

7

spot. The price is in cash but the supply of

purchased goods is deferred. Salam is beneficial

to the seller because he received the price in

advance and it was beneficial to the buyer also

because normally the price in salam is lower

than the price in spot sales (Usmani, 2002). This

contract is characterized by the advance payment

of a price for a specified good that is delivered

after a delay (Al-zaabi,2011). Salam is a type of

exchange or substitution that results in a debt

owed by the seller, it acquires the meaning of a

transaction that involves both selling and buying

and borrowing and lending (Umar,1991). Salam

is when a man delivers to another some known

and described food from the produce of common

land of known measure and weight for a definite

period in exchange for a known amount of

money, the price having to be paid before they

separate and leave their place of transaction, not

forgetting to name the place where the food is to

be handed over. If they did that, the deal would

be appropriate (Al-„Ashqar,1995).

In salam can be parallel technique. In an

arrangement of parallel salam there must be two

different and independent contracts, one where

the bank is a buyer and the other in which it is a

seller. The two contracts cannot be tied up and

performance of one should not be contingent on

the other. A salam arrangement cannot be used

as a buy back facility where the seller in the first

contract is also the purchaser in the second. Even

if the purchaser in the second contract is a

separate legal entity, but owned by the seller in

the first contract, it would not tantamount to a

valid parallel salam agreement (Usmani,2002).

The Islamic legitimacy of the salam

contract is based, to begin with, on its

concordance with the Qur‟anic verse that forbids

usury but permits/enjoins commerce: “Those

who eat interest (riba) will not stand (on the Day

of Resurrection) except like the standing of a

person struck by Satan leading him to

insanity.That is because they say: “Trading is

only like riba,” whereas God has permitted

trading and forbidden riba”(Qur‟an,2:275).

Pillars in financing Salam is that there

must be a buyer (muslam), a seller (muslam

Alaih), in this case is the bank, there should also

be a capital (money) as legal tender, items

(muslam fihi) in the form of tangible asset in

accordance with the specifications of the initial

order, and that the contract must be recited

(sighat).

Figure 5 Salam Financing Mechanism

Figure 5 describes the Salam financing

mechanism that starts as the customer makes a

request for Salam financing by orders of goods

in accordance with the specifications of what the

customer wishes, but the goods are not yet there.

Next, the bank looks for a manufacturer or

supplier to obtain the goods in question. After

getting the suppliers, the bank negotiate and

when they agree there would be a preliminary

agreement by providing downpayment for the

goods to be purchased. Once the goods in

question arrive, then the manufacturer or supplier

sends the goods to the bank to be later given to

the customer if it has met the customer‟s

specification. Once the customer receives the

item, they shall pay to the bank by cash or

installments.

Islamic

bank

Supplier Customers

Goods

1a.orders with

specification

3. Prepaid

4 Spesification product

5 delivery

1b. orders with

specification

6. Installment Payment

8

2.2.3 Istishna Financing Mechanism

Istishna is a sale transaction where a

commodity is transacted before it comes into

existence. It is an order to a manufacturer to

manufacture a specific commodity for the

purchaser. The manufacturer uses his own

material to manufacture the required goods. In

istishna, price must be fixed with consent of all

parties involved. All other necessary

specifications of the commodity must also be

fully settled (Usmani, 2002).

Financing by istishna, much like all non-

participatory forms of financing, imposes on the

public authority rigid debt obligations extending

over the full repayment period. Some of the

drawbacks of public debt apply to this debt too,

even though it is interest-free. The fact that it is

permissible in shariah carries no guarantee that it

will not be used to finance irrational projects

(Zarqa, 1997). After giving prior notice, either

party can cancel the contract before the

manufacturing party has begun its work. Once

the work starts, the contract cannot be cancelled

unilaterally (Usmani, 2002).

Istishna is financing system for the

customers who first ordered goods to the bank or

other manufacturers with certain criteria where

then they made a binding agreement on the sale

price and method of payment. Istishna is almost

the same as bai 'al-salam. The difference lies

only in the method of payment. The payment

must be upfront and immediate, whereas the

istishna payment must be at the beginning, in the

middle, or at the end, either all at once or paid

gradually. Istishna is defined as a contract to

purchase now, for a definite price, something

that may be manufactured or constructed later

according to agreed specifications. The object of

istisna is often not available now, but will be

made later by the manufacturer or contractor

(Zarqa,1997). Pillars in the istishna contract are

the muslam (buyer), muslam ilaih (seller), capital

or money, muslam fihii (goods), sighat or the

need to recite agreement verbally.

The basis for agreement is in (Qur‟an

2:282) that means ”O you who have believed,

when you contract a debt for a specified term,

write it down. And let a scribe write (it) between

you in justice. Let no scribe refuse to write as

Allah has taught him. So let him write and let the

one who has the obligation dictate. And let him

fear Allah, his Lord, and not leave anything out

of it. But if the one who has the obligation is of

limited understanding or weak or unable to

dictate himself, then let his guardian dictate in

justice. And bring to witness two witnesses from

among your men. And if there are not two men

(available), then a man and two women from

those whom you accept as witnesses - so that if

one of the women errs, then the other can remind

her. And let not the witnesses refuse when they

are called upon. And do not be (too) weary to

write it, whether it is small or large, for its

(specified) term. That is more just in the sight of

Allah and stronger as evidence and more likely

to prevent doubt between you, except when it is

an immediate transaction which you conduct

among yourselves. For (then) there is no blame

upon you if you do not write it. And take

witnesses when you conclude a contract. Let no

scribe be harmed or any witness. For if you do

so, indeed, it is (grave) disobedience in you. And

fear Allah. And Allah teaches you. And Allah is

Knowing of all things”.

Istishna is a contract where by a party

undertakes to produce a specific thing which is

possible to be made according to certain agreed-

upon specifications at a determined price and for

a fixed date of delivery. This undertaking of

production includes any process of

manufacturing, construction, assembling or

packaging. In Istishna, the work is not

conditioned to be accomplished by the

undertaking party and this work or part of it can

be done by others under his control and

responsibility. Istishna, an instrument of pre-

shipment financing and it is a contract where the

deal can be referred to something not in

existence at the time of concluding the contract,

9

while Murabahah is an order to buy goods or

commodities which are in existence in hand or

possible to be found in the market.

In an istishna contract, the buyer may

allow the manufacturer to use sub-contracttor to

carry out the contract. Thus, the manufacturer

can make a second istishna contract to fulfill its

obligations to the first contract. This new

contract is known as istishna parallel. Istisna

parallel can be done on the condition that; 1) the

contract between the bank and the sub-contractor

is apart from the first contract between the bank

and the buyer's end, and 2) the contract is done

after the first contract made valid.

The consequences when Islamic banks

using parallel contract are, first, Islamic bank as

a maker of the first contract remains the sole

party responsible for the implementing

obligations. Thus, as shani’ as the first contract,

the bank remains responsible for any error,

omission or breach of contract stemming from

parallel contract. Second, the recipient of the

subcontract maker on istisna parallel is

responsible to the Islamic Bank as a buyer. He

does not have a direct legal relationship with the

customer in the first contract. The second

Istishna contract is called parallel contract, but it

is not part of the first contract. Thus, both of the

contracts have no legal bearing. Third, where the

Bank as shani’ or parties who are ready to make

or hold the goods, the customer is responsible for

the implementation of subcontractors and

warranties arising therefrom. This obligation is

to justify the validity of istisna parallel. It is also

the basis that the bank may charge a profit, if

any.

Figure 6 Istishna Financing Mechanism

Figure 6 describes istishna financing mechanism.

It is similar to the financing system of As-salam,

the difference is in its way of payment. If the As-

salam financing system needs upfront payment,

istishna is by installments which shall be paid at

the beginning, the middle, or at the end of the

agreement. Customer makes a pay to the bank by

installments. It can be conducted at the

manufacturing or construction. The mechanism

is that the customer makes a request to make a

reservation in accordance with the specifications

of the customer wishes, but the stuff is not yet

there, or still in process. Next, the bank looks for

a manufacturer or contractor to obtain or carry

goods or products referred by the customers.

After meeting the manufacturer or suppliers, the

bank negotiate and when they agree there would

be a preliminary agreement by providing

payment by installments for the goods or

products to be purchased. Once the goods arrive,

the manufacturer or supplier sends the goods or

products to the bank to be given to the customer

or the bank through the manufacturer or

contractor to hand the goods to customers by

custom specification. Once the customer receives

the goods or products in question, they shall pay

to the bank by cash or installments.

2.3 Financing based on Lease

Financing by lease is the mechanism used

to provide facilities for customers who basically

do not have the desire to have the goods but

wanting to use the item.This type of financing

system originally was not used for ownership,

but at the end of the lease period it might work if

the transfer of ownership has been agreed in the

initial agreement.

2.3.1 Ijarah Financing Mechanism

Ijarah is a transaction where the bank

leases an object to its customers and by the

benefits received by the customer for the use of

the leased object being leased, banks earn rent.

Ijarah refers to a contract that transfers

ownership of a permitted usufruct and/or service

Islamic bank Supplier Customers

Product

2. negotiation

1a.orders with

specification

3. Terms

4 Spesification

product

5 delivery

6. Installment Payment

10

for a specified period in exchange for a specified

consideration (Central bank of Malaysia, 2014).

At the end of the lease, the bank may transfer

ownership of the leased item. Therefore, in the

Islamic banks it is called Ijarah muntahhiyah

bittamlik (lease, followed by the transfer of

ownership). The rental price and the selling price

is agreed at the beginning of the agreement. In

the case of finance leases, the transaction is

construed as a contract that represents, in

substance, a purchase or sale of an underlying

asset, instead of a lease. Hence, the revenue is

generated from sales plus the interest that

resulted from deferring the receipt of the sale

price (lease installments) (Atmeh and

Serdaneh,2012).

In principle, Ijarah is an agreement on

transfer of rights to the benefits of a goods or

service within a specific time through lease

payments or wages without a subsequent transfer

of ownership. If there is transfer of ownership,

then it will be converted into Ijarah muntahiyah

bittamlik. It is a combination of lease or sale and

purchase agreement at the end of the lease term

where there are transfer of ownership. The

ownership transfer will occur the lessor promises

to sell the leased goods at the end of the lease

term, and the lessor promises to donate the item

at the end of the lease term. In other arrangement

any call ijarah wa Iqtiqna, it is allowed that

instead of sale, the lessor signs a separate to

promise to gift the leased at the end of lease

periode, subject to his payment of all amount of

rent (Usmani, 2002).

The rules of Ijarah, in the sense of

leasing, are very similar to the rules of sale, as in

both cases something is transferred to another

person for a valuable consideration. The only

difference between Ijarah and sale is that in the

case of sale the legal title of the property is

transferred to the purchaser, while in Ijarah, the

legal title of the property remains in the

ownership of the transferor, but only the right to

use the property, is transferred to the lessee

(Usmani, 2003).

Figure 7 Ijarah Financing mechanism

Figure 7 explains that the Ijarah financing

mechanism begins with the customer submitting

the Ijarah financing application to the Islamic

bank, then based on request, bank rents or buys

goods desired by the customer or those ordered

by the customer from the owner of the goods.

After placing a deal with the bank regarding the

Ijarah object, Ijara rates, Ijarah period, and the

cost of maintenance, the Ijarah financing

contract is signed. Then the bank through the

owner of the goods or if the goods have been

handed over to the bank, the bank will submit the

goods to customers in accordance with the order.

If the Ijarah period has ended, the customer must

return the goods to the bank. Next, bank will

return the goods to the owner of the goods, or if

the bank buys the item, is returned by the

customer to the bank, it will be recorded as

assets to be leased back. Furthermore, if the

customer wants to have the item, then since the

beginning of the agreement it must be agreed by

both parties. Parties who have goods (bank)

since the beginning has to give them up so that

later after the expiry of the lease, the item will

move its ownership to the lessee with the price

has been agreed before.

2.4 Financing based on Benevolent Loans

Financing Benevolent Loans is not used

for profit, but only to facilitate the

implementation of a financing. Although it is not

Islamic bank Supplier Customers

Object/Product

2. rent or buy

5 Installment payment

3 Specification

product

4 delivery

1 Negotiation and

financing process

11

used for profit, in this model agreement the bank

can ask for costs arising from the financing

process. The size of the cost replacement of this

depends on the costs incurred in the contract.

2.4.1 Qardh (Qardh al-Hasan) Financing

Mechanism

Qardh means lending money to the needy.

The use of qardh scheme in Islamic banks is

Hajj bailout or loan money to premium

customers who have deposits in Islamic banks to

overcome the liquidity problems of customers.

The loan is secured by cash deposits owned by

the customer. An example is a pilgrimage bailout

loan, where customers are given a pilgrim

bailout loan to fulfil the qualification for

pilgrimage costs. Bank gets fee (ujrah) which

amount does not depend on the amount lent.

Among the services that could be provided by

Islamic banks that relate to CSR are al-qard al-

hasan and zakah (Arifin and Adnan, 2011).

The Qardh financing system is based on

(Qur‟an 2:245) that means “Who is he that will

lend to Allah a goodly loan so that He may

multiply it to him many times? And it is Allah

that decreases or increases (your provisions),

and unto Him you shall return”.

Qur‟an 73: 20, that means ”... So recite as

much of the Qur’an as may be easy (for you) and

offer the prayers perfectly, and give Zakat, and

lend to Allah a goodly loan, and whatever good

you send before you for yourselves, you will

certainly find it with Allah better and greater in

reward ...”

Qur‟an 2:280, that means “And if

someone is in hardship, then (let there be)

postponement until (a time of) ease. But if you

give (from your right as) charity, then it is better

for you, if you only knew”.

Qur‟an 57:11, that means “Who is it that

would loan Allah a goodly loan so He will

multiply it for him and he will have a noble

reward”.

Qardh as the transfer of ownership of an

asset or money from the original owner to

another party on condition that the asset or

money will be returned to the owner in the same

condition or form or value as when it was first

received by the other party from the owner

(Rahman, 2006). Legally, qardh means to give

anything having in the ownership of the other by

the way of virtue so that the latter may avail

himself of the same for his benefit with condition

that the same similar amount of that thing will be

paid back on demand or at the settled time. The

repayment of loan is obligatory. Loans under

Islamic law can be classified into Salaf and

qardh. The former being for a fixed time and the

latter payable on demand. Qardh is, in fact, a

particular kind of salaf (Ayub, 2007)

Qardh is benevolent loans that can benefit

our customers to meet their needs. Qardh loan

can be applied to; 1) a loan to bailout the Hajj. It

is intended to assist customers in accelerating to

get a share as participants of the pilgrimage

because if you have to raise funds privately it

might still take a long time. This loan will be

returned by the customer and paid off before or

approaching the pilgrimage departure. 2) as a

cash loans such as credit card from sharia

products, where customers can withdraw funds

through Automathic Teller Machine and

customers will return the loan at a specified time.

3) as a loans to small businesses, which

according to the bank in its calculations will

burden employers if being done through ijarah

financing mechanisms, buying and selling, as

well as profit sharing. 4) as a loan to bank

management or employees with a purpose of

facilitating the fulfillment of the needs of the

bank's employees. The loan will be returned by

the employee and to be paid in installments or

through monthly payroll deductions.

Qardh financing views the purpose of

prosperity and human affection, facilitating and

giving solution which may vouched for the

appropriate movement of wealth amongst people

in all classes in the community. The

effectiveness of qardh financing can also be

indicated from the obtained benefit of the

entrepreneurs in relation with their ability to pay

12

4b. Payment

zakah and infaq, to save money, to fulfill the

basic requirement, to pay the school fee for their

children, and to pay the cost of medical treatment

of household members (Mutamimah,et.al, 2011).

In sharia, the borrower is only to pay back the

principal amount and lenders are prohibited from

requesting compensation in any form. Even so,

sharia does not prohibit a borrower to make

payments to the lender as long as it is done with

sincerity and there is compulsion involved.

Figure 7 Qardh Financing Mechanism

Figure 7 describes the qardh financing

mechanisms that begin as qardh customers

become customers of Islamic banks to deposit

some money as savings or deposits. Next,

customers who have the intention to perform

Hajj but there is still a lack of funds may submit

an application to the Islamic banks to get

additional bailout funds to get a place or serving

as a pilgrim. Then based on the request, banks

shall provide financing in the form of pilgrimage

bailouts given to customers for services that are

paid to the agency dispatching pilgrims to Mecca

and Medina. It is to be paid by the customer

himself at the agency or client can entrust the

payment to the bank to be paid to the agency.

Next, the customer is charged the administration

to complete the financing. Customers will pay

off the loan prior to or approaching pilgrimage

departure. Bank obtains payment for qardh

financing services through the returning funds

from the customer. Furthermore, it can also be

applied to people who want a business but they

are not in financially proper conditions,

including a group of small entrepreneurs. After

the business attempt is successful, the employer

can pay back a 100% loan capital back to the

bank.

3. CONCLUSIONS

The essence of the financing is basically

the goal. The purpose of funding is to provide

assistance in the form of financial aid to those in

need, so that those in need can be helped with

financing provided. Whether it would be helpful

or not, it is started from the cooperation at the

time of the agreement. From the side of

financing provider, what has been given to

provide assistance in addition to profit is also

intended to help the lender to make ends meet,

do business, and most importantly, to get the

blessings from God (Allah). From the side those

who receive the loan, this financial assistance is

very useful for their life development in order to

break out from misery, as how Islam teaches to

assist each other with sincerity and always do

good way of God (Allah).

ACKNOWLEDGEMENTS

I would like to thank Prof. Dr. Muslich Anshori,

SE, M.Sc, Ak as Dean of Faculty of Economic

and Bussines – Airlangga University for help in

the writing process and review, and Dr.Rudi

Purwono, SE, MSE for comment, suggestion,

and review.

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