IB Final Notes

Lecture 1 Aqa’id > Ibadaa’t > Muamalaat (75% of Islamic teachings) Islamic banking comes under Fiqhul Muamlaat. Muamlaa – involvement of two parties: Offer and acceptance usually takes place. If income=expenses then no need of finance. But it doesn’t happen:

o SSU – Saving surplus units, usually households with Income > expenses

o SDU – Saving Deficit units, usually companies with Income < expenses

They offer securities like DFCs, TFCs, stocks and bondso Financial system is one where IOU is created.

o Zakat, fitra, wirasat are not part of financial system.

o Murabaha, Shirkah, Ijarah, Salam etc are part of Islamic financial system.

o In islam “You can’t sell what you don’t own” – exception is Istisna and Salam

Banks balance sheeto Left side: Loans and advances (Borrowers)

o Right side: Deposits (depositors)

Forces that usually act on banks:o Customers

o Competitors

o SBP regulations

o Financial markets

o Top management

Currencies:o Natural: Gold and silver

o Fuloos: fiat money, copper coins

Goal of Islamic banking is to bring things to permissible level in following scale:

Islamic Economic Systemo Communism vs. capitalism

o Public vs. private ownership

o Profit motive

o Definition of factors of production and distribution of money

What to, how to and for whom to produceo Allocation of resources (free market vs. state decision)

Islamic Banking Page 1

Haram Permissible Fard

Islamic Economicso First tier resources: available for all, public property e.g. water, air

o 2nd tier resources: human owned and used for production

o Concept of property in Islam

Bestowed by Allah upon human beings Examples

Qaroon and Moosa (AS) Date tree and Prophet (SAW) Hazrat Umer (RA) and extension of Masjid-e-Nabwi (SAW)

o Distribution of money

Socialism: according to the need of person in the form of wages Capitalism: according to the ability of person Islam: Primary and secondary rights

Secondary rights of needy. Poor, orphans, in-debt, prisoners etc 2.5% Zakat is right of these people

o Difference between Land and Capital of conventional and Islamic system

Islamic land: derive utility from it without consuming it e.g. land or equipment

Islamic capital: it has to be completely converted before earning fixed return on it

Islamic land Islamic capitalCan do profit/loss sharing in this, not prohibited

No intrinsic value, need to be converted first

Can earn fixed return on this Fixed returns will result in Riba


Assets

Real

Non-convertible Convertible

Financial

Lecture 2 – Mufti Kamal ud Din Secular vs. religious law

o Secular law is derived: Constitution > interpretation > past proceedings >

expert opiniono Islamic law: Mujtahids follow the same 4 steps:

Quran and Sunnah Interpretation Past cases Ijtihad

o Secular law often undermines the constitution and makes amendments to it, but

Islamic legal theory never undermines the authority, legitimacy and binding of Quran and Sunnah.

o The authenticity and interpretation of secular law is highly debated, controversial

and questioned. Question of GRAND SAYS WHO? o In Islamic system JUSTICE is:

Defined by Allah Allah defines rights and obligations and makes it binding Authority and legitimacy is given to this system by Allah

o I Islamic legal theory Mufti is higher than Qazi.

o Islamic law = Islamic ethics

Ethics go beyond law in Islam, while in secular law ethics are lower than law, rather taken out of law

Concept of INTERESTo It is considered fair and legal in secular law. Same goes for Hindu and Christian

religion which never regulates financial matters and consider it mundane to religious boundaries.

o Only Islam takes care and puts binding on interest and finance.

Categories of permissibility in:o Secular law:


Unlawful Permissible Required

o Islamic law

Islamic law can’t be applied forcefully on those who don’t practice Islam. Islamic legal system is for believers.

Authenticity and interpretationo 4 categories

1) Certainly2) Highly probable: Grades of probability e.g. Low Medium High3) Mere possibility4) Outright false

Prohibition of interest is Absolute (Qatai’). It is war with Allah. In Islam it is criminalized and illegalized.

Two legal tools that lead to Islamic Banking1) Al waqiya / Dharura (in Urdu zaroorat = need)2) Umoom e Balwa (Urdu: from ibtila, or mubtila)

A lot of people are involved in it at massive scale Still no outrage for sin People are desensitized over this Taken as a symbol of pride Nobody thinks of it as wrong or illegal

Islamic jurists want to do bare minimum at the moment to bring things from being unlawfulness (haram) to permissibility level against Interest. At least bring it to grade D from Fail.

Problem: Meezan (Islamic banking presently) banking is focusing on grade D, not beyond that. Currently doing life saving but are stuck with that. Their duty is to lead to grade A, but they are satisfied with D.

They are doing things which are Makrooh, but they are definitely RIBA free. Critiques criticize this status quo, but they compare it with level A, but they act as

layman as the present societal and governance system isn’t Islamic itself.


Unlawful Permissible Obligation

Usul ul Fiqh are about this

Concept of:1) Hierarchy2) Multiplicity: choose the option which is best

for that time and era

Lecture 3 – Riba and Its Prohibitions Riba is different from interest or usury Gharar: uncertainty – Islam prohibits that

CATEGORIES OF TRANSACTIONSale (Bai) Loan (Qard)

Dayn AariyaLeasing/rental (Ijarat ul Ashiya) Safe custody (Amana’t)

Collateral (Rehen) Gift (Hibah)Employment (Ijarat ul Ashkhaas) Agency (Wikala’t)

Settlement (Sulah) Inheritance (Wirasa’t)AQD (Contract)

Aqood-e-MuawazaCompensatory

BilateralMutually onerous

Binding

Aqood-e-Ghair MuawazaNon compensatory

UnilateralGratuitous

Not Binding Try to place transaction in one of the above categories first. Types of Riba

Riba al Quran Riba al Sunnah/HadeesRiba al Qard Riba al baiRiba al Jahiliya Riba al FadlRiba al Nasia’ (Nasia means delay) Riba al Naqd

Qard vs. Amana’t1) Qard can be used by borrower2) Amana’t can’t be used by Ameen.3) E.g. Hazrat Zubair (RA) used to keep people’s money as Qard rather than as

Amana’t, so he can use it in trade and its binding on him to return that money.4) If something happens to Amana’t due to reasons not under the control of men

(e.g. natural disaster, robbery etc), then he is not liable to pay that back, but in the case of Qard, the borrower is bound to repay the amount.

5) Amana’t and Qard are to be returned in the same form as it was given to custodian/borrower.

6) Qard is by its nature not binding, non compensatory contract. No time limits or counter compensation.

Aariya

Fungible Non fungibleUsually consumablesOne unit is as good as any other unit e.g. currency notes, wheat

Usually non consumablesEvery unit is unique e.g. Car


1) Example: You give your generator to your neighbor for use. Aariya: Same generator is to be returned, it is non fungible and unique Qard: Fuel is used and you can refill the fuel. It is fungible and

consumable. Aariya vs. Ijarah

Aariya IjarahNon compensatory CompensatoryNon binding Binding

Define usage period and rental payments

Dayn1) Loan with contract – only in the case of sale2) A/R originate from sale of something unlike bonds which are issued out of need

for capital3) All payables are Dayn4) TVM in sale is allowed under Dayn. E.g. a person can sell on credit a Rs. 100

thing at Rs. 150 after 2 years.5) BUT after 2 years if buyer comes and asks for extension and seller asks for more

money, then It is RIBA.6) Fix the payment at the time of sale. No such clause is allowed which says that “if

buyer fails to pay after 2 years then he has to pay some more amount”------ no credit plan allowed.

7) No extra compensation in Dayn and Qard. Loan where repayment period and amount in excess of principal is predetermined is not allowed.

Test Examples: Identify the transaction and its permissibility1) B extends $500,000 to A. A agrees to pay yearly LIBOR.2) B charges 25 bps on the advances he makes.3) C owes money for the goods he bought from A. C write a promissory note to A

(IOU) without any extra money. A who needs money now discount that note with B.

4) Case of zero coupon bonds.5) Factoring receivables.6) B sells stocks for $990 to A on the condition that B will buy it back from A after

2 months at $1000.7) Microfinance Company issues loans to poor people and charges a small amount

for the cost of administration.


Lecture 4 – Riba Al Fadl Qard is more than charity. Urf (custom practice)and Ma’roof(something that has become practice) -----if giving

some extra money (as gift) while returning qard becomes a custom then it is RIBA (haram) as it will become expected benefit with qard.

o Concept of Mashroot (included as condition)o Ma’roof (custom/practice) – If Tafazul (extra) become mashroot o ma’roof, it is not allowed as it is RIBA.

Riba Al Fadlo Case of exchange of date by Hazrat Bilal (RA)- he was advised by the Prophet

(SAW) to sell dates in market, get money, and buy other dates – no swap ratio mentioned for exchange of different commodities.

o Transaction is only possible when NEEDS of the parties are involved and it is beneficial for both parties.

o 6 commodities specifically mentioned:Foodstuff Currency

Wheat (al-birr) Barley (al sha’eer) Salt (malha’) Dates (tamar)

Gold (zahab bil zahab) Silver (al fusna’h)

o Zahiri School: literal meaning – Hadees applies to only these 6 things. Only those things are allowed which are mentioned in Quran and Sunnah.

o Hanbli school: all those things are permissible whish are not mentioned impermissible in NUS (Quran and Sunnah)

o Illa’t – efficient cause/attribute VS.o Hikma’t (rationale) – rationale changes, but Illa’t acts as a law.

1. E.g. not stopping at the red signal in late night when there is no traffic. Still comes into law breaking.

2. Pork can’t become halal no matter how hygienic conditions you maintain to breed pigs.

o Classification of commodities under different schools of thought:


If these things are being exchanged then take care of two things:

1. Missal ba missal – Same Quality2. Yad ba’eed – Hand to hand or on spot

o Concept of delay – Mua’jjal (from Ta’ajeel, means immediate) vs. Muajjal (from Tajeel means delay/deferment or appointed time)

o Laws of Riba al Fadl – consider two main factors deferment and inequality (3 laws)

1. Law of mathematical equivalence When a ribawi good is exchanged against its like, then shari’ah

requires strict mathematical equivalence. E.g. e.g. wheat to be exchanged with wheat

2. Law of prohibition of deferment If the exchange involves different ribawi goods, the requirement of

mathematical equivalence is dropped; however, deferment is still prohibited in cases where ribawi goods are involved in a transaction belong to same genre/genus.

2 genus are defined under Shafi’I and Maliki. 3 genus are defined under Hanbli and Hanfi. Commodities can be sold on ON-DEMAND (I’nd ut talab) Why different genus is created under each school?

o If no difference between genres than concept of these 2 laws would not be required.

o At that time all trade would be seized because of no deferment.

Examples: o Wheat and wheat exchange – same genus, same commodity

– apply law 1 and 2o Wheat and rice exchange – same genus but different

commodities, drop law 1, apply law 2o Cooking oil and wheat exchange o Shafi’I and Maliki school – same genus, different

commodity, drop law 1, apply law 2.o Hanbli and hanfi School– different genus, different

commodities, drop law 1 and 2. To avoid hassle (haraj, inconvenience) Islam softens its rulings.

3. Settlement in the same session High level of strictness for deferment in case of currency (gold &

silver) and they should be settled in the same session.


Shafi'i + Maliki

Currency (surf) Foodstuff (Ta'am)

Hanfi + Hanbli

By very fine scale of weight (gold and silver)

Volume (Kail) Weight (wazan)

Rationale/Hikmat: Eye Watched – A’in or Ta’iyun, means specification of goods.

In case of non currency, one can defer the delivery for a while to deliver the goods to the other party. But the seller can’t put a condition of delay in case of same genus/genre, though he can ask the buyer to pick the sold commodity ON DEMAND (whenever buyer wants delivery).

o TEST Examples:1. Bilal sold 5000gms of gold to Ahmed for 3500gms of silver, which

Ahmed promised to deliver on demand. Non permissible transaction, to be settled in same session.

2. Umer sold 50kgs of wheat to Ali for 50kgs of flour to be delivered in 30 days from now. Violation of law 1 & 2.

3. Hussain sold 1000 tons of rice to Ahmed, to be delivered in 30 days in exchange for spot payment of gold coins, which weight 100gms. Permissible transaction under both schools.

4. Ahsan bought 30kgs of raisins for exchange of 25Kgs of dates. Naeem delivered raisins at the time of sale, while Ahmed promised to deliver on demand. Permissible transaction under both schools.

5. A borrows from B some wheat, and return after 2 days condition. Is it allowed? If Qard, then allowed, but 2 days clause is not allowed.

Lecture 5 – Bai Bai – Sale: the exchange of a thing of value by another thing of value with mutual consent.

o 4 types of sale Bai Fasid

Defective, voidable (not void) Inherently it is fine/permissible, but has some problem e.g. 100 is

mentioned, but currency isn’t mentioned whether it is PKR or USD. Bai Batil

Inherently VOID, void at the outset. Wrongful, bai never occurs.

Bai Sahih No sale is allowed to one’s own self

o e.g. two companies owned by same person, the transfer pricing between the two isn’t a valid sale.

o Sale between Aaqa and Ghulam (master and slave)o Sale between principal and wakeel (agency)

Bai Makrooh Disliked sale


o 4 elements of sale Aqd (contract)

Contract of sale should be in past tense. Future tense isn’t allowed, there is no valid sale contract in future.

Sale must be non contingent. Can’t be based on future event. Mubee

Existable Ownership of seller: “Don’t sell what is not with you. Hadees”. , except

Salam (on fungible things, no verdict yet on non-fungibles) and Istisna. Transaction.

o E.g. Short selling (not allowed) Borrow the goods Sell it to buyer Buy it later Settle the transaction

o Things borrowed under Qard can be used, but to sell it to some other party isn’t allowed.

o Non-fungible items taken on Aariya can’t be sold at all. Specific and quantified: Can’t sell a runaway camel. Maal e mutaqawwam – illegal, non usable e.g. Alcohol, pork

Thaman Thaman (negotiated price) vs. Qeema’t (market price)

Qabza/possession Physical or constructive (hukmi) Qabza can be urfi, defined by custom e.g. transfer of papers and keys of

car to buyer.o Valid contract

Not explicitly haram. Reiterates/reinforces the basic substance of contract i.e. transfer of ownership

o Two types of contract Aqood e Muawaza Aqood e Ghair Muawaza

o Can price be negotiated against terms and conditions?


Core contract

Condition

In uqood e ghair muawaza, condition is not allowed, not a valid contract. In uqood e muawaza, it is allowed to negotiate condition with price.

Credit Sale – Bai e Muajjal (not Mua’jjal which means immediate)o Also called – Bai bis Thaman Ajal: Sale with delayed paymento Two things are to be defined:

Price Period (delay period)

o Bai al kali bil kali: you can’t have both thaman and mubee’ outstanding at the same time, one has to be delivered at the time of sale.

Mubee’ outstanding: Salam Thaman/money outstanding: Bai Muajjal

Lecture 6 – Ijarah A contract whereby the owner transfers the usufruct of a specific property to another party for

a specific period at agreed upon rentals.o Delayed ijarah is permissible – i.e. can be done for future date unlike sale.o Specific property – not consumableo Usufruct – not ownership

Duties/liabilities of Lesseeo Day to day maintenance is lessee’s responsibilityo He is also an Ameen (custodian)o Damages due to deliberate actions of lessee are to be paid by him

Using CAPM to identify rentals

o How can Jahalah be solved? Ceilings and floors keeping in view both lessor and lessee

Worst fear of the bank:o Asset liability mismatcho Re pricing risko Interest rate risk

Conventional Bank. Once property is delivered to client, bank can charge rentals from him even if user isn’t using it because usage is in his consent. However, Islamic banks start charging rentals after installation of the leased property when it comes in working condition.


Uncertainty

Gharar

Jahalah

CAPM

Case of Rf

Volatile and uncontrollable

Joint property can be leased. But is only one person wants to lease it then he can only lease it to the other partner.

Steps of Ijarah1. Contract of ijarah. Relation of principal and agent2. Separate agreement of lessor and lessee

a. No need of fresh offer and acceptanceb. No penalty on delay of payment is allowed – penalty can be paid in charityc. Pre-payment risk

i. Lease agreement can be cancelled with Iqa’la (urdu: sulah) means mutual consent

ii. In case of an damage which renders the property useless, the lessor can’t charge rentals on it.

3. Termination of contracta. Safqatein bil safaqa (ijarah o iqtina) – 2 deals in 1 deal

i. Two deals in one deal is not allowed– Case of capital lease i.e. transfer of ownership to lessee isn’t allowed in Ijarah contract. These are two different contracts (Ijarah & Sale).

ii. Solution – Unilateral promise (not a contract)1. Give it as a gift2. Promise to sell it to lessee

a. Promise isn’t enforceable by law unless it involves some financial liability e.g. promissory note.

iii. Litmus test – one contract contingent on another or not.


Lecture 7 & 8 – Murabaha (Mufti Najeeb) Murabaha

o Sell above costo Mention cost and profit margin on costo Murabaha e muajjala (Sale with deferred payment with cost and profit mentioned),

usually comes on the LHS of the bank’s balance sheet.o It is sale (transfer of ownership) not leasing (transfer of usufruct)

Partnership based modeso Musharakah – asset sideo Mudarabah – usually liability side, depositors act as Rab ul Mal and bank acts as a

Mudarib Sale based modes

o Murabaha, musawamah, salam, istisna, istijrar Story of TONY By concept bank deals in documents not in assets, so Murabaha is a delicate transaction (border

line transaction) because of operational use. Bai Amanaat

o Buyer demands from seller about cost information. If cost is disclosed by seller then there are 3 possibilities of sale

Cost to Cost: Bai Tauwlia Higher than cost: Murabaha Lower than cost: Wadiya

o If cost isn’t disclosed then it is Bai Musawamah Bai Muajjal

o Price should be fixedo Date of maturity should be fixed

Banking Murabaha – also known as Murabaha lil aamir bil shari’ah


Transfer of usufruct

with consideration

Leasing (ijarah)

without consideration

Aariya

Transfer of ownership

with consideration

Bai

without consideration

Hibbah (gift)

o Different from normal trade Murabaha. Banks doesn’t have anything in shelf or inventory. Buy as per customer requisition.

o Prudential don’t allow bank to buy or trade unless a requisition of customer is there.o Different contractual relations between bank and client exist during course of

Murabaha.o Sequence of execution of Murabaha is important; banks can’t get all documents signed

at same time from customer.o Murabaha can’t be used as substitute for a running finance.o It is usually short term as process remains fixed for short term.

Concept of Tawarruq – generate cash by selling the commodity bought under Murabaha. e.g. metal imported on Murabaha and sold in local market. It is commodity Murabaha or reverse Murabaha.

Stages of Banking Murabaha – check the slideso Promiseo Agency

Mention the commodity which client is allowed to buy as agento Goods acquisitiono Execution of Murabaha

Credit approvalo Assignment of contract is not permitted within Shariah. It is revoked/terminated and re-

created for the specific purpose.o Murabaha isn’t allowed between sister concerns or group companies unless the

ownership in each other is less than 50%, else it is Bai Inah, which is haram.o Use transaction flow chart to educate the customer – Compliance issueo Check payment procedure and timelines especially in L/C case.o Good performance of supplier guarantee is required if it is nominated by buyer.o Guarantor is know as Kafeel.o Security payment – Hamish (margin) Jiddiyah (sincerity) e.g. earnest money

Margin taken for the sincerity of client. After offer and acceptance, one can make advance payment, aka Arboon (urdu:

bia’na) Hamish jiddiyah can’t be used to cover cost of fund/opportunity cost

Operational Issueso Global agency agreement: only created in dire need. Bank gives money to its client to

pay to its suppliers. No purchase requisition is created.o Case of JIT manufacturing:

Problem of ownership Can’t segregate the time when commodity is in Bank’s ownership

o Banks don’t deal with brokers for Murabaha as they don’t take inventory risk – possession of bank is questioned.

Broker sells to some other buyer even before taking possession.


o Physical inspection of goods to be done before sale.o Pricing: KIBOR + SPREAD

It is allowed Example of two brothers one running the business of alcohol and other running

the business of juice and index its prices using alcohol prices as base.o Never delay offer and acceptance, high inventory risks for banks.o Difference between conventional and Islamic bank will be clear in case of default:

Burn the goods, and default the client o In case of non-compliance, banks disburse the profit of that transaction as charity within

3 months to charitable institutes.

Lecture 9 – Mudarbah & Musharakah – Mufti Kamal ud Din

Islamic economics Islam concern economics. How did you earn, where did you spend? Economics was imposed on Muslims after colonialism and industrialization Economic growth and development isn’t the core of the system, it isn’t the end, it is means to an

end. Islamic system is not against economic activity and profit making provided it leads to welfare of

society. It is against greed. A person’s greed should not hurt anyone e.g. credit card to promote consumerism. Islam is also about spiritual development with material development as sub f low priority

objective. Colonial system developed an economic system to extract resources out of Muslim world. After

they left, the elites of our country became neo-colonists. Public finance is resulting in continuous extraction of resources from country.

Neo classical / capitalistic Model Islamic modelIndustrialistic Collective e.g. zakatPrimary rights only Primary + secondary rights on moneyCompetition Cooperation, maximum social welfareAvailable legal and economic structure No Islamic state and legal structurePrivate property, absolute authority of owner

Allows private property which is bestoed upon humans from Allah

Because of no Islamic state, all Islamic banking initiatives are private rather than state supported.

Musharakah Primary considerations

1. More than one investors


Shareek orEntrepreneur

Islamic institute Rab ul MaalMusharakah Mudarabah

Borrower Lender

80/20 20/80

% profit/loss sharing

2. Partnership is on profit, not on input, input can be considered as scale for sharing profit.3. A person can take a dual role of sleeping or managing partner along with shirkah.

Banks now issue Musharakah (classified as Class A of Islamic contract), but presently rich people don’t want to share profit and also the risk. So, they usually go for Murabaha (Class D: border line transaction). Also banks are also hesitant to share losses with investors. They are also risk averse.

But banks themselves are working as Mudarib and are ameen of depositors money, and they are also Wakeel (agency) of that money when they lend it to someone. So, they avoid the risky investments as they have to work with “due diligence”.

Mudarabah Only one investor i.e. Rab ul Maal One role per person, either Mudarib or Rab ul maal.

Mizaaj or Characteristics of Islamic Bank


Lecture 10 – Musharakah & Mudarabah Musharakah is by its nature non-binding

o Sharing of profit, non-fixed return is allowed on real consumable and financial assets.o Only percentage of PROFITS can be fixed to make a valid Mudarabah and Msharakaho %age of return on CAPITAL isn’t permissible.

Kinds of Shirkah.

Aqd vs. Milk

Aqd MilkBasic element Offer/acceptance Mixing of ownership

Joint ownership (Urdu: Khalt)Profit motive Very purpose Not requiredProfit Sharing Agreed upon Share of ownershipUsufruct Remains with the person

who pays rentsShared between owners

Shirkat ul Wujooh: buy on deferred payment, buyer is given goods on GOODWILL Example of Hazrat Ali (RA): event of buying a camel on credit for Dirham 80 and sold on

spot for Dirham 120. Dirham 40 profit for Dirham 4 given in alms. Bai I’nah – Buy back sale

Not allowed as 2nd transaction is dependent on execution of first transaction. It is a void contract and can’t be enforced by law.

Basic Requirements of Musharakah1. All conditions of contract2. Agreed upon profit sharing ratio

Constraint: sleeping partner can’t earn more than the ratio of his investment.3. Loss to be shared in the ratio of invested capital4. Nature of capital

Hanfi school – should be liquid capital


Shirkah

Milk

Intended (iktiaree)

Unintended (ghair ikhtiaree)

Aqd

Amwal Aa'malWujooh (from

Wajeeh - Goodwill)

Shafii’ classification – fungible (dawat ul amsaal) and non-fungible (dawat ul Qeema’t)

If investment is in the form of non-fungibles, then we put it into black box (joint ownership now) and the invested value should be market value of those non-fungibles at the commencement of agreement. Determine the capital contribution ratio.

It will define loss sharing ratio, necessary for Musharakah to take place. Musharakah vs. Mudarabah

Musharakah MudarabahInvestment All partners Only rab ul maal (RM)Participation in management All partners can Rab ul maal can’t participate

without the permission of mudarib, but RM has monitoring right.Mudarib also has relationship of Ameen and he is supposed to work with due diligence.

Share in loss All partners RM onlyRevaluation gains All partners RM only

If negligence of amen is proved then he has to let go his fee. Types of Mudarabah Contract

1. Muqaiyidah: Mudarib can trade only certain things/units not others as mentioned by RM.

2. Mutaqa’: absolute right of mudarib to trade in all units. Problems occur in Musharakah when multiple transactions are involved, so better do it on

Contribution Margin or Gross Margin to avoid Gharar. Revolving credit via Musharakah

Problematic: find daily profits, as all the credit line isn’t used raher a portion of it is used. Difficult to track it to specific property.


Lecture 11 – Sukuk (Faisal Sheikh) Sukuk is certificate of something. Mostly used for securitization. NCD – negotiable certificates of

deposits, also COD.

Ijarah Sukuk Used for secondary markets, especially for financing long term bonds e.g. housing mortgages Trading of traditional bonds us actually trading of debt called Bai Dayn which isn’t allowed due

to Gharar. Sukuk is trading of assets – issuer owns the asset. Which sukuks are tradable and which are not?

o Ijarah sukuks are tradable as it is the trade of assetso Murabaha (Muajalla) and salam sukuks are not tradable as it is debt (deferred

payment). So, it is not allowed. Examples of Islamic banking shaping regulations

o GE capital corp. issued sukuk.o UK amendment – financial act 2010: sukuk as Alternative Finance Investment Bondso GoP 2006 – Euro Dollar Sukuko UK 2003 – Diminishing Musharakah made legal as financial transactiono Govt. of Bahrain issued Sukuko GoP – Wapda issued sukuk on generatorso GoP also issued sukuk on Isb-Lhr motorwayo Luxemburg – sukuk returns are tax deductible o Pakistan – Sitara Chemicals Industry – MTFS (Musharakah Term Financing Sukuk)

2009 hit on sukuk – statement by Mufti Taqi Usmani about the complex and Shariah non compliant structure of Musharakah sukuk – Musharakah sukuks should not have guaranteed returns

Musharakah vs. Ijaraho Musharakah: Returns dependent on performance of projecto Ijarah: returns are known/predictable. Deterministic returns.o Same difference between Musharakah and ijarah sukuk

Buy on credit and sale on spot analogy – Shirkat ul Wujooh1. Take short term Islamic loan for bridge finance2. Purchase an asset3. Issue ijarah sukuk4. Pay back to bank5. Transfer ownership to sukuk owners

Structureo Create SPV which is just a legal trustee


Benefit of creating SPV: assets not on the balance sheet of holding company. SPV just acts as trustee of asset, actual ownership is with investors.

If parent defaults then it has no effect on SPVo SPV then gives Ijarah to original company on behalf of investorso Sukuk can be callable and premium can be paid, as it is ownership of asset which can

earn profit. Callability doesn’t create Gharar, as it concerns mainly for transaction price not

for time period.o Expense of SPV are charges to investors.o Pakistani Law: SPV can’t hold actual tangible asset on its balance sheet as it is a financial

institution, so all sukuk in Pakistan are issued on Diminishing Musharakah. Also under STAMP DUTY ACT, every time a transaction of diminishing

Musharakah takes place, stamp duty has to be paid, which hinders the transaction of diminishing Musharakah by increasing its cost.

o Benefits of Sukuk Alternative to bonds Financing of govt. projects – transfer ownership to public to avoid destruction or

damage due to wrong usage of that property. Project financing and product financing.

Lecture 12 – Trade Finance (Faisal Sheikh) Letter of credit

o Sight and usance L/C. usance L/C involves bank guarantee and is of high price.o Conventional banks deal in documents ONLY. But Islamic banks deal in documents and

goods. Trade financing can be done through:

o Musharakah and Mudarabaho Murabaha

Export financingo Musharakah / Mudarabaho Know customer’s businesso Usance L/C Done under shirkat ul wujooh – goodwill

Bank procure goods on behalf of customer. Trade Financing through Murabaha

o Same procedure as mentioned in Lecture 7 & 8 by mufti Najeebo Murabaha or istisna financing for exports can be used.

Import financing via Murabahao Finance L/C for importero Master Murabaha agreement

Promise to buy/sell in future


All terms and conditions are mentioned in ito Agency agreement with customer

Customer as agent Allowed to buy specific commodity Agency agreement date should be before Bill of Lading date.

o Payment Scenariosi. On spot – sign musawamah declaration

No financing involved due to on-spot transaction Offer and acceptance is there as it is actual sale transaction Qabza is given to buyer if the goods are usable Customer’s acceptance doesn’t work as guarantee to pay if goods turn

out damaged.ii. Financing for certain period

1. Nostro account (A banking term to describe an account one bank holds with a bank in a foreign country) of bank is used for making international payments. Vs. Vostro account (Local currency account

maintained by a local bank for a foreign (correspondent) bank.)o Profit is calculated from the time the Nostro account is debited

till the date of paymento Murabaha receivable is created.o PAD (Payment Against Document)

Banks keep the B/L and customer pays against B/L to release the goods.

2. Shipping Guarantee e.g. Air Cargo (tricky transaction)o Goods reach before documentso Banks issue shipping guarantee and delivery ordero Price of goods isn’t formally known as it is written on Air way bill

which reaches after goods.o Or dollar value of goods is known but don’t know which date

the customer is going to make payment. So, can’t negotiate dollar rate.

o Solution: issue sub Murabaha with 110% margin based on FX rate prevailing on issuance date of shipping document. Bank later adjust with customer by paying/receiving the difference.

o Usually assume higher discount rate and later discount to customer.

o Profit doesn’t change, only cost is adjusted – so no Gharar on profit side

o Murabaha gets converted to dayn i.e. A/R


Lecture 13 – Diminishing Musharakah (Musharkat ul mutaffisah) Mostly home financing – substitute of mortgage

o In case of default: contribution wise division of asset. Contracts and Relationships involved in Diminishing Musharakah

Contracts and corresponding RelationshipsShirkah Begins with shirkat ul milkIjarah Lessor (bank) & lessee (owner)

Promise Promisor (buyer) & promissee (bank)Sale – Bai Bai (buyer), mushtree (seller, bank)

It ends with client’s ownership of property Nick name IMBT – Ijarah Muntahia (urdu: Intihaa, means ends with) bit (of) Tamleek

(ownership) MM (Murabah e Muajjila) not Modigliani & Miller DM (Diminishing Musharakah) not Deutsche Marks IMBT vs. DM

o IMBT: Ijarah Muntahia Bittamleek means "Ijarah contract ending with ownership". It is also known as Ijarah wal Iqtina' or Al Ijarah Thumma Al Bay. The above contract is similar to the Ijarah contract. However, at the end of this contract, the asset does not return to the bank, but rather the customer is given the choice to acquire the asset. No client ownership from the start of contract.

o DM: smooth transfer from small ownership to complete ownership of client DM can be Shirkatul Milk or Shirkatul Aqd

DM as Shirkatul Milk DM as Shirkatul Aqd (sub category: Shirkatul Amwal)

e.g. housing contract e.g. business / trade purposeIjarah hazir (present) Ijarah ghayab (not present)Thaman (negotiated price) is admissible, so, unilateral promise can be made

Qeema’t (market price) is valid measure. But if buyer buys at fixed price per unit which guarantees the fixed return, then this isn’t allowed. It should be P&L sharing

o Shirkatul milk can be on Qeema’t but due to fluctuation, customer and banks won’t like it.

Bai Ina’h vs. Bail bil wafa

Bai Ina’h Bai bil wafaBuy back, but second sale is contingent on first one

Second sale is just a unilateral promise by buyer (of 1st sale) to buy it from seller at some price

If 2nd sale won’t execute then first sale will be As 2nd sale is not contingent on 1st sale, so its


void failure won’t invalidate the first sale

How DM is different from conventional Mortgage?o In mortgage – ownership is with the financer, yet he doesn’t take risk of ownership.o E.g. in earthquake that destructed Margala towers, the flat financed by Meezan bank

was the loss of bank, but for the one owned by Citibank, full payment of house was taken from buyer.

TEST EXAMPLE:o Car financing through:

MM IMBT DM

o Which one will be preferred by bank, and which one will be by customer? MM: fastest transaction for bank. It is a sale and risk of ownership is passed to

buyer immediately. In case of client default bank can’t roll over the amount, no option for bank, can’t put penalty (due to riba)

IMBT: slowest transaction for bank, risk of ownership transfers to buyer at the end. In case of customer default, bank can charge penalty in increased rentals.

DM: it is in between the above two transactions.o 3 major criteria for assessment

Risk of ownership and transfer of title Case of client default Case of destruction/loss/damage of property

Cost of capital fluctuation risko Banks don’t fix KIBOR because they don’t want lower returns on their assets.o In MM, KIBOR is used only once but in Ijarah, rental can be pegged with KIBOR of that

month. Rentals can move up and down.


Lecture 14 – Salam and Istisna Salam Goods

o Can’t be on non-fungible (unique) goods.o Agricultural and trading goodso Quality and quantity are requiredo Mousuf bis zima: that can be adequately described, no Gharar no dispute

Istisna Goodso Can be on products and on services

Both violate “Don’t sell what doesn’t exist or you don’t own” Salam started with financing the farmers to grow their produce and carry out cultivation cycle. Bai al kali bil kali – deferred payment with deferred delivery is not allowed. Options of Buyer

o Khiyar-e-Wasf – option of rejecting the goods if they don’t meet their specificationso Khiyar-e-aib – option of rejection after defect. Aib by the norms of market e.g. 3 legged

chair.o Khiyar-e-Roeyat – option of rejection after inspection. Initially it was allowed to reject

the product if the buyer doesn’t like it after completion of production, but this isn’t allowed anymore.

Istisna is proved through Ijma’ (part of Islamic jurisprudence). It is based on istehsaan. Jualah vs. Istisna

Jualah IstisnaCan be on anything Only for manufactured goodsCan’t specify the amount of labor and time etc. e.g. find a lost camel and get a reward.

Specify the time and cost involved

Only on labor On labor + goods Hanfi fuqaha don’t allow Jualah.

Rules of Salamo Can’t do salam on sarf (currency) and between commodities in same genre/genus.o Wheat against barley not allowed with deferred deliveryo Use well known measure for salam, aka ma’roof measurement.

How to use salam for banking?o Parallel salam – high exposure to risk of banks due to money fluctuations, if don’t do

parallel salam.o Why banks don’t do it?

High default risk Product may fail to meet its specs Also it doesn’t require funding and financing due to parallel salam.

o Why involve banks and pay them a spread?


Bai Ina’h not allowed i.e. producer of a crop sells his produce on salam with a condition to buy it later from buyer, in order to sell the same product in market place.

o Salam VS. forward transaction

Salam Forward transaction (short selling)In salam the buyer owns the goods In short selling buyer borrows the goods

and don’t own them.Buyer is LONG on salam. Buyer is SHORT on salam.Seller is SHORT on salam Seller is LONG on salamPayment is on spot, but delivery is in future

Payment and delivery are both in future

Once in salam, buyer can’t sell salam contract, but can enter into a different salam contract which is independent from the first one. E.g. case of parallel salam results in two salam contracts rather than one contract.

Istisna for house constructiono Client enter in contract with Islamic bank on Istisna basis, who then contacts Contractor

for construction of house.

DOW Jones Index Developed a set of criteria for stock screening

o 1st Screen Primary business: 2/3rd of revenues from halal business Leverage is permissible under Shariah compliance. This is different from Shariah

enabling which results in no leverage.o 2nd Screen

Debt/market cap. A/R > 50%, then stock can only be sold at par, can’t sell it above or below actual

value. If financial assets >33% then trading of stocks of such company isn’t allowed. Income criteria: 5% haram income then it requires purification/charity Controlling shares: if company has haram income then don’t invest in

controlling shares as a director/CEO as you will be liable to take action against interest/haram income.

COBM: Cost of Being Muslim Quarterly monitoring


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