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Islamic Finance
Islamic Finance
HOME FINANCE
Under Islamic property financing, banks are required to buy an asset (i.e. property) from the
seller and sell it back to the buyer (you) with profit. The buyer will be allowed to pay for the
property in installments.
In short, the buyer requests for funds to buy the property. The bank then purchases commodities
for the buyer with a value equal to the financing amount and sells it to the buyer at a profit. The
bank then arranges to be repaid in installments.
At the same time, the buyer arranges for the bank to sell the commodities to a third party for the
value of the financing amount. The proceeds of this sale are then transferred to the buyer to
purchase the property.
2. VEHICLE FINANCE
Shariah-compliant car financing products are constructed differently , they share some common
attributes with regards to their compliance with Sharia rules. The direct participation of the
financial institution in the car sale and purchase. The nature of a financial institution’s
participation will vary, depending on the model on which car financing is base.
Financial institutions cannot benefit from penalties paid by the customer in the case of late
payment. Such charges are typically required to be donated to charity. In some cases, Shariah
scholars have allowed financial institutions to retain a portion of penalties on account of the cost
incurred in recovery.
The restriction on financial institutions to impose any additional charges or fees at their own
discretion, other than those which have been agreed upon with the customer at the beginning of
the financing period, based on the customer’s obligations in that particular contract. This
requirement will have different implications depending on the model used
For instance, in Ijarah-(leasing) based schemes, the financial institution purchases the car from
the seller before renting it to the customer.
In Murabahah- (sale on deferred payment basis) based schemes, the bank purchases the car
from the seller before selling it to the customer on a deferred payment basis.
In Musharakah-(participating equity) based models, the bank purchases the vehicle in
partnership with the customer and subsequently sells the stake to the customer. The bank holds
the risk related to the ownership of asset during the period of ownership.
3. PERSONAL FINANCE
Islamic finance doesn’t allow for the concept of interest, or riba. This generally prevents the
traditional method of making money through lending it out. This is because Shariah rules do not
allow for money to have intrinsic value, treating it only as a medium of exchange. Due to this
difference in philosophy, Malaysian banks use a different system based on the concept of Bai’
Al-‘Inah. Here, banks will use a commodity as a medium of exchange to facilitate the transfer of
funds.It is this difference that requires Shariah compliant loans to be offered in the form of
‘personal financing’ instead.
There are two ways that a Shariah compliant personal loan can happen: Murabahah or Tawarruq.
Both concepts are similar, but require different steps to achieve the same thing.
In Murabahah, the bank purchases whatever the customer wants and sells it to them with a
markup. In this case, the repayment is done in installments and the profit that would have come
from charging interest is instead replaced with the profit from the sale of the asset.
A notable difference with conventional personal loans is that the customer will be informed of
the total amount that needs to be repaid from the very start.
A Tawarruq contract builds on a Murabahah , only with more steps to reach the desired goal.
In this type of financing, the customer buys commodities from the bank (paying for the value
plus the bank’s profit rate). At this stage, the payment is deferred because the customer clearly
doesn’t have the funds yet.
Next, the customer sells the commodities to a third party to obtain cash. From here, the customer
is expected to pay the bank back for the initial purchase on an installment basis.
For example: You apply for RM200,000 in personal financing from Bank Islam. You want to
take your maximum amount of time to pay this back, so you ask for a 10 year tenure period.
In this case, the bank would help you buy RM200,000 worth of commodities. In this case, let’s
say it’s beef (almost any physical object can be a commodity). You now owe the bank
RM200,000 plus a profit of say 8%. So overall the value of the transaction is now RM216,000.
At this point, you owe the bank money and own a warehouse full of beef. To get the actual
funds, you would then sell the beef to a third party for exactly RM216,000. Giving you the
financing that you wanted in the first place.
This entire process is performed by the bank, so the customer doesn’t even need to be aware that
all of this is happening.
It should be noted that gold, silver, and currencies cannot be used as commodities for the purpose
of a Tawarruq transaction.
The Islamic bank pools investors' money and assumes a share of the profits and losses. This
process is agreed upon with the depositors. What does the bank invest in? A group of mutual
funds screened for Sharia compliance has arisen. The filter parses company balance sheets to
determine whether any sources of income to the corporation are prohibited. Companies holding
too much debt or engaged in forbidden lines of business are excluded. In addition to actively
managed mutual funds, passive funds exist as well. They are based on such indexes as the Dow
Jones Islamic Market Index and the FTSE Global Islamic Index.
Lease to Own
This arrangement is similar to the declining balance one described above, except the financial
institution puts up most, if not all, of the money for the house and agrees to sell the house to the
eventual homeowner at the end of a fixed term. A portion of every payment goes toward the
lease and the balance toward the home's purchase price.
An installment sale starts with an intermediary buying the home with a free and clear title to it.
The intermediary investor then agrees on a sale price with the prospective buyer; this price
includes some profit. The purchase may be made outright (lump sum) or through a series of
deferred (installment) payments. This credit sale is an acceptable form of finance and is not to be
confused with an interest-bearing loan.
Leasing (Ijarah)
Leasing, or Ijarah, involves selling the right to use an object (usufruct) for a specific time. One
condition is that the lessor must own the leased object for the duration of the lease. A variation
on the lease, 'ijarah wa 'iqtina, provides for a lease to be written where the lessor agrees to sell
the leased object at the lease's end at a predetermined residual value. This promise binds only the
lessor. The lessee is not obligated to purchase the item.
These are rare forms of financing, used for certain types of business. These are an exception to
gharar. The price for the item is prepaid, and the item is delivered at a definite point in the future.
Because there is a host of conditions to be met to render such contracts valid, the help of an
Islamic legal advisor is usually required
An Islamic current account provides the account holder with a guarantee on the principal amount
deposited. The account holders are not entitled to receive any profits, but do not bear any losses
either. This type of account is designed specifically to meet the needs of customers who want to
deposit or withdraw funds by cheques, through cash tellers at bank branches or through the ATM
machines. The Islamic current account is structured using the wadia or Qard contract
ISLAMIC SAVINGS ACCOUNT:
Islamic Savings account is offered to depositors primarily to fulfill their precautionary motives
of holding money, as well as to meet some of their transactionary and investment needs where
relevant. Savings accounts are designed specifically to meet the needs and requirements of
customers who authorise the bank to invest their deposited money. Customers can deposit or
withdraw funds at any time. The actual profits received are shared monthly at the ratio advertised
by the bank.
The contract that could facilitate this purpose would be Mudaraba (profit sharing). Mudaraba is a
partnership in profit whereby one party provides capital (rab-al-maal) and the other party
provides labour (mudarib). In this contract, the depositors act as rab-al-maal and the bank as
mudarib. Therefore, a portion of the deposits would be invested in various projects and the profit
shared on the basis of the agreement. In case of loss, the rab-al-maal, i.e., the depositors would
bear all the losses
INVESTMENT ACCOUNT:
Islamic investment account can be considered a substitute for conventional fixed time deposits.
This account enables customers to deposit specific sums of money with the bank throughout the
year for specific periods of time (one month, 3 months, 6 months, 9 months or 12 months) with
the option to withdraw profits at specific times. It also enables banks to hold some money for
depositors and invest on the basis of pre-agreed deposit tenure. Islamic investment account is
structured using the Mudaraba and Wakala contracts.
A Mudaraba is a partnership in profit whereby one party provides capital (rab-al-maal) and the
other party provides labor (mudarib). In this contract, the depositors act as rab-al-maal and the
bank as mudarib. Therefore, a portion of the deposits would be invested in various projects and
the profit is shared in ratios as agreed upon between the parties. In case, a loss is incurred, then
the rab-al-mall, i.e. the depositors would bear all the losses.
The term Wakala literally means preservation. Legally, Wakala can be defined asthe delegation
of one person (the principal) for another (the agent) to take their place in a known and
permissible dealing. In this regard, the agent (wakil) deals in others’ properties and preserves
them in return for a specific fee known as Wakala fee..