ISLAMIC BANKING

OPERATIONS

TOPIC 6: FINANCING II
PERSONAL
FINANCING
• Unlike other retail financing facilities such as home and
automobile that involve an asset as the underlying subject
matter as discussed earlier, personal financing on the
other hand, in most cases does not implicate any asset
acquisition
• Rather, it fulfils the financing needs of customers who
require cash or liquidity for various reasons and purposes
such as education, medical, performing pilgrimage,
marriage, payment of debt among others
• To address the diverse clientele needs and expectations,
many Islamic banks offer personal financing products
structured based on bayʿ al-ʿīnah and tawarruq contracts
ʿĪNAH PERSONAL
FINANCING
• bayʿ al-ʿīnah can be defined as a sale with immediate
repurchase
• The Resolution of the SAC-BNM in 2012 has introduced
changes to the documentation of the bay’ al-’īnah contract
• Beginning 2013, the inter-conditionality clause in the ʿīnah
contract will no longer be made effective; thus, making the
sale and buy-back transaction independent of each other
• As a result, when a bank sells an asset to a customer on a
credit basis, the bank cannot make a condition for the
customer to sell the asset back to the bank
• This gives the customer the freedom to exercise his
ownership right on the asset
• Theoretically, the customer can sell the asset to a third party
if he wishes, although in practice, it is not likely to take place
ʿĪNAH PERSONAL
FINANCING
TAWARRUQ PERSONAL
FINANCING
• Tawarruq or commodity murābaḥah can be defined as an
arrangement that involves the purchase of an asset based
on the musāwamah (supplier does not disclose its cost or
markup) or murābaḥah (supplier sells at a markup and
discloses it), and the subsequent sale of the same asset to
a third party in order to raise cash

• This transaction results in the customer receiving cash to

be used for his business or personal requirements
TAWARRUQ PERSONAL
FINANCING
RAHN PERSONAL
FINANCING
• Apart from the controversial contracts such as ʿīnah and
tawarruq, some IFIs have introduced rahn-based personal
financing

• Rahn is literally defined as a pledge or collateral. It refers

to an arrangement whereby a valuable asset is given as
security for a debt

• Under the rahn personal financing, a valuable item is

pledged as a security by the customer against an interest-
free loan (qarḍ) to be granted by the bank
RAHN PERSONAL
FINANCING
• The bank earns an income by charging a fee (ujrah) for
safekeeping services (wadī’ah) of valuable items pledged
by the customer

• If the customer, who is the debtor to the bank, is not able

to repay the loan amount, the pawned asset will be sold to
settle the outstanding debt, and any surplus will be
returned to the asset owner who is essentially the
customer
RAHN PERSONAL
FINANCING
ISLAMIC CREDIT
CARDS
• Another important and popular segment of Islamic retail
financing is Islamic alternative structures to the
conventional credit card facility

• The most common structures of Islamic credit cards are

• ʿīnah-based
• ujrah-based
• tawarruq-based
ISLAMIC CREDIT CARD
BASED ON ‘INAH
ISLAMIC CREDIT CARD
BASED ON UJRAH
ISLAMIC CREDIT CARD
BASED ON TAWARRUQ
CORPORATE
FINANCING
• Corporate financing caters to the specific needs of the
business community which may differ from retail
consumers
• Like its conventional counterpart, Islamic banking also
offers a wide range of corporate or business products
ranging from term financing to working capital financing
and trade financing
• However, in addition to debt-based products, Islamic
banks provide lease-based and equity-based alternatives
for corporate financing needs as well
SALE-BASED
CORPORATE FINANCING
• This involves purchasing of an asset such as a machinery
by the IFI and selling it to the customer at a profit
• Most of the structures are similar to the asset or property
acquisition in retail business as discussed in the previous
lecture
• These structures are modified to meet the corporate
working capital requirements using classical contracts
found in the Islamic law
• The most common debt-based structure is the murābaḥah,
although the istiṣnāʿ and salam are also used
MURĀBAHAH
FINANCING
• Murābaḥah is a trust-based sale within the Islamic law
• It is considered a trust sale due to the underlying premise
whereby the seller discloses the cost and markup of the
asset for sale, and the buyer trusts the seller’s honesty in his
disclosure
• The deferment of price is the additional caveat that entails the
role of an Islamic bank to the transaction
• Even though deferred payment is not one of the essential
conditions of the MPO—the most common adoption of
murābaḥah at banks—it still plays a role in the transaction
• For an MPO that involves no deferred payment, the profit
margin for the financial institution will be through a spot sale
and not the extra charge it receives from the deferred
payment
COMMODITY MURĀBAHAH
OR TAWARRUQ FINANCING
• Commodity murābaḥah or tawarruq are used extensively
for short-term corporate financing
• Companies acquire funds from the IFIs through the
instantaneous purchase and sale of eligible commodities
including Crude Palm Oil (CPO) through brokers
• In practice, the transactions are facilitated by the banks
themselves, acting as agents on behalf of the company,
mandated to acquire the commodity and then sell it to a
third party in a separate transaction
• Platforms such as the Bursa Suq Al-Sila' would facilitate
these transactions to resolve the short-term financing
problems for companies and the IFIs that require liquidity
management
COMMODITY MURĀBAHAH
OR TAWARRUQ FINANCING
• The structure of tawarruq short-term financing is very
much similar to the other tawarruq-based personal
financing
• The structure has received criticism from individual
scholars as well as the IFA- OIC, specifically condemning
the wide practice of an organized tawarruq
• The OIC encouraged a move towards qarḍ ḥasan (interest-
free loan) rather than tawarruq, although this has been
broadly ignored due to the obvious absence of monetary
reward to the fund providers
ISTISNĀʿ FINANCING
• Companies may also require financing for manufacturing
or construction of assets for their own use or sale to their
customers
• For example, a company named DEF Dealership wants
motorcycles manufactured to sell through their dealership
network and to bear their branding
• They found ABC Engineering who is considered a reliable
manufacturer of quality motorcycles and intend to place
an order for 100 units
• DEF approaches an IFI for corporate financing and the IFI
offers DEF an istiṣnāʿ financing option
ISTISNĀʿ FINANCING
SALAM FINANCING
• Salam is a forward sale, used for the financing of crop
harvest and agriculture as well as commodities and
utilities
• In nations with large agriculture sectors salam has been
used to solve working capital shortages for the farming
industry whilst they await the harvest
• The product must be easily available in the market to
mitigate the risk of a poor harvest
• Salam has also been used to sell utilities such as water
and electricity in advance to finance the large capital
outlay required for the building of dams and power
stations
LEASE-BASED
CORPORATE FINANCING
• Lease-based financing or ijārah are used by corporates
including the IFIs either for financing assets required for
business use or leasing out assets owned for an income

• Conventionally, lease-based financing can be classified

into two categories:
• operating lease
• finance lease
LEASE-BASED
CORPORATE FINANCING
Both have their specific advantages, depending on the
corporate’s finance strategy
In Islamic finance, ijārah can also provide both options
• Operating lease (ijārah tashghīliyyah) results in the return
of the asset to the lessor at the end of the lease period, or
scrapping of the asset at the end of its useful life
• Finance lease (ijārah tamwīliyyah) on the other hand,
assists corporates in acquiring the use of assets whilst
taking advantage of the possible tax benefits that may
arise from the finance lease deductions
LEASE-BASED
CORPORATE FINANCING
• Ijārah muntahiyah bi al-tamlīk is a type of finance lease
that involves leasing of an asset with transfer of
ownership at the end of the lease tenure
• In this type of lease, the lessee will acquire the asset in
one of the following three ways:
1. A sale, either for a token, a specified consideration,
market value of the asset or by paying in advance as part
of rentals
2. A gift (hibah) without any consideration
3. A gift (hibah) only after all instalments and outstanding
amounts are settled
LEASE-BASED
CORPORATE FINANCING
• The AAOIFI Sharīʿah Standard No. 9 clarifies that a
promise to transfer the ownership by one of these
methods is a binding promise on one party only
• A bilateral promise of the two parties is tantamount to a
contract, which is prohibited in Sharīʿah in such a case
• Nevertheless, in all cases of transfer of ownership by way
of sale or gift, it is necessary to draw up a new contract
when the promise is fulfilled
• This is because the transfer of ownership is not automatic
by virtue of the original promise document
LEASE-BASED
CORPORATE FINANCING
• Some IFIs use different terms such as ijārah wa iqtināʿ
• The difference is in the semantics:
Ijārah wa iqtināʿ and ijārah muntahiyah bi al-tamlīk are
differentiated by what transpires at the end of the lease
period. ‘Iqtināʿ’ means ‘acquisition’ whilst ‘muntahiyah bi al-
tamlīk’ means ‘end with ownership’
In practice, these terms are used interchangeably and will
depend on the ownership transfer contract either through a
gift or a sale
LEASE-BASED
CORPORATE FINANCING
• In the context of commercial practice in Malaysia, the
AITAB is predominant. It shares a similar structure with
ijārah muntahiyah bi al-tamlīk, except the contract of sale
is featured without providing the option of a gift
• The sale is executed at the end of the leasing period and
is not part of the original lease, as is the case with
conventional hire purchase
• However, it is important to note that the option to
purchase is not an obligation; hence, should not be a
precondition in executing the leasing contract as this
violates the Sharīʿah principles
IJĀRAH MUNTAHIYAH BI
AL-TAMLĪK FINANCING