Durham Islamic Finance Autumn School in

Istanbul, 2011

Islamic Financing Instruments

Professor Rodney Wilson

Presented at the
Durham Islamic Finance Autumn School 2011
jointly organised by
Durham Centre for Islamic Economics and Finance and
ISAR-Istanbul Foundation for Research and Education
Istanbul Commerce University, Istanbul
19th-22nd September 2011

Contents

Islamic banking deposits
– Current
– Investment mudaraba deposits
Financing facilities
– Murabaha and tawarruq
– Salam and parallel salam
∂

– Ijara and ijara wa iqtina
– Istisna and parallel istisna
– Mudaraba and musharaka
– Wakala
Islamic banking league tables

Rdoney Wilson, Islamic Financing

Instruments
1

Durham Islamic Finance Autumn School in
Istanbul, 2011

Retail Islamic banking deposits

Current accounts:
– Qard hasan interest free loans
– Amana trust deposits
– Wadia deposit for safekeeping (wa’d is a promise)
Treasury deposits
– Murabaha 30 or 90 day time deposit with a fixed mark-up
– Funding used for commodity trading
∂

Investment deposits
– Mudaraba profit sharing deposits
– Unspecified or specified
– Profit smoothing through an equalisation reserve
– Longer notice periods result in higher percentage of the profit share

Islamic banking financing facilities

Retail finance
– Credit cards that are fee based with pre-payment amount determining credit
limit and no interest charges
– Muraraba with bank purchasing a good on behalf of a client and supplying it
for a mark-up
– Tawarruq for cash advances through parallel murabahah
– Ijara with bank purchasing a good and the client entering a lease
agreement and paying a rent (ijara wa iqtina hire purchase)
– Diminishing musharaka Islamic partnership
∂
mortgages
Business finance
– Murabaha and ijara as above
– Salam and parallel salam for receivables finance
– Arboun deposit to secure a put option
– Istisna project finance where costs of supplies and wages covered for plant/
facility to be delivered at a future date and possible parallel istisna to
shorten commitment and enhance liquidity

Rdoney Wilson, Islamic Financing

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Durham Islamic Finance Autumn School in
Istanbul, 2011

Murabaha financing

Bank purchases goods on behalf of a client and resells
at a mark-up
– Ownership responsibilities justify return to bank
– Risks associated with ownership of the commodity
borne by financier until resale
∂

– Risks remain after resale as bank has first
purchaser responsibilities if goods defective
– Dissatisfied client could make claim on the bank
and issue of warranties

Murabaha structure

Initial transfer of title Final transfer of title

∂

Islamic
Vendor Client
bank
Payment
Deferred payment
plus mark-up

Rdoney Wilson, Islamic Financing

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Durham Islamic Finance Autumn School in
Istanbul, 2011

Tawaruq

Bank buys and owns the commodity
Commodity sold to the client at a mark-up
Purchaser can authorise bank to sell commodity for a
service commission ∂

Sale value deposited into clients account
Client repays amount plus mark-up as deferred lump
sum or in installments

Tawarruq structure

Initial transfer of title Final transfer of title

∂

Islamic
Vendor Client
bank
Payment
Deferred payment
Payment

plus mark-up

Sale

Tawarruq

Third

party

Rdoney Wilson, Islamic Financing

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Durham Islamic Finance Autumn School in
Istanbul, 2011

Salam

Financier pays price of commodity in advance in full
Quantity and delivery date and place specified
Financier may enter parallel salam to sell commodity at
a slightly higher price if period shorter to delivery
Price differential represents financier’s profit
∂

Risk involved to justify profit as time period of contracts
may not coincide and financier exposed

Parallel salam illustrated

Payment in full at inception

Investor
Asset for 90

Euros 950,000

∂
day delivery

Payment to

Investor after
Asset delivery to client

30 days, Euros 965,000
Client

Euros 1,000,000

Sale of asset for spot price

Euros 960,000

Rdoney Wilson, Islamic Financing

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Durham Islamic Finance Autumn School in
Istanbul, 2011

Ijara leasing

Operating ijara is a pure leasing arrangement
– Two parties to the contract, lessor and lessee
– Rental payment provides an income stream
– Contract of fixed duration but renewal possible
Owner and lessee responsibilities
– The lessee can be required ∂
to maintain equipment on a
periodic basis
– Owner responsible for loss or damage to asset beyond
control of lessee
– Lessee can indemnify owner against misuse or negligence
caused by lessee

Ijara structure

Transfer of title Lease of asset

∂

Islamic
Vendor Client
bank
Payment of Rental instalments
purchase price

Rdoney Wilson, Islamic Financing

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Durham Islamic Finance Autumn School in
Istanbul, 2011

Conditions and limitations of ijara

Property being leased must have a valuable use
– house or business premises should be occupied,
not a mere speculative purchase
Leased property cannot be used for purposes other
than specified in the leasing agreement
– Non halal use would∂
contravene shariah
– Restrictive covenants may be included in new
leases but uncertainties of conversion with
existing leases

Hire purchase

Ijara wa iqtina or ijara muntahia bittamleek is a
hire purchase contract
Leased asset passes as a gift or a sale at the
end of the lease period
Purchase possible during ∂
the lease period if the
remaining rental installments paid
Gradual transfer of ownership also possible
rather than an outright sale
Lower risk as lessee has ownership stake

Rdoney Wilson, Islamic Financing

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Durham Islamic Finance Autumn School in
Istanbul, 2011

Istisna

Contract to acquire goods on behalf of a third party

Price paid to a manufacturer in advance of goods
being purchased
Payments received cover∂
wages and costs of input
supplies
Applied to production of specific items
Delivery at an agreed date

Parallel istisna structure

Islamic
Deferred payments
investors
∂
Operator
Payment for sale of receivables

Payment for
Project supplies Investment
manager bank

Facility handover & payment to project manager

Rdoney Wilson, Islamic Financing

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Durham Islamic Finance Autumn School in
Istanbul, 2011

Mudaraba

Structure
– Rabb-al-maal provides the capital
– Mudarib provides the management and effort
Returns
– Profits shared on a predetermined but not necessarily
∂

equal basis
– No fixed remuneration or salary for mudarab
– Mudarab can claim expenses when traveling on
business

Mudaraba structure

Shariah board

Raab al mal
Mudarib

Partnership

company

Investments

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Durham Islamic Finance Autumn School in
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Musharaka

Shirkah or sharing
Musharaka involves a mutual contract to participate in a commercial
enterprise
Determination of returns
– Proportional distribution agreed in advance, usually relating to
investment shares
– Net profits of the business
– Losses must be shared in proportion to amounts invested
∂

Management
– All partners may be involved in the management of the
business
– May agree in advance that one party a sleeping partner

Musharaka versus equity investment

Musharaka Equity investment
Venture of limited duration Company exists in perpetuity
Partnership with joint ownership Exclusive ownership by
No exit without agreement of shareholders
partners Exit at any time if company listed
Investors obtain profit share ∂
Investors get dividends
Little probability of asset gains Focus on capital gains and market
when venture terminates value of equity

Rdoney Wilson, Islamic Financing

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Durham Islamic Finance Autumn School in
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Wakala

A contract appointing an agent to act on behalf of a
principal party
– Parallel with granting a power of attorney or an
enduring power of attorney
∂
rather than sharing in
– Wakil may be paid a fee,
profit as with mudaraba

Wakala structure

Principal

∂

Shariah board

Wakil

Investments

Rdoney Wilson, Islamic Financing

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Durham Islamic Finance Autumn School in
Istanbul, 2011

Shariah compliant assets

Country $US million, 2010
Iran 314,897
Saudi Arabia 138,238
Malaysia 102,639
UAE 85,622
Kuwait ∂
69,088
Bahrain 44,858
Qatar 34,676
Turkey 22,561
United Kingdom 18,949
Bangladesh 9,365

Source: The Banker, London, November 2010

Top ten Islamic banks

Bank Assets, Profits,
$ million $ million
Bank Melli 57,003 266
Al Rajhi Bank 45,527 1,805
Bank Saderat 43,109 N/A
Kuwait Finance House 40,317 105
∂

Bank Tejarat 34,545 396
Dubai Islamic Bank 22,834 136
Bank Sepah 22,502 388
Parsian Bank 19,783 405
Bank Maskan (Housing Bank) 19,311 284

Abu Dhabi Islamic Bank 18,619 162

Source: The Banker, London, November 2010

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