FINANCING MECHANISM OF ISLAMIC BANKING volume TIJOSS/1Taudlikhul...diminishing musharakah, a...
Transcript of FINANCING MECHANISM OF ISLAMIC BANKING volume TIJOSS/1Taudlikhul...diminishing musharakah, a...
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.
REFERENCES
1. Ahmed, Mahmood. 2014. Practice of
Mudaraba and Musharaka in Islamic
Banking. Retrieved from
http://ibtra.com/pdf/journal/v2_n1_article3.p
df. Accesed 2014.
2. Almsafir, Mahmoud Khalid & Alsmadi,
Ayman Abdalmajeed. 2013. Murabahah
Islamic bank Customers/
Entrepreneurs
Hajj / Operation
1. Deposit
2. Request
4a. Pay for Hajj
5a Cost of Administration
5b financing/Capital 100%
13
versus Interest Rate, the Equilibrium
Relationship With Macroeconomic variables
in Jordanian Economy: An ARDL
Approach. International Conference on
Innovation, Management and Technology
Research, Malaysia, 22 – 23 September,
2013
3. Al Zaabi, Obaid Saif. 2011. Salam Contract
in Islamic law : A Survey. International
association for Islamic economics Review of
Islamic Economics, Vol. 14, No. 2, 2010,
pp. 91–122.
4. Al-Ashqar, Muhammad Sulayman. 1995.
Bay al-Murabahah (Deferred Sale). Amman:
Daral-Nafa‟is, 2nd. Edition.
5. Ariffin, Noraini Mohd and Adnan,
Muhammad Akhyar. 2011. Malaysian
Islamic bankers‟ Perceptions os Al Qard Al
Hasan. international association for islamic
economics Review of Islamic Economics,
Vol. 15, No. 2, 2011, pp. 97–111.
6. Ashurst, 2009. Murabaha financing.
Ashurst‟s Islamic Finance group. Retrieved
from
https://www.ashurst.com/doc.aspx?id_Conte
nt=4298
7. Atmeh, Muhammad A and Serdaneh, Jamal
Abu. 2012. A Proposed Model for
Accounting Treatment of Ijarah.
International Journal of Business and
Management; Vol. 7, No. 18; 2012
8. Ayub, Muhammad. 2007. Understanding
Islamic Finance. West Sussex: John Wiley
& Sons, Ltd.
9. Aziz, et al. 2013. Mudarabah in Islamic
Finance: A Critical Analysis of
Interpretation and Implication. International
Journal of Asian Social Science,
2013,3(5):1236-1243.
10. Central Bank of Malaysia. 2014. Ijarah.
Issued on: 23 June 2014
11. Chapra, M.U. 2005. Towards new monetary
policy urdu trans. Farooqui, aijaz ahmed, aik
munsifana zari nizam, Karachi. 242-243.
12. Farooq, Muhammad and Ahmed, Mufti
Muhammad Mushtaq. 2013. Musharakah
Financing: Experience of Pakistani
Banks.World Applied Sciences Journal 21
(2): 181-189, 2013
13. Ibid, pp: 87.
14. Mutamimah, et al. 2011. Effectiveness of
Qard al –hasan financing as a poverty
alleviation model. Economic Journal of
emerging markets, April 2011 s(1) 27-42.
15. Rab, Hifzur. 2004. Impact of Inflation on
Mudarabah Profit : Some Observations.
J.KAU: Islamic Econ, vol.17, No.2,pp.21-25
(1425AH/2004AD)
16. Rahman, Zaharuddin Abdul. 2006.
Management Fees in „Qardhul Hasan, NST
Business Times, 20th Sept 2006.
17. Saleh, N. 1986. Unlawful gains and
legitimate profit in islamic law: Riba gharar
and islamic banking. U.K:Cambridge
University Press.
18. Siddiqui, M.N. 1969. Shirkat-o-mudarbat
kay shari asool urdu, Lahore 18-21.
19. Siddiqui, M.N. 1985. Partnership and Profit
Sharing in Islamic Law, The Islamic
Foundation, Leicester, 1985, pp.22-23.
20. Usmani, M. T. 2003. Ijarah. Retrieved from
http://www.accountancy.com.pk/docs/islam
_Ijarah.pdf.
21. Usmani, Muhammad Imran Ashraf. 2002.
Meezan Bank‟s Guide to Islamic banking.
Pakistan: Darul-Ishaat Urdu Bazar Karachi.
22. Zarqa, Muhammad Anas. 1997. Istisna‟
financing of infrastructure projects. Islamic
Economic Studies, Vol. 4, No. 2, May 1997.