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Shari’ah Parameters for Islamic Finance Contracts

Shari’ah Parameters for Murabaha.

  1. The seller (S) in this contract is the bank, and the buyer (B) is called al-Amer bil Shira.
  2. Pre-sale Order: The pre-sale agreement (the order) is not binding on B, but if he fails to fulfil his promise, S Is entitled to compensation for actual damages incurred. These may NOT include foregone profit opportunities.

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  3. The agreement must specify the quantity, quality and place of delivery of goods, the mark-up, terms of payment of sale-price, items that will be included in the cost, etc.

  4. Before consummating the sale contract, S must have owned and possessed the goods in question. 
  5. Mark-up must be known at least at the time of concluding the sale contract or even before. It may be fixed percentage of the cost, or a fixed absolute amount. While it is permissible to use a benchmark like LIBOR, the price must be known as a fixed amount.

  6. To satisfy the requirement of the seller’s possession of goods before reselling them, a seller must bear the cost of loss, damage and storage before delivery to B.

  7. S can ask B for any guarantees and collateral against the debt outstanding and against possible debtor’s delinquency.
  8. The seller may not increase the outstanding debt in case of delinquency. In such case S can foreclose on the collateral or go to court.

  9. The bills of trade arising out of the above transaction cannot be sold, but must be kept until maturity. However, such bills can be transferred at face value.

Shari’ah parameters for Istisna

  1. Istisna is a sale contract. It is a pre-production sale.
  2. The subject of the contract can be any manufactured good.

  3. It is acceptable for the price to be paid at the time of contract, at the time of delivery or at any time afterwards, in lump sum or on instalment basis.
  4. The seller can manufacture the goods himself, and he is also allowed to subcontract.

  5. Price has to be known as a fixed amount, goods sold must also be described fully at the time of contracting.

  6. Seller is fully liable vis a vis buyer for quantity, quality and potential hidden defects of goods sold. If seller has subcontracted the works to a 3rd party, he may specify that any claims must be made against such party. But seller must remain a guarantor of last resort.

Shari’ah parameters for Mudarabah

  1. The financier can claim neither fixed amount of money as profit nor a fixed percentage of the capital. Nor can be ask for a guarantee of the principal.
  2. The contract must spell out the ratio of division of profit between the two parties. They can agree on any ratio but it has to be known at the time of contracting.

  3. Only accounting loss is recognised by Shari’ah. It has to be born by the participants according to their capital contributions.
  4. The mudarib (manager) may have an escalating share of profit in accordance with the level of profit achieved.

  5. Profit (or loss) can be recognised only after liquidating of the assets of the Mudarabah. Such liquidation need not be actual sale, but can be an accounting procedure (Constructive Liquidation).

  6. Mudarabah contract can be for any term, at the end of which the contract is liquidated.
  7. While it is not permissible to take guarantees for achieving a certain level of profit or against loss, it is allowed to take such guarantees against negligence, mismanagement and for prompt repayment of capital and profit (if any) at the end of contract.

  8. The Mudarabah can be a vehicle to finance any legitimate profit-making activity. Such activity can be specified in the contract or left to the desecration of the Mudarib (manager).

Shari’ah parameters for Musharakah

  1. The basic difference from Mudarabah is that in Musharakah both parties are entitled to participate in management.
  2. It is permissible to have an escalating (or variable) profit-sharing ratios depending on the level of profits achieved.

Shari’ah parameters for operating lease

  1. Only durable goods can be the subject of a leasing contract.
  2. Owner of the asset is entitled to lease payments (rentals) as long as the usufruct of the asset is available to the lessee.

  3. The lease contract must spell very clearly who bears the maintenance costs. As a general rule responsibility against total loss and accidental damage must be at cost of the owner.
  4. Owner of the leased asset may sell it to a third party, or to the lessee himself. In either ease, the sale may include or exclude the prospective (uncollected) future rentals.

  5. The lessee may sublease at more or less rental rate to a third party, unless expressly prohibited from doing so by the terms of the lease contract.

  6. The owner of the asset can sell the leased asset and hence transfer the lease contract to the new owner. It is possible to sell asset to third party conditional on his retaining all the benefits of the old lease.

Shari’ah parameters for financial lease

A financial lease should be considered a sale contract for a deferred price. Hence, the I.O.U’s of future "rental" payments represent money debt that cannot be sold but had to be kept by the creditor till maturity. The I.O.U’s may be transferred (for their face value and stated terms).

Source: An Introduction To Islamic Banking, Shaykh Dr Mohamed Ali Elgari. Republished with permission.