ISLAMIC FINANCE GLOSSARY

ISLAMIC BANKING VERSES CONVENTIONAL BANKING:-

Islamic Banking distinguishes from Conventional Banking in three basic principles:

Interest free transactions: Riba (Interest) which is prevalent in conventional finance is completely prohibited under Islamic laws regardless of the form.

Contractual Certainty: Gharar (Uncertainty) means that the subject matter of the transaction has to be clear and existing so as to avoid any future conflicts between the parties

Maisir (Speculation) is gaining something by chance rather than by productive effort which is a common place in the conventional finance in the form of speculative activity but is prohibited under Islamic law.

• Ijara
• Ijara-wa-iktana
• Ijarah with Diminishing Musharka
• Mudaraba
• Murabaha
• Musharaka
• Qard
• Wakala
• Salam

MODLES OF ISLAMIC FINANCING:-

Following are some of the Shari'ah compliant products being used in the market:

Ijara:-

Ijara is a form of leasing. It involves a contract where the bank buys and then leases an item – perhaps a consumer durable, for example – to a customer for a specified rental over a specific period. The duration of the lease, as well as the basis for rental, are set and agreed in advance. The bank retains ownership of the item throughout the arrangement and takes back the item at the end.

Ijara-wa-iktana:-

Ijara-wa-iktana is similar to Ijara, except that included in the contract is a promise from the customer to buy the equipment at the end of the lease period, at a pre-agreed price. Rentals paid during the period of the lease constitute part of the purchase price. Often, as a result, the final sale will be for a token sum.

Ijarah with Diminishing Musharka:-

The principle of Ijara with diminishing Musharaka can be used for home-buying services. Diminishing Musharaka means that we reduce our equity in an asset with any additional capital payment that the client makes, over and above their rental payments. The client's ownership in the asset increases and ours decreases by a similar amount each time the client makes an additional capital payment. Ultimately, the bank transfers ownership of the asset entirely over to the client.

Mudaraba:-

Mudaraba refers to an investment on client behalf by a more skilled person. It takes the form of a contract between two parties, one who provides the funds and the other who provides the expertise and who agrees to the division of any profits made in advance. In other words, the bank would make Shari'ah compliant investments and share the profits with the customer, in effect charging for the time and effort.

Murabaha:-

Murabaha is a contract for purchase and resale and allows the customer to make purchases without having to take out a loan and pay interest. The bank purchases the goods for the customer, and re-sells them to the customer on a deferred basis, adding an agreed profit margin. The customer then pays the sale price for the goods over instalments, effectively obtaining credit without paying interest.

Musharaka:-

Musharaka means partnership. It involves you placing your capital with another person and both sharing the risk and reward. The difference between Musharaka arrangements and normal banking is that you can set any kind of profit sharing ratio, but losses must be proportionate to the amount invested.

Qard:-

A Qard is a loan, free of profit. The bank uses this arrangement for its current accounts. In essence, it means that the customer's current account is a loan to the bank, which is used by the bank for investment and other purposes. Obviously it has to be paid back to the customer, in full, on demand.

Wakala:-

Wakala is an agency contract, which usually includes in its terms a fee for the expertise of the agent. Banks may use it for their large deposit accounts: customer owns the capital invested, appoints the bank as their agent and pays a fee for the bank's expertise.

Salam:-

Salam (payment for future contract) is a mode of advance payment for goods which are to be delivered later and Sukuk (bond issue) essentially amounts to commercial paper that provides the subscriber with ownership or part ownership in the underlying asset.
Murabaha financing is the most popular mode of Islamic Financing and accounts for 40% of the total Islamic Financing. It has remained the most favourable mode of financing throughout the world.
Second most widely used mode of financing is Ijarah as it accounts for 30% of total financing. For the year ended December 2006 Ijarah financing amounted to Rs.19 Billion.
Musharaka is also a common mode of financing and accounts for 16% of the total Islamic Financing. Its share has increased by 4 % since September 2006 indicating its popularity among the consumers.
The market for other Islamic financing modes has still not developed and their demand is almost non existent in the market.