Modes of Islamic Financing

Murabaha (Agreed profit margin sale

with cash or deferred payment of
price)
Musawamah
Ijarah (Leasing)
Salam (Advance payment--Deferred
Delivery Sale)
Musharaka (Partnership)
Mudaraba
Istisna
1

Application of Mode

Based on the criteria for selection of modes, the

appropriate mode(s) is/(are) applied to fulfill the
customers need.

Need

Mode
Selection

Example
Murabaha
Need:
Raw material
Tenure: 6 month
Rate: Fixed
Payment: At maturity
2

Mode
Application

Shariah Principles
Promise of client to purchase units of share of financier is also
allowed.
The Transactions cannot be combined in a single arrangements
and they have to be executed independently.
This is because it is a well settled rule of Islamic Jurisprudence
that one transaction cannot be made a condition for another.
Instead of making the transactions a pre-condition for one
another there can be one-sided promises from one party to
another

Murabaha
Murabaha is a particular kind of sale where the transaction is
done on a cost plus profit basis i.e. the seller discloses
the cost to the buyer and adds a certain profit to it to
arrive at the final selling price.

Payment of Murabaha price may be:

1) At spot
2) In installments
3) In lump sum after a certain time

Murabaha
Do NOTs for Murabaha financing:

Re-negotiation of price and

Murabaha are not permitted.

roll

Discounting of Murabaha instrument is not

permitted.

over

of

Murabaha Key features

3. Payment of Murabaha price

1. Payment of Cost

Supplie
r

Bank
2. Delivery of goods

Client

Murabaha Documentation
There are a number of documents involved in a Murabaha
financing transaction. The most essential of these
documents are:
Master Murabaha Financing Agreement
Agency Agreement
Order Form
Declaration & Murabaha Contract
Purchase Evidences
Demand Promissory Note
Payment Schedule

Issues in Murabaha
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Timing of Offer & Acceptance

Rollover in Murabaha
Rebate on Early payment
Penalty in Late payment
Subject Matter
Purchase Evidence
Direct Payment
Profit recognition
Training of Customer & Bank staff
Process of Murabaha differ from product to products

Istisna - features

1. Istisnaa Agreement &

payment

Bank

Customer
9

4. Sale Proceeds

2. Delivery of Goods as per

Ultimate buyer
schedule

Buyer
3. Sale of Goods

Salam - features

1. Payment of price

Custome
10r

3. Goods delivery

Market

Bank
2. Goods delivery

3. Payment of price

IJARAH

VENDOR

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ISLAMIC BANK

CUSTOMER

Ijarah Documentation
Undertaking to Ijarah
Ijarah Agreement
Description of the Ijarah Asset
Schedule of of Ijarah Rentals
Receipt of Asset
Demand Promissory Note
Undertaking to Purchase Ijarah Asset
Sale Deed

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Ijarah Documentation
Letter of Agency

Undertaking to Lease

Lease Agreement

Undertaking to Purchase

Sale Deed
13

Diminishing MusharakahIn Diminishing Musharakah the financier and the

client participate either in joint ownership of
a property or an equipment, or in a joint
commercial enterprise
The share of the financier will be divided into a
number of units
The client will purchase these units one by one
periodically until he is the sole owner of the
property

14

Shariah Principles
Argument:
In the case of promise to sell units of share by financier one
might argue that if the promise to sale has been done before
entering into actual sale This is practically putting a condition on
the sale itself
Answer:
There is a difference between: Putting a condition on a sale and
making a separate promise , without making it a condition.
In case of condition, the sale will be valid only if the condition is
fulfilled.

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Assets
Diminishing Musharakah

BANK

Joint
Ownersh
ip
Rent

Gradual Transfer of Ownership

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Mushara
ka

CUSTOMER

An exporter has to prepare goods to meet an

export order. He needs to buy cotton yarn and
approaches a bank for financing. What options are
available?
A sugar mill needs to but sugarcane for producing
sugar cane. Suggest Islamic modes of financing
alternatives.
A doctor needs an X-ray machine and approaches
an Islamic bank for Shariah-compliant financing.
What options would you suggest for the
transaction?
An Islamic bank wants to offer car financing but
does not want to assume full ownership risk during
the tenure of the finance. What mode of finance
should it use?

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REGULATORY
FRAMEWORK
OF ISLAMIC BANKING IN
PAKISTAN

18

The Regulators/Supervisors

19

The Government of Pakistan/Ministry of

Finance
Different laws/regulations
Banking Act
Islamic Securities
State Bank of Pakistan
Banks
DFIs
Money Market
Securities & Exchange Commission of
Pakistan
NBFCs
REITs

SBP as a Regulator of Banking Sector

Regulation and supervision of the
financial
system
to
ensure
its
soundness and stability as well as to
protect the interests of investors and
depositors:
1. Comprehensive Legal Framework
2. Prudential Regulations
3. Effective

Monetary

and

Exchange

Rate Policy
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4. Efficient Supervisory Techniques

Failure of Previous Efforts

Non-availability of Shariah compliant
government securities
Ineffective code of conduct for professionals
Lack of continued research and development
in the field of Islamic finance and economics
Disoriented education system devoid of Islamic
principles
Weak Political resolve of successive
governments for Islamization of economy
21

Failure of Previous Efforts

Absence of Shariah compliance mechanism in
financial institutions
Ineffective enforcement of contracts and
inefficient system for early recovery
Inadequate training to the staff of SBP and banks
Lack of public awareness about Islamic economic
system

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CURRENT STRATEGY
Gradual approach for Transformation of
economy
Full fledged Islamic banks be established
in Private sector
Islamic banking Subsidiaries in existing
banks be allowed
Stand alone branches for Islamic banking
be allowed in existing banks
More emphasis on Shariah Compliance
Mechanism
23

REGULATORY
FRAMEWORK
APPLICABLE
REGULATIONS
Criteria for establishment of Islamic
Commercial banks in Private Sector
Criteria for establishment of Islamic
banking Subsidiaries
Guidelines for Opening of Islamic
Banking Branches
Prudential Regulations, Risk Mgmt. Corp.
Governance, Internal Controls and other
directives issued by SBP

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FORMATION OF ISLAMIC
BANKS

Clearance of Memorandum and Articles of

Association from SBP
License from SBP u/s. 27 of BCO, 1962.
Authorized businesses listed in section 7 of BCO
Commencement of Business as Scheduled Islamic
Bank
All business transactions be Shariah compliant.
Shariah Board or Shariah Advisor approved by SBP
Products and services be cleared by Shariah
Advisor
Working Procedures and Risk Management policies
be in place
25

Criteria for Establishment of

Islamic Banks
A Public Limited Company listed on the Stock
Exchange.
Minimum of 50% of shares shall be offered to
the general public.
Financial transactions be in accordance with
injunctions of SHARIAH.
Indicate the modes of finance to be used for
raising resources and extending financial
assistance.
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Criteria for Establishment of

Islamic Banks
Sponsor Directors
Number of Sponsor Directors not be less than seven.
Minimum of 15% of shares be subscribed by Sponsor
Directors
Not to dispose off their shares within 3 years and
afterwards with prior approval of SBP.
Should not be convicted, defaulters or have adverse
reputation.
Not more than 25% of the sponsor Directors shall be
from the same family
A person cannot be a Director in more than one
financial institution

Chief Executive requires prior clearance of SBP

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Criteria for Establishment of

Islamic Banks
Documents required with application
Feasibility Study/ Short Term and Long term Business
Plan:
Industry overview
Regulatory Framework
Introduction of Sponsors and their networth
Capital Mobilization Plan/Capital Structure
Products and Target Market
Competitors analysis
Financial Model/Projections
Organization structure, name of proposed Chief
Executive.
Memorandum and Articles of Associations
28

Criteria for Establishment of

Islamic Banks
Risk management guidelines, Plans for Internal
control system and scale of authority
Working system and procedures for business
operations
List of associated companies / firms of sponsor
directors and their bankers
Shariah Advisor according to Fit and Proper Criteria
Must commence operation within 6 months of the grant of
permission
Must open at least five branches within a period of 12 months
from the date of permission
Shall be subject to the prevalent banking and other laws, rules
and directives issued by SBP from time to time
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Islamic Banking Branches

Whether exclusive branches or IB

windows
Effective oversight by Head office
Shariah Compliance MechanismAdviser /Board
Adequate Training to staff and
Research & Development
Complete Segregation of Funds
30

Islamic Banking Branches

Risk management guidelines, Plans for
internal control system and scale of
authority.
Working system and procedures for business
operations
List of associated companies/firms of
sponsor directors and their bankers.
Shariah Advisor according to Fit and Proper
Criteria.
31

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IBD/IBBs - Segregation of
Business/Funds
A separate
daily trial balance of IBD / IBBs

operations
IBD/IBBs have to operate as a bank within the bank.
The common services can be shared between the
conventional and Islamic banking segments.
In case of online banking, ATMs and for selling
Shariah-based products through conventional
branches, same day transfer of funds to IBB is
mandatory; not permissible to charge any kind of
mark-up on such funds balances.
Any financing by the parent bank: on Shariah
compliant basis.

Accounting Aspects
Based on International Accounting Standards (IAS)
Forms of Financial Statements for Banks revised in 1997
and 2001 to conform to IAS.
Reviewed in light of AAOIFI standards
ICAP Committee for developing Accounting and Auditing
Standards on Islamic modes- comprises representatives
from ICAP, SBP, SECP, Islamic banks and experts from the
fields of Islamic Fiqh and law.
First Islamic Financial Accounting Standard (IFAS) 1
notified by SECP; made effective from 1 st Jan 2006.
IFAS-2 regarding Ijarah has been notified in April 07 for
implementation from July 07
Work on Musharaka standard is in process.
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Shariah compliance
Three Pronged Strategy
mechanism
Shariah Board of SBP
Essentials of Islamic modes (8 modes)
Shariah Advisor in every IBI
Product certification
Internal control
Liaison with SBP for Shariah compliance issues

Internal Shariah Review

SBP Shariah Inspection

34

SBP Shariah Board

Central Shariah Board for the industry
established at SBP and is fully functional
Current membership consists of five persons
Two Shariah scholars
One Chartered accountant
One lawyer
One banker

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SBP Shariah Board

36

Formally established in December 2003

Approved Essentials of Islamic Modes of Financing
Approved Model Agreements
Approved Fit & Proper Criteria for Shariah Advisors
Approved structure of Govt. Ijara Sukuk
Approved other Sukuk structures
Approved Instructions & Guidelines

Shariah Based Audit

Internal Shariah Review
External Shariah Review
SBP Shariah Compliance Inspection
Shariah Compliance Ratings

37

Shariah Compliance
Inspection Manual

Inspection Manual prepared by Ford Rhodes Sidat

Hyder
Targeted Product Examination has been carried out to
know more issues
The Shariah Board of SBP has approved the Manual for
Shariah Compliance inspections
It would bring improvement & standardization in
operations

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Islamic Banking Bulletin

This bulletin gives update on local as well international
developments
It contains statistical analysis, as well
Appreciated by many corners
Pasted on SBP Website
http://www.sbp.org.pk/ibd/IBB.pdf

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