1. Islamic Finance – Principles Principles of Islamic Finance Hhadith – Sahih Muslim: …gold for gold, silver for silver, dates for dates,wheat for wheat, salt for salt, barley for barley,….like for like, equal for equal, hand to hand, …. Two permissions follow two prohibitions: 1. Sales within single type, unequal exchange, with or without delay: Riba al fadl. Money should be used as medium of exchange 2. Exchange among listed goods, with or without equality, but with delay: Riba al nasia [wheat and rice so that wheat now and rice later OR gold now or silver late]. Goods can be sold on credit for gold and silver. CREDIT SALE IS ALLOWED IF GOODS EXCHANGE WITH MONEY

2. Theory & Practice of Murabahah Murabahah – Concept and Historical perspective Introduced as new form of sale in second half of first Hijrah century as a sale with necessary condition of a profit margin agreed by both the seller and purchaser [Al Mutta, Imam Malik] and without the order of purchaser [cost includes direct expenses] Modifications were made by Imam Shafi’, including an order of the purchaser, who could subsequently exercise the option not to purchase the same, and also included credit transaction Therefore, he clearly bifurcated two sale transactions, one from supplier (or vendor) to the seller and other from seller to the purchaser

3. Theory & Practice of Murabahah Murabahah – Concept and Historical perspective The contemporary banking also takes into account the cash and credit prices different from each other, as justified by Usmani The banks are also required to fulfill regulatory compliance relating to credit transactions, maximum exposure to risk, classification of credit transactions, international supervision, etc. In addition, the banks are also emphasized to follow the Shariah, and accounting standards issued by AAOIFI relating to Murabaha transactions. In Pakistan, the Islamic Financial Accounting Standard-1 issued by ICAP vide SECP Notification dated 24th August, 2005 is also required to be followed. Since the operation of Murabaha transaction resembles Riba based practice of lending, the preconditions prescribed by Shariah advisors are to be met in letter and spirit

4. 100%75% OBOB 50% 75%25% 50% 100%25% OAOA M R N A’s Capital B’s Capital A’s Share of ProfitB’s Share of Profit 90% 10% MUSHARAKAHP&L DISTRIBUTION

5. Bank arranges pool of funds Islamic Modes – Agricultural Financing ISLAMIC BANK Special Purpose Mudarabah INVESTORSINVESTORS Investment Units purchased 6 months Whole sale Purchases Retail Sales Lined up Profits Accrued

6. Financing of crop production Liquidity requirements (hiring of tractor & implements, sowing, purchase of water, hiring of labour for preparation of land and harvesting, marketing) Input requirements (seed, fertilizer, pesticides) Islamic Modes – Agricultural Financing Liquidity Hiring for land prep. Inputs in kind Sale of fertilizers, seed, pesticides Liquidity Hiring for Harvest + Marketing Exp. SALAMSALAM SALAMSALAM MURABMURAB Liquidity Hiring for land prep. Inputs in kind Delivery Payment Delivery

7. Islamic Modes/Instruments - Sale Contracts: Parallel Salam: Procedural Details : The disposal of commodity at the end of Bank can be through: –Parallel Salam:Bank may sell commodity, before the date of delivery, to some other purchaser for the date of original delivery. The period in second contract will be shorter than the original contract, but price higher than the original contract. –Unilateral Promise:Promise of purchase can be obtained from third party for delivery on the date of original contract. Price in this promise is set higher than parallel salam because the promisor has to pay nothing.

8. Islamic Modes/Instruments - Sale Contracts: Risks involved in Salam Transaction: RisksMitigants Counterparty delivery risk Client defaults after receiving price There could be dispute in quality, quantity, time of delivery, etc. in case of commodity Defective goods could be supplied Goods may be delivered late Commodity price risk The market price at delivery time could be lower than the price expected at the time of contract Liquidate security & purchase same goods from market MoU should clearly specify to avoid any dispute Collateral or security can be obtained Penalty clause – charity Parallel salam or promise to purchase

9. Islamic Modes/Instruments - Sale Contracts: Risks involved in Salam Transaction: RisksMitigants Commodity marketing risk Bank is not able to market the goods timely resulting into blocking of funds Asset holding risk Bank bears holding cost till disposal of commodity Early termination chances Clint refuse to supply the goods Parallel Salam Original seller might not supply goods in time. The buyer in parallel salam may sue the bank. Select appropriate commodities for salam, take promise with Hamish Jiddiyah or appoint client as agent Cost can be recovered in parallel transaction Salam is a binding contract. Penalty clause can be inserted – charity Bank may purchase the similar asset from market. But no such loss can be recovered from original seller

10. Principles of Islamic Finance 1.Prohibition of Riba: Prohibition in Shariah: B.Ahadith Riba al fadl: [Traditions] 1.….exchange of radi with burny dates….. 2.Gold for gold, silver…..,……, like for like, equal for equal, and hand to hand. If the commodities differ, you may sell as you wish, provided the exchange is hand to hand. 1.When illa is different, shortfall/excess and delay both are permissible 2.When commodities of exchange are similar, excess and delay both are prohibited 3.When commodities are heterogenous but illa is the same, then excess/deficiency is allowed but delay not allowed Principles of Islamic Finance

11. REFERENCE SLIDES FOR PARTICIPANTS FROM BANKS Work on Murabahah

12. Practice of Murabahah Pricing of Murabahah [Example]: Purchase of poultry feed stock Murabahah Facility:180 Days Payment:Six monthly installments Rate of Profit:Six months KIBOR+2% Murabahah transaction: Rs. 500,000 Securities:Pledge of feed stock, equitable mortgage, lien on deposit, post dated cheques, etc.

13. Practice of Murabahah Pricing of Murabahah [Example]: ParticularsAmount (Rs.) Cost of goodsRs. 500,000 Rate of ProfitKibor + 2% (Floor 11.5%) Six monthly KIBOR10% p.a. Freight & insurance5% of cost Total cost500000 x 5%500000 + 25000 =525000 Risk premium2% Profit10%+2%+2% = 14% p.a.525000 x 14% x 180/365 = 36247 Murabahah Price525000+36247= 561247 Amount of Installment 561247/6 = 93541Cost = 87500 Profit= 6041

14. Training Workshop – Islamic Microfinance Accounting of Murabahah [Example]: Advance Payment Advance Payment (Against Murabahah purchases) F&I charges To Pay order (Payment made in advance for purchase of goods) 500000 25000 525000 Arrival of Goods Murabahah purchases A/C To Advance Payment (Against Murabahah purchases) (Goods received on account of purchases) 500000

15. Training Workshop – Islamic Microfinance Accounting of Murabahah [Example]: Murabahah Contract/Sale Murabahah Facility A/C Murabahah Profit Receivable A/C To Murabahah Sale A/C (To amount of goods sold) 5250000 36247 561247 Recovery of Murabahah Price Client’s A/C To Murabahah Facility A/C To Murabahah Profit Receivable A/C (Payment received on maturity by debiting client’s A/C on 1 st installment) 93541 87500 6041

16. Training Workshop – Islamic Microfinance Accounting of Murabahah [Example]: Recovery of Murabahah Price Client’s A/C To Murabahah Facility A/C To Murabahah Profit Receivable A/C (Payment received on maturity – 2 nd installment) 93541 87500 6041 Client’s A/C To Murabahah Facility A/C To Murabahah Profit Receivable A/C (Payment received on maturity – 3 rd installment) 93541 87500 6041 Client’s A/C To Murabahah Facility A/C To Murabahah Profit Receivable A/C (Payment received on maturity – 4 th installment) 93541 87500 6041 Client’s A/C To Murabahah Facility A/C To Murabahah Profit Receivable A/C (Payment received on maturity – 5 th installment) 93541 87500 6041 Client’s A/C To Murabahah Facility A/C To Murabahah Profit Receivable A/C (Payment received on maturity – 6 th installment) 93541 87500 6041

17. Training Workshop – Islamic Microfinance Accounting of Murabahah [Example]: Profit and Loss Account Statement Murabahah Sales Less COGS Purchases F&I Profit 561247 500000 25000525000 36247

18. Sale Defined: Exchange of a thing of value with another thing of value with mutual consent OR the sale of a commodity in exchange of cash. Elements of a valid sale: Contract ( Aqd ) Subject matter ( Mabe’e) Price ( Thaman ) Possession or delivery ( Qabza )