This report is to represent the ‘Investment mechanism’ of Islami Bank Bangladesh Limited
At the very beginning would like to thank Almighty Allah for giving me the strength to finish the project within the schedule time. During the preparation of this report received generous help from many individuals which would like to mention with deepest gratitude.
First of all, must take this opportunity to thank “Islami Bank Bangladesh Limited” for giving the opportunity to complete my internship program in their organization.
As an apart of this internship program, have conducted study under Mr. Abu Zahid Md. Zoglul Pasha Chairman, Bachelor of Business Administration, Mohammadpur Kendriya College, Dhaka.
It was really a great opportunity to work on this topic, and which is really an important and exceptional report. tried to dedicate my best trying and resources. But “Too Error is Human”, not exception to this, have some limitations, also.
My ultimate constraint was time, invested beyond this report. If could give more times, could make it better in the point of view of doing “Discovery of Information”, “Recommendation” etc.
At last, just want to say that tried best to make it realistic. extremely sorry for limitations and constraints that had impact in making the “Internship Report” efficient and effective.
Internship training refers to a joint program in which business school and business houses co-operate. The prime objective of such program is to provide students on the job exposures and the opportunity to translate the bookish concentration in real life situation. Through this program good balance between theory and practice is gained. Furthermore this internship assignment is a vital requirement for obtaining Bachelor of Business Administration (BBA) Program. So was supposed to work in Islami Bank Bangladesh Limited-Shyamoli Branch and get a proper understanding of the organizational objectives, management procedures etc. and as a requirement of MBA program, have to put my understanding in a report. prepare this report dividing into three parts. In first part have discussed about Islamic banking systems and comparison with conventional banking system regarding investment. Then in the second part have discussed about the investment performance of Shyamoli Branch and at the last part overall performance of IBBL.
ABOUT THE REPORT:
Origin of the Report
The internship program of BBA students of the Department of BBA, Mohammadpur Kendriya College, is an important part of the BBA program. This program is for 60 days duration. However, assigned to Shyamoli Branch of Islami Bank Bangladesh Limited to complete the program. The period for this program was from 1st February, 2010 to 31st March, 2010. During this period worked closely with the employees of the Bank in Shyamoli Branch. A student must submit a report on the assigned topic to the department and supervisor after the completion of the internship program period.
Rationale of the Study
Theoretical knowledge is not enough for a student. It is a far difference between theoretical knowledge and practical field. So, these two should be synchronized. Our internship program is launched mainly for this purpose. Another purpose that may be is to know about the rules, regulations, and environment of an organization before getting a job. To gather some experience, which will help a student to get a good job, may be another purpose of the study.
Objectives of the study
The Primary Objective: The Primary objective of preparing this report is to represent the ‘Investment mechanism’ of Islami Bank Bangladesh Limited and to have a clear conception about all of the essential parts of the internship program.
Secondary Objective: Furthermore, the secondary objectives of this report-
1 To co-ordinate between theory and practice and to make a bridge between theoretical and practical knowledge in fulfillment of the internship program.
2 To have an overall idea about Islamic Banking System that is based on Al-Quran and Sunnah.
3 To know about the interest free Banking System within the Islamic Shariah and how it could be processed.
4 To identify the formalities maintained by both the Bank & client in sanctioning or having investment facilities.
5 To know about the process of different investment Modes and their application in the context of Islami Bank Bangladesh limited.
6 To have a clear idea regarding the requirements and the limitations at the time of applying for an investment and other formalities.
7 To identify the major problems the bank encounters in sanctioning and recovery of investment.
8 To give some suggestions to overcome the weakness and problems that exists in the existing system.
Sources of Data: Both primary and secondary sources of data are used to complete this study. These two sources are explained below:
1. Primary sources: Among the primary sources of data, the main sources are:
* Training Classes (15 days) at Islami Bank Training & Research Academy (IBTRA)
* Face to face communication with the employees in the Shyamoli Branch of Islami Bank Bangladesh Limited.
* Official records of the various department of IBBL Shyamoli Branch.
2. Secondary sources: Among the secondary sources of data, the main sources are:
* Various Manual on Investment Mechanism.
* Prospectus, Annual Report, Different Journals of IBBL.
* Relevant books.
Limitation of the study
There are some limitations in the study. The Branch of IBBL on which studied is a very busy Branch. The employees of the branch were very much busy with their activities. They had interested to help but got a little time to do that. This is the main limitation of the study.
The rely entirely on the data received from the books of Statistics, Manifesto, and the Annual Reports of Islami Bank Bangladesh Limited, and had no opportunity to verify the satisfaction level of clients and receive their suggestions in implementing the Islamic Shariah as well as other Banking activities. Because of some existing employees being too much busy, they couldn’t manage to provide required times and to pay such attention in answering all of the questions.
Background of Islami Banking
Definition of Islami banking
An Islamic bank is a financial institution which operates with the objective to implement and materialize the economic and financial principles of Islam in the arena of banking.
“An Islamic Bank is a financial institution whose status, rules and procedures expressly state its commitment to the principle of Islamic Shariah and to the banning of the receipt of interest on any of its operations”-OIC.
Objective of Islamic banking
- Islamic banks operate on Islamic principles of profit and loss sharing ,strictly avoiding interest, which is the root of all exploitation and is responsible for large-scale inflation and unemployment
- The objectives of Islamic banking are not only to earn profit, but to do good and welfare to the people. Islam upholds the concept that money, income and property belong to Allah and this wealth is to be used for the good of the society.
- An Islamic bank is committed to do away with disparity and establish justice in the economy, trade, commerce and industry; build socio-economic infrastructure and create employment opportunities.
Special Features of Islamic banking
· All activities are conducted on interest-free system according to Islamic Shariah Principles.
· Investment is made through different modes as per Islamic Shariah
· Investment Income of the Bank is shared with the Mudaraba depositor according to an agreed upon ratio ensuring a reasonably fair rate of return on their deposits
· To introduce a welfare-oriented banking system and also to establish equity and justice in the field of all economic operations
· Extend socio-economic and financial services to individuals of all economic backgrounds with strong commitment in rural uplift.
· Plays a vital role in human resources development and employment-generation particularly among the unemployed youths
· Portfolio of investment and investment policy have been specially tailored to achieve balanced growth and equitable development through diversified investment operation particularly in the priority sectors and in the less developed areas of the national economy.
Conventional and Islamic banking
Conventional banking is essentially based on the debtor-creditor relationship between the depositors and the bank on the one hand, and between the borrowers and the bank on the other. Interest is considered to be the price of credit, reflecting the opportunity cost of money.
Islam, on the other hand, considers a loan to be given or taken, free of charge, to meet any contingency. Thus in Islamic Banking, the creditor should not take advantage of the borrower. When money is lent out on the basis of interest, more often it happens that it leads to some kind of injustice.The first Islamic principle underlying such kinds of transactions is that “deal not unjustly, and ye shall not be dealt with unjustly” [2:279]. Hence, commercial banking in an Islamic framework is not based on the debtor-creditor relationship.
The second principle regarding financial transactions in Islam is that there should not be any reward without taking a risk. This principle is applicable to both labor and capital. As no payment is allowed for labor, unless it is applied to work, there is no reward for capital unless it is exposed to business risk (Ausaf Ahmed 1995, P.17)
Thus, financial intermediation in an Islamic framework has been developed on the basis of the above two principles. Consequently financial relationships in Islam have been participatory in nature. Several theorists suggest that commercial banking in an interest-free system should be organized on the principle of profit and loss sharing. The institution of interest is thus replaced by a principle of participation in profit and loss.That means a fixed rate of interest is replaced by a variable rate of return based on real economic activities (Mangla & Uppal 1990. pp.179-215, 185). The distinct characteristics which provide Islamic banking with its main points of departure from the traditional interest-based commercial banking system are: (a) the Islamic banking system is essentially a profit and loss sharing system and not merely an interest (Riba) banking system; and (b) investment (loans and advances in the Conventional sense) under this system of banking must serve simultaneously both the benefit to the investor and the benefit of the local community as well. The financial relationship as pointed out above is referred to in Islamic jurisprudence as Mudaraba.
For the interest of the readers, the distinguishing features of the conventional banking and Islamic banking are shown in terms of a box diagram as shown below:
|Conventional Banks||Islamic Banks|
|1. The functions and operating modes of conventional banks are based on manmade principles.||1. The functions and operating modes of Islamic banks are based on the principles of Islamic Shariah.|
|2. The investor is assured of a predetermined rate of interest.||2. In contrast, it promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur).|
|3. It aims at maximizing profit without any restriction.||3. It also aims at maximizing profit but subject to Shariah restrictions.|
|4. It does not deal with Zakat.||4. In the modern Islamic banking system, it has become one of the service-oriented functions of the Islamic banks to collect and distribute Zakat.|
|5. Leading money and getting it back with interest is the fundamental function of the conventional banks.||5. Participation in partnership business is the fundamental function of the Islamic banks.|
|6. Its scope of activities is narrower when compared with an Islamic bank.||6. Its scope of activities is wider when compared with a conventional bank. It is, in effect, a multi-purpose institution.|
|7. It can charge additional money (compound rate of interest) in case of defaulters.||7. The Islamic banks have no provision to charge any extra money from the defaulters.|
|8. In it very often, bank’s own interest becomes prominent. It makes no effort to ensure growth with equity.||8. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity.|
|9. For interest-based commercial banks, borrowing from the money market is relatively easier.||9. For the Islamic banks, it is comparatively difficult to borrow money from the money market.|
|10. Since income from the advances is fixed, it gives little importance to developing expertise in project appraisal and evaluations.||10. Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations.|
‘Riba’ Arabic word means Excess. Excess in case of spot transaction of one/same kind of goods. General reason – quality. Or, Excess in case of deferred transaction of same goods. Reason is time –basis.
Basic features of RIBA
The word used by the Quran concerning ‘interest’ is Riba. The literal meanings of Riba are money increase, increase of anything or increment of anything from its original amount (Maududi 1979, p.84). However, all increases are not considered as Riba in Islam. Money may increase in business activities as well. This increase is not at all considered as Riba. The increase, instead of being prohibited (Haram), is approved (Halal) in Islam. Islam prohibits only those increases that are charged on theloan with a prefixed rate.
Muslim scholars equate interest with Riba. In the Shariah, Riba technically refers to the premium that must be paid by the borrower to the lender along with the principal amount as a condition for the loan or for an extension in its maturity (Chapra 1985, p.64). In other words, Riba is the predetermined return on the use of money. In the past there has been dispute about whether Riba refers to interest or usury, but there is now consensus among Muslim scholars that the term covers all forms of interest and not only “excessive” interest (Khan 1985, p.52).
The most important characteristic of Riba is that it is the positive and definite result of money when changed. In other words, when money begets money, without being exchanged for goods or services, it is called Riba.
Its basic characteristics are:
· It must be related to loan;
· A prefixed amount of money to be paid when due;
· A time is fixed for the repayment; and
· All these elements for repayment are taken as conditions for loan.
Riba and Profit:
There are persons who try to equate Riba with profit. In effect, they are fundamentally different from each other as can be seen from the following:
|1. When money is “charged”, its imposed positive and define result is Riba||1. When money is used in trading (for e.g.) its uncertain result is profit.|
|2. By definition, Riba is the premium paid by the borrower to the lender along with principal amount as a condition for the loan.||2. By definition, profit is the difference between the value of production and the cost of production.|
|3. Riba is prefixed, and hence there is no uncertainty on the part of either the givers or the takers of loans.||3. Profit is post-determined, and hence its amount is not known until the activity is done.|
|4. Riba con not be negative, it can at best be very low or zero.||4. Profit can be positive, zero or even negative.|
|5. From Islamic Shariah point of view, it is Haram.||5. From Islamic Shariah point of view, it is Halal.|
General Banking of IBBL: an overview
IBBL is committed to conduct all banking activities in line with the Shariah principles prescribed in Islam. It has materialized the long cherished dream of the people of Bangladesh for doing their banking under Islamic Shariah. In doing so , IBBL has also established different divisions, departments and sections in accordance with banking norms.
Usually the following sections are involved to perform the general banking operations:
· Cash Section
· Bills & Remittance Section
· Ciearing and Collection Section
· Accounts Section
Scope of general banking operations
· Mobilizing deposits
Here has two principles-
1. Al- Wadeah principles
2. Mudaraba principles
· Deposit products:
1. Al-Wadeah current account
2. Mudaraba savings account
3. Mudaraba special notice account
4. Mudaraba term deposit account
5. Mudaraba hajj savings account
6. Mudaraba savings bond scheme
7. Mudaraba special savings (pension) account
8. Mudaraba monthly profit deposit scheme
9. Mudaraba muhor savings account
10. Mudaraba waqf cash deposit account
11. Mudaraba foreign currency deposit (savings) account
12. Mudaraba NRB savings bond (MNSB)
· Receipts and payments of cash
· Passing, cancellation, issuance and payment of cheque
· Maintenance of “Vaut’ and “Strong Room’
· Operations of clearing house
· Remittance related function
· Maintenance of safe deposit lockers
· Maintenance of ATM, electronic funds transfer, internet banking, phone banking etc.
· Maintenance of security
· Correspondence, receipt & dispatch.
Investment of IBBL
The special feature of the investment policy of the Bank is to invest on the basis of profit-loss sharing system in accordance with the tenets and principles of Islamic Shariah. Earning profit is not the only motive and objective of the Bank’s investment policy rather emphasis is given in attaining social good and in creating employment opportunities.
Pursuant to the Investment Policy adopted by the Bank, a ‘7-year Perspective Investment Plan’ has been drawn-up and put into implementation. The plan aims at diversification of the investment port-folio by size, sector, geographical area, economic purpose and securities to bring in phases all sectors of the economy and all types of economic groups of the society within the fold of Bank’s investment operations.
Accordingly, the plan envisages composition of the investment port-folio with 2.5% for agriculture and rural investment, 18% for industrial term investment, 13% for industrial working capital, 10% for housing and real-estate, 4% for transport and communication, 0.5% for electricity, gas, water and sanitation services, 2% for storage, 43% for import, export and local trade and trade related activities 1% for poultry and dairy,2% for Rural Development Scheme, 2.5% for other Special Scheme, 0.5% for Micro Industry and 1% for other productive purposes by the end of the plan period, i.e. the year 2002.
Further, in order to diversify investment portfolio, the Bank engaged itself in investment operations through special schemes introduced during the years. The Bank is planning to introduce yet other new investment schemes in addition to welfare-oriented Investment Schemes, Rural Development Scheme, Transport Investment Scheme, Car Investment Scheme, Small Business Investment Scheme, Doctors Investment Scheme, Household Durables Investment Scheme, Housing Investment Scheme and Agricultural Implements Investment Scheme etc. Besides, the Bank is financing various economic groups in different sectors in both urban and rural areas for upliftment of their economic condition.
Objectives and Principles
The objectives and principles of investment operations of the Bank are:
· To invest fund strictly in accordance with the principles of Islamic Shariah.
· To diversify its investment portfolio by size of investment, by sectors (public & private), by economic purpose, by securities and by geographical area including industrial, commercial & agricultural.
· To ensure mutual benefit both for the Bank and the investment-client by professional appraisal of investment proposals, judicious sanction of investment, close and constant supervision and monitoring thereof.
· To make investment keeping the socio-economic requirement of the country in view.
· To increase the number of potential investors by making participatory and productive investment.
· To finance various development schemes for poverty alleviation, income and employment generation with a view to accelerating sustainable socio-economic growth and upliftment of the society.
· To invest in the form of goods and commodities rather than give out cash money to the investment clients.
· To encourage social upliftment enterprises.
· To shun even highly profitable investment in fields forbidden under Islamic Shariah and are harmful for the society.
Allah has permitted Bai (Buying and selling i.e. trading) & prohibited Riba. Islamic Banks in all its transactions follow the verdict of Al-Quran and Sunnah and prohibit Riba in all its operations. The Banks conduct investment portfolio under three mechanism i.e. (1) Bai Mechanism; (2) Share Mechanism 7 (3) Ijara.
Meaning of Murabaha
The terms “Bai–Murabaha” have been derived from Arabic words Bai and Ribhun. The word ‘Bai’ means purchase and sale and the word ‘Ribhun’ means an agreed upon profit. “Bai-Murabaha” means sale for an agreed upon profit. Bai-Murabaha may be defined as a contract between a buyer and a seller under which the seller sells certain specific goods permissible under Islamic Shariah and the Law of the land to the buyer at a cost plus an agreed upon profit payable today or on some date in the future in lump-sum or by installments. The profit may be either a fixed sum or based on a percentage of the price of the goods.
Types of Murabaha
In respect of dealing parties Bai–Murabaha may be of two types (IBBL 1986, pp.1-2):
– Ordinary Bai-Murabaha, and
– Bai-Mudabaha order on and Promise.
Ordinary Bai-Murabaha is a direct transaction between a buyer and a seller. Here, the seller is an ordinary trader who purchases goods from the market in the hope of selling these goods to another party for a profit. In this case, the seller undertakes the entire risk of his capital investment in the goods purchased. Whether or not he earns a profit depends on his ability to find a buyer for the merchandise he has acquired.
Bai-Murabaha order on and Promiseinvolvesthree parties – the buyer, the seller and the bank. Under this arrangement, the bank acts as an intermediary trader between the buyer and the seller. In other words, upon receipt of an order and agreement to purchase a certain product from the buyer, the bank will purchase the product from the seller to fulfill the order.
However, it should be noted here that the Islamic Bank acts as a financier in this transaction. This is the case, not in the sense that the bank finances the purchase of goods by the consumers; rather it is a financier by deferring payment to the seller of the product. Thus, there is a chance that this transaction could resemble nothing more than a loan for which interest (Riba) is earned, which is contrary to Islamic beliefs.
There are some important features of Bai-Murabaha as given below.
Important Features of Murabaha
1. A client can make an offer to purchase particular goods from the bank for a specified agreed upon price, including the cost of the goods plus a profit.
2. A client can make the promise to purchase from the bank, that is, he is either to satisfy the promise or to indemnify any losses incurred from the breaking the promise without excuse.
3. It is permissible to take cash/collateral security to guarantee the implementation of the promise or to indemnify any losses that may result.
4. Documentation of the debt resulting from Bai-Murabaha by a Guarantor, or a mortgage, or both like any other debt is permissible. Mortgage/Guarantee/Cash Security may be obtained prior to the signing of the Agreement or at the time of signing the Agreement.
5. The bank must deliver the goods to the client at the date, time, and place specified in the contract.
6. It is permissible for the bank to contract with a third party to buy and receive the goods on its behalf. This agreement must be a separate contract.
These features make Bai-Murabaha distinctive from all other modes of Islamic Investment. There are certain steps to accomplish a deal of Bai-Murabaha as shown below (ABIIB 1995, p.12).
Steps of Bai-Murabaha
First Step: The client submits a proposal regarding his requirements of the bank. The clientsends a proposal with the specifications of the commodity to be acquired from the bank. The proposal also indicates details regarding the date, time and place of delivery as well as price and form of payment information. The bank responds by sending a counter proposal either accepting the buyer’s price or stipulating a different price.
Second Step: The client promises to buy the commodity from the bank on a Bai–Murabaha basis, for the stipulated price. The bank accepts the order and establishes the terms and conditions of the transaction.
Third Step: The bank informs the client (ultimate buyer) of its approval of the agreement to purchase. The bank may pay for the goods immediately or in accordance with the agreement.
The sellerexpresses its approval to the sale and sends the invoice(s).
Fourth Step:The two parties (the bank and the client) sign the Bai–Murabaha Sale contract according to the agreement to purchase.
Fifth Step:The Bank authorizes the client or its nominee to receive the commodity
The seller sends the commodity to the place of delivery agreed upon. The clientundertakes the receipt of the commodity in its capacity as legal representative and notifies the bank of the execution of the proxy.
The Bai-Murabaha has some legal rules. These rules are mentioned below (Ibid, pp.14-16).
Rules of Bai-Murabaha
1. It is permissible for the client to offer to purchase a particular commodity, deciding its specifications and committing itself to buy it on Murabaha for the cost plus the agreed upon profit.
2. It is permissible that the mutual agreement shall contain various conditions agreed upon by the two parties, especially with respect to the place of delivery, the payment of a cash security to guarantee the implementation of the operation and the method of payment.
3. It is permissible to stipulate the binding nature of the promise to purchase. Thus, the agreement can only be satisfied by either fulfilling the promise to purchase or by indemnifying the bank for any losses incurred if the promise to purchase is not fulfilled.
4. It is a condition that the bank purchases the requested commodity (first purchase contract) before selling it on Murabaha to the buyer. The contract in the first purchase must be settled, in principle, between the source seller and the bank.
5. It is permissible for the bank to authorize a second party including the buyer to receive the commodity on its behalf. This authorization must be in a separate contract, particularly if the buyer is going to receive the goods on behalf of the bank. This is necessary to avoid any conflicts with the ensuing Murabaha sale.
6. Once the bank takes ownership of the goods, it is responsible for any damages or defects. Thus, if the goods are damaged, the bank is liable and must repair the damage prior to delivering the goods to the purchaser.
7. It is a condition that the Bai-Murabaha contract be drawn at the last phase. That is after the promise to purchase and the purchase of the commodity in the name of the bank and receipt of the commodity directly by the bank or through an agent.
The areas of application of Bai-Murabaha are discussed below.
Application of Bai-Murabaha
Murabaha is the most frequently used form of finance in Islamic banking throughout the world. It is suitable for financing the different investment activities of customers with regard to the manufacturing of finished goods, procurement of raw materials, machinery, and other required plant and equipment purchases.
Murabaha Case Study
Bai mechanism system policy is covered by much well reputed company in our Bangladesh from Islami Bank Bangladesh Ltd. Murabaha system applied by Xyz Company & investment by jute Mills Corporation. The IBBL investment for the xyz company of jute mills sector. There are several agreements by the IBBL & xyz company for the jute sector business. This xyz company statement or performances are given below:
2. BAI-MUAJJAL (Deferred Sale)
Meaning of Bai-Muajjal
The terms “Bai” and “Muajjal” are derived from the Arabic words ‘Bai’ and ‘Ajal’. The word ‘Bai’ means purchase and sale and the word ‘Ajal’ means a fixed time or a fixed period. “Bai-Muajjal” is a sale for which payment is made at a future fixed date or within a fixed period. In short, it is a sale on credit.
The Bai-Muajjal may be defined as a contract between a buyer and a seller under which the seller sells certain specific goods, permissible under Shariah and law of the country, to the buyer at an agreed fixed price payable at a certain fixed future date in lump sum or in fixed installments.
There are some important features of Bai-Muajjal as given below (ABIIB).
Important Features of Bai-Muajjal
1. It is permissible and in most cases, the client will approach the bank with an offer to purchase a specific good through a Bai-Muajjal agreement.
2. It is permissible to make the promise binding upon the client to purchase the goods from the bank. In other words, the client is required to either satisfy the promise or to indemnify the bank for damages caused by breaking the promise without excuse.
3. Stock and availability of goods is a basic condition for signing a Bai-Muajjal Agreement. Therefore, the bank must purchase the goods in accordance with the specifications of the client, prior to signing the Bai-Muajjal Agreement with the client.
4. All goods purchased on behalf of a Bai-Muajjal agreement are the responsibility of the bank until they are delivered to the client.
5. The bank must deliver the goods to the client at the time and place specified in the contract.
6. The bank may sell the goods at a higher price than the purchase price to earn profit.
7. The price is fixed at the time of the agreement and cannot be altered.
8. The bank is not required to disclose the profit made on the transaction.
This type of financing by the bank is considered to be more risky than the other Islamic modes of investment previously discussed. Therefore, the application/proposal for Bai-Muajjal investment must be reviewed very carefully to ensure the client can ultimately make payment. . The following steps may be taken to ensure the Bai-Muajjal Investment is a good proposition for the bank:
1. The bank may meet with the prospective client regarding his investment needs and business experience prior to an application /proposal is submitted.
2. The bank may review the client’s past performance and other financing arrangements he may have had with the bank in the past.
3. The bank may review its current investment policy regarding this type of financing arrangement to ensure the proposal meets bank guidelines.
It should be remembered that if the Bai-Muajjal investment is not secured by first class collateral securities, it becomes more risky than investments under other modes of Islamic banking.
The following points should receive attention before making any investment decision under Bai-Muajjal.
1. Whether the goods that the client intends to purchase are marketable and have steady demand in the market.
2. Whether the price of the goods is subject to frequent and violent changes.
3. Whether the goods are perishable in short or in long-term duration.
4. Whether the quality and other specifications of the goods as desired by the client can be ensured.
5. Whether the goods are available in the market and the bank will be in a position to purchase the Goods in time and at the negotiated price.
6. Whether the sale price of the goods is payable by the client at the specified future date in lump sum or in Installments as per the agreement.
Meaning of Bai-Salam
Bai-Salam is a term used to define a sale in which the buyer makes advance payment, but the delivery is delayed until some time in the future. Usually the seller is an individual or business and the buyer is the bank.
The Bai-Salam sales serve the interests of both parties (Ibid).
1. The seller receives advance payment in exchange for the obligation to deliver the commodity at some later date. He benefits from the Salam sale by locking in a price for his commodity, thereby allowing him to cover his financial needs whether they are personal expenses, family expenses or business expenses.
2. The purchaser benefits because he receives delivery of the commodity when it is needed to fulfill some other agreement, without incurring storage costs. Second, a Bai-Salam sale is usually less expensive than a cash sale. Finally a Bai-Salam agreement allows the purchase to lock in a price, thus protecting him from price fluctuation.
Steps of Bai-Salam
1. Cash sale or Sale on Credit – The bank pays the agreed upon price at the time of the contracts inception. The seller agrees to the delivery of the commodity some specified date in the future.
2. Delivery and Receipt of the Commodity on the Specific due Date: There are several options for delivery available to the bank
a) The bank may receive the commodity and resell it to another party for cash or credit.
b) The bank may authorize the seller to find another buyer for the commodity.
c) The bank may direct the seller to deliver the commodity directly to a third party with whom the bank has entered into another agreement.
3. The Sale Contract: The bank agrees to sell the commodity for cash or a deferred price, which is higher than the Salam purchase price. The buyer agrees to purchase and to pay the price according to the agreement.
There are some rules for Bai-Salam as given below.
Rules of Bai-Salam
1. It is a condition that the commodity known by both parties to the agreement. Misunderstandings about the commodity may lead to disputes, which could void the contract.
2. It is conditions that the quality of the commodity be monitored closely, as very little variation from specifications in the contract are allowable. If the commodity cannot be monitored for quality standards, a Salam transaction is impermissible.
3. It is a condition that the commodity be deliverable on the due date. If there is uncertainty about the ability to deliver the commodity at the due date, a Salam transaction is impermissible.
4. It is permissible to draw a Salam sale contract for a total to be delivered increments on different specified future dates.
5. It is a condition that the commodity is a liability debt. The seller is obliged to deliver the commodity when it is due, according to the specifications stipulated in the contract, whether or not his firm produces the commodity or obtained from other firms.
6. Salam sales are impermissible on existing commodities because damage and deterioration cannot be assured before delivery on the due date.
7. Salam is impermissible on Land lots and real estates.
8. Salam is permissible on a commodity of a specific locality if it is assured that it is almost always available in that locality and it rarely becomes unavailable.
9. It is a condition that the purchase price in Salam is specified and advanced to the seller at the time of signing of contract.
Typical Bai-Salam transactions are discussed below:
Application of Bai-Salam
Salam sales are frequently used to finance the agricultural industry. Banks advance cash to farmers today for delivery of the crop during the harvest season. Thus banks provide farmers with the capital necessary to finance the cost of producing a crop.
Salam sale are also used to finance commercial and industrial activities. Once again the bank advances cash to businesses necessary to finance the cost of production, operations and expenses in exchange for future delivery of the end product. In the meantime, the bank is able to market the product to other customers at lucrative prices.
In addition, the Salam sale is used by banks to finance craftsmen and small producers, by supplying them with the capital necessary to finance the inputs to production in exchange for the future delivery of products at some future date.
The Bai Salam agreement is a combination of debt and trading. The capital provider has no control over the management of capital provided. However the capital provider takes all of the risk as profits cannot be determined until the commodity is delivered and the final sale price is determined. In addition the capital provider incurs the opportunity cost associated with the capital outlay. Like the other three previously discussed modes of finance there is no certain rate of return. In addition the cost of capital is uncertain ex-ante. Also, there is no correlation in the relationship of cost of capital and rate of return on capital.
4. ISTISNA’A SALE
Definition of Istisna’a Sale
The Istisna’a sale is a contract in which the price is paid in advance at the time of the contract and the object of sale is manufactured and delivered later (IDB 1992, p.28). The majority of the jurists consider Istisna’a as one of the divisions of Salam, Therefore, it is subsumed under the definition of Salam. But the Hanafie school of Jurisprudence classifies Istisna’a as an independent and distinct contract. The jurists of the Hanafie School have given various definitions to Istisna’a some of which are: “That it is a contract with a manufacturer to make something” and “It is a contract on a commodity on liability with the provision of work”. The Purchaser is called ‘Mustasnia’ contractor and the seller is called ‘Sania’ maker or manufacturer and the thing is called ‘Masnooa’, manufactured, built, made (ABIIB). Islamic banks can utilize Istisna’a in two ways.
1. It is permissible for the bank to buy a commodity on Istisna’a contract then sell it after receipt for cash or deferred payment.
2. It is also permissible for the bank to enter into a Istisna’a contract in the capacity of seller to those who demand a purchase of a particular commodity and then draw a parallel Istisna’a contract in the capacity of a buyer with another party to manufacture the commodity agreed upon in the first contract.
Each transaction is deemed a separate contract with payment being made in cash either immediately or on a deferred basis. Any disagreements that may arise are settled under each contract separately according to the provisions therein. The steps of the Istisna’a sale and the parallel Istisna’a have been discussed below.
Steps of Istisna’a Sale
Istisna’a Sale Contract: The Buyer expresses his desire to buy a commodity and brings a request to purchase the commodity to the bank. The method of payment, whether cash or deferred is set forth in the agreement. The bank agrees to deliver the commodity to the buyer at some agreed upon time in the future.
The Parallel Istisna’a Contract: In order that the bank is able to deliver said commodity in the Istisna’a agreement, the bank enters into a parallel Istisna’a agreement with a third party to either manufacture or otherwise deliver-said commodity. Obviously, the bank stipulates a price that is lower than that agreed to in the original agreement and requires delivery on or before the date stipulated in the original contract.
The seller, in the parallel agreement, agrees to manufacture the specific commodity and to deliver it on the due date agreed upon.
Delivery and Receipt of the Commodity: The seller in the parallel Istisna’a agreement, delivers the commodity to the bank on the agreed upon date. The bank, in turn, delivers the product to the buyer of the original Istisna’a contract, in accordance with the original agreement. In this way, all parties fulfill their obligations to the contract.
Rules of Istisna’a Sale
1. It is a condition in the Istisna’a contract to clearly define dimensions and specifications of the product being purchased. This is important to ensure that there is no room for dispute over what is required.
2. The Istisna’a contract is only used for objects that can be manufactured. It can not be used to purchase corn, wheat, barley, fruit or any natural product.
3. The object sold in a Istisna’a contract is a fixed liability debt and it is permissible for the object to be a custom manufactured product, made in accordance with certain specifications.
4. The maker should supply the materials. If they are supplied by the buyer, the contract is Ijara and not Istisna’a.
5. Once the contract is drawn the ownership of the asset is confirmed to the buyer and the purchase price is confirmed to the manufacturer.
6. It is not a condition in the Istisna’a contract to advance the price. Usually part of the price is paid in advance and the remainder is withheld until the time of delivery.
7. It is a condition that the time of delivery be specified in the agreement to avoid confusion that may lead to a dispute over the transaction.
8. It is a condition that the place of delivery be stated in the contract if the commodity requires special handling and delivering arrangements.
9. The buyer may stipulate in the Istisna’a contract that the commodity shall be manufactured or produced by a specific manufacturer, or manufactured with specific materials. This is not permitted in a case of Salam Sale.
Application of Istisna’a Sale
The Istisna’a contract allows Islamic banks to finance the public needs and the vital interests of the society to develop the Islamic economy in accordance with Islamic teachings. For example Istisna’a contracts are used to finance high technology industries such as the aviation, locomotive and ship building industries. In addition, this type of business transaction is also used in the production of large machinery and equipment manufactured in factories and workshops. Finally, the Istisna’a contract is also applied in the construction industry such as apartment buildings, hospitals, schools, and universities to whatever that makes the network for modern life. One final note, the Istisna’a contract is best used in those transactions in which the product being purchased can easily be measured in terms of the specified criteria of the contract.
Definition of Mudaraba
The term Mudaraba refers to a contract between two parties in which one party supplies capital to the other party for the purpose of engaging in a business activity with the understanding that any profits will be shared in a mutually agreed upon. Losses, on the other hand, are the sole responsibility of the provider of the capital. Mudaraba is also known a Qirad and Maharajah (Shirazi 1990, p.31).
Mudaraba is a contract of those who have capital with those who have expertise, where the first party provides capital and the other party provides the expertise with the purpose of earning Halal (lawful) profit which will be shared in a mutually agreed upon proportion. This type of business venture serves the interest of the capital owner and the Mudarib (agent).
The capital owner may not have the ability or the experience to run a profitable business. On the other hand, the agent (the Mudarib) may not have adequate capital to invest in a business or project. Therefore, by entering into a contract of Mudaraba each party compliments one another, allowing a business venture to be financed. The following are the steps of the Mudaraba contrac (ABIIB, p.53).
1.2 Steps of Mudaraba
The bank provides the capital as a capital owner. The Mudarib provides the effort and expertise for the investment of capital in exchange for a share in profit that is agreed upon by both parties.
1. The Results of Mudaraba: The two parties calculate the earnings and divide the profits at the end of Mudaraba. This can be done periodically in accordance with the terms of the agreement, subject to the legal rules that apply.
2. Payment of Mudaraba Capital: The bank recovers the Mudaraba capital it contributed before dividing the profits between the two parties because the profit is considered collateral for the capital.
3. Distribution of wealth resulting from Mudaraba: In the event a loss occurs, the capital owner (the bank) is responsible for the entire loss. In the event of profits, they are divided between the two parties in accordance with the agreement between them, subject to the capital being recovered first.
1.3 Rules of Mudaraba
There are some legal rules that govern the business relationship Mudaraba which are as follows.
1. It is a condition in Mudaraba that the capital be specific in nature. In other words, the amount of capital must be known at the inception of the contract. The purpose of this rule is to ensure that there is no uncertainty about the amount of capital and, thus, no uncertainty about the division of profits.
2. It is a condition that capital must be in the form of currency in circulation. However, merchandise can be contributed, so long as both parties to the business arrangement agree upon its value.
3. It is a condition that the capital cannot be subject to indebtedness.
4. It is permissible for a Mudarib to mix his private capital with the capital of the Mudaraba, thus becoming a partner. In addition, it is also permissible for the Mudarib to dispose of capital on behalf of the Mudaraba.
5. It is a condition that the capital of the Mudaraba is delivered to the Mudarib. Some of the jurists permit the capital owner to withhold capital and release it gradually according to the needs of the Mudarib since the Mudaraba adjudges unrestricted disposal.
6. It is permissible for the capital owner to deliver capital to two Mudharibs in a single contract. It is permissible for the capital owner to vary the in profit sharing agreement between the two Mudharib based upon differences in the services provided
7. It is permissible for the Mudarib to hire an assistant to perform difficult work that he is unable to perform on his own.
8. The disposal of capital by the Mudarib is restricted to reasons that are conducive to the Mudaraba. The Mudarib must not lend or donate any of the Mudaraba capital. Further, he is not allowed to enter into indebtedness nor enter into another partnership agreement with the Mudaraba capital. However, these activities are permissible if the capital owner consents and authorizes the agent to use his discretion.
1.4 Concluding Remark
It is an investment-based form of financing. The provider of capital in Mudaraba has no role in the management of the capital. However, he has to bear the risk of capital loss as well as the opportunity cost of capital for the entire period of the contract. The rate of return is quite uncertain and the cost of capital is also uncertain. Hence, there is a perfect correlation between cost of capital and rare of return on capital.
2. MUSHARAKA (PARTNERSHIP)
Meaning of Musharaka
The word Musharaka is derived from the Arabic word Sharikah meaning partnership. Islamic jurists point out that the legality and permissibility of Musharaka is based on the injunctions of the Quran, Sunnah, and Ijma (consensus) of the scholars. It may be noted that Islamic banks are inclined to use various forms of Shariakt-al-Inan because of its built-in flexibility. At an Islamic bank, a typical Musharaka transaction may be conducted in the following manner.
One, two or more entrepreneurs approach an Islamic bank to request the financing required for a project. The bank, along with other partners, provides the necessary capital for the project. All partners, including the bank, have the right to participate in the project. They can also waive this right. The profits are to be distributed according to an agreed ratio, which need not be the same as the capital proportion. However, losses are shared in exactly the same proportion in which the different partners have provided the finance for the project (Hussain 1986, p.61).
Types of Musharaka
Musharaka may take two forms:
i) Permanent Musharaka and
ii) Diminishing Musharaka.
These are discussed below (ABIIB 1995).
In this case, the bank participates in the equity of a company and receives an annual share of the profits on a pre-rate basis. The period of termination of the contract is not specified. This financing technique is also referred to as continued Musharaka.
The contributions of the partners under this mode may be equal or unequal percentages of capital for the purpose of establishing a new income-generating project or to participate in an existing one. In this arrangement, each participant owns a permanent share in the capital structure and receives his share of the Profits accordingly. This type of a partnership is intended to continue until the company is dissolved. However, one can exit the partnership by selling his share of the capital to another investor.
Permanent Musharaka is used by Islamic Banks in many income generating projects. They can provide financing to their customers, in exchange for ownership and profit sharing in the proportion agreed upon by both parties. In addition, the bank may leave the responsibility of management to the customer-partner and retain the right of supervision and follow up.
The three steps to establishing Permanent Musharaka are discussed below.
One – Partnership in Capital: The bank tenders part of the capital required in its capacity as a partner and authorizes the customer/partner to manage the project. The Partner tenders part of the capital required for the project and is entrusted with what he holds from the bank funds.
Two – Results of the Projects: The intent of the project is growth. However, the project may be profitable or it may loss money.
Three – The Distribution of wealth accrued from the Project: In the event a loss is incurred, each partner bears part of the loss proportionate to his share in capital. In the event the venture is profitable, earnings are divided between the two parties (the bank and the partner) in accordance with the agreement.
The following is a discussion of those legal rules that apply to the Musharaka relationship:
Rules for Permanent Musharaka
1. It is a condition that the capital provided by each partner is specific, existent and easily accessible. It is inappropriate to establish a company with borrowed money, for the purpose of profit.
2. It is permissible for partners to have unequal ownership in the project. The percent of ownership is set forth in the agreement.
3. It is a condition that the capital of the company is money and valuables. Some of the jurists permit contributing merchandise as invested capital. However, the merchandise must be evaluated, and the value agreed upon by all parties. Once the value has been established, it is counted as capital and stipulated in the contract as such.
4. It is a condition that each partners’ share of the profits be known to avoid uncertainty. Also, it is required that the ownership interest be in percentage terms and not a fixed sum, because this would violate the requirements of a partnership.
5. In principle, profit must be divided among partners in ratios proportionate to their shares in capital but some of the jurists permit variation in profit shares, so long as it is agreed to by all of the partners. This may be the case when one of the partners is more dexterous and more diligent and does not agree to parity, so variation in the sharing of profits becomes necessary.
6. In principle, a partnership is a permissible and non-binding contract. Thus, if a partner wishes, he could rescind the agreement provided that this occurs with the knowledge of the other partner or partners. Rescinding the agreement without the knowledge of the other pa