Project on Islamic Banking ‘n’ Islamic Insurances

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The inception of Pakistan as the first Islamic Republic created in the name of Islam.

The Objectives Resolution was adopted by the first Constituent Assembly based on the ideology of a sovereign Islamic state. This was the first step in the conception towards Pakistan’s Constitution.

The first Constitution defined Islam as State Religion and all laws to be according to the injunction of the Quran and Sunnah.

The establishment of Council of Islamic Ideology (CII) was followed by the conception of the second constitution of Pakistan.

The third constitution of Pakistan was passed allowing comprehensive legislation on Islamic principles and establishment of Federal Shariat Court.

CII presents report on the elimination of Interest genuinely considered to bethe first major comprehensive work in the world undertaken on Islamic banking and finance.

Commercial banks transformed their nomenclature stating all Rupee saving accounts as interest-free. However, foreign currency deposits in Pakistan and on lending of foreign loans continued as before.

Procedure adopted by banks in 1985 was declared unIslamic by the Federal Shariat Court (FSC). The Government and some banks/DFIs made appeals to the Shariat Appellate Bench (SAB) of the Supreme Court of Pakistan.

Al-Meezan Investment Bank is established as the first Islamic bank of Pakistan. Mr. Irfan Siddiqui appointed as first and founding Chief Executive Officer.

The Shariat Appellate Bench of the Supreme Court of Pakistan rejects the appeals and directs all laws on interest banking to cease. The government sets of a high level commission, task forces and committees to institute and promote Islamic banking on parallel banking on parallel system.

The Shariah Supervisory Board is established at Al-Meezan Investment Bank led by Justice (Retd.) Muhammad Taqi Usmani as chairman. State Bank sets criteria for establishment of Islamic commercial banks in private sector and subsidiaries and stand-alone branches by existing commercial banks to conduct Islamic banking in the country.

The first Islamic banking license is issued to Meezan Bank by the State bank of Pakistan. Societe Generale, a French commercial bank’s operations in Pakistan were amalgamated with Meezan Bank. President General Pervez Musharraf inaugurates the first commercial banking branch of MBL at the FTC Building, Karachi.

A Musharaka-based Export Refinance Scheme has been designed by the State Bank in coordination with Meezan Bank Limited, in order to provide export finance to eligible exporters on the basis of Islamic modes of financing. Efforts are underway to develop Islamic money market instruments like Ijarah Sukuk to facilitate the banks in respect of liquidity and SLR management.

Pakistan’s first Shariah compliant Mortgage facility is launched by Meezan Bank. Approved by the Shariah Supervisory Board, the product enables home purchase, home construction, renovation, as well as replacement of any existing mortgage.

Al Meezan Investment Management Limited (AMIM), a group company of Meezan Bank, introduces Meezan Islamic Fund (MIF). MIF is an open-end mutual fund that is Shariah compliant.

The State Bank establishes a dedicated Islamic Banking Department (IBD) by merging the Islamic Economics Division of the Research Department with the Islamic Banking Division of the Banking Policy Department. A Shariah Board has been appointed to regulate and approve guidelines for the emerging Islamic Banking industry.

The Government of Pakistan awards the mandate for debut of international Sukuk (Bond) offering for USD 500 million. The offering is a success and establishes a benchmark for Pakistan. Meezan Bank acted as the Shariah Structuring Advisor for this historic transaction.

Meezan Bank’s asset management arm, Al Meezan Investment Management Limited (AMIM), launches the Meezan Balance Fund (MBF). The offering was oversubscribed 1.25 times.

Meezan Bank launches the Meezan Islamic Institution Deposit Account (MIIDA), a unique product tailored exclusively for Islamic Financial Institutions (IFIs). The facility is the first of its kind in Pakistan, whereby Islamic Banks (including dedicated, as well as conventional Islamic windows) now have the opportunity to manage excess liquidity by maintaining a checking account with Meezan Bank specifically designed for this purpose.

Meezan Bank becomes the first customer of Islamic Insurance (Takaful) by signing the first Memorandum of Understanding MoU with Pak-Kuwait Takaful Company Limited (PKTCL). The signing of this MoU has ushered Pakistan into a new era of Islamic Insurance (Takaful).

A number of new dedicated Islamic Banks, namely Bank Islami and Dubai Islamic Bank, commence operations in Pakistan. Meezan continues its leadership position in the industry by more than doubling it branch network to a total of 62 branches in 21 cities, clearly establishing itself as the largest Islamic Bank of the country.

Meezan Bank, becomes the first Islamic bank to introduce 8 am to 8 pm banking at select branches in Karachi.

“The complete banking system which is free from Riba and works completely according to the Sharyia.”

The word "Riba" means excess, increase or addition, which correctly interpreted according to Shariah terminology, implies any excess compensation without due consideration (consideration does not include time value of money).

"O those who believe, fear Allah and give up what still remains of the Riba if you are believers. But if you do not do so, then be warned of war from Allah and His Messenger. If you repent even now, you have the right of the return of your capital; neither will you do wrong nor will you be wronged." Al Baqarah 2:278-9

This is the real and primary form of Riba. Since the verses of Quran has directly rendered this type of Riba as haram, it is called Riba Al Quran. Similarly since only this type was considered Riba in the dark ages, it has earned the name of Riba Al Jahiliya. Imam Abu Bakr Hassas Razi has outlined a complete and prohibiting legal definition of Riba An Nasiyah in the following words:

"That kind of loan where specified repayment period and an amount in excess of capital is predetermined."

The second classification of Riba is Riba Al Fadl. Since the prohibition of this Riba has been established on Sunnah, it is also called Riba Al Hadees.

Riba Al Fadl actually means that excess which is taken in exchange of specific homogenous commodities and encountered in their hand-to-hand purchase & sale as explained in the famous hadith:
The Prophet said, "Sell gold in exchange of equivalent gold, sell silver in exchange of equivalent silver, sell dates in exchange of equivalent dates, sell wheat in exchange of equivalent wheat, sell salt in exchange of equivalent salt, sell barley in exchange of equivalent barley, but if a person transacts in excess, it will be usury (Riba). However, sell gold for silver anyway you please on the condition it is hand-to-hand (spot) and sell barley for date anyway you please on the condition it is hand-to-hand (spot)."

These six commodities can only be bought and sold in equal quantities and on spot. An unequal sale or a deferred sale of these commodities will constitute Riba. These six commodities in fiqh terminology are called "Amwal-e-Ribawiya". Does this hadith apply only to the items mentioned in it? Does it concern sales of barley or wheat but not rice? Of dates but not raisins? A complete legal definition differs in every fiqh. Scholars such as Taoos and Qatada hold that Riba Al Fadl includes these specified types only, however a majority of Islamic scholars believe that some other commodities should also be included. In order to answer the question, which other commodities should be included, some fiqhs hold that the characteristics which are common amongst these items can be used as basis (illat) for Riba Al Fadl. An illat is the attribute of an event that entails a particular divine ruling in all cases possessing that attribute; it is the basis for applying analogy. Ribawi goods are therefore goods that exhibit one of the efficient causes occasioning application of Riba rules. Various schools define these causes differently:

The Islamic banks works completely work according to the Sharyia rules in the light of Quran and Hadiath.

The basic rules of Musharakah
Musharakah or Shirkat-ul-amwal is a relationship established by the parties through a mutual contract. Therefore, it goes without saying that all the necessary ingredients of a valid contract must be present here also. For example, the parties should be capable of entering into a contract; the contract must take place with free consent of the parties without any duress, fraud or misrepresentation, etc.

But there are certain ingredients, which are peculiar to the contract of "Musharakah". They are summarized here:

Basic rules of Capital:
The capital in a Musharakah agreement should be:
a) Quantified (Ma'loom): Meaning how much etc.
b) Specified (Muta'aiyan): Meaning specified currency etc.
c) Not necessarily be merged: The mixing of capital is not required.
d) Not necessarily be in liquid form: Capital share may be contributed either in cash/liquid or in the form of commodities. In case of a commodity, the market value of the commodity shall determine the share of the partner in the capital.

Management of Musharakah
The normal principle of Musharakah is that every partner has a right to take part in its management and to work for it. However, the partners may agree upon a condition that the management shall be carried out by one of them, and no other partner shall work for the Musharakah. But in this case the sleeping partner shall be entitled to the profit only to the extent of his investment, and the ratio of profit allocated to him should not exceed the ratio of his investment, as discussed earlier.

However, if all the partners agree to work for the joint venture, each one of them shall be treated as the agent of the other in all matters of business. Any work done by one of them in the normal course of business shall be deemed as authorized by all partners.

1. The ratio of profit for each partner must be determined in proportion to the actual profit accrued to the business and not in proportion to the capital invested by him. E.g. if it is agreed between them that 'A' will get 1% of his investment, the contract is not valid.
2. It is not allowed to fix a lump sum amount for anyone of the partners or any rate of profit tied up with his investment. Therefore if 'A' & 'B' enter into a partnership and it is agreed between them that 'A' shall be given Rs.10,000/- per month as his share in the profit and the rest will go to 'B', the partnership is invalid.
3. If both partners agree that each will get percentage of profit based on his capital percentage, whether both work or not, it is allowed.
4. It is also allowed that if an investor is working, his profit share (%) could be more than his capital base (%) irrespective whether the other partner is working or not. Eg. if 'A' & 'B' have invested Rs.1000/- each in a business and it is agreed that only 'A' will work and will get 2/3rd of the profit while 'B' will get 1/3rd. Similarly if the condition of work is also imposed on 'B' in the agreement, then also the proportion of profit for 'A' can be more than his investment.
5. If a partner has put an express condition in the agreement that he will not work for the Musharakah and will remain a sleeping partner throughout the term of Musharakah, then his share of profit cannot be more than the ratio of his investment. However, Hanbali school of thought considers fixing the sleeping partners share more than his investment to be permissible.
6. It is allowed that if a partner is not working, his profit share can be established as less than his capital share.
7. If both are working partners, the share of profit can differ from the ratio of investment. Eg. Zaid & Bakar both have invested Rs.1000/- each. However Zaid gets 1/3rd of the total profit and Bakar 2/3rd, this is allowed. This opinion of Imam Abu Hanifa is based on the fact that capital is not the only factor for profit but also labour and work. Therefore although the investment of two partners is the same but in some cases quantity and quality of work might differ.
8. If only a few partners are active and others are only sleeping partners, then the share in the profit of the active partner could be fixed at higher than his ratio of investment eg. 'A' & 'B' put in Rs.100 each and it is agreed that only 'A' will work, then 'A' can take more than 50% of the profit as his share. The excess he receives over his investment will be compensation for his services

All scholars are unanimous on the principle of loss sharing in Shariah based on the saying of Syedna Ali ibn Talib that is as follows:

"Loss is distributed exactly according to the ratio of investment and the profit is divided according to the agreement of the partners."

Therefore the loss is always subject to the ratio of investment eg. if 'A' has invested 40% of the capital and 'B' 60%, they must suffer the loss in the same ratio, not more, not less. Any condition contrary to this principle shall render the contract invalid.

After entering into a Musharakah contract, partners have the following rights: 2. Every partner has the right to terminate the Musharakah at any time after giving his partner a notice that will cause the Musharakah to end. For dissolving this partnership, if the assets are liquidated, they will be distributed pro-rata between the partners. However, if this is not the case, the partners may agree either:
a) To liquidate the assets or
b) Distribute the assets as they are.
In case of a dispute between partners whether to seek liquidation of assets or distribute non-liquid assets, the distribution of non-liquid assets will be preferred. Because after the termination of Musharakah, all the assets are in the joint ownership of the partners and a co-owner has a right to seek partition or separation and no one can compel him on liquidation. But if the assets are in a form that cannot be distributed such as machinery, then they shall be sold and the sale-proceeds shall be distributed.
3. In case of a death of any one of the partners or any partner becoming insane or incapable of effecting commercial transaction, the Musharakah stands terminated.
4. In case of damage to the share capital of one partner before mixing the same in the total investment and before affecting the purchase, the partnership will stand terminated and the loss will only be borne by that particular partner. However, if the share capital of all partners has been mixed and could not be identified singly, then the loss will be shared by all and the partnership will not be terminated.

If one of the partners wants termination of the Musharakah, while the other partner or partners like to continue with the business, this purpose can be achieved by mutual agreement. The partners who want to run the business may purchase the share of the partner who wants to terminate his partnership, because the termination of Musharakah with one partner does not imply its termination between the other partners.

However, in this case, the price of the share of the leaving partner must be determined by mutual consent. If there is a dispute about the valuation of the share and the partners do not arrive at an agreed price, the leaving partner may compel other partners on the liquidation or on the distribution of the assets themselves.

The question arises whether the partners can agree, while entering into the contract of the Musharakah, on a condition that the liquidation or separation of the business shall not be effected unless
a) The right to sell the mutually owned property since all partners are representing each other in Shirkah and all have the right to buy & sell for business purposes.
b) The right to buy raw material or other stock on cash or credit using funds belonging to Shirkah to put into business.
c) The right to hire people to carry out business if needed.
d) The right to deposit money & goods of the business belonging to Shirkah as depositor trust where and when necessary.
e) The right to use Shirkah's fund or goods in Mudarabah.
f) The right of giving Shirkah's funds as hiba (gift) or loan. If one partner for purpose of investing in the business has taken a Qard-e-Hasana, then paying it becomes liable on both.

all the partners or the majority of them wants to do so. And that a single partner who wants to come out of the partnership shall have to sell his share to the other partners and shall not force them on liquidation or separation.

This condition may be justified, especially in the modern situations, on the ground that the nature of business, in most cases today, requires continuity for its success, and the liquidation or separation at the instance of a single partner only may cause irreparable damage to the other partners.

If a particular business has been started with huge amounts of money which has been invested in a long-term project, and one of the partners seeks liquidation in the infancy of the project, it may be fatal to the interests of the partners, as well as to the economic growth of the society, to give him such an arbitrary power of liquidation or separation. Therefore, such a condition seems to be justified, and it can be supported by the general principle laid down by the Holy Prophet in his famous hadith:

"All conditions agreed upon by the Muslims are upheld, except a condition which allows what is prohibited or prohibits what is lawful".

There shall be a provision for adjudication by a Review Committee to resolve any difference that may arise between the bank and its clients (partners) with respect to any of the provisions contained in the Musharakah Agreement.

In case of Musharakah agreement between the Bank and the client, the bank shall in its own right and discretion, obtain adequate security from the party to ensure safety of the capital invested/ financed as also for the profit that may be earned as per profit projection given by the party. The securities obtained by the bank shall, also as usual, be kept fully insured at the party's cost and expenses till Islamic mode of insurance i.e. Takaful becomes operational. The purpose of this security is to utilize this only in case of damage or loss of the principal amount due to the negligence of the client.

Interest based financing Musharakah
1. A fixed rate of return on a loan advanced by the financier is predeterminedirrespective of the profit earned or loss suffered by the debtor. Musharakah does not envisage a fixed rate of return. The return is based on the actual profit earned by the joint venture.

2. The financier cannot suffer loss. The financier can suffer loss, if the joint venture fails to produce fruits.
3. Results in injustice either to the creditor or to the debtor. If the debtor suffers a loss, it is unjust on the part of the creditor to claim a fixed rate of profit. Also if the debtor earns a very high rate of profit, it is injustice to the creditor to give him only small proportion of the profit leaving the rest for the debtor. The returns of the creditor are tied up with the actual profits accrued through the enterprise. The greater the profits of the enterprise, the higher the rate of return to the creditor. If the enterprise earns enormous profits, all of it cannot be secured by the debtor exclusively but will be shared by common people e.g. Depositors in the bank.

Musharakah is a mode of financing in Islam. Following are some issues relating to the tenure of Musharakah, redemption in Musharakah and the mixing of capital in conducting musharakah. These were discussed previously, they are explained in detail here.

A question commonly asked in the operation of Musharakah is whether the capital invested needs to be in liquid form or not. The answer as to whether the contract in Musharakah can be based on commodities only or on money varies among the different schools of thought in Islam. For example if Zaid and Bakar agree to invest Rs.1000 each in a garment business and both keep their investments with themselves. Then if Zaid buys cloth with his investment will it be considered belonging to both Zaid and Bakar or only to Zaid? Furthermore if the cloth is sold, can Zaid alone claim the profit or loss on the sale? In order to answer this question the prime consideration should be whether the partnership becomes effective without mixing the two investments profit or loss. This issue can be resolved in the light of the following schools of thought of different fiqhs:

Imam Malik is of the view that liquidity is not a condition for the validity of Musharakah. Therefore even if a partner contributes in kind to the partnership his share can be determined on the basis of the evaluation according to the prevalent market price at the date of the contract.

However Imam Hanifa and Imam Ahmad do not allow capital of investment to be in kind. The reason for this restriction is as follows:

Ø Commodities contributed by one partner will always be distinguishable from the commodities given by the other partners therefore they cannot be treated as homogenous capital.
Ø If in case of redistribution of share capital to the partners tracing back each partners share becomes difficult. If the share capital was in the form of commodities then redistribution cannot take place because they may have been sold at that time.

Imam Shafi has an opinion dividing commodities into two:
Ø Dhawat-ul-Amthal: Commodities which if destroyed can be compensated by similar commodities in quality and quantity. Exampla rice, wheat etc.
Ø Dhawat-ul-Qeemah: Commodities that cannot be compensated by similar commodities like animals.

Imam Shafi is of the view that commodities of the first kind may be contributed to Musharakah in the capital while the second type of commodities cannot be a part of the capital. In case of Dhawat-ul-Amthal redistribution of capital may take place by giving to each partner the similar commodities he had invested and earlier the commodities need to be mixed so well together that the commodity of one partner cannot be distinguished from commodities contributed by the other.

Therefore, it should be remembered that the illiquid goods can be made capital of investment and the market value of the commodities shall determine the share of the partner in the capital.

In case of illiquid capital being used the mixing of capital is an issue. According to Imam Shafi partners' capital should be mixed so well that it cannot be discriminated and this mixing should be done before any business is conducted. Therefore, partnership will not be completely enforceable if any kind of discrimination is present in the partners' capital. His argument is based on the reasoning that unless both investments will be mixed the investment will remain under the ownership of the original investor and any profit or loss on trade of that investment will be entitled to the original investor only. Hence such a partnership is not possible where the investment is not mixed.

According to Imam Abu Hanifa, Imam Malik and Imam Ahmed bin Hunbul the partnership is complete only with an agreement and the mixing of capital is not important. They are of the opinion that when two partners agree to form a partnership without so far mixing their capital of investment, then if one partner bought some goods for the partnership with his share of investment of Rs. 100,000, these goods will be accepted as being owned by both partners and hence any profit or loss on sale of these goods should be shared according to the partnership agreement.

However, if the share of investment of one person is lost before mixing the capital or buying anything for the partnership business, then the loss will be borne solely by the person who's owned the capital and will not be shared by other partners. However if the capital of both had been mixed and then a part of whole had been lost or stolen the loss would have been borne by both.

Since in Hanafi, Maliki and Hanbali schools of thought mixing of the capital is not important therefore a very important present day issue is addressed with reference to this principle. If some companies or trading houses enter into partnership for setting up an industry to conduct business they need to open LC for importing the machinery. This LC reaches the importer through his bank. Now when the machinery reaches the port and the importing companies need to pay for taking possession the latter need to show those receipts in order to take possession of the goods.

Under Shafi school of thought, the imported goods cannot become the capital of investment but will remain in the ownership of the person opening the LC because at the time of opening the LC the capital has not been mixed and without mixing the capital Musharakah cannot come into existence. Under this situation if the goods are lost during shipment the burden of loss will fall upon the opener of the LC, even though the goods were being imported for the entire industry. This is because even though a group of companies had asked for the machinery or imported goods the importers had not mixed their capital at the time of investment.

Contrary to this since the other three schools of thought believe that partnership comes into existence at the time of agreement rather than after the capital has been mixed therefore the burden of loss will be borne by all. This has two advantages:

a) In case of loss the burden of loss will not fall upon one rather will be shared by all firms of the partner.
b) If the capital is provided at the time of the agreement it stays blocked for the period during which the machinery is being imported. While if the capital was not kept idle, till the actual operation could be conducted with the machinery the same capital could have been used for something else as well.

This shows that the decision of the three combined schools of thought is better equipped to handle the current import export situation.

TENURE OF MUSHARAKAH
For conducting a Musharakah agreement, questions arise pertaining to fixing the period of the agreement. For fixing the tenure of the Musharakah following conditions should be remembered:

a) The partnership is fixed for such a long time that at the end of the tenure no other business can be conducted.

b) Can be for a very short time period during which partnership is necessary and neither partner can dissolve the partnership.

Under the Hanafi school of thought a person can fix the tenure of the partnership because it is an agreement and an agreement should have a fixed period of time.

In the Hanbal school of thought the tenure can be fixed for the partnership as it's an agency agreement and an agency agreement in this school can be fixed. The Maliki school however says that Shirkah cannot be subjected to a fixed tenure. Shafi school like the Maliki consider fixing the tenure to be not permissible. Their argument is that fixing the period will prohibit conducting the business at the end of that period which in turn means that the fixing will prevent them from conducting the business.

Uses Of Musharakah / Mudarabah:

These modes can be used in the following areas (or can replace them according to Shariah rules).

· For current/ saving/mahana amdani/ investment ccounts
(deposit giving Profit based on Musharkah/Mudarbah - with predetermined ratio )

· Islamic Musharakah bonds (based on projects requiring large amounts -
profit based on the return from the project)

Mudarib :       Working Partner (brings effort)
Ras-ul-Maal : Investment
Rab-ul-Maal : Investor (brings capital)
Wakeel :        Agent
Ameen :        Trustee
Kafeel :        Guarantor

Definition:
This is a kind of partnership where one partner gives money to another for investing in a commercial enterprise. The investment comes from the first partner who is called "Rab-ul-Maal" while the management and work is an exclusive responsibility of the other, who is called "Mudarib" and the profits generated are shared in a predetermined ratio.

1. Al Mudarabah Al Muqayyadah: Rab-ul-Maal may specify a particular business or a particular place for the mudarib, in which case he shall invest the money in that particular business or place. This is called Al Mudarabah Al Muqayyadah (restricted Mudarabah).

2. Al Mudarabah Al Mutlaqah: However if Rab-ul-maal gives full freedom to Mudarib to undertake whatever business he deems fit, this is called Al Mudarabah Al Mutlaqah (unrestricted Mudarabah). However Mudarib cannot, without the consent of Rab-ul-Maal, lend money to anyone. Mudarib is authorized to do anything, which is normally done in the course of business. However if they want to have an extraordinary work, which is beyond the normal routine of the traders, he cannot do so without express permission from Rab-ul-Maal. He is also not authorized to:

a) keep another Mudarib or a partner
b) mix his own investment in that particular Modarabah without the consent of Rab-ul Maal.

Conditions of Offer & Acceptance are applicable to both. A Rab-ul-Maal can contract Mudarabah with more than one person through a single transaction. It means that he can offer his money to 'A' and 'B' both so that each one of them can act for him as Mudarib and the capital of the Mudarabah shall be utilized by both of them jointly, and the share of the Mudarib.

1. All partners invest. Only Rab-ul-Maal invests.
2. All partners participate in the management of the business and can work for it. Rab-ul-maal has no right to participate in the management which is carried out by the Mudarib only.
3. All partners share the loss to the extent of the ratio of their investment. Only Rab-ul-maal suffers loss because the Mudarib does not invest anything. However this is subject to a condition that the Mudarib has worked with due diligence.
4. The liability of the partners is normally unlimited. If the liabilities of business exceed its assets and the business goes in liquidation, all the exceeding liabilities shall be borne pro rata by all partners. But if the partners agree that no partner shall incur any debt during the course of business, then the exceeding liabilities shall be borne by that partner alone who has incurred a debt on the business in violation of the aforesaid condition. The liability of Rab-ul-maal is limited to his investment unless he has permitted the Mudarib to incur debts on his behalf.
As soon as the partners mix up their capital in a joint pool, all the assets become jointly owned by all of them according to the proportion of their respective investment. All partners benefit from the appreciation in the value of the assets even if profit has not accrued through sales. The goods purchased by the Mudarib are solely owned by Rab-ul-maal and the Mudarib can earn his share in the profit only in case he sells the goods profitably.

It is necessary for the validity of Mudarabah that the parties agree, right at the beginning, on a definite proportion of the actual profit to which each one of them is entitled. The Shariah has prescribed no particular proportion; rather it has been left to their mutual consent. They can share the profit in equal proportions and they can also allocate different proportions for Rab-ul-Maal and Mudarib. However in extreme case where the parties have not predetermined the ratio of profit, the profit will be calculated at 50:50.

The Mudarib & Rab-ul-Maal cannot allocate a lump sum amount of profit for any party nor can they determine the share of any party at a specific rate tied up with the capital. For example, if the capital is Rs.100,000/-, they cannot agree on a condition that Rs.10,000 out of the profit shall be the share of the Mudarib nor can they say that 20% of the capital shall be given to Rab-ul-Maal. However they can agree that 40% of the actual profit shall go to the Mudarib and 60% to the Rab-ul-Maal or vice versa.

It is also allowed that different proportions are agreed in different situations. For example, the Rab-ul-Maal can say to Mudarib "If you trade in wheat, you will get 50% of the profit and if you trade in flour, you will have 33% of the profit". Similarly, he can say "If you do the business in your town, you will be entitled to 30% of the profit and if you do it in another town, your share will be 50% of the profit".

Apart from the agreed proportion of the profit, as determined in the above manner, the Mudarib cannot claim any periodical salary or a fee or remuneration for the work done by him for the Mudarabah.

All schools of Islamic Fiqh are unanimous on this point. However, Imam Ahmad has allowed for the Mudarib to draw his daily expenses of food only from the Mudarabah Account. The Hanafi jurists restrict this right of the Mudarib only to a situation when he is on a business trip outside his own city. In this case he can claim his personal expenses, accommodation, food, etc. but he is not entitled to get anything as daily allowances when he is in his own city.

If the business has incurred loss in some transactions and has gained profit in some others, the profit shall be used to offset the loss at the first instance, then the remainder, if any, shall be distributed between the parties according to the agreed ratio.

The Mudarabah becomes void (Fasid) if the profit is fixed in any way. In this case, the entire amount (Profit + Capital) will be the Rab-ul-Maal's. The Mudarib will just be an employee earning Ujrat-e-Misl.

Ameen (Trustee): To look after the investment responsibly, except in case of natural calamities.
Wakeel (Agent) : To purchase from the funds provided by Rab-ul-Maal
Shareek (Partner): Sharing in any profit
Zamin (Liable): To provide for the loss suffered by the Mudarabah due to any act on his part.
Ajeer (Employee): When the Mudarabah gets Fasid due to any reason, the Mudarib is entitled to only the salary, Ujrat-e-Misl.

The Mudarabah will stand terminated when the period specified in the contract expires. It can also be terminated any time by either of the two parties by giving notice. In case Rab-ul-Maal has terminated services of Mudarib, he will continue to act as Mudarib until he is informed of the same and all his acts will form part of Mudarabah.

If all assets of the Mudarabah are in cash form at the time of termination, and some profit has been earned on the principal amount, it shall be distributed between the parties according to the agreed ratio. However, if the assets of Mudarabah are not in cash form, it will be sold and liquidated so that the actual profit may be determined. All loans and payables of Mudarabah will be recovered. The provisional profit earned by Mudarib and Rab-ul-Maal will also be taken into account and when total capital is drawn, the principal amount invested by Rab-ul-Maal will be given to him, balance will be called profit which will be distributed between Mudarib and Rab-ul-Maal at the agreed ratio. If no balance is left, Mudarib will not get anything. If the principal amount is not recovered fully, then the profit shared by Mudarib and Rab-ul-Maal during the term of Mudarabah will be withdrawn to pay the principal amount to Rab-ul-Maal. The balance will be profit, which will be distributed between Mudarib and Rab-ul-Maal. In this case too if no balance is left, Mudarib will not get anything.

These modes can be used in the following areas (or can replace them according to Shariah rules).

· For current /saving/mahana amdani/investment accounts
(deposit giving Profit based on Musharkah / Mudarabah -
with predetermined ratio )

· Islamic Musharakah bonds (based on projects requiring large amounts - profit
based on the return from the project)

Murabaha is one of the most commonly used modes of financing by Islamic Banks and financial institutions.

Definition
Murabahah is a particular kind of sale where the seller expressly mentions the cost of the sold commodity he has incurred, and sells it to another person by adding some profit thereon. Thus, Murabahah is not a loan given on interest; it is a sale of a commodity for cash/deferred price.

The Bai' Murabahah involves purchase of a commodity by a bank on behalf of a client and its resale to the latter on cost-plus-profit basis. Under this arrangement the bank discloses its cost and profit margin to the client. In other words rather than advancing money to a borrower, which is how the system would work in a conventional banking agreement, the bank will buy the goods from a third party and sell those goods on to the customer for a pre-agreed price.

Murabahah is a mode of financing as old as Musharakah. Today in Islamic banks world-over 66% of all investment transactions are through Murabahah.

A simple sale in Arabic is called Musawamah - a bargaining sale without disclosing or referring to what the cost price is. However when the cost price is disclosed to the client it is called Murabahah. A simple Murabahah is one where there is cash payment and Murabahah Muajjal is one on deferred payment basis.

An argument that arises in Murabahah is that profit or interest both are the same and Murabahah financing is the same as conventional banking. Islamic scholars however argue that in several respects a Murabahah financing structure is quite different to an overdraft organized along conventional lines and the former offers several benefits to the bank and its customers. Depositors are made to share in profits of the bank as a result of this financing. The basic difference is however the Aqd or the contract which covers the Islamic conditions. If the contract has interest element then it will be void.

1. The subject of sale must exist at the time of the sale. Thus anything that may not exist at the time of sale cannot be sold and its non-existence makes the contract void.
2. The subject matter should be in the ownership of the seller at the time of sale. If he sells something that he has not acquired himself then the sale becomes void.
3. The subject of sale must be in physical or constructive possession of the seller when he sells it to another person. Constructive possession means a situation where the possessor has not taken physical delivery of the commodity yet it has come into his control and all rights and liabilities of the commodity are passed on to him including the risk of its destruction.
4. The sale must be instant and absolute. Thus a sale attributed to a future date or a sale contingent on a future event is void. For example, 'A' tells 'B' on 1st January that he will sell his car on 1st February to 'B', the sale is void because it is attributed to a future date.
5. The subject matter should be a property having value. Thus a good having no value cannot be sold or purchased.
6. The subject of sale should not be a thing used for an un-Islamic purpose.
7. The subject of sale must be specifically known and identified to the buyer. For Example, 'A' owner of an apartment building says to 'B' that he will sell an apartment to 'B'. Now the sale is void because the apartment to be sold is not specifically mentioned or pointed to the buyer.
8. The delivery of the sold commodity to the buyer must be certain and should not depend on a contingency or chance.
9. The certainty of price is a necessary condition for the validity of the sale. If the price is uncertain, the sale is void.
10. The sale must be unconditional. A conditional sale is invalid unless the condition is recognized as a part of the transaction according to the usage of the trade.

Step by step Murabahah Financing
1. The client and the institution sign an overall agreement whereby the institution promises to sell and the client promises to buy the commodity from time to time on an agreed ratio of profit added to the cost. This agreement may specify the limit up-to which the facility may be availed.
2. An agency agreement is signed by both parties in which the institution appoints the client as his agent for purchasing the commodity on its behalf.
3. The client purchases the commodity on behalf of the institution and takes possession as the agent of the institution.
4. The client informs the institution that it has purchased the commodity and simultaneously makes an offer to purchase it from the institution.
5. The institution accepts the offer and the sale is concluded whereby ownership as well as risk is transferred to the client.

All the above conditions are necessary to effect a valid Murabahah. If the institution purchases the commodity directly from the supplier, it does not need any agency agreement.

The most essential element of the transaction is that the commodity must remain in the risk of the institution during the period between the third and the fifth stage.

The above is the only way by which this transaction is distinguished from an ordinary interest-based transaction.

Payments coming from the sale are receivables and for this, the client may be asked to furnish a security. It can be in the form of a mortgage or hypothecation or some kind of lien or charge.

The seller can ask the client to furnish a 3rd party guarantee. In case of default on payment the seller may have recourse to the guarantor who will be liable to pay the amount guaranteed to him. There are two issues relating to this:

a) The guarantor cannot charge a fee from the original client. The reason being that a person charging a fee for advancing a loan comes under the definition of riba.
b) However the guarantor can charge for any documentation expenses.

Another issue with Murabahah is that if the client defaults in payment of the price at the due date, the price cannot be changed nor can penalty fees be charged.

In order to deal with dishonest clients who default in payment deliberately, they should be made liable to pay compensation to the Islamic Bank for the loss suffered on account of default. However these should be made subject to the following conditions:

a) The defaulter may be given a grace period of at-least one-month.
b) If it is proven beyond doubt that the client is defaulting without valid excuse then compensation can be demanded.

The most essential element of the transaction is that the commodity must remain in the risk of the institution during the period between the third and the fifth stage.

The above is the only way by which this transaction is distinguished from an ordinary interest-based transaction.

1. Securities against Murabahah
Payments coming from the sale are receivables and for this, the client may be asked to furnish a security. It can be in the form of a mortgage or hypothecation or some kind of lien or charge.

2. Guaranteeing the Murabahah
The seller can ask the client to furnish a 3rd party guarantee. In case of default on payment the seller may have recourse to the guarantor who will be liable to pay the amount guaranteed to him. There are two issues relating to this:

3. Penalty of default
Another issue with Murabahah is that if the client defaults in payment of the price at the due date, the price cannot be changed nor can penalty fees be charged.

a) The defaulter may be given a grace period of at-least one-month.
b) If it is proven beyond doubt that the client is defaulting without valid excuse then compensation can be demanded.

4. Rollover in Murabahah
Murabahah transaction cannot be rolled over for a further period as the old contract ends. It should be understood that Murabahah is not a loan rather the sale of a commodity, which is deferred to a specific date. Once this commodity is sold, its ownership transfers from the bank to the client and it is therefore no more a property of the seller. Now what the seller can claim is only the agreed price and therefore there is no question of effecting another sale on the same commodity between the same parties.

5. Rebate on earlier payments
Sometimes the debtors want to pay early to get discounts. However in Islam, majority of Muslim Scholars including the major schools of thought consider this to be un-Islamic. However if the Islamic bank or financial institution gives somebody a rebate on its own, it is not objectionable especially if the client is needy.

6. Calculation of cost in Murabahah
The Murabahah can only be effected when the seller can ascertain the exact cost he has incurred in acquiring the commodity he wants to sell. If the exact cost cannot be ascertained then Murabahah cannot take place. In this case the sale will take place as Musawamah i.e. sale without reference to cost.

7. Subject matter of the sale
All commodities cannot be the subject matter in Murabahah because certain requirements need to be fulfilled. The shares of a lawful company can be sold or purchased on Murabahah basis because according to the principles of Islam the shares represent ownership into assets of the company provided all other basic conditions of the transaction are fulfilled. A buy back arrangement or selling without taking their possession is not allowed at all.

Murabahah is not possible on things that cannot become the subject of sale. For example, Murabahah is not possible in exchange of currencies.

Basic mistakes in Murabahah Financing
Some basic mistakes that can be made in practical implications of the concept are as follows:

1. The most common mistake is to assume that Murabahah can be used for all types of transactions and financing. This mode can only be used when a commodity is to be purchased by the customer. If funds are required for some other purpose Murabahah cannot be used.

2. The document is signed for obtaining funds for a specific commodity and therefore it is important to study the subject matter of the Murabahah.

3. In some cases, the sale of commodity to the client is affected before the commodity is acquired from the supplier. This occurs when the various stages of the Murabahah are skipped and the documents are signed all together. It is to be remembered that Murabahah is a package of different contracts and they come into play one after another at their respective stages.

4. It is observed in some financial institutions that Murabahah is applied on already purchased commodities, which is not allowed in Shariah and can be effected on not yet purchased commodities.

· All other services that can be sold in the form of package (i.e. services like education, medical etc. as a package)
· Securitization of Murabahah agreement (certificate) is allowed at par value only. Other wise certain rules of Islamic Finance must be met.

Bai' Muajjal
Bai' Muajjal is the Arabic acronym for "sale on deferred payment basis". The deferred payment becomes a loan payable by the buyer in a lump sum or installment (as agreed between the two parties). In Bai' Muajjal all those items can be sold on deferred payment basis which come under the definition of capital where quality does not make a difference but the intrinsic value does. Those assets do not come under definition of capital where quality can be compensated for by the price and Shariah scholars have an 'ijmah' (consensus) that demanding a high price in deferred payment in such a case is permissible.

Conditions for Bai' Muajjal
1. The price to be paid must be agreed and fixed at the time of the deal. It may include any amount of profit without qualms about riba.

2. Complete/total possession of the object in question must be given to the buyer, while the deferred price is to be treated as debt against him.

3. Once the price is fixed, it cannot be decreased in case of earlier payment nor can it be increased in case of default.

4. In order to secure the payment of price, the seller may ask the buyer to furnish a security either in the form of mortgage or in the form of an item.

5. If the commodity is sold on installments, the seller may put a condition on the buyer that if he fails to pay any installment on its due date, the remaining installments will become due immediately.

Rabb-us-salam : Buyer
Muslam ilaih :     Seller
Ra's-ul-maal :    Cash price
Muslam fih :       Purchased commodity

This mode of financing can be used by the modern banks and financial institutions especially to finance the agricultural sector. In Salam, the seller undertakes to supply specific goods to the buyer at a future date in exchange of an advanced price fully paid at spot. The price is in cash but the supply of purchased goods is deferred.

Purpose of use:
· To meet the need of small farmers who need money to grow their crops and to feed their family up to the time of harvest. When Allah declared Riba haram, the farmers could not take usurious loans. Therefore Holy Prophet allowed them to sell their agricultural products in advance.

· To meet the need of traders for import and export business. Under Salam, it is allowed for them that they sell the goods in advance so that after receiving their cash price, they can easily undertake the aforesaid business. Salam is beneficial to the seller because he received the price in advance and it was beneficial to the buyer also because normally the price in Salam is lower than the price in spot sales.

The permissibility of Salam is an exception to the general rule that prohibits forward sale and therefore it is subject to strict conditions, which are as follows:

Conditions of Salam:

1. It is necessary for the validity of Salam that the buyer pays the price in full to the seller at the time of effecting the sale. In the absence of full payment, it will be tantamount to sale of a debt against a debt, which is expressly prohibited by the Holy Prophet . Moreover the basic wisdom for allowing Salam is to fulfill the "instant need" of the seller. If its not paid in full, the basic purpose will not be achieved.

2. Only those goods can be sold through a Salam contract in which the quantity and quality can be exactly specified eg. precious stones cannot be sold on the basis of Salam because each stone differ in quality, size, weight and their exact specification is not possible.

3. Salam cannot be effected on a particular commodity or on a product of a particular field or farm eg. Supply of wheat of a particular field or the fruit of a particular tree since there is a possibility that the crop is destroyed before delivery and given such possibility, the delivery remains uncertain.

4. All details in respect to quality of goods sold must be expressly specified leaving no ambiguity, which may lead to a dispute.

5. It is necessary that the quantity of the commodity is agreed upon in absolute terms. It should be measured or weighed in its usual measure only, meaning what is normally weighed cannot be quantified and vice versa.

7. Salam cannot be effected in respect of things, which must be delivered at spot.

8. The commodity for Salam contract should remain in the market right from the day of contract up to the date of delivery or at least till the date of delivery.

9. The time of delivery should be at least fifteen days or one month from the date of agreement. Price in Salam is generally lower than the price in spot sale. The period should be long enough to affect prices. But Hanafi Fiqh did not specify any minimum period for the validity of Salam. It is all right to have an earlier date of delivery if the seller consents to it.

10. Since price in Salam is generally lower than the price in spot sale; the difference in the two prices may be a valid profit for the Bank.

11. A security in the form of a guarantee, mortgage or hypothecation may be required for a Salam in order to ensure that the seller delivers.

12. The seller at the time of delivery delivers commodities and not money to the buyer who would have to establish a special cell for dealing in commodities.

1. After purchasing a commodity by way of Salam, the financial institution can sell it through a parallel contract of Salam for the same date of delivery. The period of Salam in the second parallel contract is shorter and the price is higher than the first contract. The difference between the two prices shall be the profit earned by the institution. The shorter the period of Salam, the higher the price and the greater the profit. In this way institutions can manage their short term financing portfolios.

2. The institution can obtain a promise to purchase from a third party. This promise should be unilateral from the expected buyer. The buyer does not have to pay the price in advance. When the institution receives the commodity, it can sell it at a pre-determined price to a third party according to the terms of the promise.

Parallel Salam
1. In an arrangement of parallel Salam there must be two different and independent contracts; one where the bank is a buyer and the other in which it is a seller. The two contracts cannot be tied up and performance of one should not be contingent on the other. For example, if 'A' has purchased from 'B' 1000 bags of wheat by way of Salam to be delivered on 31 December, 'A' can contract a parallel Salam with 'C' to deliver to him 1000 bags of wheat on 31 December. But while contracting Parallel Salam with 'C', the delivery of wheat to 'C' cannot be conditioned with taking delivery from 'B'. Therefore, even if 'B' did not deliver wheat on 31 December, 'A' is duty bound to deliver 1000 bags of wheat to 'C'. He can seek whatever recourse he has against 'B', but he cannot rid himself from his liability to deliver wheat to 'C'. Similarly, if 'B' has delivered defective goods, which do not conform to the agreed specifications, 'A' is still obligated to deliver the goods to 'C' according to the specifications agreed with him.

2. A Salam arrangement cannot be used as a buy back facility where the seller in the first contract is also the purchaser in the second. Even if the purchaser in the second contract is a separate legal entity, but owned by the seller in the first contract; it would not tantamount to a valid parallel Salam agreement. For example, 'A' has purchased 1000 bags of wheat by way of Salam from 'B' - a joint stock company. 'B' has a subsidiary 'C', which is a separate legal entity but is fully owned by 'B'. 'A' cannot contract the parallel Salam with 'C'. However, if 'C' is not wholly owned by 'B', 'A' can contract parallel Salam with it, even if some share-holders are common between 'B' and 'C'.

Istijrar means purchasing goods time to time in different quantities. In Islamic jurisprudence Istijrar is an agreement where a buyer purchases something from time to time; each time there is no offer or acceptance or bargain. There is one master agreement where all terms and conditions are finalized. There are two types of Istijrar:

· Whereby the price is determined after all transactions of purchase are complete.

· Whereby the price is determined in advance but the purchase is executed from
time to time.

The first kind is relevant with the Islamic mode of financing. This kind is permissible with certain conditions.

1. In the case where the seller discloses the price of goods at the time of each transaction; the sale becomes valid only when the buyer possess the goods. The amount is paid after all transactions have been completed.

2. If the seller does not disclose each and every time to the buyer the price of the subject matter, but the contractors know that it is being sold on market value and the market value is specified and determined in such a manner that it does not vary and it does not lead to differences of the contractors.

3. If at the time of possession, the price of subject matter was unknown or contractors agree that whatever the price shall be, the sale will be executed. However, if there is significant difference in the market price and the agreed price, it may cause conflict. In such a case, at the time of possession, the sale will not be valid. However, at the time of settlement of the payment, the sale will be valid.

The validity will relate to the time of possession. Therefore the ownership of the buyer in the subject matter will be proved from the time of possession. After the payment of price the buyer's usage of the subject matter will be valid from the time of the possession.

As far as the use of Istijrar in Islamic banks is concerned, at present they are involved in four kinds of activities, namely Murabahah, Ijarah, Mudarabah and Musharakah. Out of these four, the concept of Istijrar can be applied to only the first three cases, due to the reason that Istijrar cannot be applied to borrowers of the bank. However, the same concept can however be applied to suppliers of the borrower.

However, Istijrar can work with suppliers of the borrower. In this case, the bank enters into a Murabahah with the suppliers on the basis of Istijrar. The bank enters into an Agreement to Purchase with the suppliers (which are mainly trading companies) that it will purchase assets from them at a market price or at a predetermined discount from the market price. Whenever the bank has a new customer, it can purchase the assets from the suppliers on the basis of Istijrar and sell it onwards to the customer on the basis of Murabahah.

It might very well be probable that the bank might enter into a pseudo-Istijrar agreement with the suppliers rather than a true one. This is the case when the bank enters into an agreement with the customer that it is going to sell certain assets in a certain quantity to them within a specified time period. The customer may then purchase the assets from the banks in tranches rather than at once and complete the whole purchase within the specified time period in order to complete the agreement.

The above type of Istijrar is referred to as Istijrar with Pre-agreed Sale due to the reason that the customer purchases a given amount of assets from the bank over a period of time but the price of the assets purchased is always known before the sale. Given the above, there is no difference of opinion between Shariah scholars as far as accepting this type of transaction as Bai-Ta'ati is concerned. However, the use of Ta'ati in case of a Murabahah transaction is not acceptable, as it leads indirectly to Riba in case the bank does not take possession of the assets before they are sold to the customer. Hence if Ta'ati is to be used in this case, then the only way to do it is that the bank should purchase the assets some time before selling it to the customer. This would ensure possession that is not just constructive but the bank would have title to the assets before they are sold to the customer.

Given that the above conditions are complied with to their full extent, Istijrar can be used in case of a Murabahah.

Basic Rules
Transferring of usufruct not ownership
In leasing an owner transfers its usufruct to another person for an agreed period, at an agreed consideration.

All consumable things cannot be leased out
The corpus of the leased property remains in the ownership of the seller, and only its usufruct is transferred to the lessee. Thus, anything, which cannot be used without consuming, cannot be leased out. For example money, wheat etc.

All liabilities of ownership is borne by lessor
As the corpus of the leased property remains in the ownership of the lessor, all the liabilities emerging from the ownership shall be borne by the lessor.

· It is necessary for a valid lease that the leased asset is fully identified by the parties.

Lease for specific purpose
The lessee cannot use the leased asset for any purpose other than the purpose specified in the lease agreement. However, if no such purpose is specified in the agreement, the lessee can use it for whatever purpose it is used in the normal course.

· The lessee is liable to compensate the lessor for every harm to the leased asset caused by any misuse or negligence.

· The leased asset shall remain in the risk of the lessor throughout the lease period in the sense that any harm or loss caused by the factors beyond the control of the lessee shall be borne by the lessor.

· A property jointly owned by two or more persons can be leased out, and the rental shall be distributed between all joint owners according to the proportion of their respective shares in the property.

· A joint owner of a property can lease his proportionate share only to his co-sharer, and not to any other person.

· The rental must be determined at the time of contract for the whole period of lease.

· It is permissible that different amounts of rent are fixed for different phases during the lease period, provided that the amount of rent for each phase is specifically agreed upon at the time of affecting a lease. If the rent for a subsequent phase of the lease period has not been determined or has been left at the option of the lessor, the lease is not valid.

· The determination of rental on the basis of the aggregate cost incurred in the purchase of the asset by the lessor, as normally done in financial leases, is not against the rules of Shariah, if both parties agree to it, provided that all other conditions of a valid lease prescribed by the Shariah are fully adhered to.

· The lessor cannot increase the rent unilaterally, and any agreement to this effect is void.

· The rent or any part thereof may be payable in advance before the delivery of the asset to the lessee, but the amount so collected by the lessor shall remain with him as 'on account' payment and shall be adjusted towards the rent after its being due.

· The lease period shall commence from the date on which the leased asset has been delivered to the lessee.

· If the leased asset has totally lost the function for which it was leased, the contract will stand terminated.

· The rentals can be used on or benchmarked with some Index as well. In this case the ceiling and floor rentals can be identified for validity of lease.</font>

Lease as a mode of financing
Lease is not originally a mode of financing. It is simply a transaction meant to transfer the usufruct of a property from one person to another for an agreed period against an agreed consideration. However, certain financial institutions have adopted leasing as a mode of financing instead of long term lending on the basis of interest.

This transaction of financial lease may be used for Islamic financing, subject to certain conditions. It is not sufficient for this purpose to substitute the name of 'interest' by the name of 'rent' and replace the name of 'mortgage' by the name of 'leased asset'. There must be a substantial difference between leasing and an interest-bearing loan. That will be possible only by following all the Islamic rules of leasing, some of which have been mentioned earlier.

To be more specific, some basic differences between the contemporary financial leasing and the actual leasing allowed by the Shariah are indicated below:

The commencement of lease
Unlike the contract of sale, the agreement of Ijarah can be effected for a future date. Hence, it is different from Murabaha.

In most cases of the 'financial lease' the lessor i.e. the financial institution purchases the asset through the lessee himself. The lessee purchases the asset on behalf of the lessor who pays its price to the supplier, either directly or through the lessee. In some lease agreements, the lease commences on the very day on which the price is paid by the lessor, irrespective of whether the lessee has effected payment to the supplier and taken delivery of the asset or not. It may mean that lessee's liability for the rent starts before the lessee takes delivery of the asset. This is not allowed in Shariah, because it amounts to charging rent on the money given to the customer, which is nothing but interest, pure and simple.

Rent should be charged after the delivery of the leased asset
The correct way, according to Shariah, is that the rent will be charged after the lessee has taken delivery of the asset, and not from the day the price has been paid. If the supplier has delayed the delivery after receiving the full price, the lessee should not be liable for the rent of the period of delay.

Different relations of the parties
It should be clearly understood that when the lessee himself has been entrusted with the purchase of the asset intended to be leased, there are two separate relations between the institution and the client, which come into operation one after the other. In the first instance, the client is an agent of the institution to purchase the asset on latter's behalf. At this stage, the relation between the parties is nothing more than the relation of a principal and his agent. The relation of lessor and lessee has not yet come into operation.

The second stage begins from the date when the client takes delivery from the supplier. At this stage, the relation of lessor and lessee comes to play its role. These two capacities of the parties should not be mixed up or confused with each other. During the first stage, the client cannot be held liable for the obligations of a lessee. In this period, he is responsible to carry out the functions of an agent only. But when the asset is delivered to him, he is liable to discharge his obligations as a lessee.

Difference between Murabahah and leasing:
In Murabahah, as mentioned earlier, actual sale should take place after the client takes delivery from the supplier, and the previous agreement of Murabahah is not enough for effecting the actual sale. Therefore, after taking possession of the asset as an agent, he is bound to give intimation to the institution, and make an offer for the purchase from him. The sale takes place after the institution accepts the offer.

The procedure in leasing is different, and a little shorter. Here the parties need not effect the lease contract after taking delivery. If the institution, while appointing the client its agent, has agreed to lease the asset with effect from the date of delivery, the lease will automatically start on that date without any additional procedure. There are two reasons for this difference between Murabahah and leasing:

a) It is a necessary condition for a valid sale that it should be affected instantly. Thus, a sale attributed to a future date is invalid in Shariah. But leasing can be attributed to a future date. Therefore, the previous agreement is not sufficient in the case of Murabahah, while it is quite enough in the case of leasing.
b) The basic principle of Shariah is that one cannot claim a profit or a fee for a property the risk of which was never borne by him. Applying this principle to Murabahah, the seller cannot claim a profit over a property, which never remained under his risk for a moment. Therefore, if the previous agreement is held to be sufficient for affecting a sale between the client and the institution, the asset shall be transferred to the client simultaneously when he takes its possession, and the asset shall not come into the risk of the seller even for a moment. That is why the simultaneous transfer is not possible in Murabahah, and there should be a fresh offer and acceptance after the delivery.

In leasing, however, the asset remains under the risk and ownership of the lessor throughout the leasing period, because the ownership has not been transferred. Therefore, if the lease period begins right from the time when the client has taken delivery, it does not violate the principle mentioned above.

· As the lessor is the owner of the asset and he has purchased it from the supplier through his agent, he is liable to pay all the expenses incurred in the process of its purchase and its import to the country of the lessor for example expenses of freight and customs duty etc.

· He can, of course, include all these expenses in his cost and can take them into consideration while fixing the rentals, but as a matter of principle, he is liable to bear all these expenses as the owner of the asset. Any agreement to the contrary, as is found in the traditional financial leases, is not in conformity with Shariah.

Lessee as Ameen/Liability of the parties in case of loss to the asset
As mentioned in the basic principles of leasing, the lessee is responsible for any loss caused to the asset by his misuse or negligence. He can also be made liable to the wear and tear, which normally occurs during its use. But he cannot be made liable to a loss caused by the factors beyond his control. The agreements of the traditional 'financial lease' generally do not differentiate between the two situations. In a lease based on the Islamic principles, both the situations should be dealt with separately.

Variable Rentals in Long Term Leases
In the long-term lease agreements, it is mostly not in the benefit of the lessor to fix one amount of rent for the whole period of lease, because the market conditions change from time to time. In this case, the lessor has two options:

(a) He can contract lease with a condition that the rent shall be increased according to a specified proportion (e.g. 5%) after a specified period (like one year).
(b) He can contract lease for a shorter period after which the parties can renew the lease at new terms and by mutual consent, with full liberty to each one of them to refuse the renewal, in which case the lessee is bound to vacate the leased property and return it back to the lessor.

These two options are available to the lessor according to the classical rules of Islamic Fiqh. However, some contemporary scholars have allowed, in long-term leases, to tie up the rental amount with a variable benchmark, which is so well known and well defined that it does not leave room for any dispute. For example, it is permissible according to them to provide in the lease contract that in case of any increase in the taxes imposed by the government on the lessor, the rent will be increased to the extent of same amount. Similarly it is allowed by them that the annual increase in the rent is tied up with the rate of inflation. Therefore if there is an increase of 5% in the rate of inflation, it will result in an increase of 5% in the rent as well.

Based on the same principle, some Islamic banks use the rate of interest as a benchmark to determine the rental amounts. They want to earn the same profit through leasing as is earned by the conventional banks through advancing loans on the basis of interest. Therefore, they want to tie up the rentals with the rate of interest and instead of fixing a definite amount of rental, they calculate the cost of purchasing the lease assets and want to earn through rentals an amount equal to the rate of interest. Therefore, the agreement provides that the rental will be equal to the rate of interest or to the rate of interest plus something. Since the rate of interest is variable, it cannot be determined for the whole lease period. Therefore, these contracts use the interest rate of a particular country (like LIBOR) as a benchmark for determining the periodical increase in the rent. This arrangement has been criticized on two grounds:

a) The first objection raised against it is that, by subjecting the rental payments to the rate of interest, the transaction is rendered akin to an interest based financing. This objection can be overcome by saying that, as fully discussed in the case of Murabahah, the rate of interest is used as a benchmark only. So far as other requirements of Shariah for a valid lease are properly fulfilled, the contract may use any benchmark for determining the amount of rental. The basic difference between an interest based financing and a valid lease does not lie in the amount to be paid to the financier or the lessor. The basic difference is that in the case of lease, the lessor assumes the full risk of the corpus of the leased asset. If the asset is destroyed during the lease period, the lessor will suffer the loss. Similarly, if the leased asset looses its usufruct without any misuse or negligence on the part of the lessee, the lessor cannot claim the rent, while in the case of an interest-based financing, the financier is entitled to receive interest, even if the debtor did not at all benefit from the money borrowed. So far as this basic difference is maintained, (i.e. the lessor assumes the risk of the leased asset) the transaction cannot be categorized as an interest-bearing transaction, even though the amount of rent claimed from the lessee is equal to the rate of interest.

It is thus clear that the use of the rate of interest merely as a benchmark does not render the contract invalid as an interest - based transaction. It is, however, advisable at all times to avoid using interest even as a benchmark, so that an Islamic transaction is totally distinguished from an un-Islamic one, having no resemblance of interest whatsoever.

b) The second objection to this arrangement is that the variations of the rate of interest being unknown, the rental tied up with the rate of interest will imply Jahalah and Gharar which is not permissible in Shariah. It is one of the basic requirements of Shariah that the parties must know the consideration in every contract when they enter into it. The consideration in a transaction of lease is the rent charged from the lessee, and therefore it must be known to each party right at the beginning of the contract of lease. If we tie up the rental with the future rate of interest, which is unknown, the amount of rent will remain unknown as well. This is the Jahalah or Gharar, which renders the transaction invalid.

Responding to this objection, one may say that the Jahalah has been prohibited for two reasons:

· It may lead to dispute between the parties. This reason is not applicable here, because both parties have agreed with mutual consent upon a well-defined benchmark that will serve as a criterion for determining the rent, and whatever amount is determined, based on this benchmark, will be acceptable to both parties. Therefore, there is no question of any dispute between them.

· The second reason for the prohibition of Jahalah is that it renders the parties susceptible to an unforeseen loss. It is possible that the rate of interest, in a particular period, zooms up to an unexpected level in which case the lessee will suffer. It is equally possible that the rate of interest zooms down to an unexpected level, in which case the lessor may suffer. In order to meet the risks involved in such possibilities, it is suggested by some contemporary scholars that the relation between rent and the rate of interest is subjected to a limit or ceiling. For example, it may be provided in the base contract that the rental amount after a given period, will be changed according to the change in the rate of interest, but it will in no case be higher than 15% or lower than 5% of the previous monthly rent. It will mean that if the increase in the rate of interest is more than 15%, the rent will be increased only up to 15%. Conversely, if the decrease in the rate of interest is more than 5%, the rent will not be decreased to more than 5%.

In our opinion, this is the moderate view, which takes care of all the aspects involved in the issue.

Penalty for Late Payment of Rent
In some agreements of financial leases, a penalty is imposed on the lessee in case he delays the payment of rent after the due date. This penalty, if meant to add to the income of the lessor, is not warranted by the Shariah. The reason is that the rent after it becomes due, is a debt payable by the lessee, and is subject to all the rules prescribed for a debt. A monetary charge from a debtor for his late payment is exactly the riba prohibited by the Holy Quran. Therefore, the lessor cannot charge an additional amount in case the lessee delays payment of the rent.
Penalty of late payment is given to charity
In order to avoid the adverse consequences, an alternative may be resorted to. The lessee may be asked to undertake that, if he fails to pay rent on its due date, he will pay certain amount to a charity. For this purpose the financier/lessor may maintain a charity fund where such amounts may be credited and disbursed for charitable purposes, including advancing interest-free loans to the needy persons. The amount payable for charitable purposes by the lessee may vary according to the period of default and may be calculated at per cent, per annum basis . The agreement of the lease may contain the following clause for this purpose:

"The Lessee hereby undertakes that, if he fails to pay rent at its due date, he shall pay an amount calculated at ....% p.a. to the charity Fund maintained by the Lessor which will be used by the Lessor exclusively for charitable purposes approved by the Shariah and shall in no case form part of the income of the Lessor."

This arrangement, though does not compensate the lessor for his opportunity cost of the period of default, yet it may serve as a strong deterrent for the lessee to pay the rent promptly.

Termination of Lease
If the lessee contravenes any term of the agreement, the lessor has a right to terminate the lease contract unilaterally. However, if there is no contravention on the part of the lessee, the lease cannot be terminated without mutual consent. In some agreements of the 'financial lease' it has been noticed that the lessor has been given an unrestricted power to terminate the lease unilaterally whenever he wishes, according to his sole judgment. This is again contrary to the principles of Shariah.

In some agreements of the 'financial lease' a condition has been found to the effect that in case of the termination of lease, even at the option of the lessor, the lessee shall pay the rent of the remaining lease period.

This condition is obviously against Shariah and the principles of equity and justice. The basic reason for inserting such conditions in the agreement of lease is that the main concept behind the agreement is to give an interest-bearing loan under the ostensible cover of lease. That is why every effort is made to avoid the logical consequences of the lease contract.

Naturally, such a condition cannot be acceptable to Shariah. The logical consequence of the termination of lease is that the lessor should take the asset back. The lessee should be asked to pay the rent as due up to the date of termination. If the termination has been effected due to the misuse or negligence on the part of the lessee, he can also be asked to compensate the lessor for the loss caused by such misuse or negligence. But he cannot be compelled to pay the rent of the remaining period.

Insurance of the assets
If the leased property is insured under the Islamic mode of Takaful, it should be at the expense of the lessor and not at the expense of the lessee, as is generally provided in the agreements of the current 'financial leases'.

The residual value of the leased asset
Another important feature of the modern 'financial leases' is that after the expiry of the lease period, the corpus of the leased asset is normally transferred to the lessee. As the lessor already recovers his cost along with an additional profit thereon, which is normally equal to the amount of interest which could have been earned on a loan of that amount advanced for that period, the lessor has no further interest in the leased asset. On the other hand, the lessee wants to retain the asset after the expiry of the leased period.

For these reasons, the leased asset is generally transferred to the lessee at the end of the lease, either free of any charge or at a nominal token price. In order to ensure that the asset will be transferred to the lessee, sometimes the lease contract has an express clause to this effect. Sometimes this condition is not mentioned in the contract expressly; however, it is understood between the parties that the title of the asset will be passed on to the lessee at the end of the lease term. This condition, whether it is express or implied, is not in accordance with the principles of Shariah. It is a well-settled rule of Islamic jurisprudence that one transaction cannot be tied up with another transaction so as to make the former a pre-condition for the other. Here the transfer of the asset at the end has been made a necessary condition for the transaction of lease that is not allowed in Shariah.

The original position in Shariah is that the asset shall be the sole property of the lessor, and after the expiry of the lease period, the lessor shall be at liberty to take the asset back, or to renew the lease or to lease it out to another party, or sell it to the lessee or to any other person. The lessee cannot force him to sell it to him at a nominal price, nor can such a condition be imposed on the lessor in the lease agreement. But after the lease period expires, and the lessor wants to give the asset to the lessee as a gift or to sell it to him, he can do so by his free will.

However, some contemporary scholars, keeping in view the needs of the Islamic financial institutions have come up with an alternative. They say that the agreement of Ijarah itself should not contain a condition of gift or sale at the end of the lease period. However, the lessor may enter into a unilateral promise to sell the leased asset to the lessee at the end of the lease period. This promise will be binding on the lessor only. The principle, according to them, is that a unilateral promise to enter into a contract at a future date is allowed whereby the promisor is bound to fulfill the promise, but the promisee is not bound to enter into that contract . It means that he has an option to purchase, which he may or may not exercise. However, if he wants to exercise his option to purchase, the promisor cannot refuse it because he is bound by his promise. Therefore, these scholars suggest that the lessor, after entering into the lease agreement, can sign a separate unilateral promise whereby he undertakes that if the lessee has paid all the amounts of rentals and wants to purchase the asset at a specified mutually acceptable price, he will sell the leased asset to him for that price. Once the lessor signs this promise, he is bound to fulfill it and the lessee may exercise his option to purchase at the end of the period, if he has fully paid the amounts of rent according to the agreement of lease.

In Islamic Shariah, it is allowed that instead of sale, the lessor signs a separate promise to gift the leased asset to the lessee at the end of the lease period, subject to his payment of all amounts of rent. This arrangement is called 'Ijarah wa iqtina. It has been allowed by a large number of contemporary scholars and is widely acted upon by the Islamic banks and financial institutions. The validity of this arrangement is subject to two basic conditions:

a) The agreement of Ijarah itself should not be subjected to signing this promise of sale or gift but the promise should be recorded in a separate document.
b) The promise should be unilateral and binding on the promisor only. It should not be a bilateral promise binding on both parties because in this case it will be a full contract effected to a future date, which is not allowed in the case of sale or gift.

Sub-Lease
If the leased asset is used differently by different users, the lessee cannot sub-lease the leased asset except with the express permission of the lessor. If the lessor permits the lessee for subleasing, he may sub-lease it. If the rent claimed from the sub-lessee is equal to or less than the rent payable to the owner / original lessor, all the recognized schools of Islamic jurisprudence are unanimous on the permissibility of the sub lease. However, the opinions are different in case the rent charged from the sub-lessee is higher than the rent payable to the owner. Imam Shafi and some other scholars allow it and hold that the sub lessor may enjoy the surplus received from the sub-lessee. This is the preferred view in the Hanbali School as well. On the other hand, Imam Abu Hanifah is of the view that the surplus received from the sub-lessee in this case is not permissible for the sub-lessor to keep and he will have to give that surplus in charity. However, if the sub-lessor has developed the leased property by adding something to it or has rented it in a currency different from the currency in which he himself pays rent to the owner/the original lessor, he can claim a higher rent from his sub-lessee and can enjoy the surplus.

Although the view of Imam Abu Hanifah is more precautious which should be acted upon to the best possible extent, in cases of need the view of Shafai and Hanbali schools may be followed because there is no express prohibition in the Holy Quran or in the Sunnah against the surplus claimed from the lessee. Ibn Qudamah has argued for the permissibility of surplus on forceful grounds.

Assigning of the Lease
The lessor can sell the leased property to a third party whereby the relation of lessor and lessee shall be established between the new owner and the lessee. However, the assigning of the lease itself (without assigning the ownership in the leased asset) for a monetary consideration is not permissible.

The difference between the two situations is that in the latter case the ownership of the asset is not transferred to the assignee, but he becomes entitled to receive the rent of the asset only. This kind of assignment is allowed in Shariah only where no monetary consideration is charged from the assignee for this assignment. For example, a lessor can assign his right to claim rent from the lessee to his son, or to his friend in the form of a gift. Similarly, he can assign this right to any one of his creditors to set off his debt out of the rentals received by him. But if the lessor wants to sell this right for a fixed price, it is not permissible, because in this case the money (the amount of rentals) is sold for money, which is a transaction subject to the principle of equality. Otherwise it will be tantamount to a riba transaction, hence prohibited.

In modern business, one of the ways to reduce the risk of loss due to misfortunes is through insurance. The concept of insurance where resources are pooled to help the needy does not contradict Shariah.

The concept is in line with the principles of compensation and shared responsibilities among the community. It is not a new concept, in fact it had been practised by the Muhajrin of Mecca and the Ansar of Medina following the hijra of the Prophet over 1400 years ago. It is generally accepted by Muslim Jurists
that the operation of conventional insurance does not conform to the rules and requirements of Shariah.

Conventional insurance involves the elements of uncertainity (Al-gharar) in the contract of insurance, gambling (Al-maisir) as the consequences of the presence of uncertainty and interest (Al-riba) in the investment activities of the conventional insurance companies which contravene the rules of Shariah. Takaful is an alternative form of cover which a Muslim can avail himself against the risk of loss due to misfortunes.

The Institute receives numerous requests for information about the permissibility, concept and practice of Takaful (Islamic Insurance) and about organisations engaged in Takaful business.

These requests underline important two facts. Firstly, that there is a rapidly increasing interest in it and secondly, there is an acute shortage of information on various aspects of Takaful. Moved by these factors, the Institute decided to include a section on Takaful to fill this important information gap.

The Institute has already published an International Directory of Islamic Insurance (Takaful) Organisations, listing not only the companies in this field and their particulars, but also a number of articles on various aspects of this system.