Shariah Contracts for Islamic Financial

Instruments – PART 1
Hasmah Laili binti Jamalurus
UiTM Cawangan Kedah
hasmahlaili@kedah.uitm.edu.my

1
Elements of Shariah contracts

2
 Introduction

• A valid Shari’ah contract is built upon three essentials elements:-

i. Form of the contract
ii.Subject matter of the contract
iii.The contracting parties
• These essential elements are to be met completely so as to qualify a contract to be
assigned with its prescribed legal effects such as the transfer of ownership and
conferment of the right to option.

3
 DEFINITION

Literal :
•The word ‘aqd (contract) is derived from the Arabic verb, ‘aqada, which means to tie,
to conclude or to ratify.
General meaning:
•Everything which is determined to be performed and materialized by someone.
General meaning:
•It is contract created on the basis of desire of two or more parties.

4
 PILLARS (CORNERSTONE) OF CONTRACT IN
ISLAM
According to majority of mazhab which comprises of Maliki,
Syafie and Hanbali, there are three pillars of the contract
1.Sighah or languange which includes offer and acceptance (ijab
& qabul).
2.Contracting parties; two or more persons communicating the
contract.
3.Subject matter of the ‘aqad or in other words, the property
sold and purchased such as car, house or etc.

5
 SIGHAH : OFFER & ACCEPTANCE
• Refers to an expression made by the contracting parties to declare their inner will to
undertake a contract and thereafter be bound by certain obligations.
• This expression will be manifested in an offer (ijab) made by offeror and acceptance
(qabul) made by the offeree.
• The Majallah Al-Ahkam Al-’Adliyyah defines:-
a.Offer is defined as the word first spoken for making a disposition of property & a
disposition is established by it.
b.Acceptance refers to a second word which comes from a person to whom the
ownership (of a transacted subject matter) is transferred even if it is done earlier
(than the offer made)

6
 Form of contract : Methods of Offer and
Acceptance
• Generally, offer and acceptance can be exercised in words as the will of the
contracting parties can be expressly signified in their own words.
• Can be exercised also in other methods recognised by Shari’ah such as conduct,
writing and gesture.

7
Conditions of offer and acceptance

8
 Subject Matter of the contract (mahal al-’aqd)

• Subject matter of the contract refers to the contracted object upon which the legal
rulings & effects of the contracts are manifested.
• May take a form of a corporeal property such as the subject matter of a sale
contract, pledged object in a pledge contract and usufruct in a lease contract.
• Can be also non-corporeal property such a woman in marriage contract.

9
10
 Contracting parties (al-’aqidan)

• A contract can only be established in its actually if the contracting party has a legal
capacity (ahliyyah) that render him competent (salih) to offer or accept an offer
made in a contract.
• This implies that a contract can be undertaken only by those who are legally capable
and competent to act as a contracting parties.
AHLIYYAH
• The ability to acquire rights and exercise them as well as to accept duties and
perform them.

11
12
 Conditions for contracting parties

1. Legally competent
 Measured largely by two aspects namely puberty and the prudence of financial
management.
 The contracting parties must reach the age of maturity, intellectually matured and
not a bankrupt.
2. Consent
 The contracting parties must mutually agreed to enter into the contract.
 ‘O ye believe! Eat up not up your property among yourselves in vanities. But let
there be amongst you Traffic and trade by mutual good-will; Nor kill (or destroy)
yourselves; for verily Allah hath been to you Most Merciful!’
(Surah An Nisa:29)

13
Classification of Shariah contracts

14
Classification of Shariah contracts (1)

15
Classification of Shariah contracts (2)

16
 Isqatat
Tamlikat Ishtirak Tawthiq Tafwiq/Itlaq Hifz
(Delegation)
(Waiver)
(Ownership) (Partnership) (surety/Guarantee) (saving)
•Rahn
• Musyarakah •Wakalah •Wadi’ah •Ibra’ (Rebate)
•Kafalah
• Mudharabah •Muqassah
•Hiwalah (Agent)
(Set off)

Mu`awadhah Tabarru`at
(Exchange)-applied in insurance (Charity)-applied in takaful
•Qard Hasan (Loan without
Ijarah Bay` interest)
•Hibah (Gift)
(lease) (buying & selling) •Waqf

•Tangible asset
•Intangible asset
•Wakalah bi ajr (Takaful) **Combine contract:
e.g : TAKAFUl : kafalah,tabarru’,
mudharabah, wakalah
AL-RAHN : wadiah, ujrah, dhamanah, yad al-
dhamanah

17
 Exchange-based Contracts (‘Uqud Al-Mu’awadat)

• Bay al murabahah
• Bay al istisna
• Bay al salam
• Bay al dayn
• Bay al sarf
• Bay al inah
• Bay al tawarruq
• Ijarah

18
BAY AL MURABAHAH

19
 Definition

Literally :
 Derives from the root word of RIBH which means increase or profit.
Technically :
 The sale of goods at a price covering the purchase price plus a profit
margin agreed upon by both parties concerned.
(a sale of goods with a cost plus profit pricing)

20
 Legality of Murabahah
 Cost plus sale is a legally permissible contract by the testimony of the majority of
Muslim jurists and Companions of the Prophet S.A.W.
 However, Malikis find it less desirable.

 There are various Quranic verses and Hadith approved the practice of murabahah.

21
 Legality of Murabahah

Al Quran
1.“And Allah has permitted trade”.
(Surah al-Baqarah, 2:275)

2.“But let there be among you traffic and trade by mutual good will”
(Surah al-Nisa,4:29)

Both Quranic verses proved that cost plus sale are clearly concluded by mutual
consent.

22
 LEGALITY OF MURABAHAH
Hadith
1. A valid narration reports that the Prophet S.A.W while planning for emigration to
Madinah, learned that Abu Bakar had purchased two camels. He asked him to sell
him one, at the price at which he obtained it, Abu Bakar said : “It is yours at no
price. But the Prophet S.A.W replied:“Not without a price”.
(Al Bukhari)

2. It was narrated that Ibn Mas’ud ruled that there was no harm in declared lump-sum
or percentage profit margins.

23
 Pillars of Murabahah

1. Seller
2. Buyer
3. Merchandise / goods
4. Price
5. Sighah : Offer (ijab) and Acceptance (qabul)

24
25
26
27
 Bai Bithaman Ajil
(Contract of Deferred Sale)

28
 Introduction

BBA is one of the most popular type of contracts concluded in

Malaysia and few countries in Southeast Asia.

BBA is not a kind of sale contracts, rather it is a manner in which

the payment is made.

In modern practice, it has taken shape to be kind of sale contract.

29
 Introduction
In some countries, it is known as BBA, but in some others, it is known as Bai Muajjal.

Only in Malaysia, the BBA contract exists together with murabahah.

While murabahah is applied on short term financing, BBA is applied to medium to

long term financing

30
 Definition
 Initially, BBA is refers to the mode of deferred payment agreed
between the seller and the buyer.

 The word ‘bithaman ajil’ means ‘deferred payment’ thus making it as

transaction with delayed payment.

31
 Definition

Al-Bai Sale
Thaman Price
Ajil Deferment

Therefore, BBA means sale with deferred payment

32
 Definition

 In classical fiqh books, BBA also known as

i. Bai at-Taqsit (Sale with installment payment)
ii. Bai al Muajjal (Sale with deferred payment)
iii. Bai an Nasiah (Sale with delayed payment)
iv. Bai al Aajil (Deferred sale)

33
 Concept of Bai Bithaman Ajil
 Classical:
Any sale, whether it is murabahah (mark-up sale) or normal sale (musawamah)
can use the method of BBA payment. As long the contract involve the element of
deferent of price, then it is called a BBA mode of payment.

 Modern definition:
Contract that refers to the sale and purchase transactions for the financing of an
asset on a deferred and an installment basis with a pre-agreed payment period.
The sale price will include a profit margin.

34
 Legality of BBA

 It was agreed among the scholars that this concept is legally valid.

 This means, there is no hassle of making deferment in payment in a contract

so long as it is agreed by the contracting parties and has met all the
requirements of a valid sale.

35
 Legality of BBA

 Hadith:
“From Aisyah r.a that the Prophet S.A.W bought a meal form a Jews with
deferred payment, and he mortgaged his iron shirt which made from iron”.

 It is clearly said that the payment have to be made within a specified period or
made in parts, in each month, until it is settled or to settle it in one lump sum
at a particular date in future.

36
 Objectives of BBA
 To provide financing for potential buyers who could not afford to pay cash in
advance and enable them to perform their daily responsibilities and
obligations without any financial hardship or difficulties

 To facilitate and support the smooth flow of transaction in the business

society by providing flexible modes of payment especially through credit
payment

37
 Pricing of BBA
 Higher than normal and Salam pricing.

 To compensate those traders who are willing to wait a little bit longer before
they could regain their money back.

 The strategy of flexible pricing has actually several advantages for both the
buyers and traders.

38
 Pricing of BBA

 The issue of different pricing under BBA

 A few minority scholars – part of riba nasiah

 Majority of scholars – allowed different pricing for normal sale and for
BBA

 Majma’ Fiqh Islami - Resolution no 7/2/65

39
BAY AL ISTISNA

40
 Definition

 A contract that the purchaser will make a reservation to the

manufacturer for the commodity
 The goods didn’t exist at the majlis and the manufacturer
need to complete the commodity for the purchaser.
Majallah al-Ahkam Al-’Adliyah
A contract with the maker (manufacturer), on the specific task
that is liable to complete.

41
 Definition
Imam Al-Kasani and Mawsu’ah al-Kuwaitiyah
“A contract that commisioned a worker to manufacture an item that is defined as a
liability on him”.

• During the time of Prophet Muhammad S.A.W and salafussoleh, whenever there
is a person placing an order to another person to produce shoes, sword and other
items, then, such request is called as an istisna purchase contract.

42
 Definition
Mohd Ma’sum Billah
An agreement of sale in which supplier or manufacturer is asked to supply goods or
specification at agreed rates, place and time of delivery

Maulana Taqi Usmani

To order a manufacturer to manufacture a specific commodity for the purchaser

The material of object must be from the manufacturer, if it is provided by the

customer, it would be a contract of Ijarah

43
 Legality of Istisna
Hadith
“Indeed that the Prophet S.A.W booked the making of a golden ring”.
(Narrated by Al Bukhari, Kitab al-Imam, 11/567)

‘Urf (Custom)
The legality of Istisna’ is based on a custom which prevailed from the time of the
Prophet s.a.w and is also justified having regard to the need of people.

Istihsan (legal preference)

44
 Basic rules & conditions of an istisna contract

1. The object to be manufactured must be precisely determines in its type, kind,

quality and quantity.
2. The object in an istisna contract must be something that the people familiar with
to contract it on the basis of an istisna contract.(i.e building houses, shoes and
heavy vehicles).
3. Delivery of manufactured object must be clearly specified to avoid uncertainty and
ambiguity which may lead to a later dispute among transacting parties.
4. The place of delivery should be specify.
5. The material of object must be from the manufacturer, if it is provided by the
customer, it would be a contract of Ijarah

45
 Modern Applications of Istisna’
• Islamic banks finance the construction of houses or factories on a piece of land
belonging to client. The house or factory is constructed either by the financier or
by the construction company.

• The financier for the purpose of construction is under obligation to construct

house in conformity with the specifications detailed in the agreement.

46
 Modern Applications of Istisna’
 If the financier assigns the task of construction to a third party, it is necessary that
it should supervise construction work in a regular manner

 The price of construction may be paid by the client at the time of agreement and
may be postponed till the time of delivery or any other time agreed upon between
the parties
 lump sum or installments

47
BAY AL SALAM

48
 Introduction
• This contract is crucial during the time of Prophethood and also at the time where
agricultural sector become outstanding and supreme.
• The wisdom of making salam permissible lies in the fact that salam facilitates a
type of financing to the people in need of it.
• In particular, farmers, market gardeners and merchants, among others need
working capital for their businesses and for their living expenses in running the
business.
• By using salam contract, the buyer may benefit from its permissibility at a price
below the market price.

49
 Definition
 It’s a sale with postponed delivery of the merchandise but immediate payment of
the price

 The selling of goods and products which normally does not exist with the buyer
during the time of contract such as wheat, cotton and bean

 Opposite of BBA

50
 Definition
 Definition by Muslim Scholars
i. Shafi’is and Hanbalis;
“Salam is a contract over described commodity sold as a deferred liability on
one party, in exchange for a price that is received during the contract
session”.

ii. Malikis’
“A sale in which the capital sum (price) is paid in advance and the object of sale is
deferred to a specified term”.

51
 Legality of Bai Al Salam
Bai al salam derives its legitimacy from the Quran, the Sunnah and consensus of legal
community (ijma);

Al-Quran
“O ye believe! When ye deal with each other, in transactions involving future
obligations in a fixed period of time, reduce them to writing”.
(Surah al-Baqarah, 2:282)

The above verse mentioned the permissibility to trade which involves future
obligations at a fixed period.

52
 Legality of Bai Al Salam
Al-Sunnah
The Messenger of Allah (pbuh) came to Medina and found its inhabitants using
forward (salam) contracts in fruits for one, two and three years. He (pbuh) said:
“Whoever enters into a forward contract, let him specify a known volume and weight,
and a known term, of deferment”
(Narrated by Ibn Abbas)

53
 Pillars of Bay’ Salam
1. Buyer (Rabb-us-salam)

2. Seller (Muslam ilaih)

3. Price (Ra’s-ul-mal)

4. Subject Matter (Muslam fih)

5. Sighah (Ijab & Qabul) – Offer & Acceptance

54
 Conditions of Bai Al Salam
1. Buyer/Seller
• Must possess sound mind (aqil).
• Must be intelligent.

2. Price
• The price has to be paid in full to the seller at the time of the seller at the time of
effecting the sale.
• Spot settlement price must be known to both seller and buyer.

55
 Conditions of Bai Al Salam
3. Subject Matter/Commodity
• The commodity should not yet exist when the finance is provided.
• Must be lawful asset/commodity
• Must be valuable
• Must be able to be delivered by seller to buyer
• The specification of commodity such as type, volume, weight, number, size must
be known to buyer and seller.

56
 Conditions of Bai Al Salam

4.Sighah (Ijab & Qabul)

• Absolute and in definite and decisive language.
• The acceptance must agree with the offer.
• The offer and acceptance must be made at the one and same meeting
or session.
• The exact date and place of delivery must be specified in the contract.

57
 Objectives of Bai Al Salam
• Provides the financing for small and medium enterprises

• Provides an Islamically accepted financing alternative

• Benefits the purchaser – provide goods and products at a discounted

price

58
 The Disadvantages
Of Bai Al Salam
It’s open for exploitation and for the opportunist to take advantage from the situation
to the extent that it could be considered as illegal for buyers that try to tightly
squeezed the price that the trader need to accept especially those that are really
desperate.

59
 Differences Between Istisna’ And Salam

Keeping in view this nature of istisna’ there are several points of

difference between istisna’ and salam which are summarized below:
i.The subject of istisna’ is always a thing which needs manufacturing,
while salam can be effected on any thing, no matter whether it needs
manufacturing or not.
ii.It is necessary for salam that the price is paid in full in advance, while it
is not necessary in istisna‘.

60
 Differences Between Istisna’ And Salam

iii. The contract of salam, once effected, cannot be cancelled unilaterally,

while the contract of istisna’ can be cancelled before the
manufacturer starts the work.

iv. The time of delivery is an essential part of the sale in salam while it is
not necessary in istisna’ that the time of delivery is fixed.

61
BAY AL-INAH

62
 DEFINITION

• Literal:
– Loan or advanced payment
• Technical:
– The selling of an asset with a mark up price on deferred payment,
with the intention to sell the same asset to the debtor with lower
cash price, which is meant to settle his debt.

63
 DEFINITION
• Imam al-Shafii:
– It is a credit purchase of an asset which is later sold to the original
owner or a third party, whether at a deferred or spot , higher or
lower price than the first contract, or for an exchange of goods.

• Ibn Qudamah:
– It is a sale of an asset with a deferred price, and buys back the
same asset at a lower price.
• It is a bargaining (musawamah) sale and purchase contract i.e.
without disclosing or referring to what the cost price is.
• Bay` al-`Inah conceptually refers to a sale of an asset, which is later
repurchased at a different price, whereby the deferred price is
higher
64
than the cash price.
 EVIDENCES

• Hadith:
– Rasulullah (s.a.w) has ordered Amru ibn al As to prepare the army
for the battle. He then purchased a camel in exchange for a
delayed payment of 2 camels.
(Narrated by al-Bukhari)

65
 EVIDENCES

• Muslim scholars:
– Permissible based on analogy, the contract is similar to other sale
and purchase contracts i.e. the transfer of ownership is taken
place.
– The majority view that such a sale is forbidden. They are Hanafis,
Malikis, Hanbalis and some Shafi’is.
– Imam Shafi’i, Abu Yusuf, Abu Daud and Abu Thur are of the view
that this contract of sale is not contrary to Shariah principles.

66
 PILLARS OF BAY’ AL-’INAH

• Seller and buyer

• Merchandise/goods
• Price
• Sighah

67
 FLOWS OF BAY’ AL-’INAH

3)Pay cash money

Price

A B

1) Sell Asset in 2) Buy back Asset in cash

deferred
payment

Asset

68
 CONDITIONS OF BAY’ AL-’INAH

• Shariah Advisory Council of Bank Negara Malaysia resolved that bay’

al-'inah is still necessary in Malaysian context.
• However market player are required to strengthen and enhance
their operational process and documentation to comply with the
features of bay’ al-'inah permitted.
• Bay’ al-'inah is permissible subject to the following condition:
– The transaction of al-’inah must strictly follow the mechanism
which is accepted by the Shafie school
– The transacted item must not a ribawi item
– The buyer must receive (take possession) the good before selling
it back to the original seller
69
 OPINION OF SCHOLARS

• Scholars are divided into two group:

1. Those that prohibit
• Majority of the scholar including Hanafi, Maliki and Hanbali
prohibit al-’inah transaction
• The same result adopted by the Shariah council of AAOIFI and
majority of Shariah Advisory Council in Malaysia and Brunei.

2. Those that permit

• Includes Imam Shafie and supported by Ibn Hazm and Shariah
Advisory Council of Bank Negara Malaysia
 JUSTIFICATION OF THOSE THAT PROHIBIT

• It is hilah to riba
• The underlying issue on bay’ al-'inah is the difference between the
muqtada al-’aqd  and the actual motive of the contracting parties,
whether to have a real contract of sale or as hilah for liquidity or
monetary purposes.
• The polemic in the issue of permissibility of bay’ al-'inah is the status
of hilah.
• As far as hilah is deemed as demeaning the religion, bay’ al-'inah will
not be acceptable.
• However, if hilah is regarded as a mode to solve problems (makhraj)
that is much needed by the people, bay’ al-'inah transaction may be
acceptable.
71
 JUSTIFICATION OF THOSE THAT PERMIT

• Shafii approved bay’ al-'inah as financing mode

• A sale which is followed by a subsequent sale but without any
intention to have al-'inah arrangement.
• Al-’Inah that involves two contracts of sale in which the price
of each contract (either cash or deferred) is similar to the
other.
• Al-’Inah which is concluded on an asset with a gap of time
between the two contracts, the purchase and sale contracts.
• Al-’Inah which is concluded on an asset which has changed in
certain aspect.
72
 APPLICATION

• Bay’ al-'inah has been used to construct numerous financing

product offered by the bank in Malaysia:
– Personal financing
– Working Capital Financing
– Istisna’ between 2 parties
– BBA financing products
– Islamic credit card
– Sukuk BBA
– Sukuk Murabahah
– Islamic Overdraft
–73 Murabahah Trade Financing
BAY AL TAWARRUQ

74
 DEFINITION

• Literal:
– Minted silver; seeking silver money
• Technical:
– Buying a commodity with deferred payment and selling it to a
person other than the buyer for a lower price with immediate
payment.
– Purchasing a commodity on credit and selling it to a person other
than the initial seller for a lower price on cash
• Tawarruq is a term commonly used by Hanbali school of law
• Other school mention the form of tawarruq under the rubric
or bay’ al-ajal and bay’ al-’inah
75
 EVIDENCES

• Qiyas:
– Permissible based on analogy, the contract is similar to other sale and purchase
contracts i.e. the transfer of ownership is taken place

76
 PILLARS OF BAY’ AL-TAWARRUQ

• Original seller
• Final buyer
• Mutawarriq (Customer)
• Wariq (Cash/money)
• Commodity

77
 CONDITIONS
OWNERSHIP
OF THE
COMMODITIES
AVOIDING COMMODITY
USURY IS SPECIFIED

DETAILS OF AVOIDING
THE TIME OF INAH SALES
PAYMENTS
DELIVERY IS
IMMEDIATE

78
 TYPES OF AL-TAWARRUQ

79
 TYPES OF TAWARRUQ

80
MODUS OPERANDI OF TAWARRUQ AL-FARDI

1
MUTAWARRIQ ORIGINAL SELLER
(CUSTOMER) (BANK)
2

3
4
FINAL BUYER

81
 FLOWS OF BAY’ AL-TAWARRUQ

CUSTOMER
(Mutawarriq)

1 3 5 6

BANK

2 4

Original seller Final buyer

82
CONDITIONS OF BAY’ AL-TAWARRUQ
CONDITIONS OF BAY’ AL-TAWARRUQ
 APPLICATION

• Tawarruq or commodity murabahah as one of the popularly

used principles to structure various Islamic financial
instruments. Below list of some common Islamic financial
instruments that are structured based on tawarruq:
– Commodity murabahah deposit facility and placement
– Personal financing
– Asset financing
– Cash line facility
– BNM Islamic Accepted Bills (IAB)
– Islamic Private Debt Securities (IPDS)
85
BAI AL DAYN

86
 DEFINITION

• Literal:
– Debt, pecuniary obligation, liability or obligation
• Technical:
– An exchange between A payable right upon the person and A
property on the basis of ownership of the price and the right
• Sale of debt which can be either against a debt or other than a
debtor, to the debtor or other than a debtor, on a cash basis
or a deferred payment basis.
• Sale contract in which the creditor sells his payable right upon
the debtor either to the debtor himself or to A third party at
discount price or at cost price on the spot payment basis
87
 EVIDENCES

• Hadith:
– Ibn Umar reported that: One day he came to see the Prophet (saw)
and told him: I sell camel in Baqi’ in dinars (debt) and accept dirhams
(payment), and I sell in dirhams (debt) and accept dinars (payment).
The Prophet (saw) said: It is okay, but you should try to accept it at
the day price for each before you conclude your contract.
• Narrated by Muslim

88
 EVIDENCES

• Ijma’
– Majority of scholars agree on its permissibility because there is no
single nas quoted its prohibition except the prohibition of bay’ al-
kali’ bi al-kali’.
– They hold different views about sale of debt to the third parties on
the ground that the seller will not be able to deliver the sold debt.
• Legality of bay’ al-dayn depends on its types which are
determined by the number of parties involved (whether two
or three), the party to whom the debt is sold (whether to the
debtor or non debtor) and the modes of delivery (on a spot
basis or credit basis)
89
 PILLARS OF BAY’DAYN

• Borrower
• Lender
• Third Party
• Debt
• Sighah (Ijab & Qabul)

90
 CONDITIONS OF BAY’ AL-DAYN

• No delivery risk
• The debt is confirmed and owned
• No element of riba and gharar

92
OPINION OF SCHOLARS
OPINION OF SCHOLARS
 OPINION OF SCHOLARS

95
 APPLICATION

• Bay’ al-dayn has been mainly used in Malaysia as one of the

underlying Shariah contracts in structuring various Islamic
finance facilities including:
– Islamic money markets instruments
– Islamic treasury bills
– Islamic negotiable instruments
– Islamic accepted bills
– Islamic bonds

96
BAY AL SARF

97
 DEFINITION

• Literal:
– sale and purchase of money for money including gold and silver
• Technical:
– Sale of money for money such as the sale of gold-for-gold or silver-for-silver.
• Maliki scholars considers money exchange only if the sale of gold-for-gold or silver-
for-silver but gold for silver does not belong to such transactions.
• Bay’ al-sarf is a sale of something that is price in its own nature for something
which is also a price.
• It is regarded, as the sale of price for price and each price is a consideration for the
other.

98
 EVIDENCE

• Hadith:
– Ubadah ibn Samit narrated that Rasulullah (s.a.w) said that: “Gold for gold,
silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for
salt, should be exchange like for like, equal for equal and hand-to-hand. If the
types of exchanged commodities are different, then sell them as you wish, if
they are exchanged on the basis of hand-to-hand transaction.”
• Narrated by Muslim
• Ijma’
– All Islamic scholars unanimously agree on the permissibility of bay’ al-sarf as it
has been practice by the people since the time of Prophet (s.a.w) until now
without any objections.

99
 PILLARS OF BAY’ AL-SARF

• Seller and buyer

• Merchandise/goods
• Price
• Sighah

100
 CONDITIONS OF BAY’ AL-SARF

101
 CONDITIONS OF BAY’ AL-SARF

102
 BAY’ AL-SARF CONCEPT OF ON FOREX

• Spot Basis
– Practice based on urf (customs)
– An exchange between items which are the same such as currencies with currencies. By
using analogy on the hadith, majority of fuqaha’ agree that all forms of currency should
obey the rules established for gold and silver exchanges
– A consensus among Islamic jurists on the view that currencies of different countries can be
exchanged on a spot basis at a rate different from unity, since currencies of different
countries are distinct entities with different values or intrinsic worth, and purchasing
power.

103
 BAY’ AL-SARF CONCEPT OF ON FOREX

• Forward Basis
– In general, majority of scholars on the view that currency exchange on a forward basis is not
permissible, that is, when the rights and obligations of both parties relate to a future date.
– However, recently the IFI practice bay al-sarf based on waad (promise) or murabahah commodity
1. Waad based using unilateral promise
– The customer promise to purchase/ sell foreign currency with a bank.
– A who is looking for a hedge will provide an undertaking to buy a currency from B in the
future. A is bound to fulfill its promise to B however B is not under any obligation to act on
the transaction when an offer of purchase is submitted.
– Essential elements of the promise include the purchase price of the currency and the
delivery date. The promise must not be conditional on any event.

104
 BAY’ AL-SARF CONCEPT OF ON FOREX
2. Murabahah commodity based
– Customer and bank enter into two separate murabahah transaction to facilitate
forward foreign exchange contract.
– Customer will buy commodity for spot value and sell it to the bank for purchase
price plus agreed profit payable on deferred basis.
– The bank will buy another commodity and sell it to the customer again for the
purchase price plus agreed profit on deferred basis to address the other side of the
forward deal.
– Both the customer and the bank typically will sell the commodity back to the
market to recover their initial investment.

105
 APPLICATION

• Bay’ al-sarf is applicable to modern spot forex which is based

on the spot rate which the deal settlement is expected to be
completed shortly after the contract has been executed.
• Majority of scholars opine that different currencies of different
countries consist of different intrinsic values and purchasing
power.
• There are several IFI offer products construct using bay al-sarf
such as:
– Gold investment savings account
– Shariah compliant forex investment product

106
IJARAH

107
 DEFINITION

• Literally:
– Ijarah came from the root word ‫ أجر‬which means compensation or
‫عوض‬. It also means the sale of usufruct.
• Technically:
– A contract of proposed and known usufruct with a specified and
lawful return or compensation for the effort or work which has been
expended.
– It is used to express the sale (bay’) of a known benefit in return for
its known equivalent.

– Usufruct:
• The usage of shelter for house, transportation for vehicles and others for a fee.
– Services:
• To work using physical energy or skills such as lifting goods, cleaning of office, writing, lecturing, and others
108 for a fee
 NATURE OF AL-IJARAH

• Lease is a contract by which the owner of land, a building

allows another person to use it for a specific time, usually in
return for a rent
• Al-Ijarah means a lease contract as well as a hire contract.
• Al-Ijarah, is also known as al-Kira’. It is like someone who is
selling to someone else a right to benefit or as a payment for
services with a certain price to be paid for it.
• In the context of Islamic banking it is a lease contract under
which the bank or financial institution leases equipment or a
building to one of its clients against a fixed charge.
109
 DIFFERENCES OF OPINION
OPINION REASON

Forbids contract of Some jurist including Ijarah is the sale of usufruct or services, and services is
Ijarah. Hassan al-Basri, al- something intangible and does not exist at the time of contract.
Nahrawani and others
It only can be achieve gradually over certain period and
something that not exist cannot be sold.

It is not permissible to associate bay’ (trade) with something

that could only be realized and achieved in the future

Allowed contracts Majority of jurist Even though usufruct does not exist at the time of contract,
of Ijarah including Ibn Rushd normally it could be realized or achieved

This type of usufruct or benefit could ordinarily be

accomplished, or its accomplishment or non-accomplishment is
rather similar
110
 EVIDENCE

• Quran:
– .

111
 EVIDENCE

• Hadith:
– “Give a servant his fee before his sweat dries up”
– (Al-Baihaqi)
– Reported by Ibn Abbas to the effect that Prophet (s.a.w) had himself
cupped and gave the person who cupped him his remuneration, if it
is prohibited he would not have paid him in the first place.

• Ijma’:
– The ummah had came to a consensus during the time of companion
on permissibility of Ujrah since the need of people for usufruct is
similar to their need to physical good.
112
 PILLARS OF AL-IJARAH

1. Muajjir:
– A person who give something for hire – Lessor, landlord, owner etc.
2. Musta’jir:
– A person who takes on hire – Lessee, tenant, renter etc.
3. Ma’jur:
– A thing given for rent
4. Al-Manfaah:
– The benefit from a thing – usufruct, services etc.
5. Ujrah:
– Price or fee given for the payment of rent or lease
6. Sighah:
113
– Offer (Ijab) and Acceptance (Qabul)
 FLOWS OF AL-IJARAH
• Flows of al-Ijarah (Renting/ Leasing)

Use of Manfaah

IJAB (Offer)

MUAJJIR MA’JUR (THINGS/

ASSET)
MUSTA’JIR
(OWNER)
MANFAAH

QABUL (Acceptance)

Ujrah (Fees/ Rental)

114
 TYPES OF IJARAH

115
 TYPES OF IJARAH
Based on Subject Matter of the Leased Asset
1. Ijarah ‘Ain • To lease the usufruct from the specific goods or asset
• Comprises all tangible assets.
• E.g.: property, transport, facilities and factories, etc.
2. Ijarah ‘Amal • To lease out the works or self skills
• Two type of workers:
1. Employee : person/entity that work only for the interest of a particular
employer or independent contractor; does not have right to work for any
other lessee during contract.
2. Independent contractor: offer services to the general public
• E.g: consultant, lawyer, contractor
3. Ijarah Mawsufah • Form of ijarah where asset need to be described in advance
fi al-Zimmah • The leased item/asset is not available during contract
• The asset must be delivered on a future agreed date
• No requirement should be imposed for the rental payment to be paid in
advance

116
 TYPES OF IJARAH
Based on The Contractual Relationship
1. Operating • Original form of ijarah ‘ain
Lease • Features of operating lease:
• Asset acqusition is in full ownership of the lessor – legal and
beneficial ownership
• Responsibility to maintain bear by the lessor in administrative
affairs and maintenance of asset; lessee only responsible in the
maintenance due to the usage and has to pay rent per agreed.
• Risk on the asset ander liability and responsibility of the lessor
• High risk in nature.
2. Financial Lease • Normally used and offered by Islamic bank as financial
intermediaries in:
• Obtaining desired asset
• Obtaining cash money for various purposes
• Known as al-Ijarah Thumma al-Bay’, al-Ijarah wa al-Iqtina’ or al-Ijarah
Muntahiyah bi al-Tamlik.

117
 CONDITIONS OF AL-IJARAH

• The conditions for Property

1. The property must be belong to lessor
2. The property is known to both parties and is specified
3. The property can be acquired by the lessee for his use until the end
of tenancy or lease
4. The property should be in a good condition possible for leasing
5. It is the liability of the lessor to repair damages of the property in
order to make it possible for leasing
6. It is the liability of the lessee to ensure the cleanliness and safety of
the property

118
 CONDITIONS OF AL-IJARAH

7. The liability of the lessee over the property is under the concept of
trust (wadiah yadd amanah). However, in the case of damages due to
his negligence, the lessee is liable to pay the compensation (dhaman).
8. The lessee cannot lease the property to another tenant and the
second contract is considered as illegitimate.
9. The sale of a lease property is legitimate. However, the lessee has a
right to use the property until the lease contract has expired, where
the property will then be submitted to the buyer.
10.The concept of al-Wadiah is applied when the lease contract has
expired and the lessee is still holding the property.

119
 SUBJECT MATTER OF AL-IJARAH

1. Since Ijarah is the sale of usufruct, majority of jurist forbid Ijarah on

trees and grapevines, since fruit are physical goods and Ijarah is the
sale of usufruct and not physical goods.
2. It is also not permissible to conduct Ijarah on animal for its milk;
ghee, wool or offspring; water in the river or well or canal since all
these are goods, and not eligible to be under contract of Ijarah.
3. It is also not permitted to conduct ijarah on non-arable (not fit for
cultivation) land which have ponds for fishing, canes and wildlife for
hunting since all these are goods. It is not legal to rent pond or lake
for fishing.
4. Basic principle of Ijarah: every item that could be utilized with its
original substance and part consistently being conserved or
preserved is allowed for Ijarah, and if not is not legal.

120
 CONDITIONS OF AL-IJARAH

• The conditions for Usufruct

1. The use of the service (usufruct) can be valued with money.
2. The usufruct must be valid according to Islamic commercial law.
3. The lessee should be able to make use of the property on lease.
4. The usage of the property should be made clear in order to avoid
any argument.
5. The usufruct does not entitled the lessee to own the property.
6. The lessee is not obliged to inform the lessor his intention for using
the property, except in the case of possible destruction.
7. The usufruct of property beyond its normal usage is considered as
an act of intention.
121
 CONDITIONS OF AL-IJARAH

• The conditions for Payment

1. The amount of payment of rent must be known. If the payment is
not in form of cash money, the goods in return must be specified
its quantity, types and its characteristics.
2. The payment of rent can be made in advance.
3. If the condition for payment does not prescribed to be paid in
advance, the payment begins when usufruct started.
4. If the payment is made on daily, weekly or monthly basis, the
payment should be made at the end of period unless otherwise
stated on the agreement.
5. If the property cannot be used the payment is not obliged upon the
user.

122
 CONDITIONS OF AL-IJARAH

• The conditions for Sighah

– The contract of offer and acceptance should follow all the conditions
of the contract of sale in Islam; i.e. it should be on mutual
acceptance, cannot be made in form of promises or an order and the
offer and acceptance should be the same.

123
 DIFFERENCES BETWEEN IJARAH & NORMAL SALES

IJARAH ELEMENT NORMAL SALES

Based solely on a predetermined DURATION Does not permit any time frame
time frame as part of the
requirement of the contract

A temporary contract with a NATURE A permanent contract without any

specified time frame for its expiry specified period of expiration
and due time

No transfer of ownership OWNERSHIP Transfer of ownership occurs

Usufruct and services SUBJECT Physical Goods and property

124
 MODERN APPLICATION

1. Simple ijarah
2. AITAB
3. Musharakah mutanaqisah
4. Ijarah based credit card
5. Sukuk ijarah
6. Ijarah rental swaps

125
PARTICIPATING CONTRACTS

126
 Profit Sharing Contract
MUDHARABAH

127
 Introduction

• Mudharabah concept is frequently used to portray an investment

concept in Islam.

• However, this concept is used for the purpose of financing.

• In fact, it is more suitable to be used for the purpose of financing in the

Islamic bank’s practice for banking industry and therefore, can do away
with conventional banking concept that promotes debt financing which
is not a customer friendly service.

128
• Literally : Increase or profit
Definition

• Technically : Contract for sharing the profit of a business in which one

party contributes with capital and other with his labour

129
 Legitimacy of Mudharabah
Established by the Qur’an, the Sunnah and Ijma’

Al-Qur’an
“And others who journey through the earth seeking the bounty” .
Al-Jassas explains that they seek bounty of Allah through trade and
disposition

130
 Legitimacy Of Mudharabah

Hadith:
Hadith Hakim bin Hizam
• Nabi s.a.w is reported to have said :
“There is great blessing in three things : the credit sale, the mudharabah
and mixing wheat and barley for domestic consumption, not for sale”

• Nabi s.a.w himself acted as mudharib (agent/manager) for Saidatina

Khadijah prior to his marriage.

131
 Essential Elements of Mudharabah
• Sahibul mal/Rabb al mal (Capital provider)
• Mudarib (Entrepreneur)
• Ra’sul mal (Capital)
• Al-’amal (Project/Work)
• Ribh (Profit)
• Sighah (Ijab & Qabul) – Offer & Acceptance

132
 Capital Provider & Entrepreneur
1. Capable of taking responsibility.
a) Sound mind
b) Attain the age of puberty
c) Have reached majority – able to manage their own affairs.
2. Not prohibited from dealing with their property.
3. No coercion is exerted among them.
4. Capable of appointing agent & be appointed as agent.

133
 Capital

1. Involve money only.

2. Not debt.
3. Specific amount.
4. Owner’s capital only.
5. Paid to entrepreneur

134
 Business/Project

1. Halal
2. Managed by entrepreneur

135
 Profit-Sharing

1. Shared according to agreement in fraction, ratio or

percentage, not in absolute amount.
(i.e. 80:20, 70:30)
2. Loss is to be borne by owner of capital.

136
 Sighah/Contract

1. In definite and decisive language.

2. Acceptance must agree with the offer.
3. The offer and the acceptance made at the one and the same
meeting.

137
 Categories of Mudharabah

MUTLAQAH (UNRESTRICTED) MUQAYYADAH (RESTRICTED)

The capital provider authorize the The capital provider makes certain
entrepreneur to act completely at the limitations to the activities to be
latter’s discretion in all business matter. conducted by the entrepreneur with
regards to the capital given.

The entrepreneur may buy/sell all types Also limitations in terms of kind of goods
of merchandise as he sees fit, hire helpers or person with whom trade may be
as needed, rent equipment and travel conducted.
with the equipment.

138
 Dissolution of Mudharabah
1. Unilateral termination
Any partner can terminate it unilaterally provided the other partner is made
known of this decision

2. By expiry of fixed time

If the mudharabah was for a fixed time, it will be terminated on the expiry
of that period

3. By death of any of the partners

4. By insanity of any of any the partners

139
 Dissolution Of Mudharabah

5. By disregard of express direction

The working partner is under the obligation to abide by direction of financing
partner in a restricted mudharabah. Thus if he does not comply with these
instructions the mudharabah will be dissolved by virtue of the breach of trust
on which mudharabah stands.

6. By destruction of capital
The agent will not be held liable for this destruction if he exercised maximum
care. But if it is destroyed due to his negligence or by some action on his part,
then he is responsible.

140
 Profit & Loss Sharing Partnership
MUSYARAKAH

141
 Definition

• Literally:
Intermingling of properties whereby one can’t be differentiated from
the other

• Technically:
A form of partnership where two or more persons combine either
capital or labor or creditworthiness together to carry on a business
venture on a condition that they will share the profits, enjoying similar
rights and liabilities

142
 Legitimacy Of Musyarakah

• Hadith Qudsi :
“I am the third in the partners as long as there is no
defector. If one of the partners does betray the other, I
cease to be the partner to them”.

(Hadith reported by al-Saib al-Makhzumi r.a)

143
 Musyarakah (Modus Operandi)
CAPITAL
Provide Capital Provide
Partner
capital
Partner

MANAGEMENT

Profit Losses
• Shared between the partners • Borne by the partners
• Profit sharing according to a according to capital
contractually agreed ratio contribution
• Profit sharing cannot be a fixed
amount/a fixed percentage of capital
contribution
144
 Essential Elements

1. Syuraka’ (Partners)

2. Ra’sul mal (Capital)

3. Mashru’ (Project/Business)

4. Ribh (Profit)

5. Sighah (Ijab & Qabul)

145
 Partners

1. Capable of taking responsibility.

a) Sound mind
b) Attain the age of puberty
c) Have reached majority – able to manage their own affairs.
2. Not prohibited from dealing with their property.
3. No coercion is exerted among them.
4. Capable of appointing agent & be appointed as agent.

146
 Capital

1. Any asset valued in money.

2. Not debt.
3. Specific amount.
4. From all partners.
5. Paid into capital fund.

147
 Business

1. Halal business
2. Managed by all partners.

148
 Profit Sharing

1. Profit shared according to agreement in fraction, ratio or

percentage, not in absolute amount.
2. Loss to be borne by all partners according to the proportion
of shares/equity.

149
 Contract

1. In definite and decisive language.

2. Acceptance must agree with the offer.
3. The offer and the acceptance made at the one and the same
meeting.

150
 Comparison
Mudharabah Musyarakah

The capital is financed by one party which is the The capital is financed by all the shareholders
capital provider or the owner of the business. according to the proportion agreed upon by all the
parties.

The capital must be in the form of cash money. Any type of property that could normally be
assessed and have certain commercial value could
be considered as an acceptable source of capital
e.g intellectual capital

151
 Comparison-cont’d
Mudharabah Musyarakah

The entrepreneur will be the only one that conduct All the shareholders have the right to work and
the actual business. contribute their skills, knowledge, experience and
expertise in the company.

The monetary loss will be solely borne by the The monetary loss will be jointly borne by all the
capital provider while the entrepreneur will only shareholders according to the ratio and proportion
suffer from a fruitless effort without having to bear of their respective share in the partnership.
all the capital losses.

152