KEY ISLAMIC FINANCIAL TERMS
By: ZEESHAN AHMED KHAN
and SYED MUJTABA ZAFAR
Aug 15 - 21, 2005
* BAI SALAM
A sales contract where the buyer pays in advance for the goods, which are delivered in the future. This type of financing is most often used when a manufacturer needs capital to manufacture a final product for the buyer. In return for paying in advance, the buyer receives a more favourable price (i.e. splits the profit margin with the manufacturer).
* BAI MUAJJAL (DEFERRED PAYMENT CONTRACT)
A contract involving the sale of goods on a deferred payment basis. The bank or provider of capital buys the goods (assets) on behalf of the business owner. The bank then sells the goods to the client at an agreed price, which will include a mark-up since the bank needs to make a profit. The business owner can pay the total balance at an agreed future date or make installments over a pre-agreed period. This is similar to a Murabaha contract since it is also a credit sale. There is a financial institution in Malaysia that offers an Islamic Visa card based on this type of contract.
Deception through ignorance by one or more parties to a contract. Gambling is a form of gharar because the gambler is ignorant of the result of the gamble. There are several types of gharar, all of which are haram. The following are some examples:
- Selling goods that the seller is unable to deliver;
- Selling known or unknown goods against an unknown price, such as selling the contents of a sealed box;
- Selling goods without proper description, such as shop owner selling clothes with unspecified sizes;
- Selling goods without specifying the price, such as selling at the 'going price';
- Making a contract conditional on an unknown event, such as when my friend arrives if the time is not specified;
- Selling goods on the basis of false description;
- Selling goods without allowing the buyer the properly examine the goods.
* IJARA (LEASING)
A contract where the bank or financier buys and leases equipment or other assets to the business owner for a fee. The duration of the lease as well as the fee are set in advance. The bank remains the owner of the assets. This type of contract is a classical Islamic financial product.
* IJARA WA IQTINA (LEASE TO PURCHASE)
The same as ijara except the business owner is committed to buying the equipment at the end of the lease period. Fees previously paid constitute part of the purchase price. This type of lease to purchase agreement is commonly used for home financing.
* ISTISNA (PROGRESSIVE FINANCING)
A contract of acquisition of goods by specification or order where the price is paid progressively in accordance with the progress of a job. An example would be for the purchase of a house to be constructed, payments are made to the developer or builder according to the stage of work completed. This type of financing along with bai salam are used as purchasing mechanisms, and murabaha and bai muajjal are for financing sales.
* MURABAHA (COST-PLUS FINANCING)
A contract of sale between the bank and its client for the sale of goods at a price plus an agreed profit margin for the bank. The contract involves the purchase of goods by the bank which then sells them to the client at an agreed mark-up. Repayment is usually in installments.
* MUDARABA (TRUST FINANCING)
This is an agreement between two parties, one provides 100% of the capital for a venture and the other, known as the mudarib, manages the venture using his/her skills. Profits from the project are distributed according to a pre-agreed ratio. Losses are borne only by the provider of the capital while the mudarib looses his/her time, effort, and the chance for a reward. Management is provided by the mudarib only. The mudarib does not share the loss for the simple reason being in Islam, one cannot loose what they did not contribute. This is one of the most common modes of Islamic financing.
* MUSHARAKA (PARTNERSHIP FINANCING)
This is a classical partnership agreement. All parties involved contribute to towards the financing of a venture. The parties share profits on a pre-agreed ratio while losses are shared according to each parties equity participation. Here again the reason is because in Islam, one cannot loose what they did not contribute. Management of the venture is carried out by all, some, or just one party member.
* QARD HASSAN
An interest-free loan given for either welfare purposes or for fulfilling short-term funding requirements. The borrower is only obligated to repay back the principal amount of the loan.
This term literally means an increase or addition. Technically it denotes any increase or advantage obtained by the lender as a condition of the loan. Any risk-free or "guaranteed" rate of return on a loan or investment is riba. Riba, in all forms, is prohibited in Islam. In conventional terms, riba and "interest" are used interchangeably.
Islamic law derived from three sources - the Quran, the Hadith, and the Sunnah.
This is a form of Islamic insurance based on the Quranic principle of Ta'awon or mutual assistance. It provides mutual protection of assets and property and offers joint risk sharing in the event of a loss by one of its members. Takaful is similar to mutual insurance in that members are the insurers as well as the insured. Conventional insurance is prohibited in Islam because its dealings contain several haram elements including gharar and riba, as mentioned above.