Understanding Islamic Finance - Doha Academy of Tertiary Studies

Financing Principles and Practices 361• Ijarah: Islamic banks purchase nonconsumable assets and give them on lease, getting riskand reward of the ownership of the assets; conducive to the formation of fixed assetsand medium- and long-term investments; the bank is an “accumulator” (if it keeps theassets in its ownership) or “distributor” (if it transfers the ownership and risks throughsecuritization); return can be fixed or floating but asset-related risks remain with the bankuntil the termination of Ijarah. Ijarah is most suitable for financing the public sector andbig corporations, provided they have unencumbered useable assets, and this is possiblethrough the issuance of Ijarah certificates and Sukuk.• Salam: a forward sale with prepayment in full; fulfils the seller’s needs by providinghim funds that he may use anywhere and offers the buyer a profitable business asset.It has vast potential, particularly in agriculture, agro-based industries and financing ofoverhead expenses of trade and industry; can be used for short- and, in selected cases,for medium-term financing.• Istisna‘a: also a forward sale with an order to manufacture or construct an asset withgiven specifications. It has the flexibility of payment of price, which can be immediate,deferred or in instalments. As manufacturing or construction also depends on the personaleffort and commitment of the seller/manufacturer, Istisna‘a has an additional flexibilityfor controlling any delay in delivery of the asset by the seller.• Musharakah/Mudarabah: particularly suitable for consignment-based trade transactions,for short-, medium- and long-term project financing, import financing, preshipmentexport financing and working capital financing. Project financing can be conducted underMusharakah through the issuance of TFCs or Sukuk.• Diminishing Musharakah: for financing of fixed assets like houses, motor vehicles,machinery, etc. In particular, it is suitable for financing the purchase, construction andrenovation of houses and commercial buildings. It may also involve “sale and leaseback”arrangements in cases where the property is already in the ownership of thecustomer.Box 14.1:Salient Features of Major Modes of FinancingFeaturesDiminishingMusharakahIjarahMurabahaPeriod Long-term Long-term Short/long-termRate Fixed/variable Fixed/variable FixedPrepayment allowed Yes Yes Not allowed as asystemRisk of the asset Joint Financier Financier/customerUsesNonconsumable Nonconsumable Any Halal assetsassetsassetsLate payments Controllable Controllable Loss to the bank