Understanding Islamic Finance - Doha Academy of Tertiary Studies

362 Understanding Islamic FinanceBox 14.1:(Continued)Features Salam Istisna‘a Musharakah/MudarabahPeriod Short-term Short/long-term Short/long-termRate Fixed Fixed VariablePrepayment allowed No May be structured YesRisk of the asset Financier/customer Customer/financier JointUses Salam compatible Assets to bemanufacturedAny HalalbusinessLate payments Loss to the bank Controllable No issueBox 14.2:Example of Using Salam and Murabaha CombinedAn Islamic bank can purchase cotton on the basis of Salam from growers whileoperating in the agricultural finance sector. In order to sell the cotton, it can takepromise from a textile mill that it will purchase the cotton against an agreed price.Once the cotton is ready for delivery, the bank may appoint the textile mill its agentto take delivery of the cotton from the grower. When the mill informs the bank thatit has taken delivery, the bank may sell the same to the mill (the promisor) for thealready agreed price under a Murabaha transaction.The product is beneficial to the farmer as he gets cash for the future produceand manages the risk of a fall in price or his inability to market the cotton at theharvest time.The product is beneficial to the bank for the following reasons: funds are deployedfor an extended tenure, with exposure on two different customers in different sectors;thus, risk is minimized. In a Salam transaction, a bank may end up with inventory,which creates problems for the bank. However, under the proposed structure, allproblems related to inventory will be resolved. If structured properly, the bank canearn a better margin on the transaction.The product is also beneficial to the textile mill as the mill can shield itself fromprice fluctuation in the cotton season. It is a hedging mechanism for the mill.14.3.3 Tenor of FinancingAnalysis of the cash flow of the customer is extremely important in Islamic banking fordeciding the tenor of financing for any client. In conventional banking, bankers and customersfocus on interest rates and obtain financing even in scenarios where the cash flows of theproject mismatch with the repayment capacity. The customers believe that they will manageit through rollovers and other related facilities. Although this approach is not consideredprudent, even according to the rules of conventional finance, it can work in individual cases.