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Contracts and Deals in Islamic Finance: A User’s Guide to Cash Flows, Balance Sheets, and Capital Structures

Contracts and Deals in Islamic Finance: A User’s Guide to Cash Flows, Balance Sheets, and Capital Structures

Hussein Kureshi, Mohsin Hayat

ISBN: 978-1-119-02058-5

Dec 2014

300 pages



A very accessible and concise guide to Islamic finance

Contracts and Deals in Islamic Finance provides a clear breakdown of Islamic financial contracts and deal structures for beginners. The embedded requirements within selected Islamic financial contracts, such as risk weightage, capital structures, creations of cash flows, and balance sheets, are explained fully to provide a solid understanding of the backbone of the industry. Aimed primarily at beginners and those with a background in conventional banking, this book guides readers through the major contracts, how they're applied, and how to discern a contract's legitimacy. Case studies and interviews with bankers and global regulators provide real-life examples of contract application, and the author's own experiences provide deep insight into the everyday issues that arise. Ancillary instructor's materials include PowerPoint slides and lecture notes that facilitate use in the classroom.

Literature describing the application of Islamic financial contracts is few and far between, and those providing a basic breakdown of these contracts and questioning their validity are rarer still. This book is the first of its kind, offering a basic approach to understanding Islamic contracts, designed for the true beginner.

  • Understand the current contracts applied in Islamic banking
  • Learn how contracts are applied across different jurisdictions
  • Identify illegitimate contracts and those not in the spirit of Shariah law
  • Examine the current economic realities surrounding Islamic finance

By highlighting the underlying themes in Islamic finance and assessing the current practices, this book gives readers the solid understanding and up-to-date perspective that form a solid foundation upon which successful Islamic finance is practiced. For a solid introduction to the Islamic finance industry, Contracts and Deals in Islamic Finance is an accessible, practical guide.

Related Resources

Foreword xv

Preface xvii

Acknowledgments xxi

Product Offerings xxiii

Introduction 1

CHAPTER 1 The Islamic Finance Space 5

Modern Phase of Islamic Finance 8

CHAPTER 2 Bai al Inah 13

Definitions of Bai al Inah 13

Bai al Inah Process Flow 15

Legal Issues with Bai al Inah 17

Bai al Inah as a Financial Product 19

Transfer of Ownership 20

Documentation Involved 21

Resolutions on Bai al Inah 21

Conclusion 22

CHAPTER 3 Murabahah, Bai Mu’ajjal, and Bai Bithman Ajil 23

Murabahah Sale/Credit Sale/Credit 25

Enhancements to Murabahah 26

Murabahah Working Capital 28

Credit-Based Sale/Markup or Riba 28

Bonafide Murabahah/True Sale 29

Trading House Model 31

Financial Services Division of a Manufacturer or Retailer 32

Bai Bithman Ajil 32

BBA with Inah 32

Conclusion 34

CHAPTER 4 Tawarruq 35

Issue of Price Fixing 37

Transfer of Title 38

Payment of Sales Tax 39

Applications of Tawarruq in Banking Products 40

Real Economic Activity 43

Conclusion 44

CHAPTER 5 Deferred Payment Sale or Credit Sale 45

Accounting Entries for Murabahah by Purchase Orderer 47

Accounting Entries for a Bai al Inah Contract 48

Pricing of Deferred Sales under Murabahah, BBA, Inah, and Tawarruq 49

Risk Treatment of Deferred Payment Sales 53

Fixed Income Portfolio 57

Conclusion 58

CHAPTER 6 Bai Al Wafa 59

Financial Assets as Subject of Sale 60

Bai Al Wafa and Sale of Equities 60

Bai Al Wafa and Sale of Sukuk 60

Conclusion 61

CHAPTER 7 Salaam and Istisna: Deferred Delivery Sale 63

Salaam 63

Istisna 68

Conclusion 70

CHAPTER 8 Bai al Sarf 75

Basic Rulings on Bai al Sarf 75

Conclusion 77

CHAPTER 9 Bai al Dayn 79

Purchase Price, Rental Payments, Receivables, and Debt 80

Rental Payments Due in an Ijara Contract 81

Financial Products 81

Sale of Equity 82

Conclusion 83

CHAPTER 10 Bai al Urbun 85

Conclusion 89

CHAPTER 11 Ijarah and Its Variants 91

Normal Ijarah 92

Accounting Entries for Ijarah Contract 93

Ijarah Muntahiya Bi Tamleek 95

Al Ijarah Thumma al Bai (AITAB) 95

Sale and Leaseback 96

Conclusion 97

CHAPTER 12 Wadiah 99

Forms of Wadiah 100

Enhancements to Wadiah 100

Money Creation 104

Conclusion 108

CHAPTER 13 Qard 111

Applications of the Contract of Qard 112

Qard as a Deposit Instrument 113

Recording of Qard 113

Conclusion 114

CHAPTER 14 Mudharabah 115

Simple Application of Mudharabah 117

Perpetual Mudharabah 118

Re-Mudharabah 118

Restricted Mudharabah and Unrestricted Mudharabah 118

Mudharabah as a Deposit 120

Mudharabah as a Fund 121

Interbank Mudharabah Placements 122

Indicative Rate of Return 122

Profit Sharing Ratio 123

Importance of Disclosure and Accounting Treatments 123

Mudharabah as an Asset Product 124

Accounting Treatment of Mudharabah Transactions 126

Conclusion 126

CHAPTER 15 Musharakah 129

Musharakah and Banking 130

Mushrakah as Asset Product 132

Pooling of Assets in Mushrakah 132

Mushrakah Mutanaqisah 133

Conclusion 138

CHAPTER 16 Hibah 139

Forms of Hibah 139

Restrictions on Hibah 140

Applications of Hibah in Banking 140

Enhancements to Hibah 142

Conclusion 143

CHAPTER 17 Kafalah 145

Who Can Be a Guarantor? 147

Products Based on Kafalah 148

Back-to-Back Guarantees 148

Conclusion 149

CHAPTER 18 Wakalah, Hawalah, Ibra, and Rahn 151

Wakalah 151

Hawalah 153

Ibra 156

Rahn 159

Conclusion 161

CHAPTER 19 Shariah: Sources, Interpretation, and Implementation 163

Modern-Day Ijtihad 165

Whose Shariah Is It, Anyway? 167

Conclusion 171

CHAPTER 20 Islamic Asset Management and Shariah Screening 173

Capital Markets 177

IPO Stage 177

Market Integrity 180

Market Regulation 183

Valuations 187

Zero Sum Game 188

The Role of Capital Markets in the Sphere of Islamic Finance 189

Farmer Sukuk or Equity Notes 189

Conclusion 190

CHAPTER 21 Pricing, Income Distribution, and Risk Sharing in Islamic Banks 191

Pricing of Islamic Financial Products 191

Price versus Shariah 194

Benchmark for Pricing 195

Criticism on Pricing Models 195

Profit Equalization Reserve 196

Income Distribution 199

Risk Sharing in Islamic Banks 208

Conclusion 208

CHAPTER 22 Sukuk and Rights of Sukuk Holders 209

Rights of Lenders in Debt Financing 210

Rights of Equity Holders 212

Rights of Bondholders 214

Use of Subsidiary Companies and Special-Purpose Vehicles 216

How Sukuk Financing Could Work? 221

Sale and Leaseback 223

The Role of the SPV 227

Other Sukuk Structures 228

Istisna Sukuk 228

Simple Sukuk 229

Conclusion 233

CHAPTER 23 Risk Management for Islamic Banks 235

Credit Risk 235

Market Risk 257

Liquidity Risk 269

Profit-Sharing Investment Account 269

Conclusion 273

References 273

CHAPTER 24 Asset/Liability Management for Islamic Banks 275

Gap Limit 279

Spot Rates and Forward Rates 279

Funding Scenarios 281

Short-Term and Long-Term Rates 281

Time Value of Money 288

Conclusion 290

CHAPTER 25 Takaful 291

Contract of Agency 291

Shariah Issues with Insurance 292

Contract of Tabarru 293

Product Menu 295

General Takaful Business Model 300

Concepts Related to Takaful 300

The Rights of the Fund over the Participant and the Rights of the Participant over the Fund 302

Pricing General Takaful Plans 304

Observations of General Takaful 310

Family Takaful 311

Basic Accounting Entries for Takaful 314

Takaful Operator Models 315

Distribution of Underwriting Surplus 316

Conclusion 317

CHAPTER 26 Pricing of Takaful Policies and Retakaful 319

Case Study 1: Corporate Medical Takaful Plan under General Takaful 319

Case Study 2: Corporate Medical Takaful Plan under General Takaful 322

Case Study 3: Corporate Family Takaful Plan 323

Detailed Mortality Table for Life Takaful 325

Mortality Tables and Probability Calculations 327

Risk Profiling 331

Conclusion 336

Afterword 337

About the Authors 341

Bibliography 343

Index 347