My foray into Islamic banking has brought me face to face with some complicated transactions. I have learned a great deal, for example, from having to structure complex financial deals in ways that avoid interest and satisfy other requirements of Sharia.
At times, conventional banks taking part in a Sharia-compliant transaction in a co-financing environment made the task difficult by demanding the elimination of certain clauses in financing agreements based on core Sharia principles.
Sharia offers endless opportunities to create financing structures that can facilitate complex transactions and also ensure the needs of all parties involved are satisfactorily met.
This is in contrast to conventional banking practices. There has been little in the way of true innovation where conventional banking practices are concerned since they took shape about 200 years ago. Each and every conventional banking product, no matter how it is labelled, centres around the underlying loan and interest.
Islamic banking is barely 30 years old. We are just beginning to grasp its full potential as a way to help corporations, entrepreneurs and individuals attain their financial goals.
To understand this, we need to take a closer look at how Sharia shapes Islamic banking procedures and practices. We need to then compare this to the banking practices prevailing elsewhere. This comparison will demonstrate the following Sharia principles are free from exploitative practices and work well for both individuals and businesses.
Any financing transaction conducted by a conventional bank invariably results in an interest-based debt. Under the Islamic modes of financing, there are two basic types of contracts the contracts that create a cost-free debt borne by the client, and the contracts where the bank invests its own equity through or with the client.
Some examples of the first type are:
Bai Muajjal: the sale of goods or assets owned by the bank to a client on deferred payment basis. It is not necessary for such sales to result in a profit for the bank.
For example, a previously-leased car is re-possessed by an Islamic bank. It is sold on a deferred payment basis to a third party at a price that may not cover its cost, let alone allow for a profit. This transaction will create a debt in the bank's favour, however. The debt will remain cost-free until it is paid, even if the payment is made by the purchaser beyond the due date.
Bai Murabaha: the sale of goods or assets on a deferred payment basis at cost, plus profit. The items sold under Murabaha are bought by the bank from a third party supplier at a client's specific request. While the supplier is paid by the bank upfront, the client will become indebted to the bank.
Bai Istisna: this is the sale of an asset to be built or developed by the bank and sold to the client at a profit on a given date. The sale price will be a debt borne by the client from the day the Bai Istisna contract is signed by him with the bank. He can repay the debt either while the asset is being developed or after the delivery of the asset, as per mutual agreement.
Bai Salam: The bank purchases certain goods from the client by making an upfront cash payment, with the delivery by the client deferred to a future date. In this unique structure, the client is indebted and will make payments to the bank with goods, rather than cash. This is called Dain Aini, whereas the other three structures are termed as Dain Naqdi in Sharia.
The writer is the vice-president, Sharia structuring, documentation and product development, Dubai Islamic Bank.
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