Islamic Finance - Ensuring the Viability of the Islamic product of Choice
The transfer of the title must be carried out independently of the Ijarah contract in order to make these two contracts into a workable and legal product. The transfer of title will not be impacted by the simple act of signing the Ijarah contract, unlike with a traditional hire buy. When the transfer of title is desired, another contract must be signed. In addition, a sale undertaking, or Wa'd (unilateral pledge by one party to sell), is included to make this product marketable and equivalent to a traditional hire buy agreement. When the lessee/user exercises an option, the lessor/owner agrees to sell the leased vehicle to the lessee. This is done in order to preserve the role of "option" in traditional hire buy. The financier/owner will be compelled to sell the leased asset as and when the customer/user requests it under a selling undertaking. Additionally, if he doesn't make the agreed-upon rental payments, the customer/user will grant his Wa'd to buy the leased asset back. He is bound by this Wa'd. Ijarah muntahia bi tamleek (lease ending with ownership) or Ijarah Thumma al-Bay (lease followed by a sale), also known as Islamic hire and purchase, is an example of an Islamic financial product that demonstrates how traditional contracts can be linked to more advanced and modern Islamic financial products. Simple contracts include those for a lease, sale, or commitment. However, when they are merged for a specific purpose, they create a new product that is more pertinent to the present market and helps buyers, in this case, buy vehicles in accordance with Shari'ah principles.
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Islamic Finance – Choosing the correct Islamic Contract in Hire Purchase
leasing or ijarah Insofar as it permits the transfer of the right to use an item without transferring ownership to the user or the lessee, the Islamic contract of Ijarah effectively satisfies the requirements of leasing. To fulfill the objectives and characteristics of a traditional hire buy, however, and to permit the transfer of ownership when the lease term is up, a different contract is required. In order to enable the efficient transfer of the title of the leased asset to the customer/user of the usufruct, further search must be conducted to identify a contract or contracts to complement the Ijarah contract. Ijarah muntahia bi tamleek, also known as title transfer Sales, gifts, and waivers are just a few of the contracts that can legally and effectively transfer ownership from one party to another under Islamic commercial law. Therefore, a lender under Islamic hire purchase may arrange for the sale of the leased vehicle or arrange for its gifting to the customer/user at the conclusion of the lease period. According to Shari'ah Standard No. 9, Ijarah and Ijarah muntahia bi tamleek can successfully transfer the title of the car, according to the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). The manner of transferring the title of the leased asset to the lessee under Ijarah muntahia bi tamleek shall be proven in a document, using one of the following methods: 1. by promising to sell the leased property for a token or other consideration, by paying the remaining rent in advance, or by paying the market value of the leased property. 2. an assurance to present it as a gift (for no consideration) 3. a promise to grant it, subject to the settlement of the outstanding payments. These clauses make it clear that the sale can take place by paying a token or nominal amount, counting the remaining Ijarah rents toward the purchase price, or by paying an amount that is equal to the market worth of the car the client intends to purchase. As an alternative, the financier/owner may include a gift contract to effect the transfer. This gift agreement may or may not be subject to conditions. Islamic Finance - Finding the right Islamic contract
There might have been other traditional contracts available to make the buying of a home easier, each with their own distinguishing qualities. Three actions are at the heart of the choice and use of a traditional contract to support or enable a contemporary Islamic financial product or service: (I) the selection of a certain contract or collection of contracts to serve as the primary underlying contract or template for the proposed product (II) the search for a potential contract, or combination of contracts, that could fulfill the final objective of a specific financial product. (III) the conversion of this customary contract into a commercial product by either enhancing or improving certain of its aspects in accordance with the needs of the market. The simplest way to show the connection between these three tasks is through an example. A hire purchase agreement is typically used to ease vehicle finance. In a car hire purchase agreement, the lessee is given the option to purchase the vehicle by making all of the payments outlined in the schedules. After paying all required payments before the conclusion of the hire buy period, the customer is deemed to have purchased the car. Because deferred payment conditions have been agreed upon, interest is included in the lease payments. Islamic Financial Institutions (IFIs) must provide a comparable product with comparable features. The typical characteristics of this product are I) the customer pays a rental fee to lease a car; (ii) the customer is given the option—not a requirement—to buy the car; if this is exercised, it binds the financier; and (iii) upon full payment of the scheduled rentals, the title of the car is transferred to the customer without the need for a sale agreement. This product's distinguishing feature is that it is a lease agreement with the lessee's right to purchase the leased asset and the financier's responsibility to sell the vehicle if that option is exercised by the lessee. In essence, this product's hire buy feature serves this goal. Islamic Finance - Choosing a suitable contract
Among other things, contracts for sales, leasing, partnerships, or joint ventures can be used to offer the same financial advantage that a traditional loan contract does. In Islamic finance, a person looking to buy a house might go to an Islamic bank to get the right financing because the ultimate goal is to be able to buy a house with credit. Instead of giving this customer the necessary loan, the Islamic bank will, at this customer's request, buy the desired residence from the vendor for a purchase or cost price. The customer will then purchase the identical home from the Islamic bank at the purchase price plus a profit margin, with the option to pay the selling price in installments. By doing this, the bank generates additional income through trading on a marked-up sale, whereby the difference between the buy price and the selling price would be viewed as profit gained by the bank rather than through loan for interest. A Murabahah contract is the basis of this kind of transaction. In the end, the customer is able to buy their dream home on credit without having to pay the bank any interest. In contrast to a cash sale, consumers must pay a greater price under a credit sale. The used sale contract serves as an alternative to a term loan facility under a traditional banking scheme for buying a house. Islamic Finance - Genuine Economic Activity
Muslims hold the view that money cannot generate wealth on its own and must instead be invested in productive economic ventures like trading, leasing, and investing to generate further income. Trading and sales are permitted according to the Qur'an, although riba and interest-based transactions are banned. The Qur'an states in chapter 2, verse 275, "God has made trade permissible and riba prohibited." Contracts for the sale of goods, provision of services, or investments are intended to establish a link between money and profit or revenue. To make money for Islamic banks, money must be invested in legitimate economic pursuits. Islamic Finance - taking care of consumer demands
IFIs have to create a banking system without using the interest mechanism since Shari'ah law expressly forbids both receiving and paying interest. However, this condition must be viewed in light of three crucial facts: 1. When shareholders in these IFIs invest their money in an Islamic bank, they expect a Return on Equity (ROE). 2. Islamic banks must be successful in raising money to finance the economy's business and retail sectors. 3. Like conventional banks, the majority of Islamic banks aim to turn a profit. Applying Islamic commercial law flexibly is necessary to meet these three criteria. Islamic business law does not preclude it from meeting a commercial requirement that is often met by a loan contract since it forbids lending money in exchange for interest. In Islamic finance, as opposed to conventional finance, where the borrower agrees to repay the principal plus an additional sum of money known as interest, the financial institution will finance the customer for the purchase of, say, a car or house or provide a letter of credit through sales, leasing, or other types of contracts. Islamic Finance - Traditional banking system
The fundamental tenet of conventional banking is the concept of lending while charging interest and borrowing while paying interest. A savings account represents a loan taken out by the bank from the depositor(s), for which the bank agrees to reimburse the depositor(s) with interest. According to the bank's records, it is a liability. On the other hand, when a bank funds a client, let's say to buy a house, the client is simply given a loan to enable the client to buy a house. The bank assesses interest to the borrower. The bank often charges interest on these loans at a greater rate than it does for depositors. The bank's net interest income is the difference between these two rates. This succinct description of conventional banking's characteristics reveals that an interest mechanism serves as the cornerstone of all banking operations. In other words, the intermediation of interest, which is essentially a fee or premium on money when it is given out, makes it feasible for funds to be mobilized from the surplus unit in the society (depositor) to the deficit unit (borrower). Money has a premium since it has been classified as a commodity, and the lender expects to be compensated for lending out his money. Islamic Finance - The foundation of Islamic financial goods are contracts
By this point, it should be clear that Islamic finance relies on a number of contracts to underpin its goods and services. The glossary of contract and features explains the many contract types. Specific features and conditions are added to a specified contract type to make it practical and Shari'ah compliant. In comparison to including all necessary terms and conditions to make a product Shari'ah-compliant and financially successful, choosing a specific contract is rather simple. As a result, every applicable Shari'ah principle pertaining to that contract and product must be taken into account in order for it to be a viable contract for every Islamic financial product. In this environment, it is essential to have a thorough understanding of Shari'ah principles in order to assure compliance as well as to create market-leading goods and services. The process of choosing appropriate and pertinent contracts and applying all of those contracts' guiding principles into the final product results in the development of successful Islamic financial solutions. From a Shari'ah standpoint, there is no other option when a contract has been chosen or designated as the foundation of a financial product than to incorporate its prominent principles into all facets of the product. Islamic Finance - Islamic business law's adaptability to financial demands, avoiding the necessity for interest-based lending Contracts
When the offeror and the offeree agree on a set of terms, they have reached a contract. The characteristics that set one contract apart from another are its foundation or conditions. A sale contract differs from a lease contract, for instance, and the two cannot be used for the same thing at the same time. One is committed to completing the transfer of ownership, whereas the other impacts the transfer of the right to use or usufruct while the owner or lessor retains ownership or title. Islamic Finance - Creating economically viable financial products
To make the financial product economically viable, various more components must be incorporated in order to address the aforementioned problems. Among others, these include the following: (a) a commitment made by the customer to buy a certain asset from the financier after the financier purchases the assets from the vendor in order to prevent the customer from breaking the terms of the agreement and to safeguard the financier. (b) The financier would only buy the required asset from the vendor upon the customer's request and assurance. The traditional Murabahah is transformed into a financial Murabahah, known as Murabahah li al-Amir bi al-Shira or "Murabahah to the purchase orderer," by these two extra components. The use of contracts to contemporary Islamic financial products and services is demonstrated by examples of this Murabahah and parallel Istisna' facility. |
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