Islamic Finance – Augmenting Existing Contracts
In other instances, a conventional contract is used, but it must meet additional criteria in order to be commercially viable. A contract is Shari'ah compatible in and of itself, but it does not adhere to strict and prudent banking norms. The Murabahah contract is a prime illustration. When murabahah was in use, the seller had to already own the asset in order to sell it to a consumer at a premium. Although compliant, this strategy has a lot of dangers, particularly for the financier. These issues include: It would be nearly impossible for the financier to buy all consumer goods because they are not only various but also differ within the same group of assets in terms of color, design, etc. (a) Difficulty in determining the assets that are most likely required by the customers (b) storage charges, where the financier must pay more for all assets it plans to sell to clients and then keep them in a warehouse until customers contact the financier for financing through murabahah. (c) non-productive use of capital because money was spent on things and assets that might not be sold quickly; as a result, there was less money available to invest in other investment plans that would have benefited shareholders and depositors. The worst-case scenario is that these assets may have expired or become obsolete due to changes in technology or demand; in this case, the bank could lose all of the value of the asset. (d) The financier has assumed an excessive amount of market risk because there is no assurance that the clients will approach him or her to purchase these assets in a Murabahah sale.
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Islamic Finance – Financial Engineering
Banks recognize the need for a new product when a buyer, let's say of a house, lacks sufficient funds. Jurists have proposed an alternate structure that is based on competent and recognized financial engineering, realizing that an Islamic bank is neither an ultimate purchaser nor an ultimate seller or contractor. The term "parallel Istisna" (Istisna' Muwazi) refers to a contract made up of two separate and unrelated Istisna' contracts. The bank, acting as the seller or contractor, and the consumer, acting as the purchaser, engage into the first contract. The customer may pay the Istina's purchase price under this agreement at, for instance, £120,000 payable over five years. After that initial contract, the bank, acting as the buyer, will engage into another contract of Istisna' with a different party, the seller or contractor, for a sum like £100,000, which is paid based on how well the construction is going. These two contracts must be separate in the sense that the bank in the first contract, acting as the seller, is still obligated to deliver the asset to the client as requested if the contractor in the second contract fails to produce the requisite asset as stipulated in the contract. In these two parallel Istisna' contracts, neither the buyer's nor the seller's obligation is dependent on the other. To accurately represent the actual Istisna' venture that IFIs embarked into, they must be stand-alone contracts. It is evident how a traditional contract, like an Istisna' contract, may be used successfully in the modern banking environment, not only for retail but also for corporate customers, by applying some financial engineering to the original framework. Islamic Finance - Utilizing historic contracts to satisfy current needs
Every contract described in the chapter before actually existed once. However, because there were no Islamic banks up until recently, they did not qualify as banking products. The tricky part is figuring out how to apply these contracts to an Islamic bank's role as a financial middleman as well as other Islamic institutions and marketplaces, such an Islamic insurance and stock market. By applying applicable financial engineering techniques, this has been accomplished successfully without compromising the core characteristics of the impacted contracts. For instance, an istisna' contract enables a buyer to order a product that will be created and delivered in the future. Payment options include making it in advance or in any other way that is acceptable to both the buyer and the seller/contractor. Like in the past, the buyer and the seller are typically the ultimate buyer and seller, respectively. If applicable, the contractor would be assisted in financing his construction costs by receiving an advance payment or payments based on how the project is progressing. Islamic Finance - Application of these contracts to numerous Islamic financial products and services, both potentially and actually.
Islamic financial services and products are designed to satisfy society's legitimate demands. Islamic contracts are creative in meeting the business requirements of clients, both corporate and retail. These agreements are crucial in order to replace the primary contract in all traditional banking products, which is interest, with the function of lending. The use of these numerous goods broadens the range of products available in Islamic banking. Additionally, it makes Islamic banking more difficult because practitioners and advisers must evaluate a wide range of diverse concepts that are contained in a single product. These concepts have a substantial effect on tax and legal matters as well as hazards that are pertinent, like market risk, risk of rate of return on investment, and operational risk. Comparing these financial products to straightforward loan agreements, it is clear that they are both more complex and varied. Islamic Finance - Work-related Contracts
Islamic law also recognizes contracts in which one party employs another to carry out labor for it. The agreement resembles a hire agreement. Wakalah (agency) and Ju'alah are the two distinct contracts that make up this form of agreement (commission-based). The principal will designate an agent to carry out a specific task or work for Wakalah. The principal will take on all obligations and rights. Since the charge is not a fundamental part of the Wakalah contract, the agent could be compensated for their services. If a charge is set, the agent will get payment regardless of whether the desired result was attained. Ju'alah's fee won't be paid unless the designated party has given a certain performance. Conventionally, the payment is referred to as a commission. Wakalah and Ju'alah belong to the same category, but their reward or compensation systems are different. No of how well or how little the Wakil (agent) accomplished his obligations, a charge is owed under Wakalah after that work is complete. A fund manager will receive compensation for his management services, such as 1.5% of the fund's Net Asset Value (NAV), annually. It doesn't matter whether the fund performs according to the investors' expectations or not. Ju'alah, on the other hand, only requires a single payment of the fee, allowing the employee—or maybe the fund manager—to meet the required rate of return, or "hedge rate." The fund manager's success can be encouraged and rewarded with the help of this fee structure. Islamic Finance - Flexibility in Contracts
Different sales contracts have different levels of flexibility. There are several components in sale contracts that could provide flexibility depending on the situation and need. Salam and Istisna' are both deferred delivery sales, however Istisna' has more options for how you might pay. Here, payments for any manufacturing or construction contracts may be made in full or in installments as they take place. This allows IFIs more room to design products that meet their customers' needs. Salam and Istisna' are appropriate to various topic matter, it should be noted. Salam is typically used for assets that don't require production or construction, like metal and agriculture, whereas Istisna' is only applicable for assets that do, such a building, power plant, or highway. It can be seen from a quick comparison of Murabahah, Musawamah, Istisna', and Salam that an IFI may utilize the appropriate sales contract to meet the needs of its client. Of course, IFIs are able to finance the purchase of a factory or residence that has already been built using a Murabahah or Musawamah contract. However, Istisna' would be more useful if a consumer secured financing to buy a property that was still being built. The explanation above seeks to emphasize that each contract has unique qualities that should be recognized. As all Islamic financial products and services are fundamentally founded on contracts, it will also assist you in understanding product development and enhancement. The features and qualities are a part of the contract that will eventually be turned into a commercial product and cannot be separated from it. For instance, a product of Islamic project finance based on Istisna' will need to internalize all of Istisna's characteristics as required by Islamic commercial law as well as well-established principles developed by jurists. Naturally, Istina' in this scenario will not be conceivable if the financing was intended to buy an asset that can be physically identified by reference to a specific existing asset. It would make more sense to conduct a Murabahah sale. Islamic Finance – Nature of Hiwalah / Transfer of debt
Transfer of debt 3 parties Original debt is extinguished 2 types: 1. Restricted 2. Non- restricted Recourse right to debtor -Non-applicable (except in the case of death and insolvency of the principal debtor) Islamic Finance – Nature of Guarantee
3 parties Effect Original debt is not extinguished 2 types : 1. Performance 2. Bailment Recourse right to debtor Islamic Finance - Nature of Pledge
-2 Parties -Effect Original debt is not extinguished -Types 1. Possessive pledge -Types 2. Non-possessive pledge -Recourse right to debtor -Additional asset to be provided by the debtor -Consent of the principal debtor Islamic Finance - Features of Security Contracts
There are various distinguishing characteristics that set one security contract apart from another in the context of a security contract. In actual market practice, these traits are suitable for a variety of situations. All contracts in this category share the trait of not being primary contracts with original rights and obligations. Only the rights and obligations arising from primary contracts, such as sales, leases, and, to some extent, investment arrangements, necessitate the use of a security agreement. To put it another way, these security contracts have no use in the absence of a main contract because there are no 'interests' for them to safeguard. However, they have unique characteristics that should be acknowledged in defending the rights of the major creditor. While the Hiwalah contract releases the transferor from all obligations once the transferee accepts the transfer of debt, neither the pledge nor the guarantee will absolve the principal debtor of any obligations until and unless the principal creditor has been satisfied with the payment or performance. In other words, under Hiwalah, once the transferee, who is also the primary creditor, agrees to receive the payment from the principal debtor who owes the transferor, the transferor, who is also the debtor to the principle creditor, will be freed from any duty towards the principal creditor. It is not necessary for the transferor to actually pay the principal creditor the amount owed in order for their liability to be discharged. However, there must be three parties who also happen to owe to one another in order to take advantage of this function. As a result, the major creditor who accepts the transfer of debt has no right to pursue the transferor (their immediate debtor) unless the principal debtor dies or becomes insolvent. Securities can be pledged in a variety of ways and for a variety of purposes; for instance, they can be possessive, in which case the pledgee would hold the pledged asset and forbid the pledgor from utilizing it. The item would still be in the pledgor's possession if the pledge were non-possessive, which is more usual in practice. In this case, the pledge would only place a caveat on the transfer of ownership. However, the guarantee is intended to assure performance by the principal debtor or to present a person in court (bailment). When it comes to Hiwalah, the transferee and transferor might or might not be related. Restricted Hiwalah is used when the transferee was the transferor's creditor previous to the transfer of debt. Additionally, non-restricted Hiwalah is permitted by Islamic commercial law, in which the transferee is a third party who agrees to demand payment from the principal debtor in exchange for an advance payment from the transferor equal to the amount of the debt to be collected. This procedure resembles taking into account several factors. One obligation may be protected by multiple contracts at the same time. There is no issue with a creditor in Islamic housing financing based on Murabahah requesting that the debtor produce a pledge and a guarantee from whom the creditor can seek payment should the debtor fail to make the required payments under the Murabahah sale. It goes without saying that the application of Hiwalah is special since it has certain requirements for the parties to the contract and the type of financial obligation. |
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