Islamic financial transactions are based on
fairness, profit and loss and real transactions. There are two types of Islamic
financing as follows:
Debt Financing (transfer of risks)
Debt Financing is an Islamic banking instrument on the contractual basis of
deferred exchange, offers debt based financing through various instruments
derived under the principle of exchange or more specifically, the contract of
deferred sale. There are seven Islamic financing principles that fall under the
category of Islamic Debt Financing:
Bithaman Ajil (deferred payment sale)
Al-Bai’ Bithaman Ajil (BBA) is a contract that
refers to a sale and purchase transaction for asset financing on a deferred
basis and installments with a pre-agreed term of payment. The selling price
includes profit margin.
Under this principle, banks provide funding to
customers to own property or services by buying the customer’s assets or from
‘vendors’ at a cash price and then resell the assets to customers at a purchase
price plus profit.
The customer can repay by installment and the
amount of payment depends on:
total cost of the purchase involved
The typical assets for such contracts are the
land, building, machinery and equipment.
The BBA method is considered as a method of
financing which replaces the loan-based financing method adopted by the
conventional banking system.
An asset purchase order contract where the
seller places an order to buy an asset to be delivery in the future. The buyer
requires the seller or contractor to build the asset and deliver it in the
future according to the specifications given in the sales and purchase
contract. Both parties decide on the sale and purchase price and the payment
can be deferred or arranged according to the schedule when the work is
completed. Islamic banks usually use Al-Istisna to finance construction and
A contract that refers to a sale and purchase
transaction to finance an asset which costs and profit margins are issued and
agreed upon by all parties involved. It is a cost-plus sale profit in which the
seller is required to disclose the cost price as well as the amount of profit
he is charging. The settlement to the purchase can be made either on a lump sum
payment, deferred payment or in instalments, and stated specifically in the
The legality of murabahah can be traced from Al-Quran
whereby Allah SWT in AL-Baqarah (2:275),”….And Allah SWT has permitted trade
and prohibited usury”.
A proprietary contract whereby the lessor
(proprietor) leases the assets or equipment to the customer on the agreed
rental payment and the rental period stipulated at contract. Ownership of
leased equipment is still owned by the lessor. Under Al-Ijarah contract, the
lessor has the right to re-negotiate the quantum of the lease payment at every
agreed interval. This is to ensure that the rental remains in line with market
leasing rates and the residual value of the leased asset.
The rules governing the benefit and leased
asset must be beneficial and permissible according to Shariah. Financial lease
commonly used for property financing. In a more complex structure, the ijarah
concept is also used in sukuk where ijarah allows fixed cash flows receivables
out of the underlying asset for the sukuk holders.
An agreed contract to make an item based on the
specified features. The price is to be paid immediately during the session of
contract, and the delivery of goods to the buyer is carried out later on after
the goods are completed.
This contract is regularly used for financing
agricultural production. The wisdom of the permissibility of Al Salam contract
lies in the fact that these facilities is a type of financing for people who
are in need. During the session of contract, the goods (agriculture harvest) is
not in existence. This is due to the reason to help farmers who need money for
their agricultural production.
This Tawaruq contract involves two transactions
which initially involving a credit purchase between the buyer and the seller on
an asset and then the second stage here the buyer then sells cash to a third
party. This concept is named Al-Tawarruq because when someone buys something,
it does not intend to use it or utilize it, but it is only intended to earn al-wariq,
which mean earn money.
with immediate repurchase)
Al-Inah refers to a contract involving the sale
and repurchase transactions of an assets by the seller. In this transaction,
the seller sells the asset to the buyer in cash and then buy it back at a
deferred price which is higher than the cash sale price. This transaction may
also conduct where the seller sells the asset to the buyer at a deferred price and
then buy it back in cash at a lower price than the deferred selling price. For
bank financing using Al-Inah, the bank will sell the asset (land held by banks
or other assets advised by the Bank) to the customer at a selling price which
to be paid on a deferred basis.
Equity Financing (sharing of risks)
Equity Financing is an Islamic partnership based contracts that promotes the
sharing of the risks, through Al-Musyarakah and
Al-Mudharabah. Under the principle of Al-Musyarakah and Al-Mudharabah, the
Islamic banks will channel its investment deposit into profit and loss sharing
loans. The profit and loss sharing allow banks to transfer the credit risk from
its assets to its liabilities.
Islamic Financing Principles that falls under the category of Islamic Equity
– profit and loss sharing)
The arrangement of partnership between two or
more parties to fund a business ventures which all parties will contribute
capital either in term of cash or other forms. Any gains arising from the
venture may distributed based on the previously agreed profit sharing ratio and
any losses occur will be shared base on capital contribution. This give an
incentive to invest wisely and take an active interest in the investment.
The profit sharing ratio may revise during the
period of Musyarakah, subject to the mutual agreement of the partners or based
on a certain benchmark agreed by the partners at the time of entering into the
– profit sharing)
A Contract made between two parties to finance
the business ventures. Both sides are rabb al-mal or capital provider who
provide capital and mudarib or
entrepreneur who manage the project. If the venture is profitable, profits will
be divided according to the agreed ratio. If the business is loss, it will be
fully borne by the capital providers, while mudarib
only incurred losses from loss of time, energy, and the initiative in
Profit sharing ratio determined at the
beginning of the contract. However, the profit sharing might be revise during
the tenure of the Mudharabah subject to the mutual agreement.