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"Islamic financing has been a viable alternative to western banking since the early 1970s and complies with the major concepts of Shari law, namely that:\n\ninterest (usury) should not be charged or collected;\nno form of gambling be undertaken; and\nno investment should be made in a business which is deemed to be unlawful under Shari law.\n\nBasic concepts\nThe essential basic concepts of Islamic financing are:\n1. Islamic Debt financing\nIjarah \u2013 Leasing\nIjarah structure entails\u00A0 the lender creating a special purpose vehicle (SPV) to purchase asset(s) that is the subject of the financing.\u00A0 In turn, borrower agrees to enter into a lease agreement to lease the asset(s).\u00A0 Lease payments act as part rental payments (the profit component) for use of asset and part repayment of principal debt.\u00A0\nOrdinarily transaction will take on the following elements:\n(i) borrower and lender enter into a purchase contract to buy asset that is the subject of the financing;\n(ii) borrower and lender enter into a lease contract under the terms of which borrower agrees to lease asset that is the subject of the financing;\n(iii) on completion of the lease term, borrow can either make a balloon payment to purchase asset or, alternative, if the rental has included part principal payments, can pay a small sum to the lender in exchange for ownership of asset.\nThis type of Islamic financing structure is very similar to hire purchase contracts.\u00A0 As such, assets that are commonly the subject of this type of Islamic financing include motor cars, home appliance, electronic goods, etc.\nMurabaha - Cost-plus financing / buy-sell arrangement\nEssentially works by borrower asking lender to purchase asset on the understanding that after lender has purchased asset, borrower will purchase asset from lender.\u00A0\nAgreement is made that lender on-sells asset to borrower at an increased price.\nRepayment can either be in one balloon payment or by way of installments over a period of time.\u00A0 If repayment is a balloon payment, more commonly known as a Bai\u2019 Bithaman Ajil \u2013 or deferred payment sale agreement.\nPopular structure for purchasing real estate property.\u00A0 It should be noted, however, that as lender on-sells property to borrower, all land title deeds, etc. vest with the borrower.\u00A0 Thus, security provisions of such an arrangement need to be considered carefully so that the lender can adequately protect themselves.\nComponents of this type of Islamic financing include:\n(i)\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0 on-sell arrangement;\n(ii)\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0 agreed mark-up on on-sell price;\n(iii)\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0 asset must be Shari compliant;\n(iv)\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0 asset must exist at the time of the transaction; thus, this cannot be utilized in futures trading transactions;\n(v)\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0 all terms and conditions of the arrangement must be known by all parties at the time of entering into the arrangement;\n(vi)\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0 reoccurring expenses cannot be passed on to the borrower.\n\u00A0\nBai\u2019 al-Inah \u2013 Sale and buy-back\n\u00A0Similar concept to Murabaha.\u00A0 However, due to security concerns on default, structure is changed slightly.\u00A0 Lender purchases asset on behalf of borrower.\u00A0 Borrower purchases asset from lender on deferred payment basis.\u00A0 Asset is immediately resold to lender for cash at discount.\u00A0\nPreferred financing mechanism if there is any danger that lender will become insolvent.\nMusharakah\u00A0 - Partnership\nIt's can also be referred to as Islamic venture financing\n\nAn arrangement between a lender and a borrower where both parties agree to make a capital contribution towards financing a commercial operation.\u00A0\nParties agree to share profits from the arrangement at a pre-agreed ratio.\u00A0\nLosses from the arrangement need to be shared pro-rata to the capital contributions of each of the parties.\n\nTawarroq finance - Monetary finance\n\nLender agrees to purchase a commodity on behalf of the borrower.\u00A0\nLender sells commodity to the borrower.\u00A0\nBorrower sells commodity to a third party buyer.\u00A0\nCash payment from third party buyer acts as monetary financing element of the transaction.\nBorrower repays lender in installments.\n\nQardul Hassan \u2013 Benevolent loan\n\nConsists of a loan given to a borrower on a \u201Cgoodwill\u201D basis, i.e. no interest or fees are charged\nBorrower may, at their discretion, repay more than they borrowed\nSeen as being the only \u201Cpure\u201D form of Islamic financing loan as, unlike all the other financing structures, it makes no attempt to charge riba (interest), which is prohibited under Islam.\n\nMudharabah - Profit sharing\n\nIslamic investors agree that a Mudhareb (trustee) will provide skill and expertise.\nMudhareb agrees to hold and manage the assts for Islamic investors.\u00A0\nIn return for providing services, Mudhareb earns an agreed share of profits from the assets managed on behalf of Islamic investors.\u00A0\nMudhareb cannot claim any right to the assets - merely acts as manager and trustee of assets.\n\nII.\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0 Commodities financing\nSSalam \u2013 Advance payment\n\nUnder this Islamic financing structure, purchaser agrees to make advance payment for asset/goods to be delivered at a future date.\u00A0\nIt is essential that purchase price be paid at the time of making the agreement, and not on delivery of the asset/goods - failure to comply with this requirement would alter the nature of the agreement to that of a sale of debt against debt, which is prohibited under Shari law.\n\u00A0As Shari law stipulates that items must exist at time of contract, i.e. no futures contract, asset to be purchased must be clearly stated in the purchase agreement and the quantity and quality of the purchased asset must be capable of being specified exactly \u2013 there can be no room for dispute.\n\u00A0Assets must be goods and cannot not include commodities; such as gold, silver or money.\nThe exact date and place of delivery of the asset/goods must be specified in the agreement.\nIstisna\u2019a is another Islamic financing structure that follows almost exactly the same concept as found here\n\nIII.\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0 Deposit taking functions/strong&gt;\nWWadiah - Safe-keeping\n\nAgreement between two parties where on agrees to look after the property of another.\n\u00A0Concept is used to take deposits of money, where bank acts as custodian of money deposited by customer.\nBank agrees they will refund sums deposited \u201Con call\u201D, i.e. on demand.\n\nHibah \u00A0- Gift\n\nHibah literally means a \u2018gift\u2019.\u00A0 This is used by banks to compensate depositors for lost earnings (interest) on their deposits.\u00A0 It can also be used by borrowers who have been granted Qardul Hassan loan mention above.\nNo agreement to provide Hibah can be made \u2013 it\u2019s an arbitrary payment made at the discretion of the person making it.\n\nIV.\u00A0\u00A0\u00A0\u00A0\u00A0\u00A0 Bonds/strong&gt;\nFixed-term, fixed-income, interest-bearing securities cannot be issued under Shari law.\nSSukuk \u2013 Islamic bonds\n\nAlthough fixed-income, interest-bearing bonds cannot be issued under Shari law, it is estimated that over $500 billion in corporate and government bonds issues have been made using Sukuk (Islamic bonds) mechanism.\nEssentially, Sukuk bonds are long-term bond issues made by SPVs where the bond sale proceeds are used to purchase assets that are then leased back to the issuer in return for rent.\u00A0 Rental payments constitute part repayment of the principal and part profit revenue to the bondholders.\n\nSalam bonds/strong&gt;\nIn certain circumstances, short-term bond issues can be made using the same mechanism concepts found in Salam transactions.\u00A0 It should be noted, however, that due to the precise nature of the assets/goods that are the subject of a Salam transaction, these types of bond issues are rare and for very short-term periods.\nConclusion\nThe growth of Islamic financing in the past decade has been stellar.\u00A0 Given the large amounts of cash available in the oil rich Middle-East, it is likely that the growth of Islamic financing will continue.\u00A0 Moreover, as investors in the Middle-east look to break-out an invest elsewhere, it is certain that governments around the world will need to familiarize themselves with the principal concepts of Islamic financing, and to regulate for such, if they wish to take advantage of this growth"^^<http://www.w3.org/2001/XMLSchema#string>
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