Specialized Account

Islamic Standards
Main principles of Islamic financing:

1. Wealth must be generated from legitimate trade and asset-based investment (the use of
money for the purposes of making money is expressly forbidden).

2. Risk should be shared.

3. Harmful activities (haram) should be avoided.

Examples of activities which are prohibited:

1. Charging and receiving interest (riba).

- Charging interest contradicts the principle that risk must be shared and is also
contrary to the ideas of partnership and justice

- Using money to make money is forbidden.

2. Investments in businesses involved in alcohol, gambling, or anything else that the Shariah
considers unlawful or undesirable (haram).

3. Investments in transactions that involve speculation or extreme risk. (This is seen as

gambling).

Types of Islamic Financing:

1. MUDARBAH TRANSACTIONS
2. MUSHARIKA TRANSACITONS
3. MURABAHA TRANSACTIONS
4. IJARAH FINANCING
5. PROFIT AND LOSS DISTRIBUTION IN PLS SAVING DEPOSIT

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1. MUDARBAH TRANSACTION:

Type of partnership

Mudarib Rab-ul-mal

The project might make

a loss. In this case the
1. Provides 1. Provides finance Important bank loses out. The
expertise to (Capital customer cannot be
invest money. investment) made to compensate the
2. Manage 2. Does not bank for this loss as that
would be contrary to
investment. participate in the
the mutual sharing of
3. Active management of risk.
participation. business.

Profit and loss will be shared

equally or defined basis

2. MUSHARIKA TRANSACTION:

Type of Joint venture (for agreed profit and loss sharing)

❶ ❷ ❸

1. Both parties 1. Joint ownership 1. Profit sharing as

will invest in of assets per the ratio of
business. investment or
agreed basis.
2. Active
participatio 2. Liability
n of both unlimited.
parties.

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3. MURABAHA TRANSACTION:

Form of trade credit for acquisition of asset that avoids payment of interest.

Parties

Bank Borrower

How transaction is executed?

Provides asset at Cost + Defined (Agreed) Markup

Borrower Bank
Require plant for manufacturing

Conditions for classifying it as MURABAHA transaction:

1. Asset must be in existence

2. Owned by seller
3. In the physical or constructive possession of seller
4. Subject matter of sale (Asset) cannot be “HARAM”.
5. No penalty in case of default (if there is penalty collect and
charity.
6. No buy back allowed

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4. IFAS 2 - IJARAH FINANCING:

Ijarah is a contract whereby the owner of an asset, other than consumables, transfers its usufruct
to another person for an agreed period for an agreed consideration.

Usufruct: The right to use an asset.

It is type of lease arrangement.

IFAS 2 does not apply to:

1. Lease agreements to explore for or use minerals, oil, natural gas and similar non-
regenerative resources;

2. Licensing agreements for such items as motion picture films, video recordings, plays,
manuscripts, patents and copyrights;

3. Lessors of investment property leased out under operating leases; and

4. Lessors of biological assets leased out under operating leases.

Compliance with Sharia (the Shariah essentials):

1. Ownership of lessor – only right to use is transferred

2. Only owned asset can be leased out (except sub-lease with the express permission of
the lessor).

3. The lessor must retain title to the asset and bear all risks and rewards pertaining to
ownership during the entire term of the lease. However, the lessee is responsible
for any damage or loss caused to the leased asset due to the fault or negligence of the
lessee or from non-customary use of the asset.

4. The insurance of the leased asset should be in the name of lessor and the cost of
such insurance borne by him.

5. A lease can be terminated before expiry of the term of the lease but only with the
mutual consent of the parties.

6. Either party can make a unilateral promise to buy/sell the assets.

7. The amount of rental must be agreed in advance in an unambiguous manner either

for the full term of the lease or for a specific period in absolute terms.

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Terms used in Ijarah Agreement:

Lessor = Muj’ir Lessee = Musta’jir

Lease payments = Ujrah

Treatment:

Lessor Lessee

Each year: Each year:

Cash xxx Ijarah Expense xxx

Ijarah Income xxx Cash xxx

Depreciation exp xxx

Accumulated Dep xxx

IDC Asset / Expense xxx

Cash xxx

Sale and lease back transactions:

Possible when an asset is sold with an intention to enter into an ijarah arrangement, any profit
or loss based on the asset’s fair value should be recognised immediately.

Cases:
Case 1 – Selling price is equal to fair value (recognize in Profit and Loss immediately)

Case 2 - Selling price is less than fair value (recognize in Profit and Loss immediately)

Case 3 - Selling price is greater than fair value (Excess over fair value should be amortized over
the lease term).

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Illustration:

Fair value = 1,200

Carrying amount = 1,000
Selling price = 1,300
Cash 1,300

Asset 1,000

Gain 200

Deferred gain 100

Disclosure requirements: Muj’ir/Mustaj’ir

The future ijarah payments in the aggregate and for each of the following periods:

- Not later than one year

- later than one year and not later than five years

- later than five years; and

a general description of the muj’ir (lessor’s) significant leasing arrangements.

(Note: in addition normal requirements of IAS 16 will be intact)

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5. PROFIT AND LOSS SHARING DEPOSITS

Mechanism:

Provides return and charge management fee + agreed

profit as Mudarib
Institutions offering
Investors Islamic Financial
Services (IIFS).

Investment in Institutions offering financial services

Restricted Investment funds Unrestricted Investment funds

Investment with restrictions as to where, how Investment as IIFS deems appropriate without
and for what purpose the funds should be laying down any restrictions as to where, how
invested. and for what purpose the funds should be
invested.

How it works?

Balance of investment at beginning xxx

Add: Further deposits xxx
Less: Withdrawals (xxx)
Add: Share of profit allocated and reinvested xxx
Less: Any share of losses (xxx)
xxx

Important points:

1. Profits which have been allocated but have not yet been repaid or reinvested must be
recognised and disclosed as a liability by the IIFS.

2. Any loss resulting from transactions in a jointly financed investment is accounted as

follows:

i. as a deduction from any unallocated profits; then

ii. any loss remaining should be deducted from provisions for investment losses set
aside for this purpose; then
iii. any remaining loss should be deducted from the respective equity shares in the
joint investment account holders and the IIFS according to each party’s
investment for the period.

A loss due to negligence or similar on the part of the IIFS is deducted from its share of
the profits of the jointly financed investment. Any such loss in excess of the IIFS's share
of profits is deducted from its equity share in the joint investment.

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Presentation and disclosures:

1. Balance sheet – Fund of account holder represented as (redeemable capital)

2. Notes to the financial statements:

a. Disclose following in notes on the significant accounting policies:

i. the bases applied to allocate profits between owners' equity and the
account holders
ii. the bases applied by the IIFS for charging expenses to unrestricted
account holders;
iii. the bases applied by the IIFS for charging provisions, such as provision
for non performing accounts, provisions on impairment etc.

b. The IIFS should disclose significant category of accounts and of the percentage
which the IIFS has agreed to invest in order to produce returns for them.

c. The following disclosures should be made either in the notes to the financial
statements or a separate statement:

i. the total administrative expenses charged in respect of unrestricted funds

with a brief description of their major components;

ii. details of profit allocation between owner's equity investment account

holders applied in the current financial period

iii. the percentage of profit charged by the IIFS as a mudarib during the financial
period;

iv. where the IIFS is unable to utilise all funds available for investment how the
investments made relates to the IIFS and investment account holders.

d. Disclosure should be made of sources of financing of material classes of assets

showing separately those:

i. exclusively financed by investment account holders;

ii. exclusively financed by IIFS;

iii. jointly financed by IIFS and investment account holders

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