Introduction to Islamic Banking and Finance:

Principles and Practice

Chapter 3

Financial Instruments
Learning Objectives

Upon completion of this chapter, the reader should be able to:

• Describe the sources and uses of funds and the operation of

bank accounts by Islamic banks;
• Understand how exchange-based contracts are utilized as
financial instruments in Islamic finance;
• Understand how service-based contracts are utilized as
financial instruments in Islamic finance;
• Understand how partnership contracts are utilized as
financial instruments in Islamic finance; and
• Know the nature of supporting contracts in Islamic finance,
including the unilateral supporting contracts.
 Learning Objective 3.1
Describe the sources and
Sources and Uses of Funds by uses of funds and the
operation of bank accounts
Islamic Banks by Islamic banks.

• Sources and application of funds

is the record of the cash inflows and outflows in an Islamic
bank or financial institution over a period of time

• Dual banking system

A banking system of a
country or territory that
incorporates both the
conventional and Islamic
financial systems
 Learning Objective 3.1
Describe the sources and
Sources and Uses of Funds by uses of funds and the
operation of bank accounts
Islamic Banks by Islamic banks.

Sources of Funds

Two major sources

1. Transaction deposits: risk-free funds which do not yield
return e.g. current accounts based on the wadi’ah concept
(i.e. safe keeping deposit)

2. Investment deposits: profit-making but have risk of

capital loss, depending on amount invested by bank

 While mobilizing in a Shari’ah compliant manner, issues such

as risk, return, liquidity, maturity, safety, and stability
are considered before offering the right deposit account that
would satisfy customers’ needs.
 Learning Objective 3.1
Describe the sources and
Sources and Uses of Funds by uses of funds and the
operation of bank accounts
Islamic Banks by Islamic banks.

Types of deposit accounts:

1. Current Accounts: account opened by individuals, companies
and firms by depositing cash, cheques and/or bills
o Based on concept of wadi’ah wad Damanah (Trust &
Guarantee) and Qard (benevolent loan)
2. Saving Account: funds deposited in saving account yield some
returns depending on bank financial results.
o Based on wadi’ah, mudarabah and musharakah concepts
3. Investment Account: the most important source of funds for
Islamic banks; the customer and the bank enter into a joint-
venture agreement,
o Based on mudarabah concept
o The depositor acts as the Rabb-ul-Mal & bank acts as the
Mudarib who will manage the funds.
 Learning Objective 3.1
Describe the sources and
Sources and Uses of Funds by uses of funds and the
operation of bank accounts
Islamic Banks by Islamic banks.

Types of deposit accounts:

Deposit Deposits Financing Equity-

accounts: Bank Products Based
1. Current (PLS)
account (Financial
2. Savings Intermediary) Debt-Based
account (Non-PLS)

3. Investment
account
 Learning Objective 3.1
Describe the sources and
Sources and Uses of Funds by uses of funds and the
operation of bank accounts
Islamic Banks by Islamic banks.

Types of deposit accounts:

Ex:
 Learning Objective 3.1
Describe the sources and
Sources and Uses of Funds by uses of funds and the
operation of bank accounts
Islamic Banks by Islamic banks.

Types of deposit accounts:

Ex:
 Learning Objective 3.1
Describe the sources and
Sources and Uses of Funds by uses of funds and the
operation of bank accounts
Islamic Banks by Islamic banks.

Types of deposit accounts:

Ex: [Link]
 Learning Objective 3.1
Describe the sources and
Sources and Uses of Funds by uses of funds and the
operation of bank accounts
Islamic Banks by Islamic banks.

Application of Funds

• Islamic banks apply funds to raise profits in different ways

• The main channels for the outflow of the funds include the:
- musharakah
- mudarabah
murabahah (cost-plus financing)
- ijarah (lease)
- istisna’ (manufacturing contract)
- bay salam
- bay mu’ajjal (deferred sale contract) models
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Exchange-based contracts in Islamic law have been

transformed into viable debt financing instruments:
- Murabahah (Mark-up)
- Istisna’ (Manufacture Sale)
- Salam (Forward Sale)
- Bay Dayn (Sale of Debt)
- Tawriq (Securitisation)
- Sarf (Sale of Currency)
- Tawarruq (Cash Financing)
- Bay Inah (Sale with immediate purchase)

Debt-based financing instruments: Financial instruments

that create debt-like relationships between parties
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Murabahah (Mark-up)

• Murabahah: cost-plus financing contract where a sale is

made at a specified profit margin
o Establishes a form of mutual contract between two parties
where they agree to the mark-up
o Murabahah is derived from the root word ribh which means
profit, gain or a legal addition
 Originally, it was used for trading
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.1: A Typical Murabahah Contract

 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.2: An Overview of the Murabahah Contract

 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

The specific disclosure requirements for the validity of

murabahah :
1. Goods subject to murabahah
2. Original Cost Price of the Goods and any Addition
Procurement Costs
3. Margin of Profit

Margin of profit (also net margin): Ratio determining the

degree at which profit is realised, calculated by dividing net
profits by sales
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Class case study

1. For which purpose (or commodity) are the Murabaha
mostly used ?
2. Using their 2024 financial reports compare the percentage
of financing based on Murabaha for mortgage (real-estate)
for 3 IB in Morocco
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Istisna’ (Manufacturing Contract)

• Istisna’: A manufacturing contract of a made-to-order
asset based on a deferred delivery basis. It is a transaction
on a commodity before the commodity is produced
• The manufacturer is morally obliged to produce items:
- at the agreed time
- in accordance with specifications (price, quality,
description)
• The price, specification, description and quality of the
commodity should be fixed when settling the contract
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.3: The Structure of an Istisna’ Contract

 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

The Suitability of Istisna’

The istisna’ structure is most suited for

• Project finance
• Construction
• Manufacture and design of machinery for specific purposes,
and
• Trade finance
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.4: Sukuk Transaction Using the Istisna’

Structure
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Salam or Bay al-salam (Forward Sale)

• A forward sale contract where advance payment is made for

(agricultural) commodity to be delivered later

- does not require the commodity to exist at the time of

concluding the contract
- the delivery of the commodity is deferred

Obj:
 Facilitates the commercial activities of farmers before crops
are harvested - farmers get paid in advance before a
harvest
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance
Salam (Forward Sale)
 Conditions for the validity of a salam
1. Not necessary that the goods sold exist at the time of concluding the contract.
2. Purchase price must be paid in full by the buyer at the time of concluding the
contract.
3. Delivery date and the location for delivery should be specified in the contract.
4. Quality, size, and description must be specified and agreed upon in the
contract.
5. Quantity of the goods (and the means of measurement) must be agreed upon
in absolute terms.
6. The right to demand surety from the seller is vested in the buyer in order to
guarantee delivery of the goods.
7. Ownership of the goods and all the accompanying rights can only be exercised
upon receipt of the goods.
8. The buyer may nullify the contract and exercise the performance bond if the
seller is unable to deliver the goods on the delivery date.
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.5: An Application of Bay al-Salam as a Sharī‘ah

Financial Instrument in Modern Financial Transactions
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Bay Dayn (Sale of Debt)

• Bay al-dayn (sale of debt) A sale and purchase transaction
involving a quality debt (i.e. not risky)

• Muslim jurists are not unanimous on the permissibility of

this form of sale (see p.90 e-Textbook)
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Bay Dayn Position of the Four Major Muslim Schools

• Shafi’i School: Sale of debt is allowed to a third party only

if the debt was initially guaranteed and was sold in
exchange for goods to be delivered immediately

• Hanafi School: Sale of debt not allowed in Islamic

commercial transactions

• Maliki School: Sale of debt allowed subject to conditions

• Hanbali School: divides the sale of debt into two:

- confirmed debts can be sold on the spot

- unconfirmed debts are not tradable
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Bay al-Inah (Sale with immediate repurchase)

• Bay al-Inah: commodity is sold on a cash basis, then the

seller immediately repurchases the same commodity on a
deferred payment basis at a price higher than the initial
cash price

• Used in different real estate and house financing situations

• Bay al-inah is controversial in the global Islamic finance

industry
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance
Bay al-Inah (Sale with immediate repurchase)

• Only used in Malaysia

• Bank sells an underlying asset to a client on a credit basis
and subsequently repurchases the asset from the customer
immediately at a price lower than its earlier cost price on
cash basis.
An alternative example is:
1. A client approaches a bank and concludes a sale contract for the
sale of land worth US$5,000 in cash.
2. The bank immediately concludes a separate contract with the
client for the sale of the same land for payment of US$6,000 on a
deferred payment
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance
Bay al-Inah (Sale with Immediate Repurchase)

Views on the Validity of Bay al-Inah

• The Shafi’i School: Bay al-inah contracts are permissible

in Islamic law

• The Maliki, Hanafi and Hanbali Schools: Bay al-inah is

not permissible in Islamic law because the motive of the
parties in such a contract is illegal
○ Perceived as move towards circumventing the mandatory
prohibition of Riba through a legal device (hilah).

 The majority of jurists prohibit bay al-inah justifying that

it is tainted with elements of interest
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Tawriq (Securitisation)

• Tawriq is a process of converting an asset into cash issued

as tradable certificates of investments (tradable in the
secondary market)

 equivalent term for securitization in Islamic commercial

jurisprudence.

Obj.
• issuance of certificate (sukuk or sanadat= Islamic
commercial papers) to be traded in secondary market by
investors
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Parties to Tawriq

The most important parties in securitization are:

1. Originator/Issuer of Sukuk: large corporations, governments

2. Special Purpose Vehicle (SPV)

3. Investment Banks: Islamic banks or Islamic windows of

multinational banks

4. Subscribers or Investors: individuals and corporate entities

 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

How it Works in the Secondary Market

An SPV is established to manage the underlying asset and issue
investment certificates (sukuk) to the investors (sukuk-
holders).
• Certificates represent ownership of an asset or entitlement to a
debt or a rental income in the case of usufruct.
• Agreement btw the originator and the SPV with regard to the
purchase of the underlying asset.
• Agreement btw the SPV and the investors, whether senior or
subordinate.
 initial cash flows are effected from the subscribers or investors
to the SPV and from SPV to originator.
Concept of Exchange-Based Contract
Figure 3.6: The Flow Chart of the Securitization Process
ex: Murabaha Sukuk

o PTC= Participation
Term Certificates

 Obligor pays the

cash flows that are
securitized to the
servicer who
monitors and
maintains the
asset.
 Servicer pays into
an account where
the participation
term certificates
(PTC) are issued to
the SPV for the
purpose of
monthly payments
to the investor
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Sarf (Sale of Currency)

Definition and Nature

• bay’ al-sarf: a foreign exchange contract involving

exchange of currencies either of the same or of different
kinds
Conditions:

– delivery of currencies has to be made in full on spot

– exchange must take place at the same sitting where the

contract is drawn up
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Sarf (Sale of Currency)

Validity of Foreign Exchange Contract in Islamic Law

• Trade in currency is permissible in Islamic law.

○ “Gold for gold, silver for silver, wheat for wheat, barley for
barley, dates for dates ... hand to hand ... ” (Hadith)

 Limitation:
 the exchange must be done hand-to-hand in one sitting if it
involves different currencies
 If the currencies are the same, the currencies being
exchanged must be of equal amounts, and the exchange
must take place at the same sitting
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Tawarruq (Cash Financing or Reverse Murabahah)

• Hybrid sale contract where a customer purchase a commodity
(usually from bank) with payment arranged in instalments
and in turn sells the commodity to a third party for cash
• Permissibility of Tawarruq is based on:
- The general principles of a typical contract of sale
- The absence of any bit of interest in this transaction (it does
not amount to riba)

• Permissibility of Tawarruq is subject to:

- The person must be in real need of money
- No other permissible alternative available
- The contract being free of any modicum of riba
- The customer having full possession of the commodity
 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Figure 3.7:Permissible Reverse Murabahah (Tawarruq)

 Learning Objective 3.2
Understand how exchange-
Concept of Exchange-Based Contract based contracts are used as
financial instruments in
Islamic finance

Class discussion

• After reading International Islamic Fiqh Academy resolutions

on Tawarruq (p. 98) list the arguments
 Learning Objective 3.3
Concept of Service-Based Contract Understand how service-
based contracts are used as
financial instruments in
Islamic finance
Ijarah (Leasing)

• Ijarah: Financing mechanism involving rental of an asset or

hire purchase where a form of rental fee is paid for a stipulated
period of time agreed by the parties
• In Islamic jurisprudence the term has been used in different
ways
Most common forms:
1. ijarah (leasing)
2. ijarah muntahia bi al-tamlik (ONE single financial lease contract
with ownership transfert)
3. ijarah thumma al-bay (TWO contracts = leasing and
subsequent purchase)
Payment modes:
• ujrah (fees)
• ju’alah (commission)
 Learning Objective 3.3
Understand how service-
Concept of Service-Based Contract based contracts are used as
financial instruments in
Islamic finance

• Modern application of ijarah are:

- Al-ijarah thumma al-bay’ (a contract of lease ending
with sale contract)
- Ijarah muntahia bi al-tamlik (leasing including
ownership transfer)

Ijarah Muntahia Bi al-tamlik (Financial Lease)

A typical lease contract which concludes in a transfer of

legal title and confers ownership on the lessee
- Ijarah means lease
- Tamlik denotes ownership
 Learning Objective 3.3
Understand how service-
Concept of Service-Based based contracts are used as
financial instruments in
Contract Islamic finance

Ijarah thumma al-bay (Leasing and Subsequent

Purchase)

• Ijarah thumma al-bay: a contract of lease subsequently

followed by a sale contract
• Two separate contracts are concluded under this chain
transaction
- The ijarah contract
- The purchase contract
 Learning Objective 3.3
Understand how service-
Concept of Service-Based Contract based contracts are used as
financial instruments in
Islamic finance
Figure 3.8: Ijarah Thumma bay’ Contract
 Learning Objective 3.3
Understand how service-
Concept of Service-Based Contract based contracts are used as
financial instruments in
Islamic finance

Alternative form : Ijarah mausufah fi dhimmah (Forward

Lease)

=lease agreement on a asset not yet in existence

 "wasafa" (‫" = )ﻭﺻﻑ‬described" or "specified.“ + “dhimma”=obligation

• The lessor has to deliver the asset to the lessee in

accordance with agreed specifications

 The modern application of forward lease is diverse; it can be

used in:
- Customized asset
- Construction (ex: off-plan property leasing)
 Learning Objective 3.3
Understand how service-
Concept of Service-Based Contract based contracts are used as
financial instruments in
Islamic finance

Ujrah (Fees)

• Ujrah: a payment for usufruct in the use of another

person’s property or payment for service in contract of
ijarah

• Most Islamic financial institutions charge service fees for

services rendered to customers. Services fees should be
paid for through the ujrah scheme

• Ujrah has been used by a number of banks for Sharī‘ah-

compliant credit card schemes
 Learning Objective 3.3
Understand how service-
Concept of Service-Based Contract based contracts are used as
financial instruments in
Islamic finance

Ju’alah (Commission or Reward)

• In the juristic sense, ju’alah is a one-sided contract where
reward/commission is given for accomplishment of a task

• The legality of the ju’alah contract is established in the

Qur’an and Sunnah

• There is an element of ju’alah in takaful contracts

• Ju’alah may be useful in the recovery of overdue debts

 Learning Objective 3.3
Understand how service-
Partnership Contracts in Islamic based contracts are used as
financial instruments in
Finance Islamic finance

Concept of Equity-Based Contract

• The equity-based contracts generally involve some sort of
partnership

• Partnership contracts which have been transformed into

financial instruments are
- Mudarabah (trust financing)
- Musharakah (joint-venture partnership)
- Musharakah mutanaqisah (diminishing partnership)
 Learning Objective 3.3
Understand how service-
Partnership Contracts in Islamic based contracts are used as
financial instruments in
Finance Islamic finance

Mudarabah (Trust Financing)

• Mudarabah is a form of partnership where one party (rab
al-mal) provides the funds and the other party (mudarib)
assumes the role of the entrepreneur through effective
management
– rab al-mal is the sleeping partner
– mudarib is directly involved in the day-to-day management of the
business

 parties share the profit of the business venture based on

agreed percentage and bear any loss incurred
• (financial) losses are assumed by financial capital provider,
unless caused by misconduct or negligence of the manager
the entrepreneur loses his/her labour
 Learning Objective 3.3

Partnership Contracts in Islamic Understand how service-

based contracts are used as
Finance financial instruments in
Islamic finance

Legality of Mudarabah
The legality of mudarabah contract is established in the
Qur’an, Sunnah, practices of companions, and ijma

Types of Mudarabah
• Restricted (muqayyad) = Rab al-Mal) imposes specific conditions
on how the funds should be used.
• Unrestricted (mutlaq) = passive investment

Termination of the Mudarabah Contractual Relationship

Either of the parties can terminate the contractual relationship
at any time subject to notice given to the other party within a
reasonable time prior to contract termination
 Learning Objective 3.4
Understand how
Partnership Contracts in Islamic partnership contracts are
used as financial
Finance instruments in Islamic
finance

Modern application of Mudarabah

Mudarabah in Islamic banking and finance is being used in:

- venture capital
- project financing
- unit trust
- General Investment Account (GIA)
- Specific Investment Account (SIA)
 Learning Objective 3.4
Understand how
Partnership Contracts in Islamic partnership contracts are
used as financial
Finance instruments in Islamic
finance

Musharakah (Partnership Contract)

• Musharakah is a word of Arabic origin meaning ‘sharing’

= form of shirkat al-amwal where all partners invest capital

into the joint-venture
– emphasises practical participation of parties in the partnership
business

– based on mutual trust

 Learning Objective 3.4
Understand how
Partnership Contracts in Islamic partnership contracts are
used as financial
Finance instruments in Islamic
finance

• The return of the investors is based on actual profit of the

joint-venture

• The parties must agree at the time of initiating the contract

on the proportion of profit due to each partner

• Losses are shared in accordance with the capital investment

of each of the partners

• Musharakah is considered the most viable Islamic finance

product in modern banking
 Learning Objective 3.4
Understand how
Partnership Contracts in Islamic partnership contracts are
used as financial
Finance instruments in Islamic
finance

Legality of musharakah contract

The legality of musharakah contract is established in the Qur’an,

Sunnah and the practices of the companions and predecessors
of the Prophet (PBUH).

Modern application of musharakah

Musharakah could be used effectively:
- For small and medium enterprise (SME), private equity
- In the primary Islamic capital market
 Learning Objective 3.4
Understand how
Partnership Contracts in Islamic partnership contracts are
used as financial
Finance instruments in Islamic
finance

Differences between Musharakah and Mudarabah

Contracts

• Sources of financing the business

• Rights of partners to participate in the management of the
business
• Sharing profits and losses
• Liability of the partners
• Ownership of assets
 Learning Objective 3.4
Understand how
Partnership Contracts in Islamic partnership contracts are
used as financial
Finance instruments in Islamic
finance

Musharakah Mutanaqisah (Diminishing Partnership)

• used as long-term financing
Ex:
– a bank’s share in the ownership of a property decreases gradually due
to the continuing sale of its shares to the customer against the
payment of predetermined instalments
• Musharakah Mutanaqisah is a chain of three contracts:
1. joint ownership (ex: client/bank)
2. lease (ex: financier to the client)
3. contract of sale of shares (of the joint ownership)
 Learning Objective 3.5
Supporting Contracts Know the nature of
supporting contracts in
Islamic finance, including
Hawalah (Transfer of Debt) the unilateral supporting
contracts.
In literal terms, hawalah means assignment, bill of
exchange, or promissory [Link] the juristic sense, it is a
special type of security contract which simply means debt
assignment.
Essential Elements of Hawalah
• Muhal: The creditor/person to whom the transfer is made
• Muhil: The transferor or debtor who assigns the debt
• Muhal ‘alayhi: The transferee of the assigned debt
• Al-Muhal bihi: The transferred debt, assigned from one
debtor to another
• The debt owed by the transferee to the principal debtor
• Form of contract. The contract concludes with an offer from
the principal debtor and acceptance by transferee & creditor
 Learning Objective 3.5

Supporting Contracts Know the nature of

supporting contracts in
Islamic finance, including
Figure 3.9: The Two-stage Hawalah the unilateral supporting
contracts.
Arrangement
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Modern Application of Hawalah

The modern application of hawalah comprises:

- Bills of exchange or promissory notes (suftajah)
- Issuance of cheques against current account
- Endorsement of a negotiable instrument
- Transfer of money or remittance (al-sarf)
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Rahn (Collateral/Pledge)
= collateral, pledge or mortgage offered as security for a debt
that allows the creditor to take away the debt from such
security in the event of any default on the part of the debtor

• The legality of rahn (mortgage) contract is established in the

Qur’an and Sunnah

• The significance of rahn contract is that it is a voluntary

charitable contract (tabaru’)
• The modern application of rahn contract employed in
contracts involving credit transactions such as deferred sale
or loans from IFIs
 Learning Objective 3.5
Supporting Contracts Know the nature of
supporting contracts in
Islamic finance, including
the unilateral supporting
Muqasah (Setting-off) contracts.

Muqasah: A debt settlement through a counter-

transaction or offsetting

Types of Muqasah:
1. Muqasah al-Qanuniyyah (Legal Set-off)
2. Muqasah al-Talabiyyah (Set-off on Demand)
3. Muqasah al-Ittifaqiyyah (Consensual Set-off)

Types of debt that can be set off:

• Duyun al-naqd (currency debts)

• Duyun al-‘ard (commodity debts)
• Manfa’a (usufruct)
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Legality of Muqasah

Three views have been expressed:

• First view: Muqasah is an approved method of settlement

of identical debts between two parties

• Second view: Muqasah is merely an exception to bay al-

dayn (sale of debts)

• Third view: Muqasah is a sale of debts by its real nature

because its subject matter is debt which is intangible
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Kafalah (Guarantee)

Kafalah: A binding promise to be liable for the debt of a

principal debtor in case they default or fail to redeem the
debt but such liability does not relieve the principal debtor
from liability

Legality of Kafalah
The concept of guarantee has been in practice since the
time of the Prophet (PBUH)
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Elements of Kafalah

• Makful ‘anhu (principal debtor or obligor or guaranteed)

• Kafil (surety or guarantor)

• Makful lahu (creditor or obligee)

• Makful bihi (object of guarantee)

• Sighah (expression)

Types of Kafalah
• kafalah bi al-nafs (physical guarantee)
• kafalah bi al-mal (financial guarantee)
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.
Modern Application of Kafalah

The application of kafalah in modern Islamic financial institutions

can be seen in:

• Documentary credit system which is largely used in international

trade

• Credit card transactions

• Supporting guarantee contract for the following major contracts

in Islamic finance: mudarabah, murabahah, ijarahi, salam,
istisna, and musharakah
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Wakalah (Agency)

Wakalah Contract establishing an agency relationship

between two parties for a purpose though such authority
may be general or specific. The principal party is the
muwakkil while the agent is the wakil

The legitimacy of the concept and practice of Wakalah is

established in the Qur’an and Sunnah

Modern Application of Wakalah is seen in:

- Modern Islamic banking, finance and takaful
- Corporate Wakalah
- Wakalah model of waqf
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Wadi‘ah (Safekeeping)

Wadi‘ah is a contract that entrusts one’s precious property or

money to the care of another, usually a trusted person or a
secured corporate entity i. e. the bank
• Muslim jurists unanimous in legality of wadi‘ah contract
• Wadi‘ah is used in both current accounts and savings
account
The modern types of Wadi‘ah
- Wadi‘ah yad al-amanah (Safe-keeping under a trust)
- Wadi‘ah yad al-damanah (Safe-keeping with Guarantee)
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Concept of Unilateral Supporting Contract

Contracts made unilaterally without the usual offer and

acceptance at the session of contract
- Waqf (endowment)
- Ibra’ (foregoing of right)
- Hibah (gift)
- Wa’ad (promise)
- Tabarru’ (donation)
 Learning Objective 3.5

Supporting Contracts Know the nature of

supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.
Waqf (Endowment)
Waqf: A charitable endowment in perpetuity for a specific
purpose. It assists the poor and the less privileged in the
society or benefits society at large

Ibra’ (Forgoing of Right)

Ibra’ can be defined as the waiving of one’s financial right or
ownership in totality or partially
Situations where the Islamic bank is inclined to use ibra':

- When the debtor is unable to redeem the debt

- When the customer makes an early settlement of a debt
as means to encourage such practices
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Hibah (Gift)

Hibah is the gratuitous transfer of property from one person

to another without any formal material consideration

• Hibah is used by Islamic financial institutions as a

supporting Sharī‘ah instrument in other transactions such as
al-ijarah thumma al-bay
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Wa’ad (Promise)
Wa’ad: A promise or undertaking by a party to carry out a
unilateral contract

Examples of Wa'ad:
- Murabahah transactions
- al-ijarah thumma al-bay’ contracts

Muwa’adah which is a derivative of wa’ad is a bilateral

promise in a contractual form which may be conditional or
unconditional
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Divergent Opinions of the Muslim Jurists on the Binding

Nature of Wa’ad

• Fulfilling wa’ad is recommended in financial transactions

(Shafi’i school, some Maliki jurists, and Abu Hanifah

• Fulfilling wa’ad is obligatory and it is usually enforceable

(majority of the Maliki scholars)

• Wa'ad is binding and enforceable except in cases where

it is otherwise justified (Ibn Shubrimah)
 Learning Objective 3.5
Know the nature of
Supporting Contracts supporting contracts in
Islamic finance, including
the unilateral supporting
contracts.

Tabarru’ (Donation)

• Tabarru’: a gratuitous contract/donation which is unilateral

but supportive of underlying contracts such as takaful

• Ownership in the subject matter of tabarru’ is transferred at

the time of donation from the donor to the done

• The concept of tabarru’ is applicable in takaful, as well as in

waqf donations managed by an Islamic financial institution
for the benefit of the beneficiary
Key Terms and Concepts

• Bay al-dayn
• Hawalah
• Bay al-Inah
• Hibah
• Bay al-salam
• Hilah
• Bay al-sarf
• Ibra’
• Bill of Exchange
• Ijarah
• Debt-based financing
• Ijarah mawsufah fi
instruments
dhimmah
• Dual banking system
• Ijarah muntahia bi al-tamlik
• Equity capital
• Ijarah thumma al-bay’
• General investment account
• Ijma
(GIA)
Key Terms and Concepts

• Islamic capital market • Mudarib

• Islamic finance windows • Muqasah
• Istihsan • Murabahah
• Istisna’ • Musharakah
• Ju’alah • Participation term
certificate (PTC)
• Kafalah
• Promissory note
• Legal capacity
• Rabb al-mal
• Majlis al-‘aqd
• Rahn
• Margin of profit
• Real capital
• Mudarabah
Key Terms and Concepts

• Riba • Takaful
• Secondary market • Tawarruq
• Sharī‘ah Supervisory • Tawriq
Council
• Ujrah
• Short-term liquidity
• Wa’ad
• Special investment account
• Wadi’ah
(SIA)
• Wakalah
• Special purpose vehicle
• Waqf
• Sukuk
• Tabarru’