12 - Islamic Banking Product Definition

Before we learn the practical aspects of Islamic banking, let's understand the types of products currently offered by Islamic banks throughout the world.

Murabahah

Murabahah (accurate transliteration murābaḥa) is defined as a cost-plus sale, where the seller expressly mentions the cost he has incurred on the commodities to be sold and sells it to another person by adding some profit or mark-up thereon which is known to the buyer. As the requirement includes an 'honest declaration of cost', murabaha is one of three types of bayu-al-amanah ('fiduciary' sale). Other two types of bayu-al-amanah are Tawliyah (sale at cost) and Wadiah (sale at specified loss)].

Istisna’a

Literally the word istisna’ derived from the root word sana’ or to manufacture or to construct something. Istisna’ is an order or request to manufacture something, whereby the requestor invited, induced or caused another to make or manufacture some goods for him. Technically, it is a contract to purchase for a definite price (agreed by both parties) something that may be manufactured later on according to agreed specifications between the parties. In other words, it is a contract of sale of specified items to be manufactured or constructed with an obligation on the part of the manufacturer or contractor to deliver them to the customer upon completion. The contract of Istisna’ creates a moral obligation on the manufacturer to manufacture the goods, but before he starts the work, any one of the parties may cancel the contract after giving a notice to the other. However, after the manufacturer has started the work, the contract cannot be cancelled unilaterally.

Ijarah

An agreement whereby the Bank (lessor) purchases or constructs an asset for lease according to the customer’s request (lessee), based on his promise to lease the asset for a specific period and against certain rent installments. Ijarah could end by transferring the ownership of the asset to the lessee and there must be usufruct. What does Usufruct means? Usufruct is a legal term describing a situation wherein a person or company has a temporary right to use and derive income from someone else's property (provided that it isn't damaged).

Musharakah

An agreement between the Bank and a customer to contribute to a certain investment enterprise, whether existing new, or the ownership of a certain property either permanently or according to a diminishing arrangement ending with the acquisition by the customer of the full ownership. The profit is shared as per the agreement set between parties while the loss is shared in proportion to their shares of capital in the enterprise.

Mudarabah
An agreement between the Bank and a third party whereby one party would provide a certain amount of funds which the other party (Mudarib) would invest in a specific enterprise or activity against a specific share in the profit. The Mudarib would bear the loss in case of default, negligence or violation of any of the terms and conditions of the Mudarabah.

Wakalah
An agreement between the Bank and an agent whereby the agent invests it according to specific conditions in return for a certain fee (a lump sum of money or a percentage of the amount invested). The agent is obliged to return the invested amount in case of default, negligence or violation of any of the terms and conditions of the Wakalah.

Sukuk

Sukuk is the Arabic name for a financial certificate but can be seen as an Islamic equivalent of bond. However, fixed-income, interest-bearing bonds are not permissible in Islam. Hence, Sukuk are securities that comply with the Islamic law (Shari’ah) and its investment principles, which prohibit the charging or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and non-tradability in the secondary markets.

Bai’ al-inah (sale and buy-back agreement)
The financier sells an asset to the customer on a deferred-payment basis, and then the asset is repurchased by the financier for cash at a discount. The buying back agreement allows the bank to assume ownership over the asset in order to protect against default without explicitly charging interest in the event of late payments or insolvency. Some scholars believe that this is not compliant with Shari’ah principles but this principle is still being practice by some Muslim countries, particularly Malaysia.

Bai’ bithaman ajil (deferred payment sale)
This concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit margin agreed to by both parties. This is similar to Murabahah, except Bai’ bithaman ajil is normally offered for long-term deferred payment sale while Murabahah, is normally for short term deferred payment sale e.g. up to 1 year.

Bai muajjal (credit sale)
Literally bai muajjal means a credit sale. Technically, it is a financing technique adopted by Islamic banks that takes the form of murabahah muajjal. It is a contract in which the bank earns a profit margin on the purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in installments. It has to expressly mention cost of the commodity and the margin of profit is mutually agreed. The price fixed for the commodity in such a transaction can be the same as the spot price or higher or lower than the spot price.

Musawamah
Musawamah is the negotiation of a selling price between two parties without reference by the seller to either costs or asking price. While the seller may or may not have full knowledge of the cost of the item being negotiated, they are under no obligation to reveal these costs as part of the negotiation process. This difference in obligation by the seller is the key distinction between Murabahah and Musawamah with all other rules as described in Murabahah remaining the same. Musawamah is the most common type of trading negotiation seen in Islamic commerce.

Bai salam
Bai salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods and cannot be gold, silver or currencies (these are “ribawi” items) based on these metals. Barring this, Bai Salam covers almost everything that is capable of being definitely described as to quantity, quality, and workmanship.

Actually there are more Islamic banking products currently being offered in the market but those described above are the most common offerings. It is interesting to note that some Islamic banks are trying to emulate products offered by conventional banks. My answer to this, in their effort of trying to be innovative, they may risk developing a disguished "riba" product instead a truly shariah-compliant product. To me, instead of moving forward with their so call "product innovation" they are actually moving backward. We must move forward by improving the Musharakah (equity-based) financing structure rather relying too much on debt-based products. Musharakah if properly structured, is safer than debt-based financing product. We will examine more on this in later section.

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