UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for December 9, 2010

Diminishing Musharakah (Musharakah Mutanaqisah) for Asset Financing in Islamic Finance


‘Musharaka in Arabic means “partnership”, so a diminishing musharaka is a diminishing partnership, in the sense that a home buyer and his/her bank are partners in the purchase of the home. The diminishing musharaka contract generally provides for the home buyer to contribute a deposit, while the bank pays the rest, and the two become co-owners of the home. The home buyer lives in the house, paying rent to the bank as well as regular scheduled purchases of “units” of the bank’s share of the house. As the bank’s ownership decreases/diminishes, the rent decreases accordingly, until the home buyer has bought out the bank and owns the house outright.’

Diminishing Musharaka Links:



Banque du Liban Circular Re: Musharakah

Fatwa on Islamic Home Purchase

Shariah Parameter for Musharakah Contract (Bank Negara Malaysia)

Ijarah Project Financing via Forward Lease (Ijarah Mawsufah fi Al-Zimmah)


The forward lease is a contract whereby the financier will start paying the rent to the contractor/lessor even though the asset is still under construction.  The paid rent is used to finance the construction cost.  If the project fails, the amount paid towards the rent must be refunded to the financier by the contractor/lessor.  (AMANIE)

Islamic Project Finance:

Practical Application of Forward Ijarah:

The Parameters of Forward IjÉrah and its Application in Financing Services in Islamic Financial Institutions

Islamic Project Financing via Parallel Istisna’a (Al- Istisna’a Al Muwazi)


‘Istisna’a is a contract of exchange with deferred delivery applied to specified made-to-order items.  General agreement upon principles of practice can generally be stated as:

a.)  The nature and quality of the item to be delivered must be specified;

b.)  The manufacturer must make a commitment to produce the item as described;

c.)   The delivery date is not fixed.  The item is deliverable upon completed by the manufacturer;

d.)  The contract is irrevocable after the commencement of manufacture except where delivered goods do not meet the contracted terms;

e.)   Payment can be made in one lump sum or in instalments and at anytime up to or after the time of delivery;

f.)    The manufacturer is responsible for the sourcing of inputs to the production process.

Istisna’a differs from Ijarah in that the manufacturer must procure his own raw materials.  Istisna’a’a differs from bay salam in that the subject matter of the contract is always a made-to-order item, the delivery date need not be fixed in advance, full advance payment is not required, and the istisna’a’a contract can be cancelled but only before the seller commences manufacture of the agreed items.

Parallel Istisna’a Project Financing

Parallel Istisna’a’ is based on two parallel contracts of Istisna’a.  In the first contract, the Islamic Financial Institution acting as a manufacturer/contractor concludes a contract with the customer who is the ultimate purchaser/buyer.  In the second contract, the IFI acting in the capacity of the purchaser concludes another contract with the ultimate manufacturer/contractor to acquire the same item as per the first contract specification. (AMANIE)

‘The bank:  Expresses its desire to order the manufacture of the commodity it has undertaken to manufacture in the first Istisna’a contract (with the same specification as in the first contract) and agrees with the maker on the price and the date of delivery.

The seller: Puts herself under obligation to manufacture the specific commodity and to its delivery on the due date agreed upon.’

Parallel Istisna’a  Contractual Relationship

السؤال : هل يمكن استخدام صيغة الاستصناع في عمليات يدخل فيها البنك وسيطاً بين العميل والمقاول أو الصناع الفعلي؟

الجواب : لا مانع شرعاً من إبرام عقد استصناع بين البنك والعميل وإبرام عقد استصناع آخر (الاستصناع الموازي) بين البنك والمقاول أو الصانع الفعلي ، أو بالعكس بأن يبدأ بالتعاقد مع المقاول أو الصانع الفعلي ، ثم التعاقد مع العميل ، حسبما يراه البنك مناسباً ، ويشترط في الحالتين عدم الربط بين العقدين ، فتكون هناك علاقة عقدية مستقلة بين البنك والعميل ، وعلاقة عقدية أخرى مستقلة بين البنك والمقاول أو الصناع الفعلي . ويتبين من هذا أن في الاستصناع والاستصناع الموازي ثلاثة أطراف واحد منها مشترك في العقدين وهو البنك ، إذ يكون صانعاً في عقد الاستصناع مع العميل ، ومستصنعاً في عقد الاستصناع الموازي مع المقاول أو الصانع الفعلي . وتكون الشروط متماثلة في العقدين إلا في الثمن لتحقيق هامش ربح للبنك ، وزمن التسليم لتمكين البنك من التسلم ثم التسليم ، ويجوز للبنك أن يوكل العميل (في الاستصناع الموازي) بتسلم المصنوع من المقاول أو الصانع الفعلي ، بعد تمكن البنك من القبض الحكمي . وإذا كانت هناك ضمانات صيانة للمعدات المصنوعة لمدة محددة حصل عليها البنك من المقاول أو الصانع الفعلي فيجوز للبنك أن ينقلها إلى العميل ، مع بقاء مسئولية البنك تجاه العميل إن حصل إخلال بتحمل الضمانات من المقاول أو الصانع الفعلي ، وذلك باعتبار البنك صانعاً وضامناً لعيوب المصنوع وهي مما لا يجوز التبرؤ منها ، بخلاف التبرؤ من العيوب في البيع العادي

المصدر : بنك المؤسسة العربية المصرفية الإسلامي


“Is it possible to conclude a manufacturing contract to formalize an arrangement, whereby the Bank acts as an intermediary between the customer and the manufacturer?


In Islamic law, nothing prevents the Bank from concluding a contract of manufacturing between themselves and the customer and concluding another contract of manufacturing (parallel manufacturing) between themselves and the constructor or actual manufacturer, or vice versa.

So, firstly, the Bank concludes a contract with the actual manufacturer. Then, the second contract is concluded with the customer, according to what the bank sees is suitable. The two contracts are separate contracts. Hence, there will be a contractual relationship between the Bank and the manufacturer (1st contract) and a contractual relationship between the Bank and the customer (2nd contract).

It is obvious from this that in a parallel manufacturing contract, there are three parties. One of them is the Bank, which is involved in two separate manufacturing contracts, in different capacities. In the first contract, the Bank enters the contract as a mustasni’an (customer). In the second contract, the Bank enters the contract as a manufacturer. The conditions for the two contracts are same, except in the price (in the second contract, it includes a margin for the Bank), period of delivery, and receipt and delivery for the Bank.

It is also permissible for the Bank to appoint the customer as their agent, to receive/take possession of the manufactured asset on their behalf. If there are guarantees of maintenance of manufactured asset for a specific period that the Bank has obtained from the manufacturer, it is permissible for the Bank to transfer it to the customer.

However, the Bank is still responsible if the manufacturer does not perform his duties, as agreed. This is because the Bank entered into the second contract while assuming the role of a manufacturer. Thus, the Bank is responsible for defects and cannot acquit themselves from it.”

Issued by the Arab Institute of Islamic Banking.’a/211-parallel-istisna’a-contractual-relationship.html



Istisna’a Financing of Infrastructure Projects…dp.pdf


Istisna’a Construction Financing



Fatwa on Istisna’a, Contracting, and Salam

Ijarah in Islamic Finance





“Ijarah means lease, rent or wage. Generally, Ijarah concept means selling the benefit of use or service for a fixed price or wage. Under this concept, the Bank makes available to the customer the use of service of assets / equipments such as plant, office automation, or motor vehicles for a fixed period and price.” (Wikipedia)

“Ijarah gives the Lessee the right to access the equipment on payment of the first installment. This is important as it is the access and use (and not ownership) of equipment that generates income.” (

Advantages of Ijarah

“Ijarah provides the following advantages to the Lessee:

  • Ijarah conserves the Lessee’ capital since it allows up to 100% financing.
  • Ijarah gives the Lessee the right to access the equipment on payment of the first installment. This is important as it is the access and use (and not ownership) of equipment that generates income.
  • Ijarah arrangements aid corporate planning and budgeting by allowing the negotiation of flexible terms.
  • Ijarah is not considered Debt Financing so it does not appear on the Lessee’ Balance Sheet as a Liability. This method of “off-balance-sheet” financing means that it is not included in the Debt Ratios used by bankers to determine financing limits. This allows the Lessee to enter into other lease financing arrangements without impacting her overall debt rating.
  • All payments towards Ijarah contracts are treated as operating expenses and are therefore fully tax-deductible. Leasing thus offers tax-advantages to for-profit operations.
  • Many types of equipment (i.e computers) become obsolete before the end of their actual economic life. Ijarah contracts allow the transfer of risk from the Lesse to the Lessor in exchange for a higher lease rate. This higher rate can be viewed as insurance against obsolescence.
  • If the equipment is used for a relatively short period of time, it may be more profitable to lease than to buy.
  • If the equipment is used for a long period but has a very poor resale value, leasing avoids having to account for and depreciate the equipment under normal accounting principles.


Ijarah thumma al bai’ (hire purchase)

Parties enter into contracts that come into effect serially, to form a complete lease/ buyback transaction. The first contract is an Ijarah (lease) that outlines the terms for leasing or renting over a fixed period and the second contract is a Bai that triggers a sale or purchase once the term of the Ijarah is complete. For example, in a car financing facility, a customer enters into the first contract and leases the car from the owner (bank) at an agreed amount over a specific period. When the lease period expires, the second contract comes into effect, which enables the customer to purchase the car at an agreed to price.

The bank generates a profit by determining in advance the cost of the item, its residual value at the end of the term and the time value or profit margin for the money being invested in purchasing the product to be leased for the intended term. The combining of these three figures becomes the basis for the contract between the Bank and the client for the initial lease contract.   (wikipedia)

“In cases where a buyer cannot afford to pay the asked price for an item of property as a lump sum but can afford to pay a percentage as a deposit, a hire-purchase contract allows the buyer to hire the goods for a monthly rent. When a sum equal to the original full price plus interest has been paid in equal installments, the buyer may then exercise an option to buy the goods at a predetermined price (usually a nominal sum) or return the goods to the owner. Hire purchase enables one to eventually secure ownership of the new asset. The cost can be spread over its useful life and paid for from revenue. Payment patterns can be tailored to suit individual needs, generally involving a deposit, followed by a series of monthly or quarterly installments. Hire purchase is suitable for individuals and businesses of all sizes. Funding is on balance sheet and one has a choice of fixed or variable interest rate agreements.” (


Ijarah wal iqtina is a contract under which an Islamic bank provides equipment, building, or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the promise does not become an integral part of the lease contract to make it conditional. The rentals as well as the purchase price are fixed in such manner that the bank gets back its principal sum along with profit over the period of lease.” (


Refinancing of assets owned by the client in a sale and leaseback arrangement is allowed under certain circumstances. The bank being the owner of the asset is paid rent, fixed or variable as agreed by the parties. The rental amount is often linked to Libor.

This structure involves two different contracts.  (1) Sale of asset by the customer to the financier at cash price.  (2) An option is given to the customer/developer to purchase back the asset after the expiry of the lease period.  Usually the repurchase price is tantamount to the price which the financer bought the asset.  (AMANIE)

Usufruct Financing via Ijarah Contract (Operating Lease)

The lessor is the owner of the asset who has granted the right to use the asset to the lessee.  After the expiry of the lease period, the lease may be extended or may not be renewed following which the leased asset will return back to the lessor.  The lessee has to pay a certain agreed rental during the lease period.  (AMANIE)

 International Accounting Standard (IAS) 17 defined an operating lease as a lease other than a finance lease.  Literally this is an agreement to lease certain items just like a Financial Lease but within a shorter time (usually between 12-24 months).  The lessor or the lessee can terminate the agreement at anytime on the basis that the lessor will be responsible for any damage occurring to the leased item.  This lease type is very similar to a normal rental agreement.

Asset-Financing via Ijarah Muntahhiya bi Tamlek

I.E., The financier purchases the house from the vendor and leases it to the customer with a call option to purchase the house in the following alternative arrangements.  (1) Token payment of purchase price; (2) Last rental payment is deemed to be the purchase price; (3) Gift; (4) Actual price of the house (based on financial modeling).  This structure requires two contracts, one for the lease and one for the sale.  (It is prohibited to have two sales in one.)  A Put Option is used to require the lessee to purchase the leased asset in the case of (1) Pre-payment; (2) Default payment.  (The formula would be the outstanding principle plus takaful cost – unearned profit).  (AMANIE)

Finance Lease

 “According to the International Accounting Standard 17, a finance lease is defined as a lease that transfers substantially all the risks and rewards incidental to ownership of an asset… title may or may not pass.  A finance lease is also defined as an agreement to lease certain equipment with a fixed period of time-mostly medium to long, where the leasing company will not provide any service or maintenance, repair or insurance of the leased item. The lessor will calculate payment, depending on the price of the item, plus interest and benefit.  Neither the Lessor nor the Lessee can terminate the agreement.”



Murabahah in Islamic Finance




Personal Financing: A bank may give the borrower cash for personal consumption or to buy an asset.  In this case, a bank credits the customer’s bank account with the cash. 

Asset Financing: A bank may facilitate a customer to purchase an asset by offering alternative payment plans such as installments or deferred lump sum payment.  The Islamic Bank actually delivers the asset to the customer. 

While asset financing enables the customer to own a particular asset, personal financing enables the customer to obtain cash for his consumption including the purchase of an asset.  (AMANIE)


‘Murabahah or murabaha (Arabic مرابحة, more accurately transliterated as murābahah) is a particular kind of sale, compliant with shariah, where the seller expressly mentions the cost he has incurred on the commodities for sale 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,” murabahah is one of three types of bayu-al-amanah (fiduciary sale). The other two types of bayu-al-amanah are tawliyah (sale at cost) and wadiah (sale at specified loss).

It is one of the most popular modes used by banks in Islamic countries to promote riba-free transactions. Different banks use this instrument in varying ratios. Typically, banks use murabahah in asset financing, property, microfinance and commodity import-export.[1]

The seller may not use murabahah if mudarabah or musharakah are practicable. Since those profit-sharing modes of financing involve risks, they cannot guarantee banks any income. Murabahah, with its fixed margin, offers the seller (i.e. the bank) a more predictable income stream. A profit-sharing instrument, conversely, is preferable as it shares the risks more equitably between seller and buyer.

There are, however, practical guidelines in place which aim to ensure that the murabahah transaction between the bank and the customer is one based on trade and not merely a financing transaction. For instance, the bank must take constructive or actual possession of the good before selling it to the customer. Whilst it can be justified to charge an additional margin to the customer to reflect the time value of money in terms of actual payment not being received from the customer at time zero, the bank can only impose penalties for late payment by agreeing to purify them by donating them to charity.’

Commodity Murabahah

‘Under a Commodity Murabaha financing or Tawarooq, a Bank purchases and takes title to the relevant assets (usually precious metals such as Palladium) from a third party broker. The Bank then sells the assets to the Borrower at cost plus a specified profit. Payment of the sale price is usually deferred and may be structured in accordance with the wishes of the parties. The Borrower will enter into a contract to sell the assets to the Broker for the cost price. The net result is to create a deferred payment obligation from the Borrower to the Bank. Bank and Customer will usually enter into a succession of such transactions to create monthly, quarterly or semi-annual payment obligations.

The Commodity Murabaha has been criticised by Islamic Scholars who say it should only be used as a structure of last resort where no other structure is available. In most transactions the commodities never change hands and usually there are no commodities at all, merely cashflows between banks, brokers and borrowers. Often the commodity is completely irrelevant to the Borrower’s business and there is not even enough of the relevant commodities in existence in the world to account for all the transactions taking place.[2]

I.E., Under this structure, the surplus bank may initially purchase an asset from LME at USD 10 Million (or equivalent to the amount that the deficit bank is in need of).  Next, the surplus bank will sell the asset to the deficit bank at USD 10.5 million which is payable in one week (equivalent to the period of investment).  Upon the acquisition of the asset by the deficit bank, the deficit bank may sell the asset to the market/LME for USD 10 million cash.  This USD 10 million is essentially intended for money market purposes.  (AMANIE)

Murabahah v Lending on Interest


Murabahah Presentation,Salam%20&%20Istisna%20)/Murabaha%20-%20Process,%20Documentation%20&%20Practical%20Issues%20by%20Ahme.pdf

Murabahah as A Mode of Finance


Murabahah Explained

Sharia’h Parameters Murabahah

Fatwa on Murabahah

UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance