Islamic financial transaction terminology
glossary is not limited to Islamic terms and contains Arabic and English
(sale and buy-back agreement)
The financier sells an asset to the customer on a deferred-payment
basis, and then the asset is immediately 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
Shariah principles. There is an another definition of this bai
as per the Imam ibn-e-Hijam if three persons are involved in this Sale (buy
back finance) than, this bai Inah change into bai Tawarruq. He defines
this bai as ; suppose Zhaid is in need of 2000 Rs, and he(Zhaid)goes to
Jamshed for 2000Rs,In answer to this Jamshed says I will not give u qard
(Loan)instead u can buy this item for Rs 2500 from me,so Zhaid buys this
item from Jamshed for Rs 2500,immediately Aslam (3rd)person buys the
same item from Zhaid for Rs 2000 and take the possession of the item and
handover the item to Seller i.e (Jamshed) the amount which is due to be
paid to Zhaid by Aslam is now referred to seller no 1 i.e Jamshed ,
Jamshed after receiving back the same item from Aslam(which was sold to
Zhaid for 2500)pays Zhaid Rs 2000 and writes Rs 2500 in his book against
Zhaid.In this way Jamshed earns a interest of Rs 500 This is termed as
bai Tawarruq .
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 that the debtor makes only a single
installment on the maturity date of the loan. By the application of a
discount rate, an Islamic bank can collect the market rate of interest
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
murabaha 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.
Musharakah ( joint venture with capital )is an arrangement or
agreement between two or more partners ,whereby each partner provides
funds to be used in a venture. Profits made are shared between the
partners according to the invested capital . In case of loss, each
partner looses the capital in the same ratio .If the Bank is providing
capital , same conditions apply. It is this financial risk, according to
the Shariah, that justifies the bank's claim to part of the profit. All
the parnters may or may not participate in carrying out the business.
The parnter/s who is also working, gets greater profit ratio as compared
to the sleeping partner. The Difference b/w Musharaka and Madharaba is
that, in Musharaka, each partner participates with some capital, whereas
in Madharaba, there is a capital provider, ie. a financial institution
and an enterpreneur, who has zero financial participation. Note that
Musharaka and Madharaba are commonly overlapping.
Main article: Mudarabah
"Mudarabah" is a special kind of partnership where one partner gives
money to another for investing it in a commercial enterprise. The
investment comes from the first partner who is called "rabb-ul-mal",
while the management and work is an exclusive responsibility of the
other, who is called "mudarib".
The Mudarabah (Profit Sharing) is a contract, with one party providing
100 percent of the capital and the other party providing its specialist
knowledge to invest the capital and manage the investment project.
Profits generated are shared between the parties according to a pre-agreed
ratio. Compared to Musharaka, in a Mudaraba only the lender of the money
has to take losses.
Main article: Murabaha
This concept refers to the sale of goods at a price, which includes a
profit margin agreed to by both parties. The purchase and selling price,
other costs, and the profit margin must be clearly stated at the time of
the sale agreement. The bank is compensated for the time value of its
money in the form of the profit margin. This is a fixed-income loan for
the purchase of a real asset (such as real estate or a vehicle), with a
fixed rate of profit determined by the profit margin. The bank is not
compensated for the time value of money outside of the contracted term
(i.e., the bank cannot charge additional profit on late payments);
however, the asset remains as a mortgage with the bank until the default
This type of transaction is similar to rent-to-own arrangements for
furniture or appliances that are very common in North American stores.
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 Murabaha and Musawamah with all
other rules as described in Murabaha remaining the same. Musawamah is
the most common type of trading negotiation seen in Islamic commerce.
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 based on these metals.
Barring this, Bai Salam covers almost everything that is capable of
being definitely described as to quantity, quality, and workmanship.
Basic features and conditions of Salam
1.The transaction is considered Salam if the buyer has paid the
purchase price to the seller in full at the time of sale. This is
necessary so that the buyer can show that they are not entering into
debt with a second party in order to eliminate the debt with the first
party, an act prohibited under Sharia. The idea of Salam is to provide a
mechanism that ensures that the seller has the liquidity they expected
from entering into the transaction in the first place. If the price were
not paid in full, the basic purpose of the transaction would have been
defeated. Muslim jurists are unanimous in their opinion that full
payment of the purchase price is key for Salam to exist. Imam Malik is
also of the opinion that the seller may defer accepting the funds from
the buyer for two or three days, but this delay should not form part of
2.Salam can be effected in those commodities only the quality and
quantity of which can be specified exactly. The things whose quality or
quantity is not determined by specification cannot be sold through the
contract of salam. For example, precious stones cannot be sold on the
basis of salam, because every piece of precious stones is normally
different from the other either in its quality or in its size or weight
and their exact specification is not generally possible.
3.Salam cannot be effected on a particular commodity or on a product of
a particular field or farm. For example, if the seller undertakes to
supply the wheat of a particular field, or the fruit of a particular
tree, the salam will not be valid, because there is a possibility that
the crop of that particular field or the fruit of that tree is destroyed
before delivery, and, given such possibility, the delivery remains
uncertain. The same rule is applicable to every commodity the supply of
which is not certain.
4.It is necessary that the quality of the commodity (intended to be
purchased through salam) is fully specified leaving no ambiguity which
may lead to a dispute. All the possible details in this respect must be
5.It is also necessary that the quantity of the commodity is agreed upon
in unequivocal terms. If the commodity is quantified in weights
according to the usage of its traders, its weight must be determined,
and if it is quantified through measures, its exact measure should be
known. What is normally weighed cannot be quantified in measures and
6.The exact date and place of delivery must be specified in the contract.
7.Salam cannot be effected in respect of things which must be delivered
at spot. For example, if gold is purchased in exchange of silver, it is
necessary, according to Shari'ah, that the delivery of both be
simultaneous. Here, salam cannot work. Similarly, if wheat is bartered
for barley, the simultaneous delivery of both is necessary for the
validity of sale. Therefore the contract of salam in this case is not
This is a token given voluntarily by a debtor to a creditor in return
for a loan. Hibah usually arises in practice when Islamic banks
voluntarily pay their customers a 'gift' on savings account balances,
representing a portion of the profit made by using those savings account
balances in other activities.
It is important to note that while it appears similar to interest, and
may, in effect, have the same outcome, Hibah is a voluntary payment made
(or not made) at the bank's discretion, and cannot be 'guaranteed.'
However, the opportunity of receiving high Hibah will draw in customers'
savings, providing the bank with capital necessary to create its profits;
if the ventures are profitable, then some of those profits may be gifted
back to its customers as Hibah.
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, motor
vehicle for a fixed period and price.
Advantages of Ijarah
Ijarah provides the following advantages to the Lessee:
Ijarah conserves the Lessee' capital since it allows up to 100%
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 his overall
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 short 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
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.
This type of transaction is similar to the contractum trinius, a legal
maneuver used by European bankers and merchants during the Middle Ages
to sidestep the Church's prohibition on interest bearing loans. In a
contractum, two parties would enter into three concurrent and
interrelated legal contracts, the net effect being the paying of a fee
for the use of money for the term of the loan. The use of concurrent
interrelated contracts is also prohibited under Shariah Law.
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.
Musharakah (joint venture)
Musharakah is a relationship between two parties or more, of whom
contribute capital to a business, and divide the net profit and loss pro
rata. This is often used in investment projects, letters of credit, and
the purchase or real estate or property. In the case of real estate or
property, the bank assess an imputed rent and will share it as agreed in
advance. All providers of capital are entitled to participate in
management, but not necessarily required to do so. The profit is
distributed among the partners in pre-agreed ratios, while the loss is
borne by each partner strictly in proportion to respective capital
contributions. This concept is distinct from fixed-income investing
(i.e. issuance of loans).
Qard hassan/ Qardul hassan (good loan/benevolent loan)
This is a loan extended on a goodwill basis, and the debtor is only
required to repay the amount borrowed. However, the debtor may, at his
or her discretion, pay an extra amount beyond the principal amount of
the loan (without promising it) as a token of appreciation to the
creditor. In the case that the debtor does not pay an extra amount to
the creditor, this transaction is a true interest-free loan. Some
Muslims consider this to be the only type of loan that does not violate
the prohibition on riba, since it is the one type of loan that truly
does not compensate the creditor for the time value of money.
Sukuk (Islamic bonds)
Main article: 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 (Shariah) 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.
Takaful (Islamic insurance)
Main article: Takaful
Takaful is an alternative form of cover that a Muslim can avail himself
against the risk of loss due to misfortunes. Takaful is based on the
idea that what is uncertain with respect to an individual may cease to
be uncertain with respect to a very large number of similar individuals.
Insurance by combining the risks of many people enables each individual
to enjoy the advantage provided by the law of large numbers. See Takaful
In Wadiah, a bank is deemed as a keeper and trustee of funds. A
person deposits funds in the bank and the bank guarantees refund of the
entire amount of the deposit, or any part of the outstanding amount,
when the depositor demands it. The depositor, at the bank's discretion,
may be rewarded with Hibah (see above) as a form of appreciation for the
use of funds by the bank.
Wakalah (power of attorney)
This occurs when a person appoints a representative to undertake
transactions on his/her behalf, similar to a power of attorney.