Islamic Banking and Finance: Tools of Finance

As the Islamic Financial System doesn't permit the interest-based financing tools, Islamic financial system has lots of tools of financing which are working on the participation and sharing principle such as Musharakah, Mudarabah and their variants, the deferred trading  tools such as Murabaha and forward sales  such as-Salam, a combination of tools such as Musharaka and Ijarah, Murabaha and Salam etc. and interest-free loans in particular situations.

Below we give the short details of the major tools of contract in Islam (the detailed information will be given in the upcoming chapters):

1. Mudarabah: Mudarabah is a partnership procedure in which one party arranges capital to the business venture and the other party offers entrepreneurial skills.  The profit is shared by the partners according to a pre-agreed ratio while the loss is bear by the capital provider.

2. Musharakah: Musharakah is also a partnership procedure based on profit and loss sharing arrangement in which both parties will provide both capital and entrepreneurship skills. The profit is shared as per pre-agreed ratio while the loss is shared as per the ratio of investment.

3. Murabaha–Mu’ajjal: Murabaha–Mu’ajjal is the cost-plus financing procedure in which the Islamic bank purchases goods upon a customer’s demand and sells the goods to the customer on credit sale at a profit margin in the differed payment system.

4. Salam: Salam is a sale procedure where the seller undertakes to supply some specific goods to the buyer at a future specific date to a specific place in exchange for an advanced price fully paid at the spot.

5. Ijarah: Ijarah is the process of leasing an asset and receiving rentals.

6. Istisna: Istisna is the procedure of ordering a manufacturer to manufacture a specific commodity for the purchaser. The transaction of Istisna’ comes into existence when the manufacturer starts the process of manufacturing.  Istisna is the second kind of sale where a commodity is in the contract before it comes into existence.

7. Wakala: Wakala is a contract where a person works as an agent for another person who is the capital provider. The capital provider will solely take profit or loss and the agent will receive the agency fee.