Islamic Banking is based on the principles of trade, partnership, sharing of gains and losses, and prohibition of reckless risk. It prohibits:



1. Interest-based banking
2. Gharar –unclear contracts
3. Maysir–speculation
4. Financing of haram transactions -– alcohol, gambling, pork, etc.

Lending in Islamic Banking



Islamic Financing involves a buy-sale deal or a rent to sale deal. There is always an underlying asset behind the deal. Allah reminds us: “We have permitted trade and forbidden riba”. In Islamic banking, the lender must share the risk with the borrower.



Types of Lending contracts



Murabaha – sale contract
Mudaraba – Part financing
Musharika – Partnership
Ijara – rental/lease
Tawarruq – overdraft facilities.
Istisna’a
Salam

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Murabaha



The term Murabaha comes from the Arabic word “rabh” which means profit (Short term trade financing). Client identifies goods which we wishes to buy for KShs. x and requests a bank to finance the transaction. The Bank buys the said goods and resells them to the client for KShs. x+ margin (e.g. 10% agree profit). The Client then repays within agreed timeframe.



Musharika



This is a joint enterprise formed for business where all the partners (Bank and customer) contribute capital and share the profit according to a specific ratio while any possible loss is in turn shared according to the capital contribution by the two parties. Both the bank and the client contribute capital, client brings know how. Profits/losses are thus shared on agreed ratios.



Musharika vs Interest Banking



The characteristics of Interest Based banking are:



• Fixed Rate of Return percentage
• Bank does not take any share of loss/risk
• Banks not invoved in owning and selling of goods.

Mudaraba



This is a partnership where the bank contributes 100% of the capital and the client contributes know how. Profit is in turn shared on an agreed ratio. If there are any losses, the bank absorbs it fully. This is the equivalent to 100% financing by the bank.





Uses of Musharika/Mudhariba



• Short/medium/long term financing
• Project financing
• SME set up
• Import financing
• LC’s
• Export (Pre-shipment Financing)
• Working Capital Financing.

Diminishing Musharika



This is where a client wants the bank to finance and remain a partner. The Diminishing Musharika/Murabaha is where the client buys out the shares of the bank over time. The classic examples is for example, the purchase of houses, equipment etc.

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Ijara



Ijara is the same as leasing. The bank purchases the asset/house. There is Joint ownership between the bank and the client. The client rents it from the bank. Client enters into an agreement to buy the shares from the bank over an agreed timeframe. He then buys out small amounts of shares from the bank time to time ending up with a hundred per cent (100%) ownership. Repayment is in the form of rental costs which changes as the percentage owned by the client increases. The value of the asset can also increase thus the bank has the right to charge a higher price for the sale of its shares.



Istisna’a



Istisna’a is a sales transaction where a commodity is sold before it comes into existence. For example this mode of financing may be used for home financing where the client owns land and seeks financing for the construction of a house, the financier can provide him with a constructed house on a specified piece of land. The price must be fixed with the consent of all parties involved. All other necessary specifications of the commodity must also be fully settled. The payment of an Istisna’a may be made in advance or instalments or in a lump sum at the end of the period.

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Salam



Salam is a sales transaction where a commodity, usually horticultural or agricultural goods, is sold before it comes into existence. The price of the commodity must be paid in advance to make the transaction valid.



Deposits in Islamic Banking



Clients deposits fall under the category of qard(Loan) to the bank and the bank is obliged to pay back. These loans fall under the category of Musharika. The bank is obliged to share in the profits of the bank with its depositors. Bank must protect these assets on behalf of its clients as well as get them the highest halal returns. Since banks do not pay interest, clients must therefore become a partners or Mushariks to share in the profits. The only way to become a partner is to open an investment account (Time or Saving Deposit) which allows the bank to invest one’s money. Profit sharing is then calculated and distributed. Profits will be very close to prevailing deposit rates.