To gain a good understanding of the burgeoning Islamic finance industry, it is important to appreciate the diverse range of products that are currently on offer. Certainly, with a solid foundation of Islamic contract law and the principle of Islamic finance, one is in a position to explore some of the most popular products.
 It is important to appreciate that Islamic finance is more than just financial contracts. In principle, a great deal of emphasis is placed on responsible investments; client relationships; capitalism with a moral focus; and eliminating excessive uncertainty within the markets. These ideals are clearly stipulated within Islamic law.
Therefore, by increasing our knowledge of Islamic law, we increase our understanding of Islamic finance. We will now explore some of the most popular products in Islamic finance.
Musharaka
In Arabic, the origin of the word Musharaka means to share and in the context of business and commerce, we can classify Musharaka contract as a partnership contract.
There is no doubt that the Musharaka contract is one of the most popular financial tools for the idealist in Islamic finance industry. It avoids two of the main “sicknesses” of the conventional economy, namely: interest rates and income inequality.
Interest is a predetermined fixed rate on a loan, charged irrespective of profit earned or loss suffered by the borrower.
Indeed, during the recent credit crisis, just when things got more difficult for borrowers, many banks increased their mortgage rates and repossessions of houses hit record levels. The Musharaka contract aims to avoid this by cementing the relationship of the lender and borrower, with return based on the profit earned.
In terms of income inequality, it is interesting to note the payoff in a conventional borrower-lender relationship. In such a scenario assume an industrialist borrows $10mln from the bank. If the industrialist makes a profit of 20% the return to the depositor is fixed (generally to single digit figures). We can note two points with a Musharaka. Firstly, the “lender” and “borrower” become partners and share the benefits at an equitable level. Secondly, the bank is obligated to pay a tax of 2.5% (known as Zakat), where proceeds go to help the poor in society.
Mudarabah
Mudarabah is derived from the Arabic root word: darbun meaning journey, seeking (trade or work). The Mudarabah contract is a close cousin of Musharaka contract, where one partner (Rab-ul-mal) invests in a commercial enterprise managed by another partner (Mudarib). There are three main differences between these contracts. In Mudarabah, only the Rab-ul-mal injects the capital, whereas in a Musharaka the capital input comes from all partners.
Secondly, the management of the project in a Musharaka contract is shared (i.e. all partners can manage the project), whereas in Mudarabah management is the prerogative of the Mudarib. In addition, in Musharaka profits and losses are shared, while in Mudarabah the Mudarib bears no losses (unless negligence is proven).
Murabaha
The Murabaha contact is a sales contract where the seller reveals the costs of the good or service and a mark-up to the buyer. For example, the customer identifies a house, which the bank purchases at a certain price. The bank will then sell the house to the customer at the price it purchased the house plus a mark-up, which can be paid back in installments.
The Qur’anic verse that God has permitted trade and forbidden riba indicates that the sales contract is the definitive permissible contract. The rise in the use in Murabaha has been followed by a rise in criticisms. It is important to note that the traditional use of the Murabaha contract is consistent with the Shari’ah. However, some forms (e.g. reverse Murabaha) and implementation of the contract have raised eyebrows amongst the certain stakeholders. The Islamicbanker.com Research Unit will investigate some of these concerns.
Ijara
The literal meaning of Ijara is to provide something on rent. It is a commonly used product within the Islamic banking industry, mainly due to its added flexibility. The contract involves selling "usage" (usufruct) for a specified length of time, with the lessor retaining ownership of the underlying asset. The rental payment can be either fixed or vary for the life of the lease.
It is not permissible to have a lease on certain items, namely food, money and fuel. It is also common for the lessee to own the asset, sell it and then lease it back. For example, many airline companies in the Middle East have structured products where the airplanes have been sold to investors and then leased back (in return the airline companies receive a lump sum - for selling the planes - and pay out a specified rental to the investors).
 Salam
Salam contract is where an advanced payment is made for deferred delivery of goods. This can be illustrated by the figure on the right. In such a case,the financier (Islamic bank) pays $10,000 to the seller (on the right side of the diagram) on time t. The seller is then obligated to deliver the goods at a specified time in the future, t+1. As a result of this contract, the financier takes ownership of the goods, therefore, to reduce risk and meet regulatory requirements, the financier is required to have a parallel Salam in place, which transfer ownership of the object.
As you will explore in the Islamic contract law section, generally a valid contract needs to
meet the following conditions: the object needs to be in existence; and sellers must have ownership of the object. Salam and Istisna (discussed below) are exempt from these two conditions. As a result many of the leading scholars have placed some important restrictions on the use of Salam. For example, it is stipulated that the length of a Salam must be longer than 30 days.
Istisna
An Istisna contract is an order for a manufacturer to manufacture or construct a particular commodity for the purchaser. Out of all products and instruments in Islamic banking, it is Istisna which is the most flexible. For example, under Istisna the price can be paid up front, according to progress, at completion or installments after completion. In order to avoid excessive uncertainty (Gharar), scholars' have stipulated detailed specifications before any work begins.
Notes:
1. An Introduction to Islamic Finance, Usmani, M. Taqi, 1998, Idaratul Ma’arif, Karachi, Pakistan.
2. Islamic Finance Qualification (IFQ) / workbook authors Abdul Sattar Abu Ghud et al. - Edition 2, 2007. - London : Securities and Investment Institute; Beirut : Ecole Supérieure des Affaires
3. Islamic Finance: Relevance and Growth in the Modern Financial Age, Iqbal Khan, 2007, London School of Economics
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