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2 Presentation Outline Key Products and Services Section 1 Murabaha Section 2 Ijara Section 3 Musharaka Section 4 Islamic Banks VS Conventional Banks Section Copyright Bank Nizwa. All Rights Reserved. 2

5 Structuring the FACILITY Suspense Account Account with hypothecation Murabaha Sale at Profit Lease Financing Banking Services Ijara Sharia-Compliant Insurance Manufacturing Financing Takaful Istisna Islamic Fixed Income Sukuk IFI Mudaraba Profit Sharing Loss Bearing Financing Current Account Profit-and-Loss sharing Financing Qardh Musharaka Procurement Contract Muqawala Wakala Financing by Investment Agency 2018 Copyright Bank Nizwa. All Rights Reserved. 5

Structuring the SECURITY MONEY IS A MEDIUM OF EXCHANGE NOT

Pre-documentation Stage MONEY IS A MEDIUM OF EXCHANGE NOT

9 Documentation Stage Issuance of FOL Appointment of Counsel / Solicitor Drafting Facility & Security Docs Finalizing & Execution of the Facility Stamping, Registering and Perfecting the Security MONEY IS A MEDIUM Compliance to OF EXCHANGE Covenant / NOT COMMODITY!!! Conditions Precedent 2018 Copyright Bank Nizwa. All Rights Reserved. 9

10 Common type of Agreement for Syndication Term Sheet Common Terms Agreement Inter-Financier Agreement Agency Agreement Security Agreement Novation Agreement MONEY IS A MEDIUM OF EXCHANGE NOT COMMODITY!!! 2018 Copyright Bank Nizwa. All Rights Reserved. 10

12 Murabaha What it is? Murabahah is a cost-plus sale / mark-up sale / credit sale. It refers to the sale and purchase transaction for the financing of an asset whereby the cost and profit margin (mark-up) are made known and agreed by all parties involved. The settlement for the purchase can be either on a cash basis, a deferred lump sum basis or on an installment basis, which will be specified in the agreement. Majority of transactions in Islamic banks (> 60%), globally are structured as murabaha. Being a sale transaction, it is essential that the goods / assets which are the subject of sale in a Murabaha transaction, must be existing, owned by the seller and in his/her physical or constructive possession Copyright Bank Nizwa. All Rights Reserved. 12

13 Murabaha Cont d It is necessary that the seller must have assumed the risks of ownership before selling the commodities to the buyer/customer. Murabahah, like any other sale, requires an offer and acceptance which will include certainty of price, place of delivery, and date on which the price, if deferred, will be paid. Cost and profit both are disclosed. Goods to be traded should be real goods and not credit documents 2018 Copyright Bank Nizwa. All Rights Reserved. 13

Sample of Murabaha Plain Structure Client Goods / Assets Step 6 Step 3 Step 1 Ownership, Title & Possession to the asset Step 4 Supplier / Vendor Step 7 Step 5 Step 2 Bank Nizwa Steps: 1.

14 Sample of Murabaha Plain Structure Client Goods / Assets Step 6 Step 3 Step 1 Ownership, Title & Possession to the asset Step 4 Supplier / Vendor Step 7 Step 5 Step 2 Bank Nizwa Steps: 1. Client request for financing and declare the cost as per the invoice of the asset obtained from the Supplier / Vendor. 2. The Supplier / Vendor to provide offer to sell the asset to the Bank. 3. Instantaneously, the Client will provide Promise to Purchase the asset from the bank. 4. The Supplier / Vendor will execute Sale Agreement with the Bank evidencing the transfer of ownership & title of the asset to the Bank. 5. The Bank will pay the purchase / cost price of the asset to the Supplier / Vendor. 6. The Bank will sells the asset to the Client on a mark-up sale (cost plus profit) as per the Murabaha Agreement. 7. The Client will pay the Murabaha price for certain period (such as on monthly installment basis) as per the Murabaha agreement Copyright Bank Nizwa. All Rights Reserved. 14

15 Common Murabaha Agreement Master Facility Agreement Agency Agreement Purchase Agreement Murabaha Sale Agreement MONEY IS A MEDIUM OF EXCHANGE NOT COMMODITY!!! 2018 Copyright Bank Nizwa. All Rights Reserved. 15

16 Rules to be Observed in Drafting Key Issue Subject of sale must exist It should be in ownership of the seller at the time of sale Subject of sale should be in physical or constructive possession of the seller The sale should be instant and absolute Subject matter should be assets having value Subject of sale should not be used for un-islamic purpose It should be specific and identifiable Delivery should be certain Price certainty Sale must be unconditional Cost must be revealed to buyers 2018 Copyright Bank Nizwa. All Rights Reserved. 16

Sample of Murabaha Hybrid Structure Differed payment of OMR 10 Mio (7) Acceptance of Sale + Transfer of Title (6) Bank Agreement for Mark-up Sale (1) Agency Agreement to source iron-ore

17 Sample of Murabaha Hybrid Structure Differed payment of OMR 10 Mio (7) Acceptance of Sale + Transfer of Title (6) Bank Agreement for Mark-up Sale (1) Agency Agreement to source iron-ore supplier (2) Offer to Purchase iron-ore at OMR 10 Mio in 6 months (5) Customer Delivery of iron-ore (4) Payment of OMR 6 Mio (3) Cotton Supplier 2018 Copyright Bank Nizwa. All Rights Reserved. 17

19 Ijara What it is? Ijara is leasing or renting. It refers to a manfaah (usufruct) type of contract whereby a lessor (owner) leases out an asset or an equipment to its client at an agreed rental amount and pre-determined lease period. It can also be referred to a Sub-Lease transaction. The LEGAL ownership of the leased assets remains in the hands of the lessor Copyright Bank Nizwa. All Rights Reserved. 19

Sample of Ijara Structure Client Usufruct of the Property Step 2 Step 5 Ownership, Title & Possession to the asset Step 3 Vendor / Owner Step 6 Step 4 Step 1 Title & Possession to the Property Bank

20 Sample of Ijara Structure Client Usufruct of the Property Step 2 Step 5 Ownership, Title & Possession to the asset Step 3 Vendor / Owner Step 6 Step 4 Step 1 Title & Possession to the Property Bank Nizwa Steps: 1. The Vendor / Owner to provide offer to sell the asset to the Bank. 2. Instantaneously, the client will provide Promise to lease the asset from the bank. 3. The Vendor / Owner will execute Sale Agreement with the Bank evidencing the transfer of ownership & title of the asset to the Bank. 4. The Bank will pay the purchase price to the Vendor / Owner. 5. The Bank will lease the asset to the Client under the Ijara Agreement. 6. The Client will pay the rental for certain period as per the Ijara agreement Copyright Bank Nizwa. All Rights Reserved. 20

21 Financial Lease vs Operating Lease Finance Lease Is a lease where the lessor has transferred the risks and rewards of ownership to the lessee. This includes maintenance of the asset and the risk of obsolescence. The lessee would have to bear these risks of ownership of the asset. Operating Lease Is a lease where the lessor retains ownership of the asset. This means that the risk and rewards of ownership has not been transferred to the lessee. The lessor is liable for maintenance payments on the asset. In a finance lease, the lessee would pay an amount of lease payments which covers all or most of the cost of the asset to the lessor. The lessee would also have use of the asset MONEY IS A MEDIUM OF useful EXCHANGE life. NOT COMMODITY!!! for most of its useful life. After the lease period, the asset would still have a substantial residual value left. The lease period is also usually a minor part of the asset s 2018 Copyright Bank Nizwa. All Rights Reserved. 21

22 Classification Under Accounting Standards Criteria for the classification of finance and operating leases : 1. Whether the ownership of the asset is transferred to the lessee at the end of the lease period? 2. Whether the lessee has an option to purchase the asset at a discount after the lease period 3. Whether the lease term covers more than 75% of the asset s useful life 4. Whether the present value of lease payments exceeds 90% of the cost of the asset MONEY IS A MEDIUM OF EXCHANGE NOT COMMODITY!!! 2018 Copyright Bank Nizwa. All Rights Reserved. 22

23 Common Ijara Agreement Master Facility Agreement Purchase Agreement Ijara Agreement Agency Agreement MONEY IS A MEDIUM OF EXCHANGE NOT COMMODITY!!! 2018 Copyright Bank Nizwa. All Rights Reserved. 23

24 Rules to be Observed in Drafting Key Issue Subject of sale and lease (or lease-back) must exist Ownership of the leased asset remains with the Lessor All rights and liabilities relating to ownership are borne by the Lessor. Subject matter of Lease should be Valuable, Identified and Quantified. The period of Lease must be determined in clear terms. The Lessor cannot increase the rent unilateral The Lessee is responsible for damage to the asset caused by fraud or negligence. Normal Operational maintenance is Lessee s responsibility If the leased asset is destroyed, the lease will terminate. Lease rentals for the entire lease period can be fixed or adjusted variably Copyright Bank Nizwa. All Rights Reserved. 24

25 Addendum to The Ijara Agreement Description of the Ijara Asset Schedule of Rental Payment Receipt of Asset Demand Promissory Note Undertaking to Purchase MONEY IS A MEDIUM OF EXCHANGE NOT COMMODITY!!! 2018 Copyright Bank Nizwa. All Rights Reserved. 25

26 Description of Ijara Asset Key Issue This document shall be signed after Delivery of asset to the Lessee and not earlier. It contains the detailed description about the Leased Asset agreed between the parties; 1. Legal Name 2. Year Made 3. Model 4. Engine No. 5. Chassis No. 6. Registration No. etc Copyright Bank Nizwa. All Rights Reserved. 26

27 Schedule of Ijara Rentals Key Issue This schedule contains a table which shows: 1. Amount of rental (Monthly/Quarterly/Half Yearly/Yearly) 2. Date of Payment of each rental. 3. Whether moratorium is granted or otherwise. It must also includes the date on which the first rental is due. This document shall be signed after Delivery of asset to the Lessee and not earlier with the exception of Forward Ijara Copyright Bank Nizwa. All Rights Reserved. 27

28 Receipt of Assets Key Issue This document confirms that customer has taken the possession of Leased Asset as described in the Description of Ijara Asset. This document is only signed by the Lessee on receipt of Asset, as an acknowledgement of receipt of described asset under Ijara Contact 2018 Copyright Bank Nizwa. All Rights Reserved. 28

29 Promissory Note Key Issue After signing an Ijara Agreement, the amount of rentals become Debt (Dayn) to the Lessor. Promissory Note is Lessee s acknowledgement on the future Debt amount and its promise to pay Copyright Bank Nizwa. All Rights Reserved. 29

30 Undertaking to Purchase Leased Asset Key Issue This document contains an Undertaking from the Lessee that it will purchase the Leased asset on the purchase Price corresponding to the Purchase Date. This document contains a schedule which shows Purchase Price(s) during the Ijara term on which the Lessee can purchase the asset by making lump sum payment Copyright Bank Nizwa. All Rights Reserved. 30

32 Musharaka What it is? The word Musharaka literally means sharing or to share. Also known as Shirkah. Musharakah is a sharing contract between two or more parties on: 1. Capital (cash or in-kind); 2. Profit and loss. Profit and loss sharing: 1. Profit sharing on mutual basis. 2. Loss is divided in the proportion of investment Maxim: profits are shared according to what has been agreed upon by the parties at the time of contract, and losses are to be borne according to the ratio of capital No guarantee for the loss unless by 3rd party (independent) 2018 Copyright Bank Nizwa. All Rights Reserved. 32

Provide Capital 1 80 % 20 % 20 % Provide Capital 1 Musharaka Financing

33 Sample of Musharaka Structure Lease ownership share of the asset 4 Gradual transfer of ownership of the asset 2 80 % Bank Nizwa 3 Partner / Client Provide Capital 1 80 % 20 % 20 % Provide Capital 1 Musharaka Financing Agreement Pays lease rental February 12, 2014 Copyright Bank Nizwa. All Rights Reserved. 33

34 Common Musharaka Agreement Master Facility Agreement Musharaka Agreement Purchase Agreement Ijara Agreement Agency Agreement Undertaking to Purchase EOS MONEY IS A MEDIUM OF EXCHANGE NOT COMMODITY!!! 2018 Copyright Bank Nizwa. All Rights Reserved. 34

35 Rules to be Observed in Drafting Key Issue Capability of Partners: Must be of a good credit standing and be able of entering into a contract (HC / Sub Co). The contract must take place with free consent of the parties without any fraud or misrepresentation. If one or more partners choose to become non-working or silent partners. The ratio of their profit cannot exceed the ratio which their capital investment bears so the total capital investment in Musharaka. It is not allowed to fix a lump sum amount for any of the partners, or any rate of profit tied up with the original capital. A management fee however, can be paid to the partner managing the Musharaka provided the agreement for the payment of such fee is independent of the Musharaka agreement. Losses are shared by all partners in proportion to their capital Copyright Bank Nizwa. All Rights Reserved. 35

36 Rules to be Observed in Drafting Cont d All assets of Musharaka are jointly owned in proportion to the capital of each partner. All partners must contribute their capital in terms of money (or in kind) at an agreed valuation. Share capital in a Musharaka can be contributed either in cash or in the form of assets. In the latter case, the market value of the assets shall determine the share of the partner in the capital. The rate of profit sharing should be determined: The share of each partner in the profit earned should be identified at the time of the contract. If however, the ratio is not determined before hand the contract becomes void (Fasid) Copyright Bank Nizwa. All Rights Reserved. 36

37 Rules to be Observed in Drafting Cont d Each partner has a right to take part in Musharaka management. The partners may appoint a managing partner by mutual consent One or more of the partners may decide not to work for the Musharaka and work as a passive non-management participation partner Copyright Bank Nizwa. All Rights Reserved. 37

38 Termination of Musharaka Cont d Musharaka is deemed to be terminated in any one of the following events: 1. Every partner has a right to terminate the Musharaka at any time after giving his partner a notice to this effect, whereby the Musharaka will come to an end. 2. In this case, if the asset of the musharaka is in the cash form, all of them will be distributed pro rata between the partners. But if the assets are not liquidated, the partners may agree either on the liquidation of the assets, or on their distribution or partition between the partners as they are Copyright Bank Nizwa. All Rights Reserved. 38

40 Islamic Banking (IB) vs Conventional Banking (CVB) No IB CVB 1 Its functions and operations follow Sharia on top of the regulatory requirements. FUNCTIONS & OPERATIONS Its functions and operations are based fully on man-made law. 2 In its investment product, an Islamic bank promotes the sharing of risk and profit with investor. There is no fixed profit promised. Distribution of profit is based on real profit. INVESTMENT PRODUCTS In its fixed deposit or placement product, the investor is assigned a fixed rate. In reality, it is an interest-based loan activity. 3 Profit-driven Institutions based on Sharia guidelines. AIM Aiming for revenue without ethical or moral boundaries. 4 Pays zakat as obliged by Sharia requirements over and above the CSR fulfilled by Islamic banks. ZAKAT Only focusing on normal CSR Copyright Bank Nizwa. All Rights Reserved. 40

41 Cont d No IB CVB 5 Its corporate product utilizes the trading or renting of an asset, and not the loan contract. 6 Charges compensation for any late payment, but it does not go towards the bank s earnings. Instead, it is channeled directly to charity. 7 Emphasize projects that benefit society. The main aim is to ensure real and sustainable development apart from ensuring the shareholders interest is preserve. 8 Profit is generated from income-generating asset. CORPORATE FINANCING / LOAN PENALTY PRIORITY REQUIREMENT OF ASSET The corporate loan product applies the system of giving out loans with multiplied interest. Charging a compounding penalty on a loan if there is late payment and it is part of the bank s earnings. The main priority is to protect the bank s shareholders interest. Loans are given straightforward by conventional banks where asset is not required. The concept is money breeds money Copyright Bank Nizwa. All Rights Reserved. 41

42 Cont d No IB CVB 9 Evaluation stresses on the potential or viability, performance and prospect of the project that is being financed on top of customer s payment ability. 10 Profit according to the concept of profit-loss sharing; the bank gives more attention on investing in development of the project. EVALUATION REVENUE EARNED Evaluation stresses on the ability of the borrower to pay off the loan. Not much attention is given to the progress of the customer s project. Earn revenue from fixed interest charged from loan amount to the customer. 11 The bank-customer relationship: 1) Seller / buyer. 2) Lessor / Lessee. 3) Co-owner / Partner. 4) Investor / Fund Manager. 5) Agency RELATIONSHIP The bank-customer relationship: loan lender and borrower Copyright Bank Nizwa. All Rights Reserved. 42

43 The Dos and the Don ts of Terminologies No IB CVB 1 PROFIT RATE / RENTAL RATE / INDICATIVE PROFIT RATE INTEREST RATE / PRICING 2 FINANCE / FINANCING LOAN / BORROW / BORROWING 3 LATE PAYMENT CHARGES LATE PAYMENT INTEREST 4 TENURE / RENTAL PERIOD / INVESTMENT PERIOD TENURE 5 TAKAFUL INSURANCE 6 HOME FINANCING / CAR FINANCING HOME-LOAN / CAR LOAN 7 BANK S FINANCING BANK S CREDIT / BANK S LOAN 8 INVESTMENT ACCOUNT TIME DEPOSIT / FIXED DEPOSIT 9 SUKUK BOND 2018 Copyright Bank Nizwa. All Rights Reserved. 43

Prepared By: Mohamad Noranuar bin Sajari Head, Sharia Structuring mohamad.

1 Case Study 1: Ijara Contract 1.1 LEARNING OUTCOMES. After working through Case Study 1 you should be able to do the following:

1 Case Study 1: Ijara Contract 1.1 LEARNING OUTCOMES After working through Case Study 1 you should be able to do the following: Define the Ijara contract. Define the Ijara wa Iqtina contract. Distinguish