About Mudaraba and Istisnaa
Information About Sharia-Compliant Banking Practices
Islamic banking practices adhere to modified Sharia rules. These address a growing Islamic clienteles’ requirements. Banks and other financial institutions want to serve this community . Of the various types of Islamic financial practices, Mudarabah and Istisnaa are available. They supply financial benefits globally.
What is Mudaraba?
Mudaraba predates the advent of Islam. It was once prevalent among Arabs. It is an agreement between two parties—one wishes to initiate a project or take part in an ongoing one to profit. The other party funds the project with capital. The former is the borrower and the latter, the financier.
This financial contract is prevalent and preferred among both capital owners and prospective entrepreneurs. They nurture hopes of setting up and being at the helm of their own business. In fact, the contract acts as the platform where the two parties meet—an opportunity for the capital owner with no entrepreneurial abilities to invest in a profit-making venture and reap riches and for the entrepreneur, to not only give shape to his business but also be in charge of it. Mudaraba can be a win-win situation for both parties and hence this form of financial contract has lures aplenty for both.
The role of the financier in this contract is:
- To furnish the funds and discuss with the borrower and come to an agreement regarding how to run the project.
- The borrower then takes over and manages the day-to-day functioning of the project.
- If the project makes profits, then the borrower, who is also the entrepreneur, and the financier share the profits. An agreed to ratio is used.
- If there are losses, they are borne wholly by the financier. The borrower too doesn’t earn anything by way of putting in his efforts. This is the modus operandi of a Mudaraba contract, as has been practiced for ages. It is the application of Mudaraba.
What is Istisnaa?
Istisnaa is a form of sales contract. According to one school, it is an agreement with a manufacturer to produce a specific commodity. It is one of the most flexible Islamic financial contracts in its genre.
Payment and delivery terms can be modified. In this type of contract, the manufactured good is clearly specified. It has to be produced.
Deferred payments are tied to milestones . There are other rules for this kind of a contractual agreement. A bank or any other financial institution can buy the product and then sell it. However, they need to receive cash on installment or deferred payment.
The rules also permit the financial institution to first enter into the contract as a seller. They can then negotiate with a party who demands to buy a specific good. The financial institution can then draw up a parallel Istisnaa contract, according to which it can operate as a buyer and collaborate with another party to manufacture the goods specified in the first contact.
Application of Istisnaa
The sound financial principles of the Istisnaa mode of contract make it a viable option for financing diverse types of projects: residential and commercial construction, setting up of industrial plants, infrastructure development like roads, and manufacturing of industrial goods and machinery. It can also be effectively and profitably used in projects that involve export financing.
Islamic Banking Practises
Istisnaa is for construction. It acts like Murabaha during the construction phase and then turns into an Ijara or Musharaka. It is a favoured for financial agreements in funded projects with quanitifable production like the food processing industry.
Istisnaa is good for production that needs sophisticated technology. Examples include aircrafts, ships, and locomotives. These widespread applications of Mudaraba and Istisnaa prove the overwhelming success of Islamic banking practices in funding projects, both large and small.