Vol 2 -Issue 4 SukukWhat is Islamic Sukuk?

Bonds are fixed income securities that promise the holder a specified set of payments. A bond investor has lent money to the bond issuer. In return, the issuer of the bond promises to pay interest and repay the principal on maturity.

Islamic Sukuk is a form of debt financing structured under the rules of Shariah. Sukuk are term finance certificates (TFC) of equal value representing undivided shares in ownership of assets of a particular project or special investment activity.

Difference between Sukuk and Conventional Bonds

The basic difference between conventional bonds and Sukuk lies in the way they are structured and floated. In the conventional system of bond issue and trading, the element of ‘interest’ is at the centre of all transactions. Sukuk, on the other hand, are structured in such a way that the issue is asset backed and is based on “an exchange of approved asset for some financial consideration” that allows the investors to earn lawful profits from transactions. The underlying asset, contract, and payment mechanism of the Sukuk while being commercially viable, has to be aligned with the requirements of the Shariah.

Types of Sukuk

Thus, the issuance of Sukuk requires an exchange of a Shariah compliant underlying asset for a financial consideration through the application of various Islamic commercial contracts, such as the Mudarabah, Musharakah, Ijarah, Istisna’, Salam, and Murabahah. The equity-based nature of Mudarabah and Musharakah Sukuk exposes investors to the risks connected with the performance of the project for which the financing is raised. In contrast, issuance of Sukuk on principles of Ijarah and Murabahah yields deterministic receivable and hence result in predictable and somewhat fixed returns for the prospective investors.

Mechanism of Ijarah Sukuk

The Ijarah Sukuk  is one of the most popular concepts among issuers of global Islamic Sukuk. The structure of Ijarah Sukuk can be understood from this example. If a corporation requires, for example, USD50 million for the purchase of land, real asset, equipment, aircraft, etc., it can issue Ijarah Sukuk equalling that amount in small denominations, say USD10,000 each. The firm then either purchases the asset on behalf of the Sukuk holders (investors or certificate holders) or transfers the ownership of the already acquired asset to Sukuk holders by establishing a Special Purpose Vehicle (SPV), which owns the underlying assets. The investors or Sukuk holders, own the shares of this SPV. The asset is then leased back to the firm and the lease proceeds from the asset are distributed to the Sukuk holders as dividend. The returns on the Sukuk certificates, or shares of the SPV, could be either fixed or floating. The expected returns (pre-determined rental payments) are fixed and can be treated as predictable like the coupon payments of a conventional bond.

Ijarah Sukuk can be issued through a financial intermediary, a bank, a brokerage house or directly by the users of the lease asset. A third party can also guarantee rental payments, and since the yield is predetermined and the underlying assets are not liquid but tangible and secured, the Ijarah certificate can be freely traded in the secondary markets at par, premium or discount.

Note: The prevalent system of Islamic banking the world over is truly not the ultimate and ideal solution. It is only a step towards creating an interest free environment to provide Muslims with an option. Much needs to be achieved keeping in view the injunctions of Quran and Sunnah.

Takaful: Islamic Insurance

Vol 2 -Issue 3 TakafulWhat is Takaful?

Takaful is an Arabic word that means ‘guaranteeing each other.’ It is a scheme of mutual support that provides insurance to individuals against hazards of falling into unexpected and dire needs.

Is there a need for Islamic insurance?

Yes, there definitely is a need for Islamic insurance:

  • One of the ways to reduce the risk of loss in business due to misfortunes is through insurance. The concept of insurance, where resources are pooled to help the needy, does not contradict Shariah.
  • This is not a new concept; in fact, it had been practiced by the emigrants of Makkah and the Ansar of Madinah following the migration of the Prophet (sa) over 1400 years ago. (Practices, such as A’Qila – communal assistance for killings, Hilf – mutual assistance, Tawun – self help, and Tabbaru – donation were prevalent at that time).
  • Conventional insurance involves elements of uncertainty (Al-Gharar) in the contract of insurance, gambling (Al-Maisir) as a result of the presence of uncertainty, and interest (Al-Riba) in the investment activities of the conventional insurance companies. All these contradict the Shariah. Takaful, thereby, provides an alternative.

How does Takaful run?

  1. A group of people form a pact and agree to guarantee jointly among themselves against loss or damage that may be inflicted upon any of them.
  2. A fund is set up, where every group member contributes a sum of money.
  3. Should any member or participant suffer a catastrophe or disaster, he would receive a certain sum of money or financial benefit from the fund, as defined in the pact, so as to help him meet the loss or damage.

What is Tijari Takaful?

The Takaful system can be operated within the Tijari (commercial) aspect of the private sector. Here, Takaful is based on the Islamic commercial profit-sharing principle of Mudharabah.

How does Tijari Takaful run?

  1. A group of people join to form a Takaful fund.
  2. A Takaful operator or Al-Mudharib is designated to manage the contributions to the fund.
  3. The funds are invested by the Takaful operator.
  4. The obligation to assist fellow participants financially is fulfilled.
  5. Thereafter, the profit that arises after the fulfillment of obligations is shared, according to a mutually agreed ratio.

Current practice

Theoretically, scholars suggest that the cooperative insurance can be the basis of the Islamic insurance. The model envisaged by scholars is that the management and control of a Takaful company are in the hands of the members, who are also the policyholders. The insured and the insurers are, therefore, the same people. Its main purpose is mutual security, not profit-making. However, not all companies strictly follow this recommendation. Whereas companies in Sudan follow the cooperative insurance model, companies in the ASEAN (Association of Southeast Asian Nations) region are primarily commercial in nature.

Takaful – A local form existing in Pakistan

Though not entirely conforming to Shariah laws, a local form of mutual insurance based on the principle of co-operation (Tawun) exists in Pakistan. The form is comprised of a ‘committee’ (literally, a group of people) where participants contribute a certain sum of money, and the entire pool periodically accrues to each member in turn. This total amount could be used by the participant to pay off a debt in lump sum or to cover expenses. Nevertheless, this is an informal system that does not have legal protection or cover and, therefore, is open to abuse.

Information sources:

Note: The prevalent system of Islamic banking the world over is truly not the ultimate and ideal solution. It is only a step towards creating an interest free environment to provide Muslims with an option. Much needs to be achieved keeping in view the injunctions of Quran.

Ijarah – Islamic Leasing

Vol 2 Issue2 IjaraahWhat is Ijarah?

Ijarah means: ‘to transfer the usage of a non-consumable asset by the owner (the lessor) to another person (the lessee) for an agreed period, at an agreed price (rent).’

Basic Rules of Ijarah

  • Transferring the usufruct, not the ownership, for an agreed period, at an agreed price.
  • The non-consumable asset should have identifiable value and quantity.
  • The lessor bears all liabilities of ownership, while the lessee is responsible for those of the use of property. (Example: The property tax should be paid by the lessor, while the water and electricity bills referable to the use of the house should be borne by the lessee.)
  • Throughout the leasing period, the lessee bears the risk of ownership, i.e., the reduction in the value of the real estate or any harm caused by the factors beyond the control of the lessee. However, the lessee is liable to compensate the lessor for any loss due to his/her negligence. After the lease period completes, the remaining asset should be given back to the owner (the lessor).

Additional Rules

  • The asset can be insured, preferably through a Takaful (Islamic insurance) company, at the expense of the lessor, not the lessee.
  • Ideally, the rent charged for the leased asset and its periodical increase should be benchmarked to the current prevailing market rates of the pool of similar assets classes. However, in practice, banks usually use interest rates as benchmarks. Although not preferable, these bank benchmarks can be used, until a suitable Islamic based benchmark becomes available.

Differences between Ijarah and Conventional Leasing

Leasing such as, Murabaha, is not originally an Islamic mode of financing. However, Islamic financial institutions adopted it by making some relevant modifications in the structure of the leasing contract (i.e., its terms and conditions), in order to conform it to the rules of Islamic Shariah.

In conventional leasing, instead of offering an interest-bearing loan, banks and leasing companies provide to the lessee an asset along with the risk of ownership. Many basic features of the conventional lease are Islamic, except these two:

1. In Ijarah, the lessee’s liability for the rent starts, when the lessee takes delivery of the asset and not from the day the price has been paid, either directly or through the lessee.

2. In Ijarah, there is no hire purchase arrangement at the start of the leasing contract. After the leasing period has ended, the lessor can, under a separate contract, sell the previously leased asset to the lessee or any other person. Unlike conventional leasing agreements, the Ijarah contract itself should not contain the ‘express clause,’ a pre-condition of gift or sale at the end of the lease period.

How Ijarah is practiced

An asset, usually a car, machine, equipment or household durables, is leased to the lessee on an agreed fixed rental payments for a maximum of 5 years. After the end of the leasing period, through another contract the asset is usually sold to the lessee at the book value of the asset.

In Pakistan, Ijarah form of financing is provided by Islamic Banks, Islamic windows of Commercial Banks and Modarabas. The Ijarah structuring is the most common method used for Islamic Sukuks (bonds).

Note: The prevalent system of Islamic banking the world over is least permissible and truly not the ultimate and ideal solution. It is only a step towards creating an interest free environment to provide Muslims with an option. Much needs to be achieved keeping in view the injunctions of Quran.

Mudarabah: A Special Partnership

financeWhat is Mudarabah?

It is a special kind of partnership, where one partner gives money to another for investing it in a commercial enterprise. The investment comes from the first partner (Rabb-ul-mal), whilst the management and work is the exclusive responsibility of the other partner (Mudarib).

How many types of Mudarabah are there?

There are two main types of Mudarabah:

(1) Restricted Mudarabah, where the investor specifies a particular business for the manager, who may then invest in that particular business only.

(2) Unrestricted Mudarabah, where the investor allows the manager to invest in any type of business.

How will the profits be distributed?

  • Before forming Mudarabah, the parties should agree about a definite proportion of profit, to which each one of them would be entitled.
  • The investor and the manager can share the profit equally or they can allocate different proportions.
  • They cannot allocate a fixed, lump amount, nor can they allocate a fixed percentage of the capital.
  • Different proportions of the profit can be agreed to under different situations, e.g., it can be agreed that the manager can get 35% of the profit, if he works in his hometown. If he works in another town, he can get 50% of the profit.
  • The manager cannot draw any periodical salary or fee for the work done by him for Mudarabah. However, Imam Ahmad has allowed that the manager draws his daily expenses of food from the Mudarabah account. Hanafi jurists, on the other hand, have allowed that the manager draws his expenses, if he is on a business trip outside his own city.

What happens when Mudarabah incurs both a profit and a loss?

In such situation, the profit shall be used to offset the loss. Then, the remainder, if any, shall be distributed between the partners, according to the agreed-upon ratio.

What roles does the Mudarib play?

  • A trustee responsible to look after the investment.
  • An agent for the investor, as he purchases from the funds provided by the investor.
  • A partner, who shares in any profit.
  • Liable to provide for any loss to Mudarabah, due to his actions.
  • An employee, who receives salary, when Mudarabah becomes void.

When does Mudarabah terminate?

  • When the period specified in the contract expires.
  • When either of the two parties informs the other party about the termination of the contract by serving a notice.

What happens when Mudarabah is terminated?

  • All the liabilities are paid off and receivables collected.
  • Assets are liquidated to determine the value of Mudarabah.
  • The investor receives back the amount he / she invested.
  • The balance amount is to be distributed as profit, according to the agreed ratio. If no balance is left, the manager does not get anything.

How do we apply the Mudarabah model for financing purposes?

Mudarabah can be applied to project financing business models, opening letters of credit without margins. The Mudarabah model can also be combined with the Musharakah model for financing large enterprises, import and export businesses (pre-shipment financing), etc.


  • Usmani, Muhammad Taqi. “An Introduction to Islamic Finance.” Idarat ul-Marif, Karachi, Pakistan.
  • Usmani, Dr. Muhammad Imran Ashraf. “Meezan Bank’s Guide to Islamic Banking.” Darul-Ishaat, Karachi, Pakistan.

Musharakah: Sharing Profits and Losses

Vol 1-Issue 2   Islamic FinanceWhat is Musharakah?

Musharakah means ‘sharing.’ The root of the word is Shirkah, which means ‘being a partner.’ Under Islamic law, Musharakah is a joint enterprise, formed for conducting business, in which all partners share the profit according to a specified ratio, while the loss is shared according to the ratio of the contribution.

Differences Between Interest-Based Financing and Musharakah

1. In interest-based financing, the financer predetermines a fixed rate of return on a loan, irrespective of the profit earned or loss suffered by the debtor. In Musharakah, the return is based on the actual profit earned by the joint venture.

2. If a Musharakah joint venture fails, the financier also suffers a loss. In a system based on interest, the financier secures himself against such an eventuality by fixing a rate of interest.

Basic Rules

Musharakah or Shirkat-ul-amwal is a relationship established by the parties through a mutual contract. Therefore, all the necessary ingredients of a valid contract must be present. For example, the parties should be capable of entering into a contract; the contract must take place with the free consent of the parties, without any duress, fraud, or misrepresentation. However, there are certain rules specifically related to a Musharakah contract.

Rules of Capital

The capital in a Musharakah agreement should be:

  • quantified (Ma’loom),
  • qsecified (Muta’aiyan),
  • not necessarily merged,
  • not necessarily in liquid form.


Every partner has the right to manage the business as well as to work for it. However, the partners may agree upon a condition that the management would be carried out by one of them, and no other partner would work for the Musharakah. In such case, the ‘sleeping partner’ would be entitled to the profit only to the extent of his investment – the ratio of his profit would not exceed the ratio of his investment. However, if all partners agree to work for the joint venture, each one of them would be treated as the agent of the other in all matters of business.

Rules Regarding the Distribution of Profit and Loss

1. Profit:

  • The profit ratio of each partner must be determined proportionally to the actual profit of the business and not in proportion to the capital invested by him.
  • It is prohibited to set a fixed amount for any partner or attach any specific rate of profit to his investment.
  • It is allowed for both partners to agree on profit percentage according to their investment, no matter if both of them work or not.
  • If an investor is working, his profit share can be more than his capital investment, no matter if the other partner is working or not.

2. Loss:

  • Loss is distributed exactly according to the ratio of investment.

Termination of Musharakah

A Musharakah will stand terminated in the following cases:

1.  If the purpose of forming the business has been achieved. For example, if two persons had formed a partnership for a certain project, e.g., buying a specific quantity of cars in order to sell them, and the cars are purchased and sold with mutual investment, then the contract stands terminated.

2.  Every partner has the right to terminate the Musharakah at any time, after giving his partner a notice that will cause the Musharakah to end.

3.  In case of a death of any one of the partners or any partner becoming insane or incapable of carrying out commercial transactions, the Musharakah stands terminated.

Termination of Musharakah Without Closing the Business

If one of the partners wants termination of the Musharakah, while the other partner would like to continue with the business, a mutual agreement should take place. The partner interested in the business may purchase the share of the partner wishing to terminate his partnership.

(Courtesy: Meezan Bank’s Guide to Islamic Finance)

Islamic Finance and Banking: How It All Began

financeBackground of the system

The first experiment of Islamic banking started in1963, when Mit Ghamr Saving Bank began a project offering interest free banking in Egypt. The project was a success and led the bank to open four new branches by 1967. In the same year, eight new banks started offering interest free banking.

It was the Organization of Islamic Countries (OIC) summit in 1974, in Lahore, Pakistan that fostered the concept of an “Islamic bank” and recommended the creation of an Islamic Development Bank. There are estimated to be over 200 Islamic financial institutions all over the world. The industry is said to be growing at rate of 15% per annum. Not only do a number of Islamic countries such as, Kuwait, Dubai, Saudi Arabia, Iran, Malaysia, Brunei, Bangladesh and Pakistan have Islamic financial institutions, but many non-Muslim countries also house Islamic institutions. Some of these non-Muslim countries include USA, UK, Canada, Switzerland, Australia, and Sri Lanka. Major international conventional banks, such as Citibank, ANZ Grindlays, ABN Amro, HSBC, and Standard Chartered also have Islamic windows.

Islamic banking in Pakistan

Financial institutions in Pakistan seem to follow a cautious “wait and see” approach towards Islamic banking. A number of key players have obtained a license for conducting Islamic banking operations. These include: Meezan Bank Limited, Faysal Bank Limited, Al Baraka Islamic Bank and First Islamic Investment Bank. Meezan Bank is already operating as the first Islamic bank of Pakistan since May 1, 2002 when it acquired the Pakistani operations of Societe Generale. Other banks, including Habib Bank, Habib Bank AG Zurich, National Bank of Pakistan and United Bank Limited, are in the process of initiating Islamic banking products. Muslim Commercial Bank has already set up a dedicated Islamic banking branch.

Efforts towards establishing an Islamic economic system really took off after the Supreme Court’s judgment in the latter half of 1999, ordered the government to abolish the ‘interest-based system’ and establish an alternative Shariah-based system. For the launch of Islamic banking in the country, the State Bank of Pakistan (SBP) has given three options, i.e., to establish an independent Islamic bank, to establish subsidiaries of the existing banks or any commercial bank or to set up stand-alone branches. The stand-alone branches would have to carry business only in the Islamic banking area where both deposit and grant of loans would be according to Islamic injunctions. The development of Prudential Regulations for Islamic banking is already in process. The SBP is also working towards the establishment of an Islamic banking division. The launch of Islamic T-bills, known as Ijarah Sukook, is already under serious consideration in order to solve the liquidity problems of Islamic banks.

These instruments are being developed at a rapid pace. The huge market potential for Islamic products is proof of the fact that the efforts of these entities are bearing fruit. Moreover, while the current conventional financial system has had years to reach the maturity it enjoys now, a modern model of Islamic finance has only been developing over the past few decades.  As difficulties arise and are resolved, the industry is sure to ripen.