Muhammad Aamir Ayaz MBK-11-01 Muhammad Asif MBK-11-03 Rashid Aqeel MBK-11-21 Muhammad Faheem MBK-11-32 Kashif Waseem

Group Members

Rashid Aqeel MBK-11-21

Islamic Mode of Finance

“Istisna”

You will be able to understand.o Definition of istisnao Subject matter in istisnao Contracts in istisnao Penalties in istisnao Difference of istisna from salam and

Ijarah o Application of istisna in Islamic banks

Learning Objectives

The word istisna is derived from the word Sana'a which literally means "making, manufacturing or constructing something.“

Definition:Istisna is an agreement in a sale at an agreed price whereby

the purchaser places an order to manufacture, assemble or

construct (or cause so to do) anything to be delivered at a

future date.“

Istisna

There are two parties in istisna 1. Sani2. Mustani Sani: The person who makes it is called

sani'. Mustani: person who causes it to be made

called mustani. Masnu: the thing made called Masnu.

Parties:

The contract is valid only for those objects that have to be manufactured or constructed.

The subject of Istisna (the thing to be manufactured or constructed) must be known and specified to the extent of removing any ignorance or lack of knowledge of its kind, type, quality and quantity.

In Istisna‘a, the manufacturer arranges both the raw material and the labour.

An Istisna‘a contract may be drawn for real estate developments Invalid subject matter. . It is invalid for natural things or products like animals, corn, fruit,

etc. It is not permissible that the subject matter of an Istisna‘a

contract be an existing asset.

Subject Matter of Istisna:

An Istisna‘a contract must be: definitely state in clear terms and conditions

Price must be specified

Quality and quantity of goods, the type, dimensions, period and place of delivery of the asset

The asset can be manufactured or produced by any or a specific manufacturer, or manufactured from specific materials

Essentials of contracts:

The price in Istisna‘a can be in the form of cash, any tangible goods or usufruct of identified assets.

The price should be known in advance to the extent of removing ignorance or lack of knowledge and dispute.

It is permissible that the price of Istisna‘a transactions varies in accordance with variations in delivery date.

The price, once settled, cannot be unilaterally increased or decreased.

It is not necessary in Istisna‘a price is paid in advance. The price can be paid in installments within the agreed

time period and can also be linked with the completion stages.

Price in Istisna

Istisna contract also contain the penalty clauses: an agreed amount of money for compensating the purchaser adequately if

the manufacturer is late in delivering the asset

It is not permitted to stipulate a penalty clause against the purchaser for default in any payment because this would be Riba.

In Fiqa

This principle is termed Shart-e-Jazai (penalty condition), or the condition

of decreasing the price on account of a delay in delivery of the subject

matter of Istisna .

Penalty Clause: Delay in Fulfilling the Obligations:

Muhammad Asif MBK-11-03

The Hanafi jurists generally divide the binding effect of this kind of contract into three stages.

At the first stage, where the work of manufacturing has not yet started.

At the second stage, the manufacturer may finish making the needed goods, but the purchaser has not seen the manufactured object yet.

The third stage is when the required goods have been manufactured and presented to the purchaser.

In third stage Muslims scholars have different opinions: AI-Imam Abu Hanifah is of the opinion that the purchaser can exercise

his option of inspection (Khiyar-e-RoiyyaT) after seeing the goods. Abu Yusuf, a follower of Abu Hanifah, opines that if the commodity was

in conformity to the inspections agreed upon between the parties at the time of the 'contract, the purchaser is bound to accept the goods and he cannot exercise the option of inspection (khiyar al ru'yah).

The Binding Nature of an Istisna Contract:

General ConditionCONDITIONS

Specified Conditions

Conditions for the Legality of Istisna:

In the case of general conditions, the istisna' sale must fulfill the requirement of a valid contract as discussed by the jurists:

The capacity of the contracting parties

The subject-matter

Offer and acceptance

General conditions:

1. The object must be precisely determined both in its essence and quality.

2. The recommended manufactured goods should be things that people customarily deal with in the field of manufacture. Otherwise, the contract of istisna' will be invalid.

3. It is a condition that the time of delivery is specified whether it is short or long so as to avoid ignorance, which might lead to conflict between the two parties.

4. The materials should be supplied by makers, if they are supplied by the buyer, the contract is regarded as al Ijarah and not istisna'.

5. It is a condition that the place of delivery is stated if the commodity needs loading or transportation expenses.

Specific conditions:

Two contracts are involved : Contract-1 Islamic Bank

Manufacturer

contract-2

Third party Islamic Bank

Parallel Contract – Subcontracting:

As a buyer

Istisna contract

As a supplierAs a buyer

Parallel Istisna

Delivery of commodity

Delivery of commodity

1. There must be two different and independent contracts, these two contracts cannot be tied up and performance of one should not be contingent on the other.

2. Parallel Istisna is allowed with third party only.

Conditions for Parallel Istisna:

Work in Process: Before the manufacturing both of the parties have the right to

rescind the contract. Once the seller/manufacturer initiates the work, only changes can be

done with mutual consent. The purchaser will make the payment as per the agreed schedule

and the manufacturer/seller will supply the asset as per the specifications agreed.

. If the subject matter does not conform to the specifications agreed upon, the customer has the option to accept or to refuse the subject matter.

Post Execution Scenario:

Muhammad Faheem

MBK-11-32

1. Before delivery of the asset to the purchaser, it will remain at the risk of the seller.

2. After delivery, risk will be transferred to the purchaser.3. Possession of goods can be physical or constructive.4. If manufactured goods are delivered before agreed

date, purchaser can refuse to accept the goods.5. If the condition of the subject matter does not conform

to the contractual specifications at the date of delivery, the ultimate purchaser has the right to reject the subject matter or to accept it in its present condition.

Delivery and Disposal of the Subject Matter:

Potential areas are; financing the construction industry –

apartment buildings, hospitals, schools and Universities;

Development of residential/commercial areas and housing finance schemes;

• financing high technology industries such as the aircraft industry, locomotive and shipbuilding Industries.

The Potential of Istisna:

Risk Mitigation in “Istisna”

Mitigates Risk

Security is available with the bank.

The Islamic bank is not the owner of the materials in the possession of the manufacturer for the purpose of producing the asset. It can have no claim on it in the case of any nonperformance.

Ownership of material

1.

On the basis of the rule of “Shart-e-Jazai”, the bank can put in the Istisna agreement a clause to reduce the Istisna price in the case of delay.

The bank may be unable to complete the manufacturing of goods as scheduled due to late delivery of completed goods by the subcontractor in Parallel Istisna.

Delivery risk 2.

Mitigates

Risks

The bank can take a “promise to purchase” from a third party and can make arrangements for sale through agency.

Sale of Istisna goods is not allowed before taking physical possession. This may lead to asset, price and marketing risk

Sale not permissible before delivery

3.

The manufacturer can be asked to rectify the defect.

The Manufacturer delivers defected/inferior goods, which is realized by purchaser.

Quality risk

4

Muhammad Aamir Ayaz

MBK-11-01

When manufacturer makes the commodity and presents it to the purchaser and receives the payment.

the jurists are of the opinion that the contract of istisna' can be terminated by the death of one of the contracting parties.

But nom a days! There are large corporation the manufacturer is not a single

person. Therefore it is not applicable the contract will be ended by the

death of one or two persons. it will continue as long as the corporation or company is in

existence

Termination of the Istisna' Contract:

Salam Istisna No.Difference between Istisna’ and Salam:

The Salam subject can be eithernatural products or manufactured goods.

The subject of Istisna is always a thing which needs manufacturing.

1

The price has to be paid in full in advance. The price in Istisna does not necessarily need to be paid in full in advance.

2

Penalty for late delivery shall go to charity and the P&L Account of the purchaser (bank) will be unaffected

Penalty in the form of a reduction in price on account of a delay in delivery will reflect the income of the purchaser (the principle of Shart-e-Jazai approved by the jurists.)

3

Salam is a binding contract; once executed, it cannot be rescinded without the consent of the other.

As long as work has not started,

Istisna is nonbinding; any of the parties can revoke the contract.

4

Difference between Istisna’ and Ijarah: Ijarah Istisna

The manufacturer on an Ujrahbasis uses the material provided by the buyer and he is paid the agreed wages.

The manufacturer uses his own materials and the sale price is fixed.

1

Ijarah can be only on those assetsthe corpus of which is not consumed with use.

Istisna can be of anything that needs manufacturing.

2

In Ijarah, asset risk remains withthe owner (lessor) and the lesseehas to give rental only if the assets capable of being used as per normal market practice.

In Istisna, asset risk is transferred to the purchaser soon after delivery of the item to him and he has to pay the price irrespective of what happens to the asset.

3

Kashif Waseem MBK-

Housing Finance through Istisna:

Rs.5million+rent

over a period of 5ears

Case studies:

Istisna-Housing Finance during Construction Phase

Bank Rs.5MDiminishing Musharakah

Rs.2M Customer

Deferred

Spot

Constructer

Spot

1. Suppose a builder/contractor C has announced a scheme for the construction and sale of apartments costing Rs. 7 million each. (He demands cash and has no financial relationship with the bank.)

2. Client A decides to have an apartment; he has Rs. 2 million and needs financing from bank B of Rs. 5 million for ten years.

3. A and B create a Musharakah pool of Rs. 7 million under the principle of Shirkat_ul_ milk and jointly enter into Istisna agreements with C for the construction and sale of an apartment of defined specifications and pay Rs. 7 million in four installments.

4. C starts building the apartment as per the requirements of the Istisna contract.

5. The bank appoints A its agent to supervise the construction work.

6. C hands over the apartment to A; B leases out its part of ownership to A in rent.

7. A purchases one unit of the bank’s part every month; the rental starts decreasing after each payment and after ten years, the bank’s investment is redeemed and ownership is transferred to the client.

Rs.110M

(export proceeds)

Istisna for Pre shipment Export Finance:

Istisna –pre shipment- Export

Bank Rs.100M (Istisna) Customer

Deferred

Agent

Export Rs.110M

Spot

1. Client A gets an export order for the export of ready-made garments of value Rs.110 million.

2. A approaches bank B for financing and indicates that he has the expertise to prepare the consignment.

3. B enters into an Istisna agreement with A for the supply of garments of a specified nature for Rs. 100 million within a period of three months. This contract will be a sale; A will make delivery at the agreed time.

4. B also appoints A its agent for export of the garments when they come under its ownership.

5. A foreign importer opens an L/C of value Rs. 110 million in the name of B (the L/C can also be in the name of A but that would be under an agency agreement). If an L/C has already been opened, Istisna is not possible (avoiding Bai‘ al ‘Inah).

6. A prepares the garments and informs B to take delivery; the bank takes actual/constructive delivery of the garments and henceforth the garments come under its risk/liability.

7. A exports the consignment as agent of B, sending documents on behalf of B. B gets Rs. 110 million, as per the terms of the L/C.

The above discussion can be safely concluded that istisna contract in Islamic Commercial Laws is one of the important methods of investment in Islamic banking and can play an important role in economic development. It encourages the demand for manufacturing goods, financing economic activities, contributing to the stabilization of prices of manufactured goods, promoting industrial and technological advancement and making use of the available possibilities of the economy.

Conclusion:

Meezan Bank's Guide to Islamic Banking by Dr. Imran Ashraf Usmani.

Istisna in Islamic Banking: Concept and Application by Joni Tamkin Borhan.

Understanding Islamic Finance by Muhammad Ayub. AAOIFI, 2004–5a, clauses. Muhammad al-Bashir, op.cit, pp. 80-82. Majallah al-Ahkam al- 'Adliyyah, Art. 388. Draft Shariah Parameter Reference5:Istisna Contracts by

Central Bank Of Malaysia Istisna by Al Maali Islamic Finance Training & Consultancy Islamic Banking and Finance By Mufti Muhammad Taqi

Usmani.

References: