Islamic finance-promise

Binding on both parties

Binding on one party

Sale contract

Promise without an inspection

option

Promise with an

inspection option

Binding on both

parties

first introduced by the Hanafi jurist, Imam Abu Yousuf (d.798) as the

Chief judge (qadi al-qudat) during Harun al Rashid’s reign in context of

an Istisna’ contract

The Binding Promise

The Promise Background

for a valid sale contract, either the object of sale or its

price may be absent at the time of

contract but both cannot be absent

object deferred sale & price deferred sale (prepaid & post paid sales) are valid

But sale where both price and object are deferred is an invalid sale

Price deferred Sale

Object deferred Sale

Selling an asset that exists in the balance sheet for a price that will be paid in future – Bai’ bithaman aajil - BBA

Selling an asset that doesn’t exist in the balance sheet for a price that is paid now – Salam sale

Creating demand Creating supply

Creating supply

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Creating supply

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In both cases the object of sale is not

present, thus price must be

paid in advance for a valid sale

contractIstisna’ Sale

Salam Sale

Hence Istisna’ is a sub-set of Salam because due

to the nonexistence of the object of sale, the price must be paid in advance to make the

contract valid

But what if the potential buyer in Istisna’ is short of cash and needs financing?

Consensus: In this case no valid sale contract is possible

Imam Abu Yousuf: if not sale contract

make it binding promise

The Binding Promise in Istisna’

For Istisna’, first introduced by the Hanafi jurist, Imam Abu Yousuf (d.798) as the Chief judge (qadi al-

qudat) during the Harun al Rashid’s reign

View of Imam Abu Yousuf is adopted by- The Majalah al-Ahkam al-Adliyah, the Ottoman

Codification of Islamic Law- The OIC Fiqh Academy- The IDB Shariah Board- The AAOIF Shariah Board

MPO Binding Promise

In financial Murabahah (murabahah for purchase order -MPO), the bank is selling on credit an asset that doesn't exist in its balance sheet

There could not be a valid sale contract as price is deferred and object doesn’t exist, the MPO starts as a non-binding promise with an option to inspect

However, for prudential reasons, the AAOIFI and IFSB standards adopt MPO as binding promise

Promise in Ijarah

In Ijarah also the bank doesn’t posses the asset to be leased on its balance sheet, buys the asset like in MPO based on promise by the client to lease and rents to the client as operating lease or as lease ending in ownership for the client

Promise in DM

In Declining Musharakah (DM), the client promises to buy the shares of the bank subject to the market prices that will prevail at the time of each purchase

Promise in Sukuk

In Ijarah Sukuk, the originator promises to repurchase the Sukuk assets on the initial price at the time of maturity of the contracts

Promise in Swap

In a fixed to floating rate profit swap, one party promises to sell a commodity in an equal series of Murabahah sale contracts synchronizing with the installment payments on a long dated fixed rate Murabahah

Reciprocal Promise in FX Swap

In a foreign exchange swap, both parties make mutual promise for future series of exchanges of two currencies on rates prevailing at the promise date

Pitfall of Promise

Without any exception, all the financial sales on which Islamic

banking is based are in fact promises not sales or we can say that the valid sale contracts have

been replaced by a promise

Sale not what you don’t posses has conveniently

been replaced by a promise which simply

circumvents a genuine and valid sale contract