Presented by Prof Wasimullah

Islamic Banking and Finance | Faculty of Management Sciences | International Islamic University Islamabad

Istisna

Istisna

Definition and Shariah Legitimacy Conditions of Istisna Models of Istisna

Application of Istisna

Meezan Bank Istisna Product Comparisons Accounting Treatment & Specimens

Istisna

General Rules of Sale in Islam

Existence | Ownership | Possession

Istisna Definition
Istisna is a sale transaction where commodity is transacted before it comes into existence. It is an order to producer to manufacture a specific commodity

Istisna

Shariah Legitimacy
On Bases of Urf
Sharia gives permission to recognize customs that prevailed at the time of Muhammad (SAW) but were not abrogated by the Qur'an or the Hadis.

Under Qiyas
Subject Matter in this contract does not exist but its availability is Certain

Under Istishan
Hanfi School of Thought People are Unanimous on its need

Hadis Reference
The Prophet (PBUH) required that a pulpit (platform) be built for preaching [Bukhari 2/908] The Prophet (PBUH) required that a finger ring be manufactured for Him [Bukhari 5/220 and Muslim 3/1655]

Istisna

Similarities

Istisna
Subject Matter
Manufacture able

Salam
Non Existence of Subject Matter Future Delivery Differences Subject Matter
Anything

Price
Prompt , Installments Deferred

Price
Full Advance Payment

Termination
Unilaterally Before Start of Work.

Termination
Once affected cant be unilaterally cancelled.

Time of Delivery.
Variable Delivery Time

Time of Delivery.
Fixed Delivery Time

Istisna

Subject Matter Price Delivery Security Termination

Istisna

Subject Matter
The requirement of a valid contract.
Capacity of the contracting parties, offer and acceptance

Subject Matter in accordance with Islamic Principles Manufacture able Goods

Construction process involving labor

Type, quality, quantity can be clearly Specifications

To remove factor of Garar

Use of own goods for manufacturing of Istisna Commodity.

Difference between ijara and istisna

Istisna

Price
Price fixed with Mutual consent
Price can be Money, Commodity and Usufruct Payment of Price Flexible
On Spot , Differed, In Installments

Tier Pricing System

Price according to versions in delivery Installments according to Delivery of Product

Istisna

Delivery
Time and Place of Delivery
Before Delivery risk associated with Istisna commodity lies on manufacture After Delivery risk associated with Istisna commodity lies on buyer

Possession can be physical or constructive

Istisna

Security
Right of Security for both Manufacturer and purchaser
Purchaser has right of option of defect

Istisna

Termination
After completion of Contract
Can be cancelled with Mutual Consent

Can be cancelled unilaterally before start of Work

Istisna

Direct Istisna Sale Model

Payment of Istisna Price (Always less then market price)

Manufacturer Bank
Deferred Delivery of Manufacture able goods

Istisna Goods sold to market at market Rate

Market

Istisna

Parallel Istisna Sale Model

Delivery of Istisna Product Specified order of Manufacture able Goods Usually Higher then Market Price

Payment on Spot Or Installments on Deferred Basses

3rd Party

Bank
Order to Manufacturer Same Specification Delivery Date Market Price

Manufacturer
Request for Delivery

Agency Agreement Indirect Delivery on Behalf of bank

Istisna

1
2

House Financing
Project Financing BOT Financing Working Capital Financing

Source : Islamic Banking Bulletin, Islamic Banking Department State Bank of Pakistan

Istisna

Order for House

House Financing

Installments Market Price + X

Land Construction Use of Parallel Istisna Payment Schedule Security Discrepancy

Delivery of House

Bank

Customer

Ownership of Bank

Project Financing
Industrial Projects Factory, Machinery Up gradation
Market Price Parallel Istisna

Construction of House

Constructor

Istisna

BOT Financing
After 20 Years Ownership Transfer Yearly Contract

Build Operate and Transfer ,Developmental Projects ,Toll Fee

Operate Toll Fee

Contractor Government
Ownership

Bank

Highway

Construction

Financing Agreement (Period 20 years)

Parallel Istisna

Constructor

Istisna

Working Capital Financing

Parallel Istisna at Market Price Date: (Y 1 month) Financing Requirement for Steel Structures Agency Agreement

Murabaha Replacement in Manufacturing Concern

Installments

Constructor

Specifications Market Price + X Date Y

Bank
Constructive Possession

Ithehad Steel

Delivery of Steel Structures

Istisna

Contents

Bank Requirements Process Flow

Product Magnitude
Market Share Financing Breakup Istisna Share

Pricing Factors Pricing System

Risk Management
Default Risk Delivery Risk Order Cancelation Risk Option of Defect Risk of Damage

Product Design

Product Pricing

Istisna

Bank Requirements
Process Flow

Confirm Order
Nature of Product Incompliance with Islamic Principles Credibility of Manufacturer Financial Statements, Banking Relationships, Assets and Liabilities, ECIB (Electronic Credit Information Beaurue) etc. Reliability of Order Reliable ordering Source Market Situation Easley Marketable product

Product Design

Istisna

Bank Requirements

Process Flow
Product Design

Step 1: Master Istisna Agreement

Time, Quantity, Price, Specification, Delivery Date

Step 2: Security
According to the volume of finance required.

Step 3:Istisna Price Either Full or in Installments Step 4: Request for Acceptance of Delivery
Identification & Separate storage, Goods Receiving Note , Risk Transfer

Step 5: Agency Agreement

Constructive Possession, Agency Fee

Step 6: Payment Adjustment Step 7: Order Cancellation

Agent will sale product in market with Banks mutual consent.

Istisna

Bank Requirements

Process Flow
Product Design

Step 1: Master Istisna Agreement

Time, Quantity, Price, Specification, Delivery Date

Step 2: Security
According to the volume of finance required.

Step 3:Istisna Price Either Full or in Installments Step 4: Request for Acceptance of Delivery
Identification & Separate storage, Goods Receiving Note , Risk Transfer

Step 5: Agency Agreement

Constructive Possession, Agency Fee

Step 6: Payment Adjustment Step 7: Order Cancellation

Agent will sale product in market with Banks mutual consent.

Istisna

Product Magnitude
Market Share

Series1, Musharakah, 80531.00, 0%

Istisna 8%

Series1, Tijarah, 665260.00, 1%

Series1, Salam, 601802.00, 1%

Series1, Loans and running finances, 1041695.00 , 2%

Financing Breakup Istisna Share

Series1, Istisna Diminishing Series1, Musharakah , Musharakah, 4% 9302583.00, 80531.00, 0% 24% Series1, Series1, Tijarah, Loans and 6313.00, 0% running finances, 463352.00, 1%

Series1, Diminishing Musharakah , 10544340.00, 23%

Series1, Series1, Salam, Export 486449.00, Refinance, 1% 4944295.00, 11%

Breakup of Financing of Meezan Bank in Year 2009

Series1, Ijarah , 8025530.00, 17%

Series1, Murabaha, 17080139.00, 37%

Series1, Breakup of Financing of Meezan Bank in Year 2008 Ijarah , 9553207.00, 24%

Series1, Export Refinance, 3687948.00, 9%

Series1, Murabaha, 14590314.00, 37%

Source: Meezan Bank 2009 Annual Report

Istisna

Istisna Share in Total Financing Over the Years

Product Magnitude
Market Share Financing Breakup

8.4 %
4% 0.68%

Istisna Share

Istisna Share Total Financing

2009 3729059000.00
46716610000.00

2008 1605460000.00
40626920000.00

2007 238,275,000
34,576,339,000

Source: Meezan Bank Annual Report

Istisna

Pricing System
Pricing Factors

Product Pricing

Based on Kibor Benchmark Pricing based on K + (1 to 5 %) rate of Return Suppose 10,000 is required Order Price:12000 Kibor : 12 % Return at K+1 (13%) : 11,300 | 1300 Return at K+3 (15%) : 11,500 | 1500 Return at K+5 (17%) : 11,700 | 1700 Profit of Bank is Difference of Istisna Price(price given by bank) and Sale Price of order. Istisna Price at K+1 :12000-1300 = 10,700
( Manufacturer Profit = 700 | Bank Profit = 1300)

Istisna Price at K+3 : 12000-1500 = 10,500

( Manufacturer Profit = 500 | Bank Profit = 1500)

Istisna Price at K+5 : 12000-1700 = 10,300

( Manufacturer Profit = 300 | Bank Profit = 1700)

Istisna

Pricing System

Pricing Factors
Product Pricing

Normal Market Price Istisna Price is Always Less the Market Price so that bank can earn by selling product in market at market rate. Nature of Product Easily Marketable
Volume of Product Creditability of Manufacturer Risk Factor Involved

Istisna

Risk Management

Default Risk
Delivery Risk Order Cancelation Risk Option of Defect Risk of Damage

Security In accordance with Volume of Financing Mortgage Property etc Credibility of Company Financial Statements, Banking Relationships, Assets and Liabilities, ECIB (Electronic Credit Information Beaurue) etc.

Market Dynamics

Istisna

Risk Management
Default Risk

Delivery Delayed As Istisna is a Manufacture able Product Confirm Orders Credibility of The Company is also at stake to fulfill the original order.

Delivery Risk
Order Cancelation Risk Option of Defect Risk of Damage

Tier Pricing System Price is associated with the variation in delivery date. This is permissible by Islamic Principles.

Istisna

Risk Management
Default Risk Delivery Risk

3rd Party Refuse to buy Product Reliability of Order is Checked Before Istisna Agreement Nature of Product, Easily Marketable , Product Expiry Sale to another Customer Through Agent

Order Cancelation Risk

Option of Defect Risk of Damage

Istisna

Risk Management
Default Risk

Low Quality, Deviation from Specification

Delivery Risk
Order Cancelation Risk

Bank has option to Reject Delivery of Product, and Demand Adjustment

Even it can liquidate the Security to recover any loses.

Option of Defect
Risk of Damage

Istisna

Risk Management
Default Risk Delivery Risk Order Cancelation Risk Option of Defect

After Delivery All the Risk lies with Bank. Risk of Damage is reduced using Takaful Instrument

Risk of Damage

Istisna

Comparison

Istisna
Non Interest Limitation on Use of Finance Surety of Profit Grace Period in Delivery.

Conventional Loan

Interest Based No Limitation

No Surety of Profit
No Grace Period Continuous Compounded Interest.

Istisna

Istisna

Example Details
Istisna (Purchase) Price/Cost/Principal Tenure Sale Price of the Goods sold to 3rd Party Total profit on transaction Date of Disbursement to the customer Date of Delivery Date of Sale by the Bank

1,000 1.5 months 1,200 200 1-Apr-07 15-May-07 20-May-07

At the time of Disbursement

1-Apr 2010 Istisna Financing (A/R) Pay Order / Party Account/ Cash Dr 1000 1000 Cr

Istisna

At Date of Delivery
15- May- 2010 Asset Istisna Financing (A/R) Dr 1000 1000 Cr

At Date of Sale
20 - May - 2010
Cash Asset Sale

Dr
1200

Cr
1000 200

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Istisna Model Agreement

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Istisna Model Agreement

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Istisna Model Agreement

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Istisna Model Agreement

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Istisna Model Agreement

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Istisna Model Agreement

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Istisna Model Agreement

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Istisna Model Agreement

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Islamic Banking and Finance | Faculty of Management Sciences | International Islamic University Islamabad