Shariah Banking – Business and Commercial Financing with a Difference

Mufti Ismail Ebrahim Desai

Global Islamic Financial Services Firm


Islamic banks and financial institutions offer business and commercial finance solutions that are Shariah compliant. Imagine a bank that funds your suppliers and creditors for a fixed maturity term in a Shariah-compliant manner. The bank never offers a conventional loan repayable with interest. You simply purchase your raw material and goods from the bank with a mark up.

It may be argued that charging rent or making a profit is no different than charging interest, in that ultimately the providers still makes money. But remember that the Islamic banks do not lend money for profit, as that is interest. Instead, Islamic banks purchase the actual assets and then either lease, sell or partner with the client. Therefore, the bank is legitimately allowed to profiteer on such basis. Instead of making money through interest, Islamic banks make money through profit or through rent when the bank owns the property as an asset. It is important to remember that Islamic business financing simply offers an alternative financing structure, which gives Muslim customers different options to fund their businesses in a Shariah-compliant manner.

Islamic business financing solutions in an entrepreneurial community like South Africa have been largely limited and out of reach for many aspiring and growing businesses. There are many products and mechanisms for Shariah-complaint businesses and commercial finance, but it may be difficult and confusing to understand the fundamental elements and concepts underpinning such products.


Shariah Mechanisms

There are various Shariah mechanisms used for Islamic businesses and commercial finance: Musharaka, which means ‘partnership;’ and Murabaha, meaning ‘profit;’ Ijara, which means ‘leasing;’ and Mudaraba, which means ‘sweat partnership.’ Depending on the model, the bank will add profit to the amount you pay back instead of charging interest.  Shariah products are not loans similar to conventional loans payable on interest. Islamic banks and finance houses engage in actual trade.

Mudaraba: This form of finance is rarely offered by Islamic banks and is a mechanism by which capital and labor are brought together to achieve a harmonious and profitable end. It means the capital provider is providing the funding to an entrepreneur possessed of specific skills and ideas needed to run a profitable business. The capital provider (rabb-ul-mal) may invest through the entrepreneur (mudarib) needing the start-up funds.

Islam clearly states that capital as a factor of production deserves to be rewarded. It allows the owners of capital a share in the surplus, although the amount of surplus is uncertain and there is an element of risk involved. In the context of Shariah, investors cannot demand a fixed rate of return for their investment and therefore, every case is examined by a Shariah advisor to ensure that it is eligible, and to calculate repayments of capital and the share of profit. This is done both before the investment is made, and at regular intervals thereafter.

Ijara or Leasing System: This is a leasing agreement. Under this model, the provider of capital buys capital equipment and leases it to its customers who may opt to buy the items eventually. In effect, the monthly payments will consist of two components: i) rental for the use of the equipment and ii) installments towards the purchase price.

Musharaka: This is financing through equity participation between various organizations, shareholders or partners. The partners use their capital through a joint venture or a limited partnership in order to generate a profit. This profit will be split among the shareholders according to a pre-agreed formula that is dependent on the amount of investment that each party puts in.

This financial instrument can be used in venture capital financing and is less risky to all the parties involved. In effect, all the partners must come with some form of capital rather than just their skills; this instrument will, therefore, not be applicable to a credit union where entrepreneurs have little or no capital to bring into the relationship.

Murabaha: There is usually a physical commodity traded in a Murabaha transaction. For example, a bank will finance the purchase of an asset by buying it and selling it to the client for a profit. The price can then be paid in cash, installment or deferred. The bank is between the buyer and the supplier, and is liable if anything goes wrong prior to selling the asset to the client. Title of the goods passes onto the bank’s client upon sale completion. However, the registered title may be mortgaged in favor of the bank as a security for a deferred payment. The bank utilizes its own funds to open the letter of credit. Murabaha is the most widely used Islamic trade finance product.


Other Shariah Products

Here is a list of Shariah products currently offered to fulfil various business demands and needs:


  1. Islamic Letter of Credit (LC): A written undertaking by the bank to make payment on your behalf at a determinable date in the future. Based on the Islamic concept of Wakalah, the bank is appointed to act as an agent on your behalf.
    Alternatively, letters of credit facility are also available under the concept of Murabaha where you will be appointed as an agent to purchase on behalf of the bank. Upon receipt of the shipping documents, you will submit the offer to purchase goods from the bank on a cost-plus-profit basis.
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  3. Import/Export Financing: This product provides you the working capital to finance the purchase/import of goods and raw materials, among other things, for business operations. Based on the Islamic concept of Murabaha, you will be appointed as an agent to purchase goods on behalf of the bank. Upon receipt of the shipping documents, you will submit an offer to purchase goods from the bank. The bank sells them to you on deferred terms at an agreed selling price that comprises the bank’s purchase price and a profit margin. The bank pays the cost price of goods directly to the supplier and you buy the goods from the bank on a lump sum basis at an agreed date in the future.

  1. Invoice Discounting: This product allows you to finance your cash flow and working capital requirements by selling your goods with a discount to your provider, based on the concept of Murabaha. This product has certain limitations and terms and conditions.

  1. Islamic Venture Capital and Private Equity: This product is based on Musharaka /Mudaraba where both parties become joint equity shareholders and partners in the business venture. All partnership mechanisms are agreed upfront, including partnership exit, liquidation of partnership, duties and roles, voting rights, etc.

  1. Islamic Treasury Services: There are various Shariah products offered, including Islamic forward cover, foreign exchange, profit rate and FX hedging, and corporate capital-raising services. Many companies face serious cash flow and working capital challenges due to volatile currency movements and changes, which are resolved through Islamic treasury solutions.  Companies require additional capital to fund growth, which can be achieved through corporate capital raising, which is Shariah-compliant.


Ensuring Compliance at All Stages

It is extremely important that the bank and client ensure that all the relevant stages in executing the above contracts are duly followed. Any default in following the proper sequence set out will render the transaction invalid. While many individuals sign up for such financing products, they must ensure that the terms and conditions, contracts and implementation of such documentation are also Shariah compliant.


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