A mudaraba transaction is an investment partnership. In a mudaraba arrangement, the contract is between an investor (or financier) and an entrepreneur (or investment manager) known as the mudarib. Risks and rewards are shared. In the case of a profit, both parties receive their agreed share. In the case of a loss, the investor bears any loss of capital while the mudarib loses his time and effort.
A generic mudaraba process could take the following basic form:
- Step 1: The investor and the mudarib agree on the nature of the venture and the terms of profit sharing.
- Step 2: The investor provides capital to the mudarib.
- Step 3: The mudarib undertakes the venture agreed upon between the parties.
- Step 4: Profits from the investment are shared between the investor and the mudarib.
An ijara is an Islamic lease. The bank purchases an asset and leases it to a customer for monthly payments. An ijara may include an option for the lessee to buy the asset at the end of the lease, though such a provision is not required.
A generic ijarah process could take the following basic form:
- Step 1: The bank and the customer agree on the terms of the lease.
- Step 2: The bank purchases the asset from the seller.
- Step 3: The customer leases the asset from the bank, paying a monthly rental.
- Step 4: The customer purchases the asset from the bank at the end of the lease period.
A murabaha transaction is a sale at a stated profit. In a murabaha transaction, the bank purchases something from a third party and sell it to the customer at a stated profit on a deferred payment basis. In this way, the customer can buy something without taking an interest-based loan.
A generic murabaha process could take the following basic form:
- Step 1: The customer expresses intent to engage in a murabaha transaction facilitated by the bank and, subject to bank approval, signs a 'Promise to Buy'.
- Step 2: The bank purchases the item from the seller.
- Step 3: The customer purchases the item, in installments, at the purchase price plus a stated profit.
Istisna'a refers to a contract for the acquisition of goods under specification or to order, where the price is paid at the time of contract or paid gradually, in accordance with the progress or completion of a project. This kind of contract is commonly used by Islamic institutions as an agreement with a customer to finance its various manufacturing and construction needs. Typically, the bank takes care of paying the contracted developer or builder in full, or as specific stages of the work are completed. The customer then pays the bank in installments commensurate with the client's ability to pay.