Istisna NIBAF SBP Islamabad 7 8 March 2008

Istisna’ NIBAF, SBP – Islamabad 7 – 8 March, 2008 Al – Huda Training Programme Muhammad Khaleequzzaman Head Islamic banking Department Int’l Islamic University Islamabad

Islamic Modes/Instruments - Sale Contracts: Istisna’: Order to Manufacture • Istisna’ is a sale transaction where one party buys goods and the other undertakes to manufacture ie. The commodity is transacted before it comes into existence. • Allowed by Hanafi school, while other schools prefer that raw material be provided through sale contract and manufacturer should agree to produce the final product on the basis of ijarah (contract of construction) Uses: [To fill the technology gap] – Manufacturing of implements (eg. Rice transpalnters/ rice harvesters) – Milk / vegetable / fruit processing plants – Bulk purchases of tractors – Greenhouse technology (low cost tunnels, automated green houses)

Islamic Modes/Instruments - Sale Contracts: Istisna’: Legitimacy • • 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] Sale is the transfer of ownership of some lawful, specific, known property for a fixed price which may be money or other known property, both countervalues present and delivered immediately. Variations from this pattern, such as delay in payment of a countervalue, are handled as special cases. Title of both countervalues transfer immediately at the time of sale, even if actual payment or delivery is delayed. (Vogel p/103)

Islamic Modes/Instruments - Sale Contracts: Istisna’: Conditions • • Subject matter has to be unique (substitute may or may not exist) and manufactured goods The manufacturer uses his own material to manufacture a good to differentiate from Ijarah • Kind, Quality and Quantity of subject matter must be known and agreed in absolute term • If goods manufactured conform to the specifications agreed upon, the purchaser cannot decline to accept them unless there is defect in these goods [Option of defect benefits the purchaser] • Buyer can refuse to accept goods if delivery is not made within agreed time period. A clause of variable price can be inserted in contract to compensate the buyer

Islamic Modes/Instruments - Sale Contracts: Istisna’: Conditions • • • Purchasing subject matter from the manufacturer and again selling to him equals bai Innah Price of good to be fixed in absolute and un-ambiguous terms Price of Istisna may be spot or differed (installments) through progress payments therefore Istisna is applicable where Salam is not applicable. Price can also be usufruct of the related or not related to subject matter [e. renting house or machinery to the manufacturer (eg. BOT)] The contract of Istisna can be cancelled unilaterally before the manufacturer starts the work. Once the work has been started, Istisna cannot be cancelled unilaterally.

Islamic Modes/Instruments - Sale Contracts: Parallel Istisna’: • • • Bank becomes purchase in one contract and seller/supplier in other contract. Both the contract are independent from each other Permissible only if the delivery date in the contract of sale does not precede the delivery date in the contract of purchase Prior to delivery to the customer, bank assumes all responsibilities of ownership and maintenance Some Stipulations: • • • Urboun, Guarantee, mortgage or hypothecation in the case of default in delivery, the guarantor (third party) is asked to deliver the same commodity. The buyer can sell the mortgaged property and use the sale proceed to purchase the required good from the market or to recover the price advanced by him.

Payment of Istisna’ Price FI Istisna’ Sale Transaction Client Deferred Delivery of Manufactured Goods

2 Istisna Sale Contract 1 June 06 Parallel Istisna’ 4 6 5 Delivery of Commodity 1 Aug 06 or 15 Aug 06 Bank Purchaser/ Seller Customer [ISTISNA’] 15 May 06 Delivery of Commodity 1 Aug 06 Istisna’ Contract Manufacturer/ Builder [ISTISNA’] Pays 15 May + 15 Aug – 31 Dec 06 3 Istisna Price Payment 1 June 06, 1 Jul 06, 1 Aug 06 1

Islamic Modes/Instruments - Sale Contracts: Istisna’: Example of Agricultural Implements • • A customer wants to get an automated green house to grow off season vegetables. At the same time, he prefers not to pay full cost at the front end of an expensive made to order product requiring relatively longer manufacturing process. Customer approaches bank and the later enters into back istisna’. Bank gets the project manufactured [this project requires manufacturing] The other alternative is of getting the plant manufactured and selling through Murabahah Still, …(next slide)

Islamic Modes/Instruments - Sale Contracts: Istisna’: Example of Agricultural Implements • Securitization of financing: Bank becomes arranger of mudarabah fund and passive investors gathered, investment certificates may or may not trade with the fund or secondary market

Islamic Modes/Instruments - Sale Contracts: Istisna’: Some Difference Between Istisna’ & Salam ISTISNA • The subject of istisna is always a thing to be manufactured. SALAM • The subject can be any thing. • • The price has to be paid in full in advance. • Fixed time of delivery is an essential part of the sale • The contract cannot be cancelled unilaterally. The price in istisna does not necessarily need to be paid in full in advance. • Time of Delivery need not to be fixed. • The contract can be cancelled before the manufacturer starts working.