Review of Islamic Economics, Vo1.4, No.1, (1995), pp.

1-16

ISLAMIC FINANCIAL INSTRUMENTS:

DEFINITION AND TYPES*

Abdul Awwal Sarker

Joint Director-
Puhlicatiorzs & Islamic Economics Division
Research Department, Bangladesh Bank
Dhaka, Bangladesh

1. Introduction

The elimination of interest is one of the basic requirements for the establishment of
an Islamic economic order. In recent years, a good deal of attention has been paid by
Muslim experts in economics, banking and finance to find ways and means of doing
away with interest. One important aspect to this ini~iative is laid upon the
development of risk return bearing financial instruments that can provide investors as
well as banks with a sufficient degree of liquidity, security and profitability to
encourage their constituents for making effective investment decision. This paper
seeks to point out the nature (definition and types) of the Islamic financial instruments
which have already been introduced in some Muslim countries and the possible
instruments proposed by the Islamic economists so far.
Since an Islamic economy is essentially a share economy based on profit, rent and
dividends, as reflected through different investment contracts, it should be possible to
develop a framework of Islamic securities investment-based on Mushurakah,
Mudclrabah and Murclbahah concepts and other modes of Islamic financing (e.g. Bai'
Al-Salam). Since the cost of investment in securities based on these concepts is mainly
a function of the rate of return, Islamic instruments can have a built in stabilising
influence on investments and they would also be less prone to speculation. In this
connection, it may be mentioned that the underlying principles of advanced sale (i.e.
Bai' Al-Salam), sale on deferred payment (i.e. Bai' Al-Mu'ajjal) can possibly be
operationalised in the conduct of Islamic financial markets. A brief review of some of
the existing financial instruments issued by banks, investment companies and
governments, are analysed in the following paragraphs.

* Paper Presented at a 3-day Workshop on Developing Islamic Financial Instruments held at the
Conference Room of the Bangladesh Bank. Dhaka on September 9-1 1, 1995 jointly organised by
Bangladesh Bank and Islamic Research and Training Institute, IDB, Jeddah, Saudi Arabia.
 Review of Islamic Economics, Vo1.4, No.1

2. Definition of Financial Instrument

A financial instrument is a certificate representing a common share in a fund for

investing and making a profit, issued by the body handling this investment or the body
acting on its behalf, which provides for its negotiation and conversion into liquid
money when required.

3. Islamic Modes of Finance

The scope of financial instruments is quite wide. For practical reasons, the Islamic
financial instruments are not classified in a haphazard way as short, medium and long
term but such a classification would depend on the nature of investment itself. In
Muddrabah, for example, the whole deal should be liquidated for the purpose of
realizing profits or losses. Salam dealing is another type of contract that can be
classified, by its nature, as a short-term investment. On the other hand, we find that
Musharakah can be treated as a long-term investment if it is permanent or as a
medium-term investment if it takes the form of decreasing participation. If there is an
Islamic capital market, there would be no big difference between short-term,
medium-term and long-term investments. All these differences would lose their
importance when the investor can sell, at any time, his portions in the various
investments, either in the form of Mudarabah, Mushcirakah, Murabahah or
Salam.

4. Practical Experience

Some of the Muslim countries like Pakistan, Iran, Malaysia, U.A.E, Jordan and
Sudan have introduced many Islamic financial instruments in order to mobilize the
idle resources for long-term productive and development activities on the basis of
Islamic principles. Islamic financial instruments which have been introduced in these
countries differ in nature and characteristics from the interest based ones. The modus
operandi of those financial instruments are mostly based on Mudarahah mode of
finance.

5. Definition of Mudiirabah

Mudarabah is a form of partnership where one of the contracting parties called the
Sahib al-Ma1 or the Rahb al-Mal' (the financier), provides a specified amount of
capital and acts like a sleeping or dormant partner while the other party, called the
Mudarib (entrepreneur), provides the entrepreneurship and management for carrying
out any venture, trade, industry or service with the objectives of earning profits. The
 Islamic Financial Instruments: Definition and Types

Mudcirib is in the nature of a trustee as well as an agent of the business. The Mudcirib is
required to work with honesty and sincerity and to exercise the maximum possible care
and precaution in the discharge of his functions. If he is guilty of wilful negligence,
fraud or misrepresentation, he is himself responsible for the consequences, and the
resulting loss, if any, can not be charged to the Mudcirabah account.
Mudcirabah is also synonymously termed as 'Qircid' and Mudcirib as 'Muqcirid'. In
general, the Hanafiyyah, Hambaliyyah and Zaydiyyah schools of Muslim Jurisprud-
ence have used the term Mudarabah, while the MBlikiyyah and ShBfi'iyyah have
preferred the term 'Qircid'.

6. Pakistan

Muddrabah Certificates
MudaTabah certificate is, however, one of the instruments which has already been
introduced in Pakistan under the special law called 'The Mudcirabah companies and
Mudcirabah (Flotation and Control) Ordinance, 1980'. The law was subsequently
supplemented by the Muddrabah Companies and Mudcirabah Rules, 198 1. The
Mudcirabah law provides the necessary legal framework for the Flotation of
Mudcirabahs in Pakistan. Under this law, management companies, banks and
financial institutions can register themselves as Muddrabah companies and float a
Mudcirabah for a specific or general purpose. The objects of any Mudcirahah will be
restricted only to such business as are permitted under Islamic Shari'ah. In order to
ensure that Mudcirabahs are not used in any activity that is repugnant to the tenets of
Islam, the prospectus of each Muddrabah will need a prior clearance from a Religious
Board. Furthermore, after the Mudcirabah goes into operation, the law imposes
additional responsibility on the auditors to certify that all business conducted,
investments made and expenditure incurred are in accordance with the objects, terms
and conditions of the Muddrabah. To safeguard the interest of the Muddrabah
certificate holders, a number of protective clauses have been provided including
quicker and simpler adjustment by a tribunal. In order to promote the growth of
Mudcirabahs and keep in view the larger interest of Mudcirabah certificate holders,
the entire income of Mudcirahah funds has been exempted from income tax, provided
that 90 per cent of the income is distributed to the Mudcirabah certificate
holders.

Types of Muddrabah
There are, however, two types of Mudcirabah existing in Pakistan:
1. Multi-purpose Mudcirabah: That is to say a Mudcirabah having more than one
specific purpose or objective.
2. Specific Purpose Mudcirabah: That is to say a Mudcirabah having one specific
purpose or objective.
 Review of Islamic Economics, Vo1.4, No.1

MudGrabah Companies in Pakistan

According to a latest report, it is mentioned that 37 Mudfir-abah companies have
floated their respective Mudfirahah certificates of different types and maturities. The
names of the Mudfirabah companies are:
1. Al-'At2 Leasing Mudurabah
2. Al-Z2min Leasing MudcTrahah
3. B.F. Mudcirahah
4. BRR Capital Mudfirahah
5. BRR Second Mudclrahah
6. First Allied Bank Mudclrabah
7. First Al-Noor Mudfirahah
8. First Crescent Mudcirahah
9. First D.G. Mudar.ahah
10. First Elite Capital Mudurahah
11. First Equity Mudfirahah
12. First General Leasing Mudfirahah
13. First Grindlays Mudarahah
14. First Habib Bank Mudcirabah
15. First Habib Mudfirahah (Rs. 51- each)
16. First Hajeri Mudurabah
17. First Ibrahim Mudfirahah
18. First Mehran Mudtirubah
19. First National Bank Mudcirahah (Rs. 51- each)
20. First Nishat Mudfirahah
21. First Professional Mudfirahah
22. First Providence Mudfirahah
23. First Prudential Mudcirabah
24. First Panjab Mudurabah
25. First Sannaullah Mudfirahah
26. First Tawakkul Mudfirahah
27. First Tri Star Mudfirahah
28. First UDL Mudfirabah
29. Industrial Capital Mudfirabah
30. LTV Capital Mudarabah
3 1. Mudarabah Al-M2l
32. Mudurahah Al-Tijarah
33. Schon Mudrirahah
34. Second Prudential Mudarahah
35. Third Prudential Mudfirahah
36. Trust Mudfirabah
37. Unicap Mudfirabah
 Islamic Finunciul Instruments: Definition and Types

Mudrlruhah.~have been playing a significant role in capital formation in Pakistan

and financing those segments of trade and industry which are not being catered for by
banks and financial institutions. In the wake of low savings rate in that country, the
flotation of Mudrlrahuh has provided an opportunity to the general public to invest in
Mudrlrahuh funds which essentially operate on Islamic principles based on Shari'ah.
There has been a very enthusiastic response from the general public as we have seen
the flotation of 44 MudGi-ahuhs up to June 1993 with the total capitalisation of Rs.
6.96 billion.
State Bank of Pakistan has established a separate Department called NBFl
Department to regulate and monitor the operations of Mu&3-uhahs and other
non-banking financial institutions, and have prescribed detailed rules and regulations
in this regard.

Participation Term Certificates (PTCs)

The banking and financial institutions in Pakistan have evolved a new corporate
security to replace the interest-based debentures, which is named 'Participation Term
Certificates or PTCs. Participation Term Certificates are transferable corporate
instruments based on the principles of profit and loss sharing and are intended to
replace debentures for medium and long-term local currency loans for industrial and
other financing. Instead of receiving interests, as in the case of debentures, the PTCs
holders share the profit or loss of companies involved. John Harrington of Seton Hall
University, New Jersey, USA has suggested that the PTCs may be used as a vehicle of
financing the construction of public buildings which can then be leased to the
government. Holders of PTCs would profit from rentals paid by the government and
also from gains if the properties were sold at higher prices. PTCs of this type would
reduce the need for government debt, provide an attractive earning assets to investors,
and be traded in the capital market. They w o ~ ~bel d eligible investments for banks, as
are other PTCs.

Salient Features of PTCs

(a) The certificates are for a specified period not exceeding ten years excluding
the grace period.
(b) As PTCs finance is provided for a specific period, it is secured by a legal
mortgage on the fixed assets of the company and a floating charge on the
current assets.
(c) For the purpose of allocation of profit to PTCs holders, the investment ranks
pari passu with equity and share in profits on a basis to be determined by
mutual agreement.
(d) The share of PTCs holders in the profit is deducted prior to the claim of
shareholders in the profits of the company in any given year.
(e) The proceeds of the PTCs are to be used exclusively for implementing the
project, with the sponsors being required to give an undertaking to conduct the
 Review of Islamic Economics, Vo1.4, No.1

business with diligence and efficiency in accordance with sound financial

engineering, and business practices and such other terms as may be agreed
between the parties.
(f) An option may be given to the PTCs holders to convert a certain portion of
outstanding Participation Term Certificates into ordinary shares.
(g) A riglit option is given to the existing ordinary stockholders to subscribe to the
fresh issue of PTCs.

Investment Corporation of Pakistan and PTCs

The investment Corporation of Pakistan ICP up to 1986 had entered into
arrangements for project financing on long-term basis against issues of PTCs with
various companies. The main points of such arrangements were as follows:
(a) PTCs are secured by a mortgage of all present and future movable and
immovable properties of the related projects and carry floating charge on their
current assets.
(b) The PTCs are redeemable within a period of six to ten years in half yearly
instalments from the date of commencement of commercial production.
(c) In terms of investments in PTCs the corporation is entitled to a discount at the rate
of 12% per annum from the date of disbursement to the date of commencement of
commercial production for the new projects. Furthermore, after commencement
of commercial production and for companies already in commercial production,
the corporation shall participate in the profit of the company in the same
proportion as the PTCs have with the aggregate of the amount of investment
against PTCs reserves and the paid up capital of the company. However, in order
to provide an incentive to the company for efficient management and good
performance, the corporation is to retain only such amount out of their share of
profit so as to yield 17% of the face value of PTCs in an accounting year. In case
the profit shared by the corporation is paid by the company within 30 days of the
close of its annual accounts, the company shall be entitled to a rebate at the rate of
2% and the corporation shall retain an amount equivalent to 15% of the face value
of PTCs out of their share of profit in an accounting year.
(d) In case a company makes a loss the corporation shall share the loss in the same
proportion as its respective PTCs have with equity of the company. However,
losses accruing in any accounting year will first be adjusted against the
existing reserves, if any. Further, in terms of the agreement, a company shall
issue convertible shares in favour of the corporation of the equivalent amount
of the loss incurred. Such convertible shares shall be entitled to dividend at the
same rate and in the same manner as available to ordinary shareholders.

Term Finance Certificates

TFCs are part of the non-participatory redeemable capital based on buy-back and
mark-up. It is the most criticised instrument of financing currently being used by the
 Islamic Financial Instl-uments: Definition and Types

banks and DFIs in Pakistan. Neither this mode has been recommended by the SBP nor
it has any legal basis. It was innovated by a DFIs in 1984-85 and afterwards became a
major mode of term finance in place of PTCs. The borrowing company sells the item
concerned that it had agreed to purchase merely as a consequence of a paper deal with
the firm supplying the item, to the financing institution for a certain "Sale price" and
then again purchases the same from the financing institution for a sum called
"purchase price" which is paid in instalments in accordance with the redemption dates
of the TFCs issued by the borrowing company. If TFCs are not redeemed on the due
date the borrower is required to pay to the holder of such TFCs an amount equivalent
to 20 per cent of the TFCs' face value.

ZCP and TFCs (LonglMedium-term)

The corporation has made investments in Term Finance Certificates issued by
various companies. The salient features of this mode of investment are:
a) This involves purchase from and resale of investment properties to companies
financed by the ICP.
b) The TFCs are secured by a mortgage charge of all the present and future
movable & immovable properties and a floating charge on the current assets of
the project. In addition, the borrower commits to provide to the corporation
such further securities and guarantees as it may from time to time or at any
time required.
c) Under the agreement, the corporation is entitled to a mark-up of 22% per
annum and in case of payment on due date, following rebates are
allowed:
Loans Sanctioned Rebate Rate
-before October 3, 1988 7%
- October 3, to Dec. 16, 1990 6%
- from December 16,1990 onwards 5.575%
d) The payment period generally ranges between twelve to sixteen equal half
yearly instalments starting after six months of the commencement of
commercial operations.

Foreign Exchange Certificates of Investment

Al-Faysal Investment Bank Ltd. of Pakistan recently introduced Foreign Exchange
Certificates of Investment. Special features of these certificates are as follows:
a) Higher returns than the International Market.
b) No Zakat withholding or wealth tax.
c) No restrictions on worldwide remittance.
d) Financing facility in Pak. Rupee is available against investment.
e) Maturities ranging from 3 months to 3 years.
f) Choice of Investments in Pound Sterling, Yen, US Dollar and Deutsche
Mark.
 Review of Islamic Economics, Vo1.4, No.1

7. Jordan

MuqrZradah Bonds
The Islamic Development Bank (IDB), generally encourages its member countries
to adopt the Islamic techniques in financing and development of projects. In response
to this, Hashemite Kingdom of Jordan promulgated the Muqciradah Bonds Act in
1981. The Jordanian ministry of Awqaf adopted this technique to finance a project to
set up a commercial centre (commercial shops, offices, car parks etc.).

Salient Features
"Muqdradah Bonds" as the term denotes, are based on the conclusion of a
legitimate "Muqclradah" (i.e. Muddrahah) with capital on one hand and labour on the
other and the shares of profits are determined beforehand by a definite prop~rtionof
the total. The main purpose underlying the issuance of Muqdradah Bonds is the
financing of a given project with the object of executing the project, utilizing it and
making profits. As an incentive to the subscriber of Muqciradah Bonds, Article 10 of
the Act stipulates that profits realised from investment in Muqdradah Bonds are not
subject to income tax and that the Government guarantees the principal amount of the
bonds. Article 18 of the Act also permits dealing with "Muqdradah Bonds" in Amman
Stock Market according to its rules and regulations. It also permits the transfer of
ownership of the bonds in accordance with these rules.

8. Malaysia

Government Investment Certificates

The Malaysian Government promulgated "Government Investment Act, 1983
(Laws of Malaysia Act, 275)". Under this Act, the Government has introduced
"Investment Certificates" similar to Mudcllnhah Bonds. The Government invests the
funds generated through these certificates on its own initiative in profitable projects
and distributes the profits among the certificate holders annually.
Government Investment Certificates (GICs) are issued under the concept of
al-Qard-al-Hassan whereby the lender will lend to the Government a sum of money
and the Government may, at its discretion, give a return or a dividend on this lending
to the lender. The issuance of GICs is governed by the Government Investment Act
1983. Under this Act, the Government is allowed to borrow up to RM 5.0 billion to
finance its deficit through the issuance of GICs. At present, the total outstanding
issues of GICs is RM 4.8 billion and it covers 6.5% of the total Government domestic
debt.
The return of dividend rate (if any) declared by the Government will be paid to the
holders of GICs on an annual basis on every anniversary date or on the maturity date
 Islamic Financial Instruments: Definition and Types

(i.e. in cases where the tenure of the issue is for 1 year.) The dividend rate is
determined by the Dividend Committee which comprises representatives from
Treasury Office, Bank Negara Malaysia, the Economic Planning Unit and the Islamic
Centre. The factors that are normally taken into consideration in deciding the dividend
rate are the country's economic performance, inflation rate, equivalent return on the
Government Instruments ... etc.
The Government Investment Certificate is a qualified security for the purposes of
complying with the Liquid Assets Requirement to be maintained by the financial
institutions. With regard to this, Bank Negara provides the discount window facility
for the financial institutions to buy or sell the GICs with Bank Negara. The trading of
the Government Investments Certificates will be based on the Expected Dividend
Rate and the formula for the price computation is as follows:
(axb)+lx100
Price =
(36500)
where a = Expected Dividend Rate
b = Number of days from the issue date or last dividend date to the value date
of the transaction.
Example: If the Expected Dividend Rate of 1 year GIC is 6% p.a. and the issue date of
this GIC was on June 30, 1994 and transacted on December 2, 1994, The
price will be computed as follows:
(6~155)+1xlOO
Price =
(36500)
= 102.55
If the investor purchased GICs of RM 1 million, the amount of proceed to be settled
would be RM 1,025,500.00. (Note the expected dividend rate is reviewed on a
monthly basis).
Government Investment Certificate is one of the alternative instruments used by the
Government to finance its deficit other than the issuance of Malaysian Government
Securities (interest bearing instruments) and Malaysian Treasury Bills. At present
GICs are playing an important role in developing the Islamic Banking Scheme of
Malaysia whereby the Islamic financial institutions would be able to park its excess
cash surpluses which would also enhance their return on their investment.

9. Iran

Participation Bonds
Tehran Municipality of Iran has recently (Approx. in September, 1994) issued a
bond named "Participation Bond" in accordance with Islamic principles for financing
the project of reconstruction of Navab Highway. The essential features of the bond are
as follows:
 Review of Islamic Economics, Vo1.4, No.1

Participation Bonds are issued in accordance with the Islamic Principles and
on the basis of investment in economic projects with positive rate of return.
The return should be divided between the investors and the issuer of the bonds,
who is also responsible for the completion of the project.
Participation Bonds can be issued, both by the' public and the private
sector.
In each case there should be an underwriter who accepts the floatation of the
bonds and the purchase of the issued bonds not purchased by the general
public.
For each case, the issuer should guarantee a minimum amount of profit
obtainable from the related project. Profits over and above the guaranteed
level should be distributed after the completion of the project. If the projected
minimum profit is not realized, the entire responsibility of provision of funds
for payment of the guaranteed return would fall on the issuer.
The bond should be for the purpose of financing a specific project and cannot
be used otherwise.
The bonds are issued together with special coupons for collection of returns.
Due dates of such coupons are specified at the time of the issue.
Such bonds are issued without name and on bearer basis.
The bonds are negotiable and can be transacted through Tehran Stock
Exchange.
In case of Participation Bonds issued by Tehran Municipality, the specific
details are as follows:
1. Maximum amount to be issued is Rls. 250 billion and the issue would
be in four consecutive series. So far only the first series have been
issued.
2. Bank Melli is the underwriter and, hence, the agent responsible for
floating this bond.
3. All bonds issued during the first round were sold at the time of issue.
So far there has been no secondary dealing at the Tehran Stock
Exchange.
4. As profits are paid through coupons, the face value would be identical
to the redemption value.
5 . The expected rate of return to the project is checked by the authorities
of Bank Melli. The auditor has approved that the rate of profit should
be around 25 per cent.
6. The Municipality has signed a contract with Bank Melli authorizing
the bank to pay a minimum guaranteed interest of 20 per cent.
 Islamic Financial Instruments: Definition and types

10. Gulf Countries

Islamic Investment Company of the Gulf (ZZCG)

The Islamic Investment Company of the Gulf (member of Dar Al-Ma1 Al-Islami
Group) which is the first Islamic Investment Company in the World has so far
introduced many Muduiahah instruments. In the financial mechanism, The IICG acts
as the Mudurih, i.e. the Managing Trustee, on behalf of the investors, and accordingly,
invests in Riha-free profitable projects in a bid to sharing the accruing profits as per
the ratios agreed upon in the Mudui-ahah contract. However, the Mudat-ahahs
introduced by ITCG can be grouped as follows:
A. Current Inlvstment Accounts:
i) The Fourth Islamic MudZrahah for Current Investment.
ii) Islamic Mudarahah for Current Investment (Bahrain).

B. Investment Acc,ounts for Fixed Terms:

i) The Islamic MudrTruhah for Financial Institutions/Individuals.
ii) The Islamic Mudui-ahah for Private Investment.
iii) New Islamic Mudut-ahah for Private Investment portfolio.
iv) Islamic Mudurahah lnvestment Renewable.
v) Real Estate Investment MudGrahah.

C. Investment Accounts (Current & Term Inllestment):

i) The Seventh Islamic Mudar-ahah for Investment, Savings and Takdfol
(Islamic alternative to Insurance).
ii) Development Mudat-ahah for Egypt.

The main features of the above Mudarahahs are given below:

A(i): The Fourth Islamic Mudut-ahah for Cur-rent Investmcwt
(a) Subscription in this Mudar-ahah is effective from the date of receiving the
investment funds, through buying the Mudur-ahah portions according to its
posted value.
(b) The Muddrabah funds are operated and managed in weekly cycle governed by
computerised system to compute expenses and allocate profits.
(c) The investing participant may redeem, all or part of hisher funds, within a
week of submitting an application for refund.
(d) What Allah bestows as profits, attributable to participants, is distributed, on a
weekly basis; 90% to the investor (equity owner), and 10% to the Muddrih
(Managing Trustee) namely, the Islamic lnvestment Company of the Gulf
(rrcc).

A(ii): Islamic Muddrabah f i r Current Investment (Bahrain)

(a) Through buying the Mud~7rahahportion according to its posted value at the
date of receiving investment funds.
 Review of Islamic Economics, Vo1.4, No.1

(b) The MudcIrabah funds shall be operated and managed in a weekly cycle
governed by a computerised system to compute expenses and allocate
profits.
(c) Proceeds of what Allah bestows as profit shall be distributed, on a weekly
basis; 75% to the investor and 25% to the company.
(d) Subscription to this MudcIrabah is free from issuance fee.
(e) The investor may redeem, all or part of hisher equity, within a week of
submitting a request to this effect.

B(i): The Islamic Mudiirahah for Financial Institutionllndividuals

This Mudarahah allows distribution of profits on a monthly or quarterly basis to
investors, in addition to offering them the following benefits and privileges;
(a) Short-term investment opportunities for financial institutions and businessmen.
(b) What Allah bestows as profit, at the maturity of each period (monthly or
quarterly) shall be distributed as follows:
(i) 80% to the participant of this MudcIrahah .
(ii) 20% to the company which is entrusted with managing the assets.
(c) The Mudiirahah contract allows for opening L/Cs and L/Gs as against regular
fees while the investors shall continue to be eligible for profits.
(d) The participant may redeem hisher funds, in whole or in part, by submitting a
written demand to any of the company's offices upon the expiry of the
maturity of the MudcIrabah contract (monthly or quarterly). Histher money
will be reimbursed to himher within three days from the beginning of the next
valuation date.

B(ii): The Islamic MudcIrahah for Private Investment

(a) The Investor (Rabb AS-Miil) in this MudcIrahah delegates the Islamic
Investment Company of the Gulf to invest hisher funds according to the
provisions of the Shari'ah, and under the supervision of the Religious
Supervisory Board, and as per hislher investment instruction regarding risk
taking (low, medium or high risk).
(b) The duration of the investment: 1 , 3 , 6 months or one year. Pursuant thereof to
the investor's desire, the IICG, shall manage every individual account
independently to the best advantage of the investor.
(c) Profit will be distributed as follows:
Investor Company
a. Low risk 80% 20
b. Medium risk 75% 25%
c. High risk 70% 30%

B(iii) New Islamic MudcIrabak For Privute Investment Porlfolio

(a) This Mudiirabah is a partnership between the Mudirih (IICG) and the
MudcIrabah certificate holders (Rahb Al-Miil). Minimum investment is one
 Islamic Financial Instr-uments: Dejynition and Types

million US Dollars or equivalent in other currencies. The MudGrahah funds

will be invested according to Shari'ah provisions.
(b) The investor will specify in his/her Mudarahah application the percentage of
histher funds to be invested in low or medium risk Islamic investment.
(c) The participant can withdraw by submitting a written request to the Mudar-ih,
with not less than seven working days from the Mudirahah maturity date.
What Allah bestows as profit will be invested as follows:
(a) Investment with Low Risk:
One month 75% Rahh A/-Ma1
25% Mudilr-ih
Two months 80%Rabh A/-Ma1
20% Mudcrib
Three months 85%Rahh A/-Ma1
15%Mudcfrih
One year 90% Rahh A/-Ma1
10%Mudurih

(b) Investment with Medium Risk:

One month 70% Rahb A/-Ma1
30% Mudurih
Two months 75% RahhAl-Ma1
25% Mudur-ih
Three months 80%Ruhh Al-Mill
20% Muddr-ih
One year 85%Rahh AI-Mu1
15%Mudar-ih

B(iv) Islamic Mudurabah Investment Renewable

The object of this Mud6rahah contract is to provide the opportunity for the
collective investment of the funds of the participants in this Mudfirabah with the
framework of the principles of Islamic Shari'ah.
(a) The funds of the Mudill-ahah are invested in all areas permissible under
Shari'ah and according to the MudGrabah contract. The investments begin
seven days after receiving the subscribed funds.
(b) The minimum amount of subscription is of US$70,000 or its equivalent for
one monthlthree months investment period and a minimum of US$50,000 or
its equivalent for six months/one year investment period.
(c) The investor may redeem the value of hisher certificates on the third business
day following the end of the maturity date including profits, if any.

B(v): Real Estate Investment Mudcil-ahah

The object oj'this Mudfirahah is the collective investment in Real Estate properties
on a pan-Islamic and International basis. The minimum amount is US$25,000 or other
 Review of lslamic Economics, Vol.4, No.1

equivalent currency. The participant may redeem Mudarahah units owned for at least
twenty four months in whole or in any part from liquid assets. Profit is distributed as
follows:
70% for the participant.
30% for the manager (IICG).

C(i) The Seventh Islamic Mudarabah for Investment, Savings and Takafol
1 ) This Mudcirabah is the Islamic alternative to conventional life insurance which
is not acceptable to Islamic Shari'ah as it involves Gharar, gambling, and Riba
(usury).
2) This Mudarahah offers the subscribers the benefit of investing and at the same
time saving their instalments together with the accumulated profits. It also has another
privilege which is Takafol by part of the accrued profits of the subscribers in favour of
the family of any participant who may die during the time of hisher participation.
3) Eligibility to this Mudarahah is restricted to Muslims, males or females,
provided they belong to the age group of 20 to 56 years.
4) A male is entitled to buy a maximum of four certificates while a female is
entitled to buy only two.
5 ) The participant shall pay an annual instalment on the value of the certificate
plus 30% issuance fee. The total value of the certificate is sub-divided on the number
of years that remain before the participant reaches the age of sixty, rounding up the
amount to the nearest figure.
6) A schedule showing the age and number of premiums and the value of the
annual premium and the acceptable currencies is jointly worked out to serve the
purpose. The participant shall accordingly continue to pay the premium until he/she
reaches the age of 60.
7) The participant is eligible to withdraw but not before the termination of the
second year of hisher membership; only then shall the company pay him back 95% of
the amount due (instalments + profit).
8) The participant shall enjoy the privilege of Takafol (solidarity) upon
completion of hisher first year of membership, provided that he/she is regularly
paying hisher premiums. In case of hisher death, the Company shall reimburse the
legal and authorized heirs all paid-out premiums and their due profits, plus the
premium the deceased participant should have paid until the age of 60 in TakGfol
(solidarity) from the profits of other participants.
9) A set of legal conditions is incorporated in the MudLfrahahcontract by virtue
of which the participant shall be deprived of the privilege of Takafol if helshe fails to
abide by them.
10) If the participant continues to pay all the instalments due until helshe reaches
the age of 60, he/she shall be entitled to recover them all, plus the accumulated
profits.
11) Investment dividend shall be shared at the ratio of 1/10 to the Company and
9/10 to the participants.
 Islamic Financial Instruments: Definition and tTypes

C(ii): Development Muddrabah for Egypt

Objectives and main features of the Development Mudarabah for Egypt are as
follows:
1) Contributing to economic and social development through investing in the
field of agriculture, industrial and commercial enterprises.
2) Providing the opportunity of collective investment for the funds of the
participants in this Muddrabah within the framework of the principles of
Islamic Shari'ah.
3) Benefiting by the economic circumstances and the expected growth rates.
i) Profits shall be distributed as follows:
Owner of the M. Certificates 70%
Muddrib (IICG) 30%
ii) The investor may redeem the funds owned by him upon written
request to the manager, not less then 7 working days of the funds
required by the investor.
iii) The participant undertakes to pay, personally and form his own funds
every year, theZakah due according to shari'ah together with his other
assets on which Zakah is due.

11. Islamic Development Bank, Jeddah, K.S.A.

ZDB Unit Investment Fund:

The IDB Unit Investment Fund was launched in December, 1989 which marked the
beginning of the implementation of a major bank policy. This policy was designed to
generate additional resources for the bank on a basis compatible with Shari'ah. The
fund is a U.S. Dollar denominated investment fund to be managed by the IDB in
accordance with the Islamic concept of Mudarabah, with the IDB undertaking the
role of Mudarib. The fund will be invested in a range of viable ventures in IDB
member countries. Until such time the issue of investment in equities is finally
resolved by the Islamic Fiqh Academy of the OIC (Organization of Islamic
Countries), all the investments of the fund are being made in lease and instalment sale
financing with the bulk of investments concentrated in lease financing. The IDB Unit
Investment Fund is expected to facilitate the Bank's efforts to mobilize resources by
purchasing some of its medium and long-term investments, thus providing the Bank
with resources to reinvest in other ventures.

12. Switzerland

Islamic securities: one prominent branch of Dar Al-Ma1 Al-Islami Group "Faisal
Islamic Finance (Switzerland) S.A." has issued Islamic securities as one of the
instruments in their financial packages. Due to the non-availability of data and
information regarding this securities, it is not possible to give details about it.
 Review of Islamic Economics, Vo1.4, No.1

It is evident from the above that though it was little, the Muslim theoreticians and
practitioners have helped to develop these instruments. These have proved to be
effective instrumei~ts for investment-related financing. To meet the changing
environment of financial markets some Muslim economists have suggested for
devising new types of financial instruments. Dr. M.A. Mannan of IDB suggested 10
broad variables of new financial instruments, such as:
1. Loan Certificates
2. Index-Linked Loan Certificates
3. Islamic Commercial Papers
4. Integrated Investment Bonds
5. Profit Sharing Certificates
6. Expected Rate of Dividend Certificates
7. Rent Sharing Certificates
8. Firm Commitment Certificates
9. Zakah Certificates
10. Human Capital Ceflificates
Another economist of IDB, Mohamn~adEl-Hennawi has suggested two types of
certificates which will provide the stability of resources to the Islamic banks and
enhance their development role. The suggested instruments are:
I. Islamic Certificates of Deposit (ICD) and
2. Islamic Investment Certificates (assigned to a particular project or a
group of projects).
The Islamic Research and Training Institute (IRTI) of IDB is also continuing its
efforts in developing new types of financial instruments compatible with Shur-i'ahwhich
would enable it to increase its own resources in order to meet the growing needs of its
member countries for financing. To this end, an effort has been made by the IRTI in 1991
in announcing its financial assistance for the Muslim economists and researchers to
write research papers on development of appropriate Islamic financial instruments for
foreign resource mobilization. The suggested Islamic financial instruments are:
I. Net Income Sharing Instruments
2. Gross Income Sharing Instruments
3. Sale-Based Instruments
4. Conlmodity-Linked Bonds (yet to be examined)
5. Indexed Bonds (yet to be examined)
6. Equity Bonds (yet to be examined)

Conclusion

Considering the important role of financial instruments in the mobilisation of financial

resources, Scholars, Ulemu' and Bankers with vision, courage, imagination and above
all, absolute conviction and commitment to the cause of Islam, will have to work in
tandem to examine the future prospects and possibilities of diversifying and widening the
scope, volume and size of Islamic financial instruments of different maturities.