KembaraXtra–Islamic Finance–Islamic Capital Market – Wakalah (Agency)

• Wakalah is a Shari’ah-compliant agency contract established between a principal and an agent.
• Under a Wakalah contract, the principal authorises the agent to act on their behalf in carrying out specific tasks or services.
• The agent performs the assigned duties in exchange for a payment or fee known as Ujrah.
• Wakalah is commonly used to facilitate financial and commercial transactions without transferring ownership or risk to the agent.
• In trade finance, an importer applying for a letter of credit under Wakalah authorises the bank to act on their behalf.
• The bank, acting as an agent, issues the letter of credit to the exporter’s bank on behalf of the importer.
• The issuing bank performs administrative and transactional services related to the letter of credit.
• For providing these services, the bank charges a Wakalah fee (Ujrah) to the importer.
• The bank does not bear commercial risk in the transaction unless negligence or misconduct occurs.
• Wakalah contracts are service-based and do not involve profit-and-loss sharing.
• Wakalah is governed by specific Shari’ah principles.
• The contract must clearly establish an agency relationship between the principal and the agent.
• Wakalah facilitates transactions by allowing the principal to delegate authority.
• The agent is entitled only to the agreed fee (Ujrah) and not to business profits.
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Examples of Wakalah

• Letter of Credit (Trade Finance): An importer appoints an Islamic bank as an agent under Wakalah to issue a letter of credit to the exporter’s bank in exchange for a fee.
• Investment Wakalah: An investor appoints an Islamic bank as an agent to invest funds in Shari’ah-compliant assets for a fixed agency fee.
• Takaful Operations: A Takaful operator acts as an agent under Wakalah to manage participants’ funds and earns a Wakalah fee for providing administrative and management services.

​KembaraXtra–Islamic Finance–Islamic Capital Market – Istisna (Manufacturing an Asset) ​

• Istisna is a Shari’ah-compliant long-term financial contract used in Islamic finance for manufacturing, building, or constructing assets.
• Under an Istisna agreement, one party undertakes the obligation to manufacture, build, or construct an asset according to agreed specifications.
• The manufacturer or producer is required to ensure the completion and delivery of the asset to the customer.
• Istisna differs from Salam because it does not require full advance payment at the time of contract execution.
• The flexible nature of Istisna allows customers to choose different payment structures.
• Payments under an Istisna contract may be made in instalments during the project, at the time of delivery, or after the completed asset has been delivered.
• This flexibility makes Istisna suitable for projects with long construction or manufacturing periods.
• Istisna is most commonly used in infrastructure-related projects.
• Typical applications include power plants, factories, roads, schools, hospitals, commercial buildings, and residential developments.
• An Istisna contract generally involves three major parties.
• The producer or manufacturer is responsible for constructing or manufacturing the asset.
• The bank acts as the financier, facilitating the funding of the project.
• The customer acts as the purchaser of the completed asset.
• The Istisna structure ensures that financing is linked to real asset creation rather than monetary transactions, in compliance with Shari’ah principles.

​KembaraXtra-Islamic Finance-Islamic Capital Market- Between Primary Market and Secondary Market

Primary Market

• The primary market is where fresh (new) shares or securities are issued.
• It is also known as the new issue market.
• One of the major components of the primary market is the Initial Public Offering (IPO).
• Companies receive the money raised from issuing shares in the primary market.
• Funds raised are used for business expansion and growth purposes.
• Securities are issued at a uniform price for all investors participating in the offering.
• The primary market does not provide liquidity for the securities issued.
• Underwriters act as intermediaries between the company and investors.
• Securities issued in the primary market can be sold only once.


Secondary Market

• The secondary market involves trading of already issued ans existing shares or securities.
• It is also known as the after-issue market.
• The issuing company does not receive any money from secondary market transactions.
• The amount paid by the buyer goes directly to the seller of the shares.
• Securities are exchanged between buyers and sellers.
• Trading is facilitated by stock exchanges.
• The secondary market provides liquidity to securities.
• Brokers act as intermediaries in the secondary market.
• Securities can be sold multiple times, with no restriction on the number of transactions.

One-Line Exam Summary

The primary market deals with the issuance of new securities and capital raising for companies, while the secondary market facilitates trading of existing securities among investors and provides liquidity.

KembaraXtra-Islamic Finance-Islamic Capital Market -Mudharakah(Profit and Loss Sharing Joint Venture)

• Musharakah is a profit-and-loss sharing partnership contract used in Islamic finance, where all participating parties contribute capital to a joint business venture.
• Under a Musharakah arrangement, the relationship between the parties is that of partners, not lender and borrower.
• Each partner contributes capital, which may be:
  • In cash, or
  • In kind (subject to Shari’ah rules and valuation)
• The capital contributions from all partners are pooled together to finance a collective venture or project.
• Profits generated from the Musharakah venture are:
  • Shared among the partners, and
  • Distributed based on a pre-agreed profit-sharing ratio
• The profit-sharing ratio:
  • Is determined at the time of contract formation
  • Does not necessarily have to be proportional to capital contribution, provided all partners agree


• Losses incurred under a Musharakah contract are shared strictly on a pro rata basis, meaning:
  • Losses are divided in proportion to each partner’s capital contribution
  • This rule ensures fairness and prevents unjust allocation of financial risk
• Musharakah embodies the Islamic finance principle that those who provide capital must bear financial risk.

Major Types of Musharakah Joint Ventures

1. Diminishing Musharakah (Diminishing Partnership)

• Diminishing Musharakah is a commonly used form of partnership, particularly in property acquisition and real estate financing.
• In this arrangement:
  • The bank and the investor jointly purchase a property
  • Ownership of the property is shared between the bank and the investor at the outset
• The investor gradually buys out the bank’s share in the property over time.
• Each payment made by the investor:
  • Represents the purchase of a portion of the bank’s equity
  • Reduces the bank’s ownership stake in the property
• As the bank’s ownership decreases:
  • The investor’s ownership proportion increases correspondingly
• Eventually, once all payments are completed:
  • Full ownership of the property is transferred to the investor
• During the period of shared ownership:
  • The investor may also pay rent to the bank for the bank’s remaining share of the property, depending on the structure
• This form of Musharakah is widely used because it:
  • Facilitates asset ownership
  • Avoids interest-based mortgage financing
  • Aligns with Shari’ah principles of shared risk and ownership
  
  
  
  
  
  
  
  
  
  
  

2. Permanent Musharakah

• Permanent Musharakah is generally used for long-term financing and business projects.
• In this type of Musharakah:
  • All partners contribute capital
  • The partnership does not have a predetermined or fixed end date
• The venture continues to operate indefinitely, as long as the participating partners agree to remain involved.
• Profits generated from the venture:
  • Are shared according to the agreed profit-sharing ratio
• Losses:
  • Are shared in proportion to each partner’s capital contribution
• The partnership remains functional until:
  • The partners mutually agree to terminate the arrangement, or
  • The business is dissolved according to contractual terms
• Permanent Musharakah is commonly used in:
  • Large-scale business ventures
  • Industrial projects
  • Ongoing commercial enterprises​

Overall Significance of Musharakah

• Musharakah represents a true partnership-based financing model, fully aligned with Shari’ah principles.
• It promotes:
  • Risk sharing rather than risk transfer
  • Joint ownership and responsibility
  • Long-term cooperation between financial institutions and customers
• Unlike conventional debt-based financing, Musharakah ensures that:
  • Returns are not guaranteed
  • Profits are earned only through successful economic activity
• This contract is a core pillar of Islamic finance, highlighting its ethical, participatory, and asset-based nature.

Kembaraxtra-Islamic Finance-Islamic Capital Market - Real Assets Over Monetary Assets in Islamic Finance

• The foundational principle of Islamic finance rejects the idea that money can generate more money by itself.
• Creating wealth purely through money-to-money transactions does not comply with Islamic law (Shari’ah) and is therefore legally prohibited in Islamic finance.
• Direct trading or dealing in money as a commodity, especially for profit generation, is not permissible under Islamic financial principles.
• In Islamic finance, money is not treated as a tradable asset, but as a facilitating tool that enables real economic activity.
• Money can only generate income when it is invested in real business activities, such as:
  • Trade
  • Leasing
  • Investment
  • Partnership-based ventures

Money in Islamic Finance

• t Islamic Financial Institutions (IFIs) do not operate as money lenders but instead function as:
• • Sellers
  • Lessors
  • Investors
  • Business partners


• These roles are adopted based on the specific financing needs of customers.

Sources of Funds in Islamic Finance

• Funds used by IFIs originate from two primary sources:
  • Islamic deposit accounts (such as savings and investment accounts)
  • Shareholders’ funds
• These funds are pooled together by the Islamic Financial Institution to support Shari’ah-compliant financing activities.

Transformation of Money into Real Economic Stock

• Once funds are pooled, money is transferred from a purely monetary form into real economic stock.
• This transformation occurs when IFIs use funds to:
  • Purchase real assets
  • Invest in productive projects
  • Acquire goods or services for trade or leasing


• This step ensures that money is backed by tangible or identifiable assets, fulfilling Shari’ah requirements.

Trade-Based Financing Flow

• The Islamic Financial Institution uses X amount of money to:
  • Purchase an asset from a vendor at price X


• After acquiring ownership of the asset, the IFI:
  • Sells the same asset to the customer at X + Y
  • The increment (Y) represents profit from trade, not interest


• This profit is permissible because it arises from asset ownership and sale, not from lending money.

Lease-Based Financing Flow

• Alternatively, after purchasing the asset:
  • The IFI may lease the same asset to the customer at X + Y


• In this case:
  • The IFI remains the owner of the asset
  • The customer pays rent for usage of the asset


• Rental income is considered halal (permissible) because it is generated from the usufruct (use) of a real asset.

Investment and Partnership-Based Financing

• Funds may also be used for capital investment in a project (X project).
• In such cases:
  • The IFI acts as an investor or partner
  • The customer acts as an entrepreneur or partner


• Profits generated from the project are:
  • Shared between the IFI and the customer
  • Based on an agreed profit-sharing ratio (X% profit sharing)


• Losses, if incurred, are:
  • Shared according to Shari’ah rules
  • Based on capital contribution or contractual structure

Role of Customers and Partners

• Customers may act as:
  • Buyers (in sale-based financing)
  • Lessees (in lease-based financing)
  • Partners or entrepreneurs (in investment-based financing)


• Customers are not treated as borrowers, but as active participants in economic activity.

Conceptual Shift in the Role of Money

• Figure 1.7 clearly demonstrates a conceptual shift in the role of money under Islamic finance.
• Money is no longer viewed as:
  • A commodity
  • A profit-generating object by itself
• Instead, money functions solely as:
  • An enabling entity
  • A medium to facilitate trade, leasing, and investment

Outcome for Islamic Financial Institutions (IFIs)

• By dealing in real assets rather than monetary assets, IFIs:
  • Earn profits through legitimate economic activity
  • Avoid interest-based income
  • Remain fully compliant with Shari’ah
• This asset-based approach has proven effective in:
  • Generating sustainable profits
  • Supporting real-sector growth
  • Enhancing financial stability

Overall Significance

• Islamic finance ensures that:
  • Money always enters the real economy
  • Wealth creation is tied to productive activity
  • Financial growth benefits both institutions and society


• The preference for real assets over monetary assets is therefore a defining and distinguishing feature of Islamic finance when compared to conventional financial systems.

Kembaraxtra-Islamic Finance-Islamic Capital Finance- and Loss Sharing

• The concept of profit and loss sharing is a core and pivotal principle of the Islamic financial system, distinguishing it clearly from conventional finance.
• This concept represents a unique financial approach in which Islamic Financial Institutions (IFIs) are required to share both profits and losses arising from financial transactions.
• Profit and loss sharing applies not only between IFIs and fund users but also between IFIs and depositors, making depositors active participants rather than passive earners of fixed returns.
• The sharing mechanism operates primarily through two Shari’ah-compliant contracts:
  • Mudarabah, and
  • Musharakah
• These contracts ensure that financial relationships are built on risk sharing rather than risk transfer, which aligns with Islamic ethical and legal principles.
• Beyond Shari’ah compliance, Mudarabah and Musharakah have been widely practiced historically, especially in Muslim societies.
• These contracts have been among the most frequently used financial arrangements since medieval times, demonstrating their long-standing practicality and acceptance.

Musharakah Contract

• Under a Musharakah contract, arrangements are made to facilitate joint ownership.
• Joint ownership under Musharakah can take two forms:
  • Sharikat al-milk – joint ownership of property or assets
  • Sharikat al-‘aqd – partnership formed for a commercial enterprise or business activity
• The primary intent of a Musharakah contract is to establish a mutual agreement on capital contributions by all participating parties.
• Each party’s capital contribution is determined in advance, based on the project’s planning and financial requirements.
• Both parties are involved in the implementation and management of the project, either directly or through agreed responsibilities.
• Profits generated from the project are shared between the parties according to ratios that are pre-agreed and documented in the contract.
• Profit-sharing ratios do not necessarily have to match capital contributions, as long as they are agreed upon beforehand.
• Losses incurred under a Musharakah arrangement are shared strictly in proportion to each party’s capital contribution, ensuring fairness and accountability.
• This proportional sharing of losses reinforces the principle that financial risk must be borne by those who provide capital.

Mudarabah Contract

• In a Mudarabah contract, the roles of the parties are clearly divided between:
  • Capital providers, and
  • Managers or entrepreneurs
• Within Islamic banking, depositors act as capital providers, while IFIs assume the role of fund managers.
• Depositors participate in Mudarabah through:
  • Savings accounts, or
  • Investment accounts
• Under this arrangement, depositors provide the financial capital, while the bank manages and invests the funds.
• Profits generated through Mudarabah are shared between the depositors and the bank based on a precise and pre-agreed profit-sharing ratio.
• If losses occur:
  • Depositors bear the financial loss in monetary terms, as they are the providers of capital
  • Banks do not bear monetary losses, but instead lose their time, effort, labour, management costs, and expected profits
• This structure ensures that returns are not guaranteed and depend entirely on the performance of the underlying investments.

Roles and Structure in Mudarabah

• According to Mudarabah norms:
  • The capital owner, known as Rabb al-Mal, provides the funds
  • The manager or entrepreneur, known as the Mudarib, manages the investment
• The Rabb al-Mal can be:
  • The bank, or
  • The customer
• The Mudarib can be:
  • The entrepreneur, or
  • The bank (in cases of indirect financing)
• The Mudarib commits to managing the capital with the objective of generating profit, using skill, expertise, and effort.
• Profit distribution is based on a fixed percentage, agreed upon at the beginning of the contract.
• Profits are considered part of total income, meaning:
  • They are not fixed in amount
  • They depend entirely on actual business performance

Indirect Financing and Double-Tier Mudarabah

• When Mudarabah is applied in indirect financing, the agent who receives the capital may:
  • Enter into another Mudarabah contract with a third party


• This structure is known as double-tier Mudarabah.
• In this arrangement:
  • Funds move from depositors to the bank (first tier)
  • The bank then invests the funds with entrepreneurs or businesses (second tier)
• The invested funds are channelled into productive economic activities, ensuring real-sector involvement.

Applications of Mudarabah

• Mudarabah contracts are widely used in modern Islamic finance, particularly in:
  • Mutual fund management
  • Structuring of Sukuk (Islamic bonds)


• These applications demonstrate the flexibility and scalability of Mudarabah in contemporary financial markets.

Overall Significance

• The system of profit and loss sharing through Mudarabah and Musharakah represents a distinctive and defining feature of Islamic banking.
• This approach contrasts sharply with the conventional banking system, which relies on:
  • Fixed returns, and
  • Guaranteed interest-based income


• By requiring shared responsibility for outcomes, Islamic banking promotes:
  • Ethical finance
  • Risk-sharing
  • Real economic participation


• This principle reinforces the moral, legal, and economic foundations of Islamic finance.

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