Istisna'a & Parallel Istisna'a
In this section, some technical words are defined.
Istisna'a: An Istisna'a contract refers to an agreement to sell to or buy from a customer, a non-existent asset which is to be manufactured or built according to the ultimate buyer's specifications and is to be delivered on a specified future date at a predetermined selling price.
Parallel Istisna'a: The bank, as the seller, has the option to manufacture or build the asset on its own or to engage the services of a party other than the Istisna'a ultimate buyer as supplier or subcontractor, by entering into a Parallel Istisna'a contract
Hamish Jiddiyyah: in the case of a binding MPO, the risk of selling at a loss is mitigated by securing a Hamish Jiddiyyah (HJ). It's a security deposit held as collateral upon entering into agreement to purchase or agreement to lease.
Sharia: is the body of Islamic religious law. It is the legal framework within which the public and private aspects of life are regulated for those living in a legal system based on Islamic principles of jurisprudence. Sharia deals with many aspects of day-to-day life, including politics, economics, banking, business, contracts, family, sexuality, hygiene, and social issues.
PSIA: Profit Sharing Investment Account is a financial instrument that is relatively similar to the time deposits of conventional banks. According to the terms and conditions of PSIA, depositors are entitled to receive a share of the bank's profits, but also obliged to bear all potential losses pertaining to their investment in the bank. This profit-sharing principle is core to Islamic finance, according to which investors and entrepreneurs must share the risks and rewards of a given venture.
A PSIA can be further categorised into: Unrestricted PSIA and Restricted PSIA. The Bank has full discretionary power in making investment decisions for unrestricted PSIA, but in the case of the restricted PSIA the placement of funds by the Bank is subject to investment criteria contract or agreed between the investment account holders (IAH) and the Bank at the time of contracting.
In this section, some principles which must be respected by an Istisna'a & Parallel Istisna'a contract are described.
An Istisna'a contract refers to an agreement to sell to or buy from a customer, a non-existent asset which is to be manufactured or built according to the ultimate buyer's specifications and is to be delivered on a specified future date at a predetermined selling price.
The bank, as the seller, has the option to manufacture or build the asset on its own or to engage the services of a party other than the Istisna'a ultimate buyer as supplier or subcontractor, by entering into a Parallel Istisna'a contract.
This section makes distinctions between the two main categories of Istisna'a:
(a) Full Recourse Istisna'a
The receipt of the selling price by the bank is dependent on the financial strength or payment capability of the customer for the subject matter of Istisna'a, where the source of payment is derived from the various other commercial activities of the customer and is not solely dependent on the cash flows from the underlying asset/project; and
(b) Limited and Non-recourse Istisna'a
The receipt of the selling price by the bank is dependent partially or primarily on the amount of revenue generated by the asset being manufactured or constructed by selling its output or services to contractual or potential third party buyers. This form of Istisna'a faces "revenue risk" arising from the asset's ability to generate cash flows, instead of the creditworthiness of the customer or project sponsor.
So that an Istisna'a & Parallel Istisna'a contract complies with Sharia, it is necessary to respect some rules:a) the nature and quality of the item to be delivered must be specified.
b) the manufacturer must make a commitment to produce the item as described.
c) the delivery date is not fixed. The item is deliverable upon completion by the manufacturer.
d) the contract is irrevocable after the commencement of manufacture except where delivered goods do not meet the contracted terms.
e) payment can be made in one lump sum or in instalments, and at any time up to or after the time of delivery.
f) the manufacturer is responsible for the sourcing of inputs to the production process.
Istisna'a differs from bay Salam in that
a) the subject matter of the contract is always a made-to-order item,
b) the delivery date need not be fixed in advance,
c) full advance payment is not required and
d) the Istisna'a contract can be cancelled but only before the seller commences manufacture of the agreed item(s).
3- Istisna'a stages
A Istisna'a & parallel Istisna'a contract can be divided in two stages:
· Stage I: Unbilled work-in-progress
· Stage II: After contract billing.
The calculation and the type of the risk faced by the Bank are different at the various stages of the contract for the two categories.