ISLAMIC FINANCE IN SHIPPING FINANCE

Islamic finance is a way of managing money and doing business while adhering to the moral principles of
Islam . It covers matters such as saving, investing and borrowing to buy a home.

Principles of Islamic Finance

Islamic finance strictly complies with Sharia law. Contemporary Islamic finance is based on a number of
prohibitions that are not always illegal in the countries where Islamic financial institutions are operating:

1. Paying or charging an interest

Islam considers lending with interest payments as an exploitative practice that favors the lender at the
expense of the borrower. According to Sharia law, interest is usury (riba), which is strictly prohibited.

2. Investing in businesses involved in prohibited activities

Some activities, such as producing and selling alcohol or pork, are prohibited in Islam. The activities are
considered haram or forbidden. Therefore, investing in such activities is likewise forbidden.

3. Speculation (maisir)

Sharia strictly prohibits any form of speculation or gambling, which is called maisir. Thus, Islamic
financial institutions cannot be involved in contracts where the ownership of goods depends on an
uncertain event in the future.

4. Uncertainty and risk (gharar)

The rules of Islamic finance ban participation in contracts with excessive risk and/or uncertainty. The
term gharar measures the legitimacy of risk or uncertainty in investments. Gharar is observed with
derivative contracts and short-selling, which are forbidden in Islamic finance.

In addition to the above prohibitions, Islamic finance is based on two other crucial principles:
Material finality of the transaction: Each transaction must be related to a real underlying economic
transaction.

Profit/loss sharing: Parties entering into the contracts in Islamic finance share profit/loss and risks
associated with the transaction. No one can benefit from the transaction more than the other party.

Prohibitions in Islamic Finance - Diagram

Types of Financing Arrangements

Since Islamic finance is based on several restrictions and principles that do not exist in conventional
banking, special types of financing arrangements were developed to comply with the following
principles:

1. Profit-and-loss sharing partnership (mudarabah)

Mudarabah is a profit-and-loss sharing partnership agreement where one partner (financier or rab-ul
mal) provides the capital to another partner (labor provider or mudarib) who is responsible for the
management and investment of the capital. The profits are shared between the parties according to a
pre-agreed ratio.

2. Profit-and-loss sharing joint venture (musharakah)

Musharakah is a form of a joint venture where all partners contribute capital and share the profit and
loss on a pro-rata basis. The major types of these joint ventures are:

Diminishing partnership: This type of venture is commonly used to acquire properties. The bank and
investor jointly purchase a property. Subsequently, the bank gradually transfers its portion of equity in
the property to the investor in exchange for payments.

Permanent musharkah: This type of joint venture does not have a specific end date and continues
operating as long as the participating parties agree to continue operations. Generally, it is used to
finance long-term projects.

3. Leasing (Ijarah)

In this type of financing arrangement, the lessor (who must own the property) leases the property to the
lessee in exchange for a stream of rental and purchase payments, ending with the transfer of property
ownership to the lessee.
Investment Vehicles

Due to the number of prohibitions set by Sharia, many conventional investment vehicles such as bonds,
options, and derivatives are forbidden in Islamic finance. The two major investment vehicles in Islamic
finance are:

1. Equities

Sharia allows investment in company shares. However, the companies must not be involved in the
activities prohibited by Islamic laws, such as lending at interest, gambling, production of alcohol or pork.
Islamic finance also allows private equity investments.

2. Fixed-income instruments

Since lending with interest payments is forbidden by Sharia, there are no conventional bonds in Islamic
finance. However, there is an equivalent of bonds called sukuk or “Sharia-compliant bonds.” The bonds
represent partial ownership in an asset, not a debt obligation

SHERIA - COMPLIANT INSTRUMENTS USED IN SHIPPING FINANCE

1. Mudarabah Contract

Mudarabah contract is an Islamic financial instrument in which one party participates with money and
the other with efforts. The profit shall be divided in strict proportion, and no party shall be entitled to a
predetermined amount of return. Financial losses shall be borne solely by the investor.

2. Murabahah Contract

Murabahah refers to the sale of goods; the profit margin is included in the sale price. The subject of sale
must exist, be owned by the seller, and be in his physical or constructive possession. So, the seller
assumes the risks of ownership. Murabahah requires an offer and acceptance, which must include
Certainty of Price, Place of Delivery, and Date when Price will be paid

3. Ijarah Contract

Ijarah generally means lease or rent, and it is one of the widely used Islamic banking products. Ijarah is
selling the benefit of use or service for a fixed price or wage. The bank makes an asset or equipment
available, such as a plant, office automation, or motor vehicle, for a fixed period and rent. The corpus of
the leased commodity remains in the lessor’s ownership, and only its usufruct is transferred to the
lessee.

4. Musharakah Contract

Musharakah is a business contract established by partners who agree to share business profits and
losses. Profits are distributed in the proportion mutually agreed upon in the contract. In this type of
Islamic banking product, one or more partners choose to become non-working partners, their profit
ratio cannot exceed their ratio in capital investment.

5. Salam Contract

Salam contract is an Islamic mode of financing where the seller undertakes to supply specific goods at a
future date, considering a price fully paid in advance at the time of the contract. If the full amount is not
paid, it will be tantamount to a sale of debt against debt, Haram.

6. Istisna Contract

It is one of the Islamic banking products where a buyer orders to manufacture, assemble, or construct
something at an agreed price and to be delivered at a future date. The commodity must be known and
specified, including its kind, type, quality, and quantity. The price must also be fixed in absolute and
unambiguous terms and can be paid in a lump sum or instalments, as mutually agreed.

7. Diminishing Musharakah

Diminishing Musharakah is a type of Shirkah where one partner gradually purchases the other partner’s
share. According to this concept: “A financier and his client participate in the joint ownership of a
property, or equipment, or in a joint commercial enterprise. The financier’s share is further divided into
units, and it is understood that the client will purchase those units periodically until all the financier’s
units are purchased by the

Applications of Islamic Finance Products

Murabahah is used for Islamic Trade Finance Transactions, Working Capital Finance, and Fixed Assets
Financing.

Musharakah is used for Working Capital or Running Financing, Term Finance for Joint ventures, and
Equity Participation.
Diminishing Musharakah is used to finance assets such as cars, houses, and shops.

Ijarah, or Islamic leasing, is used to finance Autos, Buildings, Machinery, and Equipment.

Istisna is used to finance manufacturing goods, constructing buildings, Exporting, and Paying overhead
expenses like salaries and utility bills.

Salam contrat is used for Agriculture or Commodity financing.