THE GREAT INTEREST RATE SLIDE

Falling!   Falling!   Falling!   Interest Rates!   They are a falling.   And how?!   From the United States to India and in Britain, in between, interest rates have been sliding as never before in history.

The rationale for the frequent cuts in the interest rates is, among other things, to make credit more affordable to individuals and corporations, with the expectation of increase in the offtake of credit, and also to create a set of new borrowers!

Central Bankers around the world seem to think that reducing interest rates would do the trick of increasing public lending.   Rather simplistic, one might argue.   Because, public lending operations are carried out by Commercial Banks that are obliged to adhere to certain norms in their lending operations.   Non adherence to these norms can not only jeopardise the loan asset, but also get them into trouble with the Regulators, the Central Banks themselves.   That apart, they (commercial banks) would be doing a disservice to their depositor customers by violating sound lending norms.   In fact, the current banking crisis in the West is, in large measure, a result of non-compliance of sound banking principles and the lending norms.

What does a Commercial Banker look for in a potential borrower?   Among other things, the borrower’s eligibility for the loan requested by him, and his capacity to repay the loan, alongwith interest in the stipulated time.  

Reducing interest rates might increase the demand for loans, but a lending decision hinges on the borrower’s financial health.   To the extent that reduction in interest rates contributes to the increase in the number of eligible borrowers (those that qualify for a loan, and have the capacity to repay the same), interest rate reduction would have served its purpose.   But is that really the case?   A simple increase in the number of people lining up before the Banks for a loan is not sufficient indication of the success of the interest rate reduction formula.

The key to increasing lending, not only to corporate borrowers but also to the retail segment, is the increase in the demand for loans from quality borrowers, and not just an increase in the supply of money available for lending.   That is the crux of the matter.   Whereas Central Banks may have control over the levers that enable them to increase the money supply, and thereby the demand for loans, they do not have control over the supply of quality borrowers.   That depends on the overall economic situation, especially the job situation.

The current job scene as it is now, with layoffs, freeze on new hiring, business failures across sectors, etc., becoming a daily occurance, the number of quality borrowers, would, in fact, tend to come down.   How then would you expect the commercial  banks to lend more?   And to who?   Must the banks lend to second and third rate borrowers and risk the health of the institution, apart from earning the wrath of the regulators?   That is the million dollar question.   It also underlines the limitations of the Central Banks in living up to the expectations of the political establishment, as well as the general public.

The coming months may see a war of sorts between the Central Banks and the Commercial Banks, each blaming the other for not doing enough to alleviate the pains of the current economic crisis.   The truth of the matter is that this crisis is a result of faulty policies  pursued over a long period of time, and can neither be wished away, nor easily resolved.

It may be some time before the crisis plays out its course, and normalcy is restored.   How long a time would that be?   Does anyone know?

Views expressed above are personal.

ISLAMIC BANKING SERVICES: ISTISNA

Definition:  Istisna refers to a contract of Manufacture!   Manufacture?   But what has Banking to do with manufacture?   Does an Islamic Bank engage in the activity of manufacturing goods?   But is an Islamic Bank not a service organisation?  

Of course, an Islamic Bank is a service organisation and not a manufacturing one.   However, under the service called Istisna the Islamic Bank contractually undertakes to manufacture but practically does not!   What it does is to supply the goods for which its customer places an order by sourcing the same from a manufacturer of such goods.

How It Works:  Firstly,  this type of contract applies to goods that have to be manufactured, like a fountain pen.   It does not apply to something like wheat or barley that are grown.   The product or commodity should have gone through the process of manufacture to be eligible for financing under Istisna contract.  

For example, a customer, running a stationery shop approaches a Bank with a proposal for purchase of, say, one million fountain pens.   He would like to stock fountain pens of different brands in different quantities, to offer a wide choice to his own customers.  

The customer gives details of the fountain pens that he wishes to deal in, the brands, the price range, etc., to the Bank.   The Bank examines the request of the customer and negotiates with him the terms and conditions under which it is prepared to supply the fountain pens to him.  

Once the customer agrees to the terms and conditions of the Bank, the Bank, in turn, approaches the manufacturer(s) of the different brands of fountain pens and negotiates for their purchase as per the request of their customer.   Naturally, the Bank negotiates to buy the fountain pens from the manufacturer(s) at a lesser rate than what it had negotiated with its customer to supply the pens.   The difference in these two rates would be the profit of the Bank from the transaction.

In the above deal, there are actually two transactions or contracts.   One between the Bank and the Customer.   And the second, between the Bank and the Seller.   The Bank acts as a go-between the manufacturer and the seller.   It makes payment directly to the seller, who’s more confident in dealing with the Bank for obvious reasons.   Similarly, the buyer does not have to deal with the manufacturer(s) and can rely on his Banker to supply him the product as per his own specifications.   The Bank enjoys the confidence of both the buyer and the seller and capitalizes on it to make a profit from the deal.   Further, the delivery of the above consigment may be made by the seller either to the Bank, or at the instructions of the Bank , to the Bank’s customer directly.   The various modalities of this transaction are worked out before hand to obviate the possibility of any trouble arising at a later date.

Pros and Cons:  As can be seen from the above, this transaction, like many others under Islamic Banking, are a bit complicated and fraught with consequences not usually faced under conventional banking.   There is a lot of emphasis on the moral and ethical aspects of commercial transactions, and this places a peculiar burden on the parties to the transaction.

It is also not easy to rescind or withdraw from transactions of this nature without loss of face, apart from monetary loss, and the possibility of losing business on account of the possibility of being branded unreliable and untrustworthy.   But the fact remains, that these type of transactions have been in vogue in Islamic communities around the world, especially in the Middle East for centuries, both in the formal and informal sectors, and have become a part and parcel of their lives.

Author’s Note:   Readers please note that this article is meant to be an introduction to one of the banking services available under Islamic Banking and not an exhaustive study of the subject.

ISLAMIC BANKING SERVICES: IJARAH

Definition:  Ijarah is the equivalent of Leasing offered by Islamic Banks and Financial Institutions.   The activity of Leasing involves permitting the usage of a property, say a car, or a shop etc, owned by one person, by another, for a consideration, i.e. a monetary return.   While the ownership of the asset remains with the owner, or the lessor, the lessee, or the person that leases out the asset, will have the freedom to put such asset to beneficial use, in order to gain some benefit from the same.   There are two types of Ijarah-Ijarah Salam and Ijarah wa Iqtina.

Ijarah Salam:  Under this type of lease agreement, the lessee retains the possession of the asset for the duration of the productive life of such asset, which may be 10 years or 15 years as the case may be.  

 For example, a person takes a car on lease whose productive life is estimated to be, say 10 years.   The lessee would be entitled to the use of the car for 10 years by paying the lease rentals as agreed upon in advance,  for the fixed amount within the stipulated date without default.   The car will remain in the possession of the lessee for the duration of its productive life cycle, in this case, 10 years, after which the lessee will return the asset to the owner, who by the way, continues to retain the ownership of the car during the lease period.   This type of lease contract is convinient to both the lessor and the lessee and fulfils their respective requirements.  

Ijarah wa Iqtina:  Under this type of lease contract, the lessee has the option, though not the compulsion, to buy the asset leased out from the lessor upon completion of the lease period.   The rate at which the asset would be purchased by the lessee would be mutually decided upon by both the parties to the lease contract.   As in the first type of lease contract, the ownership of the asset vests in the lessor and the lessee would only have the right to put the asset to beneficial use.   And the lessee would be obliged to pay the lease rentals at the rate agreed upon at the stipulated intervals without default.   At the end of the lease period, the lessee would have the option of buying the asset off the lessor and become the owner of the same.   The rate at which the asset would be sold to the lessee would depend upon the quality of the asset, the remaining life cycle of the asset, the market conditions, the demand and supply position etc.

Beneficial Arrangement:  Ijarah and Ijarah wa Iqtina contracts are  beneficial to both the lessor and the lessee.   The lessor, who owns the asset,  may not have the time and the inclination to put his asset to beneficial use and may only be incurring expenditure in maintaining the same.     This arrangement provides an ideal way for him to put his asset to good use and derive some financial benefit from it.   In the same way, the lessee may have the necessary skills to utilize the asset and derive financial benefit from the same, but may not have the capital to purchase the asset.   This lease arrangement, thus provides him the medium to possess the asset without owning it and to apply his knowledge and skills to put the asset to beneficial use.   What’s more , he has the option to buy the asset from the owner, in future, if that suits his needs.   Hence it is a mutually beneficial arrangement.

As in other types of financing under the Islamic system, the Ijarah contract also relies to a great extent upon the integrity and honesty of the parties to the contract.   Some of the most important responsibilities of the parties to the Ijarah contract are:   the lessor should not only be the owner of the asset, but must have possession of the same.   Ownership without possession, or vice versa does not fulfil the requirements of this kind of contract.   In the same way, the lessee is expected to take good care of the asset, as he would if it belonged to him, even though he not the owner of the asset.

Note:  Readers please note that this article is not an exhaustive study of the Ijarah contract, but only meant to give a basic understanding of the same.

ISLAMIC BANKING SERVICES: MUSHARIKA

Definition:  Musharika is a form of Venture Financing under the Islamic Banking System.   This type of financing is more risky compared to the Musharaka contracts, and as such, offered to only customers of high repute, integrity, and financial strength.   Usually, the customers are made partners in this contract.   This type of contract, in general, is a short term financing option in which both profits and losses are shared by the Banker and the Customer in the agreed proportion.   There are two types of Musharika contracts-Direct and Diminishing.

Direct:  Under this contract, the Bank and the Customer establish a partnership for the purpose of engaging in a commercial business and contribute to the capital of the same by mutual agreement.   As the partnership is essentially short term, the business undertaken would also be consistent with the duration of the partnership. 

All the details of the business to be undertaken are worked out in advance so as to avoid any kind of disputes and bad blood between the partners.   This usually relates to, though not restricted to, the nature of the business, the capital required for the business and the respective share of the partners in the capital, the responsibilities of the partners in conducting the business and the role to be played by each of them, the ratio in which profits and losses would be shared, and issues relating to the market conditions, the demand and supply position, the expected revenues as well as the expenditures etc.   It is to be noted here that the profit and loss sharing ratio between the partners is decided upon in advance, and is not in proportion to the capital contributed by them.

Diminishing:  The Diminishing Musharika is similar to the Direct Musharika discussed above, except that the Diminishing type provides for the exit of the Bank from the Partnership upon repayment of its share of the capital by the Customer.   That is, this contract enables the Customer become the master of the business, that was initally started as a partnership to which the Bank had also contributed capital.   The precondition being the repayment of the Bank’s share of the capital in full.

Pros and Cons:  As can be noted from the above, this type of financing fulfils the requirement of Islamic Laws for the absence of Interest in commercial transactions, by providing for sharing of profits and losses between the Bank and the Customer.   On the other hand, this type of financing is also fraught with risks not associated with conventional banking and demands a higher level of ethical and moral standards of the parties to the transaction, without which the venture is doomed to failure.   As such, this facility is extended to only top level customers with high credit rating and good track record.   But as in any business venture, the possibility of failure is a real one, and therefore, attention  needs to be paid  to each and every issue that can make or mar the success of the venture.   This only underlines the importance of the commitment of the parties to the contract to the principles of honesty, integrity, ethics, and morality in conducting themselves under the contract.

Venture financing, as a form of financing is quite popular in the West especially in regard to high technology ventures and untested technologies, with higher possiblity of failure.   Silicon Valley is a prime example of this type of financing being undertaken successfully.   In the Islamic world, however, this mode of financing in both the formal and informal sectors, has been in vogue for centuries, and stood the test of time.   In spite of the higher level of risk associated with this type of financing, it provides a vital and much needed source of finance for business and trade. 

Disclaimer:  Readers please note that this article is meant to be a brief introduction to the Musharika contract and not an exhaustive study of the same.

ISLAMIC BANKING SERVICES: MUDARABAH

Definition:  This is a type of Partnership between the Bank and the Customer for the purpose of carrying on any business, on a profit sharing basis.   The ratio of their respective shares in the profits is  decided upon mutually, in advance.   However, the losses, if any, are borne exclusively by the Bank!

How It Works:  Under this partnership, the Bank ususally provides the capital, and is called the “Rabb Al Maal”.   And the customer manages the enterprise, and is called the “Mudarib”.   The job of the Bank, or the Rabb Al Maal, is only to provide the necessary capital and let the Customer, or the Mudarib, to manage the show.   The Bank does not concern itself with the day to day running of the business.  

The Customer, or the Mudarib, has the sole responsibility of running the day to day affairs of the business, and is expected to make a success of the enterprise.   His skill and competence are, therefore, crucial to the success of this partnership.   Perhaps the most noteworthy aspect of this partnership is that the Bank shall bear all the losses, but share the profits with the Partner, the Customer or the Mudarib.   Which means, this is a fiduciary type of contract,  and much depends upon the integrity, moral and ethical standing of the Customer in making this partnership successful.    The peculiar nature of this partnership puts different kinds of pressure on the partners and hinges on the trust and faith existing between the two, apart, of course, from the competence of the Customer in managing the business.   The nature of business and the operating environment also play their own role in determining the success or otherwise of this partnership.

Another noteworthy aspect of this partnership is that the profits from the business are distributed between the Bank and the Customer only after the Bank or the Rabb Al Maal is refunded the capital provided by him for starting the business.   As an illustration, suppose the Bank or the Rabb Al Maal has provided a capital of, say, U S Dollars One Million for undertaking a particular business venture, whose life span is, say, one year.   Suppose, at the end of the year when the business venture is to come to an end, the partnership has made a profit of U S Dollars Twenty Thousand.   And suppose they have also incurred an expenditure of U S Dollars Ten Thousand as part of their business expenses.   That means they have made a net profit of U S Dollars Ten Thousand.   Now the Mudarib or the Customer has to return the capital in the amount of U S Dollars One Million to the Rabb Al Maal, the Bank, before he can lay claim to his share of the profit, as per agreed terms.   However, in certain cases, both the partners may agree upon to distribute the profits even before the cessation of the partnership.   In such an event,  care is taken to ensure the safety and security of the Bank’s capital, and the continuation of the business venture till the originally agreed upon period.   Eventually, the Bank’s capital would be repaid in any case.

Diminishing Mudarabah:  A variation of the above Mudarabah contract is the Diminishing Mudarabah.   In this type of Mudarabah, the Bank or the Rabb Al Maal agrees to sell its share of the business at agreed intervals to the Mudarib, the Customer, such that eventually the Mudarib becomes the sole owner of the business, upon full repayment of the Bank’s capital.

There is also a provision to terminate the partnership before the due date, by mutual consent, without adversely affecting the interests of either of the partners, and without jeopardising the business.   This however, makes it a risky proposition to both the Bank and the Customer and is the reason why this type of contract is not as popular as certain other contracts under Islamic Banking.

Disclaimer: This article is an introduction to the Mudarabah contract with a simple example, and is not meant to be an exhaustive study of the same.

ISLAMIC BANKING SERVICES: SALAM

What It Is:  Among the several unique financing options available from a Islamic Bank or financial institution is the sale contract called “Salam”.   This type of a sales contract provides for the forward purchase of the commodity involved.   That is, the payment for the commodity is paid in advance, and the delivery of the same is made at a later date.

Rules of the Game:  The pre-requisites of a Salam contract  are that the contracted price of the commodity must be paid in advance, and in full.   The contract, as well as the payment,  must related to a commodity that can be quantified and priced.   It cannot and should not refer or relate to a commodity that is vaguely described or is not possible of proper definition, or pricing.   In addition, the date and  time and place of delivery must be fixed in advance.

In this contract of Salam, the Bank makes payment to the Seller of the commodity, who in turn delivers the same to the Bank on the date,  time and at the place agreed upon at the time of making the contract.   The Bank in turn, may sell this commodity to another buyer, either in full, or in instalments.   The Bank has the option to enter into another Salam contract, which is a mirror of the first one,  with the second buyer.   Or the Bank could also agree to an instalment sale where it would deliver the commodity to the second buyer in parts.   In either case, the resale by the Bank, must not coincide with the receipt of the commodity by it under the first Salam.   If the Bank receives and resells the same commodity simultaneously, then the Salam contract would be vitiated and become void.   In other words, the Bank’s contract to sell to another buyer must be a seperate contract, as distinct from its first contract to buy from the seller.  

The Bank is permitted to sell the commodity it purchased from the buyer, on any date subsequent to the date of receipt of the same from the seller, under the first Salam contract.   Further, the Bank is prohibited from selling forward, that is makinga sale contract (the second Salam) even before receiving the commodity from the seller.   That would again render the Salam contract void.

Pros and Cons:  This type of sale contract, offered as a Banking product or service, presents both opportunites as well as risks to the Bank.   One of the common risks faced by the Bank is in regard to the price paid by the Bank for the commodity.   In a market on the upswing, the Bank may stand to gain from an increase in the price of the commodity in future, that is when it actually sells the same.   And vice versa.   And as with other services offered under the auspices of Islamic Banking and Finance, the integrity and morality  of the parties to the transactions plays an important and vital role to the success or otherwise of the transaction.

For those involved in conventional banking, this type of banking service, apart from being incomprehensible, may also appear to be fraught with consequences that could well be avoided, given the high degree of reliance on personal integrity, honesty, trust, and faith of the parties concerned, without actually reducing the contract to a written document that takes care of all the issues involved, especially the interests of the Banker.   But the fact is, this type of financing has been in vogue among Islamic communities around the world for centuries and has contributed immensely to the advancement of trade, industry and commerce in those communities.

Disclaimer:  The above article is a brief introduction to Salam and is not meant to be a exhaustive discussion on the service or product.

ISLAMIC BANKING SERVICES: MURABAHA

Islamic Banking,  being quite different from conventional banking, also offers different types of services to meet the various financing requirements of the Bank clientele.

Murabaha:  One such financial product or service is called “Murabaha”.   A Murabaha is a kind of  sales contract available under the realm of Islamic financing.   A customer that wishes to purchase certain goods or commodities, etc, approaches the Islamic Bank or financing istitution with all the relevant details of the goods or commodities viz the nature, quantity, quality, size, price etc, and agrees to purchase the same from the Bank at a rate to be agreed upon between them.   This rate is usually the cost of the goods plus a profit mark up of the Bank.   The Bank then places an order for the said goods from the seller and authorises him to deliver the goods to the customer (of the Bank) as per his requirements.

In the above example, there are two distinct contracts-one between the Bank and the Seller, and the other between the Bank and the Buyer.   When the seller delivers the goods to the buyer as per the Bank’s instructions,  he receives payment as per the first contract described above.   Thereafter, the buyer makes payment to the Bank as per the second contract.   This payment may be either in one lumpsum, or in instalments.   Further the price paid by the buyer to the Bank is higher than the one paid by the Bank to the seller.   This difference is the profit mark up of the Bank.

Unique Facility: This type of financing is unique to Islamic Banking and not to be found in conventional banking.   In this type of sale contract, normally the price quoted by the Bank to the customer, the buyer of the goods, is usually higher than the one quoted by the seller to the Bank.   However, it need not always be so.   Under certain circumstances, the price quoted by the Bank to the buyer may be equal to or even less than the one paid by the Bank to the seller.   That is, it may be at cost price or even at a discount, depending on the market and other factors.

Trust & Faith Based:  A certain discipline and morality is observed in the execution of these type of contracts in order to ensure protection of the interests of all the parties to the transaction, the Bank, the seller, and the buyer.   It is based on absolute trust and faith between the parties concerned.  Non adherence to the high moral standards required to participate in a service like this, on part of any of the parties, would vitiate the contract and cause loss and inconvinience to all the parties.   Therefore, utmost care is taken to avoid all the potential areas of disputes and complaints.   For example, all the details of the goods under the sale contract are described in detail, in regard to their attributes, nature, quality, quantity, price, the date, place and time of delivery etc in order to avoid any kind of dispute amongst the parties to the contract.   Further, the method of payment, that is in lumpsum or in instalments is also specified.   If the payment is to be made in instalments, then the amount and number of instalments is specified as also the time limit for payment of the instalments.   The seller of the goods must have either actual or constructive possession of the goods at the time of making the contract.  

Conclusion:  This type of financing is widely practiced by Islamic Banks and financial institutions that helps trade and industry conduct their business smoothly and efficiently.   It is noteworthy that Islamic Banks and financial institutions, both in the formal and informal sector, have been practising this kind of financing for centuries successfully.

CAR LOANS UNDER ISLAMIC BANKING

Current Scenario:  The auto industry, especially in the United States, is in a downward spiral alright, and no one has a clue what’s in store for this industry.   The same trend is noticeable in other parts of the world,  including Japan.   With the biggest names in the auto world like General Motors, yes GM, and Toyota bleeding non-stop, it is anyone’s guess how long these venerables of the auto industry can hold out against the market elements.

Time For Bargains:  For the consumers though,  especially those on the lookout for a good deal, many bargains are to be had for the asking!   This may be the best time to strike the iron i.e. buy a Car!   And there are any number of financing options available to bring that dream car of yours into the garage!

The Islamic Option:  In this article, we shall take a look at the Islamic financing option for purchasing a car.   Financing for purchase of cars under Islamic Banking is done under the contract of  ’Murabaha’.   Simply speaking, this is a cost plus profit mark up contract.

Typically, the Islamic Bank or financial institution would have certain criteria to evaluate yor creditworthiness and eligibility for a car loan, having regard to your income either from salary, or business i.e. your occupation, and other sources;  your monthly expenditures, statutory payments etc, and finally your net income.

Now, suppose after going through the above process, the Bank gives you the good news-that you are indeed eligible for a car loan of USD 25,000.00 that you had asked for, to buy your dream machine.   The next step would be to work out the profit mark up of the Bank on the loan amount.   Suppose this works out to USD 5,000.00.   That means the total cost of this deal,  for you,  is USD 30,000.00.   Of course, the Bank would have factored its  profit mark up while calculating your eligiblity amount for the car loan.   The other variation in the above case would be that the cost of the car is USD 20,000.00 and the profit mark up USD 5,000.00 or less as the case may be.

Apart from the above, other details to be worked out include:   

Down Payment:  Some Banks would require you to make a down payment for the car-that would increase your stake in your dream car,  as well as bring down the amount/number of instalments payable by you.

Repayment: The loan amount,  plus the profit mark up,  put together,  would be divided into equal  number of instalments, agreed upon, say, 60 or 72 as the case may be, and you would be required to repay the same within the stipulated time.   Some Banks offer a moratarium on repayment, that is, they allow you to start repayments after, say, two or three months after disbursing the loan.   Some other Banks also offer to rework the instalments after a part of the loan is repaid.   Say you have repaid 12 instalments.   The Bank then works out a new EMI on the balance of the loan amount remaining after payment of the 12 instalments.   Upon full repayment of the loan, your car becomes really yours!

Add-Ons: In the increasingly competitive environment that the Banking industry is functioning, it is not unusual to get a few add-ons with  your car loan – zero balance account, free/concessional insurance for the car, free advisory services in respect of the car loan, as well as other services on offer by the Bank, etc.   Do avail of the freebies!

The Delivery!: Assuming that you have already identified your baby, that is your dream car, and the place that you wish to buy at, it is now the turn of the Bank to buy the car from the dealer on your behalf,  and have it delivered to you!

Go on and Enjoy your Drive!   Of course, there are no free lunches.   Please do your due deligence before deciding to take a loan.   And don’t forget that seal belt!   HAPPY DRIVING!

HOME LOANS UNDER ISLAMIC BANKING

The major reason for the current financial and economic crisis in America is said to be a rash of  Bank failures.   And Bad Home Loans are said to be the major reason for the Bank failures in the United States.

Quite simply, American Banks had been overfinancing home buyers.   Suppose a potential home buyer approached his Banker for a home loan, and his credit rating and financial standing would entitle him to a home loan of, say, USD100,000.00, his Banker would gleefully advance him say USD150,000.00!   Naturally this borrower would not be in a position to repay the stipulated instalments because of his lower repayment capacity.   This would eventually lead to a default on part of the borrower, rendering his loan account a non performing asset.

In the light of the Banking crisis in the United States and also in Europe, it would be worthwhile and also interesting to have a look at the home loan financing scenario under the Islamic system of Banking.

Typically, under the Islamic Banking system, home loan financing is based on the principle of Profit Mark Up on the cost of the property, by mutual consent of  the Bank and the Borrower.   This type of financing is usually done under the contract of Murabaha.

It goes like this.   Suppose you are interested in buying your dream home (who’s not!).   You approach the Islamic Bank with your requirements with regard to the financing.   The Bank in turn would assess your requirements as well as evaluate your eligibility for the financing based on your income and repayment capacity.   After taking an overall view of your financial standing and credit rating, the Bank would fix a eligible amount of home loan for you.   Let us say the Bank fixes a home loan limit of USD100,000.00 for you.

This amount would include their mark up on the cost of the property.   This mark up is fixed by mutual consent .   Suppose the mark up is say USD 10,000.00.   That means the net amount of your home loan is USD90,000.00.   The next step for you,the borrower,  is to identify your dream home in the range of USD90,000.00.   After that you give details of the property thus identified to the Bank, who in turn will negotiate with the owner of the property and make a purchase of the same specifically to sell it to you.  

The next step would be to complete the formalities in regard to documentation etc.,  after which you get the possession of the home, though you are still not the owner of the same.   The ownership will vest in you once you repay the stipulated number of intalments within the repayment period fixed.   Then your dream home becomes really yours!

The main characteristics of the above type of home loan under Islamic Banking are: a proper evaluation and assessment is made of the repaying capacity of the borrower and fixation of the appropriate loan amount.   Another notable feature, which is in fact the bedrock of Islamic Banking, is the absence of Interest on the loan amount.   Instead the Bank adds up a profit margin to the cost of the asset and divides the total amount into equal instalments payable usually  monthly.

The above example is a simple type of home loan under thIslamic Banking System.   Within this system, variations are possible to suit the specific needs of the borrower.

How To Get A Bank Loan