Chapter 8 – Application of Funds (Islamic Finance)

These flashcards cover Islamic finance principles, project financing mechanisms, asset acquisition structures, Tawarruq, BBA, Ijarah variants, working-capital financing, and related advantages and challenges.

What are the three main principles on which Islamic finance is based?

Risk-sharing, social & economic development (including charity), and ethical goals that avoid riba and gharar.

Which practice—the charging of interest or riba—is prohibited in Islamic finance?

Charging interest (riba) is prohibited; profit-sharing models are used instead.

In Islamic finance, how is risk typically allocated between lender and borrower?

Both parties share risks and rewards rather than shifting all risk to the borrower.

Why must Islamic financial transactions be linked to real assets or services?

To ensure financing is ethical, productive, and compliant with Shariah (asset-backed financing).

Name two sectors that Shariah-compliant investments must avoid.

Alcohol, gambling, pork (any two of these).

What is the definition of project financing?

Loans repaid from the project’s own cash flows, with those cash flows and the project’s assets serving as collateral.

Why is Islamic project financing considered off-balance sheet for the project operator?

Because the financing generally does not appear as a liability on the operator’s balance sheet.

List four Shariah-compliant mechanisms commonly used in project financing.

Mudharabah, Musharakah, Ijarah, and Sukuk.

In a Mudharabah project-finance arrangement, who bears potential losses?

The capital provider (rab-al-mal) bears all financial losses.

How are profits and losses shared in a Musharakah joint-venture arrangement?

They are shared according to partners’ capital contribution ratios.

What does an Ijarah structure provide instead of interest?

Rental payments for the use of an asset, possibly with ownership transfer at the end of the lease.

What distinguishes Sukuk from conventional bonds?

Sukuk represent ownership in an underlying asset/project, with returns based on asset performance, not interest.

Give one advantage of Islamic project financing relating to risk.

It mitigates risk through shared-risk models that encourage prudent management.

Name one regulatory challenge facing Islamic project financing.

Lack of standardized regulatory frameworks across jurisdictions.

Define asset acquisition in a corporate context.

Purchasing a specific asset via a formal contract, creating liability for the buyer.

What are the two broad ways assets can be acquired?

Through mergers and acquisitions or through outright purchase (cash/installment).

How can issuing debentures (e.g., sukuk) help in asset acquisition?

It raises funds from investors so the buyer can develop and own the asset.

Identify the three major categories of Islamic asset-financing structures.

Sale-based (e.g., Murabaha), rental-based (Ijarah), and partnership-based (Mudarabah/Musharakah).

What is Tawarruq in Islamic finance?

A double-sale structure where an asset is bought on deferred terms then sold for cash to obtain liquidity.

When did Bank Negara Malaysia’s Shariah Advisory Council approve Tawarruq for Islamic banks?

At its 51st meeting on 28 July 2005.

In Islamic home financing using Tawarruq, what does the customer do after buying the marked-up commodity from the bank?

Appoints the bank (as agent) to resell the commodity for cash, which is then used to pay the property seller.

Which three commodities constituted the largest share of Tawarruq trading volume as of December 2022?

Crude palm oil (CPO), metals, and plastic resin.

What is the defining feature of a Bai’ Bithaman Ajil (BBA) sale?

Deferred payment for an asset at cost plus profit margin payable over time.

Why has BBA faced criticism regarding Shariah compliance?

Because it relies on the Bai’ al-Inah (buy-back) concept, which some scholars view as mimicking interest.

During a BBA transaction, what proportion of the house price does a customer typically finance through the bank in the example given?

80 % of the selling price (after a 20 % down payment).

What does the Arabic root ‘ajara’ mean in the context of Ijarah?

To recompense, compensate, or give consideration/return.

Name two common applications of Ijarah financing.

Property financing and vehicle financing (also acceptable: project financing, personal financing).

What are the two main forms of Ijarah contracts used in Islamic finance?

Ijarah Thumma al-Bai’ (AITAB) and Ijarah Muntahia bi al-Tamlik (IMBT).

When was AITAB officially approved by Malaysia’s SAC for financing products?

29 October 1998.

In an AITAB process, when does the customer become owner of the asset?

After completing all rental payments, the bank sells the asset to the customer.

What option does a customer have at the end of an IMBT lease period?

To purchase the leased asset under a separate sale contract.

Define working capital in financial management.

The difference between current assets and current liabilities used to meet operational needs.

Why are Islamic working-capital products considered flexible during crises?

Because they feature lower financial-risk structures and higher capitalization, as shown in the 2007 crisis.

How does Tawarruq-based working-capital financing differ from asset-acquisition Tawarruq?

It frees the customer to use sale proceeds for general business needs rather than for a specific asset purchase.

List the main ethical benefits of Islamic financing mechanisms highlighted in the conclusion.

Shariah compliance, risk-sharing, resource allocation to socially beneficial projects, and support for sustainable economic growth.