Temenos Transact
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Introduction to Islamic Financing

Islamic banking refers to a system of banking or banking activity that is consistent with the principles of the Shari'ah (Islamic rulings) and its practical application through the development of Islamic economics. It started during the late 20th century when a number of Islamic banks were formed to provide an alternative banking system. Islamic banking has the same purpose as conventional banking except that it operates in accordance with the rules of Shari’ah.

Shari'ah prohibits payment or acceptance of interest charges (riba) for lending and accepting money, as well as carrying out trade and other activities that provide goods or services considered contrary to its principles. To ensure adherence to these underlying Islamic principles, most Islamic banks have a Shari'ah board comprising Islamic scholars that scrutinises proposed transactions and maintains an overall review of the bank’s Islamic financing methods and operations

The following are the basic concepts of Islamic banking:

  • Interest – Cannot be charged for the mere use of money. Islamic financial institutions must trade in real assets or services.
  • Uncertainty – Does not allow any contract based occurrence or non-occurrence of a future uncertain event.
  • Speculation or gambling – Does not allow trading or investment transactions, which involve the risk of incurring losses as well as earning profits.
  • Prohibited activities or commodities – Does not finance enterprises involved in,
    • Financial services (Interest-based)
    • Gambling
    • Alcoholic liquor
  • Mobilisation of funds – Does not mobilise funds by paying interest to their depositors.

Islamic banking follows the below workflow for buying an asset and selling it to the client:

The above workflow stage is user-defined. These stages can be specified based on client requirement.

A brief description of each Islamic workflow is given below:

Work-flow Stages Description

Asset Request
  • Asset request is used for maintaining asset inventory to be sold based on requirement.
  • This request is made, when there is a requirement from the customer or client.
  • Asset can be classified into:
    • Named ( for example, vehicle, machinery, equipment)
    • Quantified (for example, agricultural produce, minerals)
  • During this stage the below details are captured:
    • Client
    • Supplier
    • Vendor/Resale Customer ID, Resale Customer Name, Resale Settle Account
    • Asset cost and number of units
    • Currency
    • Other static information specific to the asset

Asset Approval
  • During this stage, the agreement of promise to purchase is entered into between the client and the bank.
  • Specifies customer contribution in the project as down payment.
  • Specifies any additional cost incurred on the asset to be purchased.
  • This cost can paid either by the client or bank.
  • Adds the cost to the finance amount and repayment scheduled.

Asset Purchase
  • During this stage, the asset is purchased by the bank and accounted in their books of accounts.
  • Down payment contribution and additional costs can be modified.
  • It is possible to link multiple assets under the same purchase.

Payment Management
  • Vendor payments, payment to cost counterparty, reviewer payments, broker payments (for treasury transactions) are made. 
  • Payments are consolidated vendor wise and can be made ad-hoc or scheduled.
  • A certain percentage of the payment can be retained by the bank and paid subsequently as retention amount payment.

Sale or Finance
  • The purchased asset is sold to the client for which the payment is made as deferred installments.
  • In a lease (Ijara) contract where the client is a lessee, lease rentals are paid to the bank.
  • The modes of financing in Islamic banking are defined as different products, such as Murabaha, Musharaka, Ijara, Istisna, Salam, Mudaraba, and Wakala.

Islamic finance functionality comprises of,

Asset purchase related activities is designed based on Sharia based workflow. The workflow supports asset-based banking practices in Islamic banking. It comprises of requesting for the asset from suppliers, purchase of asset, client contribution management, and vendor payments.

The main functionalities are:

  • Asset capture
  • Islamic contract
  • Commodity delivery and sale
  • Asset review
  • Down payment
  • Payment management

Islamic Finance supports sale of asset through financing or outright sale. This functionality offers various Islamic finance products for sale of assets, amendment to sale conditions, and handling over dues, repurchase and repossession of asset and resale functionalities.

The finance products are grouped as shown below:

Finance Products Groups

Profit Upfront Sale

 
  • Murabaha finance
  • Ijara finance (service Ijara – Murabaha based)
  • Commodity Murabaha finance

Profit Accrual Sale

 
  • Forward Ijara finance
  • Qard Hassan finance (profit free finance)
  • Diminishing Musharaka finance
  • Bai Salam finance
  • Construction finance
  • Mudaraba financing

Multi-structured Products
  • Musawama finance
  • Wakala finance

Islamic Finance (IS) is part of Temenos’ Islamic Banking suite of products. This product functionality uses Arrangement Architecture Lending (AL) to book finance arrangements.

Islamic Banking is asset based banking where the asset is bought by the bank using asset management activities and sold to the client on deferred payment basis using finance management activities.

Configuring Islamic Banking

This section orients the user on asset purchase and finance management related activities. Asset management comprises of,

  • Asset creation
  • Asset purchase
  • Asset tracking or delivery
  • Asset review and payment activities
  • Finance management activities

The following applications provide functionalities to create and manage the assets:

Application Name Description

Asset Capture

 Used to create,
  • Asset or inventory.
  • Own application tables to capture asset specifications.
For example,
  • IS.VEHICLE
  • IS.REALESTATE
  • IS.EQUIPMENT
  • IS.MOVEQUIPMENT
  • IS.MISCASSET
IS.CONTRACT Used to,
  • Purchase assets.
  • Control credit workflow for Islamic assets.
  • Define flexible workflow status based on requirements
  • Raise flexible accounting entries based on defined workflow status.
IS.CONTRACT.DELIVERY Used to track the delivery of commodities or assets.
IS.COMMODITY.SALE Used to sell the delivered commodities to clients either partially or fully.
IS.ASSET.REVIEW Used to manage the review activities for assets
IS.PAYMENT Used to manage Islamic banking payment activities.

Islamic Finance is used to sell the asset to the client on deferred payment basis. The AA.PRODUCT.LINE application provides a high-level definition of the business components (Property Classes), required to construct a product belonging to that line. A product line is described by the property classes, which constitute it. A financial institution can use these Property Classes as building blocks  to construct individual products, which is available for sale to its customers.

Islamic finance comprises of the following Property Classes:

  • ACCOUNT
  • ACCOUNTING
  • ACTIVITY.API
  • ACTIVITY.CHARGES
  • ACTIVITY.MAPPING
  • ACTIVITY.MESSAGING
  • ACTIVITY.PRESENTATION
  • ACTIVITY.RESTRICTION
  • ALERTS
  • AGENT COMMISSION
  • BALANCE.MAINTENANCE
  • CHANGE.PRODUCT
  • CHARGE
  • CHARGE.OVERRIDE
  • CHARGEOFF
  • CLOSURE
  • CONSTRAINT
  • CUSTOMER
  • ELIGIBILITY
  • INTEREST 
  • LIMIT
  • OFFICERS
  • OVERDUE
  • PAYMENT.RULES
  • PAYMENT.SCHEDULE
  • PAYOFF
  • PAYOUT.RULES
  • PERIODIC.CHARGES
  • PRICING.RULES
  • REPORTING
  • SETTLEMENT
  • TERM.AMOUNT
  • STATEMENT
  • TAX
  • XIS.POOLID
  • XIS.FACILITY
  • XIS.DRAWING
  • XIS.FINANCE

The AA.PROPERTY is an instance of AA.PROPERTY.CLASS and these components constitute a finance product. The Property Classes and properties are made mandatory or optional based at the AA.PRODUCT.GROUP level but subject to the product line definition. AA.PRODUCT.DESIGNER is used to create the required finance products.

Illustrating Model Parameters

Parameter files and system tables need to be setup to support the Islamic banking operations. This section provides a brief overview of the system and parameter setup for holding the static data for Islamic asset management operations. Refer to, Retail Lending (AL) user guide for information on parameter setup for finance management operations.

The below parameter table are setup to support Islamic Banking operations:

Application Name Features
IS.PARAMETER This table defines,
  • Islamic product features.
  • AA products that can be used for finance.
  • Workflow status and also the status, which enables the sale process.
  • Restrictions on contract creation for specific companies.
  • Category codes and transaction types used at the time of credit workflow accounting.
  • Stage at which customer contribution or down payment can be declared.
  • Delivery tracking for specific type of assets
  • Broker or reviewer category codes and transaction types.
  • Allowed Product code range is from 1 to 9999
IS.STATUS

This table defines,

  • Applicable accounting entries for each of the defined workflow statuses are parameterised in the IS.PARAMETER table.
  • The following accounting events related workflow statuses are defined in Status field of IS.PARAMETER table.
    • Approval
    • Rev Approval
    • Purchase
    • Cost
    • Down Payment
    • Return com to Broker
    • Sell com to Sell Broker
    • Broker Settlement
    • Resale
  • Applicable accounting entries for workflow status that can be used manually as and when required using IS.CONTRACT application. The following accounting events related workflow statuses are used in the IS.CONTRACT application.
    • Sell Com To Sell Broker, Broker Settlement
    • Return Com To Broker, Broker Settlement
Broker Settlement accounting event entries are always generated along with either Return To Com To Broker or Sell Com To Sell Broker accounting events.
IS.COMMODITY This table defines,
  • Details of asset or commodity.
  • Support named assets and quantified assets.
  • Commodity active or inactive.
  • Buy broker and sell broker for commodities.
  • Allowed units and decimal quantity.
  • Definition of unit price for commodity for each buy and sell broker combination.
  • Daily allowed amount at commodity level
  • Daily allowed quantity and amount for commodity-broker combination
IS.CONTRACT.TASK This table defines,
  • User-specific tasks and actions.
  • Task or actions during asset purchase as checklist and tracks the same.
  • Tasks that can be either generic or verification type.
  • The ID of the table, which can be any text in alphanumeric format.
IS.COST.TYPE This table defines,
  • Costs incurred during purchase of asset or commodity.
  • Status active or inactive.
  • This parameter also specifies the charge code to default the charge amount for the cost in purchase contract.
IS.BROKER This table defines,
  • Broker related details specific to Islamic Treasury operations.
  • Status active or inactive.
  • Company to which broker belongs to.
  • Broker account and beneficiary details per currency for a particular company.
  • Broker type (Buy, Sell or Both).
  • Broker fee collection related setup and broker share of fee payment frequency.
IS.VENDOR This table defines,
  • Vendor details.
  • Status as 'Active' or 'Inactive'
  • Company wise configuration of vendor account
    • Vendor account and beneficiary details for each currency
  • Commodity wise rebate configuration
    • General rebate details and rebate currency, rebate type (amount or percentage)
    • Special rebate details applicable for specific period with rebate currency, rebate type (amount or percentage)
IS.REVIEWER

This table defines,

  • Reviewer related details with the name of the reviewer. Reviewer can be anyone involved in the project and does the service for a fee.
    • Appraiser
    • Project cost evaluator
    • Project Auditor
    • Advisor
    • Legal Consultant
  • Reviewer status whether 'Active' or 'Inactive'
  • Company wise configuration of reviewer account
    • Reviewer account and beneficiary details for each currency

Illustrating Model Products

Islamic finance provides the asset management and finance management functionalities for Temenos Transact.

The module allows the user to create below mentioned products:

Product Group Product Name Product Attributes
 NA Asset Capture
  • Named assets creation.
  • New asset tables are created when required by user.
  • New field names are added when required by user.
 NA Islamic Contract
  • Vendor purchase contract for named assets and quantified assets.
  • Broker purchase contract for quantified assets.
  • Automatic purchase contract workflow status update.
  • Accounting entries generation based on workflow status.
  • Down payment functionality.
  • Capture cost-related information.
 NA Commodity Delivery and Sale
  • Track delivery of commodities.
  • Sell the delivered commodity to different customers.
  • Record profit or loss amount.
 NA Asset Review
  • Capture review details and collect fee for review.
  • Split fee into customer fee and bank fee.
  • Update project status and next review date.
 NA Payment Management
  • Use multiple payment applications.
  • Support different payment types.
Finance - Profit Up-front Sale 

Commodity Murabaha
  • It is a Murabaha based short term placement operation that involves the purchase and sale of commodities in the international exchange.
  • Used for liquidity management purposes.
Ijara Finance
  • One party purchases and leases out the equipment required by the client for a rental fee.
  • The duration of the rental and fee are agreed in advance and ownership of the asset remains with the lessor.
  • At the time of contract maturity ownership.
  • Alternatively, the lessee can agree at the outset to buy the asset at the end of the lease period.
  • Profit collected at the beginning of the contract.
  • Fixed profit method and profit amount is constant.
Murabaha Finance
  • Profit is collected at beginning of the contract.
  • Fixed profit method and profit amount is constant.
  • Commodity is sold for cost plus profit, and both the buyer and seller knows the cost and the profit involved.
 Finance - Multi Structured Products 
  • Musawama Finance
  • Wakala Finance
  • Two types of finances are booked as a part of this product.
  • Purchase cost is disbursed through Wakala contract with zero profit till shipment is in possession of seller.
  • Later, Musawama contract is booked from Wakala start date with agreed profit amount.
  • Profit is collected at the beginning of the contract.
  • Fixed profit method and profit amount is constant.
 Finance - Profit Accrual Sale   Bai Salam
  • An Islamic contract in which full payment is made in advance for specific goods (often agricultural products) to be delivered at a future date.
  • Conventional profit bearing product.
Construction Finance
  • Islamic finance in which a manufacturer agrees to complete a construction project on a future date for a fixed, agreed-upon price and with product specifications that both parties agree to.
Diminishing Musharaka Finance
  • A partnership in which one of the partners promises to buy the equity share of the other partner gradually until the equity is completely transferred to him.
Forward Ijara Finance
  • Lease contract with sale of a clearly specified underlying asset, which is currently being produced or constructed, for a future delivery.
  • With forward ijara, a financier undertakes payment during the construction period, while customer's payments will start within a specific period after completion
Mudaraba Finance
  • A partnership in profit whereby the bank provides capital as (Rab Al-maal) and the customer provides labour or work  or experience as Mudarib
Qard Hassan Finance
  • A contract involving a finance with two parties on the basis of social welfare.
  • During the finance process, the repayment amount must be the same as the amount borrowed.
  • Profit rate to be defined as zero percentage.

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Published on :
Tuesday, May 28, 2024 4:15:55 PM IST