INCEIF

Global University in Islamic Finance

Kuala Lumpur, Malaysia




SHORT ESSAY
IB 2001 STRUCTURING ISLAMIC FINANCIAL REQUIREMENTS


By

Fashola Olayinka Nurudeen.
1100275


This project paper is a partial fulfilment of module IB 2001 of Part 2 of
Certified Islamic Finance Professional (CIFP)
INCEIF
March, 2014



1.0 Financial Due-diligence.
The first step to be taken is a financial due diligence. This refers to the process of
reviewing all of the available information related to that business. The goal of due
diligence is to make sure that all legal and financial issues pertaining to the business are
in order and that there are no unpleasant surprises should the bank decide to provide
financial assistance to the company.
In conducting the financial due diligence, the following steps must be taken:
1. Assessment of Current Facilities with the Conventional Bank.
The first step is to identify the various kinds of facilities the customer is enjoying with the
existing conventional banker. This will enable us know how well if the company is
servicing the various facilities and identify whether there is default or not. In addition, we
will be able to know if they really need all the facilities at the same time or needs other
alternatives.

2. Financial Position of the company.
The second step is to study the financial position of the company and see whether they
can service the various facilities. Factors to be considered here is the profitability record
of the company, level of previous performances as well as risks associated with the
company. Cash flow is also another important factor we should consider. Cash flow will
enable us to know whether there is history of steady growth in earnings or sales. Is there
any high probability that such growth will be sustained over the period of the financing?
The following should also be considered when evaluating the financial position of the
company:
Is the business collecting its accounts receivable in a timely manner?
How much bad debt does the business write off each year?
Is the business paying its debts in a timely manner?
What is the businesss profit margin?
Does the company have any outstanding liens?


3. Legal issues.
Legal issues are also very vital in due diligence, the bank would be required to ask for
copies of the businesss professional and consulting agreements; insurance policies;
licenses and permits; any documents related to intellectual property, such as patents or
trademarks; and any documents related to lawsuits the company is involved in. The banks
and her attorney should review them with the following in mind:
Are the agreements enforceable?
Does the company have the rights to its intellectual property?
Is the business adequately insured?
Are the companys licenses and permits current?
Is the company involved in any litigation, and if so, what are the potential
risks, costs, and damages?

4. Economic and Environment condition.
Next is to look at the economic environment/countries in which the company operates.
There should also be look into the sectors of operations. Is the sector profitable? Is there
any threat to their business such as physical, regulatory or international? Is the current
crisis facing European countries going to have any negative impact on the company or
its business?

5. Quality of management and employee character.
Another very important factor is to look at the characters and competence of the
companys management team. How honest and efficient they are? What about their
previous records either in the same company or other places they have worked? Thus,
managerial capacity to innovate and manage the fund financed by the bank is a key to
the success of the various facilities on offer. The bank should request for the
organizational charts, employee handbooks, employment agreements, wage and salary
information, benefits plans, noncompeting agreements, and confidentiality agreements.
These are to be reviewed keeping in mind:

Do any employee policies put the business at risk of lawsuits?
Are there any ongoing grievances with employees?
Are employees attempting to unionize, or is a third party trying to unionize them?

6. Business operations.
The bank will be requesting for a list of customers, lists of suppliers and vendors,
and an operations manual. These documents will be reviewed while considering
the following:

Does the business have adequate inventory systems in place?
Is the companys supply chain diversified so that the business isnt overly
reliant on one supplier?
Is the companys customer base diversified and growing?
Does the company have necessary equipment and infrastructure in place
for continued growth?

7. Security and collateral.
We must be sure and satisfy that the company possesses adequate net worth or
own enough quality assets to provide adequate support for the financing facilities
they are requesting for. We will also be sensitive to the futures of the security such
as age, condition, degree of specialization, technical obsolescence, marketability,
transferability and forced sale value of the assets. There should also need to
consider having various kinds of guarantees for the different kinds of financing that
will be offered to the company






2.0 Products to replace the clients conventional banking loan.
Given the current clients conventional banking loans which includes:
Term loan
Overdraft
Revolving credit
Bank guarantee
Trade Financing that include LC/TR/BA/SG
There are better Islamic financial products that can be used to replace the conventional
facility with better margin and over customer satisfactions for the client. This will also
ensure that the client is compliant to the financial rules and regulations of the new frontiers
where she intend to operate.

2.1 Capital Expenditure.
For capital expenditure the company is looking at funds to finance capital assets such as plants
and machinery that will be used in the new factory. To finance this type of assets the most
appropriate Islamic financial facility that will be offered to the client is an Ijarah facility.
2.1.1 Ijarah Facility.
An Ijarah (usufruct) type of contract whereby a lessor (owner) leases out an asset or
equipment to a client at an agreed rental fee and pre-determined lease period upon the
`aqd (contract). The ownership of the leased equipment remains in the hands of a lessor.
The following are the conditions for a valid Ijarah contract:
1. The subject matter must be in existence.
2. The contracting parties (Seller and Buyer).
3. Offer and Acceptance.
4. Disclosures of the cost price as well as the profit mark up.
Detailed below is the illustration of the flow of this type of facility:

Bank Wataniah Islami (BWI) PFM
Asset Vendor
2
1
3
Buy Asset
Lease
A promise from client to take asset
on lease


1. The client PFM identifies the asset and notifies the bank of the interest to lease
an asset, at this time the details of the asset is specified.
2. The bank BWI purchase the asset from the asset vendor and take full possession
of the asset.
3. Upon taking possession of the asset the bank BWI lease the asset to the client
PFM on agreed monthly repayment plan and tenor. Once the tenor elapse the
asset is transferred to the client.

2.1.2 The Ijarah Offer.
In order to provide a facility for the purchase of assets on fixed rate our bank- BWI will provide
an ijarah financing facility based on the following, to replace the current term loan from a
conventional bank, this offer is very compelling and attractive. It will ensure that the client is able
to operate effectively and compliant to the financial laws of Middle Eastern and Central Asia
countries where the client is expected to open new factories.



The offer An Ijarah facility
Purpose Purchase of various fixed assets including equipment
Cost USD 20 Million
Profit Margin 5.5% per annum
Tenure 5 years
Security Personal Guarantee of the Management/Takaful Guarantee/ Lien
on the Asset as the bank is still the owner of the asset until the
contract expires.
Source of Repayments Proceeds for Sale of manufactured canned foods.

In addition to the above the contract will also involve the following condition which will be detailed
in the offer letter:
1. Fees and Expenses
2. Payment of Contract Price
3. Representations and warranties
4. Undertaking
5. Conditions precedent
6. Events of default
7. Penalty
8. Indemnity
9. Set off
10. Assignment

2.1.3 Other offers.
For financing working capital other Islamic finance options that are available are
Murabaha, since the items the client wish to purchase in this stead are machineries and
are fixed asset, the bank is opting for the Ijarah facility as the most preferred because the
bank can still have the ownership rights over the asset until the lease period is over, this
will further ensures that the client make frantic effort to make the full payments as agreed
in the agreement so that the asset can be passed over to the client after completing the
payment.

2.2 Working Capital.
Working capital can be defined as current assets of the business, less current liabilities, where
the balance provides the figure available to the business to develop, build and expand its
operations. Working capital financing may be required for a number of purposes which include
raw material purchases, buying inventories, purchase of equipment and machineries, staff cost
etc. Based on shariah rules governing Islamic finance all fund should be tied to an asset thus
trading in cash is not permissible hence all working capital funds should also be tied to one form
of an asset or the other. Working capital financing can be structured using various forms of
contracts such as murabaha.

2.2.1 Murabaha Facility.
Murabaha is debt based financing instrument used by Islamic banks. It is used to finance
the purchase of assets by clients. It is a Shariah contract where one party sells an asset
to another party at cost plus profit margin (mark up). Payments are made on spot or on
deferred basis, and can be paid in lump sum or by instalment.
The following are the conditions for a valid murabaha contract:
1. The subject matter must be in existence.
2. The contracting parties (Seller and Buyer).
3. Offer and Acceptance.
4. Disclosures of the cost price as well as the profit mark up.
Detailed below is the illustration of the flow of this type of facility:

Bank Wataniah Islami (BWI)
Vendor (third party) PFM
2
4
1
3


1. The client PFM identifies the asset and notifies the vendor of the interest to
purchase the asset or raw materials
2. The client PFM notifies the bank BWI of the interest to purchase the
identified asset and the cost involved.
3. The bank BWI will purchase the asset from the vendor and take possession
of the asset.
4. Bank sells the asset to the customer on murabaha contract (cost + mark up)
and transfer ownership, subsequently the agreed fee will be paid annually.

2.2.2 The Murabaha Offer.
In order to provide a facility for the purchase of assets and raw materials required for working
capital on fixed rate our bank- BWI will provide a murabaha financing facility based on the
following: this facility will be replacing the over draft and revolving credit being enjoyed by the
client from a conventional bank.
This offer is very competitive and will ensure the client meet all the regulatory requirements in
the new frontier where it want to operate.
The offer Murabaha facility
Purpose Purchase of various fixed assets including equipment and
raw materials
Cost USD 30 Million
Mark-up rate 5.5% per annum
Tenure 5 years
Security Personal Guarantee of the Management/Takaful
Guarantee/ Lien on the Asset
Source of Repayments Proceeds for Sale of manufactured canned foods.

In addition to the above the contract will also involve the following condition which will be detailed
in the offer letter:
1. Fees and Expenses
2. Payment of Contract Price
3. Representations and warranties
4. Undertaking
5. Conditions precedent
6. Events of default
7. Penalty
8. Indemnity
9. Set off
10. Assignment

2.2.3 Other Offers.
The other offer that can be used in place of Murabaha for financing working capital is
Istisna, however Murabaha is preferred because the material the client is requesting for
in this case are consumables and Istisna is only applicable for manufactured goods and
not consumable.

2.3 Bank Guarantee
In the course of undertaking its project, the company (PFM) will require bank guarantee for
various reasons including shipping, payment, performance and tender guaranty. A bank
guarantee is an undertaking by a bank to cover different situations to support exporters or
contractors. It is an irrevocable obligation, non-cancellable usually in the form of a written
undertaking by the bank to pay an agreed sum in case of default on the part of the party, on
whose behalf it is issued.
An Islamic bank can issue letter of guarantee of various types using the contract of kafalah
.
2.3.1 Kafalah
It is defined is defined as the conjoining of the guarantors liability to that of the guaranteed in a
way that the debt or other responsibility of the original bearer is established as a joint liability of
the two of them.
The following are the conditions for a valid kafalah contract:
1. The guaranty must be of enforceable rights of the creditor.
2. The debt to be guaranteed must be valid and binding on the debtor.
3. The liability must be specific and known to both parties.


Detailed below is the illustration of the flow of this type of facility:

Bank A:
Bank Wataniah Islami (BWI)
Client: PFM
Bank B
2
1
3
EXPORTER/Contractor asking for
For Guaranty
4


1. Customer request for Bank guaranty in favour of exporter and makes deposit to Islamic
bank of the equivalent amount.
2. Islamic bank issues a bank guarantee in favour of the exporter or contractor to the
corresponding bank and charges fee/commission to its customer.
3. Bank B confirms guarantee to the exporter.
4. Exporter releases shipping documents to the importer.

2.3.2 The Kafalah offer.
The offer below will replace the current bank guarantee being enjoyed by the client PFM from a
conventional bank, this will also make the company PFM compliant and competitive in the new
market.
The offer Kafalah Bank Guarantee.
Purpose For bank guarantee to ensure the company meets her obligations.
Cost USD 10 Million
Commission 0.1% monthly
Tenure 5 years
Security Combination of deposit and fixed asset.

2.4 Trading Finance.
The term "Trade Finance" means, finance for Trade. For a trade transaction there should be a
Seller to sell the goods or services and a Buyer who will buy the goods or use the services.
While a seller (the exporter) can require the purchaser (an importer) to prepay for goods shipped,
the purchaser (importer) may wish to reduce risk by requiring the seller to document the goods
that have been shipped. Banks may assist by providing various forms of support. The exporter
will however require a bank in between the transaction. An Islamic bank can provide this kind of
service using the contract of wakala (Agency) and charges a fee for that.
To support PFM in their quest to open new factory outside their current area of operation, they
would require LC facility, this will be achieved with the wakala contract.

2.4.1 Wakala Contract
Wakala refers to a contract whereby a person is authorized to discharge a certain and well-
defined legal action.
The follow are the conditions for a valid wakala contract:
1. Muwakkil: (Principal)
2. Wakil: (Agent)
3. The subject matter:
4. Contract language (offer and acceptance).

2.3.2 The Wakala offer.
The offer below will replace the current Trade Financing offer that include LC/TR/BA/SG being
enjoyed by the client - PFM from a conventional bank, this will also make the company PFM
compliant and competitive in the new market.



The offer Wakala
Purpose For the client import obligations of machineries and building
Materials.
Cost USD 30 Million
Commission 0.2% monthly
Tenure 3 years
Security Deposit/Pledge/Guaranty



3.0 References.
Abdurahman Z A; (2010). Shariah rules in financial transactions. CIFP lecture notes Module
SH 2002
Obaidullah M; (2005). Islamic Financial Services. Islamic Economic Research Centre, King
Abdulaziz University Jeddah Saudi Arabia.
Zaharuddin Abdul Rahman (2010), Contract and the product of Islamic banking. CERT
Publication, Malaysia.