Proposed Financing Products:

Istisna & Salam

Presentation to
IBBs & Support Function
HabibMetro Islamic Banking
April 24, 2014

The Contents:
Two Proposed Products: Istisna & Salam

1. What?
2. Why?
3. How?
4. Are the products risks manageable?
5. The Concluding Remarks

1.
What?
Istisna & Salam Financing Facilities

Definitions:
Istisna:
Advance payment deferred delivery
price fully paid on spot or in tranches as per mutual
agreement
Salam:
full payment in advance deferred delivery

Definitions:
Istisna: A sale transaction where the seller undertakes to
provide the desired /required specific goods to the
buyer at a future date against either an advance price
fully paid on spot or in tranches as per mutual
agreement between the parties but supply (i.e. the
subject matter of Istisna) is deferred.

Salam: An agreement to purchase, at a predetermined

price, which is to be delivered on a specified future date
in a specified quantity and quality. The Islamic Bank as
the buyer makes full payment of the purchase price in
advance upon execution of a Salam contract.

Purpose /Scope of Proposed Facilities

Short term financing facilities (180days FC max)
Financing WK
To facilitate customers who require:
Cash Finance (CF)
Finance against firm orders
Export Pre shipment
Export Post Shipment: (the documents may only
be used as security to get financing thereon)

Differentiating nature of the Facilities:

Manufacturing commodities through Istisna
Trading / Agriculture commodities through Salam

Rs. 1 M
(EXPORT PROCEEDS)

BANK

Commodity for
Rs. 850,000 M

CUSTOMER

Export Proceeds Rs. 1.0 M

Agent

Spot

2.
Why?
Market Practice:
An analytical look at Industry
Exposure
Istisna & Salam Financing Facilities

Market Practice: Industry Exposure of Istisna & Salam (June13)

Total NPLs = Rs. 19.4Bn. Almost every IBI has ZERO of these two products except ONE IBI

3.
How?
a.
Stepwise description of Complete
Transaction Cycle (Financial Cycle)
identifying risks at each step

ISTISNA & SALAM PROCESS FLOW

Istisna: Step #01: (MOU)

1. Client and Bank sign an agreement to enter into
Master Istisna / Salam Financing Agreement (MFA)

Bank

Master Financing
Agreement

Risk neither of Bank nor Customer

Client

Istisna: Step # 02:

Relationship: Bank (Buyer) & Client (Seller). Upon delivery of
goods, the client would sell in the capacity of Agent)

Client appointed as AGENT to sell the goods on Banks

behalf to its known and declared buyers once purchased
by the Bank (by the same client).
Bank

Master Financing
Agreement
Agency
Agreement

Risk neither of Bank nor Customer

Client

Istisna: Step#03:Relationship: Bank (Buyer) & Client (Seller)

The customer requests for disbursement (IA Appendix

A) of Istisna Facility within approved Credit Line against
future delivery of goods, say 100 denim paints
Bank accepts the offer(IA Appendix B)
Bank

Master Financing
Agreement

Client

Agency
Agreement

Risk of Bank only (CR)

Advance payment /disbursement to the

Customer (seller) against future delivery

(Disbursement through Advance Against Istisna (like in Murabaha,

Supplier
however, this advance period may be of 30 to 60 days

Istisna: Steps #04

Relationship: Bank (Buyer) & Client (Seller)
The customer delivers the specified goods on maturity date (IA
Appendix C)
The Bank after taking the possession of goods (IAA Appendix A)
The Bank handover to the Agent to sell on banks behalf as per
Agency Agreement already in place (IAA Appendix B).
Delivery of goods

Bank

Customer

Advises the Agent to sell to its

buyers as per agreement & bring
proceeds in time

Agent

Goods Ownership (holding) & Selling Risks: MR + OR

The risk related to commodity is of Bank. Goods holding risk which is
minimal covered through Takaful /Insurance and repayment risk is
mitigated through Corporate Guarantee besides other securities.

Istisna: Steps #05

Relationship: Bank (Principal) & Client (Agent)
The Agent (client) sells the goods to its ultimate (already declared)
buyers and brings proceeds in time as per Agreement (IAA
Appendix C.
Selling to buyers

Ultimate Buyers

Agent

Istisna Facility adjusted

against Proceeds

Bank

Foreign/Local

Goods Sold: CR
Corporate Guarantee is in place to make the client (Agent)
responsible to bring the sale proceeds in time

(Istisna Financing Facility adjusted within Financing Cycle

3.
How? .
b. Accounting Treatment

Accounting Entries: Assumptions

Client:
M/s. ABC Textile Mills
Export Bill:
USD 10,000
Exchange Rate:
100
Discounting Factor:
15%p.a. (at minimum)
Contract Date:
1st January 2013
Maturity Date (export Bill: 30th April 2013
Entitlement: [(10,000X100)-10,000X100X15%)] = 850,000
Goods to be manufactured:
Denim Pants
Quantity:
100
Contract Price (agreed b/w parties: USD 100/Unit (i.e. Rs.10,000)
Purchase Price (Bank to Pay):
Rs. 8,500/pant (850,000/-total)
Calculation of Minimum Selling Price (MSS): Rs. 8,779/Unit
Banks Profit:
Rs. 27,945 (i.e. profit amount)
Agency Fee:
Rs. 1,000/-

At the time of execution of contract: (Jan 01, 2014)

Agency Expense
Rs. 1,000/-Dr.
Demand Deposit IBB
Rs.1,000/-Cr.

1. Payment of Purchase Price (Jan 01, 2013)

Advance against Istisna Financing Facility Rs. 850,000/-Dr
Demand Deposit IBB
Rs. 850,000/-Cr
2.Delivery of Goods:(April 10, 2013)
Istisna Goods
Rs. 850,000/-Dr
Advance against Istisna Financing Facility Rs. 850,000/-Cr
3. Selling of Goods on cash basis (April 30, 2013)
Istisna Financing
Rs. 1,000,000/-Dr
Istisna Goods
Rs. 850,000/-Cr
Deferred Istisna Income
Rs. 150,000/-Cr

4. Maturity of Contract/payment of facility: (April 30, 2013)

Demand Deposit IBB
Istisna Financing
Deferred Istisna Income
Income on Istisna

Rs. 1,000,000/-Dr
Rs. 1,000,000/-Cr
Rs. 28,945/-Dr
Rs. 28,945/-Cr

5. Payment of INCENTIVE: (April 30, 2013)

Deferred Istisna Income
Rs. 121,055/-Dr
Demand Deposit IBB
Rs. 121,055/-Cr

ISTISNA SUMMARIZED ACCOUNTING TREATMENT

Bank

Rs. 0.850M

Records
asset at
full
amount of
Purchase
Price as
Advance

Rs. 1.0M

Istisna Financing is
recorded at Rs. 1.0M
including deferred
Istisna Income of Rs.
0.150M (i.e. Pft. 0.029M+
Ag.Fee)+(Incentive 0.121M)

Mkt. Value is Rs.1M

Asset

PP is Rs.0.850M

Rs. 0.850M

Defrd. Pft.
Rs.0.150M

Diff. is the profit + incentive Fee + Agency Fee

Profit can only be accrued

once goods sold

4.
Are the products risks
manageable?
Products Risks & Mitigates
Istisna & Salam Financing Facilities

The Key Risks with mitigation

S. No

Key Risk

Mitigates

PERFORMANCE

RISK

Inherent risk f the product

Business Proposal should give clear
details
If unable to perform, Bank would
terminate the contract /disbursement
in installments

QUALITY OF
COMMODITY
RISK

Agent responsible while taking delivery

To rectify/repair/replace the goods
Bank has option to reject the goods

PRICE RISK

Ultimate buyers
Parallel Istisna /Salam may be another
way out.

The Key Risks with mitigation

Key Risk

S. No

Mitigates

5
6

INCREASED

COST

OF

MANUFACTURING

NON PERFORMANCE OF

AGENT
DEFAULT RISK

Increased cost will be borne by the

customer
In case of force majeure events in
which case Istisna price may be
increased with mutual consent
Bank must check the track record of
list of potential buyers
Goods in case of Credit MUST be
sold against LCs to minimize the risk
If the Agent found negligent, the loss
would be recovered from the Agent

The risks at various stages of the transaction

Product
Stages

Adv. Pmt
against
Contract to
deliver
Client commits to
manufacture
commodity /
provide
commodity after
certain time
period-CR

Mitigates

Goods
Delivered (to
Bank)
-IBB receives
goodMR
-Inferior Quality
goods OR

Sale of Goods via

Agent (Client)
-No additional charges
levied once goods sold /
in case of default-CR
-Commodity pricing /
repricing risk-MR
-Commodity holding-MR

Exposure should
- Ultimate orders - To cover through
be well secured by
in place
Incentive mechanism
obtaining
- Agent is made - Bank purchases at
guarantees,
responsible for
much lower price
mortgage,
quality risk
- Agent is made
hypothecations,
responsible for quality
pledge, etc
& holding risks

5.
The Concluding Remarks

The Concluding Remarks

The exposure must be on very selected basis.

Financed the tested customer having ultimate

buyers with good track history.
Advance against Istisna financing period to be
kept at minimum (i.e. 30 days).
Ultimate buyer wise limit of the sub division.

Thanks

Financing Product:
Al - Bai

Presentation to
IBBs & Support Function
HabibMetro Islamic Banking
April 24, 2014

Presentation Outline
What is Al Bai Financing
Why we need this product
Transaction Process Flow
The Accounting Entries

What is Al-Bai Financing

HMB Al Bai is a sale and agency based financing facility for customers who
sell finished goods on credit basis
The facility will enable the customers to sell their finished goods stock,

meet their working capital requirements and enjoy benefits of cash sales.
Under this concept the Bank will purchase the finished goods of the

Customers and will appoint the Customer as its agent to sell the same goods
in the market /export on behalf of the Bank and adjust the facility at
maturity date either with export proceeds / local sale receipts.
It is necessary for the validity of Finished Goods transaction that the price is

fixed with the consent of the parties (Bank and the customer) and that the
necessary specification of the required items is fully settled between them.
The Finished Goods price is ideally paid on Spot with immediate delivery
of Goods by the customer. Subsequently the customer shall sell the goods
on behalf of the bank and adjust the facility at maturity date (within facility
tenor).

6. Agency / Incentive Fee

1. HMB Al Bai Agreement

2. Delivery of Goods

Customer

3. Agency Agreement

4. Sale of Goods

Local Buyer

5. Sale Proceeds

HMB-IBB

Istisna: Step #01: (MOU)

1. Client and Bank sign an agreement to enter into
Master Al - Bai Financing Agreement (MFA)

Bank

Master Financing
Agreement

Risk neither of Bank nor Customer

Client

Istisna: Step # 02:

Relationship: Bank (Buyer) & Client (Seller). Upon delivery of
goods, the client would sell in the capacity of Agent)

Client appointed as AGENT to sell the goods on Banks

behalf to its known and declared buyers once purchased
by the Bank (by the same client).
Bank

Master Financing
Agreement
Agency
Agreement

Risk neither of Bank nor Customer

Client

Istisna: Step#03:Relationship: Bank (Buyer) & Client (Seller)

The customer requests for disbursement (advance
payment) of Al Bai Facility within approved Credit Line
against future delivery of goods, say 100 denim paints
after 100 days (Facility tenor / Financing Cycle is
120days)
Bank

Master Financing
Agreement

Client

Agency
Agreement

Risk of Bank only (CR)

Advance payment /disbursement to the

Customer (seller) against future delivery

(Disbursement through Advance Against Al-Bai (like in Murabaha,

Supplier
however, this advance period may be of 120 days

Istisna: Steps #04

Relationship: Bank (Buyer) & Client (Seller)

The customer delivers the specified goods on maturity date

(i.e. the Bank after taking the possession of goods handover
to the Agent to sell on banks behalf as per Agency
Agreement already in place).
Delivery of goods

Bank

Customer

Advises the Agent to sell to its

buyers as per agreement & bring
proceeds in time

Agent

Goods Ownership (holding) & Selling Risks: MR + OR

The risk related to commodity is of Bank. Goods holding risk which is
minimal covered through Takaful / Insurance and repayment risk is
mitigated through Corporate Guarantee besides other securities.

Istisna: Steps #05

Relationship: Bank (Principal) & Client (Agent)
The Agent (client) sells the goods to its ultimate (already declared)
buyers and brings proceeds in time as per agreement.
Selling to buyers

Ultimate Buyers

Agent

Istisna Facility adjusted

against Proceeds

Bank

Foreign/Local

Goods Sold: CR
Corporate Guarantee is in place to make the client (Agent)
responsible to bring the sale proceeds in time

(Al-Bai Financing Facility adjusted within Financing Cycle