Istisna’a and Back-to-Back Istisna’a Finance

Istisna’a and Back-to-Back Istisna’a Finance

It is no more acceptable for Islamic banks to provide finance to government sponsored projects in forms abhorrent to their articles of associations nor is acceptable for an Islamic bank to finance private sector projects by way of interest free loans. Therefore, Istisna’a has been rendered to be the most appropriate Sharia and business form to finance infrastructure projects, manufacturing aircrafts, construction of power stations, buildings, and equipments, which have to be completed on need basis. Hence, there arises the importance of Istisna’a contract as a financing tool, which is a contract that allows the sale of a commodity that does not exist at the time of contracting, while payment can be made on spot or deferred basis.

Process of Istisna’a Sale

1. The process starts when a customer expresses to the bank its intention to purchase a commodity that has to be manufactured, built or assembled with certain specifications at a specified price.
2. The bank and the customer enter into an Istisna’a contract under which the bank undertakes to have the subject commodity manufactured and delivered to the customer within a certain period in return for a specified price payable on spot or on several installments or in one stroke on deferred basis.
3. The bank then enters into a back-to-back Istisna’a contract with a third party to have the subject commodity manufactured, built or assembled.

Purpose of Financing under Istisna’a and Back-to-Back Contracts

Given the mammoth changes in the volume and value of the projects necessitated by the development drives undertaken by governments or such other projects assigned to the private sector, and in view of the lack of liquidity and insufficient financing sources in addition to lack of expertise needed, a sore need has arisen for a new form of Islamic compliant financing. Thus, Istisna’a became one of the sale contracts which could be used by Islamic banks to meet the needs and requirements of individuals and organizations which can not be financed through other sale contracts; Under Istisna’a financing contract, the underlying commodity is manufactured and the price is paid on forward basis or on installments, depending on the Istisna’a requester (the customer) and the consent of the manufacturer (the bank).

Scope of Applications

Examples of Istisna’a contracts, which may be used for the community welfare, include infrastructure projects such as construction of roads, schools, hospital, buildings, power and other facilities, in addition to myriad contracts such as manufacturing of aircrafts, vehicles and ships. It would have been difficult for the sponsors/ owners of such projects to find other suitable financing alternatives.

Parties of Istisna’a Contract

1. Istisna’a requester: is the buyer (owner of the project)
2. Manufacturer: is the bank (seller/producer) which enters into contract with the Istisna’ requester and commits itself to provide the subject commodity.
3. Contractor: is the seller, contractor or actual contractor, which concludes the back-to-back contract with the bank and starts manufacturing or construction of the subject commodity. It is the bank’s sub-contractor or supplier.
4. Product: is the commodity defined and contracted to be manufactured.

The bank is considered to be the manufacturer and principal contractor vis-à-vis the Istisna’a requester who is the owner vis-à-vis the contractor in the second contract (back to back Istisna’a contract).

Sharia Controls of Istisna’a and back-to-back Istisna’a

1. The subject product must be precisely defined with details including:
   • Product (vehicle, aircraft, real estate etc.)
   • Type (brand and make)
   • Description (product schedule of specifications)
2. Permitted Deferment
   • The subject product is to be manufactured or procured form the market. Therefore, a maturity date must be specified in order to avoid risk.
   • The term depends on the nature of the product to be manufactured in accordance with the Istisna’a contract entered into by the two parties and subject to the conditions and specifications set out in the term sheet of the contracted commodity as agreed between the two parties.
3. Price
   • The price be precisely defined and known by the two parties.
   • The price should not be affected by any increase in market prices or labor in normal circumstances.
   • The price may be adjusted if amendments are made to the contracted product by mutual agreement of the two parties.

SOURCE: http://www.bankalbilad.com.sa/en/corpser04.asp?TabId=2&ItemId=23