In the field of Islamic finance, Istisna’ plays an important role as a long-term contract involving the manufacture, construction or building of assets. This article aims to provide a comprehensive understanding of Istisna’, its application, structure, risk mitigation, documentation and its importance within the framework of Islamic finance.
What is Istisna’?
Istisna’ is an Arabic term that refers to the act of asking someone to construct, build or manufacture an asset. In Islamic finance, isisna’ is a contractual arrangement whereby one party assumes the responsibility to manufacture, build or construct assets with the obligation to deliver them to the customer upon completion. The main advantage of an Istisna’ contract is its flexibility, which allows for installment payments linked to project completion, delivery or after project completion.
Application of Istisna
Infrastructure projects are prime examples of the application of Istisna’. These projects include the construction of power plants, factories, roads, schools, hospitals, buildings and housing developments. The parties involved in an Istisna’ contract typically include the producer or manufacturer, the bank (the financier), and the customer (the buyer of the goods).
Structure of Istisna’
The structure of Istisna’ can be represented by two different frameworks: the simple Istisna’ structure and the parallel Istisna’ structure. In the simple Istisna’ structure, the buyer coordinates directly with the producer, provided that the buyer has the necessary financing. On the other hand, the parallel Istisna’ structure involves the buyer, the Islamic bank and the manufacturer (and sometimes subcontractors), allowing the buyer to obtain financing from the Islamic bank.
Validity, Amendments and Terminations
For an Istisna’ contract to be valid, the price must be fixed at the outset. In the event of unforeseen circumstances that cause a delay in delivery, the price of Istisna’ may be changed by mutual agreement. Once the manufacturer has started work, the contract cannot be cancelled unilaterally.
Risk Mitigation in Istisna’
Istisna’ contracts contain several risks that need to be mitigated. These risks include delivery risk, non-performance risk, quality risk, increased production costs and storage risk. Mitigation strategies can include linking pricing to delivery, installment payments, quality assurance agreements, producer management of increased costs, and appropriate insurance or takaful coverage.
Documentation in Istisna’
Istisna’ contracts include three sets of documents: the Master Istisna’ Agreement, the Agency Agreement and the Company Guarantee. The Master Istisna’ Agreement outlines the terms and conditions for the production of goods, while the Agency Agreement appoints the producer as the agent for the sale of goods. The Corporate Guarantee serves as a guarantee between the bank and the customer, ensuring payment obligations in case of default. In addition, Istisna’ contracts can be arranged with other Shari’ah-compliant contracts such as Kafalah, Takaful, Rahn, Hamish Gedyyah or Arbun.
Historical and Legal Basis
The Islamic basis of isisna’ can be traced back to the time of the Prophet Muhammad (peace be upon him). There are historical references that illustrate the Prophet’s involvement in requesting the construction of a pulpit for preaching and the manufacture of a finger ring. These instances provide a basis for the validity and importance of istisna’ in Islamic finance.
Istisna’, Kafalah and Takaful: Different Aspects of Shari’a-compliant Contracts
Let’s explore the difference between isisna’, kafalah and takaful, which are all Shariah-compliant arrangements within the realm of Islamic finance:
- Istisna’:
Istisna’ is a contract that involves the manufacture, construction or building of assets. It is typically a long-term contract where the manufacturer or producer takes responsibility for delivering the completed assets to the customer. Istisna contracts offer flexibility in payment terms, allowing for installment payments linked to project completion, delivery or after project completion. It is often used to finance infrastructure projects such as power plants, factories and housing developments. - Kafalah:
Kafalah, also known as guarantee or surety, is a contract in which a third party (the guarantor) provides a guarantee or assurance to fulfill the obligations of a debtor or a party involved in a transaction. The guarantor becomes the guarantor of the debtor’s obligations and assumes the responsibility of fulfilling those obligations if the debtor fails to do so. Kafalah is commonly used to secure loans, contracts or financial transactions and provides an additional layer of security to the parties involved. - Takaful:
Takaful is a cooperative insurance concept based on mutual assistance and shared responsibility. It is designed to provide protection against risk or loss in a Sharia-compliant manner. Takaful operates through a pool of participants who contribute funds to a common fund or pool to cover potential losses or claims. In the event of a covered loss, participants are entitled to a proportionate share of the fund. Takaful follows the principles of cooperation, shared responsibility and donation rather than conventional insurance concepts based on risk transfer and interest.
While isisna’ focuses on the production and delivery of assets, kafalah involves the provision of a guarantee or surety for obligations, and takaful provides a cooperative mechanism for risk sharing and protection. Each of these contracts serves a different purpose within Islamic finance, addressing different financial needs and transactions while complying with Shariah principles.
Conclusion
Istisna’ plays an important role in Islamic finance by providing a flexible and practical approach to financing infrastructure projects and asset construction. With its unique features and risk mitigation strategies, Istisna’ contracts provide a framework for mutually beneficial arrangements between producers, banks and customers. Understanding Istisna’ and its application within the Islamic financial system is essential for practitioners and individuals seeking to engage in Shari’ah-compliant financial transactions.
Disclaimer: This article is for informational purposes only and does not constitute legal or financial advice. Readers are advised to consult with appropriate professionals for guidance on specific Istisna’ transactions or related matters.
FAQ
What is istisna?
Istisna is generally a long-term sales contract between a customer and the bank, whereby Dubai Islamic Bank agrees to construct and deliver an asset at a pre-determined future time, at an agreed price. The bank takes care of paying the contracted developer or builder in full or at specific stages of project completion.
What is istisna in Islam?
Related Content. An Islamic finance technique used to finance the construction or manufacture of assets on terms compliant with Sharia. In an istisna’a transaction, a lender agrees to buy an asset to be delivered once construction or manufacturing of that asset is complete.
What does istisna meaning?
Istisna means a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and future delivery or a future payment and future delivery.
What is istisna example?
Istisna is a type of sale transaction where the buyer places an order with the seller to manufacture certain asset and the sale is completed upon delivery of the asset to the buyer. Istisna is used for providing financing facility for transactions where customer is involved in manufacturing or construction.
What is Salam and istisna?
The contracts of salaam and istisna are sale-based contracts between two or more parties that involve the sale of an asset that does not exist at the time the contract is negotiated.
Why is istisna important?
The importance of Istisna’a is a contract stems from that it has great facilitation for dealers; It covers two important aspects: the contract of delivery, which does not require the existence of the goods that must be delivered, but the price must be delivered when contracting according to the view of the majority of
Where is istisna applicable?
Istisna is widely used by Islamic banks and financial institutions to finance the construction of real estate such as buildings, warehouses, showrooms, shopping malls, residential towers and villas, as well as manufacturing activities involved in the construction of like aircrafts, ships, machines and equipment, etc.
What is istisna sale?
Istisna’a is a contract between a manufacturer/seller and a buyer under which the manufacturer/seller sells specific product(s) after having manufactured, permissible under Islamic Shariah and Law of the Country after having manufactured at an agreed price payable in advance or by instalments within a fixed period or
What is istisna Sukuk?
Category — Islamic Finance. Istisna Sukuk is based on Istisna contracts, they are instruments issued by the manufacturer of a commodity in order to obtain the value of the instruments and then produce the agreed commodity and deliver it to the Sukuk holders at the agreed time.