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Istisna': Potential Application in Malaysia

Definition
Khalid (2012) and Ayaz (2013) explained that in literal form, the word istisna is
derived from the word sanaa, which means to make, manufacture or construct something,
while istisna is an order or request to manufacture a product by a skilled person. Technically,
Bay Al-Istisna is a contractual agreement with a manufacturer to produce items with
specified description and specifications (such as date of delivery) at a predetermined price and
may be constructed at a later date. Therefore, the transaction of the commodity or asset has
taken place before it has come into existence and thus is considered as legally binding once
the contract has fulfilled all its essential elements (Usmani, 2002).
Legality
The legality on an Istisna contract is established from different legal sources, such
as the Prophets Hadith, ijma, qiyas and istihsan (Khalid, 2012). It is unanimously supported
by Muslim jurists as it is customarily practiced in business and finance sector and therefore
there is no difference of opinion on its permissibility (Ahmed, 2007). Evidence for this
underlying principle can be seen in the following two hadiths:
The Prophet (PBUH) required that a pulpit (platform) be built for preaching.
[Bukhari 2:908]
The Prophet (PBUH) required that a finger ring be manufactured for him.
[Bukhari 5:220, Muslim 3:1655]

Types
There are two types of Istisna. The types of Istisna are classical Istisna and parallel
Istisna.
Classical Istisna
Classical or simple Istisna is a contract which requires a sale of a non-existent
asset that is yet to be constructed, built or manufactured with agreed specifications and the
delivery of the assets on a specified future date at a pre-determined price (BNM, 2014).
This Istisna only involves two transacting parties; which are the customer or buyer, and the
manufacturer or seller.
According to Schoon (2009), the buyer (Al-Mustasni) would request for the
construction of an asset with specified properties, price and delivery date. Once accepted, the
seller (Al-Sani) is obliged to deliver the asset as per request of the buyer at a later
predetermined date. This situation creates a moral obligation to the seller to manufacture the
asset for the buyer. The figure below illustrates the transaction.
Figure 1: Example of classical Istisna

Source: Schoon, 2009

Parallel Istisna
Parallel Istisna is a contractual agreement which consists of two separate and
independent Istisna contracts with have similar specifications to the Istisna asset (BNM,
2014). Thus, this Istisna involves three transacting parties, which are the buyer or customer,
the bank and the contractor or developer.
Based on Schoon (2009) and Borhan (2002), in this type of Istisna, the buyer will be
in contact with the bank to seek financing for the asset. In this case, the bank will remain as
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the financier for the asset. The bank will then approach the contractor to develop the asset,
given its specifications and specified terms and conditions. Once the contractor has developed
the asset, the bank will receive ownership over the asset. The bank will then transfer the
ownership over to the buyer as the latter had initially requested for the asset. The method of
payment would be as per agreement between the two parties, either on the spot basis or upon
the delivery of the asset or by instalment. The figure below illustrates the transaction.
Figure 2: Example of parallel Istisna

Source: Schoon, 2009

Conditions for Istisna


i.

Subject matter (masnu)


According to Khalid (2012), first condition of Istisna is subject matter or masnu. The

subject matter to be manufactured must be precisely determined in its type, kind, quantity and
quality due to the fact that Istisna' contract is a form of sale of the non-existence matter. The
object of an Istisna' contract must be something that the people are familiar in order to bind
the contract with it on the bases of manufacture and construction process.
Istisna' contract is always associated with the risk of uncertainty (gharar) of the
deliverability of the subject matter which can be reduced and eliminated through the above
said mechanism. If the subject matter does not conform to the contractual requirements of the
time of delivery, the buyer has the right to either refuse or accept it.
ii.

Time of delivery
The time of delivery is not necessary to be fixed but it shall be determined and agreed

by both parties. The buyer may fix a maximum time for delivery which means that if the
manufacturer delays the delivery after the appointed time, he will not be bound to accept the
goods and pay the price as stated by Usmani (2002).
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In order to ensure that the goods will be delivered within the specified period, some
modern agreements of this nature contain a penal clause to the effect that in case of
manufacturer delays the delivery of the assets without a valid reason, the manufacturer shall
be liable for damages and subject to any penalty specified in the contract (Ayaz, 2010).
Delivery may be performed through actual or constructive delivery which enables the buyer to
take control of the asset.
The buyer may accept the delivery of Istisna assets prior to the agreed delivery date
without any price adjustment. Unless both parties agreed otherwise, the payment obligation
will take effect upon acceptance of the manufactured assets.
iii.

Price
It is important that the selling price and the specification of the subject matter be

determined and agreed by contracting parties upon entering into istisna' contract. Firstly, price
of istisna may be in the form of money, commodity and usufruct as stated by BNM (2014)..
Price of subject matter may be determined and agreed on spot or varied since it is permissible
in Istisna contract unlike in Salam contract. The price of Istisna can be paid in instalment
which can be fixed or varied with different stages of projects.

Risk Mitigation in Istisna


RISK
EXPLANATION
MITIGATION
Uncertainty About Contracts for non-existence products The Istisna contract must be as
Product

which will be manufactured later contain detailed as possible regarding


some uncertainty about the product. what the end product will be.
Islamic law prohibits finance institutions
from being part of transactions that

Delivery Risk

involve uncertainty (gharar).


Delay in delivery of goods from the On the basis of the rule of
manufacturer to the customer at maturity.

"Shart-e-Jazai", the bank can put


in the Istisna agreement a clause
to reduce the Istisna price in the

Non-Performance

case of delay.
The manufacturer is either unable or is The price can

be

paid

in

unwilling to manufacture the goods instalments.


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during assigned time.


The manufacturer delivers defected or Quality

Quality Risk

assurance

agreement.

inferior good which is realized by the The manufacturer can be asked


customer only at the time of delivery.
to rectify the defect.
Increase in Cost Cost incurred by the manufacturer turns Manufacturer is the one who
of Manufacturing

out to be higher than anticipated, which bear increase in costs, unless it is


causes the manufacturer to default on due to an unforeseen event in
performance.

which Istisna price may be

increased with mutual consent.


In the case of parallel Istisna, the goods The goods may be covered by

Storage Risk

once delivered by the manufacturer will using Takaful and by minimizing


be at the bank's risk before being sold to the
the buyer.

time

duration

between

acceptance of delivery under


Istisna and delivery to the
ultimate purchaser. The agent
will be asked to obtain Takaful as

Sale

Is

part of his services in Istisna.


Not Sale of Istisna' subject matter is not The bank can take a "promise to

Permissible

allowed

before

Before Delivery

possession. This may lead to asset, price can make arrangements for sale
and marketing risk.

taking

physical purchase" from a third party and


through agency. (Ayaz, 2013)

The Shart el Jazai is a penalty that allows for a reduction in the price of manufactured
goods if there is a delay in the delivery. Such a penalty is permitted in manufacturing
contracts since the buyer requires goods at a fixed time (Ethica Institute of Islamic Finance,
2014).

Rejection of Goods Manufactured


According to Zarqa (1997), Istisna contract may be cancelled before the construction
of the asset commences. However, issues may arise when the manufacturer or the seller
wishes to deliver the commodity to the buyer, even though the asset meets the buyers
specifications and demands. But at this point, is it deemed lawful or Shariah-compliant to
reject the asset or goods? This comes to a point where several Muslim jurists are in a
disagreement.
Even so, bearing in mind how the modern industry works, it is not encouraged for the
client to reject the goods without a justifiable and valid reason even though the goods are
manufactured in accordance with the required specification and quality.

Potential Applications of Istisna in Malaysia


Istisna is a financial instrument that can be used to finance the construction of
apartment buildings, healthcare institutions, educational institutions, mosques and factories.
Besides that, it can be used to finance the development of residential and commercial areas
and high technology industries such as the aircraft, locomotive and shipbuilding industries
(Ayub, 2007).
Even though, Istisna is not as common as Bai Bithaman Ajil (BBA) and Musyarakah
Mutanaqisah as Islamic mode of financing (Ibrahim & Kamarudin, 2014) but currently it has
making its own name in providing facility of financing especially in housing finance sector.
Moreover, Istisna contract can also be used to provide financing for constructing bridges,
roads and highways (Usmani, 2002).
An example of using Istisna as a mode of financing in house sector is when a client
has his own land which he desires to construct a house. The manufacturer may commence to
construct the house at that open land on the basis of Istisna. However, if the client has no
land and he wants to purchase the land, the manufacturer may provide him a constructed
house in a specified piece of land.

The manufacturer will be responsible for the construction of the house in full
conformity with the requirements detailed in the contract. In the case of any inconsistency, the
manufacturer will undertake such alteration at his own cost (Usmani, 2002).
Since it is not necessary in istisna to pay the price in advance or at the time of
delivery, thus the time of payment may be fixed in whatever manner they wish. However, it
may be deferred at any time according to the agreement of the parties.
On the other hand, it is not necessary that the manufacturer himself constructs the
house. He can enter into a parallel contract of Istisna with a third party, or may hire the
services of other contractor. In both cases, he can measure his cost and fix the price of Istisna
with the buyer in a manner which may give him a reasonable profit over his cost. The
payment of instalments by the client may start right from the day when the contract of Istisna
is signed by both parties. It continues during the construction of the house and after it is
completed and handed over to the buyer. In order to secure the payment of the instalments, the
title deeds of the house, land or any other property of the buyer may be kept by the
manufacturer as a security until the last instalment is paid by the buyer (Usmani, 2002).
Another example will be when a buyer wants to install a machine plant in his factory.
The buyer may choose to finance by using Istisna with a manufacturer in order for him to
manufacture the requested machine plant.

Application of Istisna in Malaysia


Istisna is most common in the property industry within Malaysia where it is being
applied by most Islamic commercial banks. Istisna home financing is the most common
application of the Istisna concept and uses parallel Istisna. As described earlier, parallel
Istisna has two separate but related contracts where the first contract is an agreement which
involves the customer and the bank, while the second contract is an agreement between the
bank and a housing developer.
Examples of financial institution that provide Istisna contract in Malaysia are as
follows:
i. Kuwait Finance House - KFH Istisna Home & Property Financing
ii. Bank Islam - Project Financing/Bridging
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iii.
Bank Muamalat Muamalat Al-Istisna Project Financing
iv.Maybank Islamic - Istisna' Wa Ijarah Term Financing
v. EXIM Bank - Overseas Project/Contract Financing
Scholars and Islamic banking practitioners in Malaysia regard Istisna as one of the
most suitable mode of financing for home financing. However, the lack of understanding
among the customers and the chance to enter into a Shariah-compliant law are still one of the
factors that repressed the growth of Istisna contracts in the country (Kante, Diallo & Sharif,
2001).
With proper application of Istisna contract, it can be assured that riba (usury) and
gharar (uncertainty) would be eliminated and the main objective of Maqasid Shariah, which is
to promote the welfare of the people, would be upheld by.

References

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