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Istisna'
Istisna’ means asking someone to construct, build or manufacture an asset. In Islamic finance,
istisna' is generally a long-term contract whereby a party undertakes to manufacture, build or
construct assets, with an obligation from the manufacturer or producer to deliver them to the
customer upon completion. In practice, the key advantage of an istisna’ contract is that it can
provide flexibility to the customer, where payments can be made in installments linked to project
completion, at delivery or after project completion. In contrast to istisna', for salam contract the
payment has to be made in full, in advance.

Istisna' Application: Examples

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Infrastructure projects are the main examples of istisna' application. This includes: construction
of power plants, factories, roads, schools, hospitals, building and residential developments. The
parties to an istisna' contract are: the Producer or Manufacturer; the Bank (i.e. the financier);
and the Customer (i.e. purchaser of goods).

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Figure 1: Istisna’ Structure

The below diagram shows istisna' structure:

Source: Islamic Banking and Finance, 2009 (Spiramus Press Ltd)

The above structure is also known as “simple istisna'”, where it is assumed that the buyer has
the required financing to directly coordinate with the manufacturer on the project. If the buyer
does not have the financing, then the below parallel istisna' structure can be used.
Figure 2: Parallel Istisna’ Structure
The parallel istisna' involves: the customer (the buyer); the Islamic bank (the seller); and the
manufacturer (in some cases it can also involve sub-contractors), where the buyer can obtain
financing from the Islamic bank The following diagram shows parallel istisna' structure:

Source: Islamic Banking and Finance, 2009 (Spiramus Press Ltd)

Istisna’ Validity, Amendments and Cancellations

In order for the istisna' to be valid, the price must be fixed from the outset. In the event of any
unforeseen event that causes a delay in delivery the price of istisna' can be amended, if it is
mutually agreed. After the manufacturer has started the work, the contract cannot be cancelled
unilaterally.

Istisna’ Risk Mitigation

Risk Description Mitigation

Delivery Risk Delay in delivery of goods from the producer to the customer at maturity. Link pricing of the istisna' to delivery.

Non-Performance The producer is either unable or is unwilling to manufacture the goods during assigned time. The price can be paid in installments.

The producer delivers defected/inferior goods, which is realized by the customer only at the time of Quality assurance agreement, with producer to rectify
Quality Risk
delivery. defects.

Increased costs of Cost incurred by the producer turns out to be higher than anticipated, which causes the producer to Producer to handle increase in costs, unless it is due to an
Production default on performance. unforeseen event.

In the case of parallel istisna’, the goods once delivered by the producer will be at the bank's risk
Storage Risk Insurance / Takaful.
before being sold to the customer.

Source: IslamicBanker.com (http://www.islamicmarkets.com); Meezan Bank.

Istisna' Documentation

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There are three sets of documentation involved in istisna':

1. Master Istisna' Agreement

The agreement is signed between the Bank and the Customer, outlining the terms and
conditions of the production of goods, including: cost price, delivery location, quantity and
quality.
2. Agency Agreement

In the case of Agency Agreement, the Bank will appoint the producer of goods its Agenet to sell
the goods. Generally, this documents also sets out the agency fees schedule (Notice of
Appointment).
3. Corporate Guarantee

This agreement is between the Bank and the Customer, guaranteeing the payment obligation in
the case of default. This can include a mortgage or pledges on receivables.
In practice Istisna' contracts can be arranged with other Sharia' compliant agreements
including: kafalah (http://www.islamicmarkets.com/dictionary/k/kafalah), takaful; rahn
(http://www.islamicmarkets.com/dictionary/r/rahn); hamish gedyyah
(http://www.islamicmarkets.com/dictionary/h/hamish-gedyyah) (security deposit), or arbun
(http://www.islamicmarkets.com/dictionary/a/arbun) (down payment).
Istisna’: Hadith

The Islamic underpinning of istisna' can be found with the following two ahadith:

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 and
Muslim 3/1655]

References
1. Sheikh Muhammad Taqi Usmani, An Introduction to Islamic Finance.
1. Meezan Bank, Istisna'.
3. Istisna' in Islamic banking: Concept & Application
(http://myais.fsktm.um.edu.my/7501/1/Istisna_in_Islamic_Banking_Concept_and_Application.pdf).
4. Islamic Banking and Finance (http://books.google.ae/books?
id=SiNaZcPUu4IC&lpg=PA36&ots=hTfLYqrJ3N&dq=%22Istisna%20structure%22&pg=PA35#v=onep
2009 (Spiramus Press Ltd).
5. Abdulkader Thomas et al, 2005, Structuring Islamic Finance Transactions, Euromoney
Books.

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