In the previous article, we discussed the basic rules and principles of bay al-istisna (manufacturing sale). Today, we are going to learn how the concept of istisna is used as a mode of financing in prevalent Islamic financial institutions. The contract of istisna is applicable for various industrial projects which can be manufactured according to given specifications. For example, the istisna contract can be used for house financing. If the client seeks financing to construct the house at his open land, the Islamic bank may undertake to construct the house on the basis of istisna contract. Likewise, the contract of istisna can be employed in advance technology industries and in the manufacturing of equipment such as aircrafts, automobiles, ships and factory equipment. As we discussed in the previous article, it is not necessary in istisna contract that financier himself construct the asset. He can enter into a parallel istisna contract with a third party. Generally, the Islamic banks uses the parallel istisna contract as they don’t have the required expertise to construct or manufacture the asset themselves. In the following, we explain both types of istisna contract in order to get the complete picture.
Types of istisna
The istisna contract can be categorized into two types: classical istisna and parallel istisna.
The classical istisna contract has been discussed by the jurists and Shariah scholars in fiqh literature. This type of istisna involves only two contracting party namely the buyer (also known as mustasni) and the seller (also known as manufacturer and sani). The classical istisna has the following mechanism:
1. The customer (buyer) approaches the manufacturer (seller) to construct a specified asset for him. They agree on specifications of the asset, the price and the date of delivery at the time of contract execution.
2. The customer pays the price to manufacture in cash or installments according to their agreement.
3. After the completion of manufacturing process, the manufacturer delivers the completed asset to customer on delivery date.
The parallel istisna contract involves three parties and It consists of two separate contracts. The first contract is between the ultimate purchaser (customer) and the seller (Islamic bank), where the Islamic bank as seller is responsible to deliver the asset to customer according to given specifications. The second istisna contract is between the Islamic bank (as buyer) and the manufacturer of the asset. The following steps are involved in parallel istisna contract.
1. The customer wants to purchase the certain assets to be manufactured or constructed (for example house) and approaches the Islamic bank for financing.
2. The Islamic bank (as seller / manufacturer) enters into istisna contract with customer. The price is determined as bank’s cost plus profit margin.
3. The Islamic bank (buyer) enters into the parallel istisna (second istisna) contract with the contractor to construct the asset (house) as per the agreed specifications with customer.
4. The Islamic bank pays the cost of construction to the contractor in the second istisna contract.
5. After the completion of manufacturing process, the Islamic bank delivers the asset to the customer (ultimate buyer) upon the delivery date. Sometimes, the Islamic bank appoints the contractor its agent to deliver the asset to the customer on its behalf.
6. The customer pays the price of istisna asset to the Islamic bank in form installments or lump sum according to their agreement.