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  • Roles and Exposure of a Bank in an Istisna'a Contract

    • CA-3.4.4

      In practice, an Islamic bank licensee can play different roles while engaging in the contract of Istisna'a, as follows:

      (a) Islamic bank licensee as a seller (al-sani') in Istisna'a contract:
      (i) In many cases, an Islamic bank licensee acts as a "seller" in the Istisna'a contract and engages the services of a contractor (other than the client) by entering into another Istisna'a contract as buyer11 or using some other Shari'a compliant contract such as Murabahah; or.
      (ii) If a parallel Istisna'a contract is used for manufacturing the asset, the Islamic bank licensee acts as a buyer in the parallel contract. The Islamic bank licensee as an intermediary calculates its cost in the parallel contract and fixes the price of Istisna'a with its client that allows it to make a reasonable profit over his cost. The two contracts, however, need to be totally independent of each other. In order to secure the payment from the ultimate buyer (i.e. the customer), the title deeds of the underlying asset, or any other collateral, may be required by the Islamic bank licensee as a security until the complete payment is made by the ultimate buyer; and
      (b) Islamic bank licensee as a buyer (al-mustasni') in Istisna'a contract:
      (i) In some cases, an Islamic bank licensee can act as a "buyer" in an Istisna'a contract where it can have an asset constructed by a contractor: (i) for its own account (which can be, for example, subsequently sold or leased on a Murabahah or Ijara basis, respectively); or (ii) on the basis of the ultimate customer's specifications; or
      (ii) If the parallel Istisna'a contract is used in this scenario with the ultimate customer, the Islamic bank licensee acts as seller in the parallel contract.

      11 Where two such parallel Istisna'a contracts exist, it is customary to refer to one of the contracts as a "parallel Istisna'a". Typically, it is the contract which is entered into second which is referred to as the "parallel Istisna'a".

      January 2015

    • CA-3.4.5

      This Section makes distinctions between two types of exposures in Istisna'a financing, as follows:

      (a) Exposure to customer:

      The receipt of the selling price by the Islamic bank licensee is dependent on the financial strength or payment capability of the ultimate customer or the contractor (cases (a) and (b) of Paragraph CA-3.4.4 respectively), where the source of payment is derived from the various other activities of the ultimate customer or contactor and is not solely dependent on the cash flows from the underlying asset/project; and
      (b) Exposure to asset (i.e. exposure to the cash flows from the completed asset): The receipt of the selling price by the Islamic bank licensee is dependent partially or primarily on the amount of revenue generated by the asset being manufactured or constructed by selling its output or services to contractual or potential third-party buyers. This form of Istisna'a faces "revenue risk" arising from the asset's ability to generate cash flows, instead of the creditworthiness of the ultimate customer or project sponsor (cases (a) and (b) of Paragraph CA-3.4.4 respectively). Such exposure normally arises when an Istisna'a contract is used in project finance and BOT (build, operate, transfer) transactions.
      January 2015

    • CA-3.4.6

      In the Istisna'a contract, the Islamic bank licensee assumes the completion risk12 that is associated with the failure to complete the project at all, delay in completion, cost overruns, occurrence of a force majeure event, and unavailability of qualified personnel and reliable seller(s) or sub-contractors, including any late completion penalty13 payable to the ultimate customer due to non-fulfilment of required specifications.

      12 In conventional project financing, the completion risk is normally borne by the project sponsor/contractor, and not by the bank, because the project sponsor/contractor has most often been asked to provide an undertaking to cover cost overruns.

      13 Normally, the contract between the bank and the contractor will specify in a penalty clause the latter's liability for penalties in case of delays for which it is responsible.

      January 2015