Mironshoh Murodullayev
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In his speech, dated 29 December 2021, President Shavkat Mirziyoyev emphasized the need for the initial implementation of an Islamic financing system over the State financial system while the country’s other neighbors, including Kazakhstan and Kyrgyzstan, had already finalized the implementation period. “The time has come to create a legal framework for introducing Islamic financial services in our country. In this regard, experts from the Islamic Development Bank and other international financial organizations will be involved,” said the President. This blog post will examine the compatibility of Uzbek legislation with Islamic financing tools.
Basic Principles of Islamic Finance
Before jumping into the discussion of the means of Islamic finance, it would be. Good to introduce the basic principles of Islamic finance, separating it from other conventional systems. There are two major categories banned in Islamic financial transactions, and they are listed below:
The first category consists of elements that are prohibited since inception; there is no debate allowed on their legitimacy. The main practices that are considered unlawful in Islamic finance are usury (riba), ambiguity in contracts (gharar), and gambling(maysir). Riba is prohibited (haram) in all its aspects. It is considered an unjustified increment in borrowing or lending money. While gharar is banned under Islam because it is associated with uncertainty, deception , and risk; maysir is forbidden on the grounds that money should be earned on the basis of work and effort, not involving a game of chance.
The second category consists of elements that are prohibited if proven to be. Here remains deep skepticism over the legal interpretation of each, i.e. threat (tahdeed), mistake (ghalat), injustice (zulm), deception (khedaa), and exploitation (istighlal).
As to the third category, it consists of a single prohibited practice in Islam because it leads to inequality, and that is monopolyor Ihtikar in Arabic. Monopoly is forbidden in Sharia.
Means of Islamic Financing
Until April 2021, when Law “On the activity of non-bank credit organizations and microfinance” was adopted, credit organizations were not allowed to enter into transactions containing Islamic financing principles. Article 4 of the Law explicitly allows credit organizations to apply Islamic financing tools, leaving them independent of whether to use or not general principles of Islamic financing. Central Bank of Uzbekistan (CBU) has not adopted a specific resolution regulating Islamic financing services. Despite this, “Sanoat Qurilish Bank” (SQB) and “Taiba Leasing” Financing Company have already started to offer services based on general Islamic financing tools. So, how do they work?
Although there are more than twenty means of financing tools in Islamic Financing, the three main ones will be discussed using the example of “car financing”.
- Murabaha (Cost Plus Profit Sale on Deferred Basis)
The first type of Islamic financing is called Murabaha. Murabaha is a financial product that can be used to purchase equipment, machinery, cars, and houses in the following order:
Firstly, the party who wants to buy a car – the customer — applies to the financing party (Islamic Credit Organization) and expresses his/her willingness to buy a car of a certain model with certain features and the times when he/she can make the payments. If the other party agrees to the financing terms, a Murabaha agreement is signed between the two parties;
Secondly, the financier buys the property of the customer’s choice from the seller using cash, for example, an item worth $10.000(in this case, ownership of the property must be transferred to the financier).
Thirdly, the Islamic bank adds its profit to the price of the purchased product (for example, $2.000) and sells it to the customer (for example, for $12.000). Payments can be made in installments over the agreed term or as a lump sum payment (which has to be disclosed) at the end of the term. Unlike conventional banks, which add percentages above, Islamic financing organizations choose to apply mark-up profits. If the interest is added to the former product, the interest rate on the product decreases as the principal amount decreases (differentiated). In the latter case, the lump sum will not be changed depending on the principal amount. In the negotiation of a contract, the purchase price (1), the markup rate (2), and payment period duration (3) should be made clear for both parties.
From the perspective of Uzbek legislation, this manner of financing is not prohibited where the party can sell anything belonging to him/her (Art. 386 of Civil Code) for any price (Art. 356 of Civil Code) and in installments (Art 419 of Civil Code). But the parties must ensure that the usual Agreement on Sales of Goods must comprise the basic elements of the procedure Murabaha transaction. Moreover, in the Murabaha transaction, the client must address it, and the credit organization must first acquire the ownership, then sell the property.
- Taqseed (Payment by Installments)
In Islamic finance, the practice of paying in installments is one of the most common types of transactions in recent times. That is, the goods will be presented to the buyer as soon as the agreement is fulfilled, and the payment will be paid in installments in the future period. It does not matter whether the price of the merchandise is more expensive, equal, or even lower than the cash payment.
For example, the entity deals with the sales of cars. The real purchase price of the cars is estimated to be 20.000 USD. The seller may put a rule that if the cars are purchased instantly, then customers will pay the real price. If the payment is deferred (for example, 12 months), then the cars will cost 24.000 USD (2.000 USD per month). Unlike Murabaha, a Taqseed sale does not include cost plus margin.
From the perspective of Uzbek legislation, this manner of financing is not prohibited where the party can sell anything belonging to him (Art. 386 of Civil Code) for any price (Art. 356 of Civil Code) and pay in installments
(Art 419 of Civil Code). Under Article 419, the Legislation explicitly gives the right the seller to sell the product in installments. On the variation of the cost, depending on whether it is in installments or in cash, the Legislation is silent, and this means that it does not matter whether the price of the merchandise is more expensive, equal, or even lower than the cash payment.
- Ijaratul Muntahiyya bit-tamleek (Lease to Own)
Ijaratul Muntahiya bit-tamleek (Islamic leasing) – a contract reached between two parties, wherein one of the parties (Lessor) rents a certain property to the other (Lessee) for a certain sum of money for a certain amount of time. Within a timeframe that has been mutually agreed upon, the Lessee makes this payment in installments. Finally, ownership of the property will pass to the Lessee upon payment of the final percentage.
The ownership of the leased asset stays with the Lessor since the Ijaratul Muntahiya bit-tamleek is also a type of lease. By executing a separate gift or sale agreement, the property is finally transferred from the Lessor to the Lessee once the Lessee has paid the agreed-upon rent. In the case of a car, an Islamic bank buys a car from a third party for a customer that cannot afford to buy it and leases it to that customer based on the customer’s promise to lease it. The lease payments and terms are agreed upon in such a way that the Islamic bank covers the cost of purchasing the vehicle and earns a profit over the term of financing, while the customer ultimately becomes the owner of the vehicle by making monthly payments.
From the perspective of Uzbek legislation, the manner of financing is not prohibited where the Lessor under the contract with Lessee purchases the property (for example, the machinery) from the third party (seller) and leases the very one to the Lessee for a specified period during which the Lessee is obliged to pay the payments in installments (Art. 2 (1) of the Law “On lease”). When the period ends and the Lessee pays the final proportion, the ownership will be transferred to him/her under the lease agreement (however, in Islamic Ijarah, the transfer must be under the independent document and should not be automatic). However, under Article 22 of the Law, the payment may be in percentages as in credit loans, but by Islamic lease contract, the payment must be fixed within a constant amount of money. Another difference between Islamic and conventional leasing is that in the latter, the ownership will be transferred directly to the Lessee by combining two transactions (leasing + selling), which is prohibited based on the Islamic perspective.
Conclusion
In conclusion, there is no prohibition on using Islamic financing methods for microcredit organizations within the framework of legislation in Uzbekistan. The only restriction is that the Central Bank has not set any regulatory framework procedures. Therefore, almost all microcredit organizations rely on general Islamic financing rules. There are two main things to consider when using each financing method. Firstly, general prohibitions in Islam, such as ‘Inah and Riba, should be avoided. Secondly, contracts should be drawn up considering the specific nature of each financing method, as it is easy to confuse Ijarah (Leasing) and Murabaha (Mark-up Sale).
Cite as: Mironshoh Murodullayev, “Perspective of Islamic Financing in Uzbekistan: Content And Comparison”, Uzbekistan Law Blog, 12.11.2022.
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