Who Crash Landed Indian Aviation

 

The Crash of Indian Aviation Sector

·       East West Airline

First Private Sector Airline

Who Killed Takeeuddin Abdul Waheed – The owner of East West Airline – Is this case of Corporate Rivalry.

Wahid was the managing director of East-West Airlines, the first private scheduled airline to begin service after liberalization. Wahid hailed from Edava near Varkala in Thiruvananthapuram district. He was killed in Mumbai when he was about to go home after a day at work.

East-West Airlines, which commenced services in 1992, shut down in 1996 after his murder.

 

Air Deccan

 

In the summer of 2005, retired army officer-turned-businessman GR Gopinath announced that he would enable Indians to fly at one rupee or less than a cent.

It was an incredulous sales pitch from the founder of the country's first budget airline.

Air Deccan, his then two-year-old no-frills airline modelled on European budget carriers like EasyJet and Ryanair, had already made flying affordable to millions of Indians. Capt Gopinath's tickets cost half of what competitors charged.

Now his airline introduced "dynamic pricing" where a small number of "early bird" customers could travel at a rupee. Latecomers would pay a higher ticket price, which would still be substantially lower than competitors. Not surprisingly, booking counters were overrun with customers, many of them first-time fliers. Critics howled such pricing methods would wreck the industry.

"The one-rupee ticket fired the imagination of the people and quickly became a buzzword," wrote Capt Gopinath in his memoir. He believed his airline had not "only broken the price barrier, but India's caste and class barrier to flying"

 

 

Jet and sahara

In the dynamic world of Indian aviation, failure of the $500-million plan to merge Jet Airways with Air Sahara has introduced a series of new twists and turns.

Explained: The rise and fall of private airlines

The suspension of operations at Jet Airways — at one time India’s largest private airline —  follows the troubles at Kingfisher, Air Deccan, and Sahara. A short history of hope and distress in a highly competitive market over the last 30 years.

Policy changes came in the 1990s — and liberalization and economic reforms gave the private aviation industry new wings of hope.

.

The beginnings

Founder promoter Naresh Goyal’s Jet Airways was one of the first private airlines in newly liberalised India. In 1993

Start-stop-start

Besides repealing The Air Corporation Act, the government announced an Open Skies policy in 1992, liberalising rules and regulations to open up the commercial aviation market. This led to the birth, over the next decade or so, of private sector players including ModiLuft, Damania Airways, Air Sahara, and East-West Airlines. Most of these new players, however, folded up soon or were merged — Jet Airways in contrast, stood out as an efficient private sector operator, gaining market share with each passing year.

 East-West

ModiLuft and East-West ceased operations in 1996. Air Sahara, which started operations in 1993 as Sahara Airlines, was acquired by Jet in 2007 — a business move that many analysts argue marked the beginning of the company’s troubles.

ModiLuft, which had an excellent record for three years until it shut down in 1996, was later acquired by Ajay Singh, who launched it as SpiceJet in 2005 along with NRI businessman Bhulo Kansagra. As SpiceJet faced difficulties, Kansagra sold his stake to US distress investor Wilbur Ross in 2008, who sold it to Sun Group’s Kalanithi Maran a couple of years later. The airline was teetering on the verge of closure when it was again acquired by Ajay Singh in 2015, who turned it profitable.

Boom and bust

The real expansion of the private airlines, and the number of domestic flyers in India, started in the 2000s. In 2003, Captain G R Gopinath started the country’s first low-cost carrier Air Deccan, which was followed by the launch of SpiceJet, IndiGo and GoAir. All these carriers followed the model of no-frills, cheaper tickets, and higher passenger load factors.

 Damania airlines

The LCC (low-cost carrier) model revolutionized the Indian aviation sector, pushing the country’s annual passenger growth rate to double digits. Alongside the LCCs, Kingfisher Airlines started operations in 2005, pitching itself in the middle of a no-frills and a full-service carrier. These new airlines posed a formidable challenge to Jet Airways, which had so far operated largely in a duopoly with state-owned carriers Air India and Indian Airlines (which were merged in 2011).

But the situation changed soon.

Air Deccan faced extreme financial difficulties and was bought by Kingfisher in 2007. However, Kingfisher itself went belly-up in 2012, while SpiceJet faced intermittent headwinds. Jet, which had a 44% share of the domestic passenger market in 2003-04, steadily lost ground — in February this year, the deeply troubled airline had only 10% of the domestic market share, fourth behind IndiGo (43.4%), SpiceJet (13.7%) and Air India (domestic, 12.8%), according to government data. In all these years, IndiGo stood out as the only carrier that improved its market share and financial performance.

In December 2004, the government announced a major policy change, allowing Indian scheduled carriers with a minimum five years’ continuous operations and a minimum of 20 aircraft (the so called 5/20 rule) to fly international routes. Jet was the key beneficiary of this policy change. In 2016, the government scrapped the 5/20 rule and replaced it with 0/20, enabling SpiceJet, IndiGo and GoAir to launch international flights in the following years.

TATA GROUP

challenges The Tata Group faced in getting approvals to start their own airline company in the 1990s. The regulatory struggle which began during the regime of Prime Minister PV Narasimha Rao continued during the regime of Prime Minister HD Deve Gowda. Innumerable bureaucratic hurdles continued to surface one after the other. In the light of the current scenario of India's civil aviation industry - where Jet Airways has closed its operations, Air India is up for sale, and legal agencies are exploring the inconsistencies that caused the downfall of India's state carrier, this story becomes even more interesting and topical. It tells us how India as a nation would have benefited if the governments of those decades had prioritized citizen well-being over political expedience in their decision making.

When Prime Minister Deve Gowda attended the World Economic Forum at Davos with Finance Minister P. Chidambaram in 1996-97, among other questions, they were asked about the ‘stop-go-stop’ status of the Tata-Singapore Airlines (SIA) venture. Their answer was that it was ‘being considered’. It would have been a diplomatic faux-pas to say anything else at a venue that was meant to project India as an attractive destination for foreign investments. 

 

In the Union Cabinet Meeting held in April 1997, Finance Minister P. Chidambaram, Industry Minister Murasoli Maran and Foreign Minister Inder Kumar Gujral endorsed the clearance of the Tata-SIA proposal. However, Civil Aviation Minister Ibrahim had supposedly brought with him papers from four unions belonging to Indian Airlines, which threatened to go on strike if the Tata Airlines proposal was accepted. He contended that workers’ interests must be protected. The Prime Minister conceded to this concern and laid the proposal to rest.

Later that month, a formal rejection letter was sent to the Tata Group citing inconsistencies in the proposal with the civil aviation policy.

There were strong mutterings in the media that the aviation minister had altered the aviation policy at Naresh Goyal’s behest to upset Tatas’ aviation dreams. M.K. Kaw, civil aviation secretary under Minister Ibrahim, acknowledged this in his autobiography (An Outsider Everywhere),

‘The minister did not clear the file, despite several attempts on my part. The history of civil aviation in this country would have taken a different trajectory if Tata-SIA had been allowed to float an airline.’ 

A bumpy ride

In 1990s, Air India’s market share steadily declined, and losses mounted. Between 1995 and 1997, it reported consolidated losses of ₹671 crores. When the Atal Bihari Vajpayee-led Government came to power in 1998, it initiated a major disinvestment programme under Minister Arun Shourie. In 2001, a decision on divesting 40% stake in Air India was taken. Given its long and rich experience, the Tata Group was specifically encouraged to participate in the process. The national carrier was an attractive investment proposition because of its lucrative slots at key Indian and international airports, flying rights to global destinations, its fleet size and market share. Tatas were interested in exploring the opportunity and collaborated with SIA to study the feasibility. Its findings revealed that robust middle level managers at Air India would be an asset in turning around the enterprise. SIA and Tata Sons offered to take 20% stake each in Air India. 

When their joint proposal emerged as sole bidders, it was almost a done deal. Yet, once again, there was an uproar. Virulent attacks by rival airline lobbyists and opposition from labour unions marred the atmosphere. Discomforted by these developments, Singapore Airlines withdrew its participation. It offered to assist the Tatas as technical advisors without any equity stake. That too cut no ice with decision makers. Tatas entry into the airline sector was successfully stonewalled one more time. [i]

 

 I am therefore taking the decision to withdraw our application.’ A decade later, in 2010, while addressing the Tenth Foundation Day of Uttarakhand at Dehradun, he shared a conversation he had with a fellow industrialist during the days when Tatas had applied for the airline. ‘You are stupid people. The Minister was asking for ₹15-crore. Why didn’t you pay the money?’ the industrialist chided Mr Tata.

‘I did not want to go to bed knowing well that I set up an airline by paying ₹15-crore as a bribe,’ was Mr Tata’s reply.

He regretted that despite being a pioneer in Indian aviation, Tata Group faced enormous problems in gaining approvals for a domestic airline. ‘We approached three Prime Ministers. But an individual thwarted our efforts to form the airlines,’ he admitted in public. He did not name the individual, though the grapevine pointed the needle to Jet Chairman Goyal. On another occasion he confessed, ‘It is not that we were thwarted that bothers me, but that vested interests combined to deny the country the benefit of a world-class competitive airline.’  

A new Sunrise

As for Air India, it had succeeded in accumulating losses of ₹50,000 crores and a debt of ₹55,000 crores by March 2018, a disdainful drain on the honest taxpayers’ money that could have been invested in vital social sector schemes. Besides the huge debt, some of the key problems plaguing the airline included routing and network issues, lack of decisive leadership, managerial complications, and internal incompatibility between the merged airlines. In his autobiographical account, M.K. Kaw regretted that the history of civil aviation in India had been a story of shameless exploitation and ruthless corruption. He called it ‘a fascinating saga of benami ownership of airlines, demands for bribes, destruction of rival airlines one-by-one, unwarranted purchase of aircraft, mismanagement of bureaucrats and politicians, free jaunts on inaugural flights, subsidized travel for many categories of travelers, VVIP flights, Haj flights and so on.’

By early 2019, Jet Airways faced operational closure; many observers calling it Karma coming a full circle. India’s characteristic Maharaja was on sale, yet no one wanted to acquire the once iconic brand that symbolized world-class air travel. Interestingly, Vistara was the only commercially successful full-service airline operating in India’s civil aviation space…  

Notes:

 

Role of E&Y in Scams and Fraud

 

EY accused of actively concealing NMC Health audit fraud from investors

 

·       EY Hidden and Manipulated account of NMC up to 6 billion USD.

This is not first time EY is accused of Manipulation and scam. In 2020, itself it is 3^rd case, where EY been accused of corruption.

NMC Health, the former FTSE 100 healthcare group, collapsed this year after discovering that more than $4bn was apparently hidden from its balance sheet in a large-scale fraud that spanned operations from Abu Dhabi to London.

EY has overseen NMC’s accounts since the healthcare company floated in London in 2012.

The quality of the firm’s audits has already been questioned due to the fact that NMC’s board included former EY partners.

·       Two Scandals Wirecard AG and Luckin Coffee, auditor is common EY. Where EY failed to fulfil its responsibilities.

These two companies have one other thing in common beyond their recent involvement in high profile accounting scandals – it turns out that both companies’ auditor was Ernst & Young, as was the case with several other companies involved in recent scandals.

As discussed in an October 17, 2020 Wall Street Journal article entitled “String of Companies That Imploded Have Something in Common: Ernst & Young Audited Them” (here), a number of EY audit clients have faced financial issues in recent months, raising questions whether there is something about EY’s audit approach that contributed to the problems or allowed the problems to happen.

 The 1.9 billion euros ($2.1 billion) missing from Wirecard’s balance sheet brought the chief executive officer’s arrest, the German payments firm’s insolvency filing and a lot of finger-pointing.

Financial data is manipulated to show nonexistent earnings. Common ways to cook the books include delaying expenses, accelerating revenues, off-balance sheet items, and nonrecurring expenses.

·       EY – and Lehman Collapse

One of the largest investment companies in the world suddenly vanished, filing bankruptcy that impacted our world today. Lehman Brothers were at the top of the charts; or at least that is what was portrayed in the media. The white collar crime that lost hundreds of billions of dollars has been inexistent, but still an unforgettable tragedy that effected the lives of so many.

The questions that must be resolved are what factors led to the Lehman Brothers’ financial crisis? What was Ernst & Young’s involvement and how did they cease to hide the facts behind Lehman Brothers’ downfall?

Lehman Brothers were one of the five largest U.S. investment companies, however on September 15, 2008, the company filed for bankruptcy.

The unpredictable collapse occurred because of several cover-ups and false information that was presented by Lehman Brothers along with the participation of one of the top accounting firms, Ernst & Young. With the assistance of the accounting firm, Lehman Brothers were able to cover up any issues that had been occurring for at least a few years.

These aspects all concluded with the involvement of Ernst and Young, by allowing the executives to manipulate these reports and not doing anything to stop it.

Ernst and Young obviously did not show any type of seniority over the Lehman Brothers by signing off and not auditing millions of fraud reports.

The firm knowingly approved the removal of billions of dollars in debt within Lehman’s quarterly reports (Freifeld, 2015). By affiliating with this scandal, Ernst & Young found themselves in a “massive accounting fraud”, leaving them with several white collar cases throughout the past seven years.

The Enron scandal of 2001 

When people mention an accounting scandal, often the Enron scandal and bankruptcy of 2001 come to mind. It was one of the most highly publicized scandals in accounting history. The big players in the scandal were CEO Jeff Skilling and CEO Ken Lay. The duo decided to keep big debts off the balance sheet. As the stock prices soared, suspicions increased. Ultimately, internal whistleblower Sherron Watkins caught the culprits. Employees lost their jobs, many investors and employees lost their retirement accounts, and shareholders lost $74 billion. Arthur Andersen was found guilty of manipulating Enron's accounts. Skilling got 24 years in jail, and Lay died before serving any prison time. 

The WorldCom scandal of 2002 

Just one year after Enron made headlines, people found out about the WorldCom Scandal of 2002. Telecommunications company WorldCom is now known as MCI, Inc. CEO at that time, Bernie Ebbers, inflated revenues with false accounting entries and under-reported line costs. The company's internal auditing department uncovered a significant $3.8 billion in fraud. Assets were inflated by up to $11 billion, leading to 30,000 lost jobs. And investors lost about $180 billion. The CFO was fired, and the controller resigned. Ebbers got 25 years in prison based on charges of fraud, filing false documents, and conspiracy. Weeks after these renowned and costly scandals, the United States Congress passed the Sarbanes-Oxley Act, the most detailed set of business regulations since the 1930s. 

The Bernie Madoff scandal of 2008 

The Bernie Madoff scandal was another famous accounting scandal in 2008. This highly publicized scandal focused on the Wall Street investment firm founded by Madoff, Bernard L. Madoff Investment Securities LLC. Investors were duped out of $64.8 billion in the most massive Ponzi scheme in history. The top players in this scandal were Madoff, his accountant David Friehling, and Frank DiPascalli. The company paid returns to investors out of their own money or money from other investors rather than from profits. Ironically, Madoff was caught when he told his sons about his scam, and they reported him to the SEC. Madoff was arrested the next day and faced 150 years in jail with $170 billion restitution. Friehling and DiPascalli also got jail time. Many recall 2008 marked the U.S. financial collapse, making this a notable year in accounting history. 

The Olympus scandal of 2011 

The Olympus scandal of 2011 was one of the biggest accounting scandals of the decade. The length of the fraud is what astounded everyone about this well-known international camera corporation. Michael Woodford, the company British chief executive, blew the whistle on inexplicable fees paid during acquisitions. The fraud totaled $1.7 billion. It was discovered the previous corporate management had buried losses since the 1990s. Acquisitions were used to cover up losses on poor investments, and the corporation had been deferring losses for over two decades. Former chairman Tsuyoshi Kikukawa, and two other executives received suspended prison sentences and one of the company advisers went to jail for four years. 

For decades, it was challenging to bring accounting scandals to light. In 1939, Kenneth McNeal wrote, “Trust in Accounting,” which evidences the poor accounting procedures of those times. In the 1960s and 1970s, various scandals arose but attracted little attention. By the new millennium, fraudsters became overconfident, got caught, and faced severe penalties. 

 

Comparison Islamic Accounting and Conventional Accounting

 

Differences between Islamic accounting and Conventional Accounting

To professional accountants and those who have received a conventional accounting education and who have been brought-up  on the idea of accounting as an ‘objective’, technical and value-free discipline, the idea of attaching a religious adjective to accounting may seem to be embarrassing and  unprofessional.

On the other hand, the development of Islamic banking and finance now embraced even by ardent capitalist institutions such as Citibank, HSBC and ANZ banks may interest accountants and other job seekers to the possibility of new opportunities in this new discipline.  Perhaps, the Enron affair has rekindled an interest in having a more honest profession who truly care about the public interest in addition to their pockets. Whatever the interest or curiosity, we hope readers will find this chapter (and hopefully the entire book) interesting, informative, and profitable and yes we hope it may even lead to a bit of soul searching.

·       Meaning of Islamic Accounting

Islamic accounting can be defined as the “accounting process” which provides appropriate information (not necessarily limited to financial data) to stakeholders of an entity which will enable them to ensure that the entity is continuously operating within the bounds of the Islamic Shari’a and delivering on its socioeconomic objectives. Islamic accounting is also a tool, which enables Muslims to evaluate their own accountabilities to God (in respect of inter-human/environmental transactions).

The above diagram illustrates the purpose of Islamic accounting. Muslims believe in the hereafter. All business activities should be in line with the shari’a or Islamic law, including business. In life, people transact through institutions such as business. These activities are classified, recorded and summarized using a philosophic filter (shari’a and Islamic accounting standards) to produce accounting statements, which people act on. If the information produced is useful and appropriate to make economic or social decisions through a moral framework, then the users will act in ways to correct their ‘sins’ and increase good behaviour leading to God’s pleasure in the hereafter. If the accounting information system misinforms or does not provide appropriate information, the business might be undertaking sinful activities, the responsibility for which will be borne by the investor as he is a participant. This may lead him to Hell.

The meaning of Islamic accounting would be clearer if we compare this with the definition of “conventional” accounting.  (Conventional) accounting as we know is defined to be the identification, recording, classification, interpreting and communication economic events to permit users to make informed decisions (AAA, 1966). From this, it can be seen that both Islamic and conventional accounting is in the business of providing information. The differences lie in the following:

Ø  The objectives of providing the information

Ø  What type of  information is identified,  and how is it   measured and valued, recorded and communicated, and

Ø  To whom is it communicated (the users)

Conventional accounting aims to permit informed decisions by users, whose ultimate purpose is to efficiently allocate scarce resources available to their most efficient (and profitable) uses by providing information efficiency in the market (FASB, 1978). Apparently this is achieved by the user making the appropriate, buy, sell or hold decisions on their investments. Islamic Accounting, on the other hand, hopes to enable users to ensure that Islamic organisations (whether business, government or NFP) abide by the principles of the Shari’a or Islamic Law in its dealings and enables the assessment of whether the objectives of the organisation are being met. At the very basic level, it can be said that Islamic organisations (whether business or otherwise) differ from their conventional counterparts by having to adhere to certain Shari’a principles and rules and also try to achieve certain socio-economic objectives encouraged by Islam.

Following from the above, the type of information which Islamic accounting identifies and measures is different. Conventional accounting concentrates on identifying economic events and transactions, while Islamic accounting must identify socio-economic and religious events and transactions. Older accountants may still remember when they  first learnt accounting. They had to prepare final accounts (i.e. balance sheet and profit and loss account). However, Americanization of the curriculum has popularised the term financial statements. Hence, the concentration of accounting has moved from stewardship based manorial accounts to accounting for money (accentuated by the monetary measurement concept).

This is not to say that Islamic accounting is not concerned with money (especially when accounting for businesses). On the contrary due to prohibition of interest-based income or expense, profit determination is more important in Islamic accounting than conventional accounting. However, Islamic accounting must be holistic in its reporting. Hence, both financial and non-financial measures regarding the economic, social, environmental and religious events and transactions are measured and reported. 

Conventional accounting mainly uses historic cost (or lower) to measure and values assets and liabilities (although the new IFRS seeks to introduce fair value measurements). The profession is well aware of the limitations of the stable unit of measure assumption of the monetary unit and to its credit has tried in the past in its inflation accounting initiatives. However, despite recommendation from its own research efforts (True blood committee?), the idea of using current values was given up due to its complexity and presumed lack of verifiability. From an Islamic point of view, at least for the purpose of computation of Zakat, current valuation is obligatory (see for example, Clarke et al, 1996) prompting calls for a current value Balance Sheet (Baydoun and Willet, 2000).

A further difference is, Islamic accounting may require a different statement altogether to deemphasize the focus on profits by the income statement provided by conventional accounting. Baydoun and Willlet (2000) have suggested a Value Added Statement to replace the Income Statement in Islamic Corporate Reports. They argue that this shows and encourages a cooperative environment in business as opposed to a destructive competitive environment.

The third category of differences is in the users of the information. Although the profession has recognised various stakeholders as users of accounting information (see for example, the Corporate Report, 1975), the users which it focuses on are shareholders and creditors (i.e. Financiers – those who provide the funds). This is obvious from the fact the FASB’s SFAC 1 dismisses a whole range of stakeholders by the term “and others”. From recent developments in finance and financial markets, accounting seems to be serving an elite group of financiers – market players and banks and other financial institutions. It has been accused of helping a group of rich people get richer (Gray et al., 1996)- a grave charge since the profession always justifies its monopoly on audit services by virtue of  the public interest.

Islamic accounting serves the whole gamut of stakeholders. Society as a whole can make corporations accountable for their actions and ensure they comply with Shari’a principles and do not harm others while making money ethically and achieve an equitable allocation and distribution of wealth among members of society especially the stakeholders of the concerned corporation.

 

Diminishing Musharkah

 

Diminishing Musyarakah

Diminishing musyarakah or musyarakah mutanaiqisah is another form of musyarakah which was developed recently by the scholars. It is a musyarakah in which the Islamic bank agrees to transfer gradually to the other partner its (the Islamic bank’s) share in the musyarakah, so that the Islamic bank’s share declines and the other partner’s share increases until the latter becomes the sole proprietor of the venture. According to this concept, a financier and his client participate either in the joint ownership of a property or an equipment, or in a joint commercial enterprise. The share of the financier is further divided into a number of units and it is understood that the client will purchase the units of the share of the financier one by one periodically, thus increasing his own share until all the units of the financier are purchased by him so as to make him the sole owner of the property or the commercial enterprise.

Diminishing musyarakah has taken different forms in different transactions. Some examples are given below:

A. It has been used mostly in house financing. The client wants to purchase a house for which he does not have adequate funds. He approaches the financier who agrees to participate with him in purchasing the required house. 20 per cent of the price is paid by the client and 80 per cent of the price by the financier. Thus the financier owns 80 per cent of the house while the client owns 20 per cent. After purchasing the property jointly, the client uses the house for his residential requirement and pays rent to the joint owner for using their ownership in the property.

At the same time, the share of the financier is further divided in eight equal units, each unit representing 10 per cent ownership of the house. The client promises to the financier that he will purchase one unit after three months. Accordingly, after the first term of three months, he purchases one unit of the share of the financier by paying 1/10th of the price of the house.

It reduces the share of the financier from 80 per cent to 70 per cent. Hence, the rent payable to the financier is also reduced to that extent. At the end of the second term, he purchases another unit increasing his share in the property to 40 per cent and reducing the share of the financier to 60 per cent and consequently reducing the rent by that proportion.

This process goes on in the same fashion until after the end of two years, the client purchases the whole share of the financier reducing the share of the financier to ‘zero’ and increasing his own share to 100 per cent. This arrangement, among other forms of diminishing partnership, allows the financier to claim rent according to his proportion of ownership in the property and at the same time allows him periodical returns of a part of his principal through purchases of the units of his share. B. ‘A’ wants to purchase a taxi to use it for offering transport services to passengers and to earn income through fares received from them, but he is short of funds. ‘B’ agrees to participate in the purchase of the taxi. Therefore, both of them purchase a taxi jointly; 80 per cent of the price is paid by ‘B’ and 20 per cent is paid by ‘A’. After the taxi is purchased, it is employed to provide transport the passengers whereby the net income of 1000 ringgit is earned on a daily basis. Since ‘B’ has 80 per cent share in the taxi it is agreed that 80 per cent of the fare will be given to him and the remaining 20 per cent will be retained by ‘A’ who has a 20 per cent share in the taxi. It means that 800 ringgit is earned by ‘B’ and 200 ringgit by ‘A’ on a daily basis. At the same time the share of ‘B’ is further divided into eight units. After three months ‘A’ purchases one unit from the share of ‘B’. Consequently the share of ‘B’ is reduced to 70 per cent and the share of ‘A’ is increased to 30 per cent, i.e. from that date ‘A’ will be entitled to 300 ringgit from the daily income of the taxi and ‘B’ will earn 700 ringgit. This process will go on until after the expiry of two years, whereby the whole taxi will be owned by ‘A’ and ‘B’ will take back his original investment along with income distributed to him as aforesaid.

Both the Buyer and the Bank will each contribute towards the purchase of the home. For example, the Bank may contribute 90% and the Buyer 10% of the purchase price. Over a period of up to 25 years, the Buyer will make monthly purchase installments through which the Bank will sell its share (90%) of the home to buyer. With each payment installment, the Bank's share in the property diminishes while the Buyer’s share correspondingly increases. While the purchase installments are being made, the Bank will charge the Buyer rent for the use of its share of the property, the rent being calculated according to the respective number of shares owned.

Many see this as little different from a conventional mortgage, because, under both methods, monthly payments are made which may be similar in amount. However, unlike a conventional mortgage, where money is lent to help with the purchase of a property, the Bank makes its profit through the property's physical use via buyer occupation as a tenant. This is one of the fundamentals of Islamic finance whereby you can charge for the use of something physical, like a property, but you cannot charge for the use of money, because this is interest. The relationship between buyer and the Bank is also quite different.

Islamic Finance - Introduction to Istisna Contract

 Istisn’a

Istisna´a, is a special kind of sale contract where a sale is transacted before the goods come into existence. It is a contract culminating in a sale at an agreed price, paid in advance, whereby the buyer places an order for the manufacture, assembly or construction, items to be delivered at a future date. The object of an Istisna´a contract should not be an identified asset which is already in existence and immediately available. The items must be specified to the extent of removing any ignorance, doubt or lack of knowledge of their kind, type, quality and quantity. In istisn’a transactions the buyer cannot before taking possession (actual or constructive) of the goods, sell or transfer ownership of the goods to any other person or party. Istisna´a is invalid for natural things or products that are not manufactured, such as animals, corn, fruits, etc

It is not necessary that the seller should be the manufacturer of the goods. The seller may enter into a contract with a third party to manufacture the goods specified in the Istisna´a contract. On this basis, banks may undertake financing based on Istisna´a by getting the subject of istisna´a manufactured through another such contract. Thus, Islamic banks can serve both as manufacturers and purchasers (see section on parallel istisna’a). Istisna´a can be used to provide the facility for financing the manufacture of goods or the construction of houses, plants, projects, bridges, roads, and highways, etc. The istisna´a contract can also be drawn-up for real estate developments on designated land owned either by the purchaser or the contractor, or on land in which either of them owns the usufruct. It involves the construction of specified buildings that will be built and sold according to specifications and, in this case, the contract of istisna´a does not specify a particular, identified place.

Where Istisna´a is used in manufacturing, the manufacturer will arrange the procurement of the materials for both manufacture and labour. If the materials for manufacture are supplied by the buyer and the manufacturer is required only to provide the labour and expertise, then it will be considered as a contract of ujrah (the financial charge, such as the agreed wage /remuneration, for using services and not of istisna´a where the material required also has to be provided by the manufacturer).  It is not always necessary in istisna´a for the full price to be paid in advance (unlike in salam, where spot payment of the price is necessary). The price may be paid in instalments within a fixed time period. Against the general rule applicable for salam, the contemporary Islamic scholars have legalised instalment payments in istisna’a based on istihsan (juristic "preference” over strict analogy.

The buyer in istisna´a is not regarded as the owner of the materials in the possession of the manufacturer for the purpose of producing the object of istisna’a contract, unless the manufacturer has previously guaranteed that such materials will only be utilised to fulfil the contract with the buyer. This form of guarantee will only be enforced in the event that the manufacturer has requested the buyer to pay part of the price in advance for acquiring some of the materials needed.

Potential of Istisna´a

Islamic banks can use istisna´a for manufacturing high technology goods such as aircrafts, ships, buildings, dams, high ways, etc. It can also be used for housing, export financing and meeting working capital requirements in industries where sale orders are received in advance. The potential areas for the application of istisna’a are indicated below:

• To finance the construction of buildings, factories, hospitals, schools and universities.

• Housing finance schemes

• To finance high technology industries such as the aircraft, locomotive and shipbuilding industries, and the various types of machines produced in big factories or workshops.

• To finance various industries where their productions can be monitored by measurement and specifications, such as in the food processing industry.