Financial contracts are sorted into three categories: full-disclosure contracts, called amanah contracts; trust-based contracts, called amanah-hand contracts; and negotiation contracts, called musawamah contracts.

• Amanah contracts require full and honest disclosure of cost and profit. The most common example is murabahah financing because it is a financing sale on the basis of cost-plus, and the amount of profit may be a lump sum or a ratio of cost. In this contract, any incidence that reduces the cost of the financier, such as a commission obtained on the contract, must be reflected in an equal reduction in the amount charged to the beneficiary.

The lease contract is separate and independent from the purchase contract, and neither is made dependent on the other.

Accounting and Auditing Organization for Islamic Financial Institutions, Shari’a Standards, 2003. Standard 9 § 3/2, p. 140.

It happened in Saudi Arabia in the year 2005 that one bank heavily used the stocks of a power company for its tawarruq transactions. The result was a great volatility in the price of that stock, to an extent that required central bank intervention to force the bank to stop using stocks in its tawarruq.

• Amanah-hand contracts include all financing transactions that imply agency or authorization to take action. This is best seen in a fund management contract. Managers are required to use the funds and make investment decisions in the best interest of the funds’ owners. Consequently, they will be charged for any fraud, neglect, or abuse of the funds, but they cannot be charged for a loss that results from changing market conditions.
• Musawamah contracts are those whose conditions are discussed, negotiated, and consented to by the parties. This can include agreeing on a rate of mark-up in murabahah or on a ratio of profit distribution in musharakah and mudarabah.

This categorization is not exclusive, as a contract may be based on consensual negotiation and, at the same time, on full and honest disclosure. Additionally, it may be a musawamah contract and an Amanah-hand contract at the same time.

👉 Read also:

• Principles of Islamic Finance: A Complete Guide
• Types of Classical Islamic Financing Contracts
• Types of Hybrid Islamic Financing Contracts

Reference:

This series is based on a paper published by Dr. Monzer Kahf in 2006.