Risk of Istishtna Agreement Financing in Sharia Banking

Abstract

Istishna contract financing has become an integral part of sharia banking practice, where sharia financial institutions use this contract to finance construction projects, manufacture, or purchase goods with a system that complies with sharia principles. However, like other financing methods, istishna contracts also involve a number of risks that need to be managed carefully by the relevant financial institutions.

This article identifies the key risks associated with istishna contract financing in the context of sharia banking. These risks include contractual risk, project risk, liquidity risk, sharia compliance risk and reputation risk.

Contractual risks arise due to uncertainty related to the conformity of purchased goods with the specifications agreed in the istishna contract, as well as delays in delivery of goods or inability to receive goods by the buyer. Meanwhile, project risk is related to changes in the project environment that can affect the quality or completion time of the funded project.

In addition, liquidity risk is related to the ability of sharia banks to fulfill their financial obligations, while sharia compliance risk is related to non-compliance with sharia principles in the process of implementing istishna contracts. Reputational risks are also a concern, especially if Islamic financial institutions are involved in controversial cases or are inconsistent with ethical and moral values in their business.

This study also explores mitigation strategies that Islamic financial institutions can adopt to manage these risks. This strategy includes implementing strict supervision and control mechanisms, portfolio diversification, careful monitoring of funded projects, and the use of sharia derivative financial instruments to manage risk.

By understanding and managing the risks associated with istishna contract financing, sharia banks can strengthen their resilience and maintain operational sustainability in facing various market challenges, while still complying with sharia principles in every financial transaction.

Keywords: Financing Risk, Istishna' Agreement & Sharia Banking

Discussion

Financing in sharia banking uses various (technical) mechanisms and contracts to ensure compliance with sharia principles. One of the methods used in the financing process is the istishna contract. An istishna contract is a sale and purchase agreement in which the seller agrees to make certain goods according to the specifications agreed with the buyer at a future time at a certain price that has also been agreed upon.

In the istishna contract, the bank acts as a manufacturer of goods and not as a seller. This differentiates it from a sale and purchase agreement (murabahah). The bank makes a profit from the difference between production costs and the sales price previously agreed with the client.

Istishna contract financing is one of the important instruments in the sharia banking industry which allows financing of projects that require the production of goods with certain specifications in accordance with sharia principles.

Even though the istishna contract is a valid instrument or contract in sharia banking, as in every other contract financing activity, there are a number of risks that need to be considered:

1.Contractual Risk: Related to the possibility of inconsistency between the contracts made between the parties involved in the istishna transaction. This risk can arise if there is ambiguity in the agreement.

• Project Risk: Refers to the risks associated with project implementation regulated by the istishna contract. This may include delays in delivery of goods or an inability to meet promised specifications.
• Liquidity Risk: This is the risk related to the availability of funds or liquidity in carrying out istishna transactions. If one party is unable to fulfill its obligations financially, this can cause an imbalance in the transaction.
• Sharia Compliance Risk: Refers to the risk that transactions carried out may not be in accordance with sharia principles. This risk arises if there is non-compliance with the rules regulated by Islamic law in the istishna contract process.
• Reputation Risk: This is the risk associated with the image or reputation of the parties involved in the istishna transaction. If there is a discrepancy or dissatisfaction in the transaction, the reputation of the parties may suffer.

To reduce the risk in financing with an istishna agreement, sharia banking takes various steps, including:

• Risk Management: Through careful risk analysis to understand the risks that may arise in the istishna contract. Establish a risk management strategy that includes diversification, insurance and clear agreements between the parties involved.
• Inspection and Supervision : Carry out strict supervision of the production process to ensure the quality of goods and the smooth delivery process.
• Good Cooperation with Related Parties: Ensure good cooperation with producers, raw material suppliers and other parties involved in the production process.
• Understanding of Laws and Regulations: Have a deep understanding of the laws and regulations related to istishna contracts to avoid potential conflicts and legal changes that could affect financing.

In the context of sharia banking, risk management and a deep understanding of sharia principles are very important to minimize risks and ensure the continuity of istishna contracts and other financing within limits in accordance with sharia principles.

Conclusion

This article has explained the risks involved in istishna contracts in sharia banking and also ways to reduce these risks. A deep understanding of these risks is crucial in maintaining financial stability. In dealing with these risks, it is important for Islamic financial institutions to implement effective risk management strategies. Through continuous innovation, development and understanding, it is possible to minimize the negative impact of these risks and improve the quality of sharia-based financial services.