Istisna is a sale by order in Islamic commercial law: the manufacturer or builder undertakes to produce an asset that does not yet exist, to precise specifications, for a price fixed at signing that can be paid upfront, in instalments or on delivery. Because the seller supplies the materials and the work, the Istisna contract is treated as a sale and not as a hire of labour, and it is the usual basis of Islamic financing for construction and manufacturing projects.
Where Istisna financing is used
Istisna financing appears wherever an asset must be built or manufactured before it can be used: a residential development, a factory extension, a ship, a pipeline, a batch of specialised machines. The customer lacks the asset today and cannot pay for it all at once, so a financier contracts to deliver the finished item at a fixed price and organises the production through a builder.
For the builder the Istisna contract creates a firm order with a known price, which makes it easier to secure materials and subcontractors. For the buyer it replaces an interest-bearing construction loan with a purchase price whose amount is known from the outset, even though the cash only leaves the buyer in stages as the work advances.
A sale of something not yet in existence
As a general rule, Sharia forbids selling what one does not own. Istisna is a recognised exception rooted in craftsmen's practice: the item will be shaped by the seller's work, who also supplies the materials, which sets it apart from a plain labour contract.
Specifications as the safeguard against gharar
Because the asset does not exist, its description must be precise enough to rule out excessive uncertainty: dimensions, materials, technical standards, drawings, place and date of delivery. Vague specifications invite disputes and may leave the contract open to challenge.
Price locked at signing, payment kept flexible
The price must be set when the contract is concluded, but settlement can follow the progress of the works. Unlike Salam, no full advance payment is required, so disbursements can be tied to milestones checked by an expert.
Can the price change during the works?
The AAOIFI standard on Istisna permits an adjustment when the buyer alters the specifications or unforeseen circumstances arise, provided both parties agree. A bank may not, however, raise the price simply because the customer is late in paying.
Milestone payments in an Istisna contract
A typical schedule ties each instalment to a verified stage: site preparation, structure completed, equipment installed, commissioning achieved. An independent engineer or expert certifies the stage before the financier pays the next tranche. The payments are part of the agreed price, so the final amount does not change merely because the work took the full time allowed.
The schedule should also say what happens to money already paid if the project stops. Where the builder fails to complete, the buyer's claim is for the delivery of the asset or for the refund of sums advanced, and the contract can require a performance bond or retention from the contractor so that the refund is backed by something more than a promise.
How banks use parallel Istisna in construction financing
The bank sells the asset to be built to the customer, then orders the same asset from a contractor under a second, independent contract. Its margin is the difference between the two prices, and it remains liable to its customer even if the subcontractor fails.
Who answers for construction defects?
Under parallel Istisna, the bank cannot escape its obligation by sending the customer to the contractor. It bears defects and delays, then pursues its own recourse against the subcontractor, which is usually backed by performance guarantees.
Late-delivery penalties that scholars accept
The OIC International Islamic Fiqh Academy has upheld, for Istisna, a penalty clause providing agreed compensation for late delivery, except in cases of force majeure. Such a clause targets the defaulting manufacturer, never late payment by the buyer.
Binding contract or mere promise?
The classical Hanafi school allowed the parties to withdraw before performance. The position now adopted by the Fiqh Academy and AAOIFI makes Istisna binding from the moment it is concluded, which gives certainty to long-term project financing.
Delivery, inspection and rejection under Istisna
Delivery in an Istisna contract is not a formality. The contract should name the place, the date and the acceptance tests, and it should state who carries the risk while the asset is in the builder's hands. If the finished asset departs from the specifications, the buyer can refuse it or demand correction, provided the agreement preserves that right in writing.
Disputes are common when specifications are described loosely, so many parties annex drawings, material lists and tolerances to the contract. A short list of inspection points, with a joint site visit before final acceptance, avoids a situation in which the financier has paid, the builder claims completion and the user refuses to take possession.
Istisna financing followed by Ijara for large projects
For a power plant, road or building, an Istisna during construction is often paired with an Ijara after completion. Rentals start on delivery, the operator repays gradually, and Sukuk can be backed by those cash flows.
Why Istisna Sukuk are not freely tradeable
Before completion, holders' rights mostly amount to a monetary claim on the buyer. Selling a debt at a price other than its face value is contested, so issuers blend these assets with tangible ones or restrict secondary trading.
Risks carried during the manufacturing phase
The bank carries credit risk on the customer, construction risk linked to the contractor, and price risk if material costs rise after the price has been fixed. Prudential standards require each of these to be measured separately.
Questions to ask before signing an order
Ask who bears cost overruns, which milestones trigger payments, what guarantees cover the contractor, how variations are handled and when ownership passes to you. The financier's Sharia board should have approved the full set of documents.
A cautious example of parallel Istisna pricing
Suppose a customer wants a warehouse and a bank agrees to sell it for 2,400,000, payable over the construction period and a short period after handover. The bank orders the same warehouse from a contractor for 2,000,000 under a separate contract. The difference of 400,000 is the bank's gross margin, from which it must cover its own costs, supervision and the risk that the contractor performs badly.
Two features keep this structure orthodox. The two Istisna contracts remain independent, so the contractor owes nothing to the customer and the customer has no claim on the contractor. And the bank may not rely on the second contract to escape responsibility under the first, because the delay or defect of its subcontractor is a risk it accepted when it set its own price.
- Check that the specifications attached to both contracts are identical.
- Ask how variations in the scope are priced and who approves them.
- Confirm the date from which the customer must start paying.
- Read the clause on defects after handover and the length of the warranty period.
Istisna and Murabaha: a difference in nature
In Istisna, the asset is manufactured or built to the customer's specifications. In Murabaha, the asset already exists and is resold to the buyer with a margin that is known to the buyer.
Points to include in the contract
The contract must identify the asset to be produced and its specifications, set the price, the payment terms and the delivery deadlines, and specify the guarantees. It must be concluded between parties with legal capacity.
The buyer may refuse the finished asset if it does not match the agreed specifications, provided the contract so provides.
Providers offering these services
- Askari Bank (Istisna) : Askari Bank describes its Istisna financing for manufacturing, assembly and construction projects delivered at a later date.