Murabahah

Most of the Islamic banks and financial institutions are using murabahah as an Islamic mode of financing, and most of their financing operations are based on murabahah.

Lessons

Murabahah - Introduction

Most of the Islamic banks and financial institutions are using murabahah as an Islamic mode of financing, and most of their financing operations are based on murabahah. That is why this term has been taken in the economic circles today as a method of banking operations, while the original concept of murabahah is different from this assumption.

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Basic Rules of Sale

‘Sale’ is defined in Shariah as ‘the exchange of a thing of value by another thing of value with mutual consent’. Islamic jurisprudence has laid down enormous rules governing the contract of sale, and the Muslim jurists have written a large number of books, in a number of volumes, to elaborate them in detail. What is meant here is to give a summary of only those rules which are more relevant to the transactions of murabahah as carried out by the financial institutions:

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Cost Calculation in Murabahah

It is already mentioned that the transaction of murabahah contemplates the concept of cost-plus sale, therefore, it can be effected only where the seller can ascertain the exact cost he has incurred in acquiring the commodity he wants to sell. If the exact cost cannot be ascertained, no murabahah can be possible. In this case, the sale must be effected on the basis of musawamah (i.e. sale without reference to cost).

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Pricing for Cash and Credit Sales

The first and foremost question about murabahah is that, when used as a mode of financing, it is always effected on the basis of deferred payment. The financier purchases the commodity on cash payment and sells it to the client on credit. While selling the commodity on credit, he takes into account the period in which the price is to be paid by the client and increases the price accordingly. The longer the maturity of the murabahah payment, the higher the price.

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Bai’ Mu’ajjal – Deferred Payment

1. A sale in which the parties agree that the payment of price shall be deferred is called a “Bai’ Mu’ajjal”. 2. Bai’ Mu’ajjal is valid if the due date of payment is fixed in an unambiguous manner.

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Default Penalty - An Alternative

If nothing is charged from the defaulters, it may be a greater incentive for a dishonest person to default continuously. The question now arises as to how the banks and financial institutions may solve this problem.

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Features of Murabahah Financing

1. Murabahah is not a loan given on interest. It is the sale of a commodity for a deferred price which includes an agreed profit added to the cost. 2. Being a sale, and not a loan, the murabahah should fulfil all the conditions necessary for a valid sale, especially those enumerated earlier in this chapter.

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Murabahah - Guarantee

The seller in a murabahah financing can also ask the client to furnish a guarantee from a third party. In case of default in the payment of price at the due date, the seller may have recourse to the guarantor, who will be liable to pay the amount guaranteed by him. The rules of Shariah regarding guarantee are fully discussed in the books of Islamic fiqh. However, I would point out to two burning issues in the context of Islamic banking.

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Murabahah as a Mode of Financing

Originally, murabahah is a particular type of sale and not a mode of financing. The ideal mode of financing according to Shariah is mudarabah or musharakah which have been discussed in the first chapter. However, in the perspective of the current economic set up, there are certain practical difficulties in using mudarabah and musharakah instruments in some areas of financing. Therefore, the contemporary Shariah experts have allowed, subject to certain conditions, the use of the murabahah on deferred payment basis as a mode of financing.

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Promise to Purchase

Another important issue in murabahah financing which has been subject of debate between the contemporary Shariah Scholars is that the bank/financier cannot enter into an actual sale at the time when the client seeks murabahah financing from him, because the required commodity is not owned by the bank at this stage and, as explained earlier, one cannot sell a commodity not owned by him, nor can he effect a forward sale.

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Rebate on Earlier Payment

Sometimes the debtor wants to pay earlier than the specified date. In this case he wants to earn a discount on the agreed deferred price. Is it permissible to allow him a rebate for his earlier payment? This question has been discussed by the classical jurists in detail. The issue is known in the Islamic legal literature as: give discount and receive soon.

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Rescheduling of Payments

If the purchaser/client in murabahah financing is not able to pay according to the dates agreed upon in the murabahah agreement, he sometimes requests the seller / the bank for rescheduling the instalments. In conventional banks, the loans are normally rescheduled on the basis of additional interest. This is not possible in murabahah payments.

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Roll Over in Murabahah

Another rule which must be remembered and fully complied with is that murabahah transaction cannot be rolled over for a further period. In an interest-based financing, if a customer of the bank cannot pay at the due date for any reason, he may request the bank to extend the facility for another term.

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Securities against Murabahah Price

Another issue regarding murabahah financing is that the murabahah price is payable at a later date. The seller/financier naturally wants to make sure that the price will be paid at the due date. for this purpose, he may ask the client to furnish a security to his satisfaction. The security may be in the form of a mortgage or a hypothecation or some kind of lien or charge. Some basic rules about this security must, therefore, be kept in mind.

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Securitization of Murabahah

Murabahah is a transaction which cannot be securitized for creating a negotiable instrument to be sold and purchased in secondary market. The reason is obvious. If the purchaser/client in a murabahah transaction signs a paper to evidence his indebtedness towards the seller/financier, the paper will represent a monetary debt receivable from him.

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Subject Matter of Murabahah

All commodities which may be subject matter of sale with profit can be subject matter of murabahah, because it is a particular kind of sale. Therefore, the shares of a lawful company may be sold or purchased on murabahah basis, because according to the Islamic principles, the shares of a company represent the holder’s proportionate ownership in the assets of the company.

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Use of Interest Rate as Benchmark

Many institutions financing by way of murabahah determine their profit or mark-up on the basis of the current interest rate, mostly using LIBOR (Inter-bank offered rate in London) as the criterion. For example, if LIBOR is 6%, they determine their mark-up on murabahah equal to LIBOR or some percentage above LIBOR. This practice is often criticized on the ground that profit based on a rate of interest should be as prohibited as interest itself.

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Murabahah

Murabahah is the most widely used mode of finance in almost all Islamic Banks. In some Islamic Banks, Murabaha constitutes more than 90% of total assets of the bank. It does have clear advantage which make it very comparable to lending in conventional banking. It is because of this Murabahah is now becoming a mode of finance practiced even by convention banks. Contrary to what many people think, Murabahah is not new. It is one form of sale contract, which is known in Islamic Shari’ah for hundreds of years, albeit, not exactly the same from banks practice now.

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Constructing a Murabaha deal

In the majority of cases, a bank client applies for a loan because he wants to buy something. This could be a new car, a house, an office building, a yacht or a new machinery for his factory. These needs and many more, can be accommodated through Murabaha contracts. Such Murabaha can be constructed as follows:

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L/C Murabaha

One of the major applications of the Murabaha contract in Islamic banking is “documentary credit”. Murabaha is used as part of an L/C opening. Whenever a merchant wants to finance the importation of good, he can approach an Islamic bank to open a murabaha L/C. The bank, applying Murabaha, will (after doing credit evaluation etc.) will ask him to sign on a written promise that he will buy these goods on deferred payment once the because the ownership of the bank and that he is willing to pay an agreed upon mark-up to the bank. The bank will then open the L/C for its own benefit. The Uniform Customs (UCC) indicates that the owner of the goods in transit are the one to his order the goods are sent and whose name is mentioned in the shipping document. The bank will inform the exporter once a L/C is opened for the account of the bank that it is the bank that is buying the goods. This do it violate established rules of the UCC. Once goods are received at the harbor (or airport etc.) they will then be sold, by the bank to its client, who will be given an authorization to clear them through customs. Cost of L/C opening as well as all other incidental expenses including any foreign exchange transaction cost will be added to the purchase price of the goods for purpose of calculating the markup and the total cost.

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Murabaha in prearranged deals

Islamic banks which are active in international markets, finance many prearranged deals using the Murabaha. This is especially done in commodity markets. This arrangement can be as follows:

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