Murabahah

Khairuddin Zakaria khairuddinzakaria@gmail.com

Q1

Define Murabahah literally and as a technical term.

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A1
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Literally: the word murabahah is derived from the word ‘ribh’, which means profit or gain. technical term: murabahah is generally defined as: the sale of a commodity at the price the seller has purchased it, with the addition of a stated profit known to both the seller and buyer. it is a cost-plus-profit sale in which the seller expressly discloses the profit. Murabahah sale in its original Islamic connotation is simply a sale. The only feature distinguishing it from other kinds of sale is that the seller in murabahah expressly tells the purchaser how much cost he has incurred and how much profit he is going to charge in addition to the cost. if a person sells a commodity for a lump sum price or installment basis without reference to the cost, this is not murabahah, even though he is earning some profit on his cost because the sale is not based on a ‘costplus’ concept. This sale is called musawamah.

Cont.
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Murabahah is a sale based on trust (amanah). Classical jurists have given several definitions of murabahah as follows: A. Ibn al-Humam’s definition, “Al-murabahah is a contract of delivery of traded goods by a seller to the buyer by offering the buyer the selling cost price plus the total profit.” B. Ibn Qudamah defined al- murabahah as, “A form of business transaction whereby the customer is informed that the goods are sold at a price which includes the cost price and profit.” C. Imam Shafi’i described murabahah as: “When someone sells an item with a contract, for instance, for every ten products the profit is one, the buyer thus, must pay the cost price, that is 90 dirham, plus the profit of 1 dirham for every ten, hence 9 dirham and therefore eventually the total financing is 99 dirham”. D. Imam Malik explained that, “Al-murabahah occurs when an item is sold and the profit taken is one dirham for every dirham of the capital spent (1 cost price + 1 profit rate = 2 total financing), or half dirham for every dirham spent (1 cost price + 0.5 profit margin =1.5 total financing), or eleven dirham for every ten dirham capital spent (10 cost price + 11 profit margin = 21 total financing). Whether the profit is lower or more than the capital, it depends on the agreement between both parties.”

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Q2

What is the basis of murabahah from alQuran and Sunnah?

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Proof from al-Qur’an There are many Qur’anic verses explicitly permitting sale in general and these verses are an indirect proof of the validity of murabahah. This is because murabahah is considered as a type of trading. Some of these verses are: 1. “And Allah has permitted trade” [2:275]. .(275:‫" ََ َ ﱠ اﻟﱠ ُ اﻟْ َﯿْ َ َ َ ﱠ َ اﻟ ﱢ َﺎ" )اﻟﺒﻘﺮة‬ ‫وأﺣﻞ ﻠﮫ ﺒ ﻊ وﺣﺮم ﺮﺑ‬ In this regard, murabahah (cost-plus sales) is clearly concluded by mutual consent and it comes under the general permission in this verse. Proof from Sunnah Some scholars have made murabahah analogous to a form of sale called tawliyyah (sale at purchase price without making profit). This is because the Prophet (pbuh) purchased a female camel from Abu Bakr r.a. for use as transportation to migrate to al-Madinah. Abu Bakr wanted to give it to the Prophet (pbuh) free-of-charge and the Prophet (pbuh) refused and said, “I will preferably take it at the acquisition price.” This Hadith indirectly implied that a commodity can be sold at the acquisition price and also the acquisition price with mark up.

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Q3

Explain the three elements of murabahah

A3
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There are three important elements of murabahah, which are: 1: Subject matter: of a murabahah transaction involves the product and the selling price. The product shall be clearly defined including its type, quantity and other descriptions. the selling price of murabahah, its cost and profit must also be disclosed to the customer clearly. 2: The contracting parties: the seller as the financier and the buyer as the customer. these two parties are important because they are the principal players in the business transaction. The seller is responsible for supplying the product ordered by the buyer and the buyer must have the full obligation to pay for the product he purchased according to the agreed terms of the agreement. Both contracting parties must be adults, rational, intelligent, and can be held accountable. 3: Statement: The contract consists of the offer by one party and the acceptance by another party. It shall contain two important elements which are the cost price of the product and the rate of profit.

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Q4

Discuss the conditions for murabhah

A4
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the scholars have outlined several conditions for murabahah. These conditions are: A. Knowledge of the initial price or cost by the buyer. The buyer must know the price at which the seller obtained the object of sale. In this regard, the sale is considered defective if the initial price is not known during the contract session. B. Knowledge of the profit margin. Otherwise, it will not be regarded as murabahah; rather it is a normal sale.

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Cont.
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No riba trading shall be involved: The product traded using the murabahah scheme cannot be paid as per the barter system trading from some ribawi items which are prohibited by the Prophet (pbuh), namely, gold for gold, silver for silver, wheat for wheat, flour for flour, dates for dates and salt for salt and barley for barley unless the weight, measurement and the calculation are equal. Murabahah is forbidden for goods or properties from these six ribawi goods. for instance, selling 100 kg of good flour at the price of 120 kg of sub quality flour, because it is clear that this kind of transaction is forbidden as it constitutes riba. C. The initial contract must be valid: The traded item or property must be lawfully owned by the seller according to Shariah requirements. If the product is acquired through forgery, then the seller or financier is not the valid owner of the item. In this situation, the transaction in the murabahah contract is not valid, as per other terms of sales in Islamic commercial transactions.

Q5

Explain the practical steps for murabahah financing

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A5

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The practical steps for murabahah financing:
Shall be as follows: First: The client and the institution sign a master agreement whereby the institution promises to sell and the client promises to buy the commodities on an agreed ratio of profit added to the cost. Second: the institution appoints the client as his agent for purchasing the commodity on its behalf, and an agreement of agency is signed by both parties. Third: The client purchases the commodity on behalf of the institution and takes possession as an agent of the institution. Fourth: The client informs the institution that he has purchased the commodity on its behalf, and at the same time, makes an offer to purchase it from the institution. Fifth: The institution accepts the offer and the sale are concluded whereby the ownership as well as the risk of the commodity is transferred to the client. All these five stages are necessary to affect a valid murabahah.

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Cont.
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If the institution purchases the commodity directly from the supplier (which is preferable) it does not need any agency agreement. the commodity must remain in the risk of the institution during the period between the third and the fifth stages. This is the only feature of murabahah which can distinguish it from an interest-based transaction. In the above steps of murabahah financing, the parties involved have different capacities at different stages as follows: A. At the first stage, the institution and the client promise to sell and purchase a commodity in future. This is not an actual sale. It is just a promise to affect a sale in future on murabahah basis. at this stage the relationship between the institution and the client is that of a promisor and a promisee. B. At the second stage, the relationship between the parties is that of a principal and an agent. C. At the third stage, the relationship between the institution and the supplier is that of a buyer and seller.

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Cont.
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D. At the fourth and fifth stages, the relationship of buyer and seller comes into operation between the institution and the client. the relation of a debtor and creditor also emerges between them simultaneously. In a murabahah contract the institution may ask the client to furnish a security to its satisfaction for the prompt payment of the deferred price. It may be in the form of signing of a promissory note or a bill of exchange, but it shall be done after the actual sale takes place, that is, at the fifth stage mentioned above. The reason is that the promissory note is signed by a debtor in favour of his creditor, but the relation of debtor and creditor between the institution and the client begins only at the fifth stage, whereupon the actual sale takes place between them.

Murabahah Parties relationship

Promisor & Promisee

Principal & Agent

Buyer & Seller

Debtor & Creditor

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Q6

Can interest rate be use as benchmark in determining?

A6
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Use of Interest Rate as Benchmark Many institutions which offer 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 six per cent, they determine their mark-up on murabahah equal to LIBOR or some percentages above LIBOR. This practice is often criticised on the grounds that profit based on a rate of interest should be as prohibited as interest itself. If a murabahah transaction fulfils all of its conditions, merely using the interest rate as a benchmark for determining the profit of murabahah does not render the transaction as invalid, haram or prohibited, because the deal itself does not contain interest. The rate of interest has been used only as an indicator or as a benchmark.

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LIBOR

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BBA LIBOR is the most widely used benchmark or reference rate for short term interest rates world-wide. It is calculated daily by the BBA. BBA LIBOR is a trademark of the BBA, and the data remains the intellectual property of the BBA. BBA: British Bankers' Association.
For more information see: http://www.bba.org.uk.

Q7

What are the remedies in situation where the client default on his payment to the institution in a murabahah contract?

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A7
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Penalty of Default If the client defaults in payment of the price at the due date, the price cannot be increased. In interest-based loans, the amount of loan keeps on increasing according to the period of default. In murabahah financing, once the price is fixed, it cannot be increased. This restriction is sometimes exploited by dishonest clients who deliberately avoid paying the price at its due date because they know that they will not have to pay any additional amount on account of default. In order to solve this problem, some contemporary scholars have suggested that the dishonest clients who default in payment deliberately should be made liable to pay compensation to the Islamic bank for the loss it may have suffered on account of default.

Cont.

In Malaysia, the regulator has agreed that the bank can charge one per cent from the total outstanding amount or the actual loss as compensation for default of payment and it shall only be charged once and not compounded. In Middle East practice, the client, when entering into a murabahah transaction, should undertake that in case he defaults in payment at the due date, he will pay a specified amount to a charitable fund maintained by the bank. It must be ensured that no part of this amount shall form part of the income of the bank.

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Q8

Is the bank allowed to give rebate for early settlement of murabahah financing?

A8
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Rebate on Early 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 early payment? This question has been discussed by the classical jurists in detail. The issue is known in Islamic legal literature as “da’ wa taajjal” (give discount and receive soon). Some earlier jurists have held this arrangement as permissible, but the majority of the Muslim jurists, including the four recognised schools of Islamic jurisprudence, do not allow it if the discount is held to be a condition for earlier payment. The view of those who allowed this arrangement is based on a Hadith in which Abdullah ibn Masud was reported to have said that when the Jews belonging to the tribe of Banu Nadir were banished from Madinah (because of their conspiracies) some people came to the Prophet (pbuh) and said; “You have ordered them to be expelled, but some people owe them some debts which have not yet matured.” Thereupon the Prophet (pbuh) said to them (that is, the Jews who were the creditors), “Give discount and receive (your debts) soon”.

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Cont.

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The majority of the Muslim jurists, however, do not accept this Hadith as authentic. Even if the Hadith is held to be authentic, the exile of Banu Nadir was in the second year after hijrah, when riba was not prohibited yet. the majority of the jurists hold that if the earlier payment is conditioned with discount, it is not permissible. However, if this is not taken to be a condition for earlier payment, and the creditor gives a rebate voluntarily, it is permissible. The Islamic Fiqh Academy takes the same view in its annual session. It means that in a murabahah transaction effected by an Islamic bank or financial institution, no such rebate can be stipulated in the agreement, nor can the client claim it as his right. if the bank gives him a rebate on its own, it is not objectionable.

Q9

What are the prohibited elements in murabahah?

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A9
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THE PROHIBITED ELEMENTS IN MURABAHAH it is important to highlight some basic mistakes often committed by the financial institutions in the practical implementation of the concept. Among these mistakes which considered as prohibited elements are: 1. some financial institutions are using murabahah for financing overhead expenses of a firm or company like paying salaries of their staff, paying the bills of electricity and settling off their debts payable to other parties. These practices are totally unacceptable because murabahah can be used only where a commodity is intended to be purchased by the customer. Other suitable modes of financing like musyarakah, leasing, etc. can be used according to the nature of the requirement.

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2. The clients sign the murabahah documents merely to obtain funds though they do not intend to use these funds to purchase a specific commodity but to use them for some other unspecified purpose. Obviously this is a fabricated deal and it is the duty of the financier to make sure that the client really intends to purchase a commodity which may be subjected to murabahah. 3. Sale of commodity to the client is affected before the commodity is acquired from the supplier. This mistake is always committed in transactions where all the documents of murabahah are signed at one time without taking into account the various stages of the murabahah. This is totally against the basic principles of murabahah.

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Cont.

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Without observing this basic feature of murabahah financing, the whole transaction turns into an interest-bearing loan. 4: Entering into a murabahah contract on commodities already purchased by their clients from a third party. This practice is unacceptable in Shariah. Once the commodity is purchased by the client himself, it cannot be purchased again from the same supplier.

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If it is purchased by the bank from the client himself and is sold to him, it is a buy-back technique, which is disputed in Shariah, especially in murabahah. In fact, if the client has already purchased a commodity and he approaches the bank for funds. he either wants to set-off his liability towards his supplier or wants to use the funds for some other purposes. In both cases, an Islamic bank should not finance the client based on murabahah because a murabahah contract can only be affected on commodities which have not been purchased by the client yet.

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Q 10

What are the important clauses that need to be included in murabahah documentation?

A 10

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DOCUMENTATION OF MURABAHAH As for the documentation of the contract of murabahah, the following are some important elements that shall be included in the documentation and samples of salient features in the contract: 1. Sale and Purchase of the Goods 2. Securities 3. Fees and Expenses 4. Payment of Contract Price 5. Events of Default 6. Penalty 6. Indemnities 7. Assignment

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‫ﺷﻜﺮا ﺟﺰﯾﻼ‬ Thank You

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