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Time Value of Money and Murabahah/BBA profits

Saiful Azhar Rosly, Ph.D

International Center For Education in Islamic Finance (INCEIF),

In conventional loans, the contractual interest rate is the sum of

· interest rate of deposits

· overhead/transaction cost
· inflation premium
· default risk premium

In the case of al-bai-bithamain ajil (BBA) facility, the Shariah can only
recognize the overhead and profit margin elements. Both usually only
command about 2% and 1% respectively. For smaller banks, the lack of
scale economies may see higher overhead cost than larger size banks.
Overall, the mark-up element should amount to about 3%.

However, banks must also impute the cost of deposit factor. Since, no
promise to pay hibah and mudarabah profits is given, this naturally
implies that Islamic banks need not worry about determining the
contractual rate of return to depositors. But how can this be if they can
declare upfront how much profit they want from each of the murabahah
and BBA sale made?

For example, the bank sells an asset for $200,00 on BBA credit term.
Accordingly, the BBA or murabahah contract gave customers the right
to know the cost price. It is then not difficult to see that given the terms
of maturity of say, 20 years, the profit rate per annum should amount to
10% with a nominal mark-up of $100,000.

But now, the question is how should the bank explain the $100,000
profit they make from the BBA sale as legitimate (halal)? Recall the
‘iwad or equivalent contervalue is the condition for a lawful sale. Any
increase, according to the majority of jurists in the Shafi’, Hanafi,
Maliki, and Hanbali schools must contain ‘iwad.

To benefit from these increases, Islamic banks must be able to provide

something of equal value in return. Hence, when someone pays
$200,000 on BBA financing at $100,000 cost price, what is the nature
of ‘iwad he receives from the bank in exchange for the $100,000 profit?

Certainly, if the transaction is made on the spot or cash basis, problem

on the nature of lawful and unlawful gains should not have risen since
no time element is involved here. Which means that the bank purchases
the goods at direct or wholesale price, it assumes the risk of ownership.
While doing so, the bank sells the goods to the customer for $200,000
on cash term.

The legitimacy of the profit made is irrelevant since the bank has indeed
delivered the ‘iwad equivalence. This shall be in the form of:

· its ability to make the goods available in the market

· absorbing market risks and risk of ownership (daman milkiyah).

In the former, we are looking at the valued-addition( kasb) factor, while

latter describes the ghorm or risk-taking aspects of sale.

However in the BBA sale, it seems that the $100,000 profit is created on
the basis of time factor alone. To some extent, we failed to understand
how a profit rate of 10% can be determined ex ente when concurrently
Islamic banks cannot declare ex ente the rates of return on deposits.
Even if we accept the assumption that the 10% profit per annum
charged on every BBA sales arises from 1) cost of deposits, say 3% 2)
overhead 2% and 3) inflation premium margin 1%, what then explain
the additional 4% stipulated in the contract.

In conventional loans, the 4% can easily be explained by credit or

default premium.. This risk premium or spread will vary according to
the type and maturity of loans coupled with the credit ratings of
borrowers. Normally, bank will charge higher spread when risk of
defaults is higher. But these can only hold for loans (qard) and not sale

So, what can indeed explain these extra profits that Islamic banks took
from BBA sales. If the answer is about risk of default, then certainly it is
not about ‘iwad. The risk of default is about the game of waiting for
payments and problem of collections. It does not concern market risk. It
may be easy to say that profit from BBA is halal since BBA is a not a loan
but a sale (al-bay’).

But one has been misled to think that BBA is a spot sale. The mark-up
from spot sale is lawful since it contains ‘iwad but can we imply the
same for BBA credit sale when no tendency of ‘iwad can be detected
there ? This is true since the profit created from BBA is a consequence of
waiting i.e. time value. In this sense, the Shariah advisors seemed to
have approved gains arising from time value via BBA financing.