‘Shar'an Contracts for Islamic Financial uments Parti | 205 ‘Types of Murabahah Contract A murabahah contract comprises the following two types: 1 Ordinary murabahah, It is a contract in which the seller who is an ofdinary trader buys @ commodity without relying on any prior promise to purchase or to sell, o without a purchase undertaking or sale undertaking, He then resells it on « murabahah basis for a price plus profit to be agreed upon in the contract ret yor bos the pie of he commadiy tothe Eater eho on aah | Figuie 61 fae bee bass he pj dn etre bass Uoush mrs - et the steed be en tie | histration 2 An Ordinary, Murabata Structure Flow 2 Murabahah to the Purchase Orderer (MPO). This type of murabahah is widely applied by Islamic financial institutions Hls) as one of their financing tools. It involves the sale of a commodity Etough a murabahah contract to the purchase orderer (MPO) for a pre- Al selling price, which includes a pre-agreed profit mark up over its Sot Price:-This is clearly specified in the customer's promise to purchase i ssel. Hence, this transaction includes a prior promise to bay ora |. Frunghiade by a person interested in aoquirng the goods on credit irom | pum isnnable iting {abnancial institution. Therefore, itis called “murabaha to the purchase ee fed instalments. ~ ger 1 The Payment is payable within a fixed future date by lump sumrr Prineipies and Operatlons tstamie Financial Syst Application Mura contracts institutions a8 a mode tor vehicle ave been widely of financing in financing, personal financing, m the use of the MPO cons products compares snuurabahah structure flow for motor Figure 62. justration: ‘A Murababal Structure Flow for Motor Vehicle Financing Salient Shari’al igh in its classical form mal ‘8 mura sabato nis clasts ralings related to its aj jlication have been. saa neato many e PP moat However, main ts moder egal lines jah sues a8 on have ed tots applicat fr laid down clearly and omibined contracts (‘uqud mura of co ‘hen it involves undertakings ike agency neerybp bias’ 41 rebate inthe event of 2 default. Cassical jurists argued contracts in which evervt sre the mode of payment of sommodity through & mura “ferred payment basis, he must di that he has purchased the comme ire ia) je aid to have committed @ betrayal (igen fabahah contract Is doe t0 involves the time value of ring money wae n° recognised’by the Shari *eeferment . deferm of Murabahah Contra ‘used by many Islamic b: financing and trade financ cept is more prevalent in c 44 t0 ordinary murabahah. Fi vehicle financing: h issues in a Murabal yy not give rise ‘Kkabal) may result in many SI that the murabalah contrat fring should be discloses the first sale. For example, money which must be The time value of mon ent (ak-ajal) earns a portion in the cts in Islamic Finance wanks and financial such as home ‘operations ing. However, financing temporary Islamic financial of the ont gure 62 shows an example wishes hah Contract to many Shariah issues as 1e8A§ y and comprehensively Py ich i a form aid down clearl structure such as MPO whi spariah issues, especially uakala and purchase undertaking wail ct is one of the trust-b25S] 14 including the cost PANG if someone boul) shich was concluded nak contract Ww nd Bue fsclose to his customer (SeC0! city on a deferred payment Pa 1h) because a murabaalt account 2518 conttall ye taken into ey inthis regard nah contract, HEE entail price of a murabal‘Shartah Contracts for shame Financial Instruments ~ Part jurists stipulated that an increment in the price of a urabahah contract is due to assigning monetary value to deferment. As such, the question that arises 1e bank must give a rebate to and whether to from this is whether t the customer in the event of default, give for early settlement, or not. This is because, both cases, the deferment which constitutes the basis for increment in a murabahah contract is no longer enjoyed by the customer since he has to settle the debt on a spot basis. 2. Disclosure of cost price. fsclose the actual cost price or purchase price of the ‘The seller is obliged to di yn the basis of murabahal asset that is intended to be sold to the customer 0 bbe ascertained or is unknown, it is ‘Therefore, if the exact cost cannot In this case, the sale must be impossible to have a murabuhah contract conducted on the basis of musawamah (bargaining): 3. Use of the interest rate as a benchmark. Many institutions do financing by way of murabahah to determine thei profit or mark up on the basis of the current interest sn London) as the criterion. For example, mm murabahah 4 rate, mostly using the LIBOR (Interbank offered rate if the LIBOR is 6%, they would determine their markup 0} equal to LIBOR or some percentage above the LIBOR. This practice is often caiticised on the grounds that profit based on 2 rate of interest should be prohibited as interest itself. iy’ AL-Istisna’ (Manufacturing Sale) stasna‘a” which means t0 filly, the word istisna’ is derived from the Arabic verb “i bay’ al-istina’(hereaf x istsna’y | {someone to manufacture an asset. Technically, Fined as a contractual agreement with a manufacturer to produce items with Edldescriptions at a determined price, ts own effort. Ifthe materials needed a xe not provided by the manufacturer the construction of an item), the BY are from mustasni’ (the person who requests BTOjurists, the legality of an istina’ contract is established from different BUreeS such as the Sunnah, ijma’, giyas and istihsan. HON Hit the first legal basis for this contract, especially in -eported that Abdullah ibn ‘Umer has reported 0 ywever, istihsan seems Jassical Islamic 207 + hy abn deine 3 cont acre ruamafactured from his own materials |. "alteeted despot elated pee ant made by seeredadaters own eri eet in teal208 {slam Financal System: y object in an ists contact [bE someting atthe Sse alae concocting Flnisnna'bass 2, sidings, dices. houses and heavy o Principles and operations «the Prophet Muhammad (p.bst) requested the manufacturing » This narration provides a clear basis for the legitimacy of ° ia’ in Islam. According to Hanafi jurists te istisna? contract is legitimate nthe basis of the people's customary practice of his ‘contractin all periods of ‘on which in tur constitutes 2 legal consensus (3) him that of a ring for him, time without any object con the legality of an itisna’ contract Basic Rules and Conditions of an Istisna’ Contract 1. ‘The object to be manufactured must be precisely determined in its type, ind, quality and quantity. This s because the ‘manufactured object is the ‘oan itsna’ contract, which requires a clear determination nna’ contract is a form of sale of y’ al-ma‘durm) which is exernpted from HS original vs associated with the risk of uncertainty of the ruling. Hence, it is alway ijeliverability of the subject matter which can De mitigated through the mned mechanism. subject matter of its essence considering that an istis the nonexistent (ba abovementior rntract must be something that the people ct it on the basis of an istisna’ contract, ects such as @ 2. The object in an istisma’ cor are familiar with to contras ie, building houses and heavy vehicles. Therefore 0 book or a shit is not valid to be the subject matter 38 the people are ‘The time of pet accustomed to contracting them on an itisna’ Basis 4 object must be clearly specified 10 avoid delivery of the manufactures incertainty and ambiguity which may lead fo 2 Tater dispute among the, transacting parties. (a) The materials should be supplied by the contract is deer the manufacturer. If they provided by the buyer, smed as fara and not isis (b) The place of delivery should be specified if the roading or transportation expe 1e commodity nee Types of Istisna’ Contract “The istisna’ contract is divided into two types, the Firs and the other, three partes. They are as follows: + of which involves two pares Classical Istisna’ sna’ contract is one that hos been thoroughly discussed by Previg snare, This type of istisna’ involves tagni” and the manufacturer a8 £4" ‘A classical ist scholars in Islamic jurisprudence litera namely the buyer as must only 6 contracting parties, 1, Musnad Anas fn Mall, Hacith No, 220 5 anmad b, Hanbol (1998), Musnod Ahmar ‘sam A-Kutub, page 258. 32, 34‘Sharh Contracts for Islami Financial Instruments ~ Part | Palle istisna’ consists of two series of separate istisna’ contracts whereby the first contract is between the ultimate purchaser (customer) and the seller (bank), contemporary Islamic finance, an istisna’ contract is applicable to various industrial productions which can be “constructed or manufactured and supervised by specification. For example, an itisna” contract can be employed in housing " construction and advanced technology industries, equipment such as aircraft, automobile, ship and factory equipment. Salient Shariah Issues in Contemporary Application AA Shariah issue in an istisna’ contract arises in the event the ‘manufacturer fails to deliver the manufactured asset on the date agreed upon. One way that can be exercised to overcome this issue is by allowing the stipulation of a punitive condition (al-shartal-jaza') upon the manufacturer in the event of his failure to deliver the purchased asset at the agreed time. DON AA TY226 SD tstemic Financial System: Principles and Operations Salient Shari’ah Issues in Bay’ AF‘Inah Stipulation of a condition that contradicts the requlrements ofa contract “Te facts that ima by’ ana agreement, there are two contracts: the fist contacts the cae contact executed by the financial institution, and the second is the repurchase (eee ict of the same sod commodity from the customer ora financial institution, His go known thatthe second contract is executed instantly, and serv 8 condition for Saresent is executed instantly Se eondtionforine the first transaction. The issue saiged in this case is that, though al-Shafi'i and llbn Hazm rasan y tidnot prohibit na they dd prohibit to sales in one sale, and they also probed he — specification of additional conditions to a contract. They argued that these prohibitions wpe pased on the hadith ofthe Prophet (pth) that prohibits the carrying out of #0 ts in one sale contract, a8 well as that of relating a sale with conditions sale contract question here is: what is the stand of contravening the requirement of that sale. The ‘contemporary schools of law with regard toa situation where an opinion #6 referred toa specific schoo! of law in one legal ruling ora situation where fo, contradicting views are ted by the same school of aw or what s called tai? combined and one of them is tej Bay’ Al-Tawarruq (Monetisation/| Cash Financing/Cash Procurement) The Definition of Tawarruq ‘ewarrug is the infinitive (masdar) of the verb tatwarraga (to eat leaves) tS said as the leaves). As for the word soarig, it refers th minted and non-minted therefore, tawarraga al-hayaroan (ie. the animal ate to dirhams minted from silver. Some say it refers to bol silver (alfa al-madhrubah or a-fidhah ghayral-madhrbah), Taxarrag 38+ ‘used by earlier generations forthe purpose of seeking silver money while it is used nowadays for seeking paper money, nd that sa valid literal ussge derived from the same word. Hence, the monetisation beneficiary is called mutawarrig, Technically, 1d in the books of the Hanbali school of law while tawarrug is a term commonly Use tawarrug under the rubric of bay’ al-ajal and bay’ al~ other schools mention the form of "ina eae and buyback)-Hence, the technical meaning varies according toits diferent types. The Al-Mawswah al-Fighigyth AI-Kueoaytyuah (Fak Encyclopedia of Kuwait) defined !avarrug as “buying a commodity with deferred payment and selling it t0 8 ‘person other than the buyer for a lower price with immediate payment” Types of Tawarruq enerally,there are three types of tawarrug and they are as follows: 14 AbTawarrug AFFardl (Tawarruq on an Individual Basis) “The OIC Islamic Figh Academy defined itas: “The purchase of acommodity possessed and owned by the seller for a delayed payment, whereupon the buyer will resell SONIA ean LS cedeSharah Controcts for Islamic Financial Instruments ~ Part | © () nanorganised tavarrug, the original seller acts as an intermediary by selling, the commodity for cash on behalf of the mulawarrig, whereas the original seller in an individual tewerrug, absolutely does not play any role in the resale of the commodity and has no relation with the final buyer, In an organised fawarrug, the mutawurrig (the monetisation beneficiary) receives the cash from the original seller, to whom he owes the delayed price, ‘whereas the cash in an individual tavarrug will be taken by the mutawarrig directly from the final buyer without the seller being involved. (ii) In an organised tawarrug, the original seller might agree beforehand with the final buyer that he will purchase the commodity. This agreement will occur through the commitment of the final buyer to the purchaser so as to avoid a fluctuation of the price, 3° AttawarrugAbMascafl (Banking Tawarrua) itis a process where the IF formally organises the sale of a commodity (other than {old or silver) between an interational commodity market or other market and the nivtaanrra fora delayed payment ona binding condition that may be stipulated in the ontractor the custom and norms guiding sucha commodity. The Ifo example, will represen the mutavarrig in selling it to another buyer for cash, whereupon the bank wl dtiver its payment to the musnareg Mustim jurists consider banking lawarrug as a form of organised tasarrug preceded by murabahah (purchase and resale with profit) for the one who orders the purchase. Both of them are structurally the same but different in terms of the entity who administers the procedures ofthe tawarrug, The Legality of Individual and Banking Tawarrug The majority of scholars and figh councils consider individual taxarrug as permissible in principle, They, however, laid down some conditions to guarantee its proper application. | There ae three diferenens bbesween tawarrag on an individual basis and organised eawarrag < ‘The majotty of scholars and figh councils consider individual tanarag 3s permissible in principle They, however, laid Sow some conditions t0 raree its proper application. AL228 Islamic Financial System: Principles and Operations As for organised and banking taarrug, scholars disagree on their permissibility. There are those who are of the opinion that banking tawarruq is permissible as long as it fulfils some conditions, and there are those who oppose banking !mwarrug and consider it as a trick to circumvent the prohibition of riba. Evidence of Those Who Support Tawarrug System Those who allow tewarug in the banking system do so on the basis ofthe following, arguments: the Banking 1 ‘Tawarrug falls under the general statement of Allah (s.w-t.) which goes thus: “Allah (s.w-t.) has permitted trade and forbidden riba” (2:275). Tawarrug is a form of trade, which has, with all its forms, been declared lawful by the comprehensive indication of the abovementioned verse, except when there is specific evidence to prohibit a particular transaction. Therefore, t2izarrng is one of the forms of trade which Allah (s.w.t) has permitted in general, and there is no clear-cut evidence that declares it unlawful 2. It was reported by Abu Seid al-Khudri and Abu Hurayrah (r.2.) that the Messenger of Allah (p-bau.h.) appointed a man as his agent in Khaybar. He brought some junayb (good quality) dates to the Prophet (pbuh), who ‘asked him, “Are all the dates of Khaybar like this?” The man replied, “No, Tswear by Allah (s.w.t), O Messenger of Allah; we exchange a saa’ of this kind of date for two saa’s of another (lower in quality), and two sau’s of this for three saa's.” Allah’s Messenger said, “Do not do that! Sell [your] batch [of dates] for dirhams and then pay for the junayb dates with the dirhams.” (Gahih Bukhari). Their angle of reasoning, from the hadith is that something may be unlawful if ts format is not in line with the format endorsed by Shari‘ah, but if we are able to reshape it to a format approved by the Shariah, it becomes permissible, Tatoarrug is an authentic form of trade transaction characterised by its conditions and essential elements, and it is free of any factors that would render it useless or invalid because its aim is to achieve monetary liquidity so that people may not fall into riba 3, The initial assumption for transactions is that they are lawful unless there is proof that prohibits such a particular transaction, whereas there is ne known ‘Shariah proof that forbids this one. Therefore, those who argue that tevoarruq is lawful are not required to provide evidence. The burden of proof lies on those who prohibit tamarrug sales because they are the ones rejecting the initial assumption of permissibility for transactions. a NIA aber?‘Sharh Contracts for Islamic Financial Instruments ~ Pat sestive of traders from their transactions isto acquire more money in Hope for less money by meas of some comedy which serves an Tiradiary between the seller and buyer. No one says that when a trader Foto come out of a transaction with more money that the transaction is Fed. The same holds tre or tawarrug because the aim of the transactions and the commodity is an intermediate instrument between Jacquie money, istinction between a seller and a mutawarri, the je two parties. To make a di gies aims at making a profit while the muatarrig sels inorder t acquire (ach, whether he gains or loses. This isso because the profit itself is a means [facquiring, money and the miutawarrg does not lose, since the deferment of payment fr the commodity ha a roe in the overall value ofthe price Necessity calls for this kind of transaction, for not everyone who wants to borrow money finds someone to lend it to them. “Tawarrug is to be considered one of the forms of Islamic financing; it helps to cover many needs and to provide sufficient liquidity through lawful means 1 approved by the Shariah, and it is extremely effective in realising (the objectives of Islamic] economic philosophy and securing benefits for traders, irrespective of whether they are individuals or organisations. Is also an important instrument by which governments can finance their trade deficits and provide necessary liquidity. 7. The position of the Islamic banking system in Islamic countries with regard to conventional banking requires that not any opportunity should be missed for increasing its profitability and providing its customers with financing instruments. ite Tawarrug in the Evidence of Those Who Reput Banking System “Those who reject tawarrug inthe banking system rely upon the following arguments: 1. Banking tawarrug clashes with the principle that matters aze to be evaluated in light of their objectives. The objective of the repeated sales in tawarruy is to procure immediate cash in exchange for a deferred payment of a larger amount of cash. 2 Tawerrug in the Islamic banking system is a means that leads to riba, and blocking of the means is acceptable in Islamic law, as it is reflected in the prohibition of a killer from inheriting the person he has Killed. Banking tawarrug leads to the same result as rib, regardless of the outer form of the contract. This is because tawarrug leads to the exchange of immediate cash for deferred payment of a larger amount of cash, and that is the reason why riba is prohibited.230 | xhibito8 nowt Shariah rameters in BEA ding Organization for lamie nani ing Ore aces 10 ere the genie (AAOIFI) in its Shariah Institutions noarrrug- Some ‘he Accounting and Au ‘tandards No. 30 outlines pplication of ta salient conditions are as follows: she contract for selling asis and t receive asinga commodity on adeferred payment be it fora spot price should be linked together #9 auch a way thatthe client loses his right (0 the commodity, Such a linkage between the 1° nen cts prohibited whether itis stipulated in the documents or regarded as anormal tradition OF incorporated in the procedures. {446 The contract for purch: at to sell on his behalf a commodity that Arr ‘The dient should not delega fe purchase from the sme institution and Seay, the inttuton should not accept SUR 8 vrlepation. If, however, the regulations do Net ert the client to sll the commodity ST Ghecugh te same institution, hemay delegate Ine institu coafterhe mighthave actually tor impliedly received the commodity not arrange a proxy of a third party 10 it from the institution. te the institution or its agen tion to do 4/8 ‘The institution shoul sell the commodity on behalf of the dient that purchased sell the commodity except by himself oF through an agent other than the orve the other regulations. he information that he or his apo} 4/9 The client should not institution, and should duly ob a should provide the client with, inted agent may. 4/10. The institution commodity. need in order to sell the vermitted when there is ions should not) it should exert) | investment proxy, Suki, 1 ‘sation only when it faces yperations and cause losses ing, It has only been Ps tions. Therefore, the institut zations, instead, wyestment or finan sie terms and condit itising liquidity for their ope ‘modes such as mudarabals, resort to mone! the flow of its 0 ation is not a mode of in ject to speci mobi ough other ‘The institution should ‘hat could interrupt Monetisé ‘anced for it and subj ‘ise monetisation as a means of ‘effort for fund mobilisation thr: investment funds, and the like. the danger of a liquidity shortage for its clients 5 the use of proxy in selling the monetsation commodity, even if ener wvords, institutions should use their O88 brokers for this purpose #8 void .d with a third party. ‘mmodity, though using ‘The institutions should 2 the proxy is to be arrange personnel for seling the monetsation <> permissible. 522 pwc, ANGI Shar Standards for samc Fant Inatitations (2010) i 1s a kind of transaction invol we prohibited sug art ‘nak, which i lars and faluxe councils ha wanking taarn blatantly Presel tween the Isla 3 Banking tawarrug is a form of interest. The majority of schol: fective cause) is also the Lawgiver. This is present in be ‘The same ‘illak (ef ig the reason why itis probibited by dpe the banking, farrag in the contractual agreement betsn the mutsoarriqto make an immediate cash payment in exchange Muluger cash payment at alate me, Classifying the organised form of q within the parameters of ‘nah i strengthened by some narrations the Salaf, especially the use of the term ‘inal for organised tawarrug. In Iparation of’Abd al-Razzaq and Ibn Abi Shaybab, Dawud ibn Abi Qasim Cagafnaratd Dat i sister ad to him: “T want to buy « commodity by inah (credit sale), 3 order it for me.” He told her, “Ihave some grain in my possession.” He further related that: “I sold the grain to her fora price in gold til a fixed time and she took possession of it.” ‘She then said: “Find someone who will buy it from me.” told her I would sell it om her behalf, and I did so. Then I had a bad impression about my action shih prompted me to consult Sa’id ibn al-Musayyib, He asked me, “Consider (this) ‘are you not the original owner?” Isad: “Iam,” and he said: “That is absolutely riba (interest, so take your capital and return the excess back fo her." Banking tawarrug is not a replacement for currency-based financing (ie, loans on interest); rather it bears a close resemblance to it, for it represents a backward step from the intended course of the Islamic banking system and its dynamic financing instruments which are based upon the principle of promoting an increase in the production and circulation of what is good and useful. 5. The commodity exchanged as part of a banking tmwarrug may either be @ ‘mere document, Le, certificates sent from one place to another, which are ‘usually in the possession of a broker; or a defective commodity stored in a ‘warehouse which becomes the subject of repeated murabahah transactions; or it may be in a warehouse solely for the purpose of being the subject of such murabahah transactions. 6 The conditions of a genuine application of fawarrug as stipulated by its supporters contravene its actual application in a banking system. The Application of Tawarruq Tawarrug, or commodity murabahah, is one of the popularly used principles to structure various Islamic financial instruments. Table 62 provides alist of some common Islamic financial instruments that are structured based on tawarrug: :L1 AlMudanwanah AtKubra fi AHimam Malik Riwayat Safnun ihn Sa‘d AFTanukhi, Volume 4, pages 244-248, ‘Shar'ah Contracts for Islamic Financial Instruments ~ Part | ar ay = Sin ghee— ‘Table 62 Some Common Islamic Financial Instruments Based on Tawarrug Istamie Financial System: Principles and Operations CEE ego e cos Ree cas es ee ee Cpe aeons Ca ad ee (One ofthe alent issues in 2 Imurabahah contracts whether the agent i allowed ro conduct deals with himsel. i " xsn trig ase arg ‘aon cant teat rh rae ti oni acon is (HE, ee acon Inigtban maranatan, I conmasty Mrsbora, Bes Malle Spl Salient Shari'ah Issues in Tawarruq The Agent Performing Deals with Himself One of the salient issues in a murabahah contract is whether the agent is allowed to conduct deals with himself. According to the most common opinion of the majority of Muslim jurists including Hanafi, Shafi'i, Maliki and Hanbali scholars, it is absolutely prohibited for the agent to buy for himself. They based their ruling on the conflict oF interest between the agent and his client. Some Malikis and Hanbalis view that itis permissible to conduct deals with one’s self if the agent does not favour himself oF if he offers more than the market price, Contemporary Mustim jurists, too, are also divided in their opinions. AAOTFI in its Shari’h Standard No. 23, item No. 6 stipulates the following: 6/102: An agent should not conduct deals with himself or with his son oF daughter who is still under his guardianship or his partner in the same contract, 6/1/5: ‘The agent should not act for both parties to the contract. jjarah (Lease) Definition of Ijarah ‘The literal definition of ijarah is “the reward given for service rendered”, It is derived from the root word gjara ~ to recompense, compensate or to give a consideration oF return, Ajr (wage) when used in the context of jarah means the reward given for work