Islamic Finance

Chapter Two: Murabaha as a Mode of Islamic

Finance (Theoretical Background)

2
Dr.Reem Essam Bedeir
1. OVERVIEW
 The Murabaha contract refers to the sale of goods with
a pre-agreed profit mark-up on the cost.
Murabaha sale is of two types:
 In the first type, the Islamic bank purchases the goods
and makes them available for sale without any prior
promise from a customer to purchase them.
 In the second type, the Islamic bank purchases the
goods ordered by a customer from a third party and then
sells these goods to the same customer.
2. MURABAHA TO THE PURCHASE ORDERER
 The Murabaha contract, which involves the customer‟s
promise to purchase the item from the institution, is
called „Murabaha to the purchase orderer‟. By this it is
distinguished from the normal type of Murabaha, which
does not involve such a promise by the customer.
 The Murabaha to the purchase orderer is the sale of an
item by the institution to a customer (the purchase
orderer) for a pre-agreed selling price, which includes a
pre-agreed profit mark-up over its cost price.
 Normally, a Murabaha to the purchase orderer
transaction involves the institution granting the
customer a Murabaha credit facility.
 3. MURABAHA TRANSACTIONS
 The basic ingredient of Murabaha is that the seller
discloses
 the actual cost he has incurred in acquiring the commodity,
and then adds some profit thereon.
 This profit may be in a lump sum form or may be based on
a percentage.
 If a person sells a commodity for a lump sum price without
any reference to the cost, this is not a Murabaha, even
though he is earning some mark-up profit on his cost,
because the sale is not based on a „cost-plus‟ concept. In this
case, the sale is called Musawamah.
4. MURABAHA BASIS
There are four elements to this contract, as follows:
An order by a prospective buyer to a seller to buy a specific
commodity promising to buy it for a profit. Sharia‟a scholars
consider this order as an invitation to do business. It is not a
commitment.
If the seller accepts this invitation, he is bound to ensure that he
can locate the commodity, buy and own it via a true and legitimate
contract.
The seller then makes an offer to the prospective buyer after the
commodity has been bought and owned by the seller.
The prospective buyer has the option to buy the commodity or
renege on his promise. If he agrees to buy, then a Murabaha
contract is formed.
 5. DEFINITION OF MUSAWAMA
Musawama is a general kind of sale in which the price of
the commodity to be traded is stipulated between the seller
and the buyer without any reference to the price paid or
cost incurred by the seller.
Unlike Murabaha, the seller in Musawama is not obliged to
reveal his costs. All other conditions relevant to Murabaha
are valid for Musawama.
 Musawama can be a preferred mode of finance where the
seller is not in a position to ascertain precisely the costs of
commodities that he is offering to sell.
6- SOME TERMINOLOGICAL ISSUES
Murabaha is one type of trust sales (buyu’ al-amanah) where
the purchaser puts his trust on the seller to disclose the latter‟s
real cost of buying the subject matter.
Based on the cost disclosed by the seller, the purchaser (with
agreement between them) buys the subject matter adding a mark-
up as a profit to the seller. The strict definition is a cash sale with
payment being made promptly.
Bai’ Muajjal, in contrast, is a deferred payment sale. In other
words, the sold item is given to the purchaser promptly in the
majlis al-aqd (session or place of contract), but the price is paid
to the seller later or as credit. It is also called an Bai’ Bithaman
Ajil (literally meaning a
sale with a defered payment).
7. WHAT MAKES MURABAHA SHARIA’A
COMPLIANT?

It may appear, at first glance, that the mark-up is just

another term for interest as charged by conventional
banks. Interest, it could be argued, is thus being
admitted through the back door.
Yet the legality of the traditional type of Murabaha is
not questioned by any of the schools of Sharia’a law.
What makes the traditional Murabaha transaction in
Fiqh books Islamically legitimate is that the bank first
acquires the asset for resale at profit, so that a
commodity is sold for money and the operation is not a
mere exchange of money for money. In the process the
bank assumes certain risks between purchase and
resale:
7. WHAT MAKES MURABAHA SHARIA’A
COMPLIANT?
In the conventional financial system, when it comes to
matters of trading, money and commodities are both
treated at par. Both can be traded. Both can be sold at
whatever price the parties agree upon. One can sell one
dollar for two dollars on the spot as well as in the
future, just as one can sell a commodity valuing one
dollar for two dollars. The only condition is that it
should be with mutual consent.
Islamic economic principles, however, do not subscribe
to this theory. According to these principles, money and
commodities have different characteristics and
therefore they are treated differently.
8. THE BASIC POINTS OF DIFFERENCE BETWEEN
MONEY AND COMMODITIES

Money has no intrinsic utility. It cannot be

used for fulfilling human needs directly. It can
only be used for acquiring goods or services.
Commodities, on the other hand, have intrinsic
utility. They can be used directly without
exchanging them for some other thing.
Commodities can be of different qualities,
whereas money has no other quality except that
it is a measure of value or a medium of
exchange.
8. THE BASIC POINTS OF DIFFERENCE
BETWEEN MONEY AND COMMODITIES
When it comes to commodities, the transaction of sale
and purchase is effected on a particular individual
commodity, or at least, on the commodities having
particular specifications. If „A‟ purchases a particular
car by pinpointing it and the seller agrees, „A‟ expects
to receive that same car. The seller cannot compel „A‟ to
take delivery of another car, even of the same type or
quality.
Money, on the contrary, cannot be pinpointed in an
exchange transaction. If „A‟ purchases a commodity
from „B‟ by showing „B‟ a particular banknote of Rs.
1000, „A‟ can still pay „B‟ with another banknote of the
same denomination, while „B‟ cannot insist that he will
only accept the same banknote that was shown to him
earlier.
9. MURABAHA AND THE SHARIA’A

Murabaha cannot be traced back to the Qur’an or to the

Sunnah. Jurists have justified the use of the principle on
other grounds. The Maliki school of jurisprudence has
acknowledged the method because it claims that it has
always been the practice of the people in Medina.
The Shafii school and the Hanafi School justify the
Murabaha technique on other grounds, but it is evident
that all the schools of jurisprudence accept the usage.
The legality of a Murabaha sale can be justified from

“It is no crime in you if you seek of the bounty of your

Lord”. Al-Baqarah 198
10. PRACTICALITIES OF IMPLEMENTING
MURABAHA
There are stages and principles that a financial
institution should apply when implementing Murabaha
as a mode of finance.
1. The client and the institution sign an overall
agreement whereby the institution promises to sell and
the client promises to buy the commodities with an
agreed ratio of profit being added to the cost. This
agreement may specify the limit up to which the
facility may be availed.
2. When a specific commodity is required by the
customer, the institution appoints the client as its
agent to purchase the commodity on its behalf, and an
agency agreement is signed by both the parties.
10. PRACTICALITIES OF
IMPLEMENTING MURABAHA
3. The client purchases the commodity on
behalf of the institution and takes possession
as an agent of the institution.
4. The client informs the institution that it has
purchased the commodity on its behalf, and at
the same time, makes an offer to purchase it
from the institution.
5. The institution accepts the offer and the sale
is concluded whereby the ownership as well as
the risk of the commodity is transferred to the
client.
11- SHARIA’A RULES CONCERNING
MURABAHA

The subject of sale must exist at the

time of sale.
The subject of sale must be owned by
the seller at the time of sale.
The subject of sale must be in the
physical or constructive possession of
the seller when he sells it to another
person.
Thank you