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Definition of 'Murabaha'

An Islamic financing structure, where an intermediary buys a property with free and clear title to it. The intermediary and prospective buyer then agree upon a sale price (including an agreed upon profit for the intermediary) that can be made through a series of installments, or as a lump

sum payment.

Investopedia explains 'Murabaha'


Murabaha is not an interest-bearing loan, which is considered riba (or excess). Murabaha is an acceptable form of credit sale under Sharia (Islamic religious law). Similar in structure to a rent to own arrangement, the intermediary retains ownership of the property until the loan is paid in full. It is important to note that to prevent riba, the intermediary cannot be compensated in addition to the agreed upon terms of the contract. For this reason, if the buyer is late on their payments, the intermediary cannot charge any late penalties.
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WEDNESDAY, OCTOBER 04, 2006

Al - Murabaha Murabaha is one of the most commonly used modes of financing by Islamic Banks and financial institutions.

Definition Murabahah is a particular kind of sale where the seller expressly mentions the cost of the sold commodity he has incurred, and sells it to another person by adding some profit thereon. Thus, Murabahah is not a loan given on interest; it is a sale of a commodity for cash/deferred price. The Bai' Murabahah involves purchase of a commodity by a bank on behalf of a client and its resale to the latter on cost-plus-profit basis. Under this arrangement the bank discloses its cost and profit margin to the client. In other words rather than advancing money to a borrower, which is how the system would work in a conventional banking agreement, the bank will buy the goods from a third party and sell those goods on to the customer for a preagreed price. Murabahah is a mode of financing as old as Musharakah. Today in Islamic banks worldover 66% of all investment transactions are through Murabahah. Difference between Murabahah and Sale

A simple sale in Arabic is called Musawamah - a bargaining sale without disclosing or referring to what the cost price is. However when the cost price is disclosed to the client it is called Murabahah. A simple Murabahah is one where there is cash payment and Murabahah Muajjal is one on deferred payment basis. Arguments against Murabahah An argument that arises in Murabahah is that profit or interest both are the same and Murabahah financing is the same as conventional banking. Islamic scholars however argue that in several respects a Murabahah financing structure is quite different to an overdraft organized along conventional lines and the former offers several benefits to the bank and its customers. Depositors are made to share in profits of the bank as a result of this financing. The basic difference is however the Aqd or the contract which covers the Islamic conditions. If the contract has interest element then it will be void. Basic rules for Murabahah Following are the rules governing a Murabahah transaction: 1. The subject of sale must exist at the time of the sale. Thus anything that may not exist at the time of sale cannot be sold and its non-existence makes the contract void. 2. The subject matter should be in the ownership of the seller at the time of sale. If he sells something that he has not acquired himself then the sale becomes void. 3. The subject of sale must be in physical or constructive possession of the seller when he sells it to another person. Constructive possession means a situation where the possessor has not taken physical delivery of the commodity yet it has come into his control and all rights and liabilities of the commodity are passed on to him including the risk of its destruction. 4. The sale must be instant and absolute. Thus a sale attributed to a future date or a sale contingent on a future event is void. For example, 'A' tells 'B' on 1st January that he will sell his car on 1st February to 'B', the sale is void because it is attributed to a future date. 5. The subject matter should be a property having value. Thus a good having no value cannot be sold or purchased. 6. The subject of sale should not be a thing used for an un-Islamic purpose. 7. The subject of sale must be specifically known and identified to the buyer. For Example, 'A' owner of an apartment building says to 'B' that he will sell an apartment to 'B'. Now the sale is void because the apartment to be sold is not specifically mentioned or pointed to the buyer. 8. The delivery of the sold commodity to the buyer must be certain and should not depend on a contingency or chance. 9. The certainty of price is a necessary condition for the validity of the sale. If the price is uncertain, the sale is void. 10. The sale must be unconditional. A conditional sale is invalid unless the condition is

recognized as a part of the transaction according to the usage of the trade. Step by step Murabahah Financing : 1. The client and the institution sign an overall agreement whereby the institution promises to sell and the client promises to buy the commodity from time to time on an agreed ratio of profit added to the cost. This agreement may specify the limit up-to which the facility may be availed. 2. An agency agreement is signed by both parties in which the institution appoints the client as his agent for purchasing the commodity on its behalf. 3. The client purchases the commodity on behalf of the institution and takes possession as the agent of the institution. 4. The client informs the institution that it has purchased the commodity and simultaneously makes an offer to purchase it from the institution. 5. The institution accepts the offer and the sale is concluded whereby ownership as well as risk is transferred to the client. All the above conditions are necessary to effect a valid Murabahah. If the institution purchases the commodity directly from the supplier, it does not need any agency agreement. The most essential element of the transaction is that the commodity must remain in the risk of the institution during the period between the third and the fifth stage. The above is the only way by which this transaction is distinguished from an ordinary interest-based transaction. Issues in Murabahah Following are some of the issues in Murabahah financing: 1. Securities against Murabahah Payments coming from the sale are receivables and for this, the client may be asked to furnish a security. It can be in the form of a mortgage or hypothecation or some kind of lien or charge. 2. Guaranteeing the Murabahah The seller can ask the client to furnish a 3rd party guarantee. In case of default on payment the seller may have recourse to the guarantor who will be liable to pay the amount guaranteed to him. There are two issues relating to this: a) The guarantor cannot charge a fee from the original client. The reason being that a person charging a fee for advancing a loan comes under the definition of riba. b) However the guarantor can charge for any documentation expenses.

3. Penalty of default Another issue with Murabahah is that if the client defaults in payment of the price at the due date, the price cannot be changed nor can penalty fees be charged. In order to deal with dishonest clients who default in payment deliberately, they should be made liable to pay compensation to the Islamic Bank for the loss suffered on account of default. However these should be made subject to the following conditions: a) The defaulter may be given a grace period of at-least one-month. b) If it is proven beyond doubt that the client is defaulting without valid excuse then compensation can be demanded. 4. Rollover in Murabahah Murabahah transaction cannot be rolled over for a further period as the old contract ends. It should be understood that Murabahah is not a loan rather the sale of a commodity, which is deferred to a specific date. Once this commodity is sold, its ownership transfers from the bank to the client and it is therefore no more a property of the seller. Now what the seller can claim is only the agreed price and therefore there is no question of effecting another sale on the same commodity between the same parties. 5. Rebate on earlier payments Sometimes the debtors want to pay early to get discounts. However in Islam, majority of Muslim Scholars including the major schools of thought consider this to be un-Islamic. However if the Islamic bank or financial institution gives somebody a rebate on its own, it is not objectionable especially if the client is needy. 6. Calculation of cost in Murabahah The Murabahah can only be effected when 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 then Murabahah cannot take place. In this case the sale will take place as Musawamah i.e. sale without reference to cost. 7. Subject matter of the sale All commodities cannot be the subject matter in Murabahah because certain requirements need to be fulfilled. The shares of a lawful company can be sold or purchased on Murabahah basis because according to the principles of Islam the shares represent ownership into assets of the company provided all other basic conditions of the transaction are fulfilled. A buy back arrangement or selling without taking their possession is not allowed at all. Murabahah is not possible on things that cannot become the subject of sale. For example, Murabahah is not possible in exchange of currencies.

Basic mistakes in Murabahah Financing Some basic mistakes that can be made in practical implications of the concept are as follows: 1. The most common mistake is to assume that Murabahah can be used for all types of transactions and financing. This mode can only be used when a commodity is to be purchased by the customer. If funds are required for some other purpose Murabahah cannot be used. 2. The document is signed for obtaining funds for a specific commodity and therefore it is important to study the subject matter of the Murabahah. 3. In some cases, the sale of commodity to the client is affected before the commodity is acquired from the supplier. This occurs when the various stages of the Murabahah are skipped and the documents are signed all together. It is to be remembered that Murabahah is a package of different contracts and they come into play one after another at their respective stages. 4. It is observed in some financial institutions that Murabahah is applied on already purchased commodities, which is not allowed in Shariah and can be effected on not yet purchased commodities. Uses of Murabahah Murabahah can be used in following conditions: Short / Medium / Long Term Finance for: Raw material Inventory Equipment Asset financing Import financing Export financing (Pre-shipment) Consumer goods financing House financing Vehicle financing Land financing Shop financing PC financing Tour package financing Education package financing All other services that can be sold in the form of package (i.e. services like education,

medical etc. as a package) Securitization of Murabahah agreement (certificate) is allowed at par value only. Other wise certain rules of Islamic Finance must be met. Bai' Muajjal Bai' Muajjal is the Arabic acronym for "sale on deferred payment basis". The deferred payment becomes a loan payable by the buyer in a lump sum or installment (as agreed between the two parties). In Bai' Muajjal all those items can be sold on deferred payment basis which come under the definition of capital where quality does not make a difference but the intrinsic value does. Those assets do not come under definition of capital where quality can be compensated for by the price and Shariah scholars have an 'ijmah' (consensus) that demanding a high price in deferred payment in such a case is permissible. Conditions for Bai' Muajjal 1. The price to be paid must be agreed and fixed at the time of the deal. It may include any amount of profit without qualms about riba. 2. Complete/total possession of the object in question must be given to the buyer, while the deferred price is to be treated as debt against him. 3. Once the price is fixed, it cannot be decreased in case of earlier payment nor can it be increased in case of default. 4. In order to secure the payment of price, the seller may ask the buyer to furnish a security either in the form of mortgage or in the form of an item. 5. If the commodity is sold on installments, the seller may put a condition on the buyer that if he fails to pay any installment on its due date, the remaining installments will become due immediately.

Murabaha
Among all the modes of Islamic finance, murabaha has played the most important role. Banks annual reports reveal that since the 1970s murabaha has been steadily responsible for the employment of about 8090% of Islamic banks resources. Murabaha in traditional fiqh (Islamic jurisprudence) is a spot sale contract where the price is based on a cost plus profit margin formula. The contract has been modified to include bai ajil (deferred payment sale) and renamed as Murabaha to the Order of the Purchaser. According to the new contract, the banks customer orders the purchase of a prescribed commodity that is available in the domestic or the foreign market. If the customers creditability is satisfactory, the bank buys the commodity, adding its markup to the market price. The bank accepts payment for the commodity in installments, which normally stretch over one year or more. When murabahapurchase is made by means of importation from foreign markets, letters of credit and foreign conventional banks are involved, and necessary shariah precautions are taken to avoid payment of interest at any step.

Murabaha, which has established a flexible mechanism for extending interest-free trade credit on short- and mediumterm bases to households and firms, has also played a significant role in financing small and microenterprises (for example Faisal Banks Um Dorman branch in Sudan). Banking risk involved in murabaha operations is significantly reduced by customers undertaking to fulfill the contract once the commodity is purchased and by collaterals in the form of mortgage rights given to the bank over the purchased commodity until its price is fully paid. The practice of murabaha has been the subject of criticism. It is held against Islamic banks that they are frequently guided by prevailing interest rates in determining their profit margin (markup) when they should instead consider market conditions for deferred payment sale, as intended in shariah. Also, (for instance in Pakistan) banks have sometimes not acted as purchasers and have merely financed customers in equivalent cash to the ordered commodity price plus markup. In this case the markup charged by the bank above the commodity price is no different from interest, which is prohibited.

Pakistan Today - By:Humayon DarFriday, 26 Aug 2011 12:16 am:

Murabaha is the most commonly used mode of financing in Islamic banking and finance. Murabaha is derived from the Arabic word ribh which means profit. Murabaha is a contract between a seller and a buyer, which requires the seller to disclose its profit to the buyer. This is considered more efficient as compared to an ordinary sale contract in terms of its informational efficiency, especially in the less developed markets that otherwise may not reveal full information on prices. Murabaha has historically been used for trading in goods that may not have well-developed markets in them. One obvious advantage of buying on a murabaha basis is that the buyer knows for sure what additional amount of money he is paying to the seller in the form of profit. Many people opine that murabaha is not necessarily an ideal mode of financing in Islamic finance, and hence argue for a more suitable financial tool as a replacement for interestbased financing. They view murabaha financing as a stratagem for replicating the economic effects of an interest-based loan. This view is, however, flawed. Murabaha differs from an interest-bearing loan in a number of ways, including but not limited to the following: 1. Interest-bearing loans are purely monetary transactions, ie, a lender gives money to a borrower who is required to return money, with an additional component (interest). Murabaha-based financing, on the other hand, involves trading of real goods and services for disclosed profit. 2. Murabaha-based financing gets the financier involved in the trading of goods and services, which is not a requirement in the case of interest-based lending. Given this nature of murabaha, it cannot be used for rescheduling of debts. Interest-based lending, on the contrary, allows people and businesses to borrow more to pay-off some of their existing loans. Thus, interest-based lending may give rise to spiralling debt. 3. Strictly speaking, there must not be a default penalty in the case of murabaha financing, which makes it more compassionate in nature than an interest-bearing loan that in most cases allows the lenders to impose additional interest payments in case a borrower fails to pay on time. In the actual practice of murabaha financing, a default penalty is imposed by financiers to curb the moral hazard on the part of the party receiving finance, but the amount of penalty is used for contributing to charity. Some people question the excessive use of murabaha financing in Islamic banking on the

grounds that this looks very similar to interest-based lending. This is not a new criticism. In fact, the Quranic verse 2:275 Allah has permitted trade and prohibited riba (interest) alludes to this criticism based on the close similarity between riba (interest) and trading. Thus the Holy Quran very clearly endorses (profit-oriented) trading of goods and services while prohibiting interest-based lending, despite the two practices being seemingly similar. Many people also criticise murabaha-based financing on the grounds that financiers buy an item from the market and immediately sell it on to the party seeking finance. This criticism, however, does not uphold in the eyes of the sharia, as the sharia does not put any minimum limit on the period of ownership of an asset by the seller before he may sell it on. Some of the sharia requirements for trading in goods and services are as follows: 1. It is required that the parties to a transaction are of sound mind and that they decide to enter into a trade by free will, without any coercion. 2. The object of sale must be halal and it must be in existence or ordinarily available in the market at the time of the sale. 3. The seller must own the object of sale before it is sold and delivered to a purchasing party. 4. An unambiguous price must be mutually agreed and paid by the purchaser to conclude the sale. Considering the above requirements, it is clear that the most important requirement for trading in goods and services is that the seller must own what they sell to another party. Hence, in the above-mentioned murabaha-based financing the real requirement for the financing party is to own and then sell the asset to the customer. The duration of ownership is not a sharia concern; rather it should be an economic decision. For a trader, the less time an item spends in the inventory, the more efficient the trade. In addition to trade financing for businesses, there are a number of possible uses of murabaha for consumer financing, including but not limited to: 1. Financing of durable goods like electronics and automobiles; 2. Home financing; 3. Store cards In a country such as Pakistan, murabaha-based financing can be used to finance a number of activities, including education of children. This can be done by setting up specialised murabaha companies for consumer financing. There are already a number of mudaraba companies and mudarabas set up under the Mudaraba Companies and Mudarabas (Floatation and Control) Ordinance 1980 and subsequent Mudaraba Companies and Mudaraba Rules. Such companies are primarily for business financing. The proposed murabaha companies must primarily focus on consumer financing. It is important that a comprehensive legal framework must be developed to regulate such a business. The requirement of disclosure of profit in murabaha trading can be used for the regulation of profit in consumer financing. This can be used as a policy tool in favour of providing affordable consumer financing to selected social groups. For example, if murabaha is used for financing of education, then the government may impose a profit ceiling in return for offering some tax incentives to the murabaha companies. Similarly, murabaha financing for buying computers can also be regulated to promote computer literacy, especially in the rural areas where still a large proportion of children have no access to computers.

These are only a few examples of the potential role that murabaha can play not only in consumer financing but in promoting a wider socio-economic agenda a government may seek to implement. A real benefit of promoting murabaha financing will be in terms of developing an alternative source of consumer financing on a localised basis. Banks mostly operate nation-wide and hence have credit policies that in general do not favour lowerincome families. Murabaha companies can be set up on a local and regional basis to promote a culture of Islamic credit unions, whereby different non-governmental organisations may attempt to join hands with professionals to develop a new model of consumer financing, by combining the rigour of banking and finance with the passion of charity and philanthropy. If done properly, this may pave the way for a more moral society, promoting social responsibility amongst individuals and businesses.

The writer is shari'a advisor to a number of banks and financial institutions and can be contacted at humayon@humayondar.com
Murabaha - as a mode of finance Originally, murabahah was a particular type of sale and not a mode of financing. The ideal mode of financing according to Shariah are mudarabah or musharakah. However in the perspective of the current economic circumstance there are certain practical difficulties in using mudarabah and musharakah as instruments in every type of financing. Therefore, the contemporary Shariah experts have allowed, subject to certain conditions, the use of murabahah on a deferred payment basis as a mode of financing. However, there are two important and essential points which must be remembered in this respect: 1. It should never be overlooked that originally murabaha was not a mode of financing. Murabahah is only a device to escape from "interest" and not an ideal instrument for carrying out the real economic objects of Islam. Therefore, Murabahah as an instrument of financing should be used as a transitory step taken in the process of the Islamization of the economy and its use should be restricted to those cases where mudarabah or musharakah are not practicable. 2. The murabahah transaction does not come into existence by merely replacing the word 'interest' by the words "profit" or "mark-up". Actually, murabahah as a mode of financing, has been allowed by the Shariah scholars with some conditions. Unless these conditions are fully observed, murabahah is not permissible. In fact it is the observance of these conditions which can draw a clear line of distinction between the interest-bearing loan and the transaction of murabahah. If these conditions are not observed, the transaction becomes invalid according to Shariah. Basic features of Murabahah financing 1. Murabahah is not a loan given o interest. It is a 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, murabahah should fulfill all the conditions necessary for a valid sale. 3. The financier must have a good title to the commodity before he sells it to his client. 4. The commodity must come into possession of the financier, whether

physically or constructively, in the sense that the commodity must be in the risk of the financier even though the risk may be for a short period. 5. The best way for murabahah according to Shariah is that financier himself purchases the commodity and keeps it in his own possession or purchases the commodity through a third person appointed by him as his agent before he sells it to the customer. However, it is also allowed that the financier may make the client himself his agent to buy the commodity on his behalf. In this case the client first purchases the commodity on behalf of his financier and takes possession as such. Thereafter, he purchases the commodity from the financier for a deferred price. His possession of the commodity in the first instance is in his capacity as an agent of the financier. In this capacity he is only a trustee while the ownership vests in the financier and the risk of the commodity is also borne by the financier as a logical consequence of the ownership. However, when the client purchases the commodity from the financier, the ownership as well as the risk is transferred to the client. 6. As mentioned earlier, the sale cannot take place unless the commodity comes into the possession of the seller but the seller can sign an agreement to sell even when the commodity is not in his possession. The same rule is applicable to murabahah. 7. In the light of the aforementioned principles, a financial institution can use the Murabahah mode of financing by adopting the following procedure:

Firstly,

the client and the institution sign an over-all agreement whereby the institution promises to sell and the client promises to buy the commodity on an agreed ratio of profit added to the cost.

Secondly, the institution appoints the client as his agent for purchasing the commodity on his behalf and an agreement of agency is signed by both the parties Thirdly, The client purchases the commodity on behalf of the institution and takes its possession as an agent of the institution Fourthly, the client informs the institution that he has purchased the commodity on its behalf and at the same time makes an offer to purchase the commodity from the institution. Fifthly, the institution accepts the offer and the sale is concluded whereupon the ownership as well as the risk of the commodity is transferred to the client.

All the abovementioned five stages are necessary to effect a valid murabaha sale. The most essential element of the transaction is that the commodity must remain in the risk of the institution during the period between the third and the fifth stage. This is the only feature of murabahah which can distinguish it from an interest-based transaction. Therefore, it must be observed with due diligence otherwise the murabahah transaction becomes invalid according to Shariah. 8. It is also a necessary condition for the validity of murabahah that the commodity is purchased from a third party. The purchase of the commodity from the client himself on a buy back agreement is not allowed in the Shariah. Thus murabahah based on 'buy-back' agreement is nothing more

than an interest-based transaction. 9. The abovementioned procedure of the murabahah financing is a complex transaction in which the parties involved have different capacities at different stages as follows: (a) At the first stage, the institution and the client agree to sell and purchase a commodity in the future. This is not an actual sale. It is only a promise to effect a sale in future on a murabahah basis. Therefore, 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. (d) At the fourth and fifth stages, the relationship of buyer and seller comes into existence between the institution and the client and since the sale is affected on a deferred payment basis the relationship of a creditor and debtor also emerges between them simultaneously. All these capacities must be kept in mind and must come into operation with all their consequential effects each at its relevant stage and these different capacities should never be mixed up or confused with each other. 10. The institution may ask the client to furnish security to its satisfaction for the prompt payment of the deferred price. It may also ask him to sign a promissory note or bill of exchange but it must be after the actual sale takes place i.e. 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 relationship of debtor and creditor between the institution and the client begins only at the fifth stage whereupon the actual sale takes place between them. 11. In the event of default by the buyer (client) in respect of the payment of the purchase price on the due date, the purchase cannot be increased. However, if he has undertaken in the agreement to pay an amount for a charitable purpose, as mentioned in clause 7 of the rules of Bai'Mu'ajjal, he shall be liable to pay the amount undertaken to be paid by him. However, the amount so recovered from the buyer shall not form part of the income of the seller/ the financier. The financier is bound to spend it for a charitable purpose on behalf of the buyer (client).

What is murabaha financing?


The Islamic Sharia Law prohibits the payment of interest. To use a mortgage is the most common form to purchase a home for many countries. On a conventional mortgage, the borrower needs to pay interest. So, the devoted Muslim avoids to purchasing a home. A few years ago, only the very rich can really afford to purchase a home. Now, mainstream financial institutions are changing to accommodate the Muslim devotees. Financial products are created. So, the Muslims are able to purchase a home.

As many countries lack the knowledge and language of Quran (Islamic bible), the Muslim scholars is needed to review the financial products. This is to make sure that the financial products are halal (permissible). The Muslim scholars also look at the money that is use by financial institution. The money must come from permissible sources. There are more and more Muslims that is living on a country with different predominantly religion. Naturally, the financial institutions are seeing the need to tap the Muslim market. It is believe to be worth in billions. The Murabaha and Ijara are the two mortgage refinancing options that meet the Islamic Sharia Law. In English, the Murabaha means deferred sale finance. As for Ijara, it means lease to own in English. In Murabaha, the borrower pays twenty percent as down payment. So, the borrower needs a substantial amount of capital in this option. First, the borrower shops for a home like the conventional mortgage. Next, the borrower pays the twenty percent down payment. Then, the financial institution purchases the home for the borrower. In return, the financial institution sells the home to borrower on a higher price. The higher price is determined by original price, repayment period, and down payment. Finally, the borrower agrees on the repayment amount and term agreement. In Ijara, the borrower looks for a suitable home. After he found a suitable home, the borrower negotiates the price to the home owner. When the price is settled, the financial institution purchases the home to gain ownership. Then, the borrower agrees to the lease agreement. On top of the lease, the borrower pays additional to pay off the mortgage. In any case, the borrower can pay off the mortgage without penalties. In reality, the Murabaha and Ijara are more expensive than the conventional mortgage. However, the Muslim devotees feel at ease. They rather pay more as long as it is permitted to their religion. Technically, the home is sold two times. First, the financial institution purchases the home. Then, the borrower purchases the home from financial institution. So, the borrower pays the mortgage refinancing closing costs two times. Recently, the mainstream financial institution charges only one closing costs for equality. Muslim communities in many countries are growing steadily. It is a dream to purchase a home someday. Nevertheless, there will be a few obstacles that will get in the way. It is just natural. Many devotees will feel guilty to take part that violates their religion. So, it is okay to pay extra. There are no complains. At first, many devotees think that conventional mortgage is the only way to proceed. Times are changing. Mainstream financial institutions bends toward their need and religion.

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