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MURABAHA
FINANCE
A PRESENTATION BY:
MUHAMMAD TAYYAB RAZA
Islamic Banking - ABN AMRO (Pakistan) Limited
At Specialized AlHuda CIBE Workshop at Avari Hotel
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LEARNING OBJECTIVES
Conceptual understanding of Murabaha
Stages involved in Murabaha
Transaction
Practical issues in Murabaha and their
resolution
Murabaha Documentation
Uses of Murabaha as Mode of Finance
(Local as well as import Murabaha)
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DERIVATION OF MURABAHA
The word Murabaha has been
derived from the Arabic word
Ribah, which has literary meaning
of profit.

TheMurabaha can be denoted as Sale


With Profit.

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DEFINITION OF MURABAHA

Murabaha is a particular kind of sale


where Seller expressly mentions the
cost it has incurred on purchase of the
Asset(s) to be sold and sells it to
another person by adding some profit,
which is known to Buyer.

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WHAT IS SALE?
Sale is defined in the Islamic Fiqh as
follows:
Exchange of a thing(subject
matter) of value with another thing
of value, with mutual consent.

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COMPONENTS OF VALID SALE

SALE

CONTRACT SUBJECT PRICE POSSESSION


MATTER

Offer/Acceptance Existence Quantified Physical


Buyer/Seller Ownership Certain Constructive
Possession
Valuable
Specific
Halal Purpose Instant and absolute
Delivery Unconditional 7
FEATURES OF MURABAHA

Murabaha finance is not a loan given


on interest, it is a sale of Asset(s) for
cash/deferred price.

It is the obligation of the Seller to


disclose the Cost and Profit to the
Buyer.
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FEATURES OF MURABAHA
Murabaha Finance can only be used for
the purchase of fresh Asset(s) only.

Buy-Back arrangement is prohibited.


This means that Murabaha transaction
cannot be executed for the Asset(s)
already purchased by the Customer.
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FEATURES OF MURABAHA
Murabaha Transaction can either be a
cash sale (Spot Payment Murabaha)
or a credit sale (Deferred Payment
Murabaha) or a combination of
both.

Payment of Murabaha Price can be


made in lump sum or in installments
or combination of both.
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FEATURES OF MURABAHA
Itis a fixed price sale and normally is
done for short term.

The Murabaha Finance can be used


to meet the working capital
requirements. However, it cannot be
used to meet the liquidity
requirements.
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VARIOUS
MODELS OF
MURABAHA
FINANCE
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MODEL - I
TWO PARTY REALTIONSHIP
Bank Customer

MODEL - II
THREE PARTY RELATIONSHIP
(Bank-Vendor) and Customer

MODEL - III
THREE PARTY RELATIONSHIP
Bank and (Vendor-Customer)
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MODEL - I
Thesimplest possible Model emerges
when the transaction involves two parties
only, i.e Bank and the Customer.
TheBank is also vendor and sells the
Asset(s) to its Customers on deferred
payment basis.
FromShariah perspective it is an ideal
Model and its profits are fully justified
because Bank assumes all risks as
Vendor/Trader. 14
MODEL I GRAPHICAL PRESENTATION

Customer Bank/Vendor
3

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MODEL I - PHASES
Phase 1:
The customer approaches Bank (Vendor) and
identifies Asset(s) and collects relevant
information including cost and profit.

Phase 2:
Bank sells Asset(s) to the Customer, transfer risk
and ownership to the Customer at certain
Murabaha Price.

Phase 3:
Customer pays Murabaha Price in lump sum or in
installments on agreed dates.
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MODEL - II
Inmost cases Murabaha Transaction
involves a third party (i.e. Vendor)
because Bank is not expected to engage
in sale of variety of products required
for variety of Customers.

TheBank directly deals with the


Vendor and purchases the Asset(s).
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MODEL II
The Bank sells the purchased
Asset(s) to the customer on cost
plus basis.

There are two distinct sale


contracts at different point of
times. First between Bank and
Vendor and second between Bank
and the Customer.
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MODEL II GRAPHICAL PRESENTATION

1 3
4
Vendor
5
2
6
Customer Bank
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MODEL II - PHASES
Phase 1:
Customer identifies and approaches the Vendor
or Supplier of the Asset(s) and collects all
relevant information.

Phase 2:
Customer approaches the Bank for Murabaha
Financing and promises to buy the Asset(s).

Phase 3:
The Bank makes payment to vendor directly. 20
MODEL II PHASES
Phase 4:
Vendor delivers the Asset(s) & transfers the
ownership of Asset(s) to the Bank.

Phase 5:
Bank sells the Asset(s) to Customer on cost
plus basis and transfers ownership.

Phase 6:
Customer pays Murabaha Price in lump sum
or in installments on agreed dates. 21
MODEL III BANKING MURABAHA

This Murabaha Model is mostly practiced


model in Banking now a days and
therefore we will look at it in more detail.
We will also look at the documentation
required at different stages of the
transaction.

It is also a three-party structure but it is bit


complicated than previous ones.
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MODEL III BANKING MURABAHA

The product of Murabaha that is being


used in Islamic Banking as a mode of
finance is something different from the
Murabaha used in normal trade .

It
is called Murabaha to the Purchase
Orderer .

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MODEL III BANKING MURABAHA

It is a bunch of contracts completed in


steps and ultimately suffices the financial
needs of the client.

THE SEQUENCE OF THEIR EXECUTION


IS EXTREMELY IMPORTANT TO MAKE
THE TRANSACTION SHARIAH
COMPLIANT.
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MODEL III GRAPHICAL PRESENTAION

3
4
Vendor 5

6
Offer Acceptance Bank
Customer
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PHASE I PROMISE TO PURCHASE AND SELL

The Customer approaches the Bank for


Murabaha Finance and promises to
purchase the Asset(s) from the Bank
which, the Customer will purchase as an
Agent of the Bank.
Master Murabaha Finance Agreement
(MMFA) shall be signed by the Bank
and the Customer at this stage. This is
basically a Memorandum of
Understanding between two parties.
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PHASE II APPOINTMENT OF AGENT
In the absence of expertise required to
purchase particular kind of Asset(s), the Bank
appoints Customer as its Agent to buy
Asset(s) on its behalf

Types of Agency Agreement

ON ASSET BASIS ON TIME BASIS

Global Agency Limited Period


Specific Agency Open Ended
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PHASE II APPOINTMENT OF AGENT
The appointment of an Agent for
purchase of Asset(s) for and on behalf
of the Bank and the ultimate sale of
such Asset(s) to the Customer shall be
independent transactions of each other
and separately documented.

However, according to Shariah


perspective, it is preferable to appoint
the Agent other than the Customer.
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PHASE II APPOINTMENT OF AGENT
Agency Agreement is not the condition
of the Murabaha if the institution can
make direct purchases from the
supplier.

Itis advisable to execute Agency


Agreement because financial institution
does not have the expertise to identify
the Asset(s) and negotiate an efficient
price.
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PHASE II DOCUMENTATION
AGENCY AGREEMENT

This agreement must contain:

Types (Global/Specific)
Description of Asset(s) to be purchased
Mode of Disbursement of Funds
Roles and Responsibilities of Agent

THIS DOCUMENTS MUST BE SIGNED BEFORE


PURCAHSE OF ASSET(S) BY THE AGENT
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PHASE III & IV
PURCHAHSE OF ASSETS BY AGENT
The Customer identifies the Vendor,
selects the Asset(s) on behalf of the Bank
and advice its particulars, including the
Vendors name and purchase price to the
Bank.

Ifthe supplier is nominated by the


Customer itself, guarantee for good
performance can be demanded from the
Customer.
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PHASE III & IV
PURCHAHSE OF ASSETS BY AGENT
The Customer takes possession of the
Asset(s) as an Agent of the Bank.
Itis the obligation of the Customer(Agent)
to ensure, at this stage, that Asset(s)
supplied is in accordance with the given
specifications.
To ensure that a fresh Asset(s) are
purchased by the Agent, Banks staff should
verify actual purchase of Asset(s). 32
PHASE III & IVDOCUMENTATION
DECLARATION FROM CUSTOMER (AGENT)

The Customer (Agent) will inform the Bank, through


this document, that it has taken the possession of
Asset(s) on behalf of the Bank.

This Transactional Document shall be an integral


part of Master Murabaha Financing Agreement
(MMFA).

This declaration must contain the statement that


Customer has inspected the Asset(s) to ensure that its
appropriateness and suitability to the customer. 33
Phase V
DISBURSEMENT OF FUNDS / PAYMENT TO VENDOR

The Bank has two options regarding for


payment of Purchase Price of Asset(s)
bought by Agent on its behalf.
a) Direct payment to Vendor by the Bank
(preferable).
b) Disbursement of Funds to Agents
(Customers) account for onward payment to
Vendor through Cross Cheque/Pay
Order/Demand Draft etc.
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PHASE V - DOCUMENTATION
LETTER OF DISBURSEMENT

This documents is request from Customer


to disburse funds for payment to Vendor.

The disbursement of funds to the Customer


shall be treated as Advance Against
Murabaha.

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PHASE VI
MURABAHA EXECUTION STAGE
(OFFER AND ACCEPTANCE)
The Customer offers to buy the Asset(s) from
the Bank which it has purchased as an Agent
of the Bank.

The Bank gives the Acceptance to the


Customers Offer.

THIS IS THE POINT WHERE THE


MURABAHA COMES IN TO EXISTENCE.
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PHASE VI
MURABAHA EXECUTION STAGE (OFFER
AND ACCEPTANCE)
It is obligatory that the point when the risk of the
Asset(s) is passed on by the Bank to the customer
be clearly identified.

It is mandatory to determine the Murabaha Price


at this stage, otherwise Murabaha shall not be
valid.

It is also mandatory to determine the date of


payment of Murabaha Price rendering the
Murabaha to be valid.
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PHASE VI
MURABAHA EXECUTION STAGE
DOCUMENTATION
a) OFFER FOR PURCHASE
The Customer offers to buy the Asset(s)
purchased by it as an Agent.
This documents should be signed after
actual possession of Asset(s) by the
Customer but before consumption of such
Asset(s).
This Transactional Document shall be an
integral part of Master Murabaha Financing
Agreement (MMFA).
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PHASE VI
MURABAHA EXECUTION STAGE
DOCUMENTATION
b) BANKS ACCEPTANCE OF OFFER

Bank accepts the Customers offer and


sells the Asset(s) purchased by
Customer(Agent) on its behalf on
Murabaha Price to be paid on agreed
future date.
The Asset(s) must be in Banks possession
by either way, i.e. physical or
constructive. 39
PHASE VI
MURABAHA EXECUTION STAGE
DOCUMENTATION
This document must contain

i. Murabaha Price (Cost+Profit)


ii. Repayment Date

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PHASE VI
MURABAHA EXECUTION STAGE
DOCUMENTATION
c) PAYMENT SHEDULE SUMMARY

The customer has three options to pay the


Murabaha Price.
i. Lump-sum payment
ii. Installment Payment
iii. Partly instant and partly in installment

This documents is required if the Customer


wishes to pay the Murabaha Price in
installments 41
PHASE VI
MURABAHA EXECUTION STAGE
DOCUMENTATION
d. DEMAND PROMISSORY NOTE

After execution of Murabaha, the


Murabaha Price will become the Debt
(Dyan) on the Customer.
This document is Customers
acknowledgement to the debt amount and
its promise to pay the debt.
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PHASE VII
PAYMENT OF MURABAHA PRICE BY CUSTOMER

Customer will pay the Murabaha Price to the


Bank on the agreed date.

The customer is not entitled to any reduction


in Murabaha price in case of early payment of
Murabaha Price.

In same way Bank can not increase the


Murabaha Price if the Customer defaults or
make delayed payment.
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SECURITIES IN MURABAHA

The institution may ask the customer to


furnish a security to its satisfaction for prompt
payment of the Deferred Murabaha price.

It is also permissible that the sold Asset(s)


itself is given to the seller as a security.

It is preferable not to take Interest bearing


instruments as securities.
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SECURITIES IN MURABAHA
Bank can obtain any of the following
security from its Customer client depending
upon the nature of credit facility, amount of
facility and credibility of the customer.
HYPOTHECATION OF ASSETS
PLEDGE OF GOODS AND/OR MARKETABLE
SECURITIES.
LIEN ON DEPOSITS.
MORTGAGE ON IMMOVABLE PROPERTIES.
BANK GUARANTEES.
PERSONEL GUARANTEES.
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MURABAHA IN FOREIGN TRADE
Murabaha

Import Export
Murabaha Murabaha

Pre-shipment Post-shipment

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USE OF MURABAHA IN IMPORTS
Agency Agreement must be signed before
opening of L/C in case of imports.
All costs/charges (e.g SWIFT charges, L/C
Opening commission) shall be included in the
cost of Murabaha Asset.
Offer and Acceptance may be signed when
the Asset(s) arrived at port.
In case of Usance L/C, Murabaha execution
stage is offer and Acceptance stage even
though the payment is made after usance
period. 47
USE OF MURABAHA IN EXPORTS

In case of Pre-shipment, normal procedure as


adopted in local Murabaha shall be strictly
followed.

In case of post-shipment, Murabaha can not


be executed for goods already exported.
However, Murabaha can be executed for fresh
purchases required for next shipment against
assignment of receivables for first shipment.
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PRACTICAL
ISSUES
IN MURABAHA
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Discount On Acquisition Of Assets
Discounts from supplier (If any)
would be passed on to the customer
at the time of Murabaha Sale by
reducing the cost of sales.

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Rise in Prices of Asset(s)
If there is a rise in prices and the amount
escalates for which financing is availed then
the transaction can only be executed if the
Bank has been informed and the Bank
subsequently accepts the same.

The institution reserves the right to reject


the purchases if made other then agreed
price.
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Change of Asset(s)

Change of Asset(s) in the agency


agreement can be done with mutual
consent.

If Agency Agreement is for specific


Asset(s) then new agreement is
required for changed Asset(s).

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Delay in Supply from the Supplier

Delay in Supply from the supplier in


case where specific time was allowed
leads to the revocation of agency
agreement. In such cases the
customer will refund the cost of
goods.

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Rebate in Early Payment
If the customer makes early payment and there is
no commitment from the institution in respect of
any discount in the price of Murabaha, than the
institution has the sole discretion in allowing
them the rebate.

But ,It is prohibited by Sharia'h Standards to give


Rebate to the client on early payment. Under
Murabaha the price is fixed, therefore, it is
recommended that issue should be brought in the
knowledge of Sharia'h advisor
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Rollover in Murabaha

Rollover is also not allowed.

Rollover
in a Murabaha Transaction
would imply that payment of earlier
Murabaha Price by executing new
Murabaha.
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Partial Murabaha

At times Customer may require partial


financing for its shipment.

In this case the share of Seller (Bank)


should be mentioned on the invoice and that
share should be separately kept to facilitate
the verification by Banks officer.

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Murabaha with Related Parties

In case of Murabaha, the Vendor and the


Customer must be independent to each other.

Banks are not allowed to enter into a


Murabaha Transaction where Vendor and
Customer are associated parties.

Parties are considered to be related parties if


one party has 33% or more shares/ownership
in the business of other party.
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JAZAKUM UALLAH

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