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Islamic Modes of Financing

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.
What is Sale?

Sale is defined in the Islamic Fiqh as an

Exchange of a thing of value with another thing

of value, with mutual consent.
Components of Valid Sale



•Existence •Quantified
•Offer/Acceptance •Physical
•Ownership •Certain
•Possession •Constructive
•Halal Purpose
Features of Murabaha

1. Murabaha finance is not a loan given on

interest, it is a sale of asset(s) for cash/deferred

2. It is the obligation of the seller to disclose the

cost and profit to the buyer.
Features of Murabaha
3. Murabaha finance can only be used for the
purchase of fresh asset(s) only.

4. Buy-back arrangement is prohibited. This means

that Murabaha transaction cannot be executed
for the asset(s) already purchased by the
Features of Murabaha
5. Murabaha Transaction can either be a cash
sale (Spot Payment Murabaha) or a credit sale
(Deferred Payment Murabaha) or a combination
of both.

6. Payment of Murabaha Price can be made in

lump sum or in installments or combination of
Features of Murabaha
7. It is a fixed price sale and normally is done for
short term.

8. The Murabaha Finance can be used to meet

the working capital requirements. However, it
cannot be used to meet the liquidity
Model - I
Two party relationship
• Bank – customer

Model - II
Three party relationship
• (Bank-vendor) and customer

Model - III
Three party relationship
• Bank and (vendor-customer)
Model - I
• The simplest possible model emerges when the
transaction involves two parties only, i.e. Bank and the

• The bank is also vendor and sells the asset(s) to its

customers on deferred payment basis.

• From Shariah perspective it is an ideal model and its

profits are fully justified because bank assumes all risks
as vendor/trader.

Customer 1 Bank/Vendor

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
Phase 3:
Customer pays Murabaha Price in lump sum or in
installments on agreed dates.
Model - II
• In most 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.

• The bank directly deals with the vendor and

purchases the asset(s).
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.
Model II – Graphical Presentation

1 Vendor 3

Customer 2 Bank

Model II - Phases
Phase 1:
Customer identifies and approaches the Vendor
or Supplier of the Asset(s) and collects all relevant
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.
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.
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.
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 order.

Model III – Banking Murabaha

• It is a bunch of contracts completed in steps and

ultimately serves the financial needs of the client.

• The sequence of their execution is extremely

important to make the transaction Shariah
Model III – Graphical Presentation


Customer 2 Bank

Offer Acceptance

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.
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
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, it is preferable to

appoint the agent other than the customer.
Phase II – Appointment of Agent
• Agency agreement is not the condition of the
Murabaha if the institution can make direct purchases
from the supplier.

• It is advisable to execute agency agreement because

financial institution does not have the expertise to
identify the asset(s) and negotiate an efficient price.
Phase II – Documentation
Agency agreement

• This agreement must contain:

a. Types (global/specific)

b. Description of asset(s) to be purchased

c. Mode of disbursement of funds

d. Roles and responsibilities of agent

• This documents must be signed before purchase of

asset(s) by the agent
Phase III & IV –
Purchase of Assets by Agent

• The customer identifies the vendor, selects the asset(s)

on behalf of the bank and advice its particulars, including
the vendor’s name and purchase price to the bank.

• If the supplier is nominated by the customer itself,

guarantee for good performance can be demanded from
the customer.
Phase III & IV –
Purchase of Asses by Agent

• The customer takes possession of the asset(s) as an agent

of the bank.

• It is the obligation of the customer(agent) to ensure, at this

stage, that asset(s) supplied is in accordance with the given

• To ensure that fresh asset(s) are purchased by the agent,

bank’s staff should verify actual purchase of asset(s).
Phase III & IV– Documentation
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.
Phase v
Disbursement of Funds / Payment to Vendor

• The bank has two options regarding 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 agent’s (customer’s)

account for onward payment to vendor through
cross cheque / pay order / demand draft etc.
Phase V - Documentation
Letter of disbursement

• This documents is a request from customer to

disburse funds for payment to vendor.

• The disbursement of funds to the customer

shall be treated as “advance against
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

• The bank gives the acceptance to the customer’s


• This is the point where the Murabaha comes in to

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
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).
Phase VI
Murabaha Execution Stage Documentation

b) Bank’s acceptance of offer

• Bank accepts the customer’s 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 bank’s possession by either

way, i.e. Physical or constructive.
Phase VI
Murabaha Execution Stage Documentation

• This document must contain

i. Murabaha price (cost+profit)

ii. Repayment date
Phase VI
Murabaha Execution Stage Documentation

c) Payment schedule 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
Phase VI
Murabaha Execution Stage Documentation

d. Demand promissory note

• After execution of Murabaha, the Murabaha

price will become the debt (dayn) on the

• This document is customer’s acknowledgement

to the debt amount and its promise to pay the
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

• In same way bank can not increase the Murabaha price if

the customer defaults or make delayed payment.
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 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.
a. Hypothecation of assets
b. Pledge of goods and/or marketable securities.
c. Lien on deposits.
d. Mortgage on immovable properties.
e. Bank guarantees.
f. Personal guarantees.
Murabaha in Foreign Trade


Import Export
Murabaha Murabaha

Pre-shipment Post-shipment
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.
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.
Practical Issues in Murabaha
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.
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.
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
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.
Rollover in Murabaha

• Rollover (renegotiate) is also not allowed.

• Rollover in a Murabaha transaction would imply

that payment of earlier Murabaha price by
executing new Murabaha.
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
Bank’s officer.
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 are considered to be related parties if one party

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