Islamic Modes:

Murabaha and Salam–

Islamic Microfinance Workshop

CIBE Training Program

Muhammad Khaleequzzaman
Head Islamic MFIing & Finance
IIU Islamabad
 Training Workshop – Islamic Microfinance

ISLAMIC MODES/INSTRUMENTS:
– Sale Contracts:
• Murabaha/Murabahah to the Purchase Orderer
• Salam/Parallel Salam
• Istisna’/Parallel istisna
– Participatory Modes:
• Mudarabah/Resource Mobilization
• Musharakah/Diminishing Musharakah
– Rent based Modes:
• Operating ijarah
• Ijarah wa iqtina’
 Training Workshop – Islamic Microfinance

Sale Defined:
Exchange of a thing of value with another thing of
value with mutual consent OR the sale of a commodity
in exchange of cash.

Elements of a valid sale:

• Contract ( Aqd )
• Subject matter ( Mabe’e)
• Price ( Thaman )
• Possession or delivery ( Qabza )
 Training Workshop – Islamic Microfinance
Rules of Sale: [Sale Defined and Elements of Sale]
1. Subject must exist at the time of sale
2. Subject must be in the ownership of seller – Physical or
constructive
3. Sale must be instant and absolute
[exception of above rules in Salam and Istisna’]
4. Subject should be halal
5. Subject must be known and identified
6. Sale must be unconditional
7. Delivery of sold item must be certain
8. Price of subject must be certain
Risks and responsibilities attached with the subject
must transfer from seller to the purchaser as a result
of sale
 Training Workshop – Islamic Microfinance
Types of Islamic Sale
• Bai muajjal
• Murabaha
• Musawama
• Salam
• Istisna

Murabaha:
Uses of Murabaha
• Sale of raw material
• Sale of cart
• Sale of equipment
• Sale of agricultural inputs
• Sale of consumer goods
• House material financing
 Theory & Practice of Murabahah

Outline:
1. Murabahah – Brief Historical Perspective
2. MFIing Murabahah/Murabahah to the
Purchase Orderer
3. Procedural details of Murabahah as practiced
by Islamic MFIs
4. Issues in Murabahah
5. Documentation

M. Khaleequzzaman IBF, IIUI

 Theory & Practice of Murabahah
Murabahah – Concept and Shariah Legitimacy
Murabahah defined:
• Selling a commodity as per cost with a defined and agreed
margin of profit (Ribh)
• Profit may be a percentage of the selling price or a lump sum.
• The transaction may be concluded with or without any promise
to purchase by the client: Ordinary Murabahah / MFIing
Murabahah or Murabahah to the Purchase Orderer.
Shariah Legitimacy of Murabahah:
• Qura’an: “It is no crime for you to seek the bounty of your
Lord” [Surah Ale Imran: 198]
“ Allah has permitted trading
and forbidden Riba ” [Surah Al-Baqarah: 275]
• Sunnah: The Prophet (PBUH) purchased a she camel from Abu
Bakr (RAA) for use as transportation from Medinah...
M. Khaleequzzaman IBF, IIUI
 Theory & Practice of Murabahah
Murabahah – Historical perspective
• Introduced as new form of sale in second half of First
Hijrah century as a sale with necessary condition of
declaring cost by the seller and agreeing on profit
margin by both the seller and the purchaser [Al-
Muwatta, Imam Malik]
• Modifications were made by Imam Shafii’, including an
order of the purchaser, who could subsequently
exercise the option not to purchase the same, and
also included credit transaction
• He clearly bifurcated two sales’ transactions

M. Khaleequzzaman IBF, IIUI

 Theory & Practice of Murabahah
Process Flow:

– Negotiation/Approval of overall limit

– MOU/Master Murabahah Facility Agreement
– Requisition + Undertaking + Security Deposit (Hamish
jiddiyah - Optional) + Invoice
2

MFI MOU/Master MFA Client

Approval of Limit 1

Requisition, Undertaking, Sec. Dep. 2

M. Khaleequzzaman IBF, IIUI
 Theory & Practice of Murabahah

– Third party appointed as agent [Optional] –

– Clint can be appointed agent [case of dire need]
– Payment to the Supplier – Direct
Payment in Supplier’s Name 2A

Agent
3 (Client)
Receipt of Payment Agent
MFIMFI Client
(3rd Party)

Agency Agreement 2
1
Supplier
Invoice Payment 3
2

M. Khaleequzzaman IBF, IIUI

 Theory & Practice of Murabahah
Possession
• Payment to supplier
• Discount of supplier/benefit to client
• Title of goods
• Transfer of risk and responsibilites

Risks and Responsibilities

Agent
(Client)
Agent
MFI Supplier
Title Goods (3rd party)

M. Khaleequzzaman IBF, IIUI

 Theory & Practice of Murabahah
Conclusion of Murabahah Personal/group sec. 4

Offer to Purchase 2
MFI Client
Acceptance of Offer 3

Receipt , Possession Report 1

Sec. Deposit/Hamish jiddiyah 3

DP Note
 Payment of Murabahah Price
Murabahah Price 1
MFI Client

Murabahah Terminates 2
M. Khaleequzzaman IBF, IIUI
 Theory & Practice of Murabahah
Purchase of poultry feed stock
• Murabahah transaction: Rs. 30,000
• Murabahah Facility: 90 Days
• Payment: Each month
• Rate of Profit: 15% p.a.
• Freight: 5% of cost of goods
• Security: Personal/group
guarantee

M. Khaleequzzaman IBF, IIUI

 Theory & Practice of Murabahah
Pricing of Murabahah [Example]:

Particulars Amount (Rs.)

Cost of goods Rs. 30,000
Rate of Profit 15% p.a.

Freight/Insurance 5% of cost
Total cost 30000 x 5% 30000 + 1500
=31500
Profit 31500 x 15% x 90/365 = 1165

Murabahah Price 31500+1165 = 32665

Installment 31500/3+1165/3 = 10888

M. Khaleequzzaman IBF, IIUI

 Theory & Practice of Murabahah
Issues in Murabahah:
• Unilateral promise/undertaking
• Invoice in the name of MFI
• Prior contractual relationship (customer and supplier)
• Vendor being third party/blood relation/wholly owned
institution of customer [Buy back (Inah)]
• Commitment or credit facility fee
• Documentation charges
• Hamish Jiddiyah/treatment/timing
• Timing of promissory note
• Rollover/Default in payment of price
• Rebate on early payment

M. Khaleequzzaman IBF, IIUI

 Theory & Practice of Murabahah
Documentation:
• Murabahah Agreement and Allied Documents:
– Parties to the Murabahah
– Subject matter
– Cost price
– Profit Margin
– Value Date – Disbursement date of Cost Price
– Contract price
– Default clause/penalty
– Right of set off i.r.o client’s credit balance
• Agency agreement as separate contract
• Purchase Requisition
• Invoice
• Receipt of payment to the supplier
M. Khaleequzzaman IBF, IIUI
 Theory & Practice of Murabahah
Documentation:
• Declaration
• Securities as per security documents
• Demand Promissory Note
• Schedule of payment

M. Khaleequzzaman IBF, IIUI

 Theory & Practice of Murabahah
Risks in Murabahah:
Risks Mitigants
Customer refuses to Promise, HJ,
purchase while holding
as agent
Customer already Direct payment to supplier, date of invoice to
purchased from be after date of agency agreement, obtain
supplier/wants other documents – gate pass, truck receipts,
liquidity/Inah physical inspection, etc.
Overdue installments Penalty to go to charity
Default risk Collateral/securities

Market (price) risk Immediately supply the item

M. Khaleequzzaman IBF, IIUI

 Theory & Practice of Murabahah
Some Applicable Guidelines from AAOIFI:
A. Measurement of asset value
• At acquisition – Measured and recorded at
historical cost.
• After acquisition –
– Asset available for sale to client shall be
measured at historical cost
– In case of default in payment of Murabahah price,
the asset shall be measured at cash equivalent
value (ie. Net realizable value).
– A provision to be created for decline in the asset
value (ie. Difference between acquisition cost and
the cash equivalent value).

M. Khaleequzzaman IBF, IIUI

 Theory & Practice of Murabahah
Some Applicable Guidelines from AAOIFI:
B. Potential discount after acquisition
• The discount shall not be considered as revenue
• However it should reduce the cost of goods.
C. Profit recognition
• Profit shall be recognized at the time of executing
contract if the term does not exceed the current
financial period.
• Profits of credit sale whose payment is due after the
current financial period shall be recognized as per
following:
– Proportionate allocation of profits
– Profit may also be recognized as and when received.

M. Khaleequzzaman IBF, IIUI

 Theory & Practice of Murabahah
Some Applicable Guidelines from AAOIFI:
D. Failure to fulfill promise having paid Hamish
Jiddiyah
• Hamish Jiddiyah to be treated as liability on Islamic
MFI.
• Treatment:
– The amount of actual loss to be deducted from
Hamish Jiddiyah

E. Penalty – Deposited in Charitable A/C on realization

M. Khaleequzzaman IBF, IIUI

Salam
 Islamic Modes – Agricultural Financing
Salam: Defined
A salam transaction is the purchase of a
commodity for deferred delivery in exchange for
immediate payment. It is a type of sale in which
the price, known as the salam capital, is paid at
the time of contracting while the delivery of the
item to be sold known as subject matter of salam
(al Muslam fihi) is deferred. Salam is also known
as Salaf (lit: borrowing)
Salam: Purposes
– Liquidity needs of farm production
– Working capital/Running Finance
– Project finance (partial requirements)
 Islamic Modes – Agricultural Financing

Salam: Shariah Legitimacy

 Allh says “O ye who believe when you deal with
each other, in transactions involving future
obligations in a fixed period time, reduce them to
writing” [Al Baqara Verse 282]
 Ibn Abbas reported, the Prophet (PBUH) came to
Medina and found that people were selling dates
for deferred delivery (salam) after a duration of
one or two years. The Prophet (PBUH) said:
“whoever pays for dates on a deferred delivery
basis (salam) should do so on the basis of
specified scale and weight” [Bukhari and Muslim]
 Islamic Modes – Agricultural Financing

Wisdom of allowing Salam

 Farmers, orchard owners, merchants can fulfill
their working capital and liquidity needs before
the commodity is ready to be sold
Three major problems and solutions
1. Risk of default by seller [personal/group
guarantee/ hypothecation]
2. MFI’s need to liquidate goods after delivery
[parallel salam]
3. Seller’s inabillity to produce or procure
commodity [receive back the same price]
 Islamic Modes – Agricultural Financing
Salam:
• An exception to the possession
• A purchase contract opposite to Murabahah
• Benefits both the seller and purchaser
• Payment of full price at spot - otherwise selling debt for
debt
• Allowed in commodities satisfying condition of Dhawatul
Amthal - quality and quantity can be specified exactly
• Product of a particular field or farm cannot be sold
• Quality and quantity decided in un ambiguous terms
• Quantity should be agreed in specific terms (by weight,
volume or measure)
 Islamic Modes – Agricultural Financing

Salam:
• Certain date and place of delivery
• The commodity should remain in the market throughout the
period of contract [Different opinions]
• The time of delivery should be sufficient to allow use of
salam capital conveniently and effect prices, preferably be at
least 15-30 days from the date of contract [Different
opinions]
• A security/guarantee or is preferred as safeguard to the risk
of default
• Only commodity is delivered and not the money
Islamic Modes – Agricultural Financing
Salam: Alternatives Available to MFIs of
Taking Delivery of Commodity:
1. By establishing a subsidiary
2. By appointing the third party or client
its agent to sell the commodity
i. The agency agreement should be
separate from the salam agreement
ii. If agent has been able to sell the
commodity at a price more than the
one agreed in agency agreement,
agent gets the difference
3. By opting for Parallel Salam or Third
party sales
 1 Payment of Salam Price 1-1-07

2 Salam Contract Wheat 2000 kg.

Signed 1-1-07 Delivery 30-6-07
Sale Proceeds

MFI Salam Farmer

Transaction Agent

3 Delivery of Wheat 30-6-07

3C Sale Proceeds less Commission

3A Sale of Wheat
Third Party
Purchaser
3B Sale Proceeds
 1 Salam Sale Contract 1-1-07, Wheat 2000kg.

2 Salam
SalamPrice
PricePayment
Payment1 June
1-1-0706

Delivery of Purchaser/
Farmer
Client
Commodity 5 Purchaser
Seller
MFI
20
30-6-07
Dec 06 MFI

2nd Salam Contract

of Price
Price
Parallel

15-1-07
Payment of
3 4

Payment
Salam

Delivery of Third Party

Third Party
Commodity 2nd Salam
2nd Salam
20 Dec
5-7-07
2006 6 15 June 06
15-1-07
 1 Salam Sale Contract 1-1-07

2 Salam Price Payment 1-1-07

Delivery of Purchaser
Farmer Commodity 4 Seller
30-6-07 MFI

Promise to Purchase
Pays 5-7-07
Third Party

15-1-07
6 3

Promise 5

Delivery of Third Party

Commodity Promise and
5-7-07 Payment
 Islamic Modes – Agricultural Financing

Rules of Parallel Salam and Third party

promise
•Both the contracts viz. salam and parallel salam
must be independent of each other
•Parallel salam is allowed only with third parties.
Therefore the original seller cannot be entered into
the parallel salam
•The third party giving unilateral promise should
not pay the price as this is not allowed in Shariah

Examples of Products
THANKS