ISLAMIC BANKING

Islamic Modes of Finance

Partnership Based Modes
i. Mudaraba (Profit Sharing)
ii. Musharaka (Joint Venture, profit sharing)
Trade Based Modes
iii. Murabaha (Cost plus Profit Sale)
iv. Musawamah (Bargain Sale)
v. Salam (Commodity Sale)
vi. Istisna (Sale an Order)
Rental Based Modes
vii. Ijarah (Leasing)
viii. Diminishing Musharka (Transfer of Ownership)
 MURABAHA
Definition & Origin
 It is derived from word ‘Ribh’ which means increase.

 In this transaction, mark up is disclosed to purchaser as per seller’s purchase

price.

 This transaction is done for a trust based sale.

 In this transaction, asset must be specified according to needs of the customer.

 The asset must be in fixed form (i.e. car, house etc.), not in monetary forms
(current/liquid asset)
 MURABAHA
Murabaha is a kind of sale agreement, its not a financing mode in its origin. The ideal
mode of financing according to Shariah is Mudaraba and Musharaka. In current
economic circumstance there are certain practical difficulties in using mudarabah and
musharakah as instruments in every type of financing. Therefore, Shariah experts
have allowed, subject to certain conditions, the use of murabahah on a deferred
payment basis as a mode of financing. Two important points must be remembered in
this case;
a. It should be overlooked that murabaha was not a mode of financing. Murabaha is
the device to escape from interest. It is a transitory step used in process of
Islamization of the economy and it should be restricted to those cases where
musharaka and mudaraba is not applicable.
b. Murabaha transaction does not came into existence by replacing the word interest
by profit. It is allowed by Shariah advisors with some conditions. The conditions
must be observed that it draws a clear line of distinction between interest bearing
loans and transaction of murabaha. If these conditions are not observed, the
transaction becomes invalid.
 MURABAHA
Background of Murabaha Transaction
 It is a trust based sale.
 No financial intermediaries involved in it.
 Customer purchase directly from supplier.
 It is cost plus profit sale.
 Payments made on deferred or on cash basis.
 Asset owned by bank.
 Purchase price, profit ratio made be to known to both parties before
transaction.
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Features of Muarabaha Financing
 Murabaha is not a loan given interest activity. It is a sale of commodity for a
deferred price which includes an agreed profit added to that cost.
 Being a sale agreement, murabaha should fulfil all the conditions laid down by
Shariah advisors to make it a valid agreement.
 The financer must have a good title of commodity before selling it to client.
 The commodity must be in the possession of financer, whether physically or
constructively.
 The best way of murabaha transaction is that financer himself purchase the
commodity and keeps it in his possession. After making full payment or the
ownership transferred to the client along with the risk associated with that asset.
 The sale can not be possible unless the possession is in the hands of seller.
 MURABAHA
Use of Murabaha in Daily Life
 Raw Material
 Inventory
 Equipment
 Asset Financing
 Import Financing
 Export Financing
 House Financing
 Vehicle Financing
 Land Financing
 Shop Financing
 Education Package, Tour Package and Medical Package
 MURABAHA
Legitimacy of Muarbaha Contract
The legality of murabaha is deduced from;
1. Quran 2. Sunnah
3. Consent of Muslim Jurists 4. Qiyas (Analogy)

The Holy Quran

The Quran generally allows the sale contracts. Among others, Quran says the
effect that;
 And Allah has permitted trade and prohibited usury. (2:282)
 O you who believe! Do not false to Allah and His Prophet (SAWW), and do not
knowingly be false to trust that has been reposed in you. (8:27)
 MURABAHA
The Sunnah
The Prophet Muhammad (SAWW) was reported to have said,
“The best earning is what man earns with his own hands and from a permissible
trade”.
Verily, a sale is what takes place when there is mutual agreement. (Ibn-e-Majah)

Muslim Jurists
Several of the jurists appealed to Ijma as a justifying factor. Badr Al Din Al Ayni
explained in his book Al Hiddayah;
‘Because the item for sale is known, so is the price. People deal it in it without
objecting to it. And when people deal without any objection, that is proof in itself its
validity’ because the Prophet Muhammad (SAWW) said;
“What is considered becoming by Muslims is considered becoming by Allah”
 MURABAHA
Analogy (Qiyas)
Since the Prophet Muhammad (SAWW) has approved the Tawliyah Sale (sale
based on cost price), the sale on mark up will be equally permissible on the
basis of analogy on the Tawaliyah Sale. The determination of cost and making
this cost known to buyer are common in both Tawliyah and Murabaha sale.
Rules for Murabaha Transactions
 Existence of Goods
 Specification and Identification of Goods
 Ownership of Goods
 Possession of Goods
 Finalization of Goods
 Risk of Goods
 MURABAHA
Different from Conventional/Interest Based Financing
a. It escapes both parties from interest as cost plus price is already added in
the agreement.
b. It follows the rules and regulations governed by the Shariah advisors.
c. It is not a loan transaction so there is no chance of interest activities.
d. This transaction is possible only when client requires an asset (fixed).
e. The ownership of the property must be in the hand of the bank.
f. Possession of the property must be in the hands of the bank until the expiry
of contact or full payment is being made.
 MURABAHA
Process Flow of Murabaha Transaction
i. The customer approaches the bank with a request for purchase of any
commodity/asset that can be legally sold on credit.
ii. The bank appoints the client its agent to purchase the commodity.
iii. The bank purchases the commodity through the client as agent.
iv. The bank makes the payment to vendor.
v. The customer takes delivery of commodity (s) on behalf of the bank as
agent.
vi. The customer makes an offer to purchase and bank accepts the offer. The
bank transfer the title over the customer upon execution of Murabaha.
vii. The customer makes payment on deferred basis without any rollover,
discount or rebate.
 MURABAHA
Nature of Relationships
 Bank and Client : Promisor and Promisee

 Bank and Client : Principal and Agent

 Bank and Supplier : Buyer and Seller

 Bank and Client : Seller and Buyer

 Bank and Client : Creditor and Debtor

 ISSUES AND PROBLEMS OF MURABAHA FINANCING
1. The Difference in Price for Cash & Credit Sales
As Murabaha is used in defferd payment basis, seller buys commodity on cash and
sells on credit, while deciding for price, period of payment must be considered.
Longer the maturity of Murabaha, higher the price. Following arguments have been
reported in this regard,
 In modern commercial transaction, the difference between money and commodity
is of no concern. Both are treated at par and thus can be traded in. One can sell one
dollar for two dollars on the spot as well as on credit, just as he can sell a
commodity in this away. But the Shariah law does not subscribe to this theory.
 Money has no intrinsic utility. Whereas, the commodities have intrinsic utility.
 The commodities can be of different qualities, money, on the other hand, has no
such quality except that it is a measure of value or a medium of exchange.
 In commodities, the contract (sale and purchase) is effected on a particular
commodity or, at least, on the commodities having particular specifications.
Money, on the contrary, cannot be pin-pointed in a transaction of exchange.
 ISSUES AND PROBLEMS OF MURABAHA FINANCING
2. Rebate in Case of Early Payment
If the customer makes early payment and there is no commitment from bank in
respect of any discount in price of Murabaha, then the bank has the sole right to
allow rebate to its client.
3. Rollover in Murabaha
 Rollover in Murabaha means booking another Murabaha against receivables
of any previous Murabaha, payment of which can not be made by the client.
 According to Shariah scolars, Murabaha can not be rolled over for a further
period. As it belongs to a specific commodity which has been sold, hence can
not be sold twice.
 The bank has the discretion to reschedule the payment without any increase
in original receivable. Any additional amount received from client as penalty
will be transferred to charity.
 ISSUES AND PROBLEMS OF MURABAHA FINANCING
4. Rescheduling for Additional Payments
 If a customer fails to pay according to time period mentioned in Murabaha
agreement, he/she may request the bank for reschedule of installments.
 In conventional banking, rescheduling is accompanied by additional interest
charges for default or timing differences.
 In case of Murabaha financing, no additional amount can be charged for
rescheduling. The amount of Murabaha price will remain unchanged.
5. Muabaha Securization
 As the ownership of commodity/assets remains with the bank, it can not be
securized further by any other asset.
 In case of default/non payment by client, the bank may sale the asset in
market and can recover its charges.
 ISSUES AND PROBLEMS OF MURABAHA FINANCING
6. Imposing Penalty on Default Payment
The penalties charges by bank for non payment or delay by the client can not
considered as bank income, this penalty will deposit in charity account.

7. Promise to Purchase (Binding or Non-Binding)

There is a clash of different Shariah scholars on this point. Some said that
promise is of a binding nature and in case of default, this matter can be
resolved through court.
Some are of the opinion that promise is not a legal obligation, it is a moral
obligation on other’s part.