murabaha and its application

1. ‫مرابحة‬
Murabahah
Week 2
Dr. Mudeer Ahmed
Copyright © 2015 INCEIF e Learning. All rights reserved.

2. Introduction to Murabahah
Root
Word Ribh which literally means
profit
Technical
Meaning Sale and purchase of an asset
where the acquisition cost and
the mark-up are disclosed to
the purchaser.
• Murabahah is for short-
term financing
• In practice, a long term
murabahah is known as
bay’bithaman ajil
(BBA)
• The terms BBA, bay’
muajjal and murabahah
are sometimes used
interchangeably
• The majority of Islamic
bank’s financing is based
on murabahah

3. Simple example of how Murabaha can be used in a Banking transaction
Ahmed wants to purchase a house
Owner of
House
1. Ahmed applies
for the financing
facility to
purchase the
house
2. Bank buys the house (cost price)
3. Sells the house for
Murabahah Price on
deferred payment basis to
Ahmed for a period of 20
years

4. Critical Conditions
The asset is recognised by the Shariah, valuable, identifiable and deliverable;
and
The asset is already in existence and owned by the seller
The object should be well-defined and specified
The bank should acquire ownership and possession prior to its resale
to the purchaser
Assume the ownership risk of the asset prior to the transfer of
ownership to the purchaser
The seller has to disclose the breakdown of the selling price to the
purchaser, which comprises the acquisition cost and the mark-up or profit
margin
The date of payment and the amount of installment should be pre-determined

5. Some Issues
Can asset under construction be sold under murabahah?
Can an asset under constructive possession of a person be sold under
murabahah? Is only physical possession of the asset acceptable?
Who assumes the ownership risk of the asset prior to the transfer of
ownership to the purchaser?
Can the takaful contribution paid by the seller may be added to the
acquisition cost?

6. Some Issues
Can asset under construction be sold under murabahah?
Can indirect expenses such as premise rental, utility bills, staff wages and labour charges,
shall not be included in the acquisition cost?
Can the Base Lending Rate (BLR), the Base Financing Rate (BFR), Karachi
Interbank Offered Rate (KIBOR), be used as reference rate when determining the profit
margin?
If the purchaser discovers that the goods are defective can he ask for compensation or a
cancellation of the sale?

7. Risk Profile
Market Risk
risk associated
with the
potential loss in
the value of the
asset owned by
IFI
Operational Risk
risks arising
from the asset
ownership
Credit Risk
arising from the
losses
associated with
the potential
failure of the
customer to
settle the
outstanding
debt obligation

8. Risk Management
In the event of default, the seller may purchase the same asset
The proceeds of the sale may be used to settle the outstanding
debt on the basis of set-off
Upon acquisition of the asset it may be leased to the same client
on the basis of ijarah muntahia bi al-tamlik
The murabahah contract may contain a clause binding the
purchaser to settle all outstanding debt before the maturity date
if he defaults on any instalment payment.

9. Murabahah to the Purchase Order
• Murabahah with wa’d (Promise) Arrangement
• Murabahah to the purchase orderer (MPO) refers to an arrangement whereby the
purchase orderer (purchaser) promises (wa`d) to purchase an identified and
specified asset from a seller on murabahah terms upon the latter’s acquisition of
the asset.
• The wa`d is binding on the purchase orderer
• The purchase orderer is held liable for breach of promise (wa`d)

10. How it Works
1. The customer specifies the asset
2. The customer signs a unilateral promise to purchase goods from the
Bank
• The status of the promise
3. Islamic banks has to play an active role in the acquisition of the
property intended for subsequent sale
4. The IFI must perform the role of a trader and a financier
• Gather market intelligence
• Negotiate with vendors
• Perform administrative and legal tasks
5. The IFI undertakes to acquire the asset from the vendor or supplier

11. Alternatively:
1. An IFI may directly purchase the asset from the supplier or appoint the
customer as an agent to acquire the asset on its behalf
2. The appointment shall be in a separate document from the murabahah
contract
3. The customer as an agent for the bank purchases the property on behalf of
the bank
4. The principal shall remain liable for the asset purchased by the purchasing
agent.
5. Agency comes to an end
6. The bank now owns the property and bears ownership liabilities and risks
7. The bank subsequently sells the asset to the customer via Murabaha/BBA
with full disclosure of the asset’s acquisition cost and profit margin
8. The asset could be sold for cash or deferred settlement

12. Collateral
Type
Third party
guarantee
mortgage/charge
or a promissory
note
security deposit

13. Collateral
Third party guarantee
• The bank can ask for a third party guarantee
• Murabahah and the contract of kafalah, to guarantee
• the purchase of the murabahah asset upon its acquisition by the seller
• the payment of the outstanding debt amount of the murabahah sale in the case of default by
the purchaser.
mortgage/charge or a promissory note
• The collateral shall be utilised to recover payment of the outstanding debt amount
security deposit
• The security deposit is used to compensate the seller against actual loss if the customer fails to
purchase the asset
• The balance would be returned to the purchaser.
• Clause on consolidation and set-off
• Reciprocal liability, bank can recover outstanding payments from customer’s deposit account
• The principle of set-off

14. Other Issues in Relation to Murabahah
Earnest Money (Urbun)
• The purchaser may place earnest money (`urbun) with the seller
• The earnest money shall be treated as part payment if the purchaser exercises the option to
continue with the contract within the specified time.
• The seller would forfeit ‘urbun if the purchaser fails to exercise the option to continue with the
contract within the specified time
Rebate (Ibra’)
• waiving part of the outstanding debt upon pre-payment or early settlement
• A rebate clause incorporated in the murabahah contract
• The seller may provide periodic ibra’ based on certain benchmark agreed by the contracting
parties in case of instalment payments
Compensation (Ta`widh) and Penalty (Gharamah)
• Late payment charges consist of
• ta`widh (compensation) for actual loss borne by the seller, which may be recognised as
income to the seller; and/or
• gharamah (penalty), which shall not be recognised as income. Instead, it shall be channelled
to charitable bodies

15. Trade Financing
Murabahah
Letter of
Credit.
• The bank purchases goods and sell
to the client for a cost plus price.
Murabahah
Working
Capital
Financing
• The bank purchases raw materials
needed by the client and sells to
him for a cost plus price.

16. Situations in which Murabahah Cannot be Used
X
finance overhead
expenses of a firm such
as salaries of their staff
merely to obtain
fund and do not
intend to
purchase
commodities or
goods
sell the
commodity to a
client before
first acquiring
the property
Finance
commodities
already
purchased by
the customer

17. Dissolution of Murabahah Contract
A murabahah
contract is
dissolved
under the
following
circumstances:
The purchaser with earnest money exercises the option
not to continue the contract within the specified time
The purchaser exercises the option of defect to terminate
the contract
Any of the contracting parties exercises the mutually
agreed options to terminate the murabahah contract
within the agreed time period;
Any of the parties terminate the contract due to breach of
terms
Both contracting parties mutually agree to terminate the
contract.

18. Summary
• Murabahah refers to a sale and purchase of an asset where the acquisition cost
and the mark-up are disclosed to the purchaser
• Islam prohibits charging fixed interest on money, but permits charging fixed
profit on sale of goods
• The majority of Islamic bank’s financing is based on murabahah
• Murabahah is not a loan given on interest; it is a sale of a commodity for
cash/deferred price

19. Thank You
Dr. Mudeer Ahmed
Assistant Professor
mudeer.khattak@iqraisb.edu.pk