Topic vii. islamic investment funds

1. Non-Participatory Modes of
Islamic Finance Contract -
Murabahah
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2. Murabahah
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 Most of the Islamic banks and financial institutions are
using murabahah as Islamic mode of financing.
 Murabahah in fact a term of Islamic Fiqh and it refers
to a particular kind of sale having nothing to do with
financing in its original sense.
 If a seller agrees with his purchaser to provide him a
specific commodity on a certain profit, it is called
murabahah transaction.
 The basic ingredient of murabahah is that the seller
discloses the actual cost he has incurred in acquiring
the commodity and then add some profit thereon.
Cost-Plus Sale
 Profit may be lump sum or percentage.

3. Murabahah
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 Payment may be at spot and on a subsequent
date.
 Therefore murabahah does not necessarily imply
the concept of deferred payment.
 Murabahah in its original Islamic connotation is
simply a sale.
 If a person sells a commodity for a lump sum
price without any reference to the cost, this is not
a murabahah, the sale is called musawamah.
 First instance, murabahah is sale, we need to
understand sale first.

4. 4
 Murabaha is initially a sales contract wherein the
seller discloses the cost of the property to be sold. In
a murabaha contract, the cost and the mark-up –
profit – are known to both parties; i.e., the seller and
the buyer.
 Murabaha is used by Islamic banks to finance
corporate purchases of working capital items( e.g.,
raw material) and individuals’ vehicles and real estate
properties.
 As practiced by most Islamic banks, murabaha is
considered as a way to escape the financing of one’s
needs through interest-based loans. Instead of
getting cash that will be reimbursed later with interest,
the bank’s customer receives the asset/commodity
that he needs and pays the price later either as a
lump sum or in installments.
 As a financing instrument, murabaha is, therefore, a
sale contract where the payment of the price is

5. The Mechanics of Murabaha
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 A typical murabaha financing involves three parties
and four steps.
 The parties: the bank’s customer, the bank, and the
vendor.
 Step 1: The customer approaches the bank to
provide him the asset/commodity he needs. Usually,
the customer has inquired on the price and has got a
price quote from the potential vendor. This information
is provided to the bank and the profit rate is agreed on
between the customer and the bank. A murabaha
agreement is signed wherein the customer promises
to buy the asset/commodity from the bank at the
agreed on price that equals the cost plus the profit.

6. The Mechanics of Murabaha
(cont’d)
6
 Step 2: The bank purchases the asset/commodity from the
vendor at cost C. Ownership is transferred to the bank,
and the asset becomes under the control of the bank,
although not necessarily delivered to the bank’s
warehouse.
 Step 3: The murabaha contract is signed by the bank and
the customer stating that the asset is sold to the customer
for a price equal to the cost, C, plus a specified profit, α.
The mode of payment is also specified in the contract. The
ownership of the asset is transferred to the customer and
the delivery takes place upon signing the necessary
documents. The contract usually contains clauses on the
collateral taken as a security against credit risk.
 Step 4: The payment of the murabaha price takes place as
scheduled in the contract signed (in step 3).

7. The Mechanics of Murabaha (cont’d)
7

8. 8
1. A murabaha financing is usually initiated by the bank’s
client who makes a promise to purchase an asset/commodity
from the bank. The issue of whether this promise is binding
on the client or not has not been settled yet from a legal –
shari’ah – standpoint. However, in the practice of murabaha,
most of the Islamic banks consider that the promise is
binding; the customer has to take delivery of the ordered
asset or has to bear the costs of his decision not to fulfill his
promise.
2. One of the main conditions for the validity of murabaha
sale is that the bank owns and takes possession of the
asset/commodity before it can sell it to its customer. This rule
is in line with the prophetic tradition stating that one cannot
sell what he does not own. This implies that the bank takes
several risks associated with ownership of the asset. Among
these risks are the risk of destruction, the risk that the asset
is defective and is returned back, and the risk of price
fluctuations of the asset. Part of the profit claimed by the
bank on a murabaha sale is justified by these risks
associated to ownership.

9. 9
3. As a financing instrument, murabaha involves the deferral
of the payment of the sale price. The deferred price is usually
greater than the spot price. Moreover, the longer the credit
period and the higher is the total price paid by the customer.
This is practiced by Islamic banks based on a juristic ruling
that the deferred price can be greater than the spot price of
an asset/commodity/service. This ruling implies that the time
value of money is accounted for in pricing assets within the
Islamic financial system.
A $ today does not have the same value in one year. For
example, $1 today is equivalent to $1.1 in one year. However,
to be valued at $1.1 in one year, the dollar has to be invested
in a real asset; i.e., it has to change from potential to real
capital. The $0.1 is a compensation for the opportunity cost
which can be measured by the expected rate of return on the
exchanged asset. P0=P1/(1+k).

10. 10
4. To minimize the risk of default, the bank can take the subject
matter of the murabaha sale or another asset as collateral.
5. In case the customer misses the payment of an installment,
no further amount is added to the initial price. The common
practice is that in case the customer defaults on the payment of
two consecutive installments, the rest of the installments become
due immediately.
6. Murabaha sales generate receivables in Islamic banks’ books
that can be seen as similar to receivables held in conventional
banks’ books. However, there is a major difference, as the
receivables in the Islamic banks’ books are related to the sale of
a real asset, while they are related to cash loans in the
conventional banks’ books.
7. LIBOR: profit rates on murabaha sales are usually
benchmarked against national and international interest rates.

11. 11

12. An Overview of the Murabahah Contract
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13. Some Basic Rules of Sale
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Sale is defined in shariah as exchange of a thing of value by
another thing of value with mutual consent.
Rules
1. The subject sale must be existing at the time of sale. Thus a
thing not come into existence cannot be sold. Example, A sells
the unborn calf of his cow to B. The sale is void.
2. The subject of sale must be in the ownership of the seller at
the time of sale.
3. The subject of sale must be in the physical or constructive
possession of the seller when he sells it to another person.
Explanation: There a difference between an actual sale and a
mere promise to sell. The actual sale cannot be affected
unless the above three conditions are fulfilled. However on the
can promise to sell something which is not yet owned or
possessed by him. The above three rules are relaxed with
respect to two type of sales. Bai Salam and Istisna.
4. The Sale must be instant and absolute. Thus a sale attributed
to a future date or a sale contingent on a future event is void.

14. Some Basic Rules of Sale
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4. The subject of sale must be a property of value.
5. The subject of sale should not be a thing which is
not used except for a haram purpose, like pork,
wine etc.
6. The subject of sale must be specifically known
and identified to the buyer.
7. The delivery of the sold commodity to the buyer
must be certain and should not depend on
contingency or chance.
8. The certainty of price is a necessary condition for
the validity of a sale.
9. This must be unconditional. A conditional sale is
invalid, unless the condition is recognized as a part
of transaction according to the usage of trade.

15. Bai Muajjal (Sale on Deferred
Payment Basis)
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 Sale in which the parties agree that the payment
of price shall be deferred is called a bai muajjal.
 Bai muajjal is valid if the date of payment is fixed
in an unambiguous manner.
 Payment date can be fixed or by specifying a
period like two months. But it cannot be fixed with
reference to a future event the date of which is
unknown or uncertain.
 If period is fixed for payment, it deemed to
commence from time of delivery.
 The deferred price may be more than the cash
price, but it must be fixed at the time of sale.

16. Bai Muajjal (Sale on Deferred
Payment Basis)
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 Once the price is fixed, it cannot be decreased in
case of earlier payment, nor it can be increased in
case of default.
 To pressurize the buyer, the buyer may be asked to
promise that in case of default, he will pay specific
amount for charitable purpose.
 If commodity sold on installments the seller may put a
condition on the buyer that if he fails to pay any
installment on its due date, the remaining installments
will become due immediately.
 The buyer can also asked to sigh a promissory note
or bill of exchange, but the note or the bill cannot be
sold to a third party at a price different from its face
value.

17. Murabahah
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 Murabahah is a particular kind of sale where the
seller expressly mentions the cost of the sold
commodity and sells to another party by adding
some profit of mark-up thereon.
 Profit can be determined by mutual consent,
either in lump sum or through an agreed ratio.
 All the expenses incurred by the seller in
acquiring the commodity shall be included in the
cost.
 If the exact cost cannot be ascertained, the
commodity cannot be sold on murabahah basis.
In this case the commodity must be sold on
musawamah.

18. Murabahah as a Mode of
Financing
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 Originally murabahah is a particular type of sale and
not a mode of financing.
 The ideal mode of financial according to shariah is
mudarabah or musharakah.
 Murabahah is only device to escape from interest
and not ideal instrument for carrying out the real
economic objectives of Islam. So its use should be
restricted only to those cases where mudarabah or
musharakah are not practicable.
 It does not come into existence by merely replacing
the word of interest by word of profit or markup. It has
been allowed by shariah scholars with some
conditions.

19. Basic Features of Murabahah
Financing
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 Murabahah is not a loan given on interest. It is the sale of
a commodity for a deferred price which includes an agreed
profit added to cost.
 Being a sale and not a loan, the murabahah should fulfill
all the conditions necessary for a valid sale.
 Murabahah cannot be used as a mode of financing except
where the client needs funds to actually purchase some
commodities.
 The financier must have owned the commodity before he
sells it to his client.
 The commodity must come into the procession of the
financier, whether physical or constructive.
 The best way is that the financier himself purchases the
commodity and keeps it in own possession or purchases
through third person.

20. Basic Features of Murabahah
Financing
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 In exceptional cases, where direct purchase from the supplier is
not practicable for some reason, it is allowed that he makes the
customer himself his agent to buy the commodity on his behalf.
 The sale cannot take place unless the commodity comes into the
possession of the seller, but the seller can promise to sell even
when the commodity is not in his possession.
 Agency agreement required if customer directly purchase
goods.
 Purchase must be from a third party. The purchase of
commodity from client himself on buyback agreement is not
allowed in shariah, it is just like interest.
 The institution may ask the client to furnish a security to its
satisfaction for the prompt payment of the deferred price. He may
ask him to sign a promissory notes or bill of exchange.
 In case of default , the price cannot be increased. However if
buyer has undertaken to pay for charitable purpose, he shall be
liable to pay the amount undertaken by him.

21. Some Issued Involved in
Murabahah
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Different Pricing for cash and credit sales
 Price in murabahah transaction as practiced by Islamic
bank is always higher than market price.
 Some people argue that the increase of price in a credit
sale is analogous to interest charged on a loan.
 According to Islamic principles, money and commodity
have different characteristics and therefore, they are
treated differently.
 Money has no intrinsic utility only a medium of exchange
and has no different quality.
 Commodity have intrinsic utility and have different
qualities, the owner is at liberty to sell them at whatever
price he wants.
 If the seller does not commit a fraud or misrepresentation,
he can sell a commodity at a price higher than the market
with the consent of the purchaser.

22. Some Issued Involved in
Murabahah
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 Any excess amount charged against late payment is
riba only where the subject matter is money on both
sides.
 But if a commodity is sold in exchange of money, the
seller, when fixing the price, may take into
consideration different factors, including the time of
payment for examples:
- Near shop
- Seller is more trustworthy
- priority in selling commodity
- Atmosphere of the shop is cleaner and more
comfortable
 In the same way if a seller increases the price
because he allows credit to his client, it is not
prohibited in shariah.

23. Some Issued Involved in
Murabahah
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 Seller can charge high price for credit payment, but
once price is fixed it cannot be changed.
 In installment sales different prices can be claimed for
different maturities but time and amount must fix at
start. Example:
The use of interest rate as benchmark
 Many institutions financing by way of murabahah
determine profit or markup on the basis of current
interest rate like LIBOR.
 This practice is criticized that profit is based on
interest.
 No doubt, the use of rate of interest for determining a
halal profit cannot be considered desirable.

24. Some Issued Involved in
Murabahah
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 Most important requirement for validity of murabahah is
that it is a genuine sale.
 Merely using the interest as a benchmark for determining
the profit of murabahah does not render the transaction as
invalid, haram or prohibited. Example:
 Better that Islamic banks and institutions should strive for
developing their own benchmark based on Islamic
principles and should get rid of interest based benchmark.
Promise to purchase
 If the client not bound to purchase the commodity after the
financier has purchased it from the supplier, the financier
has incurred huge expenses.
 Solution is to client sign a promise to purchase the
commodity when it is acquired by financer

25. Some Issued Involved in
Murabahah
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Securities against murabahah price
 Murabahah price is payable at a later, so client may be ask
to furnish a security.
 The security may be in the form of mortgage or
hypothecation or lien.
 The security can be claimed rightfully where the
transactions has created a debt or liability.
 In murabahah the financier asks for a security after he
actually sold the commodity to the client and price has
become due to him.
 It is also permissible that the client furnishes a security at
earlier stages, but after murabahah price is determined.
 For financier, it will remain high risk, if it destroyed before
the actual sale financier will be responsible for loss.

26. Some Issued Involved in
Murabahah
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 It is also permissible that the sold commodity itself is given to
the seller a security.
 It is not necessary that the purchaser takes the delivery of the
sold property before he surrender it as mortgage to the seller.
 Only condition property held for mortgage should necessarily be
specified.
Guaranteeing the murabahah
 The seller in a murabahah financing can also ask the
purchaser/client to furnish a guarantee from a third party.
 In contemporary commercial banking the guarantor normally
charge fee.
 The classical fiqh literature, the guarantee is a voluntarily
transaction and no fee can be charged on a guarantee.
 If the person cannot charge interest on financing, the guarantor
should be subject to this prohibition because he does not
advance money.

27. Some Issued Involved in
Murabahah
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 If the person who actually pays money cannot charge a fee, how can
fee be charged by a person who just give guarantee not finance.
 In international trade guarantee become necessary where importer and
exporter do not know each other.
 This question still needs further research, however unless a definite
ruling is given, no guarantee fee should be charged or paid.
Penalty of Defaults
 In murabahah financing, once a price fixed it cannot be increased.
 This restrictions is sometime exploited by dishonest clients who
deliberately avoid to pay the price at it due date.
 This characteristics should not create a big problem in a country where
all the banks and financial institutions are run on Islamic principles.
 Some contemporary scholars have suggested that the dishonest clients
who default in payments deliberately should be made liable to pay
compensation to bank for loss it may have suffered on account of
default.
 Idea of compensation is not approved by most of the scholars.

28. Some Issued Involved in
Murabahah
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The alternative suggestion
 Defaulters should be punished by depriving them
from enjoying a financial facility in future.
 Client should undertake that in case of defaults, he
will pay a specific amount to a charitable fund
maintained by the bank.
 The bank may also advance interest free loans to
the needy persons from this charitable fund.
 The proposal is meant only to pressurize the debtors.
 The penalty undertaken by the client is originally, a
self undertaken vow and penalty charged by the
financier.
 This proposal has now been implemented
successfully in a large number of Islamic financial
institutions.

29. Some Issued Involved in
Murabahah
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No roll over in murabahah
 Murabahah transaction cannot be rolled over for a further
period.
 In an interest based financing, the customer may request
the bank to extend the facility for another term.
 Roll over practice is totally against the well settled
principles of shariah.
Rebate on earlier payment
 Some earlier jurists allow discount on early payment,
but the majority of the Muslim jurists do not allow it.
 Majority of the jurists holds that if the earlier payment is
conditioned with discount, it is not permissible.
 If the creditors gives a rebate voluntarily on his own, it is
permissible.

30. Some Issued Involved in
Murabahah
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Calculation of cost in murabahah
If the exact cost cannot be ascertained, no murabahah
can be possible, then it is musawamah.
Murabahah transaction should be based on the same
currency in which the seller has purchased the
commodity from the original supplier.
If the two currencies are different, this situation may be
met with two ways:
1. If the ultimate purchaser agrees and the laws of the
country allow, the price of the second sale will be
determined in first currency.
2. Use conversion price as cost. Example

31. Some Issued Involved in
Murabahah
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Subject matter of murabahah
 All commodities which may be subject matter of sale with
profit can be subject matter of murabahah.
 Shares of lawful company may be sold or purchased on
murabahah.
 A buyback arrangement or selling the shares without
taking their possession is not allowed at all.
 Murabahah is not possible in exchange of currencies.
 Murabahah is not for commercial papers.
Rescheduling of payment of murabahah
 Rescheduling is allowed for installments
 No additional amount can be charge for rescheduling.
 The amount of the murabahah price will remain the same
in the same currency.

32. Some Issued Involved in
Murabahah
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Securitization of murabahah
 Murabahah is a transaction which cannot be
securitized for creating a negotiable instrument
to be sold and purchased in secondary market.
 If there is a mix of portfolio consisting of a
number of transactions like musharakah, leasing
and murabahah then this portfolio may issue
negotiable certificates.