1. Murabaha - Concept & AAOIFI

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Concept of Murabaha & AAOIFI Standard

Concept of Murabaha

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• Murabaha is a particular kind of sale and not a financing in itsorigin

Murabaha

origin.

• Where the transaction is done on a “cost plus profit” basis i.e. theseller discloses the cost to the buyer and adds a certain profit toit to arrive at the final selling price.

• The distinguishing feature of Murabaha from ordinary sale is:

- The seller discloses the cost to the buyer.- And a known profit is added.

• Payment of Murabaha price may be:

Murabaha

1) At spot2) In installments3) In lump sum after a certain time

• Hence, Murabaha does not necessarily imply the concept ofdeferred payment.

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• It is a contract wherein the institution, upon request by thecustomer purchases an asset from the third party(a supplier) and

Banking Murabaha

customer, purchases an asset from the third party(a supplier) andresells the same to the customer either against immediatepayment or on a deferred payment basis.

• It is a bunch of contracts completed in steps and ultimatelysuffices the financial needs of the client.

• The sequence of their execution is extremely important to make• The sequence of their execution is extremely important to makethe transaction Shariah compliant.

Basic rules for Murabaha financing:

• Asset to be sold must exist

Banking Murabaha

Asset to be sold must exist.

• Sale price should be determined.

• Sale must be unconditional.

Assets to be sold:a) Should not be used for un-Islamic purpose.b) Should be in ownership of the seller at the time of sale;

h i l t tiphysical or constructive.

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Step by step Murabaha financing

1 Client and bank sign an agreement to enter into Murabaha

Steps in Murabaha Financing

1. Client and bank sign an agreement to enter into Murabaha(MMFA).

Agreement to Murabaha

Bank Client

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2 Client appointed as agent to purchase goods on bank’s


2. Client appointed as agent to purchase goods on bank sbehalf

Agency Agreement

Bank Clientg

3. Upon submission of Order form Bank gives money to


p g yagent/supplier for purchase of goods.

Agency

Agreement to Murabaha

Bank Client

Disbursement to the agent or supplier

Agreement

Supplier

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4. The agent takes possession of goods on bank’s behalf


and informs bank through a Declaration form.

Transfer of RiskDelivery of goods Vendor

Bank Agent

5(a) Client makes an offer to purchase the goods from


5(a). Client makes an offer to purchase the goods frombank through a Murabaha Contract.

Bank Client

Offer to purchase

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5(b) Bank accepts the offer and sale is concluded


5(b). Bank accepts the offer and sale is concluded.

Murabaha Contract+

Transfer of Title

Bank Client

6. Client pays agreed price to bank according to an agreed


p y g p g gschedule. Usually on a deferred payment basis (BaiMuajjal)

Bank ClientPayment of Price

Bank Client

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Murabaha to the Purchase Orderer

(AAOIFI Shari’a Standard # 8)

1. Promise Stage - Procedures prior to the contract ofMurabaha

Stages of Murabaha

Murabaha.

2. Acquisition Stage – Acquisition of title & possession of theasset by the institution or its agent.

3. Execution Stage – Conclusion of Murabaha Contract.

4 Aft E ti St G t & t t t f M b h4. After Execution Stage – Guarantee & treatment of MurabahaReceivables.

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Promise Stage

• It is permissible for the institution to purchase the item only inresponse to its customer’s wish and application and/or from a

Promise Stage

response to its customer s wish and application and/or from aparticular source of supply.

• The customer may sign a ‘Promise to Buy’ the item from theinstitution based on his wish and application.

• The customer may obtain statement of prices from the supplier(offer of sale) addressed to the customer by name It is(offer of sale) addressed to the customer by name. It ispreferable that the invoice should be addressed to theinstitution.

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• Murabaha Transaction should exclude any prior contractualrelationship between the customer and original supplier.

Promise Stage

p g pp

• It is not permissible to transfer a contract that has beenexecuted between the customer and supplier.

• It must be ensured that the party from whom the item isbought is a third party, and not the customer or his agent, soas to avoid Bai-‘Inah (Buy Back).as to avoid Bai Inah (Buy Back).

• It is not permitted to carry out a Murabaha on deferred paymentterms where the asset involved is gold, silver or currencies.

Promise Stage

• It is impermissible to issue negotiable instruments where theunderlying asset consists of Murabaha receivables or otherreceivables.

• It is not permissible for the bank and the customer to formMusharakah in a project with the promise from any of them tobuy other’s share in Musharakah on Murabaha bases.

• It is not permitted to conclude a Murabaha contract on apcommodity that was the subject matter of a previous Murabahawith the same customer, i.e. Refinance the transaction.

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• ‘Promise to Buy’ (signed by the customer) should notbe a bilateral promise binding on both parties.

Promise Stage

• The institution can purchase the item from a supplieron a ‘sale or return’ basis. This option expires byvirtue of actual sale by the institution to the customer.

• It is impermissible to receive from the customer acommitment fee or a fee for providing a creditfacility The expenses of preparing the documents offacility.The expenses of preparing the documents ofthe contract may be borne by one of the parties. If thebank is arranger in Murabaha, it can charge a fee fromthe participating institutes.

GUARANTEES

• If the client nominates the supplier, guarantee for good

Promise Stage

e c e o a es e supp e , gua a ee o goodperformance of supplier can be demanded from the customer inhis personal capacity and not in his capacity as purchaseorderer or agent of the institution.

• It is permissible for the institution to take a sum of money (onlyin case of binding promise from the customer) as ‘HamishJiddiyah’ (i e security deposit) from the customer as anJiddiyah (i.e. security deposit) from the customer as anindication of customer’s financial capacity or to ensurecompensation of any damage arising from a breach of promise.

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• Security deposit can either be held as trust in the custody ofinstitution or it may be held as an investment trust on the basis

Promise Stage

yof Mudaraba.

• In case of breach of promise Hamish Jiddiyyah can be used torecover actual damage however, it cannot be used for coveringthe Opportunity Cost.

• The institution is allowed to take ‘Urbon’ (earnest money) afterThe institution is allowed to take Urbon (earnest money) afterconcluding the Murabaha sale with the customer. It is preferableto return to the customer that remains from Urbon afterdeducting the actual damage incurred as a result of breach.

Acquisition Stage

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• It is prohibited for the institution to sell any item in a Murabahat ti b f h i i d th it

Acquisition Stage

transaction before having acquired the item.

• The contract between the institution and the supplier can becompleted through exchanging the notices of offer &acceptance, either in written form or correspondence by anyform of modern communication.

Appointment of Agent

• It is preferable that the institution itself purchases the item

Acquisition Stage

s p e e ab e a e s u o se pu c ases e edirectly from the supplier. However, it is permissible to authorizean agent (either the purchase orderer or some 3rd party) tocarry out the purchases. In case the customer is working as theagent of the institution, he would not sell the item to himself byhimself.

• When the customer is appointed as agent to carry out theWhen the customer is appointed as agent to carry out thepurchases, the institution itself must pay directly to the supplierand obtain from the supplier the documents that confirm theexecution of sale.

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• It is obligatory to separate two liabilities of risk attaching to thepurchased item, namely the liability of the institution and theli bilit f th t t f th i tit ti

Acquisition Stage

liability of the customer as agent of the institution.

Possession of the Asset

• The institution’s actual or constructive possession must beascertained before its onward sale to the customer.

• The item must move from the responsibility of the supplier to theresponsibility of the institution .

Possession of the Asset

• It is obligatory that the point when the risk of the item is passed

Acquisition Stage

• It is obligatory that the point when the risk of the item is passedon by the institution to the customer, be clearly identified.

• The forms of taking delivery or possession of items differaccording to their nature and trade customs.

• The receipt of a bill of lading by the institution or its agent,when purchasing goods on the international market iswhen purchasing goods on the international market, isconsidered as constructive possession.

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• Taking insurance cover for the item bought to be sold by

Acquisition Stage

Murabaha is the responsibility of the institution at the stage ofits acquiring ownership. The institution may subsequently buildsuch expense into the price of Murabaha deal.

Execution Stage

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• The contract of Murabaha is not automatically concluded bymerely taking possession of the asset by the institution.

Execution Stage

• The institution is entitled to receive compensation for any actualdamage it has incurred as a result of the customer’s breach ofa binding promise.

• The institution has the obligation to disclose to the customer thecredit given by the supplier and what is added in the cost. Theinstitution can add any expense related to the item if theinstitution can add any expense related to the item if thecustomer agrees or add only the direct expenses which arenormally included in the cost if the detailed break- up of thecost is not given.

• It is not permissible to add indirect costs, such as staff salaryand the like, to the cost of the item.

Execution Stage

• If the institution receives any discount from the supplier, thecustomer should benefit from that discount by a reduction ofthe total Murabaha selling Price.

• The price of the item and the institution’s profit on theMurabaha transaction be fixed and known to both the partieson the signature of the contract of sale.

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• There is no objection to referring to any known benchmark(such as LIBOR) as a comfort indicator to determine the rate offit

Execution Stage

profit.

• The selling price of the asset becomes a debt and it is notpermitted subsequently to demand any extra payment either inconsideration of extra time given for payment or delay inpayment.

• It is permissible for the institution to stipulate in the contract acondition that the institution is free from responsibility for all orsome of the defects of the asset (Bai’-al-Bara’ah).

Execution Stage

• It can be included in the contract that if the customer fails topay on time the institution will have the right to revoke theagreement and repossess the item sold or the institution can begiven power from the customer to sell the item on behalf of thecustomer and settle the debt by the price received and ifsomething remains would be recovered from the customer.

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After Execution Stage


• The installments may become due before their originallyagreed due dates in case of the customer’s refusal to performor delay in paying any installment without any good reason.

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Securities

• It is permissible to demand from the customer:


Third party guarantee orPledge of the investment account orPledge of any item of real or moveable property orPledge of the subject matter of Murabaha

• It is permissible to require the customer to provide cheques orpromissory notes before execution of Murabaha as ap yguarantee of future indebtedness.

• It is not permissible to stipulate that the ownership of the itemwill not be transferred to the customer until the full payment of


p ythe selling.

• It is permissible to postpone the registration of the asset in thecustomer’s name as a guarantee of the full payment of theselling price.

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Charity Amount

• It is permissible to have an undertaking from the customer as


• It is permissible to have an undertaking from the customer, aspart of Murabaha contract, to pay an amount of money or apercentage of the debt to be donated to charitable causes inthe event of delay in payment/installments.

Early Payment Rebate

The institution may give up part of the selling price if the• The institution may give up part of the selling price if thecustomer pays early, provided this was not part of thecontractual agreement.

• The payment of the debt due on account of Murabaha maybe made in currency different from that in which the debt is


be made in currency different from that in which the debt isdenominated, provided the exchange rate prevailing on theday of settlement is taken.

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Thank You

1. Murabaha - Concept & AAOIFI

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