ISLAMIC REPUBLIC OF AFGHANISTAN

Ministry of Rural Rehabilitation and Development Afghanistan Rural Enterprise Development Program

Islamic Finance Product Development

The Use of the Order-to-Purchase Murābahahto Finance the Acquisition of Goods

prepared by Alberto G Brugnoni - AREDP

ISLAMIC REPUBLIC OF AFGHANISTAN

CONTENTS

I. ORDINARY MURĀBAHAH

→ I.I GENERAL FEATURES

→ I.II PARTICULAR FEATURES

→ I.III LEGITIMACY OF THE ORDINARY MURĀBAHAH

II. MURĀBAHAH BASED ON ORDER-TO-PURCHASE

→ II.I THE CONTRACT OF MURĀBAHAH FINANCING

→ II.II DEBATED ISSUES ON MURĀBAHAH FINANCING

→ II.III ACCOUNTING POLICIES

→ II.IV CHECKING AND MONITORING

→ II.V BASIC MISTAKES IN MURĀBAHAH FINANCING

→ II.VI USES OF MURĀBAHAH FINANCING

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CONTENTS

IV. TAWARRUQ→ CLASSICAL TAWARRUQ→ ORGANIZED TAWARRRUQ/COMMODITY MURĀBAHAH

→ THE MALAYSIAN EXPERIENCE

V. MURĀBAHAH V. BAY’ BI-THAMAN AJIL (BBA)

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I. ORDINARY MURĀBAHAH

In its original Islamic fiqh connotation, murābahah is simply one of the kinds of contracts of sale permitted by the Shariah:→ the word is derived from the root-word rabiha = to profit or gain→ as such, murābahah is not a mode of financing

Definition: if a seller agrees with his/her purchaser to provide a specific commodity on a certain profit added to his/her cost and disclose it, this transaction is called a murābahah:→ this is the only feature that distinguish the murābahah contract from other kind of

sales

Ordinary murābahah involves two parties: the seller and the buyer. The seller is an ordinary trader who buys a commodity without depending on a prior promise of purchase, then he displays it for murābahah sale:→ for a price and a profit to be agreed upon

All the conditions that govern the Shariah contract of sale, ought to be fulfilled for the validity of the contract of murābahah:→ these rules are a pre-requisite for its conclusion

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I.I GENERAL FEATURES

GENERAL FEATURES Murābahah is a contract that put a particular emphasis on the interest of the buyer's

needs:→ the seller acts almost as a purchaser on behalf of the buyer

Murābahah is a particular kind of sale whereas the seller expressly discloses to the purchaser the actual cost it has incurred in acquiring the commodity and discloses how much profit (mark-up) it is going to charge in addition to the cost

As a ‘honest declaration of cost’ - murābahah is one type of bay’ al-amānah ('fiduciary' sale) in Islam:→ the other two types of bay’ al-amānah are tawliyah (sale at cost) and

wadhiah (sale at specified loss)

This kind of sale was historically based on trust (amānah) with the understanding that Allāh was witnessing the honesty of the trader. If the trader was dishonest, the client’s belief in the Hereafter and in Allāh was generally sufficient for the execution of justice:→ also, the declaration of the cost allowed the prospective purchaser the ability to

better evaluate the item’s economic worth due to which he/she either accepted, rejected or renegotiated the price he/she was willing to pay

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I.I GENERAL FEATURES

→ in this sense, the purchaser could attempt to negotiate a lower price if he/she realized that the seller had paid much less for the item although the current market value was much higher

→ it also protects the consumer from against unjustified levels of profits

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I.II PARTICULAR FEATURES

PARTICULAR FEATURES The item can be sold on a murābahah basis only if the seller has purchased it on cash:

→ alternatively, the seller has to disclose the fact that the item was purchased on credit

→ this is to ensure that the seller does not demand maximum profit through falsely claiming to have outlaid the full capital

→ in this case the seller could be pressured to accept a lower profit margin since it has used others’ resources to buy the item

The profit added may be determined by mutual consent:→ the profit is left to the discretion of the seller and no ceiling rate is specified as the

maximum since this is left to the economic factors of supply, demand, production, acquisition cost, etc.

→ this should not violate Islam’s emphasis on fairness and thus the sale of items at unfair prices and exploitative rates

The profit may be in lump sum or may be based on a percentage (ration of profit) to be charged over the costs

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The payment may be at spot, or may be on a subsequent date agreed upon by the parties:→ in the latter case we have a ‘murābahah muajjal’→ therefore murābahah sale does not necessarily imply the concept of deferred

payment

All the expenses incurred by the seller in acquiring the commodity (like freight, custom duty, etc.) shall be included in the cost price and the mark-up can be applied on the aggregate cost:→ however, recurring expenses of the business (salaries, rents, etc.) cannot

be included in the cost of an individual transaction→ in fact, the profit claimed over the cost should take care of these

expenses

Murābahah is valid only where the exact cost of a commodity can be ascertained:→ if the exact cost cannot be ascertained, the commodity cannot be sold on

murābahah basis→ in this case the commodity must be sold on musāwamah (bargaining) basis

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It is imperative that the seller discloses the length of time the item on sale remained on its stock:→ this is to prevent the buyers' ignorance of the seller desire to get rid of an obsolete

item

Last but not least, where an agent sells an item on behalf of another on the basis of murābahah, it is obligated to sell it in terms of its supplier's cost

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I.III LEGITIMACY OF THE ORDINARY MURĀBAHAH

Two verses from the Qur’ān are usually quoted to allow the murābahah transaction:→ ع� و ي� ع� ي� ٱ ه� � ع ٱ� ع�� ع ع�� “And Allah has permitteth trading” [2:275]→ ع�ا ه�� ع�ا ـ�� ي� ع� ه� م�ن ��ض�� ع ع� ن ع��! ة" �ع �� ع$ ت� ع��& ه�و ع� & ع�� ـ) )� ع ت*� ت� ت+ �� ع� ي� ت-ٱ ه��.� عن ي� ع- � ه�� ع� عوٲ ي� ع�� ا� ـو ه ه1 �ا ي ع� ع() ا� هنو ع� ع�2 ع��ن ت�3 �� ع 4ٱ ‌ “O ye who believe!

Squander not your wealth among yourselves in vanity, except it be a trade by mutual consent” [4:29]

→ murābahah is clearly concluded by mutual consent and hence comes under the general permission of this verse

The ordinary murābahah sale is a legally permissible contract by the testimony of Companions of the Prophet (pbuh):→ the Prophet (pbuh) purchased a female camel from Abū Bakr (*) for use as

transportation to migrate to al-Madīnah. Abū Bakr (*) wanted to give it to the Prophet (pbuh) free-of-charge but the Prophet (pbuh) refused and said, “I will preferably take it at the acquisition price”

→ this hadith indirectly implies that a commodity can be sold at the acquisition price and also at the acquisition price with a mark-up

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I.III LEGITIMACY OF ORDINARY MURĀBAHAH

Classical jurists from all schools support that murābahah is a trust sale which comprises both cost price and margin of profit. Some definitions follow:

→ Imām Shāfi'ī - When someone sell an item with a contract, for instance for every 10 products the profit is 1, the buyer thus must pay the cost price, that is 90 dirham, plus the profit of 1 dirham for every 10, hence 9 dirham and therefore eventually the total financing is 99 dirham

→ Al-Kamāl ibn al-Humam (hanafī) - Al-murābahah is a contract of delivery of traded goods by a seller to the buyer by offering the buyer the selling cost price plus the total profit

→ Ibn Qudāma al-Māqdisi (hanbalī) - A form of business transaction whereby the customer is informed that the goods are sold at a price which includes the cost price and profit

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PREFERRED MODES OF FINANCING IN ISLAM The ideal modes of financing in Islam are the mudhārabah and mushārakah contracts:

→ however, within the current economic set up, there are certain practical difficulties in using mudhārabah and mushārakah instruments

→ hence: the use of ordinary murābahah on deferred payment basis as a mode of financing, is unanimously allowed by Shariah scholars as a transitory step taken in the process of Islamization of the economy

→ as such, murābahah is only a device to escape from interest (ribà) and not an ideal instrument for carrying out the real economic objectives of Islam

MURĀBAHAH AS A MODE OF FINANCING The ordinary murābahah sale contract is being used by today’s providers of capital (such as:

Islamic banks, Islamic financial institutions, SGs, VSLAs, etc.) as a mode of financing. It is called ‘Murābahah based on Order-to-Purchase’:→ as such, it has become one of the financing mechanisms widely accepted in the muāmalāt

system→ it is the least risky system of Islamic financing: it allows for mitigating the risks on the capital

outlay and for booking in expected profits→ it falls under the category of Natural Certainty Contract (NCC) because unlike equity

financing, the return to the financier under NCC is pre-determined and certain→ the NCC are called debt-based instruments. The bank enjoys a pre-determined return that has

no correlation with the performance of the user of finance→ these instruments have to observe conditions to ensure that they are free from ribà

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Murābahah based on Order-to-Purchase is a murābahah for a pre-agreed selling price, which includes a pre-agreed profit mark-up over its cost price, the latter having been specified in the customer's promise to purchase:→ it is widely applicable and used as one of financing tools by Islamic banks worldwide→ its use should be restricted only to those cases where mudhārabah or mushārakah

are not practicable→ being a sale, the murābahah based on Order-to-Purchase must fulfill all the

conditions necessary for a valid sale

As a mode of financing, murābahah based on Order-to-Purchase is not a loan given on interest but is the sale of a commodity for a deferred price (cost+profit)→ beware that murābahah financing does not come into existence by merely replacing

the word ‘interest’ by the words ‘profit’ or ‘mark-up

Murābahah based on Order-to-Purchase must follow certain particular rules/conditions:→ these rules/conditions must be observed→ they must implemented one after the other. The timing is a key element of the

validity of the transaction→ it is the observance of these conditions which can draw a clear line of distinction

between an interest bearing loan and a transaction of murābahah

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→ unless these conditions are fully observed, murābahah is not permissible→ If any of these conditions are neglected, the murābahah transaction is void

CONDITIONS A key condition is that the financier must have owned the commodity before it sells it to

its client:→ this is the only feature of murābahah as a mode of financing which can distinguish it

from an interest based transaction→ the sale of the commodity to the client effected before the commodity is acquired by

the seller is prohibited→ this usually happens when all the documents of the murābahah are signed

simultaneously without properly taking into account its various stages

From the above, it ensues another condition: the commodity must be in the financier’s risk:→ hence: physical or constructive possession, though for a short period of time

The best way to perform murābahah is for the financier to purchase the commodity himself (or through its agent) and keeps it in its possession, before it sells it to the customer:

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→ in exceptional cases, it is also allowed that it makes the customer itself its agent to buy the commodity on its behalf

Another key condition is that the commodity is purchased from a third party:→ entering into a murābahah contract on commodities already purchased by the client

from a third party is prohibited→ the purchase of the commodity from the client himself on ‘buy back’ agreement is

not allowed in Shariah→ murābahah based on ‘buy back’ agreement is nothing more than an interest based

transaction

Murābahah cannot be used as a mode of financing except where the client needs funds to actually purchase some commodities:→ it requires a real sale of some commodities, and not merely advancing a loan→ if the funds are required for other purposes (paying the price of a commodity already

purchased, pay utility bills, staff salary, etc.) murābahah cannot be done→ hence, is not a universal instrument which can be used for all types of financing

offered by conventional interest-based banks→ it cannot be used for personal financing/consumption needs

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As in a normal sale, the seller can promise to sell even when the commodity is not in its possession

As normal, any upfront payment towards financing the item sought by the client is deducted, and the mark-up applied only on the amount financed

If the financier purchases the item from the seller at a cash discount, the item cannot be sold on a murābahah basis if the discount is concealed

SHARIAH STANCESome contemporary Islamic jurists have allowed murābahah based on order-to-purchase on a temporary basis because is a lesser form of evil in relation to the direct use of ribà:

The principle of need (dharūra) allows for the relaxation of specific rulings in specific circumstances:→ the implications for a Muslim customer is that it does not make use of such a

contract except if he/she has a need that demands him to purchase the item on such a basis

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II.I THE CONTRACT OF MURĀBAHAH FINANCING

THE CONTRACTING PARTIES The two Contracting Parties have different capacities at different stages:

→ promisee/financier/seller: responsible for supplying the product needed/ordered by the buyer. The traded item or property must be lawfully owned by the promisor/ financier/seller according to Shariah requirements

→ promisor/customer/buyer: obligated to pay for the product it purchased according to the agreed terms

→ both must be adults, rational, intelligent and can be held accountable

THE AGREEMENT The Promissory Agreement between the would-be buyer/customer and the

seller/financier. They sign an overall agreement whereby the latter agrees to sell and the former agrees to buy the commodities on an agreed ratio of profit added to the cost:→ the relation is one of promisor and promisee → this agreement may specify the limit up to which the facility may be

availed→ the product must be clearly defined (type, quantity and other descriptions)→ NB: the cost (original price) and rate/margin of profit added to it, will have to be

disclosed clearly and truthfully in due time. The act of concealing them will render the transaction null and void!

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THE AGENCY The (possible) Agreement of Agency has the following features:

→ the relation is one of Principle and Agent→ if the institution purchases the commodity directly from the supplier

(which is preferable) there is no need of any Agreement of Agency → if a specific item is required by the customer, the institution may appoint it as its

agent for purchasing the commodity on its behalf, and an Agreement of Agency is signed by both parties

→ the customer purchases the commodity on behalf of the institution and takes its possession as an agent of the institution

→ the client informs the institution that he/she has purchased the commodity on its behalf

→ it is preferable that the supplier invoices the items in the name of the financier not in the name of the agent

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PURCHASE ORDER/THE PROMISE There is a big difference between an actual sale and a mere promise to sell:

→ the actual sale cannot be effected unless the item has come into existence, it is owned by the seller, is in its physical or constructive possession

→ however one can promise to sell (or buy) something which is not yet owned or possessed by him. This promise initially creates only a moral obligation on the promisor to fulfill his promise, which is normally not justiciable

→ nevertheless, in certain situations, where such promise has burdened the promisee with some liability, it can be enforceable through the courts of law

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DECLARATION The Offer and Acceptance. After the item comes into the possession of the seller

the actual sale can be effected. The actual transaction requires separate offer and acceptance:→ the relation is one of a buyer and a seller→ the customer makes an offer to purchase it from the financier→ the financier accepts the offer and the actual sale is concluded whereby

the ownership as well as the risk of the commodity is transferred to the customer

→ the most essential element of the transaction is that the commodity must remain in the risk of the institution before selling to the client

→ unless the sale is effected in this manner, the legal consequences of the sale shall not follow

→ products traded cannot be paid by barter with the six ‘ribawi items’ prohibited by the Prophet (pbuh) in the well-known hadith: gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt, unless weight, measurement and the calculations are exactly equal

PAYMENT SCHEDULE Since the sale is effected on deferred payment basis, the relation of a debtor

and creditor also emerges between them simultaneously:

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→ any date agreed or credit term mutually agreed upon that would solidify the creditor’s claim on the date of maturity is allowable. There is no limit to the date of repayment

COST/INITIAL PRICE The original price must be fungible:

→ i.e.: the price at which the seller obtained the goods must be measured by weight, volume or number of homogeneous goods

If the original price is not fungible (i.e.: house, clothes, etc.), then the question is whether the seller is the owner or not:→ if the seller is not the owner, the murābahah is not permitted→ if seller is the owner, two situations are possible:

if the profit margin is specified as a known amount of a different item (i.e. silver coins, a specific dress, etc.), the sale is permitted. In this case, the first price is known and the profit is known (i.e.: sale through a murābahah in exchange for the dress and a profit of 500 AFN)

if the profit is made part of the initial price (i.e.: the profit margin is 10%), the sale is not permitted, since the profit is made part of the object and not equally divisible

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CALCULATION OF COST IN MURĀBAHAH In a murābahah the profit may be fixed from the beginning:

→ at the time the mutual promise is made between the bank and the client (Purchase Order), the parties agree and fix the margin of profit which will be added to the original purchase price

→ in any case, the profit must be known and fixed before the sale is concluded (Declaration)

SECURITIES The financier/seller may ask the customer to furnish a security to its satisfaction for the

prompt payment of the deferred price

The financier/seller may also ask the client to sign a promissory note or bill of exchange, but it must be after the actual sale takes place (Declaration):→ the reason is that the promissory note is signed by a debtor in favour of his creditor,

but the relation of debtor and creditor between the institution and the client begins only when the actual sale takes place

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PENALTIES In case of default by the buyer in the payment of price at the due date, the price cannot

be increased:→ however, if he/she has undertaken, in the agreement to pay an amount for a

charitable purpose he/she shall be liable to pay the amount undertaken by him/her→ the amount so recovered from the buyer shall not form part of the income of the

financier/seller. He is bound to spend it for a charitable purpose on behalf of the buyer

→ this charge is levied only if the default is not due to financially stringent circumstances

→ for the sake of example, al-Baraka South-Africa specifies a charge of 0,07% per day on the overdue amounts (equivalent to 2.1% monthly and 25.2% annually)

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Ordinary murābahah On-Order-to-Purchase murābahah

1. The customer orders a product unavailable in his/her locality

1. The customer knows where the product is available

2. The product is not in his/her capacity. 2. The product is in his/her capacity but exceeds his/her financial capacity

3. The customer does not know the original cost 3. The customer knows the original cost

4. Only the merchant knows the original supplier 4. The customer knows the original supplier

5. The merchant searches for the product in question

5. The customer himself searches for the product

6. The merchant locates, negotiates, and orders the product

6. The customer locates, negotiates, and orders the product

7. Transactions take days or months to complete – depending on the distance, availability of product, mode of transportation, etc.

7. Transactions may take only a few minutes

8. The customer does not act as agent 8. The customer may be appointed as agent on behalf of the financier to purchase the article

9. The merchant bears all the risks of purchase and transport. 10. The customer has the right to cancel the contract upon inspection of the article

Comparison between Ordinary and On-Order-to-Purchase MURĀBAHAH

II.II DEBATED ISSUES ON MURĀBAHAH FINANCING

DIFFERENT PRICING FOR CASH AND CREDIT SALES The murābahah used as a mode of financing, it is always effected on the basis of

deferred payment. The question arises as to whether the price of a commodity in a credit sale may be increased from the price of the cash sale:→ the financier purchases the commodity on cash payment and sells it on credit. While

selling the commodity on credit, it takes into account the period in which the price is to be paid and increase the price accordingly

→ the longer the maturity of the murābahah payment, the higher the price. Hence: the price in a murābahah transaction is always higher than the market price

DIFFERENCE WITH AN INTEREST (RIBAWI) LOAN Is the increase of price in a credit sale being in consideration of the time given to the

purchaser analogous to the interest charged on a loan?→ according to ulama’ this presumption is not correct. Any excess amount charged

against late payment is ribà 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

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→ if a seller increases the price because it allows credit to his client, it is not prohibited by Shariah, because whatever the reason of increase, the whole price is against the commodity and not against money

→ while increasing the price of the commodity, the seller has kept in view the time of its payment, but once the price is fixed, it relates to the commodity and not to the time

→ if the purchaser fails to pay at a stipulated time, the price will remain the same and can never be increased by the seller

→ time may act as an ancillary factor (not as an exclusive basis as in exchange of money for money) to determine the price of the commodity but once this factor has played its role, every part of the price is attributed to the commodity

→ had it been against time, it might have been increased, if the seller had allowed him more time after the maturity

This position is accepted unanimously by all the four schools of Islamic law and the majority of Muslim jurists:→ the only condition is that at the time of the actual sale the increase in price and the

timing must be clearly stated leaving no ambiguity in the nature of the transaction→ unless this is done, the sale is invalid

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In a nutshell, the difference with a ribawi loan is that:→ where the additional amount is a part of the price, it may be charged on a one time

basis only (no additional amount in case of late payment)→ where the additional amount is not a part of the price, it will keep increasing with the

period of default

PROMISE TO PURCHASE The financier/seller cannot enter into an actual sale at a time when the client seeks

murābahah financing, because it does not yet own the required commodity and in Shariah neither the sale of a commodity not owned nor a forward sale are permitted:→ it is, therefore, bound to purchase the commodity from the supplier, taking physical

or constructive possession, and only then on sell it to the client→ but if the client is not bound to purchase the commodity after the financier has

purchased it, it may be confronted with a loss if the client refuses to purchase it

Solution to this problem is sought in the murābahah by asking the client to sign a promise to purchase the commodity when it is acquired by the financier:→ it is a unilateral promise which binds the customer and not the financier,

distinguishable from a bilateral forward contract. As such, it is allowed in Shariah

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→ a promise is recognized as morally binding by most jurists based on Qur’anic and hadith evidence and its fulfillment deemed obligatory

→ this commercial promise may also be enforceable by some Courts of Law, as the promisee has incurred liabilities on the basis of the absolute promise to purchase it

→ if the promisor backs out of his promise, the court may force him either to purchase the commodity or pay actual damages to the seller

SECURITIES AGAINST THE MURĀBAHAH PRICE The financier/seller wants to make sure that the murābahah price will be paid at the due

date. For this purpose, he may ask the client to furnish a security to his satisfaction:→ payments due from the sale are receivables and for this, the client may be

asked to furnish a security→ the financier asks for a security after he has actually sold the commodity to the client

and the price has become due to him→ it is permissible that the client furnishes a security at earlier stages, but after the

murābahah price is determined→ the security may be in the form of a mortgage or a hypothecation or some kind of

lien or charge→ it is permissible that the sold commodity itself is given to the seller as a security

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→ it is sometimes required (different schools differ on this point) that the purchaser shall take delivery (physical or constructive), then give it back to the seller as mortgage, so that the transaction of mortgage is distinguished from the transaction of sale

GUARANTEEING THE MURĀBAHAH The seller can ask the purchaser to furnish a guarantee from a third party. In case of

default of payment, the seller may have recourse to the guarantor, who will be liable to pay the amount guaranteed to him:→ the classical fiqh literature is almost unanimous on the point that the guarantee is a

voluntary transaction and the guarantor cannot charge a fee from the original client. The reason being that a person charging a fee for advancing a loan comes under the definition of ribà

→ a minority of contemporary scholars opine that this prohibition should be reviewed in light of contemporary international trade practices

→ however the guarantor can charge for any documentation expenses

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PENALTY OF DEFAULT If the client defaults on the payment at due date, the price cannot be increased nor can

penalty fees be charged:→ this restriction is sometimes exploited by dishonest clients who deliberately avoid to

pay the price at its due date→ a minority of contemporary scholars have suggested that the client who defaults

deliberately should be made liable to pay compensation equal to the profit (if any) given by that bank to its depositors during the period of default

→ and this, only after he is given a grace period of at least one month and if it appears that his default is not due to poverty

NO ROLL-OVER IN MURĀBAHAH The maturity date of the murābahah transaction can never be rolled-over for a further

period as the old contract ends. The extension of the period of payment on an additional mark-up charged (in practice another separate murābahah) is totally against Shariah→ murābahah is not a loan: it is the sale of a commodity the price of which is deferred

to a specific date→ once this commodity is sold, its ownership transfers from the bank to the

client and it is therefore no more a property of the seller. Hence the same commodity can not be sold twice

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→ now, what the seller can claim is only the agreed price and therefore there is no question of effecting another sale on the same commodity between the same parties

REBATE ON EARLIER PAYMENT The majority of jurists as well the Islamic Fiqh Academy of the OIC, hold that if the

earlier payment is conditioned with discount, it is not permissible:→ no such rebate can be stipulated in the agreement, nor can the client claim it as his

right→ however, if it is not, and the creditor gives a rebate voluntarily on his own, then it is

permissible→ his especially if the client is needy

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II.III ACCOUNTING POLICIES

The Islamic Financial Accounting Standard-1 (IFIS-1) are applied to the murābahah financing

TRANSACTION RECORDING At the time of disbursement to the client for the purchase of the goods on behalf of the

bank, or directly to the supplier, the payment will be booked in the account head named ‘Advance against Murābahah’

At the culmination of murābahah i.e. at the time of sale of goods to client with the signing of the Declaration, the ‘Advance against Murābahah’ will be adjusted into ‘Murābahah Financing’:→ financing are recorded at the deferred sale price, net of profit→ financing are stated net of specific and general provisions against non-

performing financings, if any, which are charged to the profit and loss account

Goods purchased but remaining unsold at the balances sheet date, are recorded as inventories

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REVENUE RECOGNITION Profits on murābahah financings are recognised on accrual basis profit for the period

from the date of disbursement to the date of culmination of murābahah immediately after the Declaration has been signed and the ‘Murābahah Financing’ has been booked

EXAMPLEThe following transaction is initiated:

Purchase Price/Cost/Principal = AFN 1.000

Profit Rate = 10%

Tenure = 1 Year

Total Profit on Transaction = AFN 100

Sale price (Contract price) = AFN 1.100

Date of disbursement to supplier/customer = 1 May, 2013

Date of culmination of murābahah transaction (Declaration) = 15 May, 2013

Date of maturity of murābahah = April 31, 2014

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ASSETS (AFN)

LIABILITIES (AFN)

1 May 2013 Advance against murābahah (1) 1.000

1 May 2013 Pay Order / Party Account (1) 1.000

15 May 2013 Murābahah Financing Receivable (2) 1.000

15 May 2013 Unearned Murābahah Profit Receivable (2) 100


15 May 2013 Deferred murābahah Income (2) 100

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(1) At the time of disbursement to Applicant for the purchase of goods on behalf of SG/VSLA or directly to the supplier by the SG/VSLA the transaction will be accounted for as follows

(2) At the culmination of Murābahah (15 May 2013) i.e. at the time of sale of goods to the Applicant with signing of Declaration by the SG/VSLA and the Applicant, following entries will be passed

Scenario A: Declaration signed on 15 May 2013


ASSETS(AFN)

LIABILITIES (AFN)

15 May 2013 Murābahah Profit Receivable (3) 4.10

15 May 2013 Unearned Murābahah Profit Receivable (3) 4.10

31 May 2013 Murābahah Profit Receivable (4) 4.39

31 May 2013 Unearned Murābahah Profit Receivable (4) 4.39

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(3) Booking of accrual of profit at 10% from the date of disbursement to the date of culmination, the following entry would be passed [(1000 x 10%) x 15 / 365]. In the in the Income statement there is an entry for ‘Deferred murābahah Income’ and for ‘Income on murābahah Financing’

(4) Booking of accrual of profit at 10% for remaining days of the month, the following entry would be passed. [(1000 x 10%) x 16 / 365]. In the in the Income statement there is an entry for ‘Deferred murābahah Income’ and for ‘Income on murābahah Financing

NB: these entries will be passed at the end of each month, till maturity for the accrual of profit


ASSETS (AFN)

LIABILITIES (AFN)

31 May 2013 Murābahah receivable-gross 1.100

31 May 2013 Deferred Murābahah income (5) 91.51

31 May 2013 Murābahah Profit Receivable (6) (8.49)

31 May 2013 Murābahah Financing Receivable 1.000

31 April 2014 SG/VLSA account (7) 1.100

31 April 2014 Murābahah Financing 1.000

31 April 2014 Murābahah Profit 100

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(5) [100- (1000x10%x31/365)](6) 4.10+4.39 = 8.49(7) On maturity of murābahah transaction and at the time of receiving of final payment

following entry would be passed


ASSETS (AFN)

LIABILITIES (AFN)


1 May 2013 Pay Order / Party Account (1) 1.000

15 May 2013 No Entry (2)

31 May 2013 No Entry (2)

15 Jun 2013 Murābahah Financing Receivable (3) 1.000

15 Jun 2013 Unearned Murābahah Profit Receivable (3) 100

15 Jun 2013 Advance against murābahah (3) 1.000

15 Jun 2013 Deferred murābahah Income (3) 100

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(1) At the time of payment to Applicant for the purchase of goods on behalf of SG/VSLA or directly to the supplier by the SG/VSLA the transaction will be accounted for as follows

(2) No entry would be passed for accruals of profit, as Declaration has not been received from the customer

(3) At the culmination of Murābahah (15 June 2013) i.e. at the time of sale of goods to the Applicant with signing of Declaration by the SG/VSLA and the Applicant following entries would be passed

Scenario B: Declaration signed on 15 June 2013


ASSETS (AFN)

LIABILITIES (AFN)

15 June 2013 Murābahah Profit Receivable (4) 12.60

15 June 2013 Unearned Murābahah Profit Receivable (4) 12.60

30 June 2013 Murābahah Profit Receivable (5) 4.10

30 June 2013 Unearned Murābahah Profit Receivable (5) 4.10

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(4) Booking of accrual of profit at 10% from the date of disbursement to the date of culmination, the following entry would be passed [(1000 x 10%) x (31+15) / 365]. In the Income statement there is an entry for ‘Deferred murābahah Income’ and for ‘Income on murābahah Financing’

(5) Booking of accrual of profit at 10% for remaining days of the month, the following entry would be passed. [(1000 x 10%) x 15 / 365]. In the in the Income statement there is an entry for ‘Deferred murābahah Income’ and for ‘Income on murābahah Financing

NB: these entries will be passed at the end of each month, till maturity for the accrual of profitNB: in case the murābahah declaration is not received on the due date, no entry would be passed until the declaration is received


ASSETS (AFN)

LIABILITIES (AFN)

30 Jun 2013 Murābahah receivable-gross 1.100

30 Jun 2013 Deferred Murābahah income (5) 83.30

30 Jun 2013 Murābahah Profit Receivable (6) (16.70)

30 Jun 2013 Murābahah Financing Receivable 1.000

31 April 2014 SG/VLSA account (7) 1.100

31 April 2014 Murābahah Financing 1.000

31 April 2014 Murābahah Profit 100

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(5) [100- (1000x10% x (31+30) /365)](6) 12.60+4.10 = 16.70(7) On maturity of murābahah transaction and at the time of receiving of final payment

following entry would be passed

II.IV CHECKING AND MONITORING

MURĀBAHAH MONITORING SHEET: As per the guidelines of Shariah Advisory Boards, Murābahah Monitoring Mechanism

(MMM) ought to be implemented to ensure timely receipt of Declarations & Purchase Evidences:→ this will be a self-monitoring sheet and will be used to ensure proper

execution of Murābahah transactions

PURPOSE The purpose of implementing the MMM is:

→ to improve the quality of murābahah transactions→ to reduce the gap between disbursement and purchase evidence→ to avoid delays in declaration and to streamline murābahah transactions at

all levels

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II.IV CHECKING AND MONITORING

Monthly Murābahah Status Sheet For the Month of: May, 2013VLSA:

Application number

Customer Name

Subject Matter

Payment Mode

Date of Disbur-Sement

(D)

Invoice Date

(I)

Sub-Declaration

Date (S)

Maturity Date

(M)Tenor(M-D)

Purchase Gap(I-D)

Decla-ration Gap(S-D)

Declarations Outstanding

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II.V BASIC MISTAKES IN MURĀBAHAH FINANCING

The most common mistake is to assume that murābahah can be used for all types of transactions and financing. This mode can only be used when a commodity is to be purchased by the customer:→ if funds are required for some other purpose, murābahah cannot be used

The document is signed for obtaining funds for a specific commodity and therefore it is important to study the subject matter of the murābahah

In some cases, the sale of the commodity to the client is affected before the commodity is acquired from the supplier. This occurs when the various stages of the murābahah are skipped and the documents are signed all together:→ it is to be remembered that murābahah is a package of different contracts

and they come into play one after another at their respective stages

It is observed in some financial institutions that murābahah is applied on already purchased commodities, which is not allowed in Shariah:→ murābahah can be effected only on not yet purchased commodities!

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II.VI USES OF MURĀBAHAH FINANCING

MURABAHAH CAN BE USED IN FOLLOWING CONDITIONS

SECURITIZATION Securitization of murābahah agreement (certificate) is allowed at par value

only:→ debt can be traded only at par

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Short / Medium / Long Term Finance for:

→ Raw material → Inventory

→ Equipment → Asset financing

→ Import financing → Export financing (Pre-shipment)

→ Consumer goods financing → House financing

→ Vehicle financing → Land financing

→ Shop financing → PC financing

→ Tour/Education/Medical package financing

III. TAWARRUQ

Tawarruq is the root word (masdar) for the verb tawarraqa, and means to ‘take papers‘

CLASSICAL TAWARRUQ The ‘classical tawarruq’ (tawarruq fiqhi or tawarruq fardhi) is a sale contract whereby

a buyer (mutawarriq: seeker of cash) purchases an asset (possessed and owned by the seller) on credit for a delayed payment (as it is done in ordinary murābahah) and subsequently sells the asset to a third party (an entity other than the initial seller) for a price lesser than the deferred price on cash (al-wariq):→ this transaction is called tawarruq, mainly because when the buyer

purchases the asset on deferred terms, it is not its intention to utilize the benefit from the purchased asset, rather to facilitate him to attain liquidity (waraqh maliah)

→ according to the majority of the scholars, ‘classical tawarruq‘ is legally permissible as no ribà is intended

→ it was allowed by the Organization of Islamic Countries (OIC) Fiqh Academy in its fifteenth session (Sept. 1998), on condition that the buyer should not resell the commodity to the first seller and at price lower than the purchase price (this would resemble a ‘inah sale, which is forbidden in Shariah)

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III. TAWARRUQ

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Trader (Islamic FinancialInstitution)/Seller

Third Party

Mutawarriq

Sell item ondeferred price(Cost +Profit)

Transfer ofownership


Sell itemon cash


Buy itemon cash

The point in this structure is that there is real ownership transfer to the mutawarriq who has fully right of the item

Another important thing that must be underlined is that in the classical tawarruq structure, each transaction is independent

CLASSICAL TAWARRUQ

III. TAWARRUQ

ORGANIZED TAWARRRUQ / COMMODITY MURĀBAHAH In today’s financial markets, a new form of tawarruq called ‘organized tawarruq’

(tawarruq al-munazzam or masrafi) has emerged:→ its structure in also known in the Islamic banking industry as a ‘Reverse

Tawarruq’→ the Hanbali school of law call it tawarruq, whereas other schools mention this

structure under the rubric of bay’ al-ajal and bay’ al-’inah

It is used by Islamic banks on both side of their balance sheet to replicate a conventional loan structure:→ on the Asset side, to address financing needs of their customers:

→ bank buys a commodity (mostly mineral) following the promise to purchase it by a customer (mustawriq) who needs liquidity

→ the bank on sells it to the him at a deferred price (as in classical tawarruq)

→ BUT the customer appoints the same bank as his agent and the bank sells the commodity on his behalf to a third party on cash

→ the banks hands the money over to the mustawriq

→ on the Liability side, as a deposit mobilizing instrument:→ in this case the customer firstly buys a commodity and sells it to the

Islamic bank on deferred basis→ effectively, the client is thus mimicking a fixed income deposit

.

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III. TAWARRUQ

Most scholars hold this contract voidable because:→ the bank does not hold/possess the commodity (it does not assume any

risk)→ practically, the bank does not pay the price of the commodity to the

seller, but to the mustawriq, since is his agent→ the transaction resembles agency in ribà, whereas the mustawriq takes

the lesser amount and he returns a bigger amount at the maturity date

widespread use of this form tawarruq is harmful to the industry in the long run. IFI needs to understand that tawarruq arrangement should be used in extreme cases where no option is available to avoid interest.

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III. TAWARRUQ

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Trader B

(Islamic FinancialInstitution)/Seller Trader A

Mutawarriq

3. Appoints IFIto sell warrants6. Pay deferred

2. Sellwarrants on

a deferred basis

5. Pay Cash

4.Sell warrantson cash as Agent

1. Deliver warrants

1. Pay cash

The net result of the above movements of warrants and cash is that the counterparty now holds an amount of money against an offsetting payment to the IFI for a pre-agreed principal plus a mark-up at a pre-agreed future date, thus creating a synthetic deposit

ORGANIZED TAWARRUQ / COMMODITY MURABAHAH

III. TAWARRUQ AND COMMODITY MURĀBAHAH

THE MALAYSIAN EXPERIENCE Organized tawarruq is approved and officially used in Malaysia to ease the issue of

liquidity management faced by Islamic banks:→ liquidity risk is the potential loss to banks arising from their inability either to meet

their obligation or to fund increases in asset

The Association of Islamic Banking Institutions Malaysia (AIBIM) has launched in Sept 2009 the ‘Corporate Murabahah Master Agreement (CMMA)’ in a move to boost the Islamic money market:→ it is a standard document for deposit taking between financial institutions (Deposit

Taking Entities or DTEs) and corporate customers (Deposit Placing Entities or DPEs). The latter intend to place their surplus funds with the DTEs

→ the CMMA specifies a common modus operandi for Islamic financial institutions in accepting deposits via commodity murābahah

→ the purchase by the bank, in its capacity as the agent of the customer, will be effected upon spot payment and immediate delivery by suppliers

→ it helps eliminate the need for corporate customers to vet through each and every agreement proposed by different Islamic financial institutions on the same product

→ it also provides certainty and standard methodology in ensuring principal and profit due to corporate depositors

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Similarly AIBIM has launched the’ Interbank Murābahah Master Agreement (IMMA)’ in 2009:→ it is a bilateral agreement between the Deposit-Placing Entity (DPE), or

the principal and the Deposit-Taking Entity (DTE), or the agent→ as an agent, the bank will receive instructions from the principal to buy

commodities from suppliers→ the purchase by the DTE or the bank would be effected upon spot

payment and immediate delivery by suppliers→ upon conclusion of the commodity purchase by the bank on behalf of the

principal, the bank may subsequently offer to purchase the commodities from the principal on a deferred cash payment basis, at an agreed sale price that takes into consideration the initial purchase price and the profit amount

→ the sale would then be effected upon acceptance of the offer by the principal

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To implement the two agreements, Bursa Malaysia has launched in 2009 a trading platform called ‘Suq al-Sila‘’ or ‘Commodity Murabahah House’:→ the platform aims to facilitate Islamic financial transactions, particularly

the application of commodity murābahah which is based on the principle of tawarruq

→ the platform claims to provide genuine commodity transactions where possession and delivery of the commodity can take place without any hindrance, as opposed to the controversial practice of tawarruq using a platform like the London Metal Exchange (LME) in London

Dubai Multi Commodities Centre (DMCC) has announced the inaugural Commodity Murabahah transaction on its DMCC Trade-flow platform

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V. MURĀBAHAH V. BAY’ BI-THAMAN AJIL (BBA)

BBA is a sale contract in which the payment of the price is deferred and payable at a certain particular time in the future:→ the Majallah (Hanafi-based codification) refers to BBA as Bay' al-Mu’ajjal.

This term is employed in Pakistan whereas in Bangladesh it is known as Bay‘ Muazzal

A BBA refers to the deferred mode of payment in a sale whereas the deferred payment has been made and agreed at the beginning of the contract

BBA financing is employed by bank to provide medium to long term financing to clients:→ house financing is the most popular facility granted under BBA either to

purchase existing completed houses, or construct new house on customer’s land

→ the customer sells the property purchased to the bank for a cash sum paid to the customer and the property will then be immediately resold back by the bank to the customer at higher price which include the bank’s profit on the sale, payable by the customer to the bank by monthly installments over a fixed period of time

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