Murabahah Parameter Present

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MURABAHAH PARAMETERPresented by : Hijaz Yusuff Rabiatul Adawiyah

INTRODUCTIONo Murabahah parameter is the first in a series of Shariah parameters issued to Islamic financial institutions in Malaysia. o The parameters is a standard document that provide the guidance and reference to promote greater harmonisation in the development of the Islamic finance industry in Malaysia. This initiative aims to define the essential features of Murabaha-based financial products and services that have been endorsed by Shariah boards and used by Islamic institutions. o It outlines the main Shariah requirements in the contracts and provides examples, methods and models for practical application of this mode of financing. o It will also contribute to further harmonisation in the interpretation and application of Shariah views and opinions among Shariah committee members of all IFIs.

OBJECTIVES OF THE PARAMETERS. Clarify the concepts, principles and conditions of Shariah contracts and practices.

Provide focus on the features of Shariah contracts and concepts that form the basis of Islamic financial products and services. Provide the basis for decisions on matters relating to conditions, mechanism and implementation of Shariah contracts or concepts. Facilitate Islamic finance professionals and practitioners in designing and developing Islamic financial products and services. Facilitate the formulation of policies and guidelines on Shariah contracts and concepts adopted by the Islamic financial services Industry.

Shariah Parameter Methodologyy In determining Shariah compliant Murabahah contracts, the

following considerations have been made to institute a methodology to develop the parameters:y a. Primary sources priority over secondary sources y b. Fatwas were obtained. y c. Deductive and inductive approaches were adopted.

Shariah Parameter Methodologyy Legal matters, operations and risks were made based on

resolutions by majority opinion. y Other issues are based on a minority opinion of the scholars or Shariah boards.

Classical MurabahahTrusty Trust-sale that aims to finance acquisition of assets on short

or long term basis. y Classical Murabahah involved customer that would purchase an asset from the vendor on cost-plus mark-up basis either paid in cash basis or deferred payment. y The asset would have already been owned by the vendor and the purchase price is a mark-up price which is made known before the transaction.

Murabahah in Modern Practicey Murabahah sale is a form of asset financing with an agreed

and known mark-up. y It is a Shariah compliant alternative to interest-based lending financing mechanisms. y The Murabahah contract has also been applied for taking deposit and raising sukuks. y Murabahah in Modern Practice

DefinitionLiterally Murabahah means increase. Technically, Murabahah is the cost plus profit price disclosed between the purchaser and the seller of a certain specified asset. Murabahah sale may be contracted either in the form of cash or deferred payment.

Definitiony In the Islamic financial services industry, Murabahah is

adopted in a transaction whereby three parties are involved, namely the Islamic Financial Institution (IFI), the supplier and the customer.y The Murabahah credit sale of a specified asset by an IFI to the

customer is at a disclosed mark-up price based on the IFI s cost of financing the purchase.

Pillars of a Sale Contract

Legal capacity of contracting parties Offer and acceptance Lawful and existing subject matter Certainty of the price

Legitimacy of Murabahah ContractThe Murabahah is based from: The Quran The Sunnah of the Prophet Muhammad (SAW) The consensus of the Muslim jurists The Qiyas (analogy).

Legitimacy of Murabahah Contracty THE QURAN y The Quran generally allows the sale contract. Among others,

the Quran says to the effect that Allah permitted trade and prohibited usury. (2:282)

Legitimacy of Murabahah Contracty y y y

THE SUNNAH OF THE PROPHET MUHAMMAD (SAW) There might have no direct juristic authority from the Sunnah of the Prophet (SAW) on the legitimacy of Murabahah sale. Therefore it is deemed permissible based on the general permissibility of sale in Islamic law. The Prophet Muhammad (SAW) is reported to have said: The best earning is what man earns with his own hands and from a permissible trade. (Narrated by Hakim)BNM

Legitimacy of Murabahah Contracty THE IJMA OF THE MUSLIM JURISTS y It is noted that people have inherited these transactions

(Murabahah) for ages without any objection and that would constitute consensus (Ijma) on permissibility of Murabahah.

Legitimacy of Murabahah Contracty ANALOGY (QIYAS) y Since the Prophet Muhammad (SAW) 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 Tawliyah sale. y The determination of cost and making it known to the buyer are common in both the Tawliyah and Murabahah sale.

Features of Murabahah Contract

Price of Murabahah sale

Asset of Murabahah sale

Duty of full disclosure

Wa ad (promise to buy)

Features of Murabahah ContractPRICE OF MURABAHAH SALE y Murabahah sale price shall be determined based on: y The acquisition cost plus mark-up amount or percentage determined upfront y The mark-up shall be determined mutually by the contracting parties y The mark-up shall be determined and specified upfront y Any mutually agreed benchmark adopted is allowed and must be specified upfront y The Murabahah price once agreed is a fixed price

Features of Murabahah Contracty DISCLOSURE OF PURCHASE PRICE (TRUSTEESHIP) y The purchase cost of the asset payable by the IFI to the seller shall

be disclosed to the customer before concluding the Murabahah contract. y The cost shall include the purchase price and expenses related to the acquisition of the assets or goods. y Failure of the IFI to properly disclose the purchase price as cost to determine the mark-up to the customer shall render the Murabahah contract null and void.

Features of Murabahah ContractASSET y Halal y Legally owned by the seller y Physical / constructive owned by the seller y Tangible y Intangible y Enforceable for sale y Transferable

Features of Murabahah ContractWA D (PROMISE) BY THE CUSTOMER TO PURCHASE THE ASSET ON MURABAHAH BASIS FROM THE IFIy The customer perform Wa ad (promise) to purchase the asset from the

IFI shall be binding on the customer.y The Wa d shall be separately executed from the Murabahah contract. y During the purchase requisition, the customer s application shall

contain the promise which must be duly signed by the customer.

Agency in Murabahah Contracty ContractThe IFI which appoints customer as purchasing

agent shall not waive its liability on the purchased asset to avoid money lending or cash financing. y As a purchasing agent of the IFI, the customer either can get the quotation on asset price in the name of the IFI or under the customer s own name from the supplier subject to acceptance from the IFI.

ILLUSTRATION

Illustration 1 : Murabahah FinancingA purchase orderer applies to an IFI for car financing under a Murabahah sale contract.

The IFI does not have the car but will, upon the promise of the purchase orderer to purchase the car on a mark-up basis, purchase the car from a third party, i.e. the supplier. The IFI purchases the car from the supplier, then, sells it to the purchase orderer on a deferred payment basis. The difference between the purchase price paid by the IFI to the supplier and the sale price that the IFI is selling to the purchase orderer is a mark-up for the IFI. For example, the financier purchases the car from the supplier at RM100,000 and sells on credit to the purchase orderer at RM120,000 payable in 5 years. While the supplier earns trading profit, the financier earns the financing profit through a mark-up sale.

IMPLICATION : Murabahah FinancingACCOUNTING This murabahah is meant for assets acquisition or technically known as Murabahah to the purchase orderer. Accounting treatment: i. Purchase of Asset by Bank Dr Car at cost RM100k Cr Cash RM100k ii. Murabahah sale Dr Murabahah financing RM120k Cr Car at cost RM100k Cr Deferred profits with RM20k

FINANCIAL / OTHER ISSUESPromise to buy of the purchase orderer Non-binding promise as the bank cannot sell what it does not possess. Financial Impact to the bank cost of purchasing the asset i.e. the car cost of keeping the asset i.e. inventory cost certain asset might depreciate in value i.e. car FAS2: Islamic bank may require deposit to reduce the risk and to ensure the purchase orderers seriousness:i. ii. Hamish Jiddiyah Urboun

Illustration 3 : Variation of Mark-up

Customer A : Mark up 10%

An IFI provides a Murabahah working capital financing facility to its customers

Customer B: Mark up 8% to 12%

On the other hand, Customer B requests IFI to finance regular purchase of motor vehicle spare parts on demand basis with an inventory turnover that varies between three to six months.

Customer A requests the IFI to finance the purchase of foodstuff with a shelf life not exceeding 3 months.

IFI agrees to purchase from the supplier in cash and sell to the customer A on credit, based on Murabahah contract with a mark-up of 10% of the purchase price, to be paid in full at the end of three months.

IFI agrees to purchase in cash from distributor and sell to the customer on credit, based on the Murabahah contract.

The mark-up ranges from 8% to 12% depending on the types of spare parts and terms of financing.

The different mark-up may be applied because the Murabahah contract for each customer is separately executed.

Illustration 3 : Variation of Mark-up

Accounting ImplicationVariation of Mark up due to consideration on credit risk factors i.e. customer type, goods and period of financing. Mark up price may be set differently provided that contracts are separately concluded and executed. ACCOUNTING TREATMENT: Customer A (10% markup) Murabahah sale Dr Murabahah financing RM110 Cr Foodstuff at cost RM100k Cr Deferred profits with RM10 Customer B (8% markup) Murabahah sale Dr Murabahah financing RM2160 Cr Spare Part at cost RM2000 Cr Deferred profits with RM160

Illustration 3 : Variation of Mark-up

Accounting ImplicationIF NO VARIATION OF MARK UP Financial impact The higher the acquisition cost of the asset, the higher profit the bank will earn and the higher of amount the purchase orderer has to pay. For example a 10% mark up for any asset would result: If Asset A acquired at cost of RM100, the mark-up price will be RM110 of which RM10 is the banks profit. Asset B acquired at cost of RM200, the mark-up price will be RM220 of which RM20 is the banks profits. Variation of Mark Up Important to serve the various factors of credit risk; To stimulate sales for high end assets such as those expensive asset like House, Luxury Cars and etc; and To give fair & the most reasonable price to the purchase orderer.

Illustration 9: The Effect of Currency Volatility on Murabahah Transactions

On t e r er f its client, t e IFI rc ases a car fr France f r an a nt f S 50,000 t finance t e client f r ra a a car financing at an agree ar f 10 in ala sian c rrenc . On t e rc ase a , t e exc ange rate was S 1 t R 3.50, t n t e a f t e sale f t e car t t e rc ase r erer, t e llar as e reciate t R 3.20. In rinci le, t is e reciati n as no effect on t e ra a a sale contract, and t e a ent s ould e ade according to t e rate revailing on t e da t e IFI urc ased t e asset from t e supplier. T e ura a a selling price pa a le R 192,500. t e client is (1.1 X S 50,000 X 3.5)

Illustration 9: The Effect of Currency Volatility on Murabahah Transactions

Accounting ImplicationAny asset purchased in local or foreign currency by an IFI may be sold to the purchase orderer in any other agreed currency. The acquisition cost shall be based on the exchange rate on the day IFI purchases the asset from supplier. Accounting treatment: At the time of contracting : Dr. Murabahah/BBA Financing account (RM 192,500) @ S$/RM = 3.5) Cr. Cash or Payable account (RM 175,000) Cr. Unearned Financing Income account (RM 17,500) When income is to recognise: Dr. Unearned Financing Income account (RM 17,500) Cr. Profit and Loss account ( RM17,500)

FINANCIAL IMPLICATIONy COMPARISON (in RM)Exchange Rates S(USD/MYR) 3.2 3.5 Selling price RM176,000 RM 192,500

The Murabahah selling price payable by the client is RM192,500 even though the value of the car is (1.1x3.2xUSD50,000) RM176,000. This reduce gharar in the foreign exchange exposure to the IFI and the clients

Illustration 20 : Liability of Purchase Orderer on Waad

A purchase orderer applies to an IFI to acquire a machine which costs RM50,000 through a Murabaha contract. The IFI approved his application and requested the purchase orderer to sign a unilateral promise to buy a machine after the acquisition of the machine by the IFI. As the purcahse orderer breached the waad, the IFI disposed the asset at RM45,000 and incurred an additional disposal cost of RM2,500. IFI shall be compensated for RM7,500 by the purchase orderer.

Illustration 20 : Liability of Purchase Orderer on Waad

Accounting ImplicationAccounting treatment for acquisition and disposal of the machine: Acquisition Dr Machine RM50k: Cr Cash RM50k Disposal Dr Cash Dr Rec. Cr Machine Cr P&L

RM45k RM7.5k RM50k RM2.5k

Illustration 3 : Variation of Mark-up

Financial ImplicationFinancial impact Exposure to revaluation risk in cases here assets are held crossing the follo ing financial year. Most probably, the IFI may incur revaluation loss as machine normally depreciate over time. IFI has to dedicate its resources to recover this loss hence may affect bottom line to certain extend. Other related issues Based on aad, the purchase orderer cannot be held liable and responsible to pay the price for breaching his aad. Instead, IFI may insist on amish Jiddiyah from purchase orderer in anticipation of such situation.

Illustration 22 : Refund of Purchase Orderers Deposit

Customer places 10% of cost of purchase of textile worth RM50k.

Mark-up selling price is RM75k for 6 months financing period.

Upon receipt of goods, the amount payable to the IFI is RM70k (less RM5k security deposit). If customer does not take delivery and the IFI incurs RM2k disposal cost in addition to loss of RM1k upon disposal, an amount of RM3k is deducted from the security deposit and the balance of RM2k is returned to the customer.

Illustration 20 : Liability of Purchase Orderer on Waad

Accounting ImplicationThe RM5k security deposit would be reflected under liability. The journal entry is as follow: Dr Cash RM5k Cr Security Deposit RM5k Upon acquisition of the machine Acquisition Dr Goods RM50k: Cr Cash RM50k Disposal Dr Cash RM49k Dr Sec. Dep RM3k Cr Cash RM2k Cr Goods RM50

Illustration 3 : Variation of Mark-up

Financial ImplicationSimilar to earlier example, should the disposal of goods take place in the next financial period, it would subject the inventory of goods to revaluation hence poses risk of lower market value. Should the disposal cost and disposal loss is more than the security deposit, the IFI would have to allocate resources to recover the total cost to IFI. Other related issue IFI would be in a better position as there is security deposit in cases of breach of waad.

ISSUES1 2 3 4 5 6 7 8 9 10 Timing of Offer & Acceptance 2. Rollover in Murabaha 3. Rebate on Early payment 4. Penalty in Late payment 5. Subject Matter 6. Purchase Evidence 7. Direct Payment 8. Profit recognition 9. Training of Customer & Bank staff 10. Process of Murabaha differ from product to products

1. Timing of Offer & Acceptancey A Murabaha financing arrangement consists of a series

of documents to be executed at various stages, the sequence and timing of which is extremely important. y Through this, client and the bank execute an important step of a valid Murabaha sale i.e. Offer &Acceptance. y This is to be signed by the customer when it has purchased and taken possession of the goods as the Banks agent. y Offer & Acceptance must be signed while the goods are still in existence and have not been used in the production process or sold to some other entity.

2. Rollover in Murabahay Rollover in Murabaha is not allowed since each

Murabaha transaction is for the purchase of a particular asset. A new Murabaha can only be executed for the purchase of new assets.y It is advisable that whenever practicable there

must be a gap of 1-2 days between maturity of the previous Murabaha and disbursement of the new one

3. Rebate on early paymentsy If the customer makes early payment and there

is no commitment from the institution in respect of any discount in the price of Murabaha, than the institution has the sole discretion in allowing them the rebate.y It is not recommended to make it a practice and

must be avoided in normal course of business. Such issue, if arises, should be brought in the knowledge of Shariah advisor

4. Penalty on late paymentsy As soon as the Murabaha is executed, the

Murabaha price becomes a receivable (Dayn) for the Bank. Hence, any amount charged over and above the dayn amount will be Riba.y However, it is permissible to have an

undertaking from the customer to pay an amount of money or a percentage of the debt to be donated to charitable causes in the event of delay in payment/installments.

5. Subject matter of Murabahay Goods must exists at the time of execution of Murabaha. y Murabaha cannot be done in all commodities, e.g. such as

currencies, gold, silver.y Murabaha cannot be used for paying utility bills,

wages, overhead expenses, etc.y General rules of sale related to subject matter

must be followed

6. Purchase Evidencey In order to ensure that the customer actually

purchased the assets as claimed, the customer is required to submit asset purchase evidence along with Offer & Acceptance. y The purchase evidence must confirm that the asset purchase took place after the agency agreement. y Asset purchase may be in the form of Invoices, delivery orders, truck receipts etc.

6. Purchase Evidence..(Contd)

y In some cases, however, it may be too

burdensome for the client to submit all the invoices as the number of invoices may run into hundreds.y It is suggested to furnish considerable sample of invoices

along with summary of all purchases

7. Direct Payment in Murabahay In many cases, the disbursement is made to

the customer as an agent of the bank.y In order to ensure transparency of the

Murabaha, it is preferable that disbursement / payment be made directly to the supplier.

8. Profit Recognition in Murabahay Generally in Murabaha transaction there are in

two stages: 1) Investment Stage (Agency to Purchase) 2) Financing Stage (Declaration to payment)y The profit for the Murabaha transaction can be

recognized after the goods are sold by the bank to the customer

9. Training of Customers & Bank staffy Proper training & understanding of is very

important for Bank staff dealing with the Murabaha y Customers purchase officers & accounts y staff.

10.Process of Murabaha differ from product to producty Application of Murabaha is not simple for all products y Its application differs from products to products like 1. 2. 3. 4. 5.

Sugar cane Leather Cotton Gas Petrol

y Therefore the RM/RO dealing with the customer needs to

understand and define step wise process flow along with the credit approval for each new customer/industry

CONCLUSION The importance of establishing the parameter lies in the fact that Malaysia has an Islamic Banking Act, but no Islamic Contract Act, and therefore its become a major hindrance for the Islamic finance industry. i.e. uses syariah contracts for all financing and deposit product. The Murabahah parameter provided substantive policies as it governs the rights and obligations of the Islamic bank, the supplier, as well as the consumer. Facilitates development of murabahah-based products among the IFIs. Under Murabahah parameter, consumers rights and obligations are not neglected by the Islamic banks when they trade. i.e. para 60 indicates: The liability for loss or damage of asset acquired for the purchase orderer while in the possession of IFI shall be borne by the IFI. This protection is unique to the consumer of Islamic financing products, and not available to the conventional banking. However, standardisation may hinder innovation with Islam allowing for differences in views.