ISLAMIC

FINANCE
M.Com 4th
By: Abdul Moueed
Dated: April 11, 2020
ISLAMIC MODES OF FINANCING
a) Partnership based modes of financing
1. Musharaka
2. Mudarabah
b) Trade based modes of financing

1. Murabahah (Today)
2. Salam
c) Rental based modes of financing
1. Ijarah
2. Diminishing Musharaka
 Murabahah
Trade based mode of financing
■ Murabahah is one of the most commonly used modes of
financing by Islamic Banks and financial institutions.
■ The word “Murabahah” has been derived from the Arabic word
“Ribah”, which has literary meaning of profit/excess.

“Allah has permitted trading and forbidden Riba ”

[Surah Al-Baqarah: 275]
Murabahah
Trade based mode of financing

■ Definition
Murabahah is a particular kind of sale where the seller
expressly mentions the cost of the sold commodity he has
incurred, and sells it to another person by adding some profit
thereon. Thus, Murabahah is not a loan given on interest; it is a
sale of a commodity for cash/deferred price.
 Murabahah
■ Murabaha is a particular kind of sale where the seller(Bank)
discloses its cost and profit charged thereon to the client (who
needs money).

■ It is a bunch of contracts completed in steps and ultimately

satisfy the financial needs of the client.
■ The sequence of their execution is extremely important to
make the transaction Shariah compliant.
 BANKING MURABAHAH

■ It is a contract wherein the institution, upon request by

the customer, purchases an asset or commodity from
the third party usually a supplier/vendor and resells the
same to the customer on profit either against
immediate payment or on a deferred payment basis.
■ Installments also permitted.
SCOPE OF MURABAHA

 As it is a kind of sale, there must be a seller and buyer and

some thing that is bought and sold. The institution is the seller
and the client is buyer.

 It cannot be used as a substitute for running finance facility,

which provides cash for fulfilling various needs of the client.
SCOPE OF MURABAHA

 It is a fixed price sale and normally is done for short

term.

 The transaction can be used in order to meet the

working capital requirements.
STAGES OF MURABAHA
 1. Promise Stage

 2. Agency Stage

 3. Acquiring Possession

 4. Execution of Murabaha

 5. After Execution of Murabaha

1- Promise stage

 Stage One (a) for Murabahah financing.

• Client approach the bank for facility through Murabahah.

Bank Client
Facility
approved

10
1- Promise stage

 Stage One (b) for Murabahah financing.

• Client and bank sign an agreement MOU (Memorandum of
Understanding) to enter into Murabahah.

Bank Client
Murabaha
Facility
Agreement
MOU

11
1- Promise stage

 Stage One (c) for Murabaha financing.

• Client submit the purchase requisition to the bank.

Bank Client
Purchase requisition
/Promise to the bank.

12
1- Promise stage

• The Client requests the institution to buy certain goods for

him and then sell him (client) the same after acquiring. The
prerequisite is that the goods are not already owned by the
client.

• At this stage the customer promises the institution to buy the

goods which were acquired by the institute on his request.
2- Agency stage
 Stage Two (a) for Murabahah financing.

• Client appointed as agent to purchase goods on bank’s behalf

Bank Client
Agreement to
Murabaha
Agency
Agreement

14
2- Agency stage
 Stage Two (b) for Murabahah financing.
• Bank gives money to supplier through client’s account for purchase of
goods.

Bank Client
Islamic
Agreement to
Bank Murabaha
Agency
Agreement

Disbursement to the
Supplier
15
3. Acquiring Possession

 Stage three for Murabahah financing.

• Client purchases goods on bank’s behalf and takes their possession.

Client purchases
goods and takes
Transfer of Risk Vendor possession

Bank Client

16
4. Execution of Murabahah
 Stage four (a) for Murabahah financing.

• Client makes an offer to purchase the goods from bank.

Bank Client

Offer to
Purchase

17
4. Execution of Murabahah

 Stage four (b) for Murabahah financing.

• Bank accepts the offer and sale is concluded.

Murabahah
Agreement
+
Transfer of Title

Bank Client

18
4. Execution of Murabahah

 Stage four (b) for Murabahah financing.

• Client pays agreed price (cost + profit) to bank according to an

agreed schedule. Usually on a deferred (in future) payment basis
called (Bai Muajjal).

Bank Client
Payment of Price

19
5. AFTER EXECUTION OF MURABAHA

Securities Against Murabaha Price

■ The institution may ask the customer to furnish (Provide) a security to its
satisfaction for prompt payment of the deferred price.

■ However, it is also permissible that the customer furnishes a security at

earlier stages but after the Murabahah price is determined.

■ It is also permissible that the sole commodity itself is given to the seller as
a security.

■ It is preferable not to take Interest bearing instruments as securities

(bonds, debentures).
5. AFTER EXECUTION OF MURABAHA

In Case Of Default:
■ In the case of default by the buyer (client) in the payment of price at the due
date, the price cannot be increased.

■ However if he has undertaken, in the agreement to pay certain amount (Fine)

for a charitable purpose, he shall be liable to pay the amount undertaken by
him.

■ But this recovered amount from the buyer will not be considered penalty nor
compensation, therefore it will not account to institutions income.

■ Institution is bound to spend it for a charitable purpose on behalf of the buyer.

Murabahah
GENERAL MECHANICS

VENDOR ISLAMI BANK CUSTOMER

Agreement
C

22
GENERAL MECHANICS
1. The customer approaches the Bank with the request
for financing.
2. The Bank purchases and receives title of ownership
from the vendor.
3. The Bank makes payment to the vendor.
4. The Bank transfers the title over to the customer
upon payment.
5. The customer makes payment up-front or on a
deferred basis.
 VARIOUS
MODELS OF
MURABAHAH
FINANCE
MODEL - I
TWO PARTY REALTIONSHIP
■ Bank – Customer

MODEL - II
THREE PARTY RELATIONSHIP
■ (Bank-Vendor) and Customer

MODEL - III
THREE PARTY RELATIONSHIP
■ Bank and (Vendor-Customer)
MODEL - I

■ The simplest possible model emerges when the

transaction involves two parties only, i.e. Bank
and the Customer.

■ The Bank is also vendor and sells the Asset(s)

to its Customers on deferred payment basis.

■ From Shariah perspective it is an ideal Model

and its profits are fully justified because Bank
assumes all risks as Vendor/Trader.
MODEL I – GRAPHICAL PRESENTATION

1
Customer Bank/Vendor

3
MODEL I - PHASES
Phase 1:
The customer approaches Bank (Vendor) and identifies
Asset(s) and collects relevant information including
cost and profit.

Phase 2:
Bank sells Asset(s) to the Customer, transfer risk and
ownership to the Customer at certain Murabahah Price.

Phase 3:
Customer pays Murabahah Price in lump sum or in
installments on agreed dates.
 MODEL - II
■ In most cases Murabaha Transaction involves a third
party (i.e. Vendor) because Bank is not expected to
engage in sale of variety of products required for variety
of Customers.

■ The Bank directly deals with the Vendor and purchases

the Asset(s).
MODEL II
■ The Bank sells the purchased Asset(s)
to the customer on cost plus Profit
basis.

■ There are two distinct sale contracts at

different point of times. First between
Bank and Vendor and second between
Bank and the Customer.
MODEL II – GRAPHICAL PRESENTATION

1 3
Vendor
4

5
Customer 2 Bank
6
MODEL II - PHASES

Phase 1:
Customer identifies and approaches the Vendor or
Supplier of the Asset(s) and collects all relevant
information.
Phase 2:
Customer approaches the Bank for Murabahah
Financing and promises to buy the Asset(s).
Phase 3:
The Bank makes payment to vendor directly.
MODEL II – PHASES

Phase 4:
Vendor delivers the Asset(s) & transfers the ownership of
Asset(s) to the Bank.
Phase 5:
Bank sells the Asset(s) to Customer on cost plus basis and
transfers ownership.

Phase 6:
Customer pays Murabahah Price in lump sum or in installments
on agreed dates.
MODEL III – BANKING MURABAHA

■ This Murabaha Model is mostly practiced model

in Banking now a days and therefore we will look
at it in more detail.
■ We will also look at the documentation required at
different stages of the transaction.
■ It is also a three-party structure but it is bit
complicated than previous ones.
 MODEL III – BANKING MURABAHA

■ It is a bunch of contracts completed in

steps and ultimately suffices (fulfill) the
financial needs of the client.

■ THE SEQUENCE OF THEIR EXECUTION IS EXTREMELY

IMPORTANT TO MAKE THE TRANSACTION SHARIA’H
COMPLIANT .
 MODEL III – GRAPHICAL PRESENTAION

3
Vendor
4
5

2
Customer Bank
6
Offer Acceptance
1
7
 PHASE I – PROMISE TO PURCHASE AND SELL

■ The Customer approaches the Bank for Murabaha

Finance and promises to purchase the Asset(s) from
the Bank which, the Customer will purchase as an
Agent of the Bank.
■ Master Murabaha Finance Agreement (MMFA) shall
be signed by the Bank and the Customer at this
stage. This is basically a Memorandum of
Understanding between two parties.
 PHASE II – APPOINTMENT OF AGENT

■ In the absence of expertise required to purchase

particular kind of Asset(s), the Bank appoints
Customer as its Agent to buy Asset(s) on its behalf
PHASE II – APPOINTMENT OF AGENT

■ The appointment of an Agent for

purchase of Asset(s) for and on behalf
of the Bank and the ultimate sale of
such Asset(s) to the Customer shall be
independent transactions of each other
and separately documented.

■ However, according to Sharia’h

perspective, it is preferable to appoint
the Agent other than the Customer.
PHASE II – APPOINTMENT OF AGENT

■ Agency Agreement is not the condition

of the Murabaha if the institution can
make direct purchases from the
supplier.

■ It is advisable to execute Agency

Agreement because financial
institution does not have the expertise
to identify the Asset(s) and negotiate
an efficient price.
 PHASE II – DOCUMENTATION
AGENCY AGREEMENT

■ This agreement must contain:

 Types (limited/Specific)
 Description of Asset(s) to be purchased
 Mode of Disbursement of Funds
 Roles and Responsibilities of Agent

■ THESE DOCUMENTS MUST BE SIGNED BEFORE

PURCAHSE OF ASSET(S) BY THE AGENT
 PHASE III & IV –
PURCHAHSE OF ASSETS BY AGENT

■ The Customer identifies the Vendor, selects

the Asset(s) on behalf of the Bank and
advice its particulars, including the Vendor’s
name and purchase price to the Bank.
■ If the supplier is nominated by the Customer
itself, guarantee for good performance can
be demanded from the Customer.
 PHASE III & IV –
PURCHAHSE OF ASSETS BY AGENT

■ The Customer takes possession of the

Asset(s) as an Agent of the Bank.

■ It is the obligation of the Customer(Agent) to

ensure, at this stage, that Asset(s) supplied is
in accordance with the given specifications.

■ To ensure that a fresh Asset(s) are purchased

by the Agent, Bank’s staff should verify
actual purchase of Asset(s).
 PHASE III & IV–DOCUMENTATION
DECLARATION FROM CUSTOMER (AGENT)

■ The Customer (Agent) will inform the Bank, through

this document, that it has taken the possession of
Asset(s) on behalf of the Bank.
■ This Transactional Document shall be an integral
part of Master Murabaha Financing Agreement
(MMFA).
■ This declaration must contain the statement that
Customer has inspected the Asset(s) to ensure its
appropriateness and suitability to the customer.
 Phase V
DISBURSEMENT OF FUNDS / PAYMENT TO VENDOR

■ The Bank has two options regarding for payment of

Purchase Price of Asset(s) bought by Agent on its
behalf.

a) Direct payment to Vendor by the Bank (preferable).

b) Disbursement of Funds to Agent’s (Customer’s)
account for onward payment to Vendor through Cross
Cheque/Pay Order/Demand Draft etc.
 PHASE VI
MURABAHA EXECUTION STAGE (OFFER
AND ACCEPTANCE)

■ The Customer offers to buy the Asset(s) from the Bank which it
has purchased as an Agent of the Bank.

■ The Bank gives the Acceptance to the Customer’s Offer.

■ THIS IS THE POINT WHERE THE MURABAHA COMES

IN TO EXISTENCE.
PHASE VI
Murabaha Execution Stage (Offer And
Acceptance)
■ It is obligatory that the point when the risk of the
Asset(s) is passed on by the Bank to the customer
be clearly identified.

■ It is mandatory to determine the Murabaha Price

at this stage, otherwise Murabaha shall not be
valid.

■ It is also mandatory to determine the date of

payment of Murabaha Price rendering the
Murabaha to be valid.
PHASE VI
MURABAHA EXECUTION STAGE
DOCUMENTATION
■ This document must contain

i. Murabaha Price (Cost+Profit)

ii. Repayment Date
 PHASE VII
PAYMENT OF MURABAHA PRICE BY CUSTOMER

■ Customer will pay the Murabaha Price to the Bank on

the agreed date.

■ The customer is not entitled to any reduction in

Murabaha price in case of early payment of Murabaha
Price.

■ In same way Bank can not increase the Murabaha

Price if the Customer defaults or make delayed
payment.
THANK
YOU