Islamic Banking & Finance BS Accounting & Finance

MURABAHA
 Murabaha Outline of the Presentation

 Murabaha – Defined
 Difference b/w Murabaha & Sale
 Difference b/w Conventional Financing & Murabaha
 Basics Rules of Murabaha
 Step by Step Murabaha Financing
 Issues in Murabaha
 Risk Management in Murabaha Financing
 Variants of Murabaha Financing
 Bai Muajjal
 Uses of Murabaha
Conditions of Bai Muajjal
 Accounting Treatment of Murabaha Transactions
 Murabaha Mudarabah – Defined

Murabaha
 Murabaha is a sale where the seller expressly mentions the cost of the sold commodity and sells it
to the buyer by adding certain profit thereon
 Thus, Murabaha is not a loan given on interest; rather it is a sale of a commodity
 The distinguishing feature of Murabaha from ordinary sale is:
 The seller discloses the cost to the buyer
 Adds a known profit
 Payment of Murabaha price may be
 At spot / In installments / Deferred i.e. Lump sum after a certain time
 Hence, Murabaha does not necessarily imply the concept of deferred payment
 Murabaha Banking Murabaha

 It is a contract wherein the institution, upon request by the customer, purchases an asset from the
third party (supplier) and resells the same to the customer either against immediate payment or on
a deferred payment basis
 It is a bunch of contracts completed in steps and ultimately suffices the financial needs of the client
 The sequence of their execution is extremely important to make the transaction Shariah compliant
 A simple sale in Arabic is called ‘Musawammah’ i.e. a bargaining or a regular sale without disclosing
the cost
Murabaha Conventional Financings vs Murabaha

Conventional Financing Murabaha

Qarz based contract A sale transaction
Compensation is in the form of interest Compensation is in the form of profit over sale
of commodity
Bank does not assume the ownership and risk The ownership and risk of the asset are borne
of the asset by bank

Charges penalty in case of late payment No penalty is charged in case of late payment
 Murabaha Rules of Murabaha Financing

Basic Rules for Murabaha Financing

 Subject matter must exist at the time of sale
 Subject matter must be in the ownership of the seller
 Subject matter must be in physical or constructive possession of the seller
 Sale must be instant and absolute
 Subject matter must be a property of value
 Subject of sale should not be a thing, which is used for un-Islamic purpose
 Subject of sale must be known and identified to the buyer
 The delivery of the sold commodity to the buyer must be certain and not on chance or contingent
 The price of the subject matter must be certain and determined
 Sale must be unconditional
Murabaha Step by Step Murabaha Financing

1. The Client and bank sign an overall agreement whereby bank promises to sell the commodity
and the client promises to buy it from time to time
 The set of agreement is known as MMFA
 This agreement may specify a tie limit up to which the facility may be availed

Bank Client
Agreement of
Murabaha
Murabaha Step by Step Murabaha Financing

2. An agency agreement is signed by both the parties whereby bank appoints the client as his
agent to purchase goods on bank’s behalf

Principal Agent

Bank Client
Agency Agreement
Murabaha Step by Step Murabaha Financing

3. The client purchases the goods on behalf of the bank and takes possession of the goods as
bank’s agent
Upon submission of order form, bank gives money to agent / supplier for purchase of goods

Bank Agreement to Murabaha Client

Agency Agreement

Disbursement to the agent or supplier

Supplier
Murabaha Step by Step Murabaha Financing

4. The client informs the bank that it has purchased the commodity on behalf of the bank
The agent takes possession of goods on bank’s behalf and informs the bank through a
Declaration form

Transfer of Risk Supplier Delivery of goods

Bank Agent
Murabaha Step by Step Murabaha Financing

5a. Client makes an offer to purchase the goods from bank through a Murabaha Contract

Bank Client

Offer to purchase
Murabaha Step by Step Murabaha Financing

5b. Bank accepts the offer and sale is concluded. Ownership and risk is transferred to the client

Murabaha Contract
+
Transfer of Title & Risk

Bank Client
Murabaha Step by Step Murabaha Financing

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

Usually on a deferred payment basis (Bai Muajjal)

Payment of Price
Bank Client
 Murabaha Stages of Murabaha

 Promise Stage Procedures prior to the contract of Murabaha

 Acquisition Stage Acquisition of title & possession of the asset by the institution or its
agent

 Execution Stage Conclusion of Murabaha Contract

 Post Execution Stage Guarantee & treatment of Murabaha Receivables

 Murabaha Promise Stage

Promise Stage
 It is permissible for the institution to purchase the item only in response to its customer’s wish and
application and/or from a particular source of supply
 The customer may sign a ‘Promise to Buy’ the item from the institution 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 preferable that the invoice should be addressed to the institution
 Murabaha transaction should exclude any prior contractual relationship between the customer and
original supplier
 It must be ensured that the party from whom the item is bought is a third party, and not the
customer or his agent, so as to avoid Bai Inah (Buy Back)
 Murabaha Promise Stage

Promise Stage contd…

 It is not permitted to carry out a Murabaha on deferred payment terms where the asset involved is
gold, silver or currencies
 It is impermissible to issue negotiable instruments where the underlying asset consists of
Murabaha receivables or other receivables
 It is not permissible for the bank and the customer to form Musharakah in a project with the
promise from any of them to buy other’s share in Musharakah on Murabaha bases
 It is not permitted to conclude a Murabaha contract on a commodity that was the subject matter of
a previous Murabaha with the same customer i.e. Refinance the transaction
 Murabaha Promise Stage

Promise Stage contd…

 ‘Promise to Buy’ (signed by the customer) should not be a bilateral promise binding on both parties
 The institution can purchase the item from a supplier on a ‘sale or return’ basis. This option expires
by virtue of actual sale by the institution to the customer
 It is impermissible to receive from the customer a commitment fee or a fee for providing a credit
facility
 The expenses of preparing the documents of the contract may be borne by one of the parties. If
the bank is arranger in Murabaha, it can charge a fee from the participating institutions
 Murabaha Guarantees

 If the client nominates the supplier, guarantee for good performance of supplier can be demanded
from the customer in his personal capacity and not in his capacity as an agent of the institution
 It is permissible for the institution to take a sum of money (only in case of binding promise from the
customer) as ‘Hamish Jiddiyah’ (i.e. security deposit) from the customer as an indication of his
financial capacity or to ensure compensation of any damage arising from a breach of promise
 Security deposit can either be held as trust in the custody of institution or it may be held as an
investment trust on the basis of Mudarabah
 In case of breach of promise, Hamish Jiddiyyah can be used to recover actual damage. However, it
cannot be used for covering the Opportunity Cost
 The institution is allowed to take ‘Urboon’ (earnest money). It is preferable to return to the
customer that remains from Urboon after deducting the actual damage incurred due to breach
 Murabaha Acquisition Stage

Acquisition Stage
 It is prohibited for the institution to sell any item in a Murabaha transaction before having
acquisition of the commodity either physical or constructive
 The contract between the institution and the supplier can be completed through exchanging the
notices of offer & acceptance, either in written form or correspondence by any form of modern
communication such as email
 Murabaha Acquisition Stage

Appointment of Agent
 It is preferable that the institution itself purchases the item directly from the supplier. However, it is
permissible to authorize an agent (either the purchase orderer or some 3rd party) to carry out the
purchases. In case the customer is working as an agent of the institution, he would not sell the item
to himself by himself
 When the customer is appointed as agent to carry out the purchases, the institution itself must pay
directly to the supplier and obtain from the supplier the documents that confirm the execution of
sale. It is obligatory to separate the two liabilities of risk attaching to the purchased item, namely
the liability of the institution and the liability of the customer as an agent of the institution
 Murabaha Acquisition Stage

Possession of the Asset

 The institution’s actual or constructive possession must be ascertained before its onward sale
 The item must move from the responsibility of the supplier to the responsibility of the institution
 It is obligatory that the point when the risk of the item is passed on by the institution to the
customer, be clearly identified
 Forms of taking delivery or possession of items differ according 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, is considered as constructive possession
 Taking insurance cover for the item bought to be sold by Murabaha is the responsibility of the
institution at the stage of its acquiring ownership. The institution may subsequently build such
expense into the price of Murabaha deal
 Murabaha Execution Stage

 The contract of Murabaha is not automatically concluded by merely taking possession of the asset
by the institution
 The institution is entitled to receive compensation for any actual damage it has incurred as a result
of the customer’s breach of a binding promise
 The institution has the obligation to disclose to the customer the credit given by the supplier and
what is added in the cost. The institution can add any expense related to the item if the customer
agrees or add only the direct expenses which are normally included in the cost
 It is not permissible to add indirect costs, such as staff salary and the like, to the cost of the item
 If the institution receives any discount from the supplier, the customer should benefit from that
discount by a reduction of the total Murabaha selling Price
 The cost and profit be fixed and known to both the parties on the signature of the contract of sale
 Murabaha Execution Stage

 There is no objection to referring to any known benchmark (such as KIBOR) as a comfort indicator
to determine the rate of profit
 The selling price of the asset becomes a debt and it is not permitted subsequently to demand any
extra payment either in consideration of extra time given for payment or delay in payment
 It is permissible for the institution to stipulate in the contract a condition that the institution is free
from responsibility for all or some of the defects of the asset (Bai’-al-Bara’ah)
 It can be included in the contract that if the customer fails to pay on time, the institution will have
the right to revoke the agreement and repossess the item sold or the institution can be given power
from the customer to sell the item on behalf of the customer and settle the debt by the price
received and if something remains would be recovered from the customer
 Murabaha After Execution Stage

 The installments may become due before their originally agreed due dates in case of the
customer’s refusal to perform or delay in paying any installment without any good reason
Securities
 It is permissible to demand from the customer
 Third party guarantee / Pledge of the investment account or
 Pledge of any item of real or moveable property / Pledge of the subject matter of Murabaha
 It is permissible to require the customer to provide cheques or promissory notes before execution
of Murabaha as a guarantee of future indebtedness
 It is permissible to postpone the registration of the asset in the customer’s name as a guarantee of
the full payment of the selling price
 Murabaha Charity & Rebate

Charity Amount
 It is permissible to have an undertaking from the customer, as part of Murabaha contract, 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
Early Payment Rebate
 The institution may give up part of the selling price if the customer pays early, provided this was
not part of the contractual agreement
 The payment of the debt due on account of Murabaha may be made in currency different from
that in which the debt is denominated, provided the exchange rate prevailing on the day of
settlement is taken
 Murabaha Issues in Murabaha

 Securities against Murabaha

 Payments accruing from the sale are receivables and hence client may be asked to furnish
security
 The security may be taken in the form of a mortgage or hypothecation or a lien or a charge
 Guaranteeing the Murabaha
 The seller can ask the client to furnish a third party guarantee
 In case of default on payment, the seller will have recourse to the guarantor
 There are two issues relation to this guarantee:
 The guarantor cannot charge a fee from the original client
 The guarantor, however, can charge for any documentation expenses
 Murabaha Issues in Murabaha

 Penalty for default

 If the client defaults in payment of the price on the due date, the original price can not be
changed nor any penalty can be charged due to delay in payment
 Rollover in Murabaha
 Murabaha transaction can not be rolled over for a further once the old contract ends
 Murabaha is not a loan rather it is a sale of a commodity, where the ownership of goods is
transferred to the client by the bank.
 Hence, the goods are no more a property of the bank
 The bank can only claim the Murabaha price and therefore there is no question for affecting
another sale of the same commodity
 Murabaha Issues in Murabaha

 Rebate on early payments

 Some times client wants to pay earlier than maturity to get discounts
 Majority of Muslim scholars including the major of school of though consider this to be
unislamic
 However, if the bank gives a rebate on its own, without stipulating it in a contract, it is not
objectionable but this should not be made a regular practice or a part of the contract
 Calculation of cost in Murabaha
 Murabaha can only be effected when the seller can ascertain the exact cost he has incurred in
acquiring the commodity
 If the exact cost can not be ascertained then Murabaha cannot take place. In this case, the sale
will take place as Musawammah
 Murabaha Risk Management in Murabaha

Some of the major risks and their mitigant are as follows

 Product Specific Risk
 Credit Risk
 Shariah Non-Compliance Risk
 Murabaha Risk Management in Murabaha

Product Specific Risk

 Islamic bank assumes the risk of destruction or loss of the asset prior to its sale to the customer

Risk Mitigant
 Takaful cover may be obtained for Murabaha commodity
 Reducing the time of ownership of goods by immediate sale after taking possession
 Murabaha Risk Management in Murabaha

Credit Risk
 It is the risk pertaining to the default or delay of customer in paying its obligation

Risk Mitigant
 Any Shariah compliant security may be held to cover the risk of delay in payment or default
 Robust evaluation of customer’s business performance and industry outlook
 Matching the Murabaha financing with the cash cycle of the business
 Murabaha Risk Management in Murabaha

Shariah Non-Compliance Risk

 This is the risk of Shariah non compliance regarding basic requirements of Murabaha transaction
 This non-compliance results in reduction of income of the bank as non-compliant income may lead
to loss of bank’s income
 Banks can not accept or recognize non-compliant income to their profits

Risk Mitigant
 Proper training of bank employees and the customers
 Development of easy to understand process flows for all Murabaha transactions
 Implementing strong control measures through effective policy making
 Implementing a system of Shariah audit & compliance
 Murabaha Variants of Murabaha Financing

On the basis of requirements of customers, numerous variants of Murabaha can be developed

Advance Murabaha
 Bank makes an advance payment to the supplier of assets and then sells to the customer
Credit Murabaha
 Bank sells the assets to its customer, which the bank has purchased on credit from supplier
 Outflow of funds is made after certain time of execution of Murabaha sale and financing is booked
Murabaha Pledge
 Bank keeps same goods as pledge which the bank has sold to the customer through Murabaha
Murabaha Spot
 Bank does not immediately sell the goods to the customer but keeps the assets in its inventory
 Assets held in inventory is sold to the customer as per his requirement against spot payment
 Murabaha Bai Muajjal Murabaha

 Bai Muajjal is an Arabic acronym for “sale on deferred payment basis”

 The deferred payment becomes a loan payable by the buyer in installment or lump sum
 In Bai Muajjal, all those items can be sold which comes under the definition of capital, where
quality does not make a difference but the intrinsic value does
 Those assets do not come under the definition of capital where quality can be compensated for by
price
 Shariah scholars have an Ijma (consensus) that demanding a high price in deferred payment in such
case in permissible
 Murabaha Accounting Treatment of Murabaha

 Profit Recognition
 In loan, interest income is accrued and recognized from the date of loan disbursement
 In Murabaha, the income can be accrued and recognized only after the asset has been sold
 Inventory
 The goods purchased by the Islamic banks, before being sold to customer, must be recorded in
the balance sheet of the bank
 Murabaha Receivables
 Unlike a loan transaction, Murabaha receivable shall be recorded as trade debts
Murabaha Accounting Treatment of Murabaha

1. At the time of payment to the client for purchase of goods on behalf of bank
Advance Against Murabaha xxx
Customer Account xxx
2. When bank receives possession of the goods
Inventory xxx
Advance Against Murabaha xxx
3. When the purchased goods are sold to the customer on Murabaha basis
Murabaha Financing xxx
Murabaha Profit Receivable xxx
Inventory xxx
Deferred Murabaha Income xxx
Murabaha Accounting Treatment of Murabaha

4. Recognition of income at month end

Deferred Murabaha Income xxx
Income on Murabaha Financing xxx
5. On maturity of Murabaha transaction i.e. at the time of receiving of final payment
Customer Account xxx
Murabaha Financing xxx
Murabaha Profit Receivable xxx
 Murabaha Uses of Murabaha

 Raw material financing

 Inventory financing
 Equipment financing
 Import financing
 Export financing (pre-shipment)
 Consumer goods financing
 House financing
 Vehicle financing
 Land financing
 All other services that can be sold in the form of package like education, medical as a package
Islamic Banking & Finance BS Accounting & Finance

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