Scopeof Murabaha financing
Murabaha can be used by Islamic banks as a mode of interest-free financing where only a commodity or any goods is intended to be purchased by the client. It is used to provide finance in various and diverse sectors e.g., in consumer finance for purchase of consumer durable goods, such as cars and household appliances, in real estate to provide housing finance, in the production sector to finance the purchase of machinery, equipment and raw material for manufacture, etc. Murabaha contracts are also used to issue letters of credit for import of goods and to provide short-term trade financing in which murabaha arrangement is highly suitable as goods purchased are usually disposed off in a short period.
• The client should not be a dual agent undertaking both the purchase and sale in a transaction. Where the client is appointed as an agent by the bank to purchase the goods on account of the bank for onward sale to the client, the client may take delivery of the goods in question but the bank will be responsible for making payment to the supplier once the client (acting as agent) has confirmed taking delivery of the goods and their place of storage. The purchase by the bank should be evidenced by invoices or other documents provided by the supplier to ensure that all conditions of a valid murabaha have been fulfilled.
The bank should arrange for physical inspection of the purchased goods at their place of storage on a random basis to ensure that the supplier and the client do not do any under-hand dealing.
Some significant conditions are listed below:
i) The seller should be either the owner of the object of the sale or an agent of the owner.
ii) The subject of the sale must exist at the time of sale; e.g., a bank cannot execute a murabaha on goods that have already been consumed or used.
iii) The object of sale must be in the physical or constructive possession of the seller at the time of the sale.
iv) Sale must be instant and absolute – a sale attributed to a future date or a sale contingent on a future event is void; however, one can give an understanding or a promise to buy or sell; while the right or liability will emerge only with the actual sale, upon which it becomes effective immediately.
v) The object of the sale should be specifically known and identified to the buyer, i.e., it must be identified physically or by detailed specifications, so as to distinguish the items from any other units of goods not sold.
Murabaha financing is best suited for providing short-term working capital in financing projects and also for financing local and foreign trade. While consumers can use this mode for the financing of durables, industries can also be financed through murabaha for the purchase of raw materials and semi-finished inputs. But, murabaha is not the right mode to provide financing for the purchase of easily perishable items. Similarly, it may not be suitable for housing or other longer term investments in economies with a high rate of inflation. Some have questioned the legality of this financing mode because of its similarity to riba or interest-based transactions, as murabaha transactions may give the appearance of a fixed-income loan with a fixed rate of profit determined by the profit margin agreed by the parties. However, those using the murabaha mode justify the mark-up on the basis that, for a period, the bank owns the goods acquired for their clients, thus assuming liability for the goods until the client purchases the goods from the bank at a higher price on a future date. The goods are also subjected to non acceptance by the client if there is any hidden defect. At no point in the transaction is money treated as a commodity, as it is in a conventional loan. Shari´ah scholars also generally consider murabaha to be a ‘border line’ technique owing mainly to the fixity of profit rates for the banks. They recommend that ultimately the Islamic banks should adopt the equity based modes of musharakah and mudarabah involving profit-sharing rather than a mark-up as a profit margin. But the fixing of a profit margin per se is not a problem, as prices have to be fixed in all valid trade bargains. If the Shari´ah essentials of murabaha are properly taken care of, the transaction is permissible.
Murabaha as used by Islamic Banks
Thus, the whole murabaha transaction has to be completed in two stages. In the first stage, the client requests the bank to undertake a murabaha transaction and promises to purchase the specified goods required by a client, in the second stage, the client purchases the goods acquired by the bank on a deferred payments basis and agrees to a payment schedule. A banking Murabaha is therefore quite different from a traditional murabaha for two reasons:
(1) Islamic banks do not normally maintain an inventory of goods; rather they purchase the goods on the specific request of their clients (the purchase request). The client then purchases the goods at an agreed price (the murabaha contract price) from the bank. Islamic banks normally take a binding ‘promise to purchase’ from the client that he would purchase the goods when the same are acquired by the bank. This binding ‘promise to purchase’ from the client can be incorporated into the purchase request of the client to enable the bank to purchase the goods for the client, either directly or through an agent.
(2) Islamic banks provide financing by way of credit sales to their clients. The bank cannot give the funds to the client directly and is required to make a payment to the supplier/seller of the goods to be acquired for the client. Different structures are possible for the above financing operation. Firstly, the Islamic bank may purchase the goods direct from the supplier/seller for sale onwards to the clients; this is the ideal option with respect to fulfillment of murabaha essentials, but involving bankers in retail trading business could lead to many management issues – trading and direct involvement in other real sector business activities require specific in-house expertise that banks do not normally possess. Further, it is not possible for banks to train all their staff in trading, marketing and the other real sector activities required to fulfill the rules of Islamic banking practices. The solution generally adopted by the Islamic banks is to conduct their trading activities either through the client acting as an agent of the bank or through third party agents appointed by the bank.
Default or Delay in Payment
In case of default, a murabaha contract cannot be re-negotiated or rolled over – withanother murabaha booked on the previous receivables, because the goods once sold by the bank at a pre-agreed selling price (the murabaha selling price), become the property of the client and, therefore, cannot be resold by the bank for the purpose of providing further credit. However, the payment can be rescheduled and the repayment date extended with mutual consent of the parties, provided that such an extension is not conditional upon an increase in the murabaha selling price of the goods that was originally agreed between the bank and the client. In other words, in the case of default by the client in the payment on the due date, the price cannot be increased.
The Issue of a Pre-payment Rebate
Generally, Shari´ah scholars do not allow a pre-payment rebate as they consider it similar to interest-based installments sale techniques, where the rebate allowed for early settlement of a financing is intended to reflect a refund of unearned interest. Further, in murabaha the profit on a sale on a deferred payment basis is not based on a monetary value of time (interest). However, an Islamic bank, at its discretion, can agree to give a rebate (for the unearned profits on the murabaha contract price for early settlement and from this rebate. The AAOIFI’s Shari´ah Standard on murabaha, allows a rebate to be given if it is not already stipulated in the murabahacontract. Therefore, if the client makes an early payment and there is no commitment from the bank in respect of any discount in the price of a murabaha transaction, the bank has discretion on whether to allow a rebate or not, and any such case should be decided on individual circumstances in consultation with the Shari´ah advisor.