Lecture 4

By
Rafia Ayub

Sharia Compliant modes of Islamic Banking & Finance

Participatory Modes

Mudaraba
Musharakah
Diminishing Musharakah
Equity Participation in the
form of shares in a
corporate entity

Trading Modes

Ijara
Murabaha
Musawamah
Salam
Istisna
Tawarruq (in exceptional
cases with prior approval
from SBP)

Debt based
Mode

Qard

Other Modes

Wakalah
Hawala
Kafala

Basic Principles of sale

in Shariah

Sale
the exchange of a thing of value by another thing of
value with mutual consent
There are some principles for sale in Sharia:
Existence of goods.
Ownership over goods
Possession over goods

Contract of Sale (Bai) On

Spot

OR

Deferred payment
Or Bai Muajjal

Goods can only be sold on the price mentioned herein

Musawamah

Murabaha

Tawlliyah

Wazia

Buyers Knows
Nothing
About Cost
& Profit

Cost and
Profit

In
Musawamah

In
Murabaha

Cost and
Zero Profit

In
Tawliya

Cost and
Loss

In
Wazia

MURABAHA

MURABAHA

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 or markup thereon.
1.

Contract of Sale On

Spot

OR

If Seller discloses
Cost and Profit to Buyer

It is a
Murabaha

Deferred payment
Or Bai Muajjal

 2. The profit in Murabahah can be

determined by mutual consent, either in
lump sum or through an agreed ratio of
profit to be charged over the cost.

 3. 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 markup can be applied on the aggregate
cost.

MURABAHA
Actual buyer has a few funds/ No Funds
Financer buys for Actual Buyer:Cost
Buying Expenses
Total Cost

Rs. 100,000 Paid by Financer

10,000 Paid by Financer
110,000 Borne by Financer

Profit rate on cost

20%

Price to be offered

110,000 + Recovery in
(20% of installments from
110,000)= buyer
132,000

IN CASE OF LOCAL PURCHASE

Ex-factory cost (cost at the sellers
premises

****

Insurance in transit

****

Loading & Unloading

****

Transportation cost

****

Total cost

****

IN CASE OF IMPORT
Import Value
Add: Import duty +Custom duty
Clearing & Forwarding charges
Landed cost
Inland insurance
Loading/unloading
Transportation

Total Cost

****
****
****
****
****
****
****
****

 Cost of Goods free on board (F.O.B)

Cost and freight (C&F)
Cost, Insurance, freight(CIF)

All above terms are called INCO TERMS

 4. Murabahah 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 murabahah basis.
In this case the commodity must be sold on musawamah
(bargaining) basis i.e. without any reference to the cost
or to the ratio of profit / mark-up.
The price of the commodity in such cases shall be
determined in lump sum by mutual consent.

Example (1)
Mr.A purchased a pair of shoes for Rs. 100.
He wants to sell it on murabahah with 10%
markup.
The exact cost is known.
The murabahah sale is valid.

Example (2)
Mr. A purchased a ready-made suit with a pair of
shoes in a single transaction, for a lump sum price
of Rs. 500/ Mr.A can sell the suit including shoes on
murabahah.

But he cannot sell the shoes separately on

Murabahah, because the individual cost of the
shoes is unknown.
If he wants to sell the shoes separately, he must
sell it at a lump sum price without reference to
the cost or to the mark-up.

Murabahah
as a mode of financing

MURABAHAH AS A MODE OF
FINANCING:
Originally, murabahah is a particular type of sale and not
a mode of financing.
The ideal mode of financing according to Shariah is
mudarabah or musharakah.
Therefore, the contemporary Shariah experts have
allowed, subject to certain conditions, the use of the
murabahah on deferred payment basis as a mode of
financing.

PROCESS FLOW of Murabaha

Process Flow Murabaha Financing

The client and the institution sign an overall
agreement through a Master Murabaha Financing
Agreement (MMFA)
the institution promises to sell
And the client promises to buy
Institute may require Hamish Jidyah (Security
deposit)

Bank

Agreement to
Murabaha

Client

Promise to Purchase
Full filling a promise is a noble quality and it is
advisable from the promisor to observe it & its
violation is reproachable, but it is neither mandatory
(Wajib), nor enforceable through courts.
----- Imam abu Hanifah,
Imam Al-Shafai,
Imam Ahmed

 In normal conditions, promise is not binding, but if

the promisor the promisor has caused promisee to
incur some expenses or undertake some labor or
liability on the basis of promise, it is mandatory on
him to fulfill his promise for which he may be
compelled by the courts
------ Umar b. Abdul Aziz
Hasan al-Basri,
Said b. Alshwa,
Ishaq b. Rahwaih,
Imam al-Bukhari

 Islamic Fiqh Academy Jeddah has made promises in

commercial dealings binding on the promise with
following conditions:
a) It should be unilateral promise
b) The promise must have caused the promisee to
incur some liabilities
c) If the promise is to purchase something, the
actual sale must take place at the appointed
time by the exchange of offer and acceptance.
Mere promise itself should not be taken as the
concluded sale.

(d) If the promissor backs out of his promise, the court

may force him either to purchase the commodity or
pay actual damages to the seller. The actual
damages will include the actual monetary loss
suffered by him, but will not include the opportunity
cost.

Hamish Jiddiyah (Security Deposits): Purpose

Client refuses to buy
Bank resells it to other Person
New Price is
above than
Cost of Purchase

Full
Hamish Jiddiyah
is returned

New Price is same

as cost of
Purchase

Full
Hamish Jiddiyah
is returned

New Price is lower

than the Cost of
Purchase
Refund
Hamish Jiddiyah
after deducting
the actual loss or
Claim further if
loses are not
covered

Before Murabaha if customer refuses to buy

When
Cost of
Customer Hamish
Purchase of Mark Up
refuses to Jiddiyah
Goods
buy

Resale
Price

Case-1

15,000

40,000

5,000

35,000

5,000

10,000

Case-2

15,000

40,000

5,000

25,000

15,000

Case-3

15,000

40,000

5,000

50,000

15,000

Case-4

15,000

40,000

5,000

18,000

15,000

Setoff
Refund
Hamish Hamish
Jiddiyah Jiddiyah

Further
Claim
from
Customer

7,000

Process Flow Murabaha Financing

2. Client is being appointed as an agent to
purchase goods on the Banks behalf.
agency agreement is signed.

Bank

Agreement to
Murabaha
Agency
Agreement

Client

Process Flow Murabaha Financing

3. Bank gives money to an agent/supplier for
purchase of goods.

Bank

Agreement to
Murabaha

Client

Agency
Agreement
Disbursement to the agent or supplier

Supplier

Process Flow Murabaha Financing

4. The agent takes possession of goods on the Banks
behalf.

Transfer of Risk

Bank

Vendor

Delivery
of goods

Agent

Process Flow Murabaha Financing

5(a). Client makes an offer to purchase the goods from
the Bank through a declaration.

Bank

Client
Offer to
purchase

Process Flow Murabaha Financing

5(b). Bank accepts the offer and sale is concluded /
culminated.

Murabaha Agreement
+
Transfer of Title
Bank

Client

Process Flow Murabaha Financing

6. Client pays agreed price to the Bank according to an
agreed schedule. Usually on a deferred payment basis
(Bai Muajjal)

Bank

Payment of Price

Client

1. Promise to buy in Future (by Customer)

2.Bank acquires the goods

Agency
Contract

3.Appoint
Customer
its Agent

Bank

4.Offer to purchase
is made

Customer
take
possession
and inform
bank
Customer

Relationship between Bank and Client

Before
Murabaha

Bank
Promisor

Client
Promisee

At the Time of
Murabaha

After Murabaha

Bank
Seller

Bank
Creditor

Client
Buyer

Client
Debtor

Before Murabaha Contract

Goods at Bank
Premises

Bank Is
responsible

Goods at Client
Premises

Bank Is
responsible

After Murabaha Contract

Goods at Bank
Premises

Client is
responsible

Goods at Client
Premises

Client is
responsible

After executing the murabaha contract the institution

may ask the client to furnish a security (Urboon)to its
satisfaction for the prompt payment of the deferred price.

He may also ask him to sign a promissory note or a bill

of exchange, but it must be after the actual sale takes
place

 In the case of default by the buyer in the

payment of price at the due date, the price
cannot be increased.
However, if he has undertaken, in the
agreement to pay an amount for a charitable
purpose, he shall be liable to pay the amount
undertaken by him.

Basic features of Murabahah

Financing:
Murabahah is not a loan given on interest.
Therefore no roll-over in Murabahah is allowed

It is the sale of a commodity on spot or on

deferred price which includes an agreed profit
added to the cost.

 3. Murabahah cannot be used as a mode of financing

except where the client needs funds to actually purchase
some commodities.

For Example:
if client wants funds to purchase cotton as a raw material
for his ginning factory, Bank can sell him the cotton on
the basis of muabahah.
But if funds are required for paying the price of
commodities already purchased by him, or the bills of
electricity or other utilities or for paying the salaries of his
staff, murabahah cannot be effected,
because murabahah requires a real sale of some
commodities, and not merely advancing a loan.

 4. The financier must have owned the commodity before

he sells it on Muhabahah to his client.
5. The commodity must come into the possession of the
financier, Whether physical or constructive, in the sense
that the commodity must be in his risk, though for a short
period.

ISSUES IN MURABAHA

Rebate on earlier payment is not

allowed
ometimes the debtor wants to pay earlier than the
specified date. In this case he wants to earn a
discount on the agreed deferred price.
Is it permissible to allow him a rebate for his earlier
payment?
The issue is known in the Islamic legal literature as
Give discount and receive soon

 Some earlier jurists have held this arrangement as

permissible, but the majority of the Muslim jurists,
including the four recognized schools of Islamic
jurisprudence do not allow it, if the discount is held
to be a condition for earlier payment.

Buy Back
If a person has a fixed asset of Rs. 1000,000; he sell
it to bank; and request to bank to sell the assets
again to him on installments; and he will pay
1,200,000.

Ans. No. It is a buy back arrangement and it is haram.

Rollover in Murabaha
Rollover in a Murabaha Transaction would imply that
payment of earlier Murabaha Price by executing new
Murabaha. Rollover in Murabaha is not possible
since each Murabaha transaction is for the purchase
of a particular asset.

Murabaha with Related Parties

In case of Murabaha, the Vendor and the Customer
must be independent to each other. Banks are not
allowed to enter into a Murabaha Transaction where
Vendor and Customer are associated parties. Parties
are considered to be related parties if one party has
33% or more shares/ownership in the business of
other party.

Risks in Murabahah:
Risks

Mitigants

Customer refuses to
purchase while holding
as agent

Promise, HJ,

Customer already
purchased from
supplier/wants
liquidity/Inah

Direct payment to supplier, date of invoice to

be after date of agency agreement, obtain
other documents gate pass, truck receipts,
physical inspection, etc.

Overdue installments

Penalty to go to charity

Default risk

Collateral/securities

Market (price) risk

Immediately supply the item

Some Applicable Guidelines from AAOIFI:

A. Measurement of asset value
At acquisition Measured and recorded at historical
cost.
After acquisition
Asset available for sale to client shall be measured at
historical cost
In case of default in payment of Murabahah price, the
asset shall be measured at cash equivalent value
(ie. Net realizable value).
A provision to be created for decline in the asset
value (ie. Difference between acquisition cost and the
cash equivalent value).

Some Applicable Guidelines from AAOIFI:

B. Potential discount after acquisition
The discount shall not be considered as revenue
However it should reduce the cost of goods.
C. Profit recognition
Profit shall be recognized at the time of executing contract
if the term does not exceed the current financial period.
Profits of credit sale whose payment is due after the
current financial period shall be recognized as per
following:
Proportionate allocation of profits
Profit may also be recognized as and when received.

Some Applicable Guidelines from AAOIFI:

D. Failure to fulfill promise having paid Hamish Jiddiyah
Hamish Jiddiyah to be treated as liability on Islamic
MFI.
Treatment:
The amount of actual loss to be deducted from
Hamish Jiddiyah

E. Penalty Deposited in Charitable A/C on realization

EXAMPLE
Purchase of poultry feed stock

Murabahah transaction: Rs. 30,000

Murabahah Facility: 90 Days
Payment:
Each month
Rate of Profit:
15% p.a.
Freight:
5% of cost of goods
Security:
Personal/group
guarantee

Pricing of Murabahah [Example]:

Particulars

Amount (Rs.)

Cost of goods

Rs. 30,000

Rate of Profit

15% p.a.

Freight/Insurance

5% of cost

Total cost

30000 x 5%

Profit

31500 x 15% x 90/365 = 1165

Murabahah Price

31500+1165 = 32665

Installment

31500/3+1165/3 = 10888

30000 + 1500
=31500

Case 1- Murabaha for Vehicles

ABC Suzuki Autos is a proprietorship concern, running a
vehicle showroom. The proprietor purchases cars of
different models for Suzuki directly from the
manufacturer for further resale in the market. The
delivery time varies from 3 months to 5 months and
100% payment is advance.
The client has approached MBL branch for Murabaha
Facility amounting to Rs. 25 million for purchase of
vehicle. The Murabaha facility will be for one year at a
rate of KIBOR + 3% p.a.
You have been asked to suggest the step wise process
flow, documentation & calculation involved in the above
case.

 Execution of MMFA and Agency with ABC Suzuki

Autos after approval of Limit
ABC Suzuki Autos requests (via Order Form) for
booking/purchase of vehicles from Suzuki Co worth
Rs. 25 mln
MBL issue Purchase order along with Pay Order in
favor of Suzuki Co for booking of vehicles.
Upon completion of the Order after 5 months, Suzuki
will intimate MBL along with asset description
(engine/Chassis No. etc)

 MBL will intimate ABC Autos about availability of

vehicles. ABC autos will submit Declaration (after 5
months) along with Summary Payment Schedule.
MBL will accept Declaration and will issue Delivery
Order along with Transfer Letter in favor of ABC
Autos.
On the due date (one year from the date of
disbursement), ABC Autos will pay the Contract
Price of Murabaha to MBL.
Contract Price = 25 mln * (1 + (k + 3%))

Cost

PKR (25,000,000)

Profit (K+3%) = 13.49%

(3,297,500)

Cost+Profit

(28,297,500)
Month 1

2,358,125

2,358,125

2,358,125

2,358,125

2,358,125

2,358,125

2,358,125

2,358,125

2,358,125

10

2,358,125

11

2,358,125

12

2,358,125

FAQs:
Q. Is it necessary in Murabaha to disclose
cost of commodity to be sold by the seller
(bank)?
Ans. Yes
Q. Is it a loan Agreement?
Ans. No, it is a sale of commodity for cash or
on deferred price.

 Q. How Murabaha transaction is made?

Ans. Bank will buy the goods from third party
and sell those goods to the customer for a preagreed price.
Q. Can bank appoint customer as an agent to
purchase goods as per his choice?
Ans. Yes. Customer may be appointed by bank
as an agent for purchase of goods but this
agreement of agency will be made separately
from the Murabaha.

 Q. Who will be responsible for the risk during

purchase of the commodity and its ultimate sale to
the client?

Ans. Financer will be responsible.

Q. In case of late payment from buyer, Can bank take
penalty from buyer?
Ans. Yes

 Q. Can the bank use the amount of penalty

for its own purpose?
Ans. No, penalty shall be used for charitable
purpose.
Q. Can bank take security from buyer?

Ans. Yes
Q. In Case of default of buyer, Can bank sale
the
security without the intervention of court?
Ans. Yes

Agency- FAQs
What is the meaning of appointment of customer
as an agent?
When the actual buyer comes to bank and ask
that he wants to buy goods but he does not have
money in his pocket. Further the Bank is unable
to reach to the destination of Seller.
The bank request to buyer to buy goods on
Bank's behalf.
When buyer buys then bank sells the goods to buyer
on installment.

Appointment of Customer as agent is preferable ?

It should be avoided but when the situation
makes it inevitable then appointment is not
prohibited.
When the Financer appoints the customer as
agent?
Ans. Generally customers are living far from financer,
the financer appoints him as agent and say to buy goods
on our behalf.
The Customer buys and pay to supplier on the behalf of
Financer.
Now the Financer sell to customer by adding profit on
installments.