Concept of Murabaha & AAOIFI Standard

Concept of Murabaha

Murabaha
Murabaha is a particular kind of sale and not a financing in its origin origin. Where the transaction is done on a cost plus profit basis i.e. the seller discloses the cost to the buyer and adds a certain profit to it to arrive at the final selling price. The distinguishing feature of Murabaha from ordinary sale is: - The seller discloses the cost to the buyer. - And a known profit is added.

Murabaha
Payment of Murabaha price may be: 1) At spot 2) In installments 3) In lump sum after a certain time Hence, Murabaha does not necessarily imply the concept of deferred payment.

Banking Murabaha
It is a contract wherein the institution, upon request by the customer purchases an asset from the third party(a supplier) and customer, 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.

Banking Murabaha
Basic rules for Murabaha financing:
Asset to be sold must exist. exist Sale price should be determined. Sale must be unconditional.

Assets to be sold: a) Should not be used for un-Islamic purpose. b) Should be in ownership of the seller at the time of sale; physical h i l or constructive. t ti

Step by step Murabaha financing

Steps in Murabaha Financing

1 Client and bank sign an agreement to enter into Murabaha 1. (MMFA).

Bank

Agreement to Murabaha

Client

Steps in Murabaha Financing

2 Client appointed as agent to purchase goods on bank 2. banks s behalf

Bank

Agency Agreement g

Client

Steps in Murabaha Financing

3. Upon p submission of Order form Bank g gives money y to agent/supplier for purchase of goods.
Bank

Agreement to Murabaha Agency Agreement

Client

Disbursement to the agent or supplier

Supplier

Steps in Murabaha Financing

4. The agent takes possession of goods on banks and informs bank through a Declaration form. behalf

Transfer of Risk

Vendor

Delivery of goods

Bank

Agent

Steps in Murabaha Financing

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

Bank
Offer to purchase

Client

Steps in Murabaha Financing

5(b) Bank accepts the offer and sale is concluded. 5(b). concluded
Murabaha Contract + Transfer of Title Bank Client

Steps in Murabaha Financing

6. Client p pays y agreed g price to bank according p g to an agreed g schedule. Usually on a deferred payment basis (Bai Muajjal)

Bank

Payment of Price

Client

Murabaha to the Purchase Orderer

(AAOIFI Sharia Standard # 8)

Stages of Murabaha
1. Promise Stage - Procedures prior to the contract of Murabaha Murabaha. 2. Acquisition Stage Acquisition of title & possession of the asset by the institution or its agent. 3. Execution Stage Conclusion of Murabaha Contract. 4 Aft 4. After Execution E ti St Stage Guarantee G t & treatment t t t of f Murabaha M b h Receivables.

Promise Stage

Promise Stage
It is permissible for the institution to purchase the item only in response to its customer customers 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. name It is preferable that the invoice should be addressed to the institution.

Promise Stage
Murabaha Transaction should exclude any prior contractual p between the customer and original g supplier. pp relationship It is not permissible to transfer a contract that has been executed between the customer and 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 Bai-Inah Inah (Buy Back).

Promise Stage
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 others share in Musharakah on Murabaha bases. permitted to conclude a Murabaha contract on a It is not p commodity that was the subject matter of a previous Murabaha with the same customer, i.e. Refinance the transaction.

Promise Stage
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 facility.The 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 institutes.

Promise Stage
GUARANTEES e c client e nominates o a es the e supp supplier, e , gua guarantee a ee for o good If the performance of supplier can be demanded from the customer in his personal capacity and not in his capacity as purchase orderer or 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. Jiddiyah (i e security deposit) from the customer as an indication of customers financial capacity or to ensure compensation of any damage arising from a breach of promise.

Promise Stage
Security deposit can either be held as trust in the custody of y be held as an investment trust on the basis institution or it may of Mudaraba. 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 Urbon Urbon (earnest money) after concluding the Murabaha sale with the customer. It is preferable to return to the customer that remains from Urbon after deducting the actual damage incurred as a result of breach.

Acquisition Stage

Acquisition Stage
It is prohibited for the institution to sell any item in a Murabaha t transaction ti before b f h i acquired having i d the th item. it 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.

Acquisition Stage
Appointment of Agent s p preferable e e ab e that a the e institution s u o itself se pu purchases c ases the e item e It is 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 the 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.

Acquisition Stage
It is obligatory to separate two liabilities of risk attaching to the purchased item, namely the liability of the institution and the li bilit of liability f the th customer t as agent t of f the th institution. i tit ti

Possession of the Asset The institutions actual or constructive possession must be ascertained before its onward sale to the customer. The item must move from the responsibility of the supplier to the responsibility of the institution .

Acquisition Stage
Possession of the Asset It is obligatory that the point when the risk of the item is passed on by the institution to the customer, be clearly identified. The 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, market is considered as constructive possession.

Acquisition Stage
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.

Execution Stage

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 customers 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 if the detailed break- up of the cost is not given.

Execution Stage
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 price of the item and the institutions profit on the Murabaha transaction be fixed and known to both the parties on the signature of the contract of sale.

Execution Stage
There is no objection to referring to any known benchmark (such as LIBOR) as a comfort indicator to determine the rate of profit. fit 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-Baraah).

Execution Stage

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.

After Execution Stage

After Execution Stage

The installments may become due before their originally agreed due dates in case of the customers refusal to perform or delay in paying any installment without any good reason.

After Execution Stage

Securities It is permissible to demand from the customer: Third party guarantee or Pledge of the investment account or Pledge of any item of real or moveable property or Pledge of the subject matter of Murabaha It is permissible to require the customer to provide cheques or promissory p y notes before execution of Murabaha as a guarantee of future indebtedness.

After Execution Stage

It is not permissible to stipulate that the ownership of the item payment y of will not be transferred to the customer until the full p the selling. It is permissible to postpone the registration of the asset in the customers name as a guarantee of the full payment of the selling price.

After Execution Stage

Charity Amount It is permissible to have an undertaking from the customer, 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.

After Execution Stage

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.

Thank You