Essential of Islamic Finance Essential of Islamic Finance

Mode of FinancingMode of Financing

Morabaha Morabaha ““Trade Financing”Trade Financing”

The word The word MurabahaMurabaha is taken from the is taken from the Arabic word Arabic word RibhRibh which means which means ProfitProfit..

Originally, Murabaha is a contract of sale Originally, Murabaha is a contract of sale in which a commodity is sold on profit.in which a commodity is sold on profit.

The seller tell the buyer his cost price as The seller tell the buyer his cost price as well as his profit he is adding to the cost.well as his profit he is adding to the cost.

Modern form of Murabaha has become the Modern form of Murabaha has become the single most popular technique of financing single most popular technique of financing

all over the world.all over the world.

Morabaha is a financing mode for trading Morabaha is a financing mode for trading activities on the basis of sale on profit. activities on the basis of sale on profit.

Technically, it is a contract of sale in Technically, it is a contract of sale in which the seller declares his cost and which the seller declares his cost and profit.profit.

It is an ancient practice which was seen It is an ancient practice which was seen in archives prior to the horizon of Islam. in archives prior to the horizon of Islam.

Morabaha practice developed in Islamic Morabaha practice developed in Islamic financial system with guidance of Islamic financial system with guidance of Islamic Shariah.Shariah.

Morabaha is a financing technique that Morabaha is a financing technique that involves a request by the Morahib involves a request by the Morahib (Worker) to the financier (Rab-al-Maal) (Worker) to the financier (Rab-al-Maal) for the purchase of a certain goods or for the purchase of a certain goods or equipment for him.equipment for him.

The financier after the appraisal of the The financier after the appraisal of the price and cost estimates its profit over price and cost estimates its profit over the cost which is settled as purchase the cost which is settled as purchase price in advance.price in advance.

The financier pay on behalf of the The financier pay on behalf of the Morahib and deliver the goods after Morahib and deliver the goods after taking acceptance of receiving the goods taking acceptance of receiving the goods as per requestas per request

There is a question on the legality on There is a question on the legality on Morabaha financing technique due to its Morabaha financing technique due to its similarity with Interest of Riba.similarity with Interest of Riba.

In reality it is wise to settle all the terms In reality it is wise to settle all the terms in pre-agreed as saying of Prophet in pre-agreed as saying of Prophet Muhammad, Muhammad, May Peace Be Upon Him.May Peace Be Upon Him.

““You must settle your terms in You must settle your terms in writing and in agreeing prior to writing and in agreeing prior to your trading and in trust and for your trading and in trust and for

better profitability.”better profitability.”

Morabaha Key NotesMorabaha Key Notes Financier is Rab-al-Maal & financing is Financier is Rab-al-Maal & financing is

made for the procurement of goods and made for the procurement of goods and commodities.commodities.

Morahib is the party of contract to sell the Morahib is the party of contract to sell the goods that Rab-al-Maal financed under the goods that Rab-al-Maal financed under the contract. contract.

It is not capital base contract and funds are It is not capital base contract and funds are use as financing for purchases of goods.use as financing for purchases of goods.

Morahib has to prove and satisfy the Rab-Morahib has to prove and satisfy the Rab-al-Maal of capabilities know-how of goods al-Maal of capabilities know-how of goods requested and marketing and selling plans requested and marketing and selling plans of the goods that are financed. of the goods that are financed.

How Murabaha mode of How Murabaha mode of finance operatesfinance operates

Morahib needs goods and approaches Morahib needs goods and approaches financier to get the required goods or financier to get the required goods or commodities through financingcommodities through financing

In interest-based system, money is landed on In interest-based system, money is landed on interest to the borrower who would go and interest to the borrower who would go and buy the required commodity from the market.buy the required commodity from the market.

This option is not available in Morabaha.This option is not available in Morabaha. Money cannot be lent directly to Morahib. Money cannot be lent directly to Morahib. Financing against the procurement of goods Financing against the procurement of goods

or commodity requested, directly paid to or commodity requested, directly paid to supplier in accordance to request of Morahib. supplier in accordance to request of Morahib.

Morahib approach Rab-al-Maal with his request to Morahib approach Rab-al-Maal with his request to acquire goods for trading purpose .acquire goods for trading purpose .

The request must be in writing with clear The request must be in writing with clear specification of goods required along with the specification of goods required along with the supplier identification and price declare by the supplier identification and price declare by the supplier.supplier.

Rab-al-Maal by self or through agent enter into Rab-al-Maal by self or through agent enter into purchase deal with the supplier of Morahib and purchase deal with the supplier of Morahib and negotiate the price to a minimum possible level.negotiate the price to a minimum possible level.

The supplier final price and Morahib declare price The supplier final price and Morahib declare price if differ this difference is the part of earning for if differ this difference is the part of earning for Rab-al-Maal as efforts are involve which to be Rab-al-Maal as efforts are involve which to be compensated compensated

Morahib cannot claim a part of this Morahib cannot claim a part of this earning, however Rab-al-Maal as good earning, however Rab-al-Maal as good gesture can reduce the profit on the gesture can reduce the profit on the commodity that he add on procured price commodity that he add on procured price declare by Morahib.declare by Morahib.

Morahib upon receiving the goods from Morahib upon receiving the goods from supplier issue an acceptance confirming supplier issue an acceptance confirming the quality and quantity of goods the quality and quantity of goods received from the supplier as well as received from the supplier as well as issue detail of stock kept at place.issue detail of stock kept at place.

Rab-al-Maal can also appoint its Rab-al-Maal can also appoint its Moqqadum (agent) who is allowed to Moqqadum (agent) who is allowed to receive the delivery of goods and receive the delivery of goods and commodities on behalf of Rab-al-Maal. commodities on behalf of Rab-al-Maal.

Moqqadum (agent) Moqqadum (agent) may keep the goods may keep the goods and commodities under his control and and commodities under his control and release upon the delivery order issued by release upon the delivery order issued by Rab-al-Maal to the Morahib either upon Rab-al-Maal to the Morahib either upon the payment or under differ payment the payment or under differ payment terms.terms.

It is compulsory that goods transfer from It is compulsory that goods transfer from Rab-al-Maal to Morahib should be on the Rab-al-Maal to Morahib should be on the pre-agreed price which was incorporated pre-agreed price which was incorporated in the Morabaha Financing Contract in the Morabaha Financing Contract supported by Local or Foreign Purchase supported by Local or Foreign Purchase Order duly signed by Morahib..Order duly signed by Morahib..

Murabaha transaction to be Murabaha transaction to be completed in two stages.completed in two stages.

Firstly, the Morahib requests the Firstly, the Morahib requests the Rab-al-Maal to undertake a Rab-al-Maal to undertake a Murabaha transaction and Murabaha transaction and promises to buy the commodity promises to buy the commodity specified by him. specified by him.

The promise is not a legal binding The promise is not a legal binding and Morahib may go back on his and Morahib may go back on his promise and the Rab-al-Maal takes promise and the Rab-al-Maal takes the risks of the amount financed.the risks of the amount financed.

In this situation the Arboon In this situation the Arboon amount is kept as the stake of amount is kept as the stake of Morahib, subsequently is used to Morahib, subsequently is used to cover the price margin where cover the price margin where Rab-al-Maal can sell the goods Rab-al-Maal can sell the goods by reducing the price to attract by reducing the price to attract the buyer.the buyer.

Secondly, Morahib purchases the Secondly, Morahib purchases the good acquired by the Rab-Al-good acquired by the Rab-Al-Maal on a deferred payments Maal on a deferred payments basis and agrees to a payment basis and agrees to a payment schedule on various dates.schedule on various dates.

On such arrangements the On such arrangements the profitability of Rab-Al-Maal shall not profitability of Rab-Al-Maal shall not be change and pre-agreed price of be change and pre-agreed price of resale of goods between the two resale of goods between the two parties of Morabaha contract shall parties of Morabaha contract shall remain constant.remain constant.

Murabaha sale contracts allow the Murabaha sale contracts allow the commodity sold it to the Morahib or in commodity sold it to the Morahib or in case if these are refuses to purchased case if these are refuses to purchased by Morahib then Rab-Al-Maal can sell by Morahib then Rab-Al-Maal can sell buy at best suitable price taking the buy at best suitable price taking the advantage of Arboon. advantage of Arboon.

This prime clause of the contracts and This prime clause of the contracts and it should be accepted by Morahib.it should be accepted by Morahib.

Murabaha financing widely used by the Murabaha financing widely used by the Islamic banks for various kinds of Islamic banks for various kinds of

financing requirementsfinancing requirements..

To provide finance in various and To provide finance in various and diverse sectors diverse sectors

To consumer finance for purchase of To consumer finance for purchase of consumer durable such as cars and consumer durable such as cars and household applianceshousehold appliances

To real estate to provide housing To real estate to provide housing financefinance

To manufacturing sector for To manufacturing sector for purchase of machinery, equipment purchase of machinery, equipment and raw material etc. and raw material etc.

To finance short-term To finance short-term trade for which it is trade for which it is eminently suitable.eminently suitable.

To issue letters of credit. To issue letters of credit. To finance import trade in To finance import trade in

today form of FIM today form of FIM (Finance Imported (Finance Imported merchandise) merchandise)

Confirmation Confirmation Conference on Islamic Banking held at Dubai in Conference on Islamic Banking held at Dubai in

1979 endorsed the terms & condition of 1979 endorsed the terms & condition of contract between two parties of Morabaha as:contract between two parties of Morabaha as:

This conference concluded that the Morabaha This conference concluded that the Morabaha transaction comprises a promise to transaction comprises a promise to purchase on behalf of the Morahib purchase on behalf of the Morahib

according to condition agreed upon and according to condition agreed upon and promise by the financier to conclude the promise by the financier to conclude the

sales after purchasing the commodity based sales after purchasing the commodity based on the decided conditionon the decided condition..

Fuqaha Fuqaha (Islamic Scholars)(Islamic Scholars)

According to Imam MalikAccording to Imam Malik

Both parties in Murabaha Contract Both parties in Murabaha Contract are legally bound to fulfill the terms are legally bound to fulfill the terms of contract. Any mis-declaration or of contract. Any mis-declaration or

mis-commitment from any party mis-commitment from any party towards the contract, offender towards the contract, offender

would be liable to legal proceedings. would be liable to legal proceedings. Other schools took it as religious Other schools took it as religious

obligation and legal binding if it is to obligation and legal binding if it is to the interest of the public.the interest of the public.

Contract of such nature Contract of such nature needs great technical needs great technical accuracy and a sound accuracy and a sound knowledge of Shariah. knowledge of Shariah.

The binding nature of the The binding nature of the Morabaha contract might Morabaha contract might require the endorsement of require the endorsement of the legislations in some the legislations in some Islamic countries where Islamic countries where such transactions are in such transactions are in practicepractice..

Imam BaghiImam Baghi

Contract concluded toward who Contract concluded toward who purchases the camel because of purchases the camel because of the need of the others and then the need of the others and then sell at a the higher price. Such sell at a the higher price. Such contracts end in two sales,contracts end in two sales,

Firstly, Firstly, they are purchased in they are purchased in cash.cash.

SSecondly,econdly, they are sold on they are sold on credit.credit.

Financier pays cash for Financier pays cash for commodity at the request of commodity at the request of Morahib then sells same to Morahib then sells same to Morahib on credit after adding Morahib on credit after adding its profit. In other words, its profit. In other words, financier by adding its profit financier by adding its profit loan excess to original purchase loan excess to original purchase price as interest which Morahib price as interest which Morahib will have to pay even if price of will have to pay even if price of commodity falls. commodity falls.

Such transactions fall under Such transactions fall under classification of Riba as interest. classification of Riba as interest.

Imam Al ShafaiImam Al Shafai If a man sees a commodity in the If a man sees a commodity in the

possession of another and agrees to possession of another and agrees to purchase the commodity with the purchase the commodity with the profit set by seller; such transaction profit set by seller; such transaction is valid, as it is not binding to any of is valid, as it is not binding to any of the party of the contract till the close the party of the contract till the close of the transaction. of the transaction.

If a man purchases the commodity If a man purchases the commodity and agree to pay the profit, then sale and agree to pay the profit, then sale is valid as the purchaser himself is valid as the purchaser himself agrees to offer the profit. agrees to offer the profit.

..

If Morahib requests Rab-al-Maal to If Morahib requests Rab-al-Maal to purchased separately the goods on purchased separately the goods on cash and then he shall buy in cash and then he shall buy in installments at later stage. The installments at later stage. The cash based sales accepted.cash based sales accepted.

Under second installation scenario Under second installation scenario sales would become valid provided sales would become valid provided Morahib purchase on installment or Morahib purchase on installment or at cash at an agreed price of at cash at an agreed price of contractcontract

Ibn RashidIbn RashidMorabaha sales are approved sales, Morabaha sales are approved sales,

but sales by mutual consent are but sales by mutual consent are preferable. preferable.

““Sales by mutual consent are permitted Sales by mutual consent are permitted because Morabaha sales according to because Morabaha sales according to Imam Ahmed require honesty and Imam Ahmed require honesty and integrity on the part of the seller”integrity on the part of the seller”..

Temptations has the possibility of Temptations has the possibility of being led into inaccuracy in one’s being led into inaccuracy in one’s favor of sales which is agreed by favor of sales which is agreed by

mutual consentmutual consent..

In case seller cheats with price or In case seller cheats with price or capital, sale remains valid, but capital, sale remains valid, but buyer get entitlement to claim buyer get entitlement to claim

the difference from the seller or the difference from the seller or drop the sale. drop the sale.

Some Fuqaha say that the buyer Some Fuqaha say that the buyer has no choice but is entitled to has no choice but is entitled to

deduct the difference. deduct the difference.

Morabaha sales are governed by Morabaha sales are governed by the same conditions applied to the same conditions applied to

sales in general with most sales in general with most important aspect that both important aspect that both

buyers and sellers should know buyers and sellers should know the amount of the financing and the amount of the financing and

the yield.the yield.

The seller must declare,The seller must declare,

I bought for 100 and claim it for I bought for 100 and claim it for with a profit of tenwith a profit of ten..

Selling in Installments of Selling in Installments of Differed SalesDiffered Sales

Time has to be agree on the price Time has to be agree on the price based on the period of credit based on the period of credit term.term.

Morahib must agree to pay on Morahib must agree to pay on maturity.maturity.

If unable to fulfill financier has If unable to fulfill financier has the right to claim the goods by the right to claim the goods by confiscating his confiscating his Arboon Arboon which which ultimately covers the price ultimately covers the price including the compensation for including the compensation for the loss of timethe loss of time. .

MorahibMorahib have to reveal have to reveal quantity of stock in hand to quantity of stock in hand to financier.financier.

Any discrepancy to original Any discrepancy to original delivered quantity would be delivered quantity would be paid by the Morahib. paid by the Morahib.

In case of failure to pay, In case of failure to pay, Morahib can be legally Morahib can be legally punished for punished for misappropriation and theft.misappropriation and theft.

Some Fuqaha forbid such types of Some Fuqaha forbid such types of sale, considering the increase in price sale, considering the increase in price as Interest, a category of Riba. While as Interest, a category of Riba. While some of the Fuqaha permit such some of the Fuqaha permit such sales as it is based on mutual sales as it is based on mutual agreement, and agree with Allah as agreement, and agree with Allah as said in Holy Quran: said in Holy Quran:

Whereas Allah permitted trading Whereas Allah permitted trading and forbidden usury and O’ ye and forbidden usury and O’ ye who believe! Misuse not yours who believe! Misuse not yours wealth among your selves in pride, wealth among your selves in pride, except it be a trade by mutual except it be a trade by mutual consent”.consent”.

““

Financial institutions use Morabaha Financial institutions use Morabaha financing in both ways, financing in both ways,

Differed sales of cost price for those Differed sales of cost price for those who need the commodity for their who need the commodity for their personal use and not for trade as personal use and not for trade as seen in seen in Consumer Financing.Consumer Financing.

On short term basis with limited On short term basis with limited installments provided to those who installments provided to those who cannot afford to pay in one go but cannot afford to pay in one go but with an ability to pay in installments. with an ability to pay in installments.

Morabaha Cost-plus Morabaha Cost-plus FinancingFinancing

This is a contract of sale between Financier This is a contract of sale between Financier and Morahib at a price which includes a and Morahib at a price which includes a profit margin agreed by both parties.profit margin agreed by both parties.

As a financing technique, it involves the As a financing technique, it involves the purchase of goods by financier on requested purchase of goods by financier on requested by Morahib.by Morahib.

Goods then sold to Morahib with a built-in Goods then sold to Morahib with a built-in profit.profit.

Repayment in installments are specified in Repayment in installments are specified in the contract as the contract as Murabaha Cost-Plus Murabaha Cost-Plus Financing.Financing.

Selling in Installments of Selling in Installments of Differed SalesDiffered Sales

Differed sales or sales by installment could be Differed sales or sales by installment could be carried out on the basis of the cost price of carried out on the basis of the cost price of commodity.commodity.

There is no disagreement on such type of sale There is no disagreement on such type of sale and could be carried out and allowed. and could be carried out and allowed.

Differed sale could be at a higher price than Differed sale could be at a higher price than the actual one of the commodity. the actual one of the commodity.

Some Fuqaha disagree on that type of sale. Some Fuqaha disagree on that type of sale. But most agree to such sales as seller But most agree to such sales as seller informs the buyer of cash price and price on informs the buyer of cash price and price on deferred payment terms as clear terms for deferred payment terms as clear terms for two types of sales transaction.two types of sales transaction.

Islamic jurists proposed Islamic jurists proposed forms of partnershipforms of partnership to provide credit & to provide credit &

finance for finance for Agricultural, Agricultural,

Manufacturing and for Manufacturing and for trading purposes.trading purposes.

These are These are

Consecutive Consecutive PartnershipPartnership

This instrument of financing is a real innovation on the This instrument of financing is a real innovation on the part of the Islamic banks.part of the Islamic banks.

Islamic banks take depositors of one financial year as Islamic banks take depositors of one financial year as partners in the proceeds of that financial year without partners in the proceeds of that financial year without matching with the periods of projects in which matching with the periods of projects in which depositors funds are invested. depositors funds are invested.

Pending proceeds from previous years, for which Pending proceeds from previous years, for which accruals or provisions were made are included in the accruals or provisions were made are included in the proceeds of the year in question.proceeds of the year in question.

Yields corresponding to the same financial year are Yields corresponding to the same financial year are excluded if they are not yet due and left to a future year. excluded if they are not yet due and left to a future year.

This accounting system is necessary to reconcile the This accounting system is necessary to reconcile the depositors' withdraw regardless liquidation of depositors' withdraw regardless liquidation of investment in which their funds are used.investment in which their funds are used.

Continuity of the bank's investments which constantly Continuity of the bank's investments which constantly flow in a mixed basket to make regular accounts every flow in a mixed basket to make regular accounts every financial year, as an accounting unit for this basket financial year, as an accounting unit for this basket

Agricultural Agricultural PartnershipsPartnerships Privately owned agricultural land could be utilized Privately owned agricultural land could be utilized

one of the three ways:one of the three ways: (a) directly by the owner,(a) directly by the owner, (b) indirectly by renting it (Ijarah)(b) indirectly by renting it (Ijarah) (c) through agricultural partnership. (c) through agricultural partnership.

The two main frameworks in traditional Islamic The two main frameworks in traditional Islamic law for agricultural enterprise are law for agricultural enterprise are

Muzara’ aMuzara’ a (share cropping) (share cropping) MusaqaMusaqa (water partnership or tree-sharing). (water partnership or tree-sharing).

Both these techniques typically afford a Both these techniques typically afford a partnership between capital and labor. partnership between capital and labor.

Sharecropping Sharecropping Muzara' a (sharecropping or crop partnership) is a contract Muzara' a (sharecropping or crop partnership) is a contract

whereby landlord puts his agricultural land at farmer's whereby landlord puts his agricultural land at farmer's disposal to farm.disposal to farm.

Farmer undertakes to give owner an amount of agricultural Farmer undertakes to give owner an amount of agricultural products. This framework is based on a partnership products. This framework is based on a partnership between capital and laborbetween capital and labor. .

Tree-sharingTree-sharingMusaqa (water partnership or tree-sharing) is a contract Musaqa (water partnership or tree-sharing) is a contract

whereby one person trim and water fruit trees own by whereby one person trim and water fruit trees own by other person or are at his disposal, in exchange for an other person or are at his disposal, in exchange for an amount of realize through the sale of the fruits on pre-amount of realize through the sale of the fruits on pre-agreed upon. agreed upon.

If a contract of Musaqa or tree sharing is related to fruitless If a contract of Musaqa or tree sharing is related to fruitless trees, like willows and sycophants, it is not valid.trees, like willows and sycophants, it is not valid.

However, it would be valid in such trees as henna whose However, it would be valid in such trees as henna whose leaves are used or trees whose flowers are used.leaves are used or trees whose flowers are used.