Murabaha & Musawamah

Murabaha & Musawamah

Murabaha & Musawamah LECTURE By Dr. Syed Zulfiqar Ali Shah Murabaha & Musawamah

Summary of Last Lecture Money Monetary Policy & Islamic Finance Currency Rate Fluctuation & Settlement of Debts Summary The Philosophy and Features of Islamic Finance

Plan of Today’s Lecture Introduction Conditions of Valid Bai Murabaha- A Bai Al Amanah Bai Murabaha in Classical Literature The Need for Murabaha Specific Conditions of Murabaha Possible Structures of Murabaha Murabaha To Purchase Orderer (MPO) Murabaha & Musawamah

INTRODUCTION Murabaha & Musawamah

Introduction Trading is one of the most common activities of Islamic banks. While conventional banks simply finance trading businesses by providing funds, Islamic banks have to be involved in the sale and purchase process for goods according to the trading rules prescribed by the Shar¯ı´ah. They are entitled to profit by undertaking business risk like real sector businesses. However, Islamic banks’ trading pattern is different from the general trading business. Banks’ clients normally need a credit facility and the banks are selling goods on credit and thus creating receivables. Credit sale (Bai‘ Mu´ajjal) may take a number of forms, important among which are: Musawamah, or normal sale, in which parties bargain on price, a sale is executed and goods delivered while payment is deferred. Murabaha & Musawamah

Introduction (Cont’d) Murabaha, a “cost-plus sale”, in which parties bargain on the margin of profit over the known cost price. The seller has to reveal the cost-incurred by him for acquisition of the goods and provide all cost-related information to the buyer. Experts in Islamic economics and finance generally advise the use of profit/loss sharing modes and discourage extensive use of Murabaha or other trading modes. But, as its permissibility is beyond doubt and all Islamic banks operating in the world are using this technique excessively as an alternative to the conventional modes of credit, studying Murabaha from the point of view of Islamic banking is crucial, and hence is the subject of the present chapter. The technique of Murabaha that is currently being used in Islamic banking is something different from the classical Murabaha used in normal trade. This transaction is concluded with a prior promise to buy or a request made by a person interested in acquiring goods on credit. Murabaha & Musawamah

Introduction (Cont’d) As such, it is called “Murabaha to Purchase Orderer” (MPO). The AAOIFI’s Shar¯ı´ah Standard on Murabaha is also based on this arrangement. We shall discuss the general rules of Murabaha and various structures that financial institutions can adopt for sale to help their clients. Various aspects to be discussed in this regard include the nature of Murabaha as we find in classical literature on Islamic jurisprudence, the sorts of goods eligible for selling through Murabaha on credit, disclosure to the buyer by the seller, combining other contracts or subcontracts for Murabaha arrangements by Islamic banks, the concept of Khiyar (option to rescind the sale) and possible defects in the object of sale, prepayment or late payment by the client, the possibility of liquidated damages/solatium to banks and the modern application of Murabaha along with issues involved. Fixity of price, taking ownership, risk related to ownership and possession of the object of contract by the bank before sale to the client, timings of Murabaha Murabaha & Musawamah

Introduction (Cont’d) and the principles regarding Murabaha receivables need more focus for their impact on Shar¯ı´ah compliance. Murabaha & Musawamah

CONDITIONS OF VALID BAI Murabaha & Musawamah

Conditions of Valid Bai Keeping in mind the importance given by Islamic banks to Murabaha, below is a recap on the salient features and conditions for a valid sale: The people uttering offer and acceptance in respect of a valid sale should be qualified to enter into the contracts. 2. The sale should take place with free and mutual consent of the seller and the purchaser. 3. Offer and acceptance must include certainty of price, certainty of date and place of delivery and certainty about the time of payment of the price. The seller should be either the owner of the object of sale (Mabi‘) or an agent of the owner. The Mabi‘ should be alienable. Transfer of title requires acquisition Murabaha & Musawamah

Conditions of Valid Bai (Cont’d) of title by the purchaser, which implies assuming the risks related to ownership, including the risk of damage, destruction, pilferage or theft, the risk of obsolescence and the price or market risk. 6. The subject of sale must exist at the time of sale; as such, one cannot sell the unborn calf of one’s cow, or a bank cannot execute Murabaha on goods that have already been consumed or used. 7. The Mabi‘ should be well-defined and in the ownership of the seller. Hence, what is not owned by the seller cannot be sold; for example, A sells to B a car which he intends to purchase from C (still owned by C) Since the car is not owned by A at the time of sale, the sale is void. 8. The subject of sale must be in the physical or constructive possession of the seller at the time of sale. Constructive possession means that the buyer has not taken physical delivery of the goods, but the ownership risk of the goods has been transferred to him. Murabaha & Musawamah

Conditions of Valid Bai (Cont’d) Sale must be instant and absolute – a sale attributed to a future date or a sale contingent on a future event is void. For example, A says to B on 1st of January: “I sell my car to you on the 1st of February”. The sale is void, because it is contingent on a future event. He can give an understanding or a promise, but the sale will have to be executed on 1st February, and it is only then that rights and liabilities will emerge. The subject of sale should be lawful and an object of value. A thing having no value according to the usage of trade cannot be sold; similarly, the subject of sale should not be a thing used for any prohibited purpose, e.g. pork, wine, etc. 11. The subject of sale should be specifically known and identified to the buyer, i.e. it must be identified by pointing out or by detailed specifications so as to distinguish it from other units of goods not sold. For example A says to B: “I sell 100 cotton bales out of the Murabaha & Musawamah

Conditions of Valid Bai (Cont’d) bales lying in that building”, if A does not identify the bales, the sale is void, because in the case of loss to the cotton, it would be difficult to ascertain who suffered how much loss. 12. The delivery of the sold commodity to the buyer should be certain and should not depend on a contingency or chance. For example, if A sells his car, which has been snatched, to a person in the hope that he will manage to get it back, the sale is void. 13. A certain price is stipulated once and for all. For example, A says to B: “If you pay in one month, the price is $50 and if in two months, the price will be $55”; as the price is uncertain, the sale is void. A can give the two options to B, but B must select one option to have one definite price to validate the sale. 14. The sale must be unconditional. A conditional sale is invalid, unless the condition is a part of any usual practice of trade not expressly prohibited by the Shar¯ı´ah. Murabaha & Musawamah

Conditions of Valid Bai (Cont’d) There are also certain other conditions which are applicable to each form of sale separately. The conditions related to Bai‘ Murabaha are discussed in next slides: Murabaha & Musawamah

MURABAHA- A BAI AL AMANAH Murabaha & Musawamah

Murabaha- A Bai Al Amanah Forms of Bai‘ can be described from the point of view of the cost of any item to the seller –we may call it the original cost. Since the original cost or purchase price is the starting point in Bai‘ Murabaha, it is appropriate to refer briefly to all such lawful forms of Bai‘ which become effective with express mention of the original cost. Such a classification of Bai‘ includes Tawliyah, Wadhi‘ah or Mohatah and Murabaha. These forms require an honest declaration of the cost by the seller and as such are referred to in the Fiqh literature as Buyoo‘ al Am¯an¯at (fiduciary sales). Among fiduciary sales, Tawliyah means resale at the stated original price with no profit or loss to the seller. Wadhi‘ah or Mohatah means resale at a discount from the original cost. The last one, Murabaha, is sale with a fixed profit margin over the cost. Another, and the most common, form is Bai‘ Musawamah, which is an ordinary sale and signifies sale for a price which is mutually agreed upon between the seller and the purchaser Murabaha & Musawamah

Murabaha- A Bai Al Amanah (Cont’d) without any reference to the purchase price/cost to the seller. In other words, it refers to bargaining on price of the commodity being traded. All these forms could be either on a spot or deferred payment basis. While in Musawamah the parties freely agree on the price, in Murabaha the seller informs the buyer of his original cost and the parties agree on a stipulated profit to be added to that cost. Murabaha & Musawamah

BAI MURABAHA IN CLASSICAL LITERATURE Murabaha & Musawamah

Bai Murabaha in Classical Literature Murabaha is derived from Ribh, which means gain, profit or addition. In Murabaha, a seller has to reveal his cost and the contract takes place at an agreed margin of profit. This contract was practised in pre-Islamic times. Imam Malik has mentioned this sale in Al-Mu’watta – the first formally coded book on traditions of the holy Prophet (pbuh). A renowned Hanafi jurist Al-Marghinani has defined Murabaha as “the sale of anything for the price at which it was purchased by the seller and an addition of a fixed sum by way of profit”. Ibn Qudama, a Hanbali jurist, has defined it as “the sale at capital cost plus a known profit; the knowledge of capital cost is a precondition in it. Thus the seller should say: ‘My capital involved in this deal is so much or this thing has cost me (Dm) 100 and I sell it to you for this cost plus a profit of (Dm) 10’. This is lawful without any controversy among the jurists”. According to Imam Malik, Murabaha is conducted and completed by Murabaha & Musawamah

Bai Murabaha in Classical Literature (Cont’d) exchanging goods and price including a mutually agreed profit margin, then and there. It is important to observe that to him, no credit is involved in Murabaha. Malik is as a whole do not like this sale as it requires so many conditions, the fulfilment of which is very difficult. However, they do not prohibit it. Imam Shaf’ie in Kitabul Umm expanded this concept to include credit transactions. It has been defined in similar words in other books of Fiqh. By definition, therefore, it is basic for a valid Murabaha that the buyer must know the original price, additional expenses if any and the amount of profit. Accordingly, Murabaha is a contract of trustworthiness. Murabaha & Musawamah

THE NEED FOR MURABAHA Murabaha & Musawamah

The Need For Murabaha Actually, Murabaha is meant for some restricted situations. Al-Marghinani has suggested that the purpose of Murabaha (and Tawliyah) is the protection of innocent consumers lacking expertise in trade from the tricks and stratagems of cunning traders. A person who lacks skill in making purchases in the market on the basis of Musawamah is obliged to have recourse to a Murabaha dealer who is known for his honesty in this particular type of trade, and thus purchases the article from that person by paying him an agreed addition over the original purchase price. This leaves the actual buyer satisfied and secure from the fraud to which he was exposed for want of skill. Hence, it is evident that the main purpose of this form of Bai‘ is to protect innocent purchasers from exploitation by cunning traders. Imam Ahmad prefers ordinary sale over Murabaha in the following words: Murabaha & Musawamah

The Need For Murabaha (Cont’d) “To me, ordinary sale (Musawamah) is easier than Murabaha, because Murabaha implies a trust (reposed in the seller) and seeking of ease on behalf of the buyer, and it also requires detailed description to the buyer; there is every likelihood that selfishness may overcome the seller, persuading him to give a false statement or that mistake may occur which makes it exploitation and fraud. Avoidance of such a situation is, therefore, much better and preferable”. The same ideas have been expressed by a Jafari jurist on the authority of Imam Hussain ibn Ali. After basing the sale price on the original cost of the goods to the seller, the purchaser is provided with a modicum of protection against unjust exploitation by unscrupulous merchants. It is important to observe, however, that modern Murabaha is conducted mainly by banks and financial institutions on a deferred payment basis. Upon execution of Murabaha & Musawamah

The Need For Murabaha (Cont’d) Murabaha, a receivable is created that becomes the liability of the customer. The aspect of disclosing details of the banks’ cost price, though a necessary condition of Murabaha, does not remain a serious issue between the parties, particularly in view of the fact that the customer himself is involved one way or the other in locating and purchasing the goods. Murabaha & Musawamah

SPECIFIC CONDITIONS OF MURABAHA Murabaha & Musawamah

Specific Conditions of Murabaha It is quite obvious that a transaction under Murabaha should meet all the general conditions applicable to an ordinary sale. The specific conditions regarding lawful transactions of Murabaha pertain to the goods subject to Murabaha, the original price paid by the seller, any additional costs to compute the total costs serving as the basis of Murabaha and the margin of profit charged on the cost so determined. An account of these conditions follows: Goods to be traded should be real, but not necessarily tangible. Rights and royalties are examples of non tangibles that can be traded through Murabaha, as they have value, are owned and can be sold on credit. 2. Any currency and monetary units that are subject to the rules of Bai‘ al Sarf cannot be sold through Murabaha, because currencies have to be exchanged simultaneously. Murabaha & Musawamah

Specific Conditions of Murabaha (Cont’d) 3. Similarly, credit documents that represent debt owed by someone cannot be the subject of Murabaha, first because debt cannot be sold except when it is subject to the rules of Hawalah and second because any profit taken on the debt would be Riba. 4. The seller must state the original price and the additional expenses incurred on the sale item and he must be just and true to his words. The additional expenses such as transport, processing and packing charges, etc. that enhance the value of the commodity in any way, and that are added as a custom by the merchant community in the original price, can be added into the purchase price to form the basis of Murabaha. It is, however, requisite that the seller, in making or including such an addition, should say: “This article has cost me so much”, and not: “I have purchased this at such a rate,” because the latter assertion would be false. Murabaha & Musawamah

Specific Conditions of Murabaha (Cont’d) The traditional jurists had some differences in this regard. The Hanafi school permits the seller to include in the base price of Murabaha all expenses he has incurred in relation to it, which have somehow modified the object (tailoring, dyeing for cloth) and those which have not modified it but were nevertheless incurred for the object’s sake (transportation, storage costs, commission). The Malik is divide the expenses into three groups: expenses that directly affect the object of the sale and that can be added to the base price of the object; expenses that are incurred after the profit has been calculated and do not directly alter the sale object, like services which the seller might not have provided himself (transportation and storage expenses), which can also be added and expenses which represent the services that the seller could have provided himself but did not provide, such as packing charges, sales commission, etc. – these cannot be added. Murabaha & Musawamah

Specific Conditions of Murabaha (Cont’d) According to Shafi‘es also, the expenses of the last category cannot be added to the cost. The Hanbalis’ view is more pragmatic, according to which all expenses can be added with mutual consent, provided the buyer is informed about the break-down of these expenses. 5. The prospective seller in Murabaha is required to disclose all aspects relating to the commodity, any defects or additional benefits and the mode of payment to the original seller/supplier. All schools of thought are unanimous on the point that the buyer in Murabaha ought to be informed if the original price was on credit, since credit prices are often higher than cash prices. All also agree that the original purchase price deliberately inflated violates the concept of Murabaha. If an Islamic bank receives a rebate for goods purchased, even after the Murabaha sale of such a contract, the client/buyer is entitled to benefit from the rebate as well. Murabaha & Musawamah

Specific Conditions of Murabaha (Cont’d) 6. The margin of profit on the price so reached has to be mutually agreed upon between buyer and seller. The price, once fixed as per agreement and deferred, cannot be further increased except for rebate received from the supplier as mentioned above. Any Majhul (unspecified) price cannot become a basis for Murabaha, as it involves the semblance of uncertainty which renders Murabaha sale unlawful. It is, therefore, a prerequisite that the price or cost paid by the seller must be expressed in identical units, such as dirhams and dinars, or specific articles of weight or measurement; because if the original price is an article of which all the units are not similar, the exact price at which the original buyer has become owner of the article will remain unknown. 8. If the seller gives an incorrect statement about the original price/cost of goods, the buyer, according to Imam Malik, may rescind the sale unless the seller returns to him the difference between his Murabaha & Musawamah

Specific Conditions of Murabaha (Cont’d) his real and the stated cost, in which case the sale is binding. The Hanafis give the buyer the unqualified option to rescind, while the Hanbalis consider the sale binding after the return of the difference between the correct and the stated costs. The Shafi‘es have two versions, one of which agrees with the Hanbalis and the other with the Hanafis. 9. The purchaser in Murabaha has the right of option, even in the absence of this condition or its stipulation in the contract. If he discovers that the seller has defrauded him by false statement regarding particulars of the article, its price, additional expenses or if the seller himself has bought the commodity on a deferred payment basis and sold it on prompt payment without informing him, or if any practice on the part of the seller involves the semblance of illegal sale, the purchaser will be at liberty either to accept or reject the bargain as he pleases If, however, the purchaser detects cheating Murabaha & Musawamah

Specific Conditions of Murabaha (Cont’d) after he has used that commodity or it has been destroyed in his hands, he is not entitled to make any deduction from the price according to Imam Abu Hanifa and his disciple Muhammad, because the commodity against which he has to practise his right of option does not exist. According to Abu Yusuf and Ibn-abi-Laila, also Hanafi, deduction will be made even after the destruction of the commodity. The message we get from the above is that Murabaha is a lawful kind of sale but has its own limitations. The Medieval Murabaha was not a mode of financing, it was a kind of trade. Contemporary jurists have accepted it as a mode of business and an alternative to financing with certain limitations. These relate to the level of transparency and justice which Islam ordains for commercial activities. It is in view of this requirement that Maliki fuqaha consider this form of sale Naqis (defective). This means that the permissibility of Murabaha is not as absolute as is the case of Murabaha & Musawamah

Specific Conditions of Murabaha (Cont’d) ordinary sale. There is no doubt that jurists have justified Murabaha on the grounds that it provides protection to the innocent, unskilled and inexperienced purchasers, but as we do not find any reference regarding its prohibition for experienced people or traders, it can therefore be adopted subject to the fulfilment of the juristic conditions, as an alternative to interest-bearing transactions for those activities which the Shar¯ı´ah boards of various banks may allow. Murabaha & Musawamah

Thank You…. Murabaha & Musawamah

Murabaha & Musawamah