Principles of Islamic banking and finance/PIBF201/Fixed income Islamic modes of finance/Murabaha

'''Introduction '''

Most of the Islamic banks and financial institutions are using murabaha as an Islamic mode of financing, and most of their financing operations are based on murabaha. That is why this term has been taken in the economic circles today as a method of banking operations, while the original concept of murabaha is different from this assumption.

“Murabahah” is, in fact, a term of Islamic Fiqh and it refers to a particular kind of sale having nothing to do with financing in its original sense. If a seller agrees with his purchaser to provide him a specific commodity on a certain profit added to his cost, it is called a murabahah transaction. The basic ingredient of murabahah is that the seller discloses the actual cost he has incurred in acquiring the commodity, and then adds some profit thereon. This profit may be in lump sum or may be based on a percentage.

The payment in the case of murabaha may be at spot, and may be on a subsequent date agreed upon by the parties. Therefore, murabahah does not necessarily imply the concept of deferred payment, as generally believed by some people who are not acquainted with the Islamic jurisprudence and who have heard about murabahah only in relation with the banking transactions.

Murabahah, in its original Islamic connotation, is simply a sale. The only feature distinguishing it from other kinds of sale is that the seller in murabahah expressly tells the purchaser how much cost he has incurred and how much profit he is going to charge in addition to the cost.

If a person sells a commodity for a lump sum price without any reference to the cost, this is not a murabahah, even though he is earning some profit on his cost because the sale is not based on a “cost-plus” concept. In this case, the sale is called “musawamah.”

This is the actual sense of the term “murabahah” which is a sale, pure and simple. However, this kind of sale is being used by the Islamic banks and financial institutions by adding some other concepts to it as a mode of financing. But the validity of such transactions depends on some conditions which should be duly observed to make them acceptable in Shari'ah.

In order to understand these conditions correctly, one should, in the first instance, appreciate that murabaha is a sale with all its implications, and that all the basic ingredients of a valid sale should be present in murabahah also. Therefore, it will be appropriate to begin with some fundamental Shari'ah rules without which a sale may not be valid. After that you will learn what are some of the other conditions and procedures that must be followed to make a valid murabaha sale.

'''Basic Rules of Sale '''



‘Sale’ is defined in Shariah as ‘the exchange of a thing of value by another thing of value with mutual consent’. Throughout the centuries Muslim jurists have created a huge literature on the conditions and producers that validate a sale as permissible. They can be listed as follows:

1: The subject of sale must be existing at the time of sale. Thus, a thing which has not yet come into existence cannot be sold. If a non-existent thing has been sold, though by mutual consent, the sale is void according to Shariah.

2: The subject of sale must be in the ownership of the seller at the time of sale.

3: The subject of sale must be in the physical or constructive possession of the seller when he sells it to another person. “Constructive possession” means a situation where the possessor has not taken the physical delivery of the commodity, yet the commodity has come into his control, and all the rights and liabilities of the commodity are passed on to him, including the risk of its destruction.

There is a big difference between an actual sale and a mere promise to sell. The actual sale cannot be effected unless the above three conditions are fulfilled. However one can promise to sell something which is not yet owned or possessed by him. This promise initially creates only a moral obligation on the promisor to fulfil his promise, which is normally not justifiable. Nevertheless, in certain situations, specially where such promise has burdened the promise with some liability, it can be enforceable through the courts of law. In such cases the court may force the promisor to fulfil his promise, i.e. to effect the sale, and if he fails to do so, the court may order him to pay the promise the actual damages he has incurred due to the default of the promisor.1

But the actual sale will have to be effected after the commodity comes into the possession of the seller. This will require separate offer and acceptance, and unless the sale is effected in this manner, the legal consequences of the sale shall not follow.

The rules mentioned in paragraphs 1 to 3 are relaxed with respect to two types of sale, namely:

(a) Bai’ Salam

(b) Istisna’

The rules of these two types will be discussed later in a separate section.

4: The sale must be instant and absolute. Thus a sale attributed to a future date or a sale contingent on a future event is void. If the parties wish to effect a valid sale, they will have to effect it afresh when the future date comes or the contingency actually occurs.

5: The subject of sale must be a property of value. Thus, a thing having no value according to the usage of trade cannot be sold or purchased.

6: The subject of sale should not be a thing which is not used except for a haram purpose, like pork, wine etc.

7: The subject of sale must be specifically known and identified to the buyer. The subject of sale may be identified either by pointing at or by detailed specification which can distinguish it from other things not sold.

8: The delivery of the sold commodity to the buyer must be certain and should not depend on a contingency or chance.

9: The certainty of price is a necessary condition for the validity of a sale. If the price is uncertain, the sale is void.

10: The sale must be unconditional. A conditional sale is invalid, unless the condition is recognized as a part of the transaction according to the usage of trade.

Murabaha is Generally not an Instrument of Financing

Once you comprehend the characteristics of a sale transaction, it is important to understand that Murabahah cannot be used as a mode of financing except where the client needs funds to actually purchase some commodities. For example, if he wants funds to purchase cotton as a raw material for his ginning factory, the Bank can sell him the cotton on the basis of murabahah. But where the funds are required for some other purposes, like 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.