Murabaha (trade with mark-up cost) is one of the most widely used instruments for short term financing and accounts for nearly 75 per cent of Islamic financial products marketed worldwide.

1. Definition Of Murabaha

Referring to ‘cost-plus sale ’, murabaha is the sale of a commodity at a price that includes a set profit of which both the vendor (marketer) and the consumer are aware.

This transaction is one of the trust based contracts as the seller (Islamic bank) explicitly discloses the purchasing price and profit margin to the buyer (customer).

2. Legitimacy Of Murabaha

The legitimacy and permissibility of the Murabaha sale is derived from the verses of the Quran in which Allah, Most High, says,

Those who eat Riba (usury) will not stand (on the Day of Resurrection) except like the standing of a person beaten by Shaitan (Satan) leading him to insanity. That is because they say: “Trading is only like Riba (usury),” whereas Allah has permitted trading and forbidden Riba (usury). So, whosoever receives an admonition from his Lord and stops eating Riba (usury) shall not be punished for the past; his case is for Allah (to judge); but whoever returns [to Riba (usury)], such are the dwellers of the Fire – they will abide therein (02:275), and “O you who believe! Eat not up your property among yourselves unjustly except it be a trade amongst you, by mutual consent…. (04:29).

3. Types of Murabaha

Simple Murabaha :

In an ordinary Murabaha sale, two parties; a seller and a buyer make a transaction where the seller buys a commodity without a prior promise of purchase (by the purchaser) and resell it to the buyer at cost plus profit basis.

Murabaha to the purchase orderer :

This transaction is concluded with a prior promise to buy a certain commodity, submitted by a person interested in acquiring goods through the islamic financial institution. the Islamic bank agrees to buy an asset or goods from a third party, and then resells the goods to its client with a mark-up. The client purchases the goods against either immediate or deferred payment. it is the most widely used Financing instruments in islamic banks, that’s why we will discuss it in detail.

4. Principles Of Murabaha :

Procedures prior to the Murabaha contract:

It is necessary that the purchaser should express its wish to acquire an item through the seller prior to the contract. But the expression of the customer does not constitute a promise or commitment except when it has been expressed in due form. The seller can purchase the items on its own behalf but only in response to its customer’s wish and application.

The promise to buy is not the integral part of a Murabaha transaction, but is intended to provide assurance unilaterally by the purchaser (customer). A bilateral promise is not permissible except if there is an option to cancel the promise, which may be exercised either by both promisors or by either one of them. The seller, in case of a binding promise, can take a sum of money as security deposit (Hamish Jiddiyyah). In case of the customer’s breach of its binding promise, the seller is entitled only to an amount equal to the actual loss from the security deposit (Hamish Jiddiyyah/ هامش الجدية).

Murabaha Contracting parties:

The parties who are involved in a Murabaha contract are the seller (Islamic Bank) as the financier and the buyer as the customer.

Subject matter :

The subject matter of a Murabaha contract involves the asset and the selling price.

The asset :

shall be clearly defined including its type, quantity and other descriptions and must be permissible from Shariah perspective. The seller (Islamic Bank) must assume the risk of the ownership in the asset it intends to sell. Hence, it has to acquire (possession) the asset before entering into the Murabaha Sale Contract with the purchaser.

The selling price:

The selling price of Murabaha asset including its cost and profit margin must be disclosed to the purchaser clearly. The selling price and the seller’s profit are required to be fixed and known at the time of signing the contract. Payment of the price of the item can either be short term or long term installments. The seller cannot receive any commitment fee or a fee for providing the credit period from the purchase.

Conclusion of a Murabaha:

The contract of Murabaha consists of the offer by one party and the acceptance by another party. The Murabaha contract can be concluded by means of meeting or exchanging the offer and acceptance in any customary form of modern communication. It cannot be concluded automatically or by force, if the purchaser refuses to conclude the Murabaha. The forms of taking delivery or possession of items differ according to their nature and different trade customs. In case of the purchaser’s breach of contract, the seller (Islamic Bank) is entitled to receive compensation for actual damage it has incurred as a result of the breach.

Guarantees and treatments:

The seller (Islamic Bank) may ask the purchaser to provide lawful security like a pledge or third party guarantee or cheques or promissory notes, etc., against failure of purchaser in installment payments. However, it cannot be stipulated that the ownership of the item will not be transferred to the purchaser until full payment of the selling price. The seller may on its absolute discretion give up a part of the selling price if the purchaser pays early, but the date for payment cannot be extended in exchange for an additional charge or payment.

Murabaha Oprational Procedure :

1. A Customer who is in need to acquire prescribed commodity approaches the Islamic Bank and applies for finance through Murabaha (Mark-up Sale) transaction.
2. As per Customer’s financing requirement Bank assesses the customer’s creditworthiness and approves the request.
3. The Bank seeks an undertaking from the Customer to buy the the commodity in question from the Bank once latter purchases it and takes possession. Along with other details the Islamic Bank’s profit is also stipulated.
4. The Islamic Bank buys the prescribed commodity.
5. After getting the possession of the purchased commodity the Islamic Bank sells it to the customer through a Murabaha Sale Contract after adding its profit (mark-up) to the cost.
6. The Customer may settle his finance early by paying the full outstanding. It is, however, allowed under Shariah for Murabaha Seller (Islamic Bank) to forgo any part of the Murabaha Sale Price at the time of early settlement and grant some rebate on its sole discretion.

5. Murabaha Risks

In islamic banking Murabaha mode of finance resembles, in its risk profile, conventional lending. Except for bank’s purchase of the goods and resell to the client, Murabaha creates a bank asset similar to that of conventional banks, with much-the same risks, the main difference are basically :

Risks related to changes in price of the goods when such goods are owned by the bank prior to sale to the client. No specific length of time is required by Shari’ah hence such time can be reduced to the minimum to control commercial risks. What is necessary, however, is that ownership as defined by Shari’ah is sustained in such time. Hence, these risks can be significantly reduced through efficient procedures. Furthermore, since murabahah is effectively cost-plus, change in the prior of goods will not affect the sale price to the client since it is based on cost of purchase.

Shari’ah does not permit any financial penalty to be imposed on delinquent debtors for purpose of compensating the creditor. This is clearly a major disadvantage over conventional banking. This makes the risk related to the client default or failure to pay on time is relatively high. Many Islamic banks opt for fining the client and then pay such fines to charity to avoid the risk of falling into the definition of usury in Shari’ah.

Murabaha is a fixed-return type of finance. It is naturally exposed to interest rate risks. Because of this, most Murabahas in Islamic banks are short-term.

Some observers see this mode of Islamic finance to be very close to a conventional interest-based lending operation. However, a major difference between murabaha and interest-based lending is that the mark-up in murabaha is for the services the bank provides (for example, seeking and purchasing the required goods at the best price) and the mark-up is not stipulated in terms of a time period. Thus, if the client fails to make a deferred payment on time, the mark-up does not increase from the agreed price owing to delay. Also the bank owns the goods between the two sales, which means it carries the associated risks.