Showing posts with label Islamic Banking. Show all posts
Showing posts with label Islamic Banking. Show all posts

25 February 2009

Murabahah Trade Financing

Originally, Murabahah is a particular type of sale and not a mode of financing. However, in the perspective of the current economic set up, there are certain practical difficulties in using Mudarabah and Musyarakah instruments in some areas of financing. Therefore, the contemporary Syariah experts have allowed, subject to certain conditions, the use of Murabahah on deferred payment basis as a mode of financing. But there are two essential points which must be fully understood in this respect:

1. It should never be overlooked that, originally Murabahah is not a mode of financing. It is only a device to escape from “interest” and not an ideal instrument for carrying out the real economic objectives of Islam. Therefore, this instrument should be used as a transitory step taken in the process of Islamization of the economy, and its use should be restricted only to those cases where Mudarabah or Musyarakah are not practicable.

2. The second important point is that the Murabahah transaction does not come into existence by merely replacing the word “interest” by the words “profit” or “mark-up”. Actually, Murabahah as a mode of finance, has been allowed by the Syariah scholars with some conditions. Unless these conditions are fully observed, Murabahah is not permissible. In fact, it is the observance of these conditions which can draw a clear line of distinction between an interest bearing loan and a transaction of Murabahah. If these conditions are neglected, the transaction becomes invalid according to Syariah.

Basic Features of Murabahah Financing:

1. Murabahah is not a loan given on interest. It is the sale of a commodity for a deferred price which includes an agreed profit added to the cost.

2. Being a sale, and not a loan, the Murabahah should fulfil all the conditions necessary for a valid sale, especially those enumerated earlier in this chapter.

3. 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.

4. The financier must have owned the commodity before he sells it to his client.

5. The commodity must come into the possession of the financier, whether physical or constructive, in the sense that the commodity must be in his risk, though for a short period.

6. The best way for Murabahah, according to Syariah, is that the financier himself purchases the commodity and keeps it in his own possession, or purchases the commodity through a third person appointed by him as agent before he sells it to the customer. However, in exceptional cases, where direct purchase from the supplier is not practicable for some reason, it is also allowed that he makes the customer himself his agent to buy the commodity on his behalf. In this case the client first purchases the commodity on behalf of his financier and takes its possession as such. Thereafter, he purchases the commodity from the financier for a deferred price. His possession over the commodity in the first instance is in the capacity of an agent of his financier. In this capacity he is only a trustee, while the ownership vests in the financier and the risk of the commodity is also borne by him as a logical consequence of the ownership. But when the client purchases the commodity from his financier, the ownership, as well as the risk, is transferred to the client.

7. As mentioned earlier, the sale cannot take place unless the commodity comes into the possession of the seller, but the seller can promise to sell even when the commodity is not in his possession. The same rule is applicable to Murabahah.

8. In the light of the aforementioned principles, a financial institution can use the Murabahah as a mode of finance by adopting the following procedure:

(i) The client and the institution sign an overall agreement whereby the institution promises to sell and the client promises to buy the commodities from time to time on an agreed ratio of profit added to the cost. This agreement may specify the limit up to which the facility may be availed.

(ii) When a specific commodity is required by the customer, the institution appoints the client as his agent for purchasing the commodity on its behalf, and an agreement of agency is signed by both the parties.

(iii) The client purchases the commodity on behalf of the institution and takes its possession as an agent of the institution.

(iv) The client informs the institution that he has purchased the commodity on his behalf, and at the same time, makes an offer to purchase it from the institution.

(v) The institution accepts the offer and the sale is concluded whereby the ownership as well as the risk of the commodity is transferred to the client.

All these five stages are necessary to effect a valid Murabahah. If the institution purchases the commodity directly from the supplier (which is preferable) it does not need any agency agreement. In this case, the second phase will be dropped and at the third stage the institution itself will purchase the commodity from the supplier, and the fourth phase will be restricted to making an offer by the client.
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