UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Murabahah in Islamic Finance

 

Murabahah is basically a sale-and-purchase agreement(s) for the financing of an asset or project for a cost plus a profit margin (mark-up), which is usually benchmarked against a conventional index such as LIBOR.  Therefore, Murabahah is also known as ‘cost-plus financing and frequently appears as a form of trade finance based upon letters of credit.

Under this structure, banks can purchase goods from a third party at the request of a client and sell the goods to the client at cost plus a mark-up with the goal of making a profit.  ‘Where a trader acts on behalf of another party in buying goods, the Murabahah mark-up may be seen as a payment for the trader’s service in locating, transporting and delivering the goods.’ (http://www.islamic-finance.com/item_murabaha_f.htm)

According to Islamicfinance.com, ‘The gain made by the seller is not seen as a reward for the use of his money capital, since it is not permissible to rent out money in Islam, but is instead seen as a profit on the sale of goods. However, this kind of sale of goods for money should be distinguished from a transaction in which a bank or financier buys an item and simultaneously sells it on at a profit to a customer. This operation is known as ‘Murabahah to the purchase-orderer’.’

According to Norton Rose, the original cost price of the asset is disclosed by the seller to the purchaser at the time of contracting and according to islamicfinance.com, the amount of the profit margin in money terms should be specified as well.  In addition according to Norton Rose, although often referred to as a singular Murabahah contract, the cost-plus financing may be achieved through using two separate contracts.  Norton Rose states that the way in which the two contracts are executed must be done carefully so as to be in compliance with the Sharia’h.

‘Islamic banks can engage in Murabahah because in contrast to conventional banks, trading is allowed.    Murabahah is considered legal in Islam and is for the benefit of the contractors and the community as a whole.  The concept is based on the fact that certain people are not skilled in buying and selling and enter into sale transactions with reliance on merchants to act in good faith and conduct a fair deal based on their duties as Muslims.’  (The Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan)

Advantages of Murabahah

  1. Banks trading the goods ensure that there is a ready buyer.
  2. The buyer provides the bank information on the supplier of the goods.
  3. Banks have the chance to make a profit from cost-plus financing.

(The Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan.  (2003), islamicfinance.com, and Norton Rose)

A Murabahah Transaction Usually Involves the Following Steps

  1. The purchaser/client submits an order to the bank to purchase the goods.
  2. The bank agrees to finance the purchase of the goods.
  3. The bank sends an offer to the purchaser/client.
  4. The purchaser accepts the offer, which binds the purchaser contractually to purchase the goods.  (Purchase Undertaking)
  5. The bank pays the supplier and purchases the goods using spot payment.
  6. The purchaser, acting for herself, enters into a contract to buy the goods from the bank.
  7. The purchaser purchases the goods from the bank for immediate delivery with deferred payment.
  8. On the due date, the purchaser pays the purchase price plus the mark-up.

(The Principles of Islamic Finance)

 

 

Terms of Murabahah

‘The subject matter of the Murabahah contract must be in existence, under the ownership, and in the physical or constructive possession of the seller at the time of contracting.

Where it is practiced in the modern financial market, Murabahah usually obeys the following terms:

  1. The end user settles the amount outstanding in one lump sum upon delivery or thereafter.
  2. The Settlement Date must be specified.
  3. The financier maintains ownership of the purchased items until delivery.
  4. The financier bears all the costs and risks of ownership until delivery.
  5. The end user and financier must pre-agree and specify the mark-up to be applied.
  6. The mark-up applies to all relevant costs incurred by the financier.
  7. The goods subject to the transaction must be specified.
  8. The cost of the required items and other relevant costs must be specified prior to contracting.
  9. In the event of default by the end user, the financier only has recourse to the items financed and no further mark-up or penalty may be applied to the sum outstanding although the seller may alternatively require the buyer to make a pre-specified donation to an agreed charity.
  10. The item purchased by the financier cannot be under the ownership of the financier, but must instead belong to a third party at the time of contracting.
  11. The seller may require the buyer to furnish security for the payment due, but only at the time when delivery of the purchased items to the buyer is made.’ (islamicfinance.com)

Risk Mitigation in Murabahah

1.  The purchase from the supplier and sale to the buyer may be done at the same time in order to minimize risk of liability for damage to the goods or the goods not matching specifications or meeting delivery dates, etc.( This may be seen as a ‘Murabahah to the purchase-orderer’ ) (The payment of the marked-up price is usually done at a later date, which in addition to risk, involves the provision of credit).

Side Note: ‘Scholars accept a transaction in which the aggregate value of the deferred installments equals the spot price (since even if such a transaction is viewed as a combination of a sale of goods with a loan advanced by the seller to the buyer, the loan in this case would be interest-free)’. (islamicfinance.com)

2.  The Bank can negotiate with the buyer to waive her rights to any claims against the bank for breach of warranty.  (indemnification)

 

The Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan.  (2003),

 

 

Sharia’h Parameter Reference 1: Murabahah Contract Frequently Asked Questions (Bank Negara Malaysia)

http://www.bnm.gov.my/guidelines/05_shariah/01_murabahah_02_faq.pdf

Murabahah Contract by Malaysia International Islamic Finance Corporation/ Bank Negara Malaysia

http://www.mifc.com/index.php?ch=menu_know_principals_murabahah&pg=menu_know_principals_mur_final

1 Comment

  UAE Laws Online wrote @

Very well explanied about Murabahah in Islamic Finance , it is good article that is clearing lot of doubts people have about Finance in Islam.


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