Murabaha

Not to be confused with Murabba.

Murabaḥah, murabaḥa or murâbaḥah (Arabic مرابحة) is an Islamic term for a sale where the buyer and seller agree on the markup for the item(s) being sold.[1] In recent decades it has become a term for "the most prevalent financing mechanism" in Islamic (i.e. "shariah compliant") finance, based on murabaḥa purchases.[2] As an Islamic financing structure, the seller is the "lender", typically selling something the borrowing person or company needs for their business. The buyer/borrower pays in periodic installments, and at a higher price than the seller/lender paid for the item(s), but with a profit margin agreed on by both parties.[2] The profit made by the seller/lender is not regarded as interest on a loan, (or any kind of compensation for the use of the lender's capital), as this would be forbidden as riba. Instead it is seen as "a profit on the sale of goods".[2] Murabaha is similar to a rent-to-own arrangement, with the intermediary retaining ownership of the property until the loan is paid in full.[3]

As the requirement includes an "honest declaration of cost", Murâbaḥah is one of three types of bayu-al-amanah (fiduciary sale). The other two types of bayu-al-amanah are tawliyah (sale at cost) and wadiah (sale at specified loss). If the exact cost of the item(s) cannot be or are not ascertained, they are sold on the basis of musawamah (bargaining).[2] Different banks use this instrument in varying ratios. Typically, banks use murabahah in asset financing, property, microfinance and commodity import-export.[4] The seller may not use Murâbaḥah if profit-sharing modes of financing such as mudarabah or musharakah are practicable. Since those involve risks, they cannot guarantee banks any income. Murabahah, with its fixed margin, offers the seller (i.e. the bank) a more predictable income stream. A profit-sharing instrument, conversely, is preferable as it shares the risks more equitably between seller and buyer.

There are, however, practical guidelines in place which aim to ensure that the Murâbaḥah transaction between the bank and the customer is one based on trade and not merely a financing transaction. For instance, the bank must take constructive or actual possession of the good before selling it to the customer. Whilst it can be justified to charge an additional margin to the customer to reflect the time value of money in terms of actual payment not being received from the customer at time zero, the bank can only impose penalties for late payment by agreeing to purify them by donating them to charity.

The accounting treatment of Murâbaḥah, and its disclosure and presentation in financial statements, vary from bank to bank.

Details

Under a Commodity Murâbaḥah financing or Tawarooq, a Bank purchases and takes title to the relevant assets (such as precious metals like Palladium) from a third party broker. The Bank then sells the assets to the Borrower at cost plus a specified profit. Payment of the sale price is usually deferred and may be structured in accordance with the wishes of the parties. The Borrower will enter into a contract to sell the assets to the Broker for the cost price. The net result is to create a deferred payment obligation from the Borrower to the Bank. Bank and Customer will usually enter into a succession of such transactions to create monthly, quarterly or semi-annual payment obligations. [5]

Criticism

The Commodity Murâbaḥah has been criticised by Islamic Scholars who say it should only be used as a structure of last resort where no other structure is available. In most transactions the commodities never change hands and usually there are no commodities at all, merely cash-flows between banks, brokers and borrowers. Often the commodity is completely irrelevant to the Borrower's business and there is not even enough of the relevant commodities in existence in the world to account for all the transactions taking place.[6]

The following is an example of a Murabaha contract: Adam approaches a Murabaha bank in order to finance the purchase of a $10,000 automobile from “Cash-Only-Automobiles”. The bank agrees to purchase the automobile from “Cash-Only-Automobiles” for $10,000 and then sell it to Adam for $12,000 which is to be paid by Adam in equal installments over the next two years.

Banks that use this product say that it is not interest because the amount that Adam owes is fixed and does not increase if he is delinquent on payments. Therefore, we are simply looking at a standard sale wherein a trader buys an item for one price and sells it for an increased price. Put differently, the argument for Murabaha is:

1. Does Islam allow someone to buy a car for $10,000 and sell it for $12,000? Yes.
2. Does Islam allow someone to make a purchase on a deferred payment basis? Yes.
From 1 & 2, neither the bank nor Adam have done anything wrong and Murabaha is permissible in Islam.

However, one must not forget to mention that: The same car that is being sold for $12,000 on a deferred payment basis is being sold for $10,000 on a cash basis.

Now let’s analyze the Murabaha example:

Adam has two options:
1. “Cash-Only-Automobiles” will sell him the car for $10,000 but are not willing to wait to receive the full price.
2. The Murabaha Bank will sell him the car for $12,000 and is willing to wait two years to receive the full price.

Adam’s choice to purchase from the Murabaha Bank reflects his desire to not pay the full price of the car today. In other words, he prefers to pay part of the price today and be indebted with the rest. The Murabaha Bank agrees to be owed by Adam the price of his car in return for the amount that it is owed being $2,000 more than the price of the car today.

Now that the picture is complete, let’s discuss whether Murabaha involves interest (Riba) by first defining interest:

Interest in Islam is the charging of a predetermined return for the use of money.[7] The verse which prohibits interest in the Quran, a Muslim’s primary source of jurisprudence, is the following:

“O you who believe! Observe your duty to Allah and give up what remains [due to you] from interest, if you are [in truth] believers. And if you do not, then be warned of war [against you] from Allah and His Messenger. And if you repent then you have your principal [without interest]. Wrong not, and you shall not be wronged.”[8]

So, did the bank charge Adam a predetermined return for the use of its money? Clearly yes. The bank charged $2,000 in return for Adam’s use of its $10,000 to buy a car. Whether the bank hands Adam the money or it hands the money to the dealership is irrelevant because in either case Adam is the one who decided where it was spent.

The fact that no penalties are assessed if Adam is delinquent on his payments simply means that the amount of interest in the Murabaha contract is predetermined to be $2,000.

Further, assume Adam goes to a traditional bank and borrows $10,000 at a %9.5 annual interest rate (at this rate he will owe $2,000 in interest in two years). Also assume that the interest on the loan is capped once it reaches $2,000. In other words, once Adam pays $2,000 in interest it stops accruing. Almost all Muslims agree that this traditional loan is prohibited in Islam. So how is the traditional bank’s loan different from the earlier Murabaha contract?

Further still, if Adam pays off the traditional bank’s loan early he will end up paying less in interest than he would with the Murabaha bank’s financing.

In conclusion, the Murabaha bank hasn’t eliminated interest at all it just guarantees for itself the amount of interest it collects.[9]

See also

References

  1. ↑ Usmani, Taqi. An Introduction to Islamic Finance. Creative Commons Attribution-No Derivative Works 3.0. p. 65. Retrieved 4 August 2015.
  2. 1 2 3 4 Islamic Finance: Instruments and Markets. Bloomsbury Publishing. 2010. p. 131. Retrieved 4 August 2015.
  3. ↑ "Murabaha". Investopedia. Retrieved 3 August 2015.
  4. ↑ Government of Pakistan: Securities and Exchange Commission of Pakistan
  5. ↑ "A Simple Introduction to Islamic Mortgages". 14 May 2015.
  6. ↑ "Misused murabaha hurts industry". Arabian Business. 1 February 2008.
  7. ↑ Khan, Mohsin S.; Mirakhor, Abbas (1987). Theoretical Studies in Islamic Banking and Finance. Islamic Publications International. p. Pg. 18.
  8. ↑ Three Translations of the Koran (Al-Qur'an) Side by Side. Library of Alexandria. p. Verse 002:278. ISBN 9781613101810.
  9. ↑ Kayali, Rakaan. "Murabaha: Halal or Haram?". Practical Islamic Finance.

External links

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