Islamic Trade Finance Murabaha: The Bankers’ Perspective

Islamic Trade Finance Murabaha:The Bankers’ Perspective Saleem Khan

Murabaha • Islam prohibits charging fixed interest on money, but permits charging fixed profit on sale of goods. This clears a common misconception that charging fixed profit is haram. • Islamic banks therefore use a sale-based transaction (Murabaha) instead of a term loan for financing purchase of assets by their clients, especially for working capital requirements • Over 60% of all business volume of Islamic banks comprises of Murabaha transactions

Murabaha • Murabaha is a particular kind of sale • Where the transaction is done on a “cost plus profit” basis i.e. the seller discloses the cost to the buyer and adds a certain profit to it to arrive at the final selling price • The distinguishing feature of Murabaha from ordinary sale is • - The seller discloses the cost to the buyer • - And a known profit is added

Murabaha • Murabaha is simply a sale transaction • Which is being used by Islamic Financial institutions as a mode of financing by routing the transaction through Bai Muajjal.

Murabaha • As per the rules of Shariah the seller cannot sell the goods unless they come into his ownership. • However, since goods are to be purchased from the market, they need to be identified and purchased. • The bank , being a financial institution does not have the expertise to identify the goods and negotiate an efficient price. • The customer, however, being in the industry, can do this. The Bank therefore appoint him, in the first step of the transaction, to identify and procure the goods on the bank’s behalf.

Murabaha • Once the customer purchase the goods the risk of the goods transfers to the Bank. Bank can now sell these goods to the customer. • Please note that the customer play two different roles in this transaction. On that of Bank’s agent and other of purchaser. These roles should be clearly segregated to make the transaction halal. • This process is explained in detail in next slides.

Murabaha Bank Client Agreement to Murabaha Step by step Murabaha financing 1. Client and bank sign an agreement to enter into Murabaha.

Murabaha Bank Client Agency Agreement Agreement to Murabaha Step by step Murabaha financing 2. Client appointed as agent to purchase goods on bank’s behalf

Murabaha Bank Client Agency Agreement Agreement to Murabaha Disbursement to the client Step by step Murabaha financing 3. Bank gives money to client for purchase of goods. Islamic Bank

Murabaha Client purchases goods and takes possession Vendor Transfer of Risk Bank Client Step by step Murabaha financing 4. Client purchases goods on bank’s behalf and takes their possession.

Murabaha Bank Client Offer to purchase Step by step Murabaha financing 5. Client makes an offer to purchase the goods from bank.

Murabaha Murabaha Agreement + Transfer of Title Bank Client Step by step Murabaha financing 6. Bank accepts the offer and sale is concluded.

Murabaha Bank Client Payment of Price Step by step Murabaha financing 7. Client pays agreed price to bank according to an agreed schedule. Usually on a deferred payment basis (Bai Muajjal)

Murabaha -Risks • In a conventional transaction the banks takes risk on the client, however in a Murabaha transaction the Bank takes the following risks: • Asset Risk • Since for a short period of time the risk of Asset is transferred to the bank. • Credit Risk • Since once money is receivable from the customer, the risk of non-payment does exist

Murabaha -Mitigants • Assets Risk can be minimized by getting the asset insured from a reputable insurance company. • Credit Risk of the Murabaha transaction can be mitigated by conventional credit-risk mitigation procedures.

Murabaha Issues in Murabaha • Rollover in Murabaha • Rollover in Murabaha is not possible since each Murabaha transaction is for a particular asset. A new Murabaha can only be executed for the purchase of a new asset.

Murabaha Issues in Murabaha • Rebate on early payments • Prohibited by Meezan Bank’s Shariah Supervisory Board since it make the Murabaha transaction similar to conventional debt.

Murabaha Issues in Murabaha • Can only be used for financing of assets, not operating expenses. • Asset should be clearly specified. • Cannot be done for assets already purchased • Murabaha is a package of different contracts The sequence of their execution is extremely important to make the transaction halal.

Murabaha Conclusion • Murabaha transaction is the simplest from of an Islamic Financial Transaction. • Murabaha can be used to finance the purchase of any assets which is recognized as Mal-e-Mutaqawam (Valuable) under Shariah. • A wide range of customer needs can be catered through financing purchase of different assets by the customers.

Murabaha Meezan Bank’s Experience • Meezan Bank has been using Murabaha to finance purchase of raw material by its clients. • We have successfully entered into Murabaha transactions with a number of clients. Some of them are: • Client Transaction Volume (Rs. in Millions) • ICI 270 • PSO 200 • PARCO 100 • Newage Cables 75 • Sitara Chemicals 50

Islamic Trade Finance Murabaha: The Bankers’ Perspective