Islamic Modes: Murabaha and Salam Islamic Microfinance Workshop CIBE Training Program Muhammad Khaleequzzaman Head

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2. Training Workshop – Islamic Microfinance ISLAMIC MODES/INSTRUMENTS: Sale Contracts: Murabaha/Murabahah to the Purchase Orderer Salam/Parallel Salam Istisna’/Parallel istisna Participatory Modes: Mudarabah/Resource Mobilization Musharakah/Diminishing Musharakah Rent based Modes: Operating ijarah Ijarah wa iqtina’

3. Sale Defined: Exchange of a thing of value with another thing of value with mutual consent OR the sale of a commodity in exchange of cash. Elements of a valid sale: Contract ( Aqd ) Subject matter ( Mabe’e) Price ( Thaman ) Possession or delivery ( Qabza ) Training Workshop – Islamic Microfinance

4. Training Workshop – Islamic Microfinance Rules of Sale: [Sale Defined and Elements of Sale] Subject must exist at the time of sale Subject must be in the ownership of seller – Physical or constructive Sale must be instant and absolute [exception of above rules in Salam and Istisna’] 4. Subject should be halal 5. Subject must be known and identified 6. Sale must be unconditional 7. Delivery of sold item must be certain Price of subject must be certain Risks and responsibilities attached with the subject must transfer from seller to the purchaser as a result of sale

5. Training Workshop – Islamic Microfinance Types of Islamic Sale Bai muajjal Murabaha Musawama Salam Istisna Murabaha: Uses of Murabaha Sale of raw material Sale of cart Sale of equipment Sale of agricultural inputs Sale of consumer goods House material financing

6. Outline: Murabahah – Brief Historical Perspective MFIing Murabahah/Murabahah to the Purchase Orderer Procedural details of Murabahah as practiced by Islamic MFIs Issues in Murabahah Documentation 

7. Theory & Practice of Murabahah Murabahah – Concept and Shariah Legitimacy Murabahah defined: Selling a commodity as per cost with a defined and agreed margin of profit (Ribh) Profit may be a percentage of the selling price or a lump sum. The transaction may be concluded with or without any promise to purchase by the client: Ordinary Murabahah / MFIing Murabahah or Murabahah to the Purchase Orderer. Shariah Legitimacy of Murabahah: Qura’an: “It is no crime for you to seek the bounty of your Lord” [Surah Ale Imran: 198] “ Allah has permitted trading and forbidden Riba ” [Surah Al-Baqarah: 275] Sunnah: The Prophet (PBUH) purchased a she camel from Abu Bakr (RAA) for use as transportation from Medinah...

8. Theory & Practice of Murabahah Murabahah – Historical perspective Introduced as new form of sale in second half of First Hijrah century as a sale with necessary condition of declaring cost by the seller and agreeing on profit margin by both the seller and the purchaser [Al- Muwatta, Imam Malik] Modifications were made by Imam Shafii’, including an order of the purchaser, who could subsequently exercise the option not to purchase the same, and also included credit transaction He clearly bifurcated two sales’ transactions

9. Process Flow: Negotiation/Approval of overall limit MOU/Master Murabahah Facility Agreement Requisition + Undertaking + Security Deposit (Hamish jiddiyah - Optional) + Invoice Theory & Practice of Murabahah

10. Third party appointed as agent [Optional] – Clint can be appointed agent [case of dire need] Payment to the Supplier – Direct Theory & Practice of Murabahah

11. Possession Payment to supplier Discount of supplier/benefit to client Title of goods Transfer of risk and responsibilites Theory & Practice of Murabahah

12. Conclusion of Murabahah Theory & Practice of Murabahah

13. Purchase of poultry feed stock Murabahah transaction: Rs. 30,000 Murabahah Facility: 90 Days Payment: Each month Rate of Profit: 15% p.a. Freight: 5% of cost of goods Security: Personal/group guarantee Theory & Practice of Murabahah

14. Theory & Practice of Murabahah

15. Theory & Practice of Murabahah Issues in Murabahah: Unilateral promise/undertaking Invoice in the name of MFI Prior contractual relationship (customer and supplier) Vendor being third party/blood relation/wholly owned institution of customer [Buy back (Inah)] Commitment or credit facility fee Documentation charges Hamish Jiddiyah/treatment/timing Timing of promissory note Rollover/Default in payment of price Rebate on early payment

16. Theory & Practice of Murabahah Documentation: Murabahah Agreement and Allied Documents: Parties to the Murabahah Subject matter Cost price Profit Margin Value Date – Disbursement date of Cost Price Contract price Default clause/penalty Right of set off i.r.o client’s credit balance Agency agreement as separate contract Purchase Requisition Invoice Receipt of payment to the supplier

17. Theory & Practice of Murabahah Documentation: Declaration Securities as per security documents Demand Promissory Note Schedule of payment

18. Theory & Practice of Murabahah Risks in Murabahah:

19. Theory & Practice of Murabahah Some Applicable Guidelines from AAOIFI: A. Measurement of asset value At acquisition – Measured and recorded at historical cost. After acquisition – Asset available for sale to client shall be measured at historical cost In case of default in payment of Murabahah price, the asset shall be measured at cash equivalent value (ie. Net realizable value). A provision to be created for decline in the asset value (ie. Difference between acquisition cost and the cash equivalent value).

20. Theory & Practice of Murabahah Some Applicable Guidelines from AAOIFI: B. Potential discount after acquisition The discount shall not be considered as revenue However it should reduce the cost of goods. C. Profit recognition Profit shall be recognized at the time of executing contract if the term does not exceed the current financial period. Profits of credit sale whose payment is due after the current financial period shall be recognized as per following: Proportionate allocation of profits Profit may also be recognized as and when received.

21. Theory & Practice of Murabahah Some Applicable Guidelines from AAOIFI: D. Failure to fulfill promise having paid Hamish Jiddiyah Hamish Jiddiyah to be treated as liability on Islamic MFI. Treatment: The amount of actual loss to be deducted from Hamish Jiddiyah E. Penalty – Deposited in Charitable A/C on realization

22. Salam

23. Islamic Modes – Agricultural Financing  Salam: Defined A salam transaction is the purchase of a commodity for deferred delivery in exchange for immediate payment. It is a type of sale in which the price, known as the salam capital, is paid at the time of contracting while the delivery of the item to be sold known as subject matter of salam (al Muslam fihi) is deferred. Salam is also known as Salaf (lit: borrowing) Salam: Purposes Liquidity needs of farm production Working capital/Running Finance Project finance (partial requirements)

24. Salam: Shariah Legitimacy Allh says “O ye who believe when you deal with each other, in transactions involving future obligations in a fixed period time, reduce them to writing” [Al Baqara Verse 282] Ibn Abbas reported, the Prophet (PBUH) came to Medina and found that people were selling dates for deferred delivery (salam) after a duration of one or two years. The Prophet (PBUH) said: “whoever pays for dates on a deferred delivery basis (salam) should do so on the basis of specified scale and weight” [Bukhari and Muslim]

25. Wisdom of allowing Salam Farmers, orchard owners, merchants can fulfill their working capital and liquidity needs before the commodity is ready to be sold Three major problems and solutions Risk of default by seller [personal/group guarantee/ hypothecation] MFI’s need to liquidate goods after delivery [parallel salam] Seller’s inabillity to produce or procure commodity [receive back the same price]

26. Salam: An exception to the possession A purchase contract opposite to Murabahah Benefits both the seller and purchaser Payment of full price at spot - otherwise selling debt for debt Allowed in commodities satisfying condition of Dhawatul Amthal - quality and quantity can be specified exactly Product of a particular field or farm cannot be sold Quality and quantity decided in un ambiguous terms Quantity should be agreed in specific terms (by weight, volume or measure)

27. Salam: Certain date and place of delivery The commodity should remain in the market throughout the period of contract [Different opinions] The time of delivery should be sufficient to allow use of salam capital conveniently and effect prices, preferably be at least 15-30 days from the date of contract [Different opinions] A security/guarantee or is preferred as safeguard to the risk of default Only commodity is delivered and not the money

28. Islamic Modes – Agricultural Financing Salam: Alternatives Available to MFIs of Taking Delivery of Commodity: By establishing a subsidiary By appointing the third party or client its agent to sell the commodity The agency agreement should be separate from the salam agreement If agent has been able to sell the commodity at a price more than the one agreed in agency agreement, agent gets the difference 3. By opting for Parallel Salam or Third party sales

32. Rules of Parallel Salam and Third party promise Both the contracts viz. salam and parallel salam must be independent of each other Parallel salam is allowed only with third parties. Therefore the original seller cannot be entered into the parallel salam The third party giving unilateral promise should not pay the price as this is not allowed in Shariah Examples of Products

33. THANKS