ISLAMIC REPUBLIC OF AFGHANISTAN

ISLAMIC REPUBLIC OF AFGHANISTAN Ministry of Rural Rehabilitation and Development Afghanistan Rural Enterprise Development Program Islamic Finance Product DevelopmentThe Use of the Order-to-Purchase Murābahahto Finance the Acquisition of Goodsprepared by Alberto G Brugnoni - AREDP

CONTENTS • I.ORDINARY MURĀBAHAH • I.I GENERAL FEATURES • I.II PARTICULAR FEATURES • I.III LEGITIMACY OF THE ORDINARY MURĀBAHAH • II. MURĀBAHAH BASED ON ORDER-TO-PURCHASE • II.I THE CONTRACT OF MURĀBAHAHFINANCING • II.II DEBATED ISSUES ON MURĀBAHAH FINANCING • II.IIIACCOUNTING POLICIES • II.IV CHECKING AND MONITORING • II.V BASIC MISTAKES IN MURĀBAHAH FINANCING • II.VI USES OF MURĀBAHAH FINANCING

CONTENTS • IV. TAWARRUQ • CLASSICAL TAWARRUQ • ORGANIZED TAWARRRUQ/COMMODITY MURĀBAHAH • THE MALAYSIAN EXPERIENCE • V. MURĀBAHAH V. BAY’ BI-THAMAN AJIL (BBA)

I.ORDINARY MURĀBAHAH • In its original Islamic fiqhconnotation, murābahah is simply one of the kinds of contracts of sale permitted by the Shariah: • the word is derived from the root-word rabiha=to profit or gain • as such, murābahah is not a mode of financing • Definition: if a seller agrees with his/her purchaser to provide a specific commodity on a certain profit added to his/her cost and disclose it, this transaction is called a murābahah: • this is the only feature that distinguish the murābahah contract from other kind of sales • Ordinary murābahahinvolves two parties: the seller and the buyer. The seller is an ordinary trader who buys a commodity without depending on a prior promise of purchase, then he displays it for murābahahsale: • for a price and a profit to be agreed upon • Alltheconditions that govern the Shariah contract of sale, ought to be fulfilled for the validity ofthecontract of murābahah: • these rules are a pre-requisite for its conclusion

I.I GENERAL FEATURES • GENERAL FEATURES • Murābahah is a contractthat put a particular emphasis on the interest of the buyer's needs: • the seller acts almost as a purchaser on behalf of the buyer • Murābahah is a particular kind of sale whereas the seller expresslydiscloses tothe purchaser the actual cost it has incurred in acquiring the commodity and discloses how much profit (mark-up) it is going to charge in addition to the cost • As a ‘honest declaration of cost’ - murābahahis one type of bay’ al-amānah('fiduciary' sale) in Islam: • the other two types of bay’ al-amānahare tawliyah(sale at cost) and wadhiah(sale at specified loss) • This kind of sale was historically based on trust (amānah) with the understanding that Allāh was witnessing the honesty of the trader. If the trader was dishonest, the client’s belief in the Hereafter and in Allāh was generally sufficient for the execution of justice: • also, the declaration of the cost allowed the prospective purchaser the ability to better evaluate the item’s economic worth due to which he/she either accepted, rejected or renegotiated the price he/she was willing to pay

I.I GENERAL FEATURES • in this sense, the purchaser could attempt to negotiate a lower price if he/she realized that the seller had paid much less for the item although the current market value was much higher • it also protects the consumer from against unjustified levels of profits

I.II PARTICULAR FEATURES • PARTICULAR FEATURES • The item can be sold on a murābahah basisonly if the seller has purchased it on cash: • alternatively, the seller has to disclose the fact that the item was purchased on credit • this is to ensure that the seller does not demand maximum profit through falsely claiming to have outlaid the full capital • in this case the sellercould be pressured to accept a lower profit margin since it has used others’ resources to buy the item • The profit added may be determined by mutual consent: • the profit is left to the discretion of the seller and no ceiling rate is specified as the maximum since this is left to the economic factors of supply, demand, production, acquisition cost, etc. • this should not violate Islam’s emphasis on fairness and thus the sale of items at unfair prices and exploitative rates • The profit may be in lump sum or may be based on a percentage (ration of profit) to be charged over the costs

I.II PARTICULAR FEATURES • The payment may be at spot, or may be on a subsequent date agreed upon by the parties: • in the latter case we have a ‘murābahah muajjal’ • thereforemurābahah sale does not necessarily imply the concept of deferred payment • All the expenses incurred by the seller in acquiring the commodity (like freight, custom duty, etc.) shall be included in the cost price and the mark-up can be applied on the aggregate cost: • however, recurring expenses of the business (salaries, rents, etc.) cannot be included in the cost of an individual transaction • in fact, the profit claimed over the cost should take care of these expenses • Murābahahis valid only where the exact cost of a commodity can be ascertained: • if the exact cost cannot be ascertained, the commodity cannot be sold on murābahah basis • in this case the commodity must be sold on musāwamah(bargaining) basis

I.II PARTICULAR FEATURES • It is imperative that the seller discloses the length of time the item on sale remained on its stock: • this is to prevent the buyers' ignorance of the seller desire to get rid of an obsolete item • Last but not least, where an agent sells an item on behalf of another on the basis of murābahah, it is obligated to sell it in terms of its supplier's cost

I.III LEGITIMACY OF THE ORDINARY MURĀBAHAH • Two verses from the Qur’ān are usually quoted to allow the murābahah transaction: • وأَحَلَّ ٱللَّهُ ٱلۡبَيۡعَ “And Allah has permitteth trading” [2:275] • يَـٰٓأَيُّهَاٱلَّذِينَ ءَامَنُواْ لَا تَأۡڪُلُوٓاْ أَمۡوَٲلَكُم بَيۡنَڪُم بِٱلۡبَـٰطِلِ إِلَّآ أَن تَكُونَ تِجَـٰرَةً عَن تَرَاضٍ۬ مِّنكُمۡ‌ۚ“O ye who believe! Squander not your wealth among yourselves in vanity, except it be a trade by mutual consent” [4:29] • murābahah is clearly concluded by mutual consent and hence comes under the general permission of this verse • Theordinary murābahah saleis a legally permissible contract by the testimony of Companions of the Prophet (pbuh): • the Prophet (pbuh) purchased a female camel from Abū Bakr (*) for use as transportation to migrate to al-Madīnah. Abū Bakr(*) wanted to give it to the Prophet (pbuh) free-of-charge but the Prophet (pbuh) refused and said, “I will preferably take it at the acquisition price” • this hadith indirectly implies that a commodity can be sold at the acquisition price and also at the acquisition price with a mark-up

I.III LEGITIMACY OF ORDINARY MURĀBAHAH • Classical jurists from all schools support that murābahahis a trust sale which comprises both cost price andmargin of profit. Some definitions follow: • Imām Shāfi'ī- When someone sell an item with a contract, for instance for every 10 products the profit is 1, the buyer thus must pay the cost price, that is 90 dirham, plus the profit of 1 dirham for every 10, hence 9 dirham and therefore eventually the total financing is 99 dirham • Al-Kamāl ibn al-Humam(hanafī) - Al-murābahahis a contract of delivery of traded goods by a seller to the buyer by offering the buyer the selling cost price plus the total profit • IbnQudāma al-Māqdisi (hanbalī) - A form of business transaction whereby the customer is informed that the goods are sold at a price which includes the cost price and profit

II. MURĀBAHAHBASED ON ORDER-TO-PURCHASE • PREFERRED MODES OF FINANCING IN ISLAM • The ideal modes of financing in Islam are the mudhārabah andmushārakah contracts: • however, within the current economic set up, there are certain practical difficulties in using mudhārabahand mushārakahinstruments • hence: the use of ordinary murābahah on deferred payment basis as a mode of financing, is unanimously allowed by Shariah scholars as a transitory step taken in the process of Islamization of the economy • as such, murābahah is only a device to escape from interest (ribà) and not an ideal instrument for carrying out the real economic objectives of Islam • MURĀBAHAH AS A MODE OF FINANCING • The ordinary murābahah sale contract is being used by today’s providers of capital (such as: Islamic banks, Islamic financial institutions, SGs, VSLAs, etc.) as a mode of financing. It is called ‘Murābahah based on Order-to-Purchase’: • as such, it has become one of the financing mechanisms widely accepted in the muāmalāt system • it is the least risky system of Islamic financing: it allows for mitigating the risks on the capital outlay and for booking in expected profits • it falls under the category of Natural Certainty Contract (NCC) because unlike equity financing, the returnto the financier under NCC is pre-determinedand certain • the NCC are called debt-based instruments. The bank enjoys a pre-determined return that has no correlation with the performance of the user of finance • these instruments have to observe conditions to ensure that they are free from ribà

II. MURĀBAHAHBASED ON ORDER-TO-PURCHASE • Murābahah based on Order-to-Purchase is a murābahah for a pre-agreed selling price, which includes a pre-agreed profit mark-up over its cost price, the latter having been specified in the customer's promise to purchase: • it is widely applicable and used as one of financing tools by Islamic banks worldwide • its use should be restricted only to those cases where mudhārabahor mushārakahare not practicable • being a sale, the murābahah based on Order-to-Purchasemust fulfill all the conditions necessary for a valid sale • As a mode of financing, murābahah based on Order-to-Purchase is not a loan given on interest but is the sale of a commodity for a deferred price (cost+profit) • beware that murābahah financing does not come into existence by merely replacing the word ‘interest’ by the words ‘profit’ or ‘mark-up • Murābahah based on Order-to-Purchase must follow certain particular rules/conditions: • these rules/conditions must be observed • they must implemented one after the other. The timing is a key element of the validity of the transaction • it is the observance of these conditions which can draw a clear line of distinction between an interest bearing loan and a transaction of murābahah

II. MURĀBAHAHBASED ON ORDER-TO-PURCHASE • unless these conditions are fully observed, murābahah is not permissible • If any of these conditions are neglected, the murābahah transaction is void • CONDITIONS • A key condition is that the financier must have owned the commodity before it sells it to its client: • this is the only feature of murābahahas a mode of financing which can distinguish it from an interest based transaction • the sale of the commodity to the client effected beforethe commodity is acquired by the seller is prohibited • this usually happens when all the documents of the murābahahare signed simultaneously without properly taking into account its various stages • From the above, it ensues another condition: the commodity must be in the financier’s risk: • hence: physical or constructive possession, though for a short period of time • The best way to perform murābahah is for the financier to purchase the commodity himself (or through its agent) and keeps it in its possession, before it sells it to the customer:

II. MURĀBAHAHBASED ON ORDER-TO-PURCHASE • in exceptional cases, it is also allowed that it makes the customer itself its agent to buy the commodity on its behalf • Another key condition is that the commodity is purchased from a third party: • entering into a murābahah contract on commodities already purchased by the client from a third party is prohibited • the purchase of the commodity from the client himself on ‘buy back’ agreement is not allowed in Shariah • murābahahbased on ‘buy back’ agreement is nothing more than an interest based transaction • Murābahah cannot be used as a mode of financing except where the client needs funds to actually purchase some commodities: • it requires a real sale of some commodities, and not merely advancing a loan • if the funds are required for other purposes (paying the price of a commodity already purchased, pay utility bills, staff salary, etc.) murābahah cannot be done • hence, is not a universal instrument which can be used for all types of financing offered by conventional interest-based banks • it cannot be used for personal financing/consumption needs

II. MURĀBAHAHBASED ON ORDER-TO-PURCHASE • As in a normal sale, the seller can promise to sell even when the commodity is not in its possession • Asnormal, any upfrontpaymenttowards financing the item sought by the client isdeducted, and the mark-upapplied only on the amount financed • If the financier purchases the item from the seller ata cash discount, the item cannot be sold on a murābahahbasis if the discount is concealed • SHARIAH STANCE • Some contemporaryIslamic jurists have allowed murābahah based on order-to-purchase on a temporary basis because is a lesser form of evil in relation to the direct use of ribà: • The principle of need (dharūra) allows for the relaxation of specific rulings in specific circumstances: • the implications for a Muslim customer is that it does not make use of such a contract except if he/she has a need that demands him to purchase the item on such a basis

II.I THE CONTRACT OF MURĀBAHAH FINANCING • THE CONTRACTING PARTIES • The two Contracting Parties have different capacities at different stages: • promisee/financier/seller: responsible for supplying the product needed/ordered by the buyer. The traded item or property must be lawfully owned by the promisor/ financier/seller according to Shariah requirements • promisor/customer/buyer: obligated to pay for the product it purchased according to the agreed terms • both must be adults, rational, intelligent and can be held accountable • THE AGREEMENT • The Promissory Agreement between the would-be buyer/customer and the seller/financier. They sign an overall agreement whereby the latter agreesto sell and the former agreesto buy the commodities on an agreed ratio of profit added to the cost: • the relation is one of promisor and promisee • this agreement may specify the limit up to which the facility may be availed • the product must be clearly defined (type, quantity and other descriptions) • NB: the cost (original price) and rate/margin of profit added to it, will have to be disclosed clearly and truthfullyin due time. The act of concealing them will render the transaction null and void!

II.I THE CONTRACT OF MURĀBAHAH FINANCING • THE AGENCY • The (possible) Agreement of Agency has the following features: • the relation is one of Principle and Agent • if the institution purchases the commodity directly from the supplier (which is preferable) there is no need of any Agreement of Agency • if a specific item is required by the customer, the institution may appoint it as its agent for purchasing the commodity on its behalf, and an Agreement of Agency is signed by both parties • the customer purchases the commodity on behalf of the institution and takes its possession as an agent of the institution • the client informs the institution that he/she has purchased the commodity on its behalf • it is preferable that the supplier invoices the items in the name of the financier not in the name of the agent

II.I THE CONTRACT OF MURĀBAHAH FINANCING • PURCHASE ORDER/THE PROMISE • There is a big difference between an actual sale and a mere promise to sell: • the actual sale cannot be effected unless the item has come into existence, it is owned by the seller, is in its physical or constructive possession • however one can promise to sell (or buy) something which is not yet owned or possessed by him. This promise initially creates only a moral obligation on the promisor to fulfill his promise, which is normally not justiciable • nevertheless, in certain situations, where such promise has burdened the promisee with some liability, it can be enforceable through the courts of law

II.I THE CONTRACT OF MURĀBAHAH FINANCING • DECLARATION • The Offer and Acceptance. After the item comes into the possession of the seller the actual sale can be effected.The actual transaction requires separate offer and acceptance: • the relation is one of a buyer and a seller • the customer makes an offer to purchase it from the financier • the financier accepts the offer and the actualsale is concluded whereby the ownership as well as the risk of the commodity is transferred to the customer • the most essential element of the transaction is that the commodity must remain in the risk of the institution before selling to the client • unless the sale is effected in this manner, the legal consequences of the sale shall not follow • products traded cannot be paid by barter with the six ‘ribawi items’ prohibited by the Prophet (pbuh) in the well-known hadith: gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt, unless weight, measurement and the calculations are exactly equal • PAYMENT SCHEDULE • Since the sale is effected on deferred payment basis, the relation of a debtor and creditor also emerges between them simultaneously:

II.I THE CONTRACT OF MURĀBAHAH FINANCING • any date agreed or credit term mutually agreed upon that would solidify the creditor’s claim on the date of maturity is allowable. There is no limit to the date of repayment • COST/INITIAL PRICE • The original price must be fungible: • i.e.: the price at which the seller obtained the goods must be measured by weight, volume or number of homogeneous goods • If the original price is not fungible (i.e.: house, clothes, etc.), then the question is whether the seller is the owner or not: • if the seller is not the owner, the murābahahis not permitted • if seller is the owner, two situations are possible: • if the profit margin is specified as a known amount of a different item (i.e. silver coins, a specific dress, etc.), the sale is permitted. In this case, the first price is known and the profit is known (i.e.: sale through a murābahah in exchange for the dress and a profit of 500 AFN) • if the profit is made part of the initial price (i.e.: the profit margin is 10%), the sale is not permitted, since the profit is made part of the object and not equally divisible

II.I THE CONTRACT OF MURĀBAHAH FINANCING • CALCULATION OF COST IN MURĀBAHAH • In a murābahah the profit may be fixed from the beginning: • at the time the mutual promise is made between the bank and the client (Purchase Order), the parties agree and fix the margin of profit which will be added to the original purchase price • in any case, the profit must be known and fixed before the sale is concluded (Declaration) • SECURITIES • The financier/seller may ask the customer to furnish a security to its satisfaction for the prompt payment of the deferred price • The financier/seller may also ask the client to sign a promissory note or bill of exchange, but it must be after the actual sale takes place (Declaration): • the reason is that the promissory note is signed by a debtor in favour of his creditor, but the relation of debtor and creditor between the institution and the client begins only when the actual sale takes place

II.I THE CONTRACT OF MURĀBAHAH FINANCING • PENALTIES • In case of default by the buyer in the payment of price at the due date, the price cannot be increased: • however, if he/she has undertaken, in the agreement to pay an amount for a charitable purpose he/she shall be liable to pay the amount undertaken by him/her • the amount so recovered from the buyer shall not form part of the income of the financier/seller. He is bound to spend it for a charitable purpose on behalf of the buyer • thischargeis levied only if the default is not due to financially stringent circumstances • for the sake of example, al-Baraka South-Africa specifies a charge of 0,07% per day on the overdue amounts (equivalent to 2.1% monthly and 25.2% annually)

II.I THE CONTRACT OF MURĀBAHAH FINANCING Comparison between Ordinary and On-Order-to-Purchase MURĀBAHAH

II.II DEBATED ISSUES ON MURĀBAHAH FINANCING • DIFFERENT PRICING FOR CASH AND CREDIT SALES • The murābahahused as a mode of financing, it is always effected on the basis of deferred payment. The question arises as to whether the price of a commodity in a credit sale may be increased from the price of the cash sale: • the financier purchases the commodity on cash payment and sells it on credit. While selling the commodity on credit, it takes into account the period in which the price is to be paid and increase the price accordingly • the longer the maturity of the murābahahpayment, the higher the price. Hence: the price in a murābahah transaction is always higher than the market price • DIFFERENCE WITH AN INTEREST (RIBAWI) LOAN • Is the increase of price in a credit sale being in consideration of the time given to the purchaser analogous to the interest charged on a loan? • according to ulama’ this presumption is not correct. Any excess amount charged against late payment is ribàonly where the subject matter is money on both sides • but if a commodity is sold in exchange of money, the seller, when fixing the price, may take into consideration different factors, including the time of payment

II.II DEBATED ISSUES ON MURĀBAHAH FINANCING • if a seller increases the price because it allows credit to his client, it is not prohibited by Shariah, because whatever the reason of increase, the whole price is against the commodity and not against money • while increasing the price of the commodity, the seller has kept in view the time of its payment, but once the price is fixed, it relates to the commodity and not to the time • if the purchaser fails to pay at a stipulated time, the price will remain the same and can never be increased by the seller • time may act as an ancillaryfactor (not as an exclusive basis as in exchange of money for money) to determine the price of the commodity but once this factor has played its role, every part of the price is attributed to the commodity • had it been against time, it might have been increased, if the seller had allowed him more time after the maturity • This position is accepted unanimously by all the four schools of Islamic law and the majority of Muslim jurists: • the only condition is that at the time of the actual sale the increase in price and the timing must be clearly stated leaving no ambiguity in the nature of the transaction • unless this is done, the sale is invalid

II.II DEBATED ISSUES ON MURĀBAHAH FINANCING • In a nutshell, the difference with a ribawi loan is that: • where the additional amount is a part of the price, it may be charged on a one time basis only (no additional amount in case of late payment) • where the additional amount is not a part of the price, it will keep increasing with the period of default • PROMISE TO PURCHASE • The financier/seller cannot enter into an actual sale at a time when the client seeks murābahah financing, because it does not yet own the required commodity and in Shariah neither the sale of a commodity not owned nor a forward sale are permitted: • it is, therefore, bound to purchase the commodity from the supplier, taking physical or constructive possession, and only then on sell it to the client • but if the client is not bound to purchase the commodity after the financier has purchased it, it may be confronted with a loss if the client refuses to purchase it • Solution to this problem is sought in the murābahahby asking the client to sign a promise to purchase the commodity when it is acquired by the financier: • it is a unilateral promise which binds the customer and not the financier, distinguishable from a bilateral forward contract. As such, it is allowed in Shariah

II.II DEBATED ISSUES ON MURĀBAHAH FINANCING • a promise is recognized as morally binding by most jurists based on Qur’anic and hadith evidence and its fulfillment deemed obligatory • this commercial promise may also be enforceable by some Courts of Law, as the promisee has incurred liabilities on the basis of the absolute promise to purchase it • if the promisor backs out of his promise, the court may force him either to purchase the commodity or pay actual damages to the seller • SECURITIES AGAINST THE MURĀBAHAHPRICE • The financier/seller wants to make sure that the murābahahprice will be paid at the due date. For this purpose, he may ask the client to furnish a security to his satisfaction: • payments due from the sale are receivables and for this, the client may be asked to furnish a security • the financier asks for a security after he has actually sold the commodity to the client and the price has become due to him • it is permissible that the client furnishes a security at earlier stages, but after the murābahah price is determined • the security may be in the form of a mortgage or a hypothecation or some kind of lien or charge • it is permissible that the sold commodity itself is given to the seller as a security

II.II DEBATED ISSUES ON MURĀBAHAH FINANCING • it is sometimes required (different schools differ on this point) that the purchaser shall take delivery (physical or constructive), then give it back to the seller as mortgage, so that the transaction of mortgage is distinguished from the transaction of sale • GUARANTEEING THE MURĀBAHAH • The seller can ask the purchaser to furnish a guarantee from a third party. In case of default of payment, the seller may have recourse to the guarantor, who will be liable to pay the amount guaranteed to him: • the classical fiqhliterature is almost unanimous on the point that the guarantee is a voluntary transaction and the guarantor cannot charge a fee from the original client. The reason being that a person charging a fee for advancing a loan comes under the definition of ribà • a minority of contemporary scholars opinethat this prohibition should be reviewed in light of contemporary international trade practices • however the guarantor can charge for any documentation expenses

II.II DEBATED ISSUES ON MURĀBAHAH FINANCING • PENALTY OF DEFAULT • If the client defaults on the payment at due date, the price cannot be increased nor can penalty fees be charged: • this restriction is sometimes exploited by dishonest clients who deliberately avoid to pay the price at its due date • a minority of contemporary scholars have suggested that the client who defaults deliberately should be made liable to pay compensation equal to the profit (if any) given by that bank to its depositors during the period of default • and this, only after he is given a grace period of at least one month and if it appears that his default is not due to poverty • NO ROLL-OVER IN MURĀBAHAH • Thematurity date of the murābahah transaction can never be rolled-over for a further period as the old contract ends. The extension of the period of payment on an additional mark-up charged (in practice another separate murābahah) is totally against Shariah • murābahah is not a loan: it is the sale of a commodity the price of which is deferred to a specific date • once this commodity is sold, its ownership transfers from the bank to the client and it is therefore no more a property of the seller. Hence the same commodity can not be sold twice

II.II DEBATED ISSUES ON MURĀBAHAH FINANCING • now, what the seller can claim is only the agreed price and therefore there is no question of effecting another sale on the same commodity between the same parties • REBATE ON EARLIER PAYMENT • The majority of jurists as well the Islamic FiqhAcademy of the OIC, hold that if the earlier payment is conditioned with discount, it is not permissible: • no such rebate can be stipulated in the agreement, nor can the client claim it as his right • however, if it is not, and the creditor gives a rebate voluntarily on his own, then it is permissible • his especially if the client is needy

II.III ACCOUNTING POLICIES • The Islamic Financial Accounting Standard-1 (IFIS-1) are applied to the murābahah financing • TRANSACTION RECORDING • At the time of disbursement to the client for the purchase of the goods on behalf of the bank, or directly to the supplier, the payment will be booked in the account head named ‘Advanceagainst Murābahah’ • At the culmination of murābahah i.e. at the time of sale of goods to client with the signing of the Declaration, the ‘Advanceagainst Murābahah’willbeadjustedinto ‘Murābahah Financing’: • financing are recorded at the deferred sale price, net of profit • financing are stated net of specific and general provisions against non-performing financings, if any, which are charged to the profit and loss account • Goods purchased but remaining unsold at the balances sheet date, are recorded as inventories

II.III ACCOUNTING POLICIES • REVENUE RECOGNITION • Profits on murābahah financings are recognised on accrual basis profit for the period from the date of disbursement to the date of culmination of murābahahimmediately after the Declaration has been signed and the ‘Murābahah Financing’has been booked • EXAMPLE • The following transaction is initiated: • Purchase Price/Cost/Principal = AFN 1.000 • Profit Rate = 10% • Tenure = 1 Year • Total Profit on Transaction = AFN 100 • Sale price (Contract price) = AFN 1.100 • Date of disbursement to supplier/customer = 1 May, 2013 • Date of culmination of murābahah transaction (Declaration) = 15 May, 2013 • Date of maturity of murābahah = April 31, 2014

II.III ACCOUNTING POLICIES Scenario A: Declaration signed on 15 May 2013 At the time of disbursement to Applicant for the purchase of goods on behalf of SG/VSLA or directly to the supplier by the SG/VSLAthe transaction will be accounted for as follows At the culmination of Murābahah (15 May 2013) i.e. at the time of sale of goods to the Applicant with signing of Declaration by the SG/VSLA and the Applicant, following entries will be passed

II.III ACCOUNTING POLICIES Booking of accrual of profit at 10% from the date of disbursement to the date of culmination, the following entry would be passed [(1000 x 10%) x 15 / 365]. In the in the Income statement there is an entry for ‘Deferred murābahahIncome’ and for ‘Income on murābahah Financing’ (4) Booking of accrual of profit at 10% for remaining days of the month, the following entry would be passed. [(1000 x 10%) x 16 / 365]. In the in the Incomestatement there is an entry for ‘Deferred murābahah Income’ and for ‘Income on murābahah Financing NB: these entries will be passed at the end of each month,till maturity for the accrual of profit

II.III ACCOUNTING POLICIES • (5)[100- (1000x10%x31/365)] • 4.10+4.39 = 8.49 • On maturity of murābahahtransaction and at the time of receiving of final payment following entry would be passed

II.III ACCOUNTING POLICIES Scenario B: Declaration signed on 15 June 2013 At the time of payment to Applicant for the purchase of goods on behalf of SG/VSLA or directly to the supplier by the SG/VSLAthe transaction will be accounted for as follows (2) No entry would be passed for accruals of profit, as Declaration has not been received from the customer (3) At the culmination of Murābahah (15 June 2013) i.e. at the time of sale of goods to the Applicant with signing of Declaration by the SG/VSLA and the Applicant following entries would be passed

II.III ACCOUNTING POLICIES Booking of accrual of profit at 10% from the date of disbursement to the date of culmination, the following entry would be passed [(1000 x 10%) x (31+15) / 365]. In the Income statement there is an entry for ‘Deferred murābahah Income’ and for ‘Income on murābahah Financing’ Booking of accrual of profit at 10% for remaining days of the month, the following entry would be passed. [(1000 x 10%) x 15 / 365]. In the in the Income statement there is an entry for ‘Deferred murābahah Income’ and for ‘Income on murābahah Financing NB: these entries will be passed at the end of each month,till maturity for the accrual of profit NB: in case the murābahahdeclaration is not received on the due date, no entry would be passed until the declaration is received

II.III ACCOUNTING POLICIES • (5)[100- (1000x10% x (31+30) /365)] • 12.60+4.10 = 16.70 • On maturity of murābahahtransaction and at the time of receiving of final payment following entry would be passed

II.IV CHECKING AND MONITORING • MURĀBAHAH MONITORING SHEET: • As per the guidelines of Shariah Advisory Boards, MurābahahMonitoring Mechanism (MMM) ought to be implemented to ensure timely receipt of Declarations & Purchase Evidences: • this will be a self-monitoring sheet and will be used to ensure proper execution of Murābahah transactions • PURPOSE • The purpose of implementing the MMM is: • to improve the quality of murābahah transactions • to reduce the gap between disbursement and purchase evidence • to avoid delays in declaration and to streamline murābahah transactions at all levels

II.IV CHECKING AND MONITORING

II.V BASIC MISTAKES IN MURĀBAHAH FINANCING • The most common mistake is to assume that murābahah can be used for all types of transactions and financing. This mode can only be used when a commodity is to be purchased by the customer: • if funds are required for some other purpose, murābahah cannot be used • The document is signed for obtaining funds for a specific commodity and therefore it is important to study the subject matter of the murābahah • In some cases, the sale of the commodity to the client is affected before the commodity is acquired from the supplier. This occurs when the various stages of the murābahah are skipped and the documents are signed all together: • it is to be remembered that murābahah is a package of different contracts and they come into play one after another at their respective stages • It is observed in some financial institutions that murābahahis applied on already purchased commodities, which is notallowed in Shariah: • murābahahcan be effected only on not yet purchased commodities!

II.VI USES OF MURĀBAHAH FINANCING • MURABAHAH CAN BE USED IN FOLLOWING CONDITIONS • SECURITIZATION • Securitization of murābahahagreement (certificate) is allowed at par value only: • debt can be traded only at par

III. TAWARRUQ • Tawarruqis the root word (masdar) for the verb tawarraqa, and means to ‘take papers‘ • CLASSICAL TAWARRUQ • The ‘classical tawarruq’ (tawarruqfiqhi or tawarruqfardhi)is a sale contract whereby a buyer (mutawarriq: seeker of cash) purchases an asset (possessed and owned by the seller) on credit for a delayed payment (as it is done in ordinary murābahah) andsubsequently sells the asset to a third party (an entity other than the initial seller) for a price lesser than the deferred price on cash (al-wariq): • this transaction is called tawarruq, mainly because when the buyer purchases the asset on deferred terms, it is not its intention to utilize the benefit from the purchased asset, rather to facilitate him to attain liquidity (waraqhmaliah) • according to the majority of the scholars, ‘classical tawarruq‘is legally permissible as no ribàis intended • it was allowed by the Organization of Islamic Countries (OIC) Fiqh Academy in its fifteenth session (Sept. 1998), on condition that the buyer should not resell the commodity to the first seller and at price lower than the purchase price (this would resemble a ‘inahsale, which is forbidden in Shariah)

III. TAWARRUQ CLASSICAL TAWARRUQ Buy item on cash Third Party (Islamic Financial Institution)/Seller Trader Transfer of ownership Sell item on cash Transfer of ownership Sell item on deferred price (Cost +Profit) Transfer of ownership Mutawarriq • The point in this structure is that there is real ownership transfer to the mutawarriq who has fully right of the item • Another important thing that must be underlined is that in the classical tawarruqstructure, each transaction is independent

III. TAWARRUQ • ORGANIZED TAWARRRUQ / COMMODITY MURĀBAHAH • In today’s financial markets, a new form of tawarruq called ‘organized tawarruq’ (tawarruq al-munazzamormasrafi) has emerged: • its structure in also known in the Islamic banking industry as a ‘Reverse Tawarruq’ • the Hanbali school of law call it tawarruq, whereas other schools mention this structure under the rubric of bay’ al-ajal and bay’ al-’inah • It is used by Islamic banks on both side of their balance sheet to replicate a conventional loan structure: • on the Asset side, to address financing needs of their customers: • bank buys a commodity (mostly mineral) following the promise to purchase it by a customer (mustawriq) who needs liquidity • the bank on sells it to the him at a deferred price (as in classical tawarruq) • BUT the customer appoints the same bank as his agent and the bank sells the commodity on his behalf to a third party on cash • the banks hands the money over to the mustawriq • on the Liability side, as a deposit mobilizing instrument: • in this case the customer firstly buys a commodity and sells it to the Islamic bank on deferred basis • effectively, the client is thus mimicking a fixed income deposit • .

III. TAWARRUQ • Most scholars hold this contract voidable because: • the bank does not hold/possess the commodity (it does not assume any risk) • practically, the bank does not pay the price of the commodity to the seller, but to the mustawriq, since is his agent • the transaction resembles agency in ribà, whereas the mustawriqtakes the lesser amount and he returns a bigger amount at the maturity date • widespread use of this form tawarruqis harmful to the industry in the long run. IFI needs to understand that tawarruqarrangement should be used in extreme cases where no option is available to avoid interest.

III. TAWARRUQ ORGANIZED TAWARRUQ / COMMODITY MURABAHAH 1. Deliver warrants (Islamic Financial Institution)/Seller Trader A 1. Pay cash 3. Appoints IFI to sell warrants 6. Paydeferred 2. Sell warrants on a deferred basis 4.Sell warrants on cash as Agent Mutawarriq Trader B 5. Pay Cash The net result of the above movements of warrants and cash is that the counterparty now holds an amount of money against an offsetting payment to the IFI for a pre-agreed principal plus a mark-up at a pre-agreed future date, thus creating a synthetic deposit

III. TAWARRUQ AND COMMODITY MURĀBAHAH • THE MALAYSIAN EXPERIENCE • Organized tawarruqis approved and officially used in Malaysia to ease the issue of liquidity management faced by Islamic banks: • liquidity risk is the potential loss to banks arising from their inability either to meet their obligation or to fund increases in asset • The Association of Islamic Banking Institutions Malaysia (AIBIM) has launched in Sept 2009 the ‘Corporate Murabahah Master Agreement (CMMA)’ in a move to boost the Islamic money market: • it is a standard document for deposit taking between financial institutions (Deposit Taking Entities or DTEs) and corporate customers (Deposit Placing Entities or DPEs). The latter intend to place their surplus funds with the DTEs • the CMMA specifies a common modus operandi for Islamic financial institutions in accepting deposits via commodity murābahah • the purchase by the bank, in its capacity as the agent of the customer, will be effected upon spot payment and immediate delivery by suppliers • it helps eliminate the need for corporate customers to vet through each and every agreement proposed by different Islamic financial institutions on the same product • it also provides certainty and standard methodology in ensuring principal and profit due to corporate depositors • .

III. TAWARRUQ AND COMMODITY MURĀBAHAH • Similarly AIBIM has launched the’ Interbank Murābahah Master Agreement (IMMA)’ in 2009: • it is a bilateral agreement between the Deposit-Placing Entity (DPE), or the principal and the Deposit-Taking Entity (DTE), or the agent • as an agent, the bank will receive instructions from the principal to buy commodities from suppliers • the purchase by the DTE or the bank would be effected upon spot payment and immediate delivery by suppliers • upon conclusion of the commodity purchase by the bank on behalf of the principal, the bank may subsequently offer to purchase the commodities from the principal on a deferred cash payment basis, at an agreed sale price that takes into consideration the initial purchase price and the profit amount • the sale would then be effected upon acceptance of the offer by the principal

ISLAMIC REPUBLIC OF AFGHANISTAN