MURABAHAH

1. MURABAHAH COST PLUS PROFIT OR MARK-UP

2. Definition • Murabahah or murabaha, (Arabic مرابحه): • A sale transaction, compliant with shariah, where the seller expressly mentions the cost he has incurred on the commodities to be sold and sells it to another person by adding some profit or mark-up, which is known to the buyer. • An 'honest declaration of cost‘ - murabaha is one type of bai-al-amanah ('fiduciary' sale) • The other two types of bai-al-amanah are Tawliyah (sale at cost) and Wadiah (sale at specified loss).

3. Murabahah concept • The sale of goods at a price, which includes a profit margin agreed to by both parties. • The purchase and selling price, other costs, and the profit margin must be clearly stated at the time of the sale agreement. The bank is compensated for the time value of its money in the form of the profit margin. • In practice: A fixed-income loan for the purchase of a real asset (such as real estate or a vehicle), with a fixed rate of profit determined by the profit margin. The bank is not compensated for the time value of money outside of the contracted term (i.e., the bank cannot charge additional profit on late payments); but, the asset remains as a mortgage with the bank until the Murabaha is paid in full.

4. Rukun Murabahah • Seller • Buyer • Asset • Price (Mark-up) • Ijab and Qabul

5. Natural Certainty Contract (NCC) • These instruments falls under NCC because unlike equity financing, the return to the financier under NCC is pre-determined. It is certain. • These are called debt-based instruments. The bank enjoys a pre-determined return that has no corelation with the performance of the user of finance. • These debt–based instruments have to observe conditions of trading to ensure it is free from Riba. • If a normal sale, in which the seller does not disclose the profit, it is known as Musawwamah. Both murabahah and musawwamah are valid in Shariah.

6. Murabahah and Al Bai Bhitaman Ajil (BBA) • In Murabahah, both parties to the transaction must know the cost and also the profit. This is a trust-sale where the buyer trusts that the seller has made a truthful disclosure about the cost and mark-up. • Payment of the price may be spot or deferred depending on the agreement. • A Bai Bithaman Ajil (BBA) refers to the deferred mode of payment in a sale. It is also known as Bai Mu’ajjal. • In BBA- the deferred payment has been made and agreed at the beginning of the contract.

8. Example 1: Classical Murabahah • Jamil needs to buy a car and he approaches an Islamic bank who is the vendor for cars. • Jamil chooses to purchase a car that costs RM50,000. The bank sells the car to him at RM60,000 (RM50,000 cost + RM10,000 profit). He would have the option to pay the Islamic bank in deferred installments over 8 years.

9. Example 1 • In case 1- if Jamil choses to pay in installments, then it is a Murabahah (because cost and profit were disclosed) and also a BBA (because price was paid deferred). • BBA has been subject to some controversies regarding its permissibility because the price charged in a deffered sale is higher than its spot price. • According to majority of scholars, the deferred price may be more than the spot price, however the price must be fixed at the time of sale.

10. Example 2: Murabahah Financing • Company XY wants to buy a machine that costs RM150,000 but it does not have enough money. • The company approaches an Islamic bank for financing. The Islamic bank buys the machine from the supplier and sells to Company XY for RM200,000 ( the cost + profit to bank). • The company agreed and will pay the bank in installment over 10 years.

12. Murabahah Financing • At times, a BBA/Murabahah instrument may appear similar to conventional bank loans. • Some argue that Islamic banks merely substitute the interest rate with profit rate. Thus, shariah law has imposed several constraints to ensure that Murabahah is free from Riba.

13. Conditions in Murabahah • 1.The subject of sale must exist in the ownership and possession (physical or constructive) of the bank at the time of sale to its client. As a seller (i.e. owner of goods) the bank is exposed to ownership risks such as price risk and risk of destruction of asset before actual delivery to client. This risk-bearing legitimates the bank’s profit.

14. Conditions in Murabahah • 2.The price of the sale must be fixed at the time of contract. This is important to avoid gharar (uncertainty) in the transaction. • 3.The first sale and purchase between the bank and the producer of the commodity must be an independent transaction from the second sale and purchase i.e. the bank must purchase the commodity from a third party and not the client himself. • 4.A Murabahah/BBA must not involve sale of forbidden commodities such as liquor, pork and the like.

15. Issues in Murabahah • In Shariah, ownership transfers to the buyer upon the conclusion of the sale (i.e. day 1) although payment is in deferred term. • Thus, Islamic banks need to create a charge over the assets financed using a Murabahah/BBA if it would like to seek assurance for the payment of the sale price. • A major problem in Murabahah/BBA financing relates to default by clients.

16. Cont. • Originally, Shariah does not allow the banks to charge penalties on late payments. However, this has resulted in moral hazards where some clients deliberately makes late payment. • To overcome this problem, scholars have allowed the banks to charge penalties for late payment, however this amount should be chanelled to charity and doesnot serve as extra income to the bank. • In the case of early repayment by the clients, some scholars allow granting a rebate to the client (known as ibra’). • Rebate or discount should be done voluntarily and is done at the discretion of the bank.

17. BaiBhithamanAjil (BBA) • BBA was introduced in Malaysia by Bank Islam Malaysia Bhd (BIMB) since13 May 1983. • Surah Al-Baqarah (282): "Wahai orang yang beriman, apabila kamu bermuamalah tidak secara tunai untuk tempoh yang tidak ditentukan, hendaklah kamu menulisnya." • Permissible to sell in deferred payment and give time for debtor to pay their debt. This is and alternative from conventional debt.

18. COURT DECISION • Malaysian court rules bai bithaman ajil valid-bank • Wed Apr 1, 2009 3:16pm IST • KUALA LUMPUR, April 1 (Reuters) - A Malaysian court has ruled that a bai bithaman ajil contract involving Bank Islam is valid, the bank said on Wednesday. • "The court of appeal also reiterated that a bai bithaman ajil contract is a sale transaction and therefore must not be compared to a loan transaction," Bank Islam said in a statement.

19. BBA house financing v.s. conventional house financing • Conventional housing loan – • -on the basis of debtor/creditor relationship. -The amount of loan is being charged interest & quoted at a certain percentage above the base lending rate (BLR) over the loan period, repayable in periodic installment. • -The BLR will fluctuate up or down and it will affect the total loan cost. • -Simultaneously, arrears in conventional loans are normally capitalized.

20. BBA house financing v.s. conventional house financing • BBA contract – • -a seller-buyer relationship will be established. • -the selling price is fixed upfront. • -The sales price is then repaid in periodic installments and the agreed installments will remain fixed throughout the financing period. • - customer’s interest rate risk is eliminated and arrears will not be capitalized.