Lecture 5 MURABAHAH 1

Overview 2 What is Murabahah? Rules of Murabahah How Does Murabahah Work? Security and Guarantee Difference between Murabahah and Short Term Loan?

What is Murabahah? Most of the IB and IFI are using murabahah as an Islamic modes of financing, and most of their financing operations are based on murabahah. Murabahah is in fact a term of Islamic Jurisprudence and it refers to a particular kind of sale commodity. 3

What is Murabahah? The basic ingredient of murabahah is that the seller discloses the actual cost he has incurred in acquiring good, and then adds some profit thereon. The only feature distinguishing it from other kinds of sale is that the seller in murabahah expressly tells the purchaser how much cost he has incurred and how much profit he had added to a commodity.(Cost Plus Concept) 4

Rules of Murabahah The subject of the sale must be in the ownership of the seller at the time of sale (what is not owned by seller cannot be sold). The Sale must be instant and absolute and unconditional (a sale is contingent on a future event is not valid). The subject of a sale must have a property value. The Subject of sale must be specifically known and identified for the buyer. 5

Rules of Murabahah Certainty of the price is necessary condition for the validity of a sale. The delivery of the sold commodity to the buyer must be certain and should not depend on a contingency or chance (stolen car cannot be sold). 6

How does Murabahah work? 7 SELLER Islamic Banking Buyer 1.Purchase of GOOD. 3. Sale of GOOD. 2.$$$ at spot 4.$$$ at deferred

Purchase Order of Murabahah It is the situation where a customer ask the IB to purchase an asset and then sell it to him on the Murabahah basis. 8 Customer Promises the IB to buy an asset Bank Buys and Owns the Asset Customer is obligated to fulfill his promise

Security and Guarantee Another issue regarding murabahah financing is that murabahah price is payable at a later date. The seller naturally want to make sure that the price will be paid at the due date against misconduct and deception. It’s permissible to ask for a guarantee or collateral in Murabahah: Purchased Asset Any other property Personal Guarantee Third Party Guarantee(no fee for the guarantor) 9

Murabahah vs Short Term Loan 10 Murabahah: -Sale of Tangible Asset -Profit Margin (Cost Plus Mark Up) -No penalty acceptable for delay in payments. -Commodity has got intrinsic value and quality in condition. Short Term Loan: -Advance Money (money is treated as commodity) -Interest Rate on Balance outstanding -Penalty Acceptable for delay in payments. -Money does not have any intrinsic value and quality in its condition, it is only medium of exchange.

Why Seller of commodity charges higher price in deferred payment? His shop is nearer to the buyer who does not want to go to the place which is far away. The seller is more trust worthy for the buyer than others, and the purchaser has more confidence in him and he will give him required thing without any defect. The seller gives the buyer priority in selling commodities having more demands. The atmosphere of the shop of the seller is cleaner and more comfortable than others. The seller is more courteous in his dealings than others. 11

Example: Purchase Order: Customer “A” ask IB to purchase special equipment from abroad. That equipment will be used for the company to produce special goods. IB bought that equipment for US dollars and incurred other expenses such as: transportation and import taxes. Transportation cost is 1500$ and import tax is 15% on the price imported good. And IB adds 2000$ of profit on incurred expenses and will be sold to a Customer “A”. Customer agrees to buy equipment on the basis of Murabahah. What is price of good that Customer buys from IB? What is import tax in terms of dollars paid by IB? And What is total cost of that equipment? Why Customer does not buy equipment himself from abroad? Give valid reasons? 12