Islamic Trade Finance Murabaha By Faraz Younus Bandukda Manager, Research and Product development Al Meezan Investment Management Limited

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 features of Murabaha from ordinary sale is -The seller discloses the cost to the buyer -A known profit is added Murabaha

Murabaha is simply a sale transaction This 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 plays two different roles in this transaction. One that of Bank’s agent and the other of purchaser. These roles should be clearly segregated to make the transaction halal. This process is explained in detail in next slides. Murabaha

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

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

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

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

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

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

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

Murabaha -Risks In a conventional transaction the bank takes risk on the client, however in a Murabaha transaction the Bank takes the following risks: 1. Asset Risk Since for a short period of time the risk of Asset is transferred to the bank. 2. 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.

 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 and penalty on early payments Prohibited by Meezan Bank’s Shariah Supervisory Board since it makes the Murabaha transaction similar to conventional debt. Default and late payment by client Additional amount cannot be charged to the client. The price has been fixed at the time of the contract Cumpulsory charity clause can be added in the payables contract but not in the sales contract 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 Can’t be done for services as ownership cannot be transferred Murabaha is a package of different contracts The sequence of their execution is extremely important to make the transaction halal. Murabaha Issues in Murabaha

In order to raise cash based funds, client usually sells the goods to some one else at a higher profit –Allowed only if the client’s core business is the same –Selling it back to Islamic Bank in any case is not allowed Mimicks the riba based transaction Murabaha Buy Back Transaction

Murabaha transaction is the simplest form 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 Conclusion

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: Murabaha Meezan Bank’s Experience Client Transaction Volume (Rs. in Millions)  ICI 270  PSO 200  PARCO100  Newage Cables75  Sitara Chemicals50