(sale on deferred payment basis) Rules of Bai Muajjal (sale on deferred payment basis)

Bai Muajjal 1.Bai Muajjal is valid if the payment date is agreed upon Payment date can be fixed by date (e.g. 1st November) time (e.g. 3 months) But it cannot be fixed to an event, the occurrence of which is uncertain The deferred price may be more than the fixed price But it must be fixed at the time of sale. Once the price is fixed it cannot be increased in case of late payment or decreased in case of earlier payment. In order to pressurize the buyer for timely payment the buyer may be asked to promise that in case of late payment he will donate a certain sum to charity In this case, the seller will receive the money from buyer and use it for charitable purpose

Bai Muajjal 3. If the sale is made on installments the seller may put a condition that in case of default in a single payment, the seller may ask for full repayment of balance installments 4. In order to secure the payment, the seller may ask the buyer to deposit a security as surety 5. The seller can also take a promissory note from the buyer, but this note cannot be traded at any value other than par

Murabaha

Murabaha Islam prohibits charging interest on money, but permits charging profit on sale of goods Therefore, a sale-based transaction (Murabaha) can be used instead of loan-based transactions for financing purchase of assets by clients, especially for working capital requirements Over 60% of all business volume of Islamic banks comprises of Murabaha transactions 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 feature of Murabaha from ordinary sale is - The seller discloses the cost to the buyer - And a known profit is added

Murabaha The profit may be added On a lump sum basis As a percentage of cost Payment of Murabaha price may be 1) At spot 2) In installments 3) In lump sum after a certain time Hence, Murabaha does not necessarily imply the concept of deferred payment

Murabaha Murabaha is simply a sale transaction Which is being used by Islamic Financial institutions as a mode of financing The validity of Murabaha financing transaction depends on whether conditions imposed by Shariah are being met Since Murabaha is a sale transaction Rules of Shariah regarding sale should be understood to judge if a Murabaha transaction is valid We will now have a look at rules of sale in Islamic Shariah

Murabaha Basic rules for MURABAHA financing 1. Asset to be sold must exist. 2. Sale price should be determined. 3. Sale must be unconditional. 4. Assets to be sold a) should not be used for un-Islamic purpose. b) should be in ownership of the seller at the time of sale. c) should be in physical or constructive possession of the seller BASIC RULES FOR MURABAHA Following are the rules governing a murabaha transaction: 1.The subject of sale must be existing at the time of the sale. Thus anything that may not be existing at the time of sale cannot be sold and makes the contract void. 2.The subject matter should be in ownership of the seller at the time of sale. If he sells something that he has not acquired himself then the sale becomes void. 3. The subject of sale must be in physical or constructive possession of the seller when he sells it to another person. Constructive possession means a situation where the possessor has not taken physical delivery of the commodity yet it has come into his control and all rights and liabilities of the commodity are passed on to him including the risk of its destruction.

Murabaha Option-1 Bank purchases goods from the vendor and sells them to the client on deferred payment basis. Delivery of goods to Client Payment to vendor Vendor Bank Client

Step by step Murabaha financing Option - 2 Step by step Murabaha financing 1. Client and bank sign an agreement to enter into Murabaha. Bank Client STEP BY STEP MURABAHA FINANCING 1.The client and the institution sign an overall agreement whereby the institution promises to sell and the client promises to buy the commodity from time to time on an agreed ratio of profit added to the cost. This agreement may specify the limit up-to which the facility may be availed. 2.An agency agreement is signed by both parties in which the institution appoints the client as his agent for purchasing the commodity on its behalf. 3.The client purchases the commodity on behalf of the institution and takes possession as the agent of the institution. 4.The client informs the institution that it has purchased the commodity and simultaneously makes an offer to purchase it from the institution. 5.The institution accepts the offer and the sale is concluded whereby ownership as well as risk is transferred to the client. All the above are necessary to effect a valid murabaha. If the institution purchases the commodity directly from the supplier it does not need any agency agreement. Note: The most essential element of the transaction is that the commodity must remain in the risk of the institution during the period between the third and the fifth stage. The above is the only way by which this transaction is distinguished from an ordinary interest-based transaction Agreement to Murabaha

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

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

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

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

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

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

Murabaha Issues in Murabaha 1. Securities against Murabaha/Guaranteeing the Murabaha Once the sales transaction is over, the Murabaha price is a debt payable by the client and can be secured like any other debt Hence, one can take a security or guarantee for Murabaha repayment 2. 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. Rebate on early payments and penalty on late payments These are normally prohibited by Shariah Board since they make the Murabaha transaction similar to conventional debt. ISSUES IN MURABAHA Following are some of the issues in murabaha financing: 1.Securities against Murabaha Payments coming from the sale are a receivable and for this the client may be asked to furnish a security. It can be in the form of a mortgage or hypothecation or some kind of lien or charge. 2.Guaranteeing the Murabaha The seller can ask the client to furnish a 3rd party guarantee. In case of default on payment the seller may have recourse to the guarantor who will be liable to pay the amount guaranteed to him. There are 2 issues relating to this: a)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 riba. b)However the guarantor can charge for any documentation expenses. 3.Penalty of default Another issue with murabaha is that if the client defaults in payment of the price at the due date, the price cannot be changed nor can penalty fees be charged.

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 Murabaha is a package of different contracts And the sequence of their execution is important BASIC MISTAKES IN MURABAHA FINANCING Some basic mistakes that can be made in practical implications of the concept are as follows: 1.The most common mistake is to assume that Murabaha 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 murabaha cannot be used. 2.The document is signed for obtaining funds for a specific commodity and therefore it is important to study the subject matter of the murabaha. 3.In some cases sale of commodity to the client is effected before the commodity is acquired from the supplier. This occurs when the various stages of the Murabaha are skipped and the documents are signed all together. It is to be remembered that Murabaha is a package of different contracts and they come into play one after another at their respective stages. 4.It is observed in some financial institutions that Murabaha is applied on already purchased commodities, which is not allowed in Shariah and can be effected on not yet purchased commodities.