Murabaha to the Purchase Orderer PRESENTED BY MOHAMMAD

Murabaha to the Purchase Orderer. PRESENTED BY MOHAMMAD MOHSIN AHMED at Al. Huda CIBE Workshop at Avari Hotel – Karachi 1

MURABAHA l. Murabaha is a particular kind of sale where the seller discloses its cost and profit charged thereon. l The price in this sale can be both on spot and deferred. 2

BANKING MURABAHA l. The product of Murabaha that is being used in Islamic banking as a mode of finance is something different from the Murabaha used in normal trade. l This transaction is concluded with a prior promise to buy, submitted by a person interested in acquiring goods through the institution. 3

BANKING MURABAHA l It is called Murabaha to the purchase orderer. l It is a bunch of contracts completed in steps and ultimately suffices the financial needs of the client. l The sequence of their execution is extremely important to make the transaction Shariah compliant. 4

BANKING MURABAHA It is a contract wherein the institution, upon request by the customer, purchases a asset from the third party usually a supplier/vendor and resells the same to the customer either against immediate payment or on a deferred payment basis. 5

SCOPE OF MURABAHA l. As it is a kind of sale, there must be a seller and buyer and some thing that is bought and sold. The institution is the seller and the client is buyer. l. It cannot be used as a substitute for running finance facility , which provides cash for fulfilling various needs of the client. 6

SCOPE OF MURABAHA l. It is a fixed price sale and normally is done for short term. l. The transaction can be used in order to meet the working capital requirements however it cannot be used to meet liquidity requirements. 7

STAGES OF MURABAHA l 1. Promise Stage l 2. Agency Stage l 3. Acquiring Possession l 4. Execution of Murabaha l 5. After Execution of Murabaha 8

STAGES OF MURABAHA PRIOMISE STAGE 9

CREDIT APPROVAL (under Shariah perspective) Points to Be Considered While Approving Credit l. It is essential that the transaction between two parties must be genuine , not fictitious and should exclude any prior contractual relationship between the customer and original supplier. l. It is not permissible to transfer a contract that has been executed before between client and supplier. However revocation of prior contract between the supplier and the client can allow the institution to enter in Murabaha 10

CREDIT APPROVAL (under Shariah perspective) Points to Be Considered While Approving Credit l. The Institution must insure that the party from whom the item is bought is a third party and not the customer or his agent. In this manner the transaction can be saved from Bai Inah (Buy Back) which is not allowed in sharia. 11

CREDIT APPROVAL (under Shariah perspective) l Nature of the Business to be in scope of the Murabaha. Nature of business should be Halal in order to finance it through Murabaha. l Differed payment not permissible in case of Gold, Silver and Currencies. l Cyclical nature of the business 12

CREDIT APPROVAL (under Shariah perspective) SPECIFIED Commodities study in respect of – Uniqueness – Pricing – Active Market – Risk Profile – Cash Flow Analysis Commitment Fee not permissible. After these consideration limit may be approved 13

CONTINUED l The Client orders the institution to buy certain goods for him and sell him the same after acquiring. The prerequisite is that the goods are not already owned by the client. l. At this stage the customer promises the institution to buy the goods which were acquired by the institute on his request. 14

CONTINUED If the supplier is nominated by the client himself, guarantee for good performance can be demanded. l An advance payment (called Hamish jiddiyyah) may be received from the customer as a form of security deposit. l In case of breach of promise Hamish Jiddiyyah can be used to recover actual damage however it cannot be used for covering the Cost of Funds / Opportunity Cost. l 15

STAGES OF MURABAHA AGENCY STAGE 16

AGENCY STAGE l Agency Agreement is not the condition of the Murabaha if the institution can make direct purchases from the supplier. l The financial institution, does not have the expertise to identify the goods and negotiate an efficient price. l The customer, however, being in the industry, can do this. l The institution therefore appoints him as its Agent (which is also permissible), in the first step of the transaction, to identify and procure the goods on institution behalf. 17

AGENCY STAGE l. This is done by execution of Agency Agreement between the institution and the customer. l. However according to Sharia Perspective it is preferable to appoint the Agent other then customer. l. If goods are acquired from third party the execution of agency agreement will be between the institution & the third party. 18

AGENCY STAGE TYPES OF AGENCY AGREEMENT 1. GLOBAL AGENCY AGREEMENT When the purchase of commodity is not of consistent nature. 2. SPECIFIC AGENCY AGREEMENT When the purchase of commodity is of consistent nature. 19

STAGES OF MURABAHA ACQUIRING POSSESION 20

ACQUIRING POSSESION l. Advance payment can be made to the supplier. l. Discount On Acquisition Of Assets Discounts from supplier (If any) would be passed on to the customer at the time of Murabaha Sale by reducing the cost of sales. 21

ACQUIRING POSSESION l. If there is a rise in prices and the amount escalates for which financing is availed than the transaction can only be executed if the bank has been informed and the bank subsequently accepts the same. l. The institution reserves the right to reject the purchases if made other then agreed price. 22

ACQUIRING POSSESION l. Change of commodity in the agency agreement can be done with mutual consent. l. Delay in Supply from the Supplier. Delay in Supply from the supplier in case where specific time was allowed leads to the revocation of agency agreement. In such cases the customer will refund the cost of goods. 23

ACQUIRING POSSESION Rejection On Ground Of Quality If the customer rejects the goods on ground of inferior quality before the execution of Murabaha, new quality can be acquired through new Murabaha. After execution of Murabaha the bank will not be liable for any discrepancies. 24

ACQUIRING POSSESION l l Acquisition Of Title & Possession Of The Asset 1. Institution must take actual or constructive possession of the item. l The forms of taking delivery or possession of items differ according to their nature and customs. l The item must move from the responsibility of the supplier to the responsibility of the institution. l It is obligatory that the point when the risk of the item is passed on by the institution to the customer, be clearly identified. 25

ACQUIRING POSSESION 2. Goods must exists at the time of execution of Murabaha. l If the above two are not fulfilled than the institution cannot execute Murabaha. l Documentary evidence required at the time of possession before execution of Murabaha i. e delivery challan, gate passes and sales tax invoices. l Murabaha payment to be made directly to the supplier by the bank. 26

ACQUIRING POSSESION l. Importance of Physical Inspection l. Registration is in the name of institution for those items where registration is required. 27

STAGES OF MURABAHA EXECUTION OF MURABAHA 28

EXECUTION OF MURABAHA l Customer, as an Agent, confirms that goods have been purchased & same are in his possession and that payment has been made to the supplier. l Customer makes an offer to purchase the goods from the institution. l Institution accepts the offer by stating the Cost price plus amount of Profit and the due date for Payment by which sale is concluded. l At this stage relation of a buyer & seller comes into operation between the institution & the client, & since the sale is effected on deferred payment basis, the relation of debtor and creditor also emerges between them simultaneously. 29

EXECUTION OF MURABAHA l Customer having received delivery of Goods as per Purchase Requisition confirms that goods have been examined and are satisfactory in respect of quality and suitability for his use. l The customer also releases the institution from any liability in respect of the goods in any manner 30

AFTER EXECUTION OF MURABAHA Securities Against Murabaha Price l The institution may ask the customer to furnish a security to its satisfaction for prompt payment of the deferred price. l However, it is also permissible that the customer furnishes a security at earlier stages but after the Murabaha price is determined. l It is also permissible that the sole commodity itself is given to the seller as a security. l It is preferable not to take Interest bearing instruments as securities. 31

AFTER EXECUTION OF MURABAHA CASE OF DEFAULT l In the case of default by the buyer in the payment of price at the due date, the price cannot be increased. l However if he has undertaken, in the agreement to pay certain amount for a charitable purpose, he shall be liable to pay the amount undertaken by him. l But this recovered amount from the buyer will not be considered penalty nor compensation, therefore it will not account to institutions income. l Institution is bound to spend it for a charitable purpose on behalf of the buyer. 32

ISSUES IN MURABAHA Rebate in Early Payment l. If the customer makes early payment and there is no commitment from the institution in respect of any discount in the price of Murabaha, than the institution has the sole discretion in allowing them the rebate. Rollover in Murabaha l. Rescheduling is allowed but repricing is not allowed. l. Rollover is also not allowed. 33

ISSUES IN MURABAHA Buy Back Ø Under Murabaha Financing once the goods purchased by the client from the Bank the same goods cannot be Pledged/ Hypothecated for raising finance facility from the Islamic Bank. Rebate on Early Payments l It is prohibited by Shariah Standards to give Rebate to the client on early payment as under Murabaha the price is fixed. 34

Murabaha Step by step Murabaha financing 1. Client and bank sign an agreement to enter into Murabaha. Islamic Bank Agreement to Murabaha Client 35

Murabaha Step by step Murabaha financing 2. Client appointed as agent to purchase goods on bank’s behalf Bank Agreement to Murabaha Agency Client Agreement 36

Murabaha Step by step Murabaha financing 3. Bank gives money to client for purchase of goods. Islamic Bank Client Agreement to Murabaha Agency Agreement Disbursement to the client 37

Murabaha GENERAL MECHANICS VENDOR ISLAMIC BANK Agreement CUSTOMER • The customer approaches the Bank with the request for financing The Bank purchases and receives title of ownership from the vendor The Bank makes payment to the vendor The Bank transfers the title over to the customer upon payment The customer makes payment up-front or on a deferred basis 38

Risk Management IN MURABAHA 39

Risk Dimensions Banking Risks Credit Liquidity Credit Interest Rate Market Islamic Banks also face -Additional asset risk Foreign Exchange -Greater fiduciary risks -Greater legal risk Solvency Operational 40

Legal and Shari’a Risks l Legal and Shari’a compliance risk – Completeness of Legal documentation for various contracts – Adherence to AAOIFI Shari’s standards – Role of Shari’a supervisory boards/ advisers in mitigating Shari’a risk l Live cases – Mistiming in signing of Commodity Murabaha contracts can lead to lost income 41

RISK IN Murabaha l Title to assets transferred to the customer at the time of purchase l Usually the customer then provides same or other assets as collateral. l Role of purchasing department is essential while customer is taking from various institutions banking murabaha facility. 42

END OF PRESENTATION JAZAKAMUALLAH 43