Checklist Description
This checklist describes murabahah sale instruments, where a buyer purchases items at an agreed profit margin, avoiding riba.
Definition
Murabahah is a transaction in which a buyer purchases items at a profit margin agreed by both parties. The profit made by the seller is not regarded as a reward for the use of his or her capital, since it is not permissible to rent out money in Islam, but is instead seen as a profit on the sale of goods.
It is important to note that the profit in murabahah can be determined by mutual consent either in terms of a lump sum or through an agreed ratio of profit, which will be charged above the cost of the item.
All the expenses incurred by the seller in acquiring the commodity, such as freight, customs duties, and other costs, may be included in the cost price, and the markup can be applied to the aggregate cost.
Murabahah is valid only when it is possible to determine the exact cost of a commodity. If the exact cost cannot be ascertained, the commodity cannot be sold on a murabahah basis. In such an eventuality, the commodity must be sold on the basis of musawamah (bargaining), i.e. without any reference to the cost or to the profit/markup ratio. The price of the commodity in such cases shall be determined in lump sum by mutual consent.
In modern Islamic financial practice, murabahah has become an established mode of asset financing with an agreed and known markup. Being the most prevalent financing mechanism in Islamic finance, the murabahah sale instrument has provided a shariah-compliant alternative to interest-based financing mechanisms. The murabahah contract has also been applied for deposit-taking and issuance of sukuk.
Murabahah can be applied to large-scale projects. For example, it may be used to fund a plantation, whereby participants purchase seedlings and fertilizers and then sell these seedlings and fertilizers to the plantation operator at an agreed markup.
It can also be used to facilitate liquidity management, risk management in the Islamic financial market, and Islamic financial product offerings. For example, an Islamic bank can buy a commodity from the commodity market at the spot price and sell it to a corporate client on a deferred basis. This client can then sell the commodity back to the commodity market at the spot price for cash, returning to the bank the original sum plus an agreed markup.
Advantages
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Murabahah is not an interest-bearing loan, which is considered riba (excess). Murabahah is an acceptable form of credit sale under shariah. The agreement is similar in structure to a rent-to-own arrangement, with the intermediary retaining ownership of the property until the loan is paid in full.
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Because the Islamic bank that arranges a murabahah transaction does so as a partner, it is, in theory, concerned to ensure that the person who receives the money to make purchases is able to repay it. This should ensure that it behaves more cautiously than Western institutions, providing greater financial stability.
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Muslims can take advantage of the interest-free loans available from Western institutions if the seller decides not to charge a markup.
Disadvantages
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Murabahah is not applicable in all cases. For example, it cannot be used when the price of the good cannot be determined.
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The agreed markup is not subject to inflation or fluctuations in the currency.
Action Checklist
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Determine the markup, in the form of an absolute amount or a certain percentage of acquisition cost, and make sure that it is specified before the conclusion of the murabahah contract.
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Determine the benchmark to be used to find the agreed markup. Any mutually agreed benchmark, including but not limited to conventional financial benchmarks such as the base lending rate, may be used to determine the markup in the murabahah contract.
Dos and Don’ts
Do
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Ensure that you understand the full acquisition cost, which may include direct expenses (costs incurred to enable the acquisition of goods) such as storage and delivery.
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Ensure that indirect expenses, such as staff wages and labor charges that are not part of the cost of acquisition, are not included in the acquisition cost. They are not allowed to be included.
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Note that in the contract, the asset transfer date and the title transfer date may not coincide.
Don’t
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Don’t forget that whenever a purchase order involves a transaction requiring the issuance of a letter of credit, the commission for issuing the letter is not part of the acquisition cost.
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Don’t forget that any additional direct expenses not specified in the agreement relating to a murabahah contract and incurred after the conclusion of the contract shall be borne by the customer, provided that a clause to that effect is already incorporated in the contract.
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