Islamic Modes: Murabaha and Salam– Islamic Microfinance Workshop CIBE Training Program Muhammad...

Islamic Modes:Murabaha and Salam–

Islamic Microfinance Workshop

CIBE Training ProgramMuhammad Khaleequzzaman

Head Islamic MFIing & Finance IIU Islamabad

Training Workshop – Islamic Microfinance

ISLAMIC MODES/INSTRUMENTS:– Sale Contracts:

• Murabaha/Murabahah to the Purchase Orderer• Salam/Parallel Salam• Istisna’/Parallel istisna

– Participatory Modes:• Mudarabah/Resource Mobilization• Musharakah/Diminishing Musharakah

– Rent based Modes:• Operating ijarah• Ijarah wa iqtina’

Sale Defined:Exchange of a thing of value with another thing of value with mutual consent OR the sale of a commodity in exchange of cash.

Elements of a valid sale:• Contract ( Aqd )• Subject matter ( Mabe’e)• Price ( Thaman )• Possession or delivery ( Qabza )


Training Workshop – Islamic MicrofinanceRules of Sale: [Sale Defined and Elements of Sale]1. Subject must exist at the time of sale

2. Subject must be in the ownership of seller – Physical or constructive

3. Sale must be instant and absolute

[exception of above rules in Salam and Istisna’]

4. Subject should be halal

5. Subject must be known and identified

6. Sale must be unconditional

7. Delivery of sold item must be certain

8. Price of subject must be certain

Risks and responsibilities attached with the subject must transfer from seller to the purchaser as a result of sale


Types of Islamic Sale• Bai muajjal• Murabaha• Musawama• Salam• Istisna

Murabaha:Uses of Murabaha• Sale of raw material• Sale of cart• Sale of equipment • Sale of agricultural inputs• Sale of consumer goods • House material financing

Outline:

1. Murabahah – Brief Historical Perspective

2. MFIing Murabahah/Murabahah to the Purchase Orderer

3. Procedural details of Murabahah as practiced by Islamic MFIs

4. Issues in Murabahah

5. Documentation

Theory & Practice of Murabahah

M. Khaleequzzaman IBF, IIUI

Theory & Practice of MurabahahMurabahah – Concept and Shariah Legitimacy

Murabahah defined:• Selling a commodity as per cost with a defined and agreed

margin of profit (Ribh) • Profit may be a percentage of the selling price or a lump sum.• The transaction may be concluded with or without any promise

to purchase by the client: Ordinary Murabahah / MFIing Murabahah or Murabahah to the Purchase Orderer.

Shariah Legitimacy of Murabahah:• Qura’an: “It is no crime for you to seek the bounty of your

Lord” [Surah Ale Imran: 198]

“ Allah has permitted trading and forbidden Riba ” [Surah Al-Baqarah: 275]

• Sunnah: The Prophet (PBUH) purchased a she camel from Abu Bakr (RAA) for use as transportation from Medinah...


Theory & Practice of MurabahahMurabahah – Historical perspective• Introduced as new form of sale in second half of First

Hijrah century as a sale with necessary condition of declaring cost by the seller and agreeing on profit margin by both the seller and the purchaser [Al- Muwatta, Imam Malik]

• Modifications were made by Imam Shafii’, including an order of the purchaser, who could subsequently exercise the option not to purchase the same, and also included credit transaction

• He clearly bifurcated two sales’ transactions


Process Flow:

– Negotiation/Approval of overall limit

– MOU/Master Murabahah Facility Agreement

– Requisition + Undertaking + Security Deposit (Hamish jiddiyah - Optional) + Invoice

2


MFI ClientMOU/Master MFA

Approval of Limit 1

Requisition, Undertaking, Sec. Dep. 2


– Third party appointed as agent [Optional] – – Clint can be appointed agent [case of dire need]– Payment to the Supplier – Direct


Client

MFI

Supplier3

2Agency Agreement

Payment Supplier

Agent (3rd Party)

MFI

Supplier2

1Agency Agreement

Payment

Agent (Client)

Receipt of Payment

3

Payment in Supplier’s Name 2 A


Invoice

Possession• Payment to supplier• Discount of supplier/benefit to client• Title of goods• Transfer of risk and responsibilites


MFIAgent

(3rd party)SupplierTitle Goods

Agent(Client)

Risks and Responsibilities


Conclusion of Murabahah

Client Acceptance of Offer

1

2

3

Offer to Purchase

Receipt , Possession Report

Payment of Murabahah Price

Murabahah Terminates

1

MFI Client Murabahah Price

2

MFI

Sec. Deposit/Hamish jiddiyah

Personal/group sec. 4

3


DP Note


Purchase of poultry feed stock

• Murabahah transaction: Rs. 30,000• Murabahah Facility: 90 Days• Payment: Each month• Rate of Profit: 15% p.a.• Freight: 5% of cost of

goods • Security: Personal/group

guarantee



Particulars Amount (Rs.)

Cost of goods Rs. 30,000

Rate of Profit 15% p.a.

Freight/Insurance 5% of cost

Total cost 30000 x 5% 30000 + 1500 =31500

Profit 31500 x 15% x 90/365 = 1165

Murabahah Price 31500+1165 = 32665

Installment 31500/3+1165/3 = 10888

Pricing of Murabahah [Example]:




Issues in Murabahah:• Unilateral promise/undertaking• Invoice in the name of MFI• Prior contractual relationship (customer and supplier)• Vendor being third party/blood relation/wholly owned

institution of customer [Buy back (Inah)]• Commitment or credit facility fee• Documentation charges• Hamish Jiddiyah/treatment/timing• Timing of promissory note• Rollover/Default in payment of price• Rebate on early payment


Theory & Practice of MurabahahDocumentation:• Murabahah Agreement and Allied Documents:

– Parties to the Murabahah– Subject matter– Cost price– Profit Margin– Value Date – Disbursement date of Cost Price– Contract price – Default clause/penalty– Right of set off i.r.o client’s credit balance

• Agency agreement as separate contract • Purchase Requisition• Invoice• Receipt of payment to the supplier



Documentation:• Declaration• Securities as per security documents• Demand Promissory Note• Schedule of payment


Theory & Practice of MurabahahRisks in Murabahah:Risks Mitigants

Customer refuses to purchase while holding as agent

Promise, HJ,

Customer already purchased from supplier/wants liquidity/Inah

Direct payment to supplier, date of invoice to be after date of agency agreement, obtain other documents – gate pass, truck receipts, physical inspection, etc.

Overdue installments Penalty to go to charity

Default risk Collateral/securities

Market (price) risk Immediately supply the item


Theory & Practice of Murabahah Some Applicable Guidelines from AAOIFI:

A. Measurement of asset value• At acquisition – Measured and recorded at

historical cost. • After acquisition –

– Asset available for sale to client shall be measured at historical cost

– In case of default in payment of Murabahah price, the asset shall be measured at cash equivalent value (ie. Net realizable value).

– A provision to be created for decline in the asset value (ie. Difference between acquisition cost and the cash equivalent value).



B. Potential discount after acquisition • The discount shall not be considered as revenue• However it should reduce the cost of goods.

C. Profit recognition • Profit shall be recognized at the time of executing

contract if the term does not exceed the current financial period.

• Profits of credit sale whose payment is due after the current financial period shall be recognized as per following:– Proportionate allocation of profits

– Profit may also be recognized as and when received.



D. Failure to fulfill promise having paid Hamish Jiddiyah

• Hamish Jiddiyah to be treated as liability on Islamic MFI.

• Treatment: – The amount of actual loss to be deducted from

Hamish Jiddiyah

E. Penalty – Deposited in Charitable A/C on realization


Islamic Modes – Agricultural Financing

Salam: Defined

A salam transaction is the purchase of a commodity for deferred delivery in exchange for immediate payment. It is a type of sale in which the price, known as the salam capital, is paid at the time of contracting while the delivery of the item to be sold known as subject matter of salam (al Muslam fihi) is deferred. Salam is also known as Salaf (lit: borrowing)

Salam: Purposes– Liquidity needs of farm production– Working capital/Running Finance– Project finance (partial requirements)

Salam: Shariah Legitimacy Allh says “O ye who believe when you deal with

each other, in transactions involving future obligations in a fixed period time, reduce them to writing” [Al Baqara Verse 282]

Ibn Abbas reported, the Prophet (PBUH) came to Medina and found that people were selling dates for deferred delivery (salam) after a duration of one or two years. The Prophet (PBUH) said: “whoever pays for dates on a deferred delivery basis (salam) should do so on the basis of specified scale and weight” [Bukhari and Muslim]


Wisdom of allowing Salam Farmers, orchard owners, merchants can fulfill

their working capital and liquidity needs before the commodity is ready to be sold

Three major problems and solutions1. Risk of default by seller [personal/group

guarantee/ hypothecation]

2. MFI’s need to liquidate goods after delivery [parallel salam]

3. Seller’s inabillity to produce or procure commodity [receive back the same price]


Salam:• An exception to the possession

• A purchase contract opposite to Murabahah

• Benefits both the seller and purchaser

• Payment of full price at spot - otherwise selling debt for debt

• Allowed in commodities satisfying condition of Dhawatul Amthal - quality and quantity can be specified exactly

• Product of a particular field or farm cannot be sold

• Quality and quantity decided in un ambiguous terms

• Quantity should be agreed in specific terms (by weight, volume or measure)


Salam:

• Certain date and place of delivery

• The commodity should remain in the market throughout the period of contract [Different opinions]

• The time of delivery should be sufficient to allow use of salam capital conveniently and effect prices, preferably be at least 15-30 days from the date of contract [Different opinions]

• A security/guarantee or is preferred as safeguard to the risk of default

• Only commodity is delivered and not the money



Salam: Alternatives Available to MFIs of Taking Delivery of Commodity:

1. By establishing a subsidiary2. By appointing the third party or client

its agent to sell the commodityi. The agency agreement should be

separate from the salam agreementii. If agent has been able to sell the

commodity at a price more than the one agreed in agency agreement, agent gets the difference

3. By opting for Parallel Salam or Third party sales

Payment of Salam Price 1-1-07

Sale Proceeds

MFI Farmer

Delivery of Wheat 30-6-07

Salam Transaction Agent

Third PartyPurchaser

Salam Contract Wheat 2000 kg.Signed 1-1-07 Delivery 30-6-07

Sale of Wheat

Sale Proceeds less Commission

1

3A

3

2

3B

3C

Sale Proceeds

Client Delivery of Commodity20 Dec 06

PurchaserMFI

Third Party2nd Salam15 June 06

Delivery of Commodity20 Dec 2006

Parallel Salam

1

2

5

Salam Price Payment 1 June 06

2nd S

alam

Co

ntr

act

Pay

men

t o

f P

ric

e

Farmer Delivery of Commodity

30-6-07

Purchaser/SellerMFI

Third Party2nd Salam

15-1-07

Delivery of Commodity

5-7-07

Salam Sale Contract 1-1-07, Wheat 2000kg. 1

2

5

3 4

Salam Price Payment 1-1-07

2nd S

alam

Co

ntr

act

Pay

men

t o

f P

ric

e15

-1-0

7

6

Farmer Delivery of Commodity

30-6-07

PurchaserSellerMFI

Third PartyPromise and

Payment

Delivery of Commodity

5-7-07

Third PartyPromise

Salam Sale Contract 1-1-071

2

5

3

4

6

Salam Price Payment 1-1-07

Pa

ys

5

-7-0

7

Pro

mis

e to

Pu

rch

ase

15

-1-0

7

Rules of Parallel Salam and Third party promise

•Both the contracts viz. salam and parallel salam must be independent of each other

•Parallel salam is allowed only with third parties. Therefore the original seller cannot be entered

into the parallel salam

•The third party giving unilateral promise should not pay the price as this is not allowed in

Shariah

Examples of Products


THANKS

Islamic Modes: Murabaha and Salam– Islamic Microfinance Workshop CIBE Training Program Muhammad...

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