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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 Microfinance
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
Training Workshop – Islamic Microfinance
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...
M. Khaleequzzaman IBF, IIUI
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
M. Khaleequzzaman IBF, IIUI
Process Flow:
– Negotiation/Approval of overall limit
– MOU/Master Murabahah Facility Agreement
– Requisition + Undertaking + Security Deposit (Hamish jiddiyah - Optional) + Invoice
2
Theory & Practice of Murabahah
MFI ClientMOU/Master MFA
Approval of Limit 1
Requisition, Undertaking, Sec. Dep. 2
M. Khaleequzzaman IBF, IIUI
– Third party appointed as agent [Optional] – – Clint can be appointed agent [case of dire need]– Payment to the Supplier – Direct
Theory & Practice of Murabahah
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
M. Khaleequzzaman IBF, IIUI
Invoice
Possession• Payment to supplier• Discount of supplier/benefit to client• Title of goods• Transfer of risk and responsibilites
Theory & Practice of Murabahah
MFIAgent
(3rd party)SupplierTitle Goods
Agent(Client)
Risks and Responsibilities
M. Khaleequzzaman IBF, IIUI
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
Theory & Practice of Murabahah
DP Note
M. Khaleequzzaman IBF, IIUI
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
Theory & Practice of Murabahah
M. Khaleequzzaman IBF, IIUI
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]:
Theory & Practice of Murabahah
M. Khaleequzzaman IBF, IIUI
Theory & Practice of Murabahah
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
M. Khaleequzzaman IBF, IIUI
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
M. Khaleequzzaman IBF, IIUI
Theory & Practice of Murabahah
Documentation:• Declaration• Securities as per security documents• Demand Promissory Note• Schedule of payment
M. Khaleequzzaman IBF, IIUI
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
M. Khaleequzzaman IBF, IIUI
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).
M. Khaleequzzaman IBF, IIUI
Theory & Practice of Murabahah Some Applicable Guidelines from AAOIFI:
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.
M. Khaleequzzaman IBF, IIUI
Theory & Practice of Murabahah Some Applicable Guidelines from AAOIFI:
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
M. Khaleequzzaman IBF, IIUI
Salam
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]
Islamic Modes – Agricultural Financing
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]
Islamic Modes – Agricultural Financing
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)
Islamic Modes – Agricultural Financing
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
Islamic Modes – Agricultural Financing
Islamic Modes – Agricultural Financing
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
Islamic Modes – Agricultural Financing
THANKS