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7/29/2019 Profit From Trading Activities - Shari'ah Law Perspective
1/23
PROFIT FROM TRADING ACTIVITIES:
SHARIAH LAW PERSPECTIVE
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1. Introduction: [572]
This Quranic versestates that Allah has made sale permissible and usury forbidden (275:2)
Islam postulates a unique nexus of contracts among the Creator, man and society on the basis of
the Divine Law that directly affects the workings of the various social, political, economic, and
financial systems. Therefore, to understand the way in which economic affairs are to be
organized in an Islamic system, it is first necessary to comprehend the nature of this relationship.
What differentiates Islam from other systems of thought is its unitary perspective, which refuses
to distinguish between the sacred and the profane and which insists that all of its elements must
constitute an organic whole. Consequently, one cannot study a particular aspect or part of an
Islamic systemits economic system, sayin isolation, without an understanding of the
conceptual framework that gives rise to that part or aspect, any more than one can study a part of
a circle without conceptualizing the circle itself.
The meta-framework for Islam specifies the rules of behavior within the context of its
fundamental principles. The core and fundamental axioms of Islamic ideology are the belief in
(1) the Unity and Oneness of the Creator (tawheed), (2) the prophethood (Nubuwwa), and (3)
the ultimate return of everything to the Creator ftr the final accountability and judgment
(Maaad).
The first and most important of these principles is the Oneness and Uniqueness of the Creator, a
corollary of which is the unity of the creation, particularly the unity of mankind. The axiom of
Unity and Oneness of the Creator requires the belief that all creation has one omniscient and
omnipresent CreatorAllah (swt)who has placed humans on this earth to pursue their own
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felicity and perfection. Further, it requires that the orbit of mans life is seen to be much longer,
broader and deeper than the material dimension of life in this world.
In a series of verses, the Quran exhorts people to take collective and unified social action to
protect the collectivity from all elements of disunity. These and many other verses order human
beings to work hard toward social unity and cohesion in constructing their societies, and
preserve and defend that unity. Unity and social cohesion are so central among the Divine
objectives set out for mankind in the Quran that it can be argued that all conduct prohibited by
Islam is that which ultimately leads to disunity and social disintegration. Conversely, all
righteous conduct prescribed by Islam is that which leads to social integration, cohesiveness and
unity. As a result, Islam is a call both to the individual and to the collective and has given the
latter an independent personality and identity, which will be judged on its own merits or
demerits separately from the individuals that constitute the collectivity. The final judgment on
individual actions will have two dimensions: one as the individual and the other as a member of
the collectivity (Iqbal & Mirakhor, 2011).
A central aim of Islam is to establish a just and moral social order through human agency. This
all-embracing desideratum of the Islamic system is the ruling principle from which human
thought and behavior, the substantive and regulative rules of the Shariah, the formation of the
community and the behavior of polity and of political authority derive their meaning and
legitimacy. It is this emphasis on justice that distinguishes the Islamic system from all other
systems. It is via the concept of justice that the raison detre of the rules governing the economic
behavior of the individual and economic institutions in Islam can be understood. What gives the
behavior of a believer its orientation, meaning, and effectiveness is acting with the knowledge
that justice evokes Allahs (swt) pleasure; and injustice, His displeasure. Whereas justice in
Western thought is a quality of the behavior of one individual in relation to another and his
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actions can be perceived as unjust only in relation to the other, in Islam it has implications and
consequences for the first individual as well. That is, even when one does injustice to someone
else, there is always reciprocity, in that through injustice to others, ultimately, one also does
injustice to oneself and receives its results both here and in the hereafter.
Since this paper is about Islamic finance, or to be more precise Sale, a digression on the relevant
basic principles may be helpful. Islams unconditional prohibition of riba changes the landscape
of a financial system. This prohibition implies the prohibition of pure debt security and
ultimately of leverage through debt. It is important to note that debts based on a predetermined
rate tied to the principal are prohibited. Other modes of financing based on the principle of the
sharing of risk and reward are recommended. The elimination of interest and the promotion of
risk-sharing modes of financing are the rationale behind Islamic finance practiced today. While
acknowledging the expressions of skepticism, and even cynicism, regarding the present practices
of Islamic finance, it appears that there is a consensus among an overwhelming majority of
scholars on two fundamental propositions: (j) interest is riba, and (ii) risk-and-reward sharing is
an Islamic alternative to a system based on interest-rate debt. The notion of having a system that
operated without interest and debt came under immediate challenge, with analysts suggesting the
folly of adopting such a system. The prohibition of interest would, they argued, result in infinite
demand for loanable funds and zero supply. A zero-interest system would be incapable of
equilibrating demand for and supply of loanable funds. Such a system would mean that there
would be no savings and, thus, no investment and no growth. There could be no monetary
policy, they said, since no instruments of liquidity management could exist without a fixed,
predetermined rate of interest. Any country adopting such a system could almost guarantee that
there would be a one-way capital flight.
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By 1988, this challenge was met when academic research, using modern analytical financial and
economic theory, showed that:
A modem financial system can be designed without the need for an ex-ante, determined,positive, nominal fixed-interest rate. Indeed, it was shown that there was no satisfactory
explanation for the existence of such a rate.
Moreover, it was shown that not having such an interest rate (that is, the absence of adebt contract) did not necessarily mean that there would be zero return on capital.
The basic proposition of Islamic finance was that the return on capital would bedetermined ex post, and that the magnitude of that return was determined on the basis of
the return to the economic activity in which the funds were employed.
It was the expected return that determined investment. It was also the expected rate of return, and income, which determined savings. Therefore,
there was no justification for assuming that in such a system there would be no savings
and investment.
It was shown that in such a system there would be positive growth. Monetary policy in such a system would function as in the conventional system, its
efficacy depending on the availability of instruments designed to manage liquidity.
Finally, it was shown that, in an open-economy macroeconomic model without an ex-ante fixed-interest rate, but with returns to investment determined ex post, there was no
justification to assume that there would be a one-way capital flight.
Therefore, the system which prohibited a fixed ex-ante interest rate and allowed the rate of
return on capital to be determined ex post, based on the returns to the economic activity in which
the funds were employed, was theoretically viable.
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In demonstrating the analytical viability of such a system, the research also clearly differentiated
it from the conventional system in which, based on debt contracts, risks and rewards were shared
asymmetrically, with the debtor carrying the greatest part of the risk, and with governments
enforcing the contract. Such a system had a built-in incentive structure that promoted a moral
hazard and asymmetric information and thus required close monitoring. The costs could be
managed if monitoring could be delegated to an institution that could act on behalf of the
collectivity of depositors/investors; hence the existence of banking institutions (Iqbal &
Mirakhor, 2011).
During the 1950s-60s, Lloyd Metzler of the University of Chicago had proposed an alternative
system in which contracts were based on equity rather than debt, and in which there was no
guarantee of nominal values of liabilities since these were tied to the nominal values of assets.
Metzler showed that such a system did not have the instability characteristic of the conventional
banking system. In his now-classic article, Khan (1987)showed the affinity of Metzlers model
with Islamic finance. Using Metzlers basic model, Khan demonstrated that this system
produces a saddle point and is, therefore, more stable than the conventional system.
To understand the economic system of Islam, in which Islamic finance plays a major role, we
need to discuss some of its key characteristics. Before that, however, a general statement
regarding the Islamic economy is necessary. It can be stated categorically that Islam requires, as
one of its specific objectives, a healthy, dynamic, and growth-oriented economy, without which
the higher aims of Islam cannot be accomplished. A dynamic and growing economy is
considered healthy only when its rules, institutions, organizations and their operations, as well as
the behavior of the individual and the collectivity, are in conformity with the Shariah.
Iqbal and Mirakhor (2011) have defined the Islamic economic system as:
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A collection of institutions (that is, formal and informal rules of conduct and their enforcement
characteristics) designed by the Law-Giver (that is, Allah (swt) through the rules prescribed in
the Quran, operationalized by the sunnah of the Prophet (pbuh) and extended to new situations
by (ijtihad) to deal with allocation of scarce resources, production and the exchange of goods
and services and the distribution of the resulting income and wealth.
The following section will cover the part of the Islamic economic section of interest to this
paper, Islamic finance; followed by section 3, which contains the different types of contracts
available for use in an Islamic society.
2. Islamic FinanceThe first section of the paper have covered the Islamic economics as whole and declared it as
what could be the true savior for the entire world economic problems. So what difference does
Islamic finance bring to the table as a part of that system that the current conventional system
doesnt have? To answer this question, the simple example given by Ethica (2012) shall be
given to emphasize the difference.
Lets take $10,000, for instance. And let's compare what a conventional bank can do with this
$10,000 and what an Islamic bank can do.
The conventional bank looks for a credit worthy customer and lends at 5% interest. The bank is
not concerned about what happens to this money other than that it gets repaid. The customer, on
the other hand, has already found a borrower willing to pay 7%. This borrower runs a small
credit co-op for students and lends at 10%. One of these students is enterprising enough to lend
to his unemployed brother at 15%. Who has just discovered the power of compounding interest
and now lends to street vendors at 25%, and so on. There are poor people paying upwards of
40% per month! Now obviously the conventional banks are not to blame for everything that
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happens after theyve made the initial loan. But we can blame the power of compounded
interest.Interest, and the fact that you dont need actual cash to lend money means that the
original $10,000 could keep passing hands until we pump out over $100,000 of artificial wealth.
Artificial is right. How much actual cash is there? Only $10,000. With interest, we managed to
turn $10,000 into much more.
Now what happens if the street vendors go out of business? Or the unemployed brother doesnt
find his job? Or the credit co-op goes bankrupt? Loans dont get repaid. And if enough people
cant repay their loans, lenders get into all sorts of trouble. This vicious cycle sets off a domino
effect of defaults. Now what if instead of a $10,000 personal loan, it is a million dollar business
loan, or a billion dollar World Bank loan. Compounding interest grows so fast that borrowers are
often unable to repay. People, economies, and the environment pay the price as we grow more
desperate to meet rising debts.
AS for the Islamic bank, with this $10,000 the Islamic bank only invests in actual assets and
services. It might buy machinery, lease out a car, or invest in a small business. But, throughout,
the transaction is always tied to a real asset or service and this is the central point: ones cant
simply compound assets and services like the compound interest-based loans. An asset or
service can only have one buyer and one seller at any given time. Interest, on the other hand,
allows cash to circulate and grow into enormous sums.
Thats basically the difference between Islamic finance and conventional finance: the difference
between buying and selling something real and borrowing and lending something fleeting. Of
course, this is a simplified example but is enough to make the two systems distinguishable. But
to make it clear, the following is a list of the basic principles that Islamic finance is based on
(Iqbal & Mirakhor, 2011):
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Prohibition of interest: Prohibition of riba, a term literally meaning an excess andinterpreted as any unjustifiable increase of capital, whether in loans or sales, is the
central tenet of the system. More precisely, any positive, fixed, predetermined rate tied to
the maturity and the amount of principal (that is, guaranteed regardless of the
performance of the investment) is considered riba and is prohibited. The general
consensus among Islamic scholars is that riba covers not only usury but also the charging
of interest as widely practiced. A direct implication of the prohibition of interest is that
pure debt securities with predetermined interest rates are also prohibited.
riba is the most prominent widespread principle this might be because it the most
obvious and yet the simplest to explain among them. Aside from that, it is also one of
two principles that havebeen clearly mentioned in the Quran in the verse mentioned
right at the beginning of this paper. The other verse mentioned being sanctity of
contracts below.
This prohibition is based on arguments of social justice, equality, and property rights.
Islam encourages the earning of profits but forbids the charging of interest because
profits, determined ex-post, symbolize successful entrepreneurship and the creation of
additional wealth. By contrast, interest, determined ex-ante, is a cost that is accrued
irrespective of the outcome of business operations and may not create wealth if there are
business losses. Social justice demands that borrowers and lenders share rewards as well
as losses in an equitable fashion and that the process of wealth accumulation and
distribution in the economy be fair and representative of true productivity.
Risk sharing: Because interest is prohibited, pure debt security is eliminated from thesystem and therefore suppliers of funds become investors, rather than creditors. The
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provider of financial capital and the entrepreneur share business risks in return for shares
of the profits and losses.
Asset-based: The prohibition of debt and the encouragement of risk sharing suggest afinancial system where there is a direct link between the real and the financial sector. As
a result, the system introduces a materiality aspect that links financing directly with the
underlying asset so that the financing activity is clearly and closely identified with the
real-sector activity. There is a strong link between the performance of the asset and the
return on the capital used to finance it.
Money as potential capital:Money is treated as potential capitalthat is, itbecomes actual capital only when it is combined with other resources to undertake a
productive activity. Islam recognizes the time value of money, but only when it acts as
capital, not when it is potential capital.
Prohibition of speculative behavior: An Islamic financial system discourages hoardingand prohibits transactions featuring extreme uncertainty, gambling, and risk.
Sanctity of contracts and the preservation of property rights: Islam upholdscontractual obligations and the disclosure of information as a sacred duty. This feature is
intended to reduce the risk of asymmetric information and moral hazard. Islam places
great importance on the preservation of property rights, defines a balance between the
rights of individuals, society and the state, and strongly prohibits encroachment on
anyones property rights.
3. Islamic Finance ContractsBasically, a contract is an enforceable agreement. Its essence is commitment. Islam anchors all
socio-political-economic relations on contracts. The fabric of the Shariah itself is contractual in
its conceptualisation, content and application. Its very foundation is the primordial covenant
between the Creator and humans. In an unambiguous verse (152:6), the Quran urges the
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believers to fulfil the covenant of Allah. This is extended to the terms and conditions of all
contracts through another clear verse (1:5) in which believers are ordered to be faithful to their
contracts. They are ordered to protect faithfulness to their covenants and what has been placed in
trust with them as a shepherd protects sheep (8:32; also 34:17;172:2; 91-92:16). Thus, believers
do not treat obligations of contracts lightly; they will take on contractual obligations only if they
intend fully to fulfil them. Hence, their commitments are credible.
Contracts are means of coming to terms with future risks and uncertainty. They allocate risks by
providing for future contingencies and set obligations for each party and each state in the future
as well as remedies for breach of contracts. Generally, there are four motives for entering into a
contract: sharing of risk, transfer of risk, alignment of incentives, or to minimise transaction
costs. Mudharabah, Musharakah, and the purchase of equity shares are examples of risk sharing.
Entering into an insurance contract is an example of transferring risks for a fee to those who can
better bear them. Risk shifting occurs when the risks of a transaction or a contract between two
parties are shifted to a third party. This concept was discussed by economists Michael Jensen
and William Meckling in 1976 in the context of corporate managers resorting to debt finance
instead of issuing additional equity, thus shifting the risk of debt burden to other stakeholders.
To align incentives, one party (usually the principle) enters into a contract with another (an
agent) through which incentives are created for the latter to take actions that serve their joint-
surplus maximisation objective. Contracts that are designed to reduce transaction costs are
usually aimed at establishing stable, long-term relationships between parties in order to avoid
ex-ante information, search and sorting costs as well as ex-post bargaining costs (Mirakhor,
February 2012).
There is an organic relationship between contract and trust. Without the latter, contracts become
diffi
cult to negotiate and conclude and costly to monitor and enforce. When and where trust is
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weak, complicated and costly, administrative devices are needed to enforce contracts. Problems
are exacerbated when, in addition to a lack of trust, property rights are poorly defined and
protected. Under these circumstances, it becomes difficult to specify clearly the terms of a
contract since transaction coststhat is search and information costs, bargaining and decision
costs, contract negotiations and enforcement costsare high. Consequently, there is less trade,
fewer market participants, less long-term investment, lower productivity and slower economic
growth. Weakness of trust creates the problem of lack of credible commitment which arises
when parties to an exchange cannot commit themselves or do not trust that others can commit
themselves to performing contractual obligations. Empirical research has shown that where the
problem of lack of commitment exists and is significant, it leads to disruption in economic,
political and social inter- action among people. Long-term contracting will not be possible and
parties to exchange opt for spot market or very short-term transactions. Considering these issues,
one can appreciate the strong emphasis that the Quran [as well as the Messenger (saw)] has
placed on trust, (see 27:8 and 57:4) and on the need to fulfil terms and conditions of contracts,
covenants, and promises one makes. These rules solve the problem of credible commitment and
trust, thus facilitating long-term contracts. To illustrate the importance of trust, consider the role
of complete contracts in the neo-classical theory of competitive equilibrium. A complete
contract fully specifies all future contingencies relevant to the exchange. In the real world a vast
majority of contracts are incomplete. This requirement, therefore, is considered too stringent and
unrealistic. Not only ignorance about all future contingencies make writing complete contracts
impossible, even if all future contingencies are known, it would be nearly impossible to write a
contract that can accommodate them all. However, if the parties to a contract trust each other,
they can agree to enter into a simple contract and commit to revising its terms and conditions as
contingencies arise.
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A contractof Salecomprises the following elements: the existence of two parties who must be
capable of entering into contracts, i.e. they must be mature and sane; an offer (Ijab) and
acceptance (Qabul); a legal (Sharie) basis of union between the two declarations and the
contractual obligations; and free from all prohibited factors. Muslim jurists in general hold that,
intrinsically, the essential elements of a contract are threefold and if these elements are not found
properly, the Sale is invalid (Ayub, 2007):
The form, i.e. offer and acceptance (Sighah); The contracting parties (Aqidain); The subject matter (Maqud alayh).
According to Mansuri (2006), who has included some other factors, there are seven components
in a contract:
The concurrence of offer and acceptance; The unity of the Majlis (session/meeting) of a contract; Plurality of the contracting parties; Sanity or the power of distinction of the contracting parties; Subject matter susceptible to delivery; The object (Mahall) defined; The beneficial nature of the object, in that trade in it is permitted as per Shariah rules.
The form of the contract (the offer and acceptance) is the procedure or the means by which a
contract is made. Juristic rules require that the offer should be in clear language and
unconditional. There should be conformity of the offer and acceptance on the subject matter and
the consideration and issuance of the offer and its acceptance should be in the same session. We
briefly discuss these rules in the following paragraphs.
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An offer (Ijab) is the necessary condition of a valid contract. It has been defined as a declaration
or a firm proposal made first with a view to creating an obligation, while the subsequent
declaration is termed acceptance (Qabul). Ijab signifies the willingness of a party to do
something positive. Islamic law is silent on whether the willingness of a party to abstain from a
thing also constitutes Ijab or not. Offer and acceptance can be conveyed in a number of ways,
namely: by words, by gesture or indication or by conduct. An offer is considered cancelled in
the following cases:
Withdrawal of the offer by the maker; Death of a party or loss of its capacity to enter into the contract; Termination of the Majlis, i.e. contractual session, without concluding the contract; Destruction of the subject matter; Lapse of the time fixed for acceptance.
It is a requirement of Islamic law that acceptance should conform to the offer in all its details
and that it should be accepted in the same meeting if the offer is made to be effective from that
session. If a seller makes an offer to a potential buyer: I sell you this commodity for so much,
but the buyer does not answer him before they separate, the sale is not concluded and the offer
no longer exists. However, if the buyer gets a specified time from the seller, they can conclude
the sale within that time on the basis of that offer.
The subject matter of a contract may include the object of the contracts, a commodity or the
performance of an act. The contract, according to the Mejelle, can be of one of four categories
with reference to subject matter (Turkey, Tyser, Demetriades, & Effendi, 1967):
1. Sale of property to another person for a price. This is the commonest category of sale.2.
Sale by exchange of money for money.
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3. Sale by barter4. Sale by immediate payment against future delivery.
The contractual obligation of one party according to Islamic law is the consideration for the
contractual obligation of the other party. Detailed conditions in respect of subject matter in
various types of contracts are different, but on the whole, the subject matter should be in
existance, valuable, usable, capable of ownership/title, capable of delivery/possession, specified
and quantified and the seller must have its title and risk. If a non-existent thing is sold, even with
mutual consent, the sale is void according to the Shariah(Ayub, 2007).
Below are some other necessary conditions regarding the subject matter:
The basic attributes of the merchandise should consist of pure materials, which should beobjects of intrinsic/legal value having some use. The commodity, service or performance
must not include things prohibited by the Shariah like wine, pork and intoxicants. It
must be ritually and legally clean and permissible. It is further required that the purpose
of the contract and the underlying cause should also not be contrary to the objectives of
the Shariah.
Legality of the subject matter requires that the commodities should be owned bysomeone. It also requires that it should be free from legal charge.
The subject matter should fulfil the objective of the contract. Thus, perishable goods likevegetables cannot be the subject of a pledge.
The subject matter should not be harmful to the contracting parties or the public ingeneral.
The part to discuss, before listing the actual available Islamic contracts or procedures, would be
on the validity of Muamalat (economic activities related to the exchange of goods and services):
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a. All transactions, to be valid and enforceable, must be based on free mutual consent of theparties.
b. All valid contracts must be free from excessive uncertainty (Gharar) about the subjectmatter or the consideration (price) given in exchange.
c. As have been emphasized in this paper, avoiding riba, which the increase withoutcorresponding consideration could be either in exchange or loan transactions.
d. Avoiding Qimar includes every form of gain or money, the acquisition of which dependspurely on luck and chance. Maisir means getting something too easily or getting a profit
without working for it.
e. The prohibition of two mutually contingent and inconsistent contracts.f. The conformity of contracts with Maqasid of Shariah.g. A person is entitled to profit only when he bears the risk of loss in business.h. Everything that is not prohibited is permissible. The principle of permissibility
establishes the fact that all agreements and conditions contained in them are permissible
as long as they do not contradict any explicit text of the Quran or Sunnah.
For the remaining part of this section, one of the actual options of sale and trade contracts
available in Islamic financial system will be listed along with descriptions of them (Abdul
Rahman & Lahsasna, 2012; Ethica, 2012; Mansuri, 2006; Turkey et al., 1967; Zaher & Kabir
Hassan, 2001):
Murabahah
Murabahah one of the most commonly used modes of financing by Islamic banks and
financial institutions comprising of 66% of all investment transactions. It is basically a cost-
plus profit financing transaction in which a tangible asset is purchased by an Islamic
institution at the request of its customer from a supplier. In other words, it is a sale of a
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commodity for cash/deferred price. The Islamic institution then sells the asset to its customer
on a deferred sale basis with a mark-up reflecting the institutions profit. Murabahah
involves the banks purchase of a commodity on behalf of a client and its resale to the latter
on a cost-plus-profit basis. Under this arrangement the bank discloses its cost and profit
margin to the client. In other words rather than advancing money to a borrower, which is
how the system would work in a conventional banking agreement, the bank will buy the
goods from a third party and sell those goods to the customer for a pre-agreed price. The
mark-up on the asset cannot be altered during the life of the contract.
The main difference between Murabahah and sale is that in a simple sale in Arabic is called
Musawamah - a bargaining sale without disclosing or referring to what the cost price is.
However when the cost price is disclosed to the client it is called Murabahah. A simple
Murabahah is a sale where there is cash payment and a Murabahah Muajjal is a sale based
one a deferred payment.
Basic Rules for Murabaha. The following rules govern a Murabahah transaction:
1. The subject of sale must exist at the time of the sale. Thus anything that may not exist at
the time of sale cannot be sold and its non-existence makes the contract void.
2. The subject matter should be in the ownership of the seller at the time of sale. If he sells
something that he has not acquired himself then the sale becomes void.
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.
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4. The sale must be instant and absolute. Thus a sale attributed to a future date or a sale
contingent on a future event is void. For example, A tells B on 1st January that he
will sell his car on 1st February to B, the sale is void because it is attributed to a
future date.
5. The subject matter should be a property having value. Thus a good having no value
cannot be sold or purchased.
6. The subject of sale should not be a thing used for an un-Islamic purpose.
7. The subject of sale must be specifically known and identified to the buyer. For example,
A owner of an apartment building says to B that he will sell him an apartment. Now
the sale is void because the apartment to be sold is not specifically mentioned or
pointed out to the buyer.
8. The delivery of the sold commodity to the buyer must be certain and should not
depend on a contingency or chance.
9. The certainty of price is a necessary condition for the validity of the sale. If the price is
uncertain, the sale is void.
10. The sale must be unconditional. A conditional sale is invalid unless the condition is
recognized as a part of the transaction according to the usage of the trade.
Step by Step Murabahah 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 its agent for purchasing the commodity on its behalf.
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3. The client purchases the commodity on the institutions behalf and takes possession as
the institutions agent.
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 conditions are necessary to effect a valid Murabahah. If the institution
purchases the commodity directly from the supplier, it does not need any agency
agreement.
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.
Issues in Murabaha
The following are some of the issues in a Murabahah financing:
1. Securities against Murabaha
Payments coming from the sale are receivables 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
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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 two issues relating to this:
a) The guarantor cannot charge a fee from the original client. The reason being that charging
a fee for advancing a loan is analogous to Riba.
b) However the guarantor can charge for any documentation expenses.
3. Penalty of default
Another issue with Murabahah is that if the client defaults on payment on the due date, the
price cannot be changed nor can penalty fees be charged.
In order to deal with dishonest clients who deliberately default on payments should be made
liable to pay compensation to the Islamic bank for the loss suffered on account of default.
However, these should be made subject to the following conditions:
a) The defaulter may be given a grace period of at least one month.
b) If it is proven beyond doubt that the client is defaulting without a valid excuse then
compensation can be demanded.
4. Rollover in Murabaha
A Murabahah transaction cannot be rolled over for a further period when the old contract
ends. It should be understood that a Murabahah is not a loan but rather a commodity sale,
which is deferred to a specific date. Once the commodity is sold, its ownership transfers
from the bank to the client and it is therefore no more the sellers property. Now what the
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seller can claim is only the agreed price and therefore there is no question of effecting
another sale for the same commodity between the same parties.
5. Rebate on earlier payments
Sometimes debtors want to pay early to get discounts. However, in Islam, the majority of
Muslim scholars including the major schools of thought consider this to be un-Islamic.
However, if the Islamic bank or financial institution gives somebody a rebate at its own
discretion without it being pre-agreed, it is not objectionable especially if the client is
needy.
6. Calculation ofMurabahah cost
The Murabahah can only be effected when the seller can ascertain the exact cost he has
incurred in acquiring the commodity he wants to sell. If the exact cost cannot be
ascertained then a Murabahah cannot take place. In this case the sale will take place as
a Musawamah i.e. a sale without reference to cost.
7. Subject matter of the sale
All commodities cannot be the subject matter in a Murabahah because certain
requirements need to be fulfilled. The shares of a lawful company can be sold or
purchased on a Murabahah basis because according to the principles of Islam, shares
represent ownership in a companys assets provided all other basic conditions of the
transaction are fulfilled. A buy back arrangement or selling without taking their
possession is not allowed at all.
A Murabahah is not possible for things that cannot become the subject of a sale. For
example, a
Murabahah is not possible for the exchange ofcurrencies.
Basic Mistakes in Murabahah Financing
Some basic mistakes that can be made in practical implications of the concept are as
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follows:
1. The most common mistake is to assume that a Murabahah 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. Iffunds are required for some other purpose, a Murabahah
cannot be used.
2. The document is signed for obtaining funds for a specific commodity and therefore it is
important to specify Murabahah subject matter.
3. In some cases, the sale of the commodity to the client is effected before the commodity is
acquired from the supplier. This occurs when the various stages of the Murabahah are
skipped and the documents are signed all together. It is to be remembered that a
Murabahah 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 a Murabahah is applied on already
purchased commodities, which is not allowed in the Shariah and can be effected on not
yet purchased commodities only.
Conclusion
Murabahah, of course, is only one type of contract. There are more contracts and
options that this paper can handle. To list a few, there is the Mudharabah, Ijarah, Salam,
Istisna, and Musharakah. All of these and much more are available to cater for every
possible commercial non-commercial need. The Islamic economy didnt leave excuse
not to abide by its rules; Muslims should just work hard to find the answer.
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