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Murabaha and Salam - Al Huda

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					     Islamic Modes:
   Murabaha and Salam–
Islamic Microfinance Workshop

 CIBE Training Program
                    Muhammad 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’
       Training Workshop – Islamic Microfinance

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
Rules 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
      Theory & Practice of Murabahah

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



                                  M. Khaleequzzaman IBF, IIUI
         Theory & Practice of Murabahah
Murabahah – 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 Murabahah
Murabahah – 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
      Theory & Practice of Murabahah
Process Flow:
  – Negotiation/Approval of overall limit
  – MOU/Master Murabahah Facility Agreement
  – Requisition + Undertaking + Security Deposit (Hamish
    jiddiyah - Optional) + Invoice

                               2

       MFI            MOU/Master MFA                Client




                      Approval of Limit     1

              Requisition, Undertaking, Sec. Dep.   2
                                                     M. Khaleequzzaman IBF, IIUI
   Theory & Practice of Murabahah

– Third party appointed as agent [Optional] –
– Clint can be appointed agent [case of dire need]
– Payment to the Supplier – Direct
                   Payment in Supplier’s Name      2A

                                                                Agent
                                3                              (Client)
                       Receipt of Payment          Agent
          MFIMFI                                  Client
                                                (3rd Party)



                     Agency Agreement       2
                                            1
                                                      Supplier
Invoice                  Payment            3
                                            2

                                                    M. Khaleequzzaman IBF, IIUI
   Theory & Practice of Murabahah
Possession
  •   Payment to supplier
  •   Discount of supplier/benefit to client
  •   Title of goods
  •   Transfer of risk and responsibilites




      Risks and Responsibilities
                                                              Agent
                                                             (Client)
                                                     Agent
  MFI                        Supplier
                  Title                 Goods      (3rd party)




                                                M. Khaleequzzaman IBF, IIUI
       Theory & Practice of Murabahah
    Conclusion of Murabahah        Personal/group sec.           4


                         Offer to Purchase    2
        MFI                                                Client
                        Acceptance of Offer   3

                Receipt , Possession Report   1

              Sec. Deposit/Hamish jiddiyah    3
                                                                  DP Note
   Payment of Murabahah Price
                         Murabahah Price      1
        MFI                                                Client

                      Murabahah Terminates        2
                                                      M. Khaleequzzaman IBF, IIUI
       Theory & Practice of Murabahah
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




                                   M. Khaleequzzaman IBF, IIUI
         Theory & Practice of Murabahah
                 Pricing of Murabahah [Example]:

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


                                                   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 Murabahah
Documentation:
• 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 Murabahah
Risks in Murabahah:
Risks                    Mitigants
Customer refuses to      Promise, HJ,
purchase while holding
as agent
Customer already         Direct payment to supplier, date of invoice to
purchased from           be after date of agency agreement, obtain
supplier/wants           other documents – gate pass, truck receipts,
liquidity/Inah           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)
       Islamic Modes – Agricultural Financing

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 solutions
1.   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
Salam: Alternatives Available to MFIs of
        Taking Delivery of Commodity:
 1. By establishing a subsidiary
 2. By appointing the third party or client
    its agent to sell the commodity
      i.  The agency agreement should be
          separate from the salam agreement
      ii. 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
       1   Payment of Salam Price 1-1-07


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

MFI                    Salam                      Farmer
                    Transaction                       Agent

            3   Delivery of Wheat 30-6-07


  3C   Sale Proceeds less Commission
                                       3A   Sale of Wheat
                         Third Party
                         Purchaser
                                       3B   Sale Proceeds
          1 Salam Sale Contract 1-1-07, Wheat 2000kg.

             Salam Price Payment June 06
          2 Salam Price Payment 1 1-1-07


                       Delivery of              Purchaser/
Farmer
 Client
                       Commodity        5        Purchaser
                                                  Seller
                                                   MFI
                         30-6-07
                        20 Dec 06                  MFI




                                                     2nd Salam Contract



                                                                          Payment of Price
                                                                          Payment of Price
                                                                              15-1-07
  Parallel                                       3                                           4

  Salam

                        Delivery of                  Third Party
                                                     Third Party
                       Commodity                     2nd Salam
                                                     2nd Salam
                       20 Dec 2006
                          5-7-07        6            15 June 06
                                                       15-1-07
         1   Salam Sale Contract 1-1-07

         2   Salam Price Payment 1-1-07


                     Delivery of                Purchaser
Farmer               Commodity          4         Seller
                      30-6-07                      MFI




                                                               Promise to Purchase
                                                 Pays 5-7-07




                                                                                     15-1-07
Third Party                                 6                                                  3

 Promise                            5




                      Delivery of                Third Party
                      Commodity                 Promise and
                        5-7-07                    Payment
     Islamic Modes – Agricultural Financing


 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

				
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