muhammad khaleequzzaman head islamic banking department int’l islamic university islamabad

Islamic Modes of Financing PRODUCTS – Murabahah, Salam

and IstisnaMirpur, Azad Kashmir

11 – 12 June, 2008 Al – Huda Training Programme

Muhammad KhaleequzzamanHead Islamic banking DepartmentInt’l Islamic University Islamabad

Islamic Modes –

Sale Modes:

1. Murabahah to the purchase orderer

2. Salam as financing mode of Islamic banks

3. Istisna’ and parallel Istisna’

Participatory Modes:

1. Mudarabah (asset and liabilities side)

2. Musharakah as a mode for house finance

Rent based Modes:

1. Operating lease (Ijarah)

2. Ijarah wa Iqtina’

Contents:

1. Murabahah – Historical perspective

2. Spot and Deferred Murabahah

3. Banking Murabahah/Murabahah to the Purchase Orderer

4. Why Unilateral Promise?

5. Why Security Deposit?

6. Why Agency?

7. Issue of default / penalty

8. Pricing of Murabahah

Islamic Modes – Murabahah


Murabahah:Murabahah is simply a sale contract which fixes the price in terms of the sellers cost plus a specified percentage markup. The seller must disclose all items of expense which are included in the cost ie. All direct expenses incurred in acquiring that goods – trust relationship between bank and the clkient.

Uses of Murabaha• Sale of raw material• Sale of equipment• Sale of agricultural inputs• Sale of real estate and vehicles

Process Flow:Approval of Credit Facility – Negotiation/Approval of overall limit

– MOU/Murabahah Facility Agreement

– Requisition + Undertaking + Security Deposit

Bank ClientMOU/Facility Agreement

Approval of Limit

2

1

Requisition, Undertaking, Sec. Dep. 3


Process Flow:Agency/Payment to Supplier– Client appointed as agent [Optional] – When the

option to be used?– Payment to the Supplier – Direct

Client

Bank

Supplier3

2Agency Agreement

Payment Supplier

Client

Bank

Supplier2

1Agency Agreement

Payment


Process Flow:Acquiring / Possession /First sale

– Physical Possession / Constructive Possession• Payment to supplier• Discount of supplier• Title of goods• Transfer of risk and responsibilites

BankAgent

(Client)SupplierTitle Goods


Process Flow:

Execution of Murabahah / second Sale– Receipt / Possession report / Offer of client – Acceptance of offer by the bank– Return of security deposit– Delivery of goods / Transfer of Risk & responsibility– Ownership changes– Payment of earnest money (Urboun)

Payment of Murabahah Price– Client pays Murabaha price as per agreed schedule– Collateral released– Murabahah terminates


• Execution of Murabahah

Client Acceptance of Offer

1

2

3

Offer to Purchase

Receipt , Possession Report

Payment of Murabahah Price

Murabahah Terminates

1

IB Client Murabahah Price

2

IB

Hamish jiddiyah

Urboun/Securities 4

3


Purchase of poultry feed stock

• Murabahah transaction: Rs. 100,000• Murabahah Facility: 90 Days• Payment: Lump sum• Rate of Profit: Six months

KIBOR+2%• Freight: 5% of cost of

goods • Securities: Pledge of feed stock,

post dated cheques



Particulars Amount (Rs.)

Cost of goods Rs. 100,000

Rate of Profit Kibor + 2%

Six monthly KIBOR 10% p.a.

Freight 5% of cost

Total cost 100000 x 5% 100000 + 5000 =105000

Profit 10%+2% = 12% p.a. 105000 x 12% x 90/365 = 3107

Murabahah Price 105000+3107= 108107

Pricing of Murabahah [Example]:

Book Keeping of Murabahah: Funds are advanced to supplier for purchase

of goods and F&I paid On arrival of goods Murabahah purchase

account effected [bank becomes owner] Murabahah Facility A/C and Murabahah Profit

Receivable A/C are effected against Murabahah Sale A/C [goods sold]

Client’s A/C is effected against Murabahah Facility A/C and Murabahah Profit Receivable A/C (Murabahah price recovered]


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Islamic Modes – Agricultural Financing

Salam: Forward PurchaseA 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 delivery of the item to be sold, known as subject matter of salam, is deferred. Salam is also known as Salaf (lit: borrowing)

Uses:– Purchase of commodities (financing for

production of agricultural commodities/ minerals)

– Liquidity requirements of sugar mills, etc.

Islamic Modes – Salam

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 Beneficial for both seller and

purchaser

Three major problems

1. Risk of default by seller

2. Bank’s need to liquidate goods after delivery

3. Seller’s inabillity to produce or procure commodity


Principles/conditions

An exception to the possession

A contract opposite to Murabahah

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

Allowed in fungible commodities

Product of a particular origin cannot be specified

Quality and quantity decided in un ambiguous terms

Allowed in fungible commodities




Principles/conditions Allowed in fungible commodities



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


Parallel Salam:The disposal of commodity at the end of Bank

can be through:– Parallel Salam:MFI may sell commodity, before the

date of delivery, to some other purchaser for the date of original delivery. The period in second contract will be shorter than the original contract, but price higher than the original contract.

– Unilateral Promise: Promise of purchase can be obtained from third party for delivery on the date of original contract. Price in this promise is set higher than parallel salam because the promisor has to

pay nothing.


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 [Agency allowed]

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


Bank transacts purchase of wheat Contract against payment of certain price

Commodity to be delivered in six months

Bank apprehends trend of depressed prices in the prospect OR requires liquidity

Bank’s position at disadvantage as compared to other purchasers contracting lower spot price but cannot undo the contractual obligation –

Bank can keep the original contract and enter another salam contract with a buyer expecting trend otherwise… can lower the price risk

Islamic Modes – Salam – Example

BLANK SLIDE

LAST SLIDE


muhammad khaleequzzaman head islamic banking department int’l islamic university islamabad

Documents

islamic modes murabahahbook

purchase of goods

ownermurabahah facility

cost of goods securities

goods trust relationship

murabaha price

purchase orderersalam

salereceipt possession