Musawamah is the negotiation of a selling price between two parties without reference by the seller to either costs or asking price. While the seller may or may not have full knowledge of the cost of the item being negotiated, they are under no obligation to reveal these costs as part of the negotiation process. This difference in obligation by the seller is the key distinction between Murabahah and Musawamah with all other rules as described in Murabahah remaining the same. Musawamah is the most common type of trading negotiation seen in Islamic commerce.
SALAM AND ISTISNA'
It is one of the basic conditions for the validity of a sale in Shari'ah that the commodity (intended to be sold) must be in the physical or constructive possession of the seller.
This condition has three ingredients:
Firstly, the commodity must be existing; therefore, a commodity which does not exist at the time of sale cannot be sold.
Secondly, the seller should have acquired the ownership of that commodity. Therefore, if the commodity is existing, but the seller does not own it, he cannot sell it to anybody.
Thirdly, mere ownership is not enough. It should have come in to the possession of the seller, either physically or constructively. If the seller owns a commodity, but he has not taken its delivery himself or through an agent, he cannot sell it.
There are only two exceptions to this general principle in Shari'ah. One is Salam and the other is Istisna'. Both are sales of a special nature, and in the present chapter the concept of these two kinds of sale and the extent to which they can be used for the purpose of financing will be explained.
Difference between Istisna' and Ijarah:
It should also be kept in mind that the manufacturer, in istisna' undertakes to make the required goods with his own material. Therefore, this transaction implies that the manufacturer shall obtain the material, if it is not already with him, and shall undertake the work required for making the ordered goods with it. If the material is provided by the customer, and the manufacturer is required to use his labour and skill only, the transaction is not istisna'. In this case it will be a transaction of ijarah whereby the services of a person are hired for a specific fee paid to him.
When the required goods have been manufactured by the seller, he should present them to the purchaser. But there is a difference of opinion among the Muslim jurists whether or not the purchaser has a right to reject the goods at this stage. Imam Abu Hanifah is of the view that he can exercise his 'option of seeing' (khiyar-ur-ru'yah) after seeing the goods, because istisna' is a sale and if somebody purchases a thing which is not seen by him, he has the option to cancel the sale after seeing it. The same principle is also applicable to istisna'.
However, Imam Abu Yousuf says that if the commodity conforms to the specifications agreed upon between the parties at the time of the contract, the purchaser is bound to accept the goods and he cannot exercise the option of seeing.
This view has been preferred by the jurists of the Ottoman Empire, and the Hanafi law has been codified according to this view, because it is damaging in the context of modern trade and industry that after the manufacturer has used all his resources to prepare the required goods, the purchaser cancels the sale without assigning any reason, even though the goods are in full conformity with the required specifications.
As pointed out earlier, it is not necessary in istisna' that the time of delivery is fixed. However, the purchaser may fix a maximum time for delivery which means that if the manufacturer delays the delivery after the appointed time, he will not be bound to accept the goods and pay the price.
In order to ensure that the goods will be delivered within the specified period, some modern agreements of this nature contain a penal clause to the effect that in case the manufacturer delays the delivery after the appointed time, he shall be liable to a penalty which shall be calculated on a daily basis. Can such a penal clause be inserted in acontract of istisna' according to Shari'ah? Although the classical jurists seem to be silent about this question while they discuss the contract of istisna', yet they have allowed a similar condition in the case of ijarah. They say that if a person hires the services of a person to tailor his clothes, the fee may be variable according to the time of delivery. The hirer may say that he will pay Rs.100/- in case the tailor prepares the clothes within one day and Rs. 80/- in case he prepares them after two days.
On the same analogy, the price in istisna' may be tied up with the time of delivery, and it will be permissible if it is agreed between the parties that in the case of delay in delivery, the price shall be reduced by a specified amount per day.
Difference between Istisna' and Salam:
Keeping in view this nature of istisna' there are several points of difference between istisna' and salam which are summarized below:
i. The subject of istisna' is always a thing which needs manufacturing, while salam can be affected on any thing, no matter whether it needs manufacturing or not.
ii. It is necessary for salam that the price is paid in full in advance, while it is not necessary in istisna'.
iii. The contract of salam, once affected, cannot be cancelled unilaterally, while the contract of istisna' can be cancelled before the manufacturer starts the work.
iv. The time of delivery is an essential part of the sale in salam while it is not necessary in istisna' that the time of delivery is fixed.
Istisna' as a Mode of Financing:
Istisna' can be used for providing the facility of financing in certain transaction, especially in the house finance sector.
If the client has his own land and he seeks financing for the construction of a house, the financier may undertake to construct the house at that open land, on the basis of istisna', and if the client has no land and he wants to purchase the land also, the financier may undertake to provide him a constructed house in a specified piece of land.
Since it is not necessary in istisna' that the price is paid in advance, nor is it necessary that it is paid at the time of delivery, (it may deferred at any time according to the agreement of the parties), therefore, the time of payment may be fixed in whatever manner they wish. The payment may also be in installments.
On the other hand, it is not necessary that the financier himself constructs the house. He can enter into a parallel contract of istisna' with a third party, or may hire the services of a contractor (other than the client). In both cases, he can calculate his cost and fix the price of istisna' with his client in a manner which may give him a reasonable profit over his cost. The payment of installments by the client may start, in this case, right from the day when the contract of istisna' is signed by the parties, and may continue during the construction of the house and after it is handed over to the client. In order to secure the payment of the installments, the title deeds of the house or land, or any other property of the client may be kept by the financier as a security, until the last installment is paid by the client.
The financier, in this case, will be responsible for the construction of the house in full conformity with the specifications detailed in the agreement. In the case of any discrepancy, the financier will undertake such alteration at his own cost as may be necessary for bringing it in harmony with the terms of the contract.
The instrument of istisna' may also be used for project financing on similar lines. If a client wants to install an air conditioning plant in his factory, and the plant needs to be manufactured, the financier may undertake to prepare the plant the contract of istisna' according to the aforesaid procedure. Similarly, the contract of istisna' can be used for building a bridge or a highway.
The modern BOT (Buy, Operate and Transfer) agreements may also be formalized on the basis of istisna'. If a government wants to construct a highway, it may enter into a contract of istisna' with a builder. The price of istisna', in this case, may be the right of the builder to operate the highway and collect tolls for a specified period.
Understanding of ISTISNA'
'Istisna' is the second kind of sale where a commodity is transacted before it comes into existence. It means to order a manufacturer to manufacture a specific commodity for the purchaser. If the manufacturer undertakes to manufacture the goods for him with material from the manufacturer, the transaction of istisna' comes into existence. But it is necessary for the validity of istisna' that the price is fixed with the consent of the parties and that necessary specification of the commodity (intended to be manufactured) is fully settled between them.
The contract of istisna' creates a moral obligation on the manufacturer to manufacture the goods, but before he starts the work, any one of the parties may cancel the contract after giving a notice to the other. However after the manufacturer has started the work, the contract cannot be cancelled unilaterally.
Some Rules of Parallel Salam
Since the modern Islamic Banks and Financial Institutions are using the instrument of parallel Salam, some rules for the validity of this arrangement are necessary to observe:
1. In an arrangement of parallel salam, the bank enters two different contracts. In one of them, the bank is the buyer and in the second one the bank is the seller. Each one of these contracts must be independent of the other. They cannot be tied up in a manner that the rights and obligations of one contact are dependent on the rights and obligations of the parallel contract. Each contract should have its own force and its performance should not be contingent on the other.
For Example, if A has purchased from B 1000 bags of wheat by way of Salam to be delivered on 31 December, A can contract a parallel Salam with C to deliver to him 1000 bags of wheat on 31 December. But while contracting Parallel Salam with C, the delivery of wheat to C cannot be conditioned with taking delivery from B. Therefore, even if B did not deliver wheat on 31 December, A is duty bound to deliver 1000 bags of wheat to
C. He can seek whatever recourse he has against B, but he cannot rid himself from his liability to deliver wheat to C.
Similarly, if B has delivered defective goods which do not conform with the agreed specifications, A is still obligated to deliver the goods to C according to the specifications agreed with him.
2. Parallel Salam is allowed with a third party only. The seller in the first contract cannot be made purchaser in the parallel contract of salam, because it will be a buy-back contract, which is not permissible in Shari'ah.
Even if the purchaser in the second contract is a separate legal entity, but it is fully owned by the seller in the first contract the arrangement will not be allowed, because in practical terms it will amount to 'buy-back' arrangement. For example A has purchased 1000 bags of wheat by way of Salam from B, a joint stock company. B has a subsidiary C, which is a separate legal entity but is fully owned by B. A cannot contract the parallel salam with
C. However, if C is not wholly owned by B, A can contract parallel salam with it, even if some shareholders are common between B and C.
Salam as a Mode of Financing
It is evident from the foregoing discussion that salam was allowed by Shari'ah to fulfill the needs of farmers and traders. Therefore, it is basically a mode of financing for small farmers and traders. This mode of financing can be used by the modern banks and financial institutions, especially to finance the agricultural sector. As pointed out earlier, the price in salam may be fixed at a lower rate than the price of those commodities delivered at spot. In this way, the difference between the two prices may be a valid profit for the banks or financial institutions. In order to ensure that the seller shall deliver the commodity on the agreed date, they can also ask him to furnish a security, which may be in the form of a guarantee or in the form of a mortgage or hypothecation. In the case of default in delivery, the guarantor may be asked to deliver the same commodity, and if there is a mortgage, the buyer / financier can sell the mortgaged property and the sale proceeds can be used either to realize the required commodity by purchasing it from the market or to recover the price advanced by him.
The only problem in salam which may agitate the modern banks and financial institutions is that they will receive certain commodities from their clients, and will not receive money. Being conversant with dealing in money only, it seems to be cumbersome for them to receive different commodities from different clients and to sell them in the market. They cannot sell these commodities before they are actually delivered to them, because it is prohibited in Shari'ah.
But whenever we talk about the Islamic modes of financing, one basic point should never be ignored. The point is that the concept of the financial institutions dealing in money only is foreign to Islamic Shari'ah. If these institutions want to earn a halal profit, they shall have to deal in commodities in one way or the other, because no profit is allowed in Shari'ah on advancing loans only. Therefore, the establishment of an Islamic economy requires a basic change in the approach and in the outlook of the financial institutions. They shall have to establish a special cell for dealing in commodities. If such a special cell is established, it should not be difficult to purchase commodities through salam and to sell them in the spot markets.
However, there are two other ways of benefitting from the contract of Salam.
Firstly, after purchasing a commodity by way of salam, the financial institutions may sell it through a parallel contract of salam for the same date of delivery. The period of salam in the second (parallel) transaction being shorter, the price may be a little higher than the price of the first transaction, and the difference between the two prices shall be the profit earned by the institution. The shorter the period of salam, the higher the price and the greater the profit. In this way the institutions may manage their short term financing portfolios.
Secondly, if a parallel contract of salam is not feasible for one reason or another, they can obtain a promise to purchase from a third party. This promise should be unilateral from the expected buyer. Being merely a promise, and not the actual sale, their buyers will not have to pay the price in advance. Therefore, a higher price may be fixed and as soon as the commodity is received by the institution, it will be sold to the third party at a pre-agreed price, according to the terms of the promise.
A third option is sometimes proposed that, at the date of delivery, the commodity is sold back to the seller at a higher price. But this suggestion is not in line with the dictates of Shari'ah. It is never permitted by the Shari'ah that the purchased commodity is sold back to the seller before the buyer takes its delivery, and if it is done at a higher price it will be tantamount to riba which is totally prohibited. Even if it is sold back to the seller after taking delivery from him, it cannot be prearranged at the time of original sale. Therefore, this proposal is not acceptable at all.
Conditions of Salam
1. First of all, it is necessary for the validity of salam that the buyer pays the price in full to the seller at the time of effecting the sale. It is necessary because in the absence of full payment by the buyer, it will be tantamount to sale of a debt against a debt, which is expressly prohibited by the Holy Prophet (SW).
Moreover, the basic wisdom behind the permissibility of salam is to fulfill the instant needs of the seller. If the price is not paid to him in full, the basic purpose of the transaction will be defeated.
Therefore, all the Muslim jurists are unanimous on the point that full payment of the price is necessary in Salam. However, Imam Malik is of the view that the seller may give a concession of two or three days to the buyers, but this concession should not form part of the agreement.
Salam can be affected in those commodities only the quality and quantity of which can be specified exactly. The things whose quality or quantity is not determined by specification cannot be sold through the contract of salam. For example, precious stones cannot be sold on the basis of salam, because every piece of precious stones is normally different from the other either in its quality or in its size or weight and their exact specification is not generally possible.
Salam cannot be affected on a particular commodity or on a product of a particular field or farm. For example, if the seller undertakes to supply the wheat of a particular field, or the fruit of a particular tree, the salam will not be valid, because there is a possibility that the crop of that particular field or the fruit of that tree is destroyed before delivery, and, given such possibility, the delivery remains uncertain. The same rule is applicable to every commodity the supply of which is not certain.
It is necessary that the quality of the commodity (intended to be purchased through salam) is fully specified leaving no ambiguity which may lead to a dispute. All the possible details in this respect must be expressly mentioned.
It is also necessary that the quantity of the commodity is agreed upon in unequivocal terms. If the commodity is quantified in weights according to the usage of its traders, its weight must be determined, and if it is quantified through measures, its exact measure should be known. What is normally weighed cannot be quantified in measures and vice versa.
The exact date and place of delivery must be specified in the contract.
7. Salam cannot be affected in respect of things which must be delivered at spot. For example, if gold is purchased in exchange of silver, it is necessary, according to Shari'ah, that the delivery of both be simultaneous.
Here, salam cannot work. Similarly, if wheat is bartered for barley, the simultaneous delivery of both is necessary for the validity of sale. Therefore the contract of salam in this case is not allowed.
All the Muslim jurists are unanimous on the principle that salam will not be valid unless all these conditions are fully observed, because they are based on the express ahadith of the Holy Prophet (SW). The most famous hadith in this context is the one which the Holy Prophet (SW) has said:
"Whoever wishes to enter into a contract of salam, he must effect the Salam according to the specified measure and the specified weight and the specified date of delivery."
However, there are certain other conditions which have been a point of difference between the different schools of the Islamic jurisprudence.
Some of these conditions are discussed below:
1. It is necessary, according to the Hanafi school, that the commodity (for which salam is effected) remains available in the market right from the day of contract upto the date of delivery. Therefore, if a commodity is not available in the market at the time of the contract, salam cannot be affected in respect of that commodity, even though it is expected that it will be available in the markets at the date of the delivery.
However, the other three schools of Fiqh (i.e. Shafi', Maliki, and Hanbali) are of the view that the availability of the commodity at the time of the contract is not a condition for the validity of salam. What is necessary, according to them, is that it should be available at the time of delivery.
This view can be adopted in the present circumstances.
2. It is necessary, according to the Hanafi and Hanbali schools that the time of delivery is, at least, one month from the date of agreement. If the time of delivery is fixed earlier than one month, salam is not valid. Their argument is that salam has been allowed for the needs of small farmers and traders and therefore, they should be given enough opportunity to acquire the commodity. They may not be able to supply the commodity before one month. Moreover, the price in salam is normally lower than the price in spot sales. This concession in the price may be justified only when the commodities are delivered after a period which has a reasonable bearing on the prices. A period of less than one month does not normally affect the prices. Therefore, the minimum time of delivery should not be less than one month.
Imam Malik supports the view that there should be a minimum period for the contract of salam. However, he is of the opinion that it should not be less than fifteen days, because the rates of the market may change within a fortnight.
This view is, however, opposed by some other jurists, like Imam Shafi' and some Hanafi jurists also. They say that the Holy Prophet (SW) has not specified a minimum period for the validity of salam. The only condition, according to the Hadith, is that the time of delivery must be clearly defined. Therefore, no minimum period can be prescribed. The parties may fix any date for delivery with mutual consent.
This view seems to be preferable in the present circumstances, because the Holy Prophet (SW) has not prescribed a minimum period. The jurists have prescribed different periods which range between one day to one month. It is obvious that they have done so on the basis of expedience and keeping in view the interest of the poor sellers. But the expediency may differ from time to time and from place to place. Likewise, sometimes it is more in the interest of the seller to fix an earlier date. As far as the price is concerned, it is not a necessary ingredient of salam that the price is always lower than the market price on that day. The seller himself is the best judge of his interest, and if he accepts an earlier date of delivery with his free will and consent, there is no reason why he should be forbidden from doing so.
Certain contemporary jurists have adopted this view being more suitable for the modern transactions.
Understanding of SALAM
Salam is a sale whereby the seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advanced price fully paid at spot.
Here the price is cash, but the supply of the purchased goods is deferred. The buyer is called "rabb-us-salam", the seller "muslam ilaih", the cash price is "ra's-ul-mal" and the purchased commodity is termed as "muslam fih", but for the purpose of simplicity, I shall use the English synonyms of these terms.
Salam was allowed by the Holy Prophet (SW) subject to certain conditions. The basic purpose of this sale was to meet the needs of small farmers who needed money to grow their crops and to feed their families upto the time of harvest. After the prohibition of riba, they could not take usurious loans. Therefore, it was allowed for them to sell the agricultural products in advance.
Similarly, the traders of Arabia used to export goods to other places and to import some other goods to their homeland. They needed money to undertake this type of business. They could not borrow from the userers after the prohibition of riba. It was, therefore, allowed for them that they sell the goods in advance. After receiving their cash price, they could easily undertake the aforesaid business.
Salam was beneficial to the seller, because he received the price in advance, and it was beneficial to the buyer also, because normally, the price in salam used to be lower than the price in spot sales.
The permissibility of salam was an exception to the general rule that prohibits the forward sales, and therefore, it was subjected to some strict conditions.
Conclusions of Murabaha
Following conclusions may be summarized as the basic points to remember:
i. Murabahah is not a mode of financing in its origin. It is a simple sale on a cost-plus basis. However, after adding the concept of deferred payment, it has been devised to be used as a mode of financing only in cases where the client intends to purchase the commodity. Therefore, it should neither be taken as a ideal slamic mode of financing, nor a universal instrument for all sorts of financing. It should be taken as a transitory step towards the ideal Islamic system of financing based on musharakah or mudarabah. Otherwise its use should be restricted to areas where musharakah or mudarabah cannot work.
ii. While approving a murabahah facility, the sanctioning authority must make sure that the client really intends to purchase commodities which may be subject matter of murabahah. It should never be taken as merely a paper-work having no genuine basis.
iii. No murabahah can be effected for overhead expenses, paying the bills or settling the debts of the client, nor can it be effected for purchase of currencies.
iv. It is the foremost condition for the validity of murabahah that the commodity comes in the ownership and physical or constructive possession of the financier before he sells it to the customer on murabahah basis. There should be a time in which the risk of the commodity is borne by the financier. Without having its ownership or assuming the risk of the commodity, though for a short while, the transaction is not acceptable to Shariah and the profit accruing therefrom is not halal.
iv. The best way to effect murabahah is that the financier himself purchases the commodity directly from the supplier and after taking its delivery sells it to the client on murabahah basis. Making the client agent to purchase on behalf of the financier renders the arrangement dubious. For this very reason some Shariah Boards have forbidden this technique, except in cases where direct purchase is not possible at all. Therefore, the agency concept should be avoided as far as possible.
v. If in cases of genuine need, the financier appoints the client his purchase to the commodity on his behalf, his different capacities (i.e. as agent and as ultimate purchaser) should be clearly distinguished. As an agent, he is a trustee, and unless he commits negligence or fraud, he is not liable to any loss so far as the commodity in his possession as agent of the financier. After he purchases the commodity in his capacity as agent, he must inform the financier that, in fulfilling his obligation as his agent, he has taken delivery of the purchased commodity and now he extends his offer to purchase it from him. When, in response to this offer, the financier conveys his acceptance to this offer, the sale will be deemed to be complete, and the risk of the property will be passed on to the client as purchaser. At this point, he will become a debtor and the consequences of indebtness will follow. These are the necessary requirements of murabahah financing which can never be dispensed with. While describing the concept of "Murabahah as a mode of financing" we have already identified five stages of murabahah under agency agreement. Each and every step out of these five is necessary in its own right and neglecting any one of them renders the whole arrangement unacceptable.
It should be noted with care that murabahah is a border-line transaction and a slight departure from the prescribed procedure makes it step in the prohibited area of interest-based financing. Therefore this transaction must be carried out with due diligence and no requirement of Shariah should be taken lightly.
vi. Two different prices for cash and credit sales are allowed on condition that ither of the two options is specifically elected by the customer. Once the price is fixed, it can neither be increased because of late payment, nor decreased on earlier payment.
vii. In order to assure that the purchaser will pay the price promptly, he may undertake that in case of default, he will pay a certain amount to the charitable fund maintained by the financing institution. This amount may be based on per cent per annum concept, but it must invariably be spent for purely charitable purposes and should in no case form part of the income of the institution.
viii. In case of earlier payment, no rebate can be claimed by the client. However, the institution may at it own option, forego some part of the price without making it a precondition in the agreement.
Basic Mistakes in Murabahah Financing
i. The first and the most glaring mistake is to assume that murabahah is a universal instrument which can be used for every type of financing offered by conventional interest based-banks and NBFIs. Under this false assumption, some financial institutions are found using murabahah for financing overhead expenses of a firm or company like paying salaries of their staff, paying the bills of electricity etc. and setting off their debts payable to other parties. This practice is totally unacceptable, because murabahah can be used only where a commodity is intended to be purchased by the customer. If funds are required for some other purpose, murabahah cannot work. In such cases, some other suitable modes of financing, like musharakah, leasing etc. can be used according to the nature of the requirement.
ii. In some cases, the clients sign the murabahah documents merely to obtain funds. They never intend to employ these funds to purchase a specific commodity. They just want funds for unspecified purpose, but to satisfy the requirement of the formal documents, they name a fictitiously commodity, after receiving the money, they use it for whatever purpose they wish. Obviously this is a fictitious deal, and the Islamic financiers must be very careful about it. It is their duty to make sure that the client really intends to purchase a commodity which may be subject to murabahah. This assurance must be obtained by the authorities sanctioning the facility to the customer. Then, all necessary steps must be taken to confirm that the transaction is genuine for example:
a. Instead of giving funds to the customer, the purchase price should be paid directly to the supplier.
b. If it becomes necessary that the client is entrusted with funds to purchase the commodity on behalf of the financier, his purchase should be evidenced by invoices or similar other documents which he should present to the financier.
c. Where either one of the above two requirements is not possible to be fulfilled, the financing institution should arrange for physical inspection of the purchased commodities.
Anyhow, the Islamic financial institutions are under an obligation to make sure that the murabahah is a real and genuine transaction of actual sale and is not being misused to camouflage an interest-based loan.
iii. In some cases, sale of commodity to the client is affected before the commodity is acquired from the supplier. This mistake is invariably committed in transactions where all the documents of murabahah are signed at one time without taking into account the various stages of the murabahah. Some institutions have only one murabahah agreement which is signed at the time of disbursement of money, or in some cases, at the time of approving the facility. This is totally against the basic principles of murabahah. It has already been explained in this article that the murabahah arrangement practiced by the banks is a package of different contracts which come into plat one after another at their respective stages. These stages have been fully highlighted earlier while discussing the concept of 'Murabahah Financing'. Without observing this basic feature of murabahah financing, the whole transaction turns into an interest-bearing loan. Merely changing the nomenclature does not make it lawful in the eyes of Shariah. The representatives of the Shariah Boards of the Islamic banks, when they check the transactions of the bank with regard to their compliance with Shariah, must make sure that all these stages have been really observed, and every transaction is effected at its due time.
iv. International commodity transactions are often resorted for liquidity management. Some Islamic banks feel that these transactions, being asset-based, can easily be entered into on murabahah basis, and they enter the field ignoring the fact that the commodity operations as in vogue in the international markets, do not conform to the principles of Shariah. In many cases, they are fictitious transactions where no delivery takes place. The parties end up paying differences. In some cases, there are real commodities but they are subject to forward sales or short sales which are not allowed in Shariah. Even if the transactions are restricted to spot sales, they should be formulated on the basis of Islamic principles of Murabahah by fulfilling all the necessary conditions already mentioned.
v. It is observed in some financial institutions that they effect murabahah on commodities already purchased by their clients from a third party. This is again a practice never warranted by the Shariah. Once the commodity is purchased by the client himself, it cannot be purchased again from the same supplier. If it is purchased by the bank from the client himself and is sold to him, it is a buy-back technique which is not allowed in Shariah, especially in murabahah. In fact, if the client has already purchased a commodity, and he approaches the bank for funds, he either wants to set-off his liability towards his supplier, or he wants to use the funds for some other purpose. In both cases an Islamic bank cannot finance him on the basis of the murabahah. Murabahah can be effected only on commodities not yet purchased by the client.
Important Issues Involved in Murabahah:
So far the basic concept of Murabahah has been explained. Now, it is proposed to discuss some relevant issues with reference to the underlying Islamic principles and their practical applicability in murabahah transactions, because without correct understanding of these issues, the concept may remain ambiguous and its practical application may be susceptible to errors and misconceptions.
1. Different Pricing for Cash and Credit Sales:
The first and foremost question about murabahah is that, when used as a mode of financing, it is always effected on the basis of deferred payment. The financier purchases the commodity on cash payment and sells it to the client on credit.
While selling the commodity on credit, he takes into account the period in which the price is to be paid by the client and increase the price accordingly. The longer the maturity of the murabahah payment, the higher the price. Therefore the price in a murabahah transaction, as practiced by the Islamic banks, is always higher than the market price. If the client is able to purchase the same commodity from the market on cash payment, he will have to pay much less than he has to pay in a murabahah transaction on deferred payment basis. The question arises as to whether the price of a commodity in a credit sale may be increased from the price of the cash sale. Some people argue that the increase of price in a credit sale, being in consideration of the time given to the purchaser, should be treated analogous to the interest charged on a loan, because in both cases an additional amount is charged for the deferment of payment. On this basis they argue that the murabahah transactions, as practiced in the Islamic banks, are not different in essence from the interest-based loans advanced by conventional banks.
This argument, which seems to be logical in appearance, is based on a misunderstanding about the principles of Shariah regarding the prohibition of riba. For the correct comprehension of the concept the following points must be kept in view:
The modern capitalist theory does not differentiate between money and commodity in so far as commercial transactions are concerned. In the matter of exchange, money and commodity both are treated at par. Both can be traded in. Both can be sold at whatever price the parties agree upon. One can sell one dollar for two dollars on the spot as well as on credit, just as he can sell a commodity valuing one dollar for two dollars. The only condition is that it should be with mutual consent.
The Islamic principles, however, do not subscribe to this theory. According to Islamic principles, money and commodity have different characteristics and therefore, they are treated differently. The basic points of difference between money and commodity are the following:
(i) Money has no intrinsic utility. It cannot be utilized for fulfilling human needs directly. It can only be used for acquiring some goods or services. The commodities, on the other hand, have intrinsic utility. They can be utilized directly without exchanging them for some other thing.
(ii) The commodities can be of different qualities, while money has no quality except that it is a measure of value or the medium of exchange. Therefore, all the units of money, of same denomination, are 100% equal to each other. An old and dirty note of Rs. 1000/- has the same value as a brand new note of Rs. 1000/-, unlike the commodities which may have different qualities, and obviously an old and used car may be much less in value than a brand new car.
(iii) In commodities the transaction of sale and purchase is effected on a particular individual commodity, or at least, on the commodities having particular specifications. If A has purchased a particular car by pinpointing it and seller has agreed, he deserves to receive the same car. The seller cannot compel him to take the delivery of another car, though of the same type or quality. This can only be done if the purchaser agrees to it which implies that the earlier transaction is cancelled and a new transaction on the new car is effected by mutual consent.
Money, on the contrary, cannot be pinpointed in a transaction of exchange. If A has purchased a commodity from B by showing him a particular note of Rs. 1000/- he can still pay him another note of the same denomination, while B cannot insist that he will take the same note as was shown to him.
Keeping these differences in view, Islam has treated money and commodities differently. Since money has no intrinsic utility, but is only a medium of exchange which has no different qualities, the exchange of a unit of money for another unit of the same denomination cannot be effected except at par value. If a currency note of Rs. 1000/- is exchanged for another note of Pakistani Rupees, it must be of the value of Rs. 1000/-. The price of the former note can neither be increased nor decreased from Rs. 1000/- even in a spot transaction, because the currency note has no intrinsic utility nor a different quality (recognized legally), therefore any excess on either side is without consideration, hence not allowed in Shariah. As this is true in a spot exchange transaction, it is also true in a credit transaction where there is money on both sides, because if some excess is claimed in a credit transaction (where money is exchanged for money) it will be against nothing but time.
The case of the normal commodities is different. Since they have intrinsic utility and have different qualities, the owner is at liberty to sell them at whatever price he wants, subject to the forces of supply and demand. If the seller does not commit a fraud or a misrepresentation, he can sell a commodity at a price higher than the market rate with the consent of the purchaser. If the purchaser accepts to buy it at that increased price, the excess charged from him is quite permissible for the seller. When he can sell his commodity at a higher price in a cash transaction, he can also charge a higher price in a credit sale, subject only to the condition that he neither deceives the purchaser, nor compels him to purchase, and the buyer agrees to pay the price with his free will. It is sometimes argued that the increase of price in a cash transaction is not based on the deferred payment, therefore it is permissible while in a sale based on deferred payment, the increase is purely against time which makes it analogous to interest. This argument is again based on the misconception that whenever price is increased taking the time of payment into consideration, the transaction comes within the ambit of interest. This presumption is not correct.
Any excess amount charged against late payment is riba only where the subject matter is money on both sides. But if a commodity is sold in exchange of money, the seller, when fixing the price, may take into consideration different factors, including the time of payment. A seller, being the owner of a commodity which has intrinsic utility may charge a higher price and the purchaser may agree to pay it due to various reasons, for example:
(i) his shop is nearer to the buyer who does not want to go to the market which is not so near.
(ii) The seller is more trust-worthy for the purchaser than others, and the purchaser has more confidence in him that he will give him the required thing without any defect.
(iii) The seller gives him priority in selling commodities having more demand.
(iv) The atmosphere of the shop of the seller is cleaner and more comfortable than other shops.
(v) The seller is more courteous in his dealings than others.
These and similar other considerations play their role in charging a higher price from the customer. In the same way, if a seller increases the price because he allows credit to his client, it is not prohibited by Shariah if there is no cheating and the purchaser accepts it with open eyes, because whatever the reason of increase, the whole price against a commodity and not against money. It is true that, while increasing the price of the commodity, the seller has kept in view the time of its payment, but once the price is fixed, it relates to the commodity, and not to the time. That is why if the purchaser fails to pay at a stipulated time, the price will remain the same and can never be increased by the seller. Had it been against time, it might have been increased, if the seller allows him more time after the maturity.
To put it another way since money can only be traded in at par value, as explained earlier, any excess claimed in a credit transaction (of money exchange of money) is against nothing but time. That is why if the debtor is allowed more time at maturity, some more money is claimed from him. Conversely, in a credit sale of a commodity, time is not the exclusive consideration while fixing the price.
The price is fixed for the commodity, not for time. However, time may act as an ancillary factor to determine the price of the commodity, like any other factor from those mentioned above, but once this factor has played its role, every part of the price is attributed to the commodity.
The upshot of this discussion is that when the money is exchanged for money, no excess is allowed, neither in cash transaction, nor in credit, but where a commodity is sold for money, the price agreed upon by the parties may be higher than the market price, both in cash and credit transactions. Time of payment may act as an ancillary factor to determine the price of a commodity, but it cannot act as an exclusive basis for and the sole consideration of an excess claimed in exchange of money for money.
This position is accepted unanimously by all the four schools of Islamic law and the majority of the Muslim jurists. They say that if a seller determines two different prices for cash and credit sales, the price of the credit sale being higher than the cash price, it is allowed in Shariah. The only condition is that at the time of the actual sale, one of the two options must be determined, leaving no ambiguity in the nature of the transaction. For example, it is allowed for the seller, at the time of bargaining, to say to purchaser, "If you purchase the commodity on cash payment, the price would be Rs. 100/- and if you purchase it on credit if six months, the price would be Rs. 110/-." But the purchaser shall have to select either of the two options. He should say that he would purchase it on credit for Rs. 110/-. Thus, at the time of the actual sale, the price will be known to both parties.
However, if either of the two options is not determined in specific terms, the sale will not be valid. This may happen in those installment sales in which different prices are claimed for different maturities. In this case the seller draws a schedule of prices according to schedule of payment. For example, Rs. 1000/- are charged for the credit of 3months, Rs. 1100/- for the credit of 6 months, Rs. 1200/- for 9 months and so on. The purchaser takes the commodity without specifying the option he will exercise, on the assumption that he will pay the price in future according to his convenience. This transaction is not valid, because the time of payment, as well as the price, is not determined. But if he chooses one of these options specifically and says, for example,that he purchases the commodity on 6 months credit with a price of 1100/- the sale will be valid.
Another point must be noted here. What has been allowed above is that the price of the commodity in a credit sale is fixed at more than the cash price. But if the sale has taken place at cash price, and the seller has imposed a condition that in case of late payment, he will charge 10% per annum as a penalty or as interest, this is totally prohibited; because what is being charged is not a part of the price; it its an interest charged on a debt.
The practical difference between the two situations is that where the additional amount is a part of the price, it may be charged on a one time basis only. If the purchaser fails to pay it on time, the seller cannot charge another additional amount. The price will remain the same without any addition. Conversely, where the additional amount is not a part of the price it will keep increasing with the period of default.
2. The Use of Interest-Rate as a Benchmark:
Many institutions financing by way of murbahah determine their profit or mark-up on the basis of the current interest rate, mostly using LIBOR (Inter-Bank offered rate in London) as the criterion. For example, if LIBOR is 6%, they determine their mark-up on murabahah equal to LIBOR or some percentage above LIBOR. This practice is often criticized on the ground that profit based on a rate of interest should be prohibited as interest itself.
No doubt, the use of the rate of interest for determining a halal profit cannot be considered desirable. It certainly makes the transaction resemble an interest-based financing, at least in appearance, and keeping in view the severity of prohibition of interest, even this apparent resemblance should be avoided as far as possible. But one should not ignore the fact that the most important requirement for validity of murabahah is that it is a genuine sale with all its ingredients and necessary consequences. If a murabahah transaction fulfils all the conditioned enumerated in this chapter, merely using the interest rate as a benchmark for determining the profit of murabahah does not render the transaction invalid, haram or prohibited, because the deal itself does not contain interest. The rate of interest has been used only as an indicator or as a benchmark. In order to explain the point, let me give an example.
A and B are two brothers. A trades in liquor which is totally prohibited in Shariah. B, being a practicing Muslim dislikes the business of A and starts the business of soft drinks, but he wants his business to earn as much profit as A earns through trading in liquor, therefore he resolves that he will charge the same rate of profit from his customers as A charges over the sale of liquor. Thus he has tied up his rate of profit with the rate used by A in his prohibited business. One may question the propriety of his approach in determining the rate of his profit, but obviously no one can say that the profit charged by him in his halal business is haram, because he used the rate of profit of the business of liquor as a benchmark.
Similarly, so far as the transaction of murabahah is based on Islamic principles and fulfils all its necessary requirements, the rate of profit determined on the basis of the rate of interest will not render the transaction as haram.
It is, however true that the Islamic banks and financial institutions should get rid of this practice as soon as possible, because, firstly, it takes the rate of interest as an ideal for halal business which is not desirable, and secondly because it does not advance the basic philosophy of Islamic economy having no impact on the system of distribution.
Therefore, the Islamic banks and financial institutions should strive for developing their own benchmark. This can be done by creating their own inter-bank market based on Islamic principles. The purpose can be achieved by creating a common pool which invests in asset-backed instruments like musharakah, ijarah, etc. If majority of the assets of the pool is in tangible form, like leased property or equipment, shares in business concerns etc. its units can be sold and purchased on the basis of their net asset value determined on periodical basis. These units may be negotiable and may be used for overnight financing as well. The banks having surplus liquidity can purchase these units and when they need liquidity, they can sell them. This arrangement may create inter-bank market and the value of the units may serve as an indicator for determining the profit in murabahah and leasing also.
3. Promise to Purchase:
Another important issue in murabahah financing which has been subject of debate between the contemporary Shariah scholars is that the bank / financier cannot enter into an actual sale at a time when the client seeks murabahah financing from him, because the required commodity is not owned by the bank at this stage and, as explained earlier, one cannot sell a commodity not owned by him, nor can he effect a forward sale. He is, therefore, bound to purchase the commodity from the supplier, then he can sell it to the client after having its physical or constructive possession.
On the other hand, if the client is not bound to purchase the commodity after the financier has purchased it from the supplier, the financier may be confronted with a situation where he has incurred huge expenses to acquire the commodity, but the client refuses to purchase it. The commodity may be of such a nature that it has no common demand in the market and is very difficult to dispose of. In this case the financier may suffer unbearable loss.
Solution to this problem is sought in the murabahah arrangement by asking the client to sign a promise to purchase the commodity when it is acquired by the financier. Instead of being a bilateral contract of forward sale, it is a unilateral promise from the client which binds himself and not the financier. Being a onesided promise, it is distinguishable from the bilateral forward contract.
This solution is subjected to the objection that a unilateral promise creates a moral obligation but it cannot be enforced, according to Shariah, by the courts of law. This leads us to the question whether or not a one-sided promise is enforceable in Shariah. The general impression is that it is not, but before accepting this impression at its face value, we will have to examine it in the light of the original sources of Shariah.
A thorough study of the relevant material in the books of Islamic jurisprudence would show that the fuqahah (the Muslim jurists) have different views on the subject. Their views may be summarized as follows:
(i) Many of them are of the opinion that 'fulfilling a promise' is a noble quality and it is advisable for the promisor to observe it, and its violation is reproachable, but it is neither mandatory (wajib), nor enforceable through courts. This view is attributed to Imam Abu Hanifah, Imam al-Shafii, Imam Ahmad and to some Maliki jurists. However, as will be shown later, many Hanafis and Malikis and some Shafii jurists do not subscribe to this view.
(ii) A number of the Muslim jurists are of the view that fulfilling a promise is mandatory and a promisor is under moral as well as legal obligation to fulfil his promise. According to them, promise can be enforced through courts of law. This view is ascribed to Samurah b. Jungdub, the well known companion of the Holy Prophet (SW) Umar b. Abdul Aziz, Hasan al Basri, Sa'id b. al-Ashwa, Ishaq b. Rahwaih and Imam al-Bukhari. The same is the view of some Maliki jurists, and it is preferred by Ibn-al-'Arabi and Ibnal-Shat, and endorsed by al-Ghazzali, the famous Shafii jurist, who says the promise is binding, if it is made in absolute terms. The same is the view of Ibn Shubrumah. The third view is presented by some Maliki jurists.
They say that in normal conditions, promise is not binding, but if the promisor has caused the promisee to incur some expenses or undertake some labour or liability on the basis of promise, it is mandatory on him to fulfil his promise for which he may be compelled by the courts.
Some contemporary scholars have claimed that the jurists who have accepted the binding nature of a promise have done so only with regard to unilateral gifts or other voluntary payments, but none of them has accepted the binding nature of a promise to effect a bilateral commercial or monetary transaction. However, based on a close study, this notion does not seem to be correct, because the Maliki and Hanafi jurists have allowed 'Bai ' bil wafa' on the basis of binding promise. Bai'bil wafa' is a special kind of sale whereby the purchaser of an immovable property undertakes that whenever the seller will give him the price back, he will sell the house to him. The question of validity of Bai'bil wafa' has already been discussed in detail in the first chapter while explaining the concept of house financing on the basis of 'diminishing musharakah'. The gist of the discussion is that if repurchase by the seller is made a condition for the original sale, it is not a valid transaction, but if the parties have entered into the original sale unconditionally, but the seller has signed a separate and independent promise to repurchase the sold property, this promise will be binding on the promisor and enforceable through the courts.
The binding nature of the promise in this case has been admitted by both Maliki and Hanafi jurists. Obviously, this promise does not relate to a gift. It is a promise to affect a sale in future. Still, the Maliki and Hanafi jurists have accepted it as binding on the promisor and enforceable through the courts. It is a clear proof of the fact that the jurists who hold the promises to be binding to not restrict it to the promises of gifts etc. The same principle is applicable, according to them, to the promises whereby the promisor undertakes to enter into a bilateral contract in future.
In fact, the Holy Qur'an and the Sunnah of the Holy Prophet (SW) are very particular about fulfilling promises. The Holy Qur'an says:
"And fulfil the covenant. Surely, the covenant will be asked about (in the Hereafter)." (Bani Isra'il :34)
"O those who believe, why do you say what you not do. It invites Allah's anger that you say what you not do." (Al-Saf:2 to 3)
Imam Abu Bakr al-Jassas has said that this verse of the Holy Qur'an indicates that if one undertakes to do something, no matter whether it is a worship or a contract, it is obligatory on him to do it.
The Holy Prophet (SW) is reported to have said:
"There are three distinguishing features of a hypocrite: when he speaks, tells a lie,
when he promises, he backs out and when he is given something in trust, he breaches
the trust."
This is only one example. There is a large number of injunctions in the ahadith of the Holy Prophet (SW) where it is ordained to fulfil the promises and it is clearly prohibited to back out, except for a valid reason.
Therefore, it is evident from these injunctions that fulfilling promise is obligatory. However, the question whether or not a promise is enforceable in courts depends on the nature of the promise. There are certainly some sorts of promises which cannot be enforced through courts. For example, at the time of engagement the parties promise to go through the marriage. These promises create a moral obligation, but obviously they cannot be enforced through courts of law. But in commercial dealings, where a party has given an absolute promise to sell or purchase something and the other party has incurred liabilities on that basis, there is no reason why such a promise should not be enforced. Therefore, on the basis of the clear injunctions of Islam, if the parties have agreed that this particular promise will be binding on the promisor, it will be enforceable.
This is not a question pertaining to Murabahah alone. If promises are not enforceable in the commercial transactions, it may seriously jeopardize commercial activities. If somebody orders a trader to bring from him a certain commodity and promises to purchase it from him, on the basis of which the trader imports it from abroad by incurring huge expenses, how can it be allowed for the former to refuse to purchase it? There is nothing in the Holy Qur'an or Sunnah which prohibits the making of such promises enforceable.
It is only on these grounds that the Islamic Fiqh Academy Jeddah has made the promises in commercial dealings binding on the promisor with the following conditions:
(i) it should be one-sided promise.
(ii) The promise must have caused the promisee to incur some liabilities
(iii) If the promise is to purchase something, the actual sale must take place at the appointed time by the exchange of offer and acceptance. Mere promise itself should not be taken as the concluded sale.
(iv) If the promisor backs out of his promise, the court may force him either to purchase the commodity or pay actual damages to the seller. The actual damages will include the actual monetary loss suffered by him, but will not include the opportunity cost.
On this basis, it is allowed that the client promises to the financier that he will purchase the commodity after the latter acquires it from the supplier. This promise will be binding on him and may be enforced through courts in the manner explained above. This promise does not amount to the actual sale. It will be simply a promise and the actual sale will take place after the commodity is acquired by the financier for which exchange of offer and acceptance will be necessary.
4. Securities Against Murabahah Price:
Another issue regarding murabahah financing is that the murabahah price is payable at a later date. The seller/financier naturally wants to make sure that the price will be paid at the due date. For this purpose, he may ask the client to furnish a security to his satisfaction. The security may be in the form of a mortgage or a hypothecation or some kind of lien or charge. Some basic rules about this security must, therefore, be kept in mind.
(i) The security can be claimed rightfully where the transaction has created a liability or a debt. No security can be asked from a person who has no incurred a liability or debt. As explained earlier, the procedure of murabahah financing comprises of different transactions carried out at different stages. In the earlier stages of the procedure, the client does not incur a debt. It is only after the commodity is sold to him by the financier on credit that the relationship of a creditor and a debtor comes into existence.
Therefore, the proper way in a transaction of murabahah would be that the financier asks for a security after he has actually sold the commodity to the client and the price has become due on him, because at this stage the client incurs a debt. However, it is also permissible that the client furnishes a security at earlier stages, but after the murabahah price is determined. In this case, if the security is possessed by the financier, it will remain at his risk meaning thereby that if it is destroyed before the actual sale to the client, he will have either to pay the market price of the mortgaged asset, and cancel the agreement of murabahah, or sell the commodity required by the client and deduct the market price of the mortgaged asset from the price of the sold property.
(ii) It is also permissible that the sold commodity itself is given to the seller as a security. Some scholars are of the opinion that this can only be done after the purchaser has taken its delivery and not before. It means that the purchaser shall take its delivery, either physical or constructive, from the seller, then give it back to him as mortgage, so that the transaction of mortgage is distinguished from the transaction of sale. However, after studying the relevant material, it can be concluded that the earlier jurists have put this condition in cash sales only and not in credit sales.
Therefore, it is not necessary that the purchaser takes the delivery of the sold property before he surrenders it as mortgage to the seller. The only requirement would be that the point of time whereby the property is held to be mortgaged should necessarily be specified, because from that point of time, the property will be held by the seller in a different capacity which should be clearly earmarked. For example, A sold a car to B on first of January for a price of Rs. 500,000/- to be paid on 30th June. A asked B to give a security for payment at the due date. B has not yet taken delivery of the car and he offered to A that he should keep the car as mortgage from 2nd January. If the car is destroyed before 2nd January the sale will be terminated and nothing will be payable by B. But if the car is destroyed after the second of January, sale is not terminated, but it will be subject to the rules prescribed for the destruction of a mortgage. According to Hanafi jurists, in this case, the seller will have to bear the loss of the car, to the extent of its market price or its agreed sale price, whichever is lesser. Therefore, if the market price of the car was 450,000/- he can claim only the remaining part of the agreed sale price (i.e.Rs.50,000/-in the above example) . If the market price of the car is Rs. 500,000/- or higher, nothing can be claimed from the purchaser.
This is the view of the Hanafi school. The Shafii and Hanbali jurists hold that if the car is destroyed by the negligence of the mortgagee, he will have to bear the loss, according to its market price, but if the car is destroyed without any fault on his part, he will not be liable to anything, and the purchaser will bear the loss and will have to pay the full price.
It is clear from the above example that the possession of A over the car as a seller carries effects and consequences different from his possession as a mortgagee and therefore it is necessary that the point of time on which the car is held by him as a mortgagee should clearly be defined. Otherwise different capacities will be mixed up giving rise to dispute and rendering the security invalid.
5. Guaranteeing the Murabahah:
The seller in a murabahah financing can a so ask the purchaser/client to furnish a guarantee from a third party. In case of default in the payment of price at the due date, the seller may have recourse to the guarantor, who will be liable to pay the amount guaranteed by him. The rules of Shariah regarding guarantee are fully discussed in the books of Islamic fiqh. However, I would point out to two burning issues in the context of Islamic banking.
(i) The guarantor in the contemporary commercial atmosphere does not normally guarantee a payment without a fee charged from the original debtor. The classical Fiqh literature is almost unanimous on the point that the guarantee is a voluntary transaction and no fee can be charged on a guarantee. The most the guarantor can do is to claim his actual secretarial expenses incurred in offering the guarantee, but the guarantee itself should be free of charge. The reason for this prohibition is that the person who advances money to another person as a loan cannot charge a fee for advancing a loan, because it falls under the definition of riba, or interest which is prohibited. The guarantor should be subject to this prohibition all the more, because he does not advance money. He only undertakes to pay a certain amount on behalf of the original debtor in case he defaults in payment. If the person who actually pays money cannot charge a fee, how can fee be charged by a person who has merely undertaken to pay and did not pay anything in actual terms?
Suppose, A has borrowed 100 US dollars from B who asked him to produce a guarantor. C says to A, "I pay off your debt to B right now, but you will have to pay me 110 dollars at a later date." Obviously 10 dollars charged from A are not allowed, being interest. Then D comes to A and says, "I stand as a guarantor to you, but you will have to pay me 10 dollars for this service."
If we allow to charge a fee for guarantee, it will mean that C cannot charge 10 dollars despite the fact that he has actually paid the amount, and D can charge 10 dollars, despite the fact that he has merely committed to pay only when A fails to pay. This being unfair apparently, the Muslim jurists have forbidden the charging of a fee for guarantee, so that both C and D, in the above example, may stand on equal footing.
(ii) However, some contemporary scholars are considering the problem from a different angle. They feel that guarantee has become a necessity, especially in international trade where the sellers and the buyers do not know each other, and the payment of the price by the purchaser cannot be simultaneous with the supply of the goods. There has to be an intermediary who can guarantee the payment. It is utterly difficult to find the guarantors who can provide this service free of charge in required numbers. Keeping these realities in view, some Shariah scholars of our time are adopting a different approach. They say the prohibition of guarantee fee is not based on any specific injunction of the Holy Qur'an or the Sunnah of the Holy Prophet (SW). It has been deducted from the prohibition of riba as one of its ancillary consequences. Moreover, guarantees in the past were of a simple nature. In today's commercial activities, the guarantor sometimes needs a number of studies and a lot of secretarial work. Therefore, they opine, the prohibition of the guarantee fee should be reviewed in this perspective. The question still needs further research and should be placed before a larger forum of scholars.
However, unless a definite ruling is given by such a forum, no guarantee fee should be charged or paid by an Islamic financial institution. Instead they can charge or pay a fee to cover expenses incurred in the process of issuing a guarantee.
6. Penalty of Default:
Another problem in murabaha financing is that if a client defaults in payment of the price at the due date, the price cannot be increased. In interest-based loans, the amount of loan keeps on increasing according to the period of default. But, in murabahah financing, once the price is fixed, it cannot be increased. This restriction is sometimes exploited by dishonest clients who deliberately avoid to pay the price at its due date, because they know that they will not have to pay any additional amount on account of default.
This characteristic of murabahah should not create a big problem in a country where all banks and financial institutions are run on Islamic principles, because the government or the central bank may develop a system where such defaulters may be penalized by depriving them from obtaining any facility from any financial institution. This system may serve as deterrent against deliberate defaults.
However, in the countries where the Islamic banks and financial institutions are working in isolation from the majority of financial institutions run on the basis of interest, this system can hardly work, because even if the client is deprived to avail of a facility from an Islamic bank, he can approach the conventional institutions.
In order to solve this problem, some contemporary scholars have suggested that the dishonest clients who default in payment deliberately should be made liable to pay compensation to the Islamic bank for the loss it may have suffered on account of default. They suggest that the amount of this compensation may be equal to the profit given by that bank to its depositors during the period of default. For example, the defaulter has paid the price three months after the due date. If the bank has given to its depositors a profit at the rate of 5%, the client has to pay 5% more as compensation for the loss of the bank. However, the scholars who allow this compensation make it subject to the following conditions.
(i) The defaulter should be given a grace period of at least one month after the maturity date during which he must be given weekly notices warning him that he should pay the price, otherwise he will have to pay compensation.
(ii) It is proved beyond doubt that the client is defaulting without valid excuse. If it appears that his default is due to poverty, no compensation can be claimed from him. Indeed, he must be given respite until he is able to pay, because the Holy Qur'an has expressly said:
"And if he (the debtor) is short of funds, then he must be given respite until he is well off." (2:280)
(iii) The compensation is allowed only if the investment account of the Islamic bank has earned some profit to be distributed to the depositors. If the investment account of the bank has not earned profit during the period of default, no compensation shall be claimed from the client.
This concept of compensation, however, is not accepted by the majority of the present day scholars (including the author). It is the considered opinion of such scholars that this suggestion neither conforms to the principles of Shariah nor is it able to solve the problem of default.
First of all, any additional amount charged from a debtor is riba. In the days of jahiliyyah (before Islam) the people used to charge additional amounts from their debtors when they were not able to pay at the due date. They used to say: "Either you pay off your debt or you increase the payable amount."
The aforementioned suggestion of paying compensation to the credit/seller resembles the same attitude. It can be argued that the above suggestion is theoretically different from the practice of jahilliyah in that the suggestion is to grant the debtor a grace period of one month to make sure that he is avoiding payment without a valid cause and to exempt him from compensation if it appears that his non-payment is due to poverty or hardship. But in practical application of the concept, these conditions are hardly fulfilled, because every debtor may claim that his default is due to his financial inability at the due date, and it is very difficult for a financial institution to hold an inquiry about the final acquisition of each client and to verify whether or not he was able to pay.
What the banks normally do is that they presume that every client was able to pay unless he has been declared as bankrupt or insolvent. It means that the concession allowed in the suggestion can be enjoyed by the insolvent people. Obviously, insolvency is a rare phenomenon, and in this rare situation, even the interest-based banks cannot normally recover interest from the borrower. Therefore, the suggestion leaves no practical and meaningful difference between an interest based financing and an Islamic financing.
So far as grace period is concerned, it is a minor concession which is sometimes given by the conventional banks as well. Once again, in practical terms, there is no material difference between interest and the late payment charged as compensation.
It is argued in favour of charging compensation that the Holy Prophet (PBUH) has condemned the person who delays the payment of his dues without a valid cause. According to the well-known hadith he has said:
"The well off person who delays the payment of his debt, subjects himself to punishment and disgrace."
The argument runs that the Holy Prophet (PBUH) has permitted to inflict a punishment on such a person. The punishments may be of different kinds, including the imposition of a monetary penalty. But this argument overlooks the fact that even if it is assumed that imposing fine or a monetary penalty is allowed in the Shar'iah, it is imposed by a court of law and is normally paid to the government. Nobody has allowed a situation where an aggrieved party imposes a fine on its own (and for its own benefit) without a judgement of a court, competent to decide the matter.
Moreover, had it been a recognized punishment, it should have been imposed even if the investment account has earned no profit during that period, because the guilt of the defaulter is established and it has no nexus with the profit of the investment account of the bank.
In fact, the suggestion of the compensation equal to the rate of profit of the investment account is based on the concept of opportunity cost of money. This concept is foreign to the principles of Shar'iah. Islam does not recognize opportunity cost of money, because after the elimination of interest from the economy, money has no definite return. It is always exposed to loss as well as it has the ability to earn a profit. And it is the risk of loss which makes it entitled to gain a return.
Another point is worth the attention. The one who defaults in the payment of debt is, at the most, like a thief or a usurper. But the study of the rules prescribed for theft and usurpation would show that a thief has been subjected to a very severe punishment of amputating his hands, but he was never asked to pay an additional amount to compensate the victim of theft. Similarly, if a person has usurped the money of another person, he may be punished by the way of ta'zier, but no Muslim jurist has ever imposed on him a financial penalty to compensate the owner.
Imam al-Shafi'i is of the view that if someone usurps the land of another person, he will have to pay the rent of the land according to the market rate. But if he has usurped the money, he will return the equal amount of money and not more. All these rules go a long way to prove that the opportunity cost of money is never recognized by the Islamic Shar'iah, because, as explained above, money has no definite return or any intrinsic utility.
On the basis of what is stated above, the idea of compensation to be charged from a defaulter is not approved by most of the contemporary scholars. The question was thoroughly discussed in the annual session of the Islamic Fiqh Academy, Jeddah, and it was resolved that no such compensation is allowed in Shar'iah.
All this discussion relates to the impermissibility of the proposed compensation in Shar'iah. Now it is to be noted that this proposal does not solve the problem of default at all. To the contrary, it may encourage the debtors to commit as much default as they wish. The reason is that, according to this suggestion, the defaulter is asked to pay compensation equal to the return earned by the depositors during the period of default. It is evident that the rate of return earned by the depositors is always less than the rate of profit paid by the customer in a Murabahah transaction. Therefore, the customer will be paying after default, much less than he was paying before the default. Therefore, he would willingly accept to pay this amount and not pay the amount of price which he will invest in a more profitable activity. Suppose the rate of profit agreed in a murabahah transaction of six months is 15% p.a. and the rate of profit declared to the depositors is 10% p.a. It means that if the client withholds the price of murabahah after its maturity date and keeps it for another six months, he will have to pay the compensation at the rate of 10% p.a. which is much less than the rate of original murabahah (i.e. 15%). As such he will default and enjoy another facility for the next six months at a lesser rate.
This proposal, therefore, is not only against Sha'riah, but also deficient in meeting the problem of default.
The Alternative Suggestion:
The question now arises as to how the banks and financial institutions may solve this problem. If nothing is charged from the defaulters, it may be a greater incentive for a dishonest person to default continuously. Here is the answer to this question:
We have already mentioned that the real solution to this problem is to develop a system where the defaulters are duly punished by depriving them from enjoying a financial facility in future. However, as commented earlier, this may be only where the whole banking system is based on Islamic principles, or the Islamic banks are given due protection against defaulters. Therefore, a time when this goal is reached, we may need some other alternative. For this purpose it was suggested that the client, when entering into a murabahah transaction, should undertake that incase he defaults in payment at the due date, he will pay a specified amount to a charitable fund maintained by the bank. It must be ensured that no part of this amount shall form part of the income of the bank.
However, the bank may establish a charitable fund for this purpose and all amounts credited therein shall be exclusively used for purely charitable purpose approved by the Shar'iah. The bank may also advance interest-free loans to the needy persons from this charitable fund.
This purpose is based on a ruling given by some Maliki jurists who say that if a debtor is asked to pay an additional amount in case of default, it is not allowed by Shar'iah, because it amounts to charging interest. However, in order to assure the creditor of prompt payment, the debtor may undertake to give some amount in charity incase of default. This is, in fact, a sort of Yamin (vow) which is self-imposed penalty to keep oneself away from default. Normally, such 'vows' create a moral or religious obligation and are not enforceable through courts. However, some Maliki jurists allow can be made it justiceable, and there is nothing in the Holy Qur'an or the Sunnah of the Holy Prophet (PBUH) which forbids making this 'vow' enforceable through the courts of law.
Therefore, in cases of genuine need, this view can be acted upon. But, while implementing this proposal, the following points must be kept in mind.
i. The proposal is meant only to pressurize the debtors on paying their dues promptly and not to increase the income of the creditor/financier, nor to compensate him for his opportunity cost. Therefore, it must be ensured that no part of the penalty forms part of the income of the bank in any case, nor can it be used to pay taxes or set-off any liability of the financier.
ii. Since the amount of penalty is not deserved by the financier as his income, but it goes to charity, it may be any amount willfully undertaken by the debtor. It can also be determined on percent per annum basis. Therefore, it may serve as a real deterrent against deliberate default, unlike the former suggestion of compensation which, as explained earlier, may tend to encourage the defaults.
iii. Since the penalty undertaken by the client is originally a self-undertaken vow, and not the penalty charged by the financier, the agreement should reflect this concept. Therefore, the proper wording of the penalty clause would be on the following pattern:
"The client hereby undertakes that if he defaults in payment of any of his dues under this agreement, he shall pay to the charitable account/fund maintained by the Bank/Financier a sum calculated on the basis of …% per annum for each day of the default unless he establishes through the evidence satisfactory to the Bank/Financier that his nonpayment at the due date was caused due to poverty or some other factors beyond his control".
iv. Give the stipulated amount to any charity of his own choice, but in order to ensure that he will pay, the charitable account or fund maintained by the financier/bank is specified in the proposed undertaking. This specific undertaking does not violate any principle of the Shar'iah. However, it is necessary that the bank or the financial institution maintains a separate fund, or at least, a separate account for this purpose and the amounts credited to that account must be spent in well-defined charities known to the client/debtor. This proposal has now been implemented successfully in a large number of Islamic financial institutions.
7. No Roll-Over in Murabahah:
Another rule which must be remembered and fully compiled with is that the murabahah transaction cannot be rolled over for a further period. In an interest-based financing, if a customer of the bank cannot pay at the due date for any reason, he may request the bank to extend the facility for another term. If the bank agrees, the facility is rolled over on the terms and conditions mutually agreed at that point of time, whereby the newly agreed rate of interest is applied to the new term. It actually means that another loan of the same amount is readvanced to the borrower.
Some Islamic banks or financial institutions, who misunderstood the concept of murabahah and took it as merely a mode of financing analogous to an interestbased loan, started using the concept of roll-over to murabahah also. If the client requests them to extend the maturity date of the murabahah, they roll it over and extend the period of payment on an additional mark-up charged from the client which practically means that another separate murabahah is booked on the same commodity. This practice is totally against the well-settled principles of Shar'iah. It should be clearly understood that murabahah is not a loan. It is the sale of a commodity the price of which is deferred to a specific date. Once the commodity is sold, its ownership is passed onto the client. It is no more the property of the seller. What the seller can legitimately claim is the agreed price which has become a debt payable by a buyer. Therefore, there is no question of affecting another sale on the same commodity between the same parties. The roll-over in murabahah is nothing but interest-pure and simple-because it is an agreement to charge an additional amount on the debt created by the murabahah sale.
8. Rebate on Earlier Payment:
Sometimes the debtor wants to pay earlier than the specified date. In this case he wants to earn a discount on the agreed deferred price. Is it permissible to allow him a rebate for his earlier payment? This question has been discussed by the classical jurists in detail . The issue is known in the Islamic legal literature as (Give the discount and recieve soon). Some earlier jurists have held this arrangement as permissible, but the majority of the Muslim jurists, including the four recognized schools of Islamic jurisprudence do not allow it, if the discount is held to be a condition for earlier payment.
The view of those who allow this arrangement is based on a hadith in which Abdullah ibn 'Abbas is reported to have said that when the Jews belonging to the tribe of Banu Nadir were banished from Madinah (because of their conspiracies) some people came to the Holy Prophet (PBUH) and said , " You have ordered them to been expelled, but some people owe them some debts which have not matured". Thereupon the Holy Prophet (PBUH) said to them (i.e., the Jews who were the creditors):
"Give discount and receive (your debts) soon."
The majority of the Muslim jurists, however, do not accept this hadith as authentic. Even Imam al-Baihaqi, who has reported this hadith in his book, has expressly admitted that this is a weak narration. Even if the hadith is held to be authentic, the exile of Banu Nadir was in the second year after hijrah, when riba was not yet prohibited.
Moreover, al-Waqidi has mentioned that Banu Nadir used to advance usurious loans. Therefore, the arrangement allowed by the Holy Prophet (SW) was that the creditors forego the interest and the debtors pay the principle sooner. Al-Waqidi has narrated that Sallam b. Abu Huqaiq, a Jew of Banu Nadir, is had advanced eighty dinars to Usaid ibn Hudayr payable after one year with an addition of 40 dinars. Thus, Usaid owed him 120 dinars after one year. After this arrangement, he paid the principle amount of 80 dinars and Sallam withdrew from the rest. For these reasons, the majority of the jurists hold that if the earlier payment is conditioned with discount, it is not permissible. However, if this is not taken to be a condition for earlier payment, and the creditor gives a rebate voluntarily on his own, it is permissible.
The same view is taken by the Islamic Fiqh Academy in its annual session. It means that in a murabahah transaction effected by an Islamic bank or financial institution, no such rebate can be stipulated in the agreement, nor can the client claim it as his right. However, if the bank or a financial institution gives him a rebate on its own, it is not objectionable, especially where the client is a needy person. For example, if a poor farm has purchased a tractor or agricultural inputs on the basis of murabahah, the bank should give him a voluntarily discount.
9. Calculation of Cost in Murabahah:
It is already mentioned that the transaction of murabahah contemplates the concept of cost-plus sale, therefore, it can be effected only where 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, no murabahah can be possible. In this case, the sale must be effected on the basis of musawamah (i.e. sale without reference to cost).
This principle leads to another rule: the murabahah transaction should be based on the same currency in which the seller has purchased the commodity from the original supplier. If the seller has purchased it for Pakistani rupees, the onward sale to the ultimate purchaser has occurred in U.S. dollars, the price of murabahah should be based on dollars as well, so that the exact cost may be ascertained.
However, in the case of international trade, it may be difficult to base both purchases on the same currency. If the commodity intended to be sold to the customer is imported from a foreign country, while the ultimate purchaser is in Pakistan, the price of the original sale has to be paid in a foreign currency and the price of the second sale will be determined in Pak. Rupees.
This situation may be met with in two ways. Firstly, if the ultimate purchaser agrees and the laws of the country allow, the price of the second sale may also be determined in dollars.
Secondly, if the seller has purchased the commodity by converting Pakistani Rupees into dollars, the exact amount of Pak rupees paid by the seller to convert them into dollars can be taken as the cost price and the profit of murabahah can be added thereon.
In some cases, the bank purchases the commodity from abroad at a price payable after three months or in different installments, and sells the commodity to his client before he pays the full price to the supplier. Since he pays the price in dollars, its equivalent in Pakistani Rupees are not known at the time when the commodity is sold to the client. Due to fluctuation in the price dollars in Pak Rupees, the bank may have to pay more than anticipated at the time of murabahah sale. For example, the rate of U.S. dollars at the time of murabahah was Rs. 40/- for one dollar. The price of murabahah was settled according to this rate, but when the bank paid the price to the supplier, the dollar rate increased to Rs. 41/- for one dollar, meaning thereby that the cost of the bank increased by 2.5%. In order to meet this situation, some financial institutions put a condition in the murabahah agreement that in case of such fluctuation in currency rates, the client shall bear the additional cost. According to the classical Muslim jurists, murabahah based on this condition is not valid because it leads to uncertainty of the price at the time of sale. Such uncertainty continues upto a date after three months when the buyer actually pays the price to the supplier. Such uncertainty renders the transaction invalid. Therefore, there are following options open to the bank in this issue:
i. The bank should purchase that commodity on the basis of L/C at sight and should pay the price to the supplier before effecting sale with the customer. In this case no question of fluctuation in currency rates will be involved. The murabahah price can be determined on the basis of the market rate of dollars on the date when the bank has paid the price to the supplier.
ii. The bank determines the murabahah price in US dollars rather than in Pak rupees, so that the deferred murabahah price is paid by the customer in dollars. In this case the bank will be entitled to receive dollars from the customer and the risk of the fluctuation in dollar's price will be borne by the purchaser.
iii. Instead of murabahah, the deal may be on the basis of musawamah (a sale without reference to the cost of the seller) and the price may be fixed as to cover the anticipated fluctuation in the currency rates.
10. Subject-Matter of Murabahah:
All commodities which may be subject matter of sale with profit can be subject matter of murabahah, because it is a particular kind of sale. Therefore, the shares of a lawful company may be sold or purchased on murabahah basis, because according to the Islamic principles, the shares of a company represent the holder's proportionate ownership in the assets of the company. If the assets of a company can be sold with profit, its shares can also be sold by way of murabahah. But it goes without saying that the transaction must fulfill all the basic conditions, already discussed, for the validity of a murabahah transaction.
Therefore, the seller must first acquire the possession of the shares with all their rights and obligations, and then sell them to his client. A buy back arrangement or selling the shares without taking their possession is not allowed at all. Conversely, no murabahah can be effected on things which cannot be subject matter of sale, For example murabahah is not possible in exchange of currencies, because it must be spontaneous or, if deferred, on the marginal rate prevalent on the date of transaction. Similarly, the commercial papers representing a debt receivable by the holder cannot be sold or purchased except at par value, and therefore no murabahah can be effected in respect of such papers. Similarly, any paper entitling the holder to receive a specified amount of money from the issuer cannot be negotiated. The only way of its sale is to transfer if for its face value.
Therefore, they cannot be sold on murabahah basis.
11. Rescheduling of the Payments in Murabahah:
If the purchaser/client in murabahah financing is not able to pay according to the dates agreed upon in the murabahah agreement, he sometimes requests the seller/ the bank for rescheduling the installments. In conventional banks, the loans are normally rescheduled on the basis of additional interest. This is not possible in murabahah payments. If the installments are rescheduled, no additional amount can be charged for rescheduling. The amount of murabahah price will remain the same in the same currency.
Some Islamic banks proposed to reschedule the murabahah price in a hard currency different from the one in which the original sale took place. This was proposed to compensate the bank through appreciation of the value of the hard currency. Since this benefit was proposed to be drawn from rescheduling, it is not permissible. Rescheduling must always be on the basis of the same amount in the same currency. At the time of payment however, the purchaser may pay with the consent of the seller, in a different currency on the basis of the exchange rate of that day (i.e. the day of payment) and not the rate of the date of transaction.
12. Securitization of the Murabahah:
Murabahah is a transaction which cannot be securitized for creating a negotiable instrument to be sold and purchased in the secondary market. The reason is obvious. If the purchaser/client in a murabahah transaction signs a paper to evidence his indebtedness towards the seller/financier, the paper will represent a monetary debt receivable from him. In other words, it represents money payable by him. Therefore the transfer of this paper to a third party will mean the transfer of money. It has already been explained that where money is exchanged for money (in the same currency) the transfer may be at par value. It cannot be sold or purchased at a lower or higher price. Therefore, the paper representing a monetary obligation arising out of a murabahah transaction cannot create a negotiable instrument . If the paper is transferred, it must be at par value.
However, if there is a mixed portfolio consisting of a number of transactions like musharakah, leasing and murabahah, then this portfolio may issue negotiable certificates subject to certain conditions more fully discussed in the chapter of "Islamic funds".
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