Islamic Fiance: Some misperceptions about Murabaha

There are some misperceptions about Murabaha and it's important that we discuss them. It will help us understand that the function of Murabaha does not violate Sharia principles in any manner whatsoever.
By Sohail Zub airi January 27, 2003

There are some misperceptions about Murabaha and it's important that we discuss them. It will help us understand that the function of Murabaha does not violate Sharia principles in any manner whatsoever. Why different prices for cash and credit sale under a Mura-baha transaction? An Islamic bank deals in goods under Murabaha in different ways. In case of establishing a letter of credit on customer's behalf, the goods upon receipt could be delivered to the customer against cash downpayment, which inclu-des usual fee and commission besides some exchange profit. On the other hand, bank can also allow a customer to settle the amount upon completion of the agreed period. The price of goods under Murabaha, in case of allowing deferred payment terms to the customer, is always higher then when he pays cash. Some quarters argue that increasing the price of Murabaha goods for the deferred payment period is akin to charging the interest. Let us examine this issue for our better understanding. Please keep in mind that, according to Sharia, money and commodity have different characteristics and therefore, they are treated differently. The owner of a commodity is at liberty to set the price and the buyer too has his own free will whether to buy the commodity at a certain price. As such, an additional amount charged on payment being made on deferred basis will be considered interest only when the subject matter is money on both sides, e.g. a loan. 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 taken by the buyer in settling the amount. This is because if the seller would have got the spot payment, he was in a position to re-invest it immediately in the other goods and earn more profit. By allowing time to the buyer for payment, he is getting deprived of that additional profit. On the other hand, buyer willingly takes it upon himself to compensate the seller for such lost profit. Therefore, it is not prohibited by Sharia to set different prices of the same commodity if sold on cash or deferred payment basis provided the buyer has accepted either of the price willingly since the agreed price is against a commodity and not against money. However, the most important aspect which differentiates an Islamic bank from a conventional one is that once the price is fixed, it can not be changed irrespective of whether the buyer pays in time or defaults. This position is accepted unanimously by all schools of Islamic jurisprudence and majority of the Muslim jurists. Why use an interest rate as benchmark? We have discussed it earlier in this column that benchmarking of Murabaha profit, or profit for any Islamic financing product for that matter, is based on various cogent reasons such as wider understanding of the interest rate benchmarks in the region, the absence of an Islamic profit benchmark and the fear on the part of the customer for ending up paying higher than the market. The most essential requirement for validity of a Murabaha transaction is the existence of genuine sale with all ingredients enumerated in the last week's column. Therefore, merely the use of interest rate as benchmark for determining the profit does not render the transaction invalid because the deal itself does not contain the element of interest. Why promise to purchase? It has been the subject of debate that the bank should not enter into an actual sale at a time when the client seeks Murabaha finan-cing from it simply because the required commodity is not owned by the bank at that stage.

This argument stems from the principle that one cannot sell a commodity not owned by him, nor can he effect a forward sale under Sharia. Obtaining promise to purchase from the client, therefore, tantamount to forward sale and should therefore be avoided. Imagine the situation where a bank enters into a Murabaha transaction with a customer without having obtained promise to purchase. The bank buys the commodity on behalf of client who fails to turn up to purchase it from the bank. The bank is now stuck with the goods which may be costly and have specific use and hence difficult to dispose of. It is therefore, vital to bind the customer by way of obtaining promise to purchase at the time of entering into Murabaha transaction in order to safeguard bank's interest. It is important to understand that the promise to purchase is not a bilateral contract as required in forward sale in conventional banking environment. It is simply a unilateral promise from the client which binds him and not the bank. Being a one-sided promise, it is easily distinguishable from the bilateral forward sale contract. This leads to another argument that a unilateral promise only creates a moral obligation but it cannot be enforced. Can a one-sided promise is enforceable in Sharia? In short, the answer is yes, since Sharia implies high importance to fulfilling the promise irrespective of the circumstances faced by the promisor. Could there be a rollover in Murabaha? Some people consider that Murabaha could be rolled over by adding the profit for the extended period if the buyer agrees to bear it. This contention is incorrect. A Murabaha transaction cannot be rolled over for a further period as it belongs to a specific commodity which has already been sold and hence can not be sold twice. It needs to be clearly understood that Murabaha is not a loan transaction but the sale of a commodity the price of which is deferred to a specific date. Once the commodity is sold, its ownership is passed on to the client irrespective of the terms of payment. Hence it is no more the property of the seller. As such how can the bank sell a commodity which is not owned by it? Will an Islamic bank allow rebate on earlier payment of Murabaha? The question in the minds of many people is whether they can earn a discount by paying the Murabaha amount earlier than it is due? This issue has been discussed by the Sharia scholars in detail, concluding that since Murabaha represents sale of a specific commodity, the price of which is a settled issue, there can be no rebate or discount on voluntary early payment by the buyer. A majority of jurists opine that if the early payment is conditioned with discount, it is not permissible. However, if the rebate is not an attraction for prepayment, and the bank gives an allowance voluntarily, it may be permissible under Sharia. What needs to be understood is that the customer can not claim it to be his right and hence it can not be made a condition of the Murabaha agreement.