University of Nairobi Fundamentals of Islamic Finance 2022

UNIVERSITY OF NAIROBI
SCHOOL OF BUSINESS
DEPARTMENT OF FINANCE AND ACCOUNTING
BACHELOR OF SCIENCE IN FINANCE DEGREE PROGRAMME

FUNDAMENTALS OF ISLAMIC FINANCE

DFI 212

Saturday, Nov 2022

DFI 212 MURABAHA

University of Nairobi Fundamentals of Islamic Finance 2022

MURABAHA
MURABAHA
Literally, the word Murabaha is derived from the word ‘ribh’, which means profit or gain.
Technically, it is defined as the sale of a commodity at the price the seller has purchased it,
with the addition of a stated profit known to both the seller and buyer. In short, the seller
expressly discloses the profit in a cost – plus – profit sale.

The only feature distinguishing it from the other kinds of sale is that the seller in Murabaha
expressly tells the purchaser how much cost he has incurred and how much profit he is going
to charge in addition to the cost. Due to the special nature of Murabaha, jurists have
considered it as a sale based on trust.

LEGALITY
The legality of Murabaha can be traced from Qur’an, Sunnah and the majority of Muslim
Jurists. In the Qur’an Allah (s.w.t) has generally legalized sale contract, one of which is the
Murabaha contract. He says “O you who believe, Eat not up your property among,
yourselves unjustly except if it is a trade amongst yourselves, by mutual consent.” (4:
29) In this regard, a Murabaha contract is a contract concluded based on mutual consent, and
hence, it falls under the general permission of acquiring wealth in this verse.

DFI 212 MURABAHA

University of Nairobi Fundamentals of Islamic Finance 2022

CONDITIONS
The following conditions are important elements of Murabaha;-
A. Subject Matter
Subject matter of a Murabaha transaction involves the product and the selling price.
The product, which is the object of sale in this transaction, shall be clearly defined
including its type, quantity and other descriptions. Murabaha being a sale and not a
loan and cannot be used as a mode of financing except where the client needs
funds to actually purchase some commodities. (It requires a real sale)

i. The cost price must be disclosed to the contracting parties

The act of concealing the cost price and the profit earned in a Murabaha
transaction without the customer’s knowledge will render the transaction null
and void. Knowing the price is a condition of validity of a sale contract. If the
buyer does not know the original price, then the Murabaha contract is
deemed voidable (fasid) until it is disclosed.

ii. The mark – up (profit) must be disclosed to the contracting party

Since the profit constitutes part of the selling price, it must be agreed upon
between the contracting parties in the contract because the selling price,
which includes the original price and the mark – up, is actually a condition of
validity of the sale contract.

iii. The original price should be of fungible things

The price in a Murabaha contract should be of a fungible property such as
the approximate (mutaqaribah), weighable (muwazunat), measurable
(makilat) and countable (adadiyat)

iv. Validity of Initial contract

The seller through a valid contract must acquire an item that is sold through
a Murabaha contract. If the initial contract is voidable (fasid), then the
second sale is not permitted to be contracted on the basis of Murabaha
because the Murabaha contract is actually the resale of a commodity at a
similar price with cost plus

DFI 212 MURABAHA

University of Nairobi Fundamentals of Islamic Finance 2022

B. The Contracting Parties

It involves the seller as the financier and the buyer as the customer. In the Murabaha
contract, these two parties are important because they are the principle players in
the business transaction.

C. Offer and Acceptance

The contract must consist of offer and acceptance. The contract shall contain two
important elements, which are the cost price of the product and the rate of profit
a. Knowledge of the initial price or cost by the buyer. The buyer must know the
price at which the seller obtained the object of sale, since knowledge of the
price is a fundamental condition for the validity of a Murabaha sale
b. Knowledge of the profit margin. The profit margin is a component of the price
at which the buyer obtains the item, knowledge of that margin is essential
otherwise it will not be regarded as Murabaha, rather it is a normal sale.

DFI 212 MURABAHA

University of Nairobi Fundamentals of Islamic Finance 2022

Steps For Murabaha Financing

a. The client and the institution sign a master agreement whereby the institution
promises to sell and the client promises to buy the commodities on agreed ratio of
profit added to the cost

b. When the customer requires a specific commodity, the institution appoints the client
as his agent for purchasing the commodity on its behalf, and both parties sign an
agreement of agency.

c. The client purchases the commodity on behalf of the institution and takes possession
as an agent of the institution

d. The client informs the institution that he has purchased the commodity on his behalf,
and at the same time, makes an offer to purchase it from the institution

e. The institution accepts the offer and the sale is concluded whereby the ownership as
well as the risk of the commodity is transferred to the client.

i. If the institution purchases the commodity directly from the supplier, it

does not need any agency agreement, in this case, the second phase will
be dropped and the third stage the institution itself will purchase the
commodity from the supplier
ii. The most essential element of the transaction is that the commodity must
remain in the risk of the institution during the period between the third and
the fifth stages.

DFI 212 MURABAHA

University of Nairobi Fundamentals of Islamic Finance 2022

Legal Capacity
a. At the first stage, the institution and the client promise to sell and purchase a
commodity in future, this is not an actual sale. It is just a promise to affect a sale in
future on Murabaha basis. Thus at this stage the relationship between the institution
and the client is that if a promisor and promise.

b. At the second stage, the relationship between the parties is that of a principal and
an agent

c. At the third stage, the relationship between the institution and the supplier is that of a
buyer and seller

d. At the fourth and fifth stages, the relationship of buyer and seller comes into
operation between the institution and the client, and since the sale is effected on a
deferred payment basis, the relation of debtor and creditor also emerges between
them simultaneously

DFI 212 MURABAHA

University of Nairobi Fundamentals of Islamic Finance 2022

Types of Murabaha Contract

Murabaha contract comprises the following two types
Ordinary Murabaha
It is a contract in which the seller who is an ordinary trader buys a commodity
without relying on any prior promise to purchase or to sell, or without a purchase
undertaking or sale undertaking. He then resells it on a Murabaha basis for a price
plus profit to be agreed upon in the contract

Murabaha to the Purchase Orderer (MPO)

This type of Murabaha is widely applied by Islamic financial institutions as one of
their financing tools. It involves the sale of a commodity through a Murabaha
contract to the purchase orderer (MPO) for a pre – agreed selling price, which
includes a pre- agreed profit mark – up over its cost price.

This is clearly specified in the customer’s promise to purchase the asset

This transaction includes a prior promise to buy or a request made by a person
interested in acquiring the goods on credit from any financial institutions.
Therefore, it is called ‘Murabaha to the purchase orderer.’ The payment is
payable within a fixed future date by lump sum or fixed installments.

DFI 212 MURABAHA

University of Nairobi Fundamentals of Islamic Finance 2022

Application of Murabaha Contract in Islamic Finance

Murabaha contracts have been widely used by many Islamic banks and financial
institutions as a mode of financing in various financing operations such as home
financing, motor vehicle financing, personal financing and trade financing

Illustration of Murabaha structure flow for motor vehicle financing

i. The customer identifies the motor vehicle to be acquired
ii. The bank purchases the identified motor vehicle from the owner on
cash basis
iii. The bank sells the motor vehicle to the customer at a cost plus profit
on credit basis
iv. The customer pays the bank within the agreed terms of financing
1
The bank purchases
an asset from the
vendor on cash basis.
VENDOR BANK

2
The bank sells the
asset to the client at
a cost plus profit on
deferrred basis 3
The client pays the
bank within agreed
CLIENT
terms of financing

DFI 212 MURABAHA

University of Nairobi Fundamentals of Islamic Finance 2022

Shari’ah Issues Related To Murabaha

There are several Shari’ah issues related to the contract of Murabaha and these includes
1. Use of Interest Rate as Benchmark
Many financial institutions that offer financing by way of Murabaha determine their
profit or mark – up based on the current interest rate, mostly using LIBOR as their
criterion. This practice is often criticized because profit is based on a rate of interest
should be as prohibited as interest itself. It makes the transaction resemble an
interest – based financing, at least in its appearance.

However, one should not ignore that the most important requirement for validity of
Murabaha is a genuine sale. If a Murabaha transaction fulfils all of its conditions,
then using interest rate as a benchmark for determining profit does not render the
transaction invalid because the deal itself does not contain interest.

2. Promise to Purchase
There are scholars who have argued that a financial institution cannot enter into an
actual sale at the time when the client seeks Murabaha financing. This is because
the required commodity is not owned by the bank at this stage and the known
principle in fiqh is that one cannot sell what he does not own.

The financial institution is bound to purchase commodity from the supplier and only
then can he sell it to the client after having physical or constructive possession.

The commodity may lack common demand in the market and may be very difficult to
dispose it.

The customer is therefore required to sign a promise to purchase a commodity

when it is acquired by the financier, instead of being a bilateral contract of forward
sale.

The promise is a one sided promise, hence a unilateral promise which creates a
moral obligation but it cannot be enforced thus it may seriously jeopardize
commercial activities.
According to Fiqh Academy unilateral promise in commercial dealings are binding on
the promisor with the following conditions
i. It should be a one – sided promise
ii. The promise must have caused the promise 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
iv. If the promisor backs out of his promise, the court may force him either to
purchase the commodity or pay actual damage to the seller
DFI 212 MURABAHA
University of Nairobi Fundamentals of Islamic Finance 2022

On the above 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.

3. Securities against Murabaha Price

The seller/ financier naturally want 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 charge. Some basic rules about
this security include the fact that 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 not incurred a liability or debt.

Therefore, the proper way in a Murabaha transaction 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 to him because at this stage the client incurs a debt. However, it is
permitted that the client furnishes a security at earlier stages but after the Murabaha
price is determined

DFI 212 MURABAHA

University of Nairobi Fundamentals of Islamic Finance 2022

4. Guaranteeing Murabaha
The seller in a Murabaha financing can ask the 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.

One of the issues debated by scholars related to a third party guarantee is whether
the guarantor can charge a fee or not. The classical scholars unanimously agreed
that a guarantee is a voluntary transaction and no fee can be charged on a
guarantee.

However, some contemporary scholars have allowed charging of a fee to cover

expenses incurred in the process of issuing a guarantee.

5. Penalty of Default
In interest – based loans, the amount of loan keeps on increasing according to the
period of default. In Murabaha financing once the price is fixed, it cannot be
increased. This restriction is sometimes exploited by dishonest clients who
deliberately avoid paying the price at its due date, because they know that they will
not have to pay any additional amount on account of default.

The regulator in Malaysia for instance has allowed a bank to charge one percent
from the total outstanding amount. In the Middle East, the customer undertake that in
case he defaults in payment at the due date, he will pay a specified amount to a
charitable fund maintained by the bank thus no part of this amount form part of the
income of the bank. Therefore, in order to assure the creditor of prompt payment, the
debtor may undertake to give some amount in charity in case of default.

6. Rebate on Early Payment

In case a debtor wants to earn a discount on the agreed deferred price, some earlier
jurists have held this arrangement to be permissible while others have considered it
impermissible. Therefore, majority of jurists including the Islamic Fiqh Academy 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, it is permissible.

7. Rescheduling of Payments in Murabaha

In conventional financial institutions the loans are normally rescheduled based on
additional interest, this is not possible in Murabaha payments.

DFI 212 MURABAHA