Murabaha

Murabahah is the mark-up disclosed to the purchaser as per the seller’s purchase price for a trust-sale
of a certain specified asset, excluding monetary assets including debt. Murabahah sale may be
contracted either in the form of cash or deferred payment. By definition, consequently, it's far simple
for a valid Murabaha that the purchaser need to recognize the unique rate, additional costs if any and
the quantity of income. Accordingly, Murabaha is a settlement of trustworthiness.

In the Islamic financial services industry, Murabahah is adopted in a transaction known as Murabahah
to the Purchase Orderer (MPO) whereby three parties are involved, namely the Islamic Financial
Institution (IFI), the supplier and the purchase orderer (customer). The Murabahah credit sale of a
specified asset by an IFI to the purchase orderer (customer) is at a disclosed mark-up price based on
the IFI’s cost of financing the purchase. For the purpose of this parameter, the technical definition of
Murabahah is Murabahah to the Purchase Orderer. In order to avoid ambiguity, this Murabahah
parameter is meant only for the purpose of financing acquisition of assets. Murabahah contract which
is meant for cash financing known as Tawarruq is not within the scope of this parameter. This
definition also excludes monetary assets including debt.

Legitimacy of Murabaha:
The Quran:

The Quran generally allows the sale contract. Among others, the Quran says to the effect that “…
Allah permitted trade and prohibited usury”. (2:282)

The Sunnah:

The Prophet (PBUH) permitted the sale of a commodity for more than its purchase price: "if the two
commodities are different, buy and sell as you wish"(narrated by Muslim in Sahih Muslim, 1587).

The Ijma;

It is noted that people have inherited these transactions (Murabahah) for ages without any objection
and that would constitute consensus (Ijma‘) on permissibility of Murabahah. For example Imam
Malik has mentioned this sale in Al-Mu’watta –the first formally coded book on traditions of the holy
Prophet (pbuh). A renowned Hanafi jurist Al-Marghinani has defined Murabaha as “the sale of
anything for the price at which it was purchased by the seller and an addition of a fixed sum by way
of profit”.
The Qiyas:

Since the Prophet Muhammad (SAW) has approved the Tawliyah sale (sale based on cost price), the
sale on mark-up will be equally permissible on the basis of analogy on the Tawliyah sale. The
determination of cost and making it known to the buyer are common in both the Tawliyah and
Murabahah sale.

Conditions of Murabaha:
 The seller should make the original acquisition cost known to the buyer.
 Goods to be traded should be real, but not necessarily tangible.
 The original purchase contract should be sahih (valid).
 The seller should disclose the specific terms applicable to the purchase price (i.e., if the
murabaha price will be paid at the contract date or in installments).
 The seller should reveal all defects or faults that have occurred to the underlying item after
acquisition.
 In case the seller breaches any of the above stipulations, the buyer shall have the option to
nullify the contract bilaterally, proceed with the sale in its current state, or have recourse to the seller
for discrepancies.
 Any currency and monetary units that are subject to the rules of Bai‘al Sarf cannot be sold
through Murabaha, because currencies have to be exchanged simultaneously.

Classical and Traditional use of Murabaha:

Murabaha in the classical sense, as we have seen from the linguistic definition, involves a simple sale
transaction, whereby the seller declares his cost and his profit. However, Murabaha as practiced
today by Islamic financial institutions is rather different, in a classical Murabahah practice, no
financial intermediaries are involved and the customer would purchase an asset from the supplier on
cost plus mark-up basis. Payments are made either on a deferred or cash basis. The asset would have
already been owned by the supplier and the purchase price is a mark-up price which is made known
before the transaction. In modern Islamic financial practice, Murabahah sale established itself as a
mode of asset financing with an agreed and known mark-up. Being the most prevalent financing
mechanism in Islamic finance, the Murabahah sale instrument has provided a Sharia-compliant
alternative to interest-based financing mechanisms. The Murabahah contract has also been applied for
deposit taking and issuance of sukuk.
Issues in Murabaha:
Avoiding buy back: it is also called Bai Inah, it is a double sale by which brower and lender sale and
then resale an object between them which results in a riba. So according to AAOIFI standards Islamic
banks have to be vigilant that the goods required by the clients are not already owned by him.

Khiyar (Option to Rescind the Sale) in Murabaha: Although it is not necessary in modern
murabaha but if there is some defect in the product which customer bought from the seller then option
of khiyar is available in which customer can reject the goods on the grounds of inferior quality. But
now a days bank make the customers their agent to purchase the goods in this way the option of
khiyar is eliminated because buyer has bought the goods himself.

Time of executing Murabaha: Time is issue that when the bank can sell goods to its client. But
according to Sharia’s scholar’s bank can sell the good after taking the possession of it. If can’t be
done without taking possession.

Default by the client: If a client is unable to pay the installment because of any genuine issue then
Islamic banks cannot charge additional cost for their revenue like the conventional banks do. In fact
Islamic banking do charge late fee which is solely for the purpose of charity it cannot be used as
revenue in any form.

Rebate: Islamic Banks gives discounts on early payments of the debt by their client. This is perhaps
(according to some scholars) prohibited under Islamic Law. Hence, in case of Murabaha Financing,
Islamic Banks give the rebate as conventional banks give the discounts. This is why, such Murabaha
transactions have been criticized by the scholars. The only thing which Islamic Banks can do is they
can give gifts and some special services to such clients.

Potential of Murabaha:
The murabaha can play a vital role in the development of the society as a whole. The current model of
Murabaha has faced some criticism that it is neglecting low income consumers. It was originally
started to reduce the poverty, but in its modern use it is not implemented as it was. It can be done if
government and non-government organization join in hands to make a consumer model of financial
banking with the passion of charity and philanthropy.
 Ijarah
Ijarah in Islamic banking and finance can simply mean leasing or hiring. These two interpretations are
used interchangeably in the literature, but the focus in this section is on the former definition. The
term ijarah originates in the Arabic verb ‘ajara’ which denotes ‘rewarding’ or ‘recompensing’.
Literally, ijārah is derived from the noun ‘al-ajr’ which means compensation, reward, consideration,
return or counter value (al-‘iwad) against the use of an object. From a juristic (fiqh) definition, ijarah
refers to a contract to utilize a lawful benefit against a consideration (Al-Zuhayli 2002). In ijarah, the
right to use the object is transferred to the hirer, not its ownership. Hence, ijarah is a sale of usufruct
not of a physical entity. Technically, ijarah is an agreement between two parties, one being the owner
of the asset, who gives possession of the assets for the use of the other party, the hirer, on an agreed
rental over a mutually agreed period.

In the Islamic commercial context, ijarah refers to a contractual relationship between an owner of a
property and a person who wishes to lease the property. Both parties will enter into a lease contract or
is also referred to as a hire contract. For example, Al-Rajhi Bank (2001) defines ijarah as a process by
which usufruct of a particular property is transferred to another person in exchange for a rent claimed
from him. In the context of Islamic banking, Salleh (1986) views it as a lease contract under which
the bank or financial institution leases equipment or a building to one of its clients against a fixed
charge. The bank will usually put the property up for rent every time the lease period terminates, so
the property will not remain unutilised for a long period of time. The title of the property remains
with the bank; hence it assumes the risk of recession and other risk associated with ownership. From
the above-given definitions, ijarah has been well understood as a contract in which the owner of a
property transfers a legal right to use and derive profit from the property, to another person, for an
agreed period, at an agreed consideration. In this instance, the owner is called a lessor (mu’ajir); the
person who uses the property is known as a lessee or hirer (musta’jir); the subject matter is the
usufruct of the property (manfa‘ah); and the consideration refers to a rent (ujrah).

Legitimacy of Ijarah:
The legality of Ijarah is deduced from the Quran, Sunnah of the prophet Muhammad (SAW) and the
consensus of the Muslim jurists (ijma‟). Several verses can be quoted as evidence of Ijarah, on of it
surah 28: 267. Also the Sunnah mention, Abdullah bin Umar narrates: “Allah‟s apostle gave the land
of khaibar to the Jews to work on and cultivate and take half of its yield.” Ibnu Umar adde, “the land
was used to be rented for a certain portion (of its yield).” Sahih Bukhari.

It is also known that the Muslim jurists during the time of the companions that the Prophet (SAW)
reached a consensus on the permissibility of ijarah (Al-Zuhayli, 2003). The practice of ijarah has been
allowed at that time, because there was a need for such transaction. Ijarah is an important contract
like sale. If sale is permitted for the purpose of acquiring a property, thus, ijarah is necessarily
allowed for purpose of using a usufruct of the property (Sulaiman, 1992).

Modern use of Ijarah:

To study Ijarah as a mode of financing, we shall discuss the process of entering into modern Ijarah,
purchase of the asset to be leased, treatment of Takaful and other expenses, miscellaneous rules
relating to determination of rental, commencement and payment of rental, some common mistakes,
commonly raised objections and their answers, termination of the contract and the possibility and
modus operandi of transfer of ownership to the lessee. Non-bank financial institutions or companies
(NBFIs/NBFCs) in almost all countries of the world, and banking institutions in countries like
Germany, Japan, etc. are using leasing as a business mode. The forms of leasing these institutions are
using are “financial lease”, also termed hire–purchase; “financing lease”, also referred to as “security
lease”; and “operating lease”. We briefly describe modern forms of leasing below.

1. Operating lease (Al-ijarah ‘ain)

Traditionally, the only kind of Ijarah that was only operating lease, whereby one owns an asset or
equipment and leases it to others for rental for a specified period. This form of ijarah is known in
Islamic banking and finance as operating lease. In this form of lease, the ownership of the leased
assets will remain with the bank at the end of the lease period. In operating lease, the bank may
already own a property which it wants to lease it out. In other words, operating lease is not preceded
by a promise to lease or the concept is not based on prior promise.

2. Financial lease (Ijarah Muntahia Bittamleek)

The evolution of modern Islamic banking and finance has created another form of ijarah known as
Ijarah Muntahia Bittamleek (IMB) or financial lease. The IMB is defined as a form of transfer of
ownership of usufructs of some assets, such as buildings or equipment, for a particular period in
consideration for a defined rent which is usually higher than the normal rental to encourage the lessor
to transfer the leased assets to the lessee at the end of the lease period after the lessee has paid all
instalments without delay.

In a financial lease, it is necessary to clearly state the method of transfer of ownership in the
agreement. The final transfer will occur at the end of the lease period. The manner of transfer must be
put separately in a different document attached to the lease agreement. The transfer of ownership
could take place in one of the following manner:

 Promise to transfer the ownership on the basis of ordinary or conditional gift: The financial
lease attached to the concept of gift is the most applied method by Islamic financial institutions. The
difference between ordinary and conditional gifts is that gift without payment condition is not strong
by law as opposed to gift with a condition on payment of all rental instalments. The conditional gift is
similar to a contract which makes it stronger. This is because once the client pays the last installment,
the bank is obliged to transfer the property.
 Promise to transfer the property through sale: In this form, the financial lease agreement is
concluded with an understanding that the lessor or the bank will sell the property to the client. The
sale may take place through a nominal value because the major part of the selling price has been paid
in the form of rental. It must be noted that the sale may also take place prior to the maturity of the
lease agreement. In this case, the sale price may be the market value of the property or the
outstanding rental. The parties may also agree on sale price that will be paid on instalment.

3- Security or Financing Lease

A security lease in the conventional set-up is just a financing transaction and nothing more than a
disguised security agreement for the amount financed to the lessee. It involves the effective transfer
of all risks and rewards associated with the ownership to the lessee.

The Conditions for an Ijarah Contract to be Valid:

The conditions for an ijara contract to be valid are rooted in the fundamentals of the Sharia law and
thus have earned approval from Islamic scholars all over the world.

An Asset that needs to Last

From the above specifications, stem other notable conditions for an ijara contract to be valid. For
instance, the lessee will pay the first installment of the rent only after he has fully acquired the asset
or the right to use it. The lessee should also be convinced that the asset is in a condition to lend itself
to usage, before he makes the first lease payment. One of the most critical conditions for an ijara
contract to be valid is that the asset under the contract must not perish in use during the leasing
period.

The conditions for an ijara contract to be valid that ensure transparency in the transaction process
include the following—the amount and frequency of the rental payments should be determined right
at the time of entering into the contract. The schedule and the amount to be tendered as rent may or
may not be uniform throughout the entire leasing period. In fact, if agreed to by both the lessor and
the lessee, the amount of rental payment may even be modified during the term of the contract.

Obligations of Owning the Asset

Other obvious conditions for an ijara contract to be valid include the following—the lessor must have
full possession and absolute right of ownership of the asset before he enters into an ijara contract. He
must also agree to bear the maintenance costs and risks associated with owning the asset. However,
as per the conditions for an ijara contract to be valid, the lessor is entitled to claim compensation if
the asset under the contract has sustained damages due to the negligence of the lessee, furthermore it
is permissible for the lessor and lessee to enter into an agreement whereby the lessee is responsible
for the maintenance costs associated with owning the asset.

Cannot be Similar

The simplicity and ease of comprehension and execution of this mode of Islamic financing can be
readily gauged from these conditions for an ijara contract to be valid—the rental payment cannot be
made from an object manufactured and the rent, on the part of the lessor, cannot be a similar right of
use for an identical asset.

Issues of Ijarah:
With respect to the modus operandi of modern leasing business, Islamic banks face five sets of issues
and problems.

1. One problem in Ijarah relates to burdens of the asset on the lessee or the lessor. For example, the
Shar¯ı´ah provides that the duty of repairing the goods, other than normal maintenance, falls solely
on the lessor, since the repairs benefit him as the owner. A clause in the contract purporting to shift
ownership-related costs, other than the normal operating expenses, to the lessee is invalid, because it
unjustly enriches the lessor.

2. Another problem arises due to Islamic banks’ lack of knowledge of the Ijarah principles. If a
specified unit of asset is to be leased, the Ijarah agreement should be executed only after the asset is
in the possession of the lessor (or that of the lessee in capacity of agent of the lessor). If the
agreement is signed at the time of disbursement of the money to the supplier and there is any delay in
delivery of the asset to the lessee – the bank fails to deliver the asset to the lessee on the date
specified in the Ijarah agreement – no rental is due for the period between the agreement date and the
date of actual delivery. Therefore, Islamic banks should enter into a “promise to lease” at the
beginning and the actual Ijarah contract should be executed at the time when the asset is made
available by the supplier.

While determining the rental, they can keep in mind the whole period for which their funds remain
invested, i.e. the supply period and the lease period.

3. If any damage occurs to the asset during the supply stage, the lessee (client) serving as agent is not
responsible for it until any fault on his part is proved. The rental, if received in advance, should be
adjusted accordingly, unless it is agreed that the lease be extended by an equivalent period after its
original expiry date.
4. Another problem relates to the fact that the usufruct is extended to the future and may therefore be
risky and unstable, particularly if the usufruct is reduced materially in the future. In this respect,
Islamic law has the provision of cancellation of lease if any factors or events cause the usufruct to be
less than normally expected. For example, nearly all schools of Islamic jurisprudence allow the
reduction or abolition of rental of land if the produce of leased farmland is damaged due to any
natural calamity like drought, floods, etc. According to Imam Muhammad, if the crop of leased land
is destroyed dueto any natural calamity, Ijarah will become invalid and the lessee will be entitled to
aconventional wage.

5. A big problem emerges in the case of a default in payment of rental by the lessee, as the penalty
taken for late payment has to be given to charity.

Potential of Ijarah:
Ijarah is the most important mode for financing operations of Islamic banks for meeting the needs of
the retail, corporate and public sectors, and it has huge, as yet unrealized, potential. It is used directly
for plant and machinery, automobiles, housing, consumer durables, etc. and indirectly for Sukuk
issues by the corporate and government sectors. Ijarah is conducive to the formation of fixed assets
and medium- and long-term investments in the economy.

The potential is by dint of a number of features of Ijarah as given below:

• Payment of Ijarah rental can be unrelated to the period of taking usufruct by the lessee, i.e. it can be
made before the beginning of the lease period, during the period or after the period, as the parties may
mutually decide. Accrual of rent, however, is based on the possibility of usage of the asset by the
lessee.

• Ijarah can be contracted on an existing asset or a building and even an asset that is yet to be
constructed, as long as it is fully described in the contract and is not for identifieditems, provided that
the asset and the rent both are clearly known to the parties at the time of the contract.

• The Ijarah rate can be fixed or floating, provided a clear formula is mutually agreed with a floor and
a cap. Rental has to be stipulated in clear terms for the first term of lease, and for future renewable
terms it could be constant, increasing or decreasing by benchmarking.

• Holders of Ijarah Sukuk jointly acquire ownership in the asset, bear the price risks and the
ownership-related costs and share its rent by leasing it to any user(s).

The flexibility described above can be used to develop different contracts and Sukuk that may suit
different purposes of issuers and holders. Governments can use this concept as an alternative tool to
interest-based borrowing, provided they have durable useable assets. Use of assets is necessary, while
it does not matter whether these assets are commercially viable or not. Funds mobilized by issuance
of Ijarah Sukuk may be used to purchase assets
For leasing and the rentals received from the users distributed among the Sukuk holders. Ijarah Sukuk
can be traded in the secondary market on market price; the purchasers replace the sellers in the pro
rata ownership of the relevant assets and all rights and obligations of the original subscribers pass on
to them. Hence, they may help in solving the problems of liquidity management faced by the Islamic
banks and financial institutions. Hence, Ijarah has great potential for financing public sector projects
without the involvement of interest. Ijarah Sukuk/certificates can be issued to raise funds from the
primary financial market for projects to be started afresh, or they can be issued against already
existing projects. They can also be sold in the secondary market at a price to be determined by
themarket.
References:

 https://www.investment-and-finance.net/islamic-finance/tutorials/conditions-of-
murabaha.html
 Ayinde, O. L. (2012). A Critical Evaluation of the Compatibility between Traditional and
Contemporary Applications of Murabahah Transactions. Aceh International Journal of Social
Science, 1(1).
 Ayub, M. (2013). Understanding Islamic finance.
 Ebrahim, Shahid & Sultan, Hussam. (2011). Murabaha. FEN Professional & Practitioner
Journal - Forthcoming. 10.2139/ssrn.1923606.
 http://ijara.co/wp-content/uploads/2013/07/Islamic-Leasing-Document.pdf