Securitization of Murabahah
Murabahah is a transaction which cannot be securitized for creating a negotiable instrument to be sold and purchased in 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 transfer of this paper to a third party will mean transfer of money. It has already been explained that where money is exchanged for money (in the same currency) the transfer must be at par value. It cannot be sold or purchased at a lower or a 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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Some Basic Mistakes in Murabahah Financing
After explaining the concept of murabahah and its relevant issues, it will be pertinent to highlight some basic mistakes often committed by the financial institutions in the practical implementation of the concept.
1. 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.
2. 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 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 murabahah is a real and genuine transaction of actual sale and is not being misused to camouflage an interest-based loan.
3. In some cases, sale of commodity to the client is effected 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 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 play 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.
4. International commodity transactions are often resorted to 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 subjected 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 in this book.
5. 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 murabahah. Murabahah can be effected only on commodities not yet purchased by the client.
From the foregoing discussion on different aspects of murabahah financing, the following conclusions may be summarized as the basic points to remember:
1. Murabahah is not a mode of financing in its origin. It is a simple sale on 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 a commodity. Therefore, it should neither be taken as an ideal Islamic 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. If in cases of genuine need, the financier appoints the client his agent to purchase 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 is 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 indebtedness 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.
7. Two different prices for cash and credit sales are allowed on condition that either 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.
8. 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.
9. In case of earlier payment, no rebate can be claimed by the client. However, the institution may at its own option, forego some part of the price without making it a pre-condition in the agreement.
Source: Republished with the kind permission of Sheikh Muhammad Taqi Usmani.