We are coming to the end of our explanation of how Murabahah plays a very important role in pushing Islamic finance.
One major motivation for Islamic banks and financial institutions is that by entering into a Murabahah transaction, the financial institution assumes the credit risk, similar to any conventional banking facility since the resultant Murabahah debt is akin to the conventional loan transaction in that perspective (debt). That’s it.
Also, a Murabahah transaction has a distinctive feature which is not found in a conventional term loan. This is the acquisition of the asset by the financial institution prior to its sale to the customer. During this period, there is no way that any Islamic financial institution could wriggle out of its ownership risk. So if the asset is destroyed prior to the financial institution entering into the Murabahah agreement with the client, unquestionably the financial institution shall bear the loss and the customer will not be held responsible in this case. Financial institutions may resort to Islamic insurance to cover such situations which is perfectly alright from the Shariah scholars’ perspective.
A lot of Islamic banks use the agency structure to shift their ownership responsibility to the customer in almost all situations. However, Shariah scholars have not been receptive to this ‘risk aversion’ approach since they believe it stains the decorum of entering into a Murabahah transaction taught by our beloved Prophet Mohammed (peace be upon him) whereby the return from a transaction is not considered permissible unless the seller under the Murabahah is exposed to the risk of losing the Murabahah asset prior to entering into the Murabahah contract.
Nevertheless, in extreme situations where the supplier shall not ship the good to any other party except to its counterpart (financial institution’s customer), the financial institution may appoint the customer as its undisclosed agent to buy the goods from supplier and in this situation, the constructive title and constructive possession shall pass to the financial institution before entering into the Murabahah transaction with the customer. We had discussed this principle in the early chapters.
Let us try to complete our understanding of the Murabahah transaction as follows before we move on to other Islamic sale contracts:
• When the customer has fulfilled his ‘promise to purchase’ and executed the Murabahah contract, the Islamic bank will have two options, namely either to refund the security margin and enter into a Murabahah contract for the full value of the goods; or adjust the security margin and sign the Murabahah contract for the residual value of the goods. Both options are permissible in Shariah. Do note that the purpose of the security margin is to assure the financial institution as to the customer’s credibility to consume the Murabahah transaction. Based on several satisfactory transactions, the Islamic bank may remove the condition of obtaining the security margin altogether for the customer.
• In cases when the customer is authorized to import the item as the institution’s agent, it is obligatory to adopt Shariah procedures which would ensure that certain conditions are observed. These conditions include the requirement that the financial institution itself must pay the supplier, and not pay the price of the item into the account of its customer as the agent, and that the financial institution should obtain from the supplier (through the agent) the documents that confirm that a sale has actually taken place. These include commercial invoices, bills of lading, packing lists, bills of exchange and certificates of origin, among others.
• In cases where the financial institution appoints the customer as its agent for the acquisition of certain goods, the agent will act as the principal in dealing with the counterparty, and will undertake the purchase directly in its name but on behalf of the financial institution as the principal. This is to facilitate the continuation of a smooth execution of transactions.
• The condition that possession of the item must be taken by the Islamic bank (before its onward sale to the customer) has a specific purpose: the goods must move from the ownership and responsibility of the supplier to the responsibility of the financial institution (either directly or through an agent). Similarly, it is obligatory that the point when the risk of the ownership of the goods is passed on by the financial institution to the customer be clearly demarcated, particularly with reference to the stages in which the item is transferred from one party to another.
• The forms of taking delivery or possession of items differ according to their nature and different trade customs. Taking possession may be actual in the case of physical delivery or transportation to the acquirer (financial institution) or its agent, but may also take place constructively by placing the item at the acquirer’s disposal so as to enable him/her to deal with it at his/her will, even though no physical delivery has taken place. This particularly relates to third country shipment deals.
• The receipt of a bill of lading by the financial institution or its agent, when purchasing goods on the international market, is considered as constructive possession. The same would apply to the financial institution’s receipt of the airway bill or the rail/truck receipt. Also, the logistic and warehousing entities’ certificates of storage will also be considered as constructive possession for the financial institution.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Sohail Zubairi is the projects advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected].
Next Week: Explanation of the final few parameters of the Murabahah contract to continue.