islamic banking-ijarah & murabaha (چیک)

7/23/2019 ISLAMIC BANKING-IJARAH & MURABAHA ()

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MURABAHA


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Murabaha is a particular kind of sale where the

seller discloses its cost and profit charged thereon.

The price in this sale can be both spot and

deferred.


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SCOPE OF MURABAHA

It is a fixed price sale and normally is done

for short term.

The transaction can be used in order to

meet the working capital requirements;however it cannot be used to meet liquidity

requirements.


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PROCESS FLOW OF MURABAHA

Customer submits the purchase requisition to the bank.

Customer may be appointed as agent to purchase goods on

banks behalf.

Bank gives money to supplier either directly or through

Customers account for purchase of goods.

Customer purchases goods on banks behalf and takes

their possession.

Customer makes an offer to purchase the goods from the bank.

Bank accepts the offer and sale is concluded.

Customer pays agreed price to bank according to an agreed

schedule.


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- The Bank may ask the customer to furnish a security to its

satisfaction for prompt payment of the deferred price.

- It is also permissible that the customer furnishes a security at the

inception of the Relationship but it becomes effective after the

creation ofCustomers indebtedness.

- It is also permissible that the sold commodity itself is given to the

seller as a security.

- It is preferable not to take Interest bearing instruments as

securities.

SECURITIES AGAINST MURABAHA


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- The Customer requests the Bank to buy certain goods for

him and sell these to him after taking ownership and

possession. Purchase requisition contains the details of the

goods required to be purchased from the Supplier, theirCost and expected date of delivery.

- The prerequisite is that the goods are not already owned

by the Customer. They should always be bought from athird party.

PURCHASE REQUISITION


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- If the supplier is nominated by the Customer

himself, guarantee for good performance can be

demanded.

PERSONAL GUARANTEE


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- An advance payment (called Hamish Jiddiyyah)

may be received from the customer as a form of

security deposit

- In case of breach of promise, Hamish Jiddiyyah

can be used to recover actual damages. However itcannot be used for recovering the Cost of Funds /

Opportunity Cost.

HAMISH JIDDIYYAH


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- Discounts from Supplier (If any) would be

passed on to the customer at the time ofMurabaha Sale by deducting these from the

cost because Murabaha is always a Cost-plus

Sale.

- Similarly, in case of Suppliers Credit, the term

of credit must be identical or longer.

DISCOUNT ON ACQUISITION OF ASSETS


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- Change of commodity(ies) specified in the

agency agreement can be done with mutualconsent.

CHANGE OF COMMODITY


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- If there is an increase in prices and the cost

escalates, then the transaction can only be

executed if the bank has been informed andaccepts such increase.

- The Bank reserves the right to reject the

purchases if made at other than agreed price.

INCREASE IN PRICES


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- Delay in Supply from the supplier, in case where

specific time was allowed, leads to therevocation of the contract of Purchase and(in

some cases) the Agency Agreement. In such

cases the customer will refund the cost of goods.

DELAY IN SUPPLY FROM THE SUPPLIER


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- Bank must take actual or constructive possession of the

Commodity(ies).

- The forms of taking delivery or possession of Commodity(ies)

differ according to their nature and customs.

- The Commodity must move from the responsibility of the

supplier to the responsibility of the Bank.

- It is obligatory that the points in time when the risk of the item is

passed on to the Bank by the Supplier and by the Bank to the

customer, are clearly identified.

ACQUISITION OF TITLE & POSSESSION OF

THE ASSETS


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- Goods must exists at the time of execution of

Murabaha.

-If the above two requirements are not fulfilled, then theBank cannot execute Murabaha

- Documentary evidence, e.g., delivery Challan, gate

passes and sales tax invoices must be obtained at the

time of acquisition of Goods before execution of

Murabaha.

ACQUISITION OF TITLE & POSSESSION OF

THE ASSETS


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- In the case of default by the Customer in the payment of price on

the due date, the price cannot be increased.

- However, if Customer has undertaken in the agreement to pay

certain amount for a charitable purpose, then Customer shall be

liable to pay this amount to a Charity Account separately maintained

by the Bank.

- This amount will neither be considered penalty nor compensation

and it will not form a part of Banks income.

- Bank is bound to spend it for a charitable purpose on behalf of the

Customer.

CASE OF DEFAULT


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- If the customer makes early payment and there is no

commitment from the Bank in respect of any discount in

the price of Murabaha, then the Bank has the sole

discretion in allowing a rebate.

- But it is prohibited by Shariah Standards to give Rebate

to theC

ustomer on early payment as under Murabahathe price is fixed. So it is recommended that issue should

be brought to the knowledge of Shariah Advisor.

REBATE ON EARLY PAYMENT


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- Rescheduling is allowed but re-pricing is not allowed

- Rollover is also not allowed.

ROLLOVER IN MURABAHA


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- Under Murabaha Financing, once the goods have been

purchased by theC

ustomer, the same goods cannot besold and bought back for availing finance facility from the

Islamic Bank.

BUY BACK


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Master Murabaha Facility Agreement

Agency Agreement Order Form / Draw Down Notice/Purchase Requisition

Declaration with Purchase Evidence

Demand Promissory Note

Payment Schedule

MURABAHA DOCUMENTATION


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Master Murabaha Financing Agreement

It is an agreement between the Customer and the Bank

whereby the Customer agrees to purchase goods from

the Bank from time to time as per the terms and

conditions of the agreement.

This is an overall facility agreement under which various

Sub-Murabaha may be executed from time to time

Hence it needs to be signed once at the time the facility

is sanctioned.


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Agency Agreement

Through this agreement, the Bank appoints the customer as

its agent to select and procure specified goods for the Bank.

This agreement needs to be signed once between theCustomer and the bank to cover the specified agency period.

The disbursement of funds is made under this agreement.

The customer should provide a comprehensive list of assets

and commodities that he may procure during the course ofbusiness from time to time.


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Order Form

This document is executed at the time of each sub-

Murabaha request, i.e., each time when the customer

requires Murabaha for purchase of assets.

Through this document, the customer requests the bank to

purchase the assets from the supplier and undertakes that

he will purchase the assets from the bank once the bank

acquires the asset from the Supplier.

The customer also undertakes to compensate for the actual

loss the bank may suffer in case he fails to purchase the

assets from the bank.


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Declaration

This is the most important part of the Murabaha process

Declaration is to be signed by the customer immediately after the

purchase of goods as Banks agent and before their consumption.

This document establishes the actual sale transaction, i.e. transfer of

ownership of goods from the Bank to the Customer

At this stage the specific details of the assets must be known i.e.quantity, quality, cost etc.

continued.


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Purchase evidence in the form of bills, sale invoice, sales tax invoice,must be furnished along with the Declaration specifying the full

details of the goods purchased

The cost of goods must be inclusive of all costs including sales tax,transportation and handling etc.

Proper timing of declaration is extremely important especially in

cases of perishable or immediately consumable commodities.

Murabaha Price (Cost of Goods + Profit) should be determined at

this stage and stated clearly in the Declaration.


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Payment Schedule

The Payment Schedule specifies the amount that Customer will pay

from time to time or in lump sum, towards the settlement of

Murabaha Price.

This shall be prepared after the execution ofDeclaration

The dates mentioned in the schedule correspond to the day when

the payment becomes due from theC

ustomer.


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PRACTICAL ISSUES IN MURABAHA

1. Subject Matter

2. Timing of Offer & Acceptance

3. Purchase Evidence

4. Direct Payment5. Profit Recognition

6. Penalty on Late Payment

7. Rebate on Early Payment

8. Rollover in Murabaha

9. Training ofCustomer & Bank Staff

10. Process of Murabaha may differ from Product to Product


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Subject matter of Murabaha

Goods must exist at the time of execution of Murabaha

Murabaha cannot be done in all commodities e.g., Currencies,

Gold, Silver.

Murabaha cannot be used for paying utility bills, wages, overhead

expenses etc.

General rules of sale related to subject matter must be followed.


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Timing of Offer & Acceptance

A Murabaha Financing Agreement consists of a series ofdocuments to be executed at various stages, the sequence and

timing of which is extremely important.

Through the Declaration which contains Offer & Acceptance, the

Customer and the bank complete an important step of a validMurabaha Sale.

This is to be signed by the customer when he has purchased and

taken possession of the goods as the Banks Agent.

Offer & Acceptance must be signed while the goods are still in

existence and have not been used in the production process or

sold to some other entity.


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Purchase Evidence

In order to ensure that the customer actually purchased the assets as

claimed, the customer is required to submit asset purchase evidence along

with Offer & Acceptance.

The purchase evidence must confirm that the asset was purchased after the

Agency Agreement

Purchase evidence may be in the form of invoice, delivery orders, truck

receipts etc.

In some cases, however, it may be too burdensome for the Customer to

submit all the invoices as the number of invoices may run into hundreds.

For example, cotton purchases are generally in small quantities from various

sources and hence for each Sub-Murabaha there may be too many invoices

to submit. It is suggested to furnish considerable sample of invoices along

with summary of all purchases.


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Penalty on Late Payment

As soon as the Murabaha is executed, the Murabaha Price

becomes a receivable for the Bank. Hence, any amount charged

over and above the Agreed Amount will be RIBA.

However, it is permissible to obtain an undertaking from the

customer that in case of delay/default in payment of Murabaha

Price or any part thereof, he will pay an amount of money or a

percentage of the debt to be spent for charitable purposes at the

discretion of the Bank.


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Rebate on Early Payment

If the customer makes early payment and there is no commitment

from the Bank in respect of any discount in the price of

Murabaha, then the Bank has the sole discretion in allowing the

rebate.

It is not recommended to make it a practice and must be avoided

in normal course of business. Such issue should be brought to the

knowledge of Shariah Advisor.


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Rollover in Murabaha

Rollover in Murabaha is not allowed since each Murabaha

transaction is for the purchase of a particular asset. A new

Murabaha can only be executed for the purchase of new assets.

It is advisable that whenever practicable there must be a gap of1-2

days between maturity of the previous Murabaha and

disbursement of the new one.


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RISK DIMENSIONS

Banking Risks

Credit

Operational

Solvency

Foreign Exchange

Competition

Pricing

Liquidity


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I J A R A H


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Definition and Basic Conditions

Transferring of usufruct (body) of an asset to another person for an

agreed period, at an agreed consideration.

The Asset should be a thing of value, identified and quantified.

Anything which cannot be used without consuming cannot be

leased out, e.g., Money, Wheat etc.


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Difference between Ijarah &

Conventional Lease

Two contacts into one contract is not permissible in Shariah. Therefore, we

cannot have the agreements of hire and purchase combined into one

agreement but we can undertake / promise to purchase/sell the leased

asset such that the promise is binding only on the Promisor

Ijarah rental can only be charged after delivery of asset to the Lessee.

The rental decided at the time of the agreement cannot fluctuate except

in the manner agreed between the Parties.

Expenses under Ijarah are as follows:

Lessor expenses relating to the corpus of the asset i.e. Insurance,

Accidental Repairs etc. will be borne by the Lessor

Continued.


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Lessee actual operating / overhead expenses and routinemaintenance charges related to use of the asset will be borne by

the Lessee.

All risks and rewards are for the account of the Lessor.

In case, the insurance claim is rejected, the loss will be borne by

the Lessor (Bank) and not the Lessee.

In case the asset is not working or breaks down, the Lessor

cannot charge rent for that period unless the Lessee is found

guilty of misuse of the assets, negligence or of willful misconduct


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Difference between Ijarah & Murabaha

In Murabaha once the sale is completed, the entire risk is shifted to the

purchaser, while in lease only the usufruct is transferred to the Lesseeand the risk remains with the Lessor.

In Ijarah, if the Lessee acts as the banks agent and makes any payment,

he is not required to inform the bank that he has taken possession as is

the case in Murabaha. Once he has taken possession, the rent will start

immediately.

Murabaha attributed to a future date is invalid in Shariah, but Lease can

be attributed to a future date.

A Murabaha cannot be attributed to a future date as in this case, the sale

would be effected spontaneously upon the Agent taking delivery from

the supplier. The seller would never bear the risk of the commodity

which Shariah does not permit. But in Leasing it is permissible, because

in leasing the asset remains under the risk and ownership of the Lessor

throughout the leasing period.


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Pricing Criteria in Islamic Banking

Some instruments for handling the Price Risk:-

1. No long term Murabaha

2. Adjustment in subsequent deals

3. Floating rate in Ijarah

4. Tiered profit in Musharakah / Mudarabah

5. Capping of profit in Musharakah / Mudarabah

6. Reviewing of profit ratios in Musharakah / Mudarabah

7. Voluntarily withdrawal from any amount due by any of the

8. parties


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BASIC RULES OF IJARA

The rental must be determined at the time of contract for the

whole period of lease.

It is permissible that different amounts of rent are fixed for

different periods during lease tenor, provided that the amount of

rent for each period is either specifically agreed upon at the time

of affecting the lease or prior to the beginning of each such

period.

The determination of rental on the basis of the aggregate cost

incurred in the purchase of the asset by the Lessor, as is normallydone in financial lease, is not against the rules of Shariah.

Tenure of Lease agreement must be fixed & specified in clear

terms Continued


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The rentals for the first period must be fixed at the time of execution ofLease Agreement and will remain fixed till the first rental revision date.

Specific date of each periodic rental becoming due must be clearly

mentioned in the rental schedule.

Purchase date and respective purchase price must be mentioned clearly

in the undertaking to purchase.

Insurance cost incurred by the bank must be recovered in the lease

rentals.

In case the customer is acting as an agent of the bank for Insurance, the

customer will pay the insurance premium but this cost will be

reimbursed to the Customer by the bank.


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IJARA AS A MODE OF FINANCING

The commencement of lease

Unlike the contract of sale, the agreement of Ijarah can be

effected for a future date. Hence, it is different from

Murabaha.

Rent should be charged after the delivery of the lease asset

Different relations of the parties

There are two separate relations between the Bank and the

Customer: one of an agent and the other of a Lessee.

Continued


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Expenses consequent to ownership to the Lessor

As the Lessor is the owner of the asset, he is liable to pay all the

expenses incurred in the process of its purchase and its import to the

country of the Lessor, for example freight and customs duty etc.

Lessee as Ameen

The Lessee is responsible for any loss caused to the asset due to misuse

or negligence. He is also liable for normal wear and tear

Variable Rentals in Long Term Leases

In this case the Lessor has two options:

A lease contract can have a condition that the rent shall beincreased according to a specified proportion (e.g., 5%) after a specified period

(e.g., 1 year)

He can contract lease for a shorter period after which the

parties can renew the lease at new terms and by mutual consent.

Continued


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Charity for late payment of Rent

The Lessor cannot charge an additional amount in case the Lessee delayspayment of rent. He can, however, recover an amount to be spent for charity.

The residual value of the leased Asset

Even after the expiry of the lease period, the corpus of the leased asset cannot

be transferred to the Lessee through the agreement of lease itself, because in

this case the lease becomes a contract of hire purchase.

It is a well settled rule of Islamic jurisprudence that one transaction cannot be

tied up with another transaction so as to make the former a pre-condition for

the other.

However, the Lessor may enter into a unilateral undertaking to sell the leased

asset to the Lessee at the end of the lease period. This undertaking will be

binding on the Lessor only.

Continued


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Termination of lease

If the Lessee contravenes any term of the agreement the Lessor has a right to

terminate the lease contract unilaterally.If not, then it can be terminatedthrough mutual consent only. However, in such a case he cannot charge rentals

for the remaining period.

Takaful/Insurance of the Asset

If the leased property is insured, whether under the Islamic mode of Takaful or

conventional insurance, it should be at the expense of the Lessor and not at theexpense of the Lessee.

Ijarah Wa Iqtina

The Lessor may sign a separate promise to gift the leased asset to the Lessee at

the end of the lease period, subject to payment of all rentals as agreed. Thevalidity of this arrangement is subject to two basic conditions:

Firstly, the agreement of Ijarah, itself should not be subjected to the signing of

this promise of sale or gift.

Secondly the promise should be unilateral and binding on the Promisor only.

Continued


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Sub-Lease

If the leased asset is used differently by different users, the Lessee cannot sub-

lease the leased asset except with the express permission of the Lessor.

Sale and leaseback transaction

Sale Agreement must be executed before entering into Lease Agreement. There

should be a time lag between the execution of the two agreements

Asset cannot be sold back to the Customer before one (1) year passes, even on

the occurrence of an event of default.


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PRACTICAL ISSUES

Expenses such as Import duties, taxes etc are not added to the Costof the Asset.

Where Customer himself / herself arranges Insurance:-

- No Insurance Agency agreement is executed with the

Customer

- Insurance Expense is not reimbursed to the Customer

In case of loss / damage, the insurance claim received is shared

with the Customer although the Customer has no right to claimsuch benefit.

At the time of maturity or early termination of Lease Agreement, a

Sale Deed is not executed to effect transfer of ownership.


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IJARAH FINANCING FOR ASSETS IMPORTED

VIA

SIGHT LC


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IMPORT IJARAH

The Importer opens the LC as an agent of the Bank

The Importer places order with the foreign supplier on behalf of the Bank

Upon receipt of documents, the Bank makes payment to the foreign

supplier

The Ijarah Agreement with the Customer becomes effective.

A specified rental will be agreed at this point in time. However, rental

would be charged once the asset becomes workable/usable by the Lessee

or is delivered to him.

After the term of Ijarah Agreement is completed, the bank may sell the

asset to the importer at an agreed price.


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IJARAH FINANCING FOR ASSETS IMPORTED

VIA

USANCE LC


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IMPORT IJARAH

After necessary approvals, FBL and theC

ustomer enter into anIjarah Agency Agreement listing the assets to be imported.

Under Ijarah Agency, FBL appoints the customer as its agent to

import the asset and pay relevant duties, taxes, transportation, and

other charges to port authorities for securing the release of theasset.

All such payments made by Importer shall be reimbursed by Bank

and will constitute a part of the total cost of the asset.

The customer takes delivery of the asset as banks agent and pays

the applicable duties and taxes etc.


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IMPORT IJARAH

(Contd)

At the time of execution of Lease Agreement, Forward Cover

is taken to fix the cost of the imported goods in PKR.

After installation of asset,Ijarah Agreement between the Bankand the Customer becomes effective and the lease rentals

start in the manner agreed .

islamic banking-ijarah & murabaha (چیک)

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