MURABAHA AS A FINANCING INSTRUMENT

In its development, Islamic banking and finance (IBF) has been criticized for being grown apart from the normative principles of Islamic economics, being form-oriented through applying some Islamic rules, instead of having the substance (Asutay, 2012). Its operations and products are getting more similar to conventional operations, but without riba (Asutay, 2010). Murabaha is one of the financing instruments that has many critics despite its popularity, due to its similarity with conventional system. Thus, this paper is aimed to explore the concept and issues of murabaha and its application as financing instrument.

Islamic banking is said to stay in “murabahah regime” (Iqbal and Molyneux, 2005:124). Murabaha (debt-like financing based on fixed-return modes) is predominantly used by IBF as financing instruments as it is considered more profitable, although musharakah and mudarabah (equity-financing based on profit/loss sharing) are much preferred to be used as an alternative for interest system (Asutay, 2007; Iqbal and Molyneux, 2005). This dominance of murabaha is claimed to serve as “a cover for interest from the back door” (Cicakza, 2011). However, being under pressure to safeguard the interest of the depositors and to compete with the conventional banks, utilizing mudaraba contract for financing is deemed to be not preferrable provided the difficulties, such as, the uncertainty of “ex post rate of profit”, the agency problem, liquidity problem, high risk and its long-term nature (Cicakza, 2011; Vogel and Hayes, 1998). Thus, such deferred contracts are needed to help Islamic banks in the competition as it generates certain income with a lower risk (Cicakza, 2011).

Murabaha

Murabaha, according to Vogel and Hayes (1998:140) is simply defined as: “a sale contract which fixes the price in terms of the seller’s cost plus a specified percentage markup.” Using this transaction, a trader purchase the goods needed by the end consumer and then he would sell it to the consumer at a price which is calculated by adding all costs incurred and the profit margin (Iqbal and Mirakhor, 2007). Traditionally, its purpose is to protect “innocent consumers” – who lack of knowledge and expertise in trading – from cunning traders (Al-Marghinani, 1957, cited in Ayub, 2007). In this contract, the seller is required to reveal all elements of cost incurred for acquiring the commodities to the consumers (Vogel and Hayes, 1998) and the contract should take place at an agreed margin (Ayub, 2007). It should be noted that it is a “spot sale contract” (Ahmad, 2010:7), meaning that no credit is involved.

Murabaha-Mu’ajjal

Murabaha is not made to be a financing technique, since it is originally a sales contract, thus it requires some adjustments to be readily used in Islamic banks. In the development, murabaha is modified to include bai’ mu’ajjal, which is a deferred payment system of sales of goods (Ahmad, 2010). Combining both concepts means that murabaha could be paid in credit basis. These concepts are allowed provided that the price and the period of payment are fixed and agreed before the deal; and that the trader should borne the risk of the commodity until the ownership has been transferred to the customers (Ayub, 2007).

Murabaha with Order to PurchaseIt is the form of modern murabaha usually used by Islamic banks, where the banks purchase a prescribed goods from a third party per customers’ order and then, resell it to the customers

on deferred payment once the banks have obtained the goods (Vogel and Hayes, 1998). As trading involves the need to hold the inventories which is considered risky and costly, adjustment was made in the murabaha, adding the necessity to have the customer’s promise to buy the goods purchased by the banks (Hassan, 2007). Hence, it could be seen that this transaction offers great advantage for the banks, as they could avoid being the trader and minimize the high risks and costs of temporary ownership of the goods. As the consequence, this method is claimed to be highly similar to the conventional commercial loan (Vogel and Hayes, 1998).

In the practice, murabaha can be done through direct trading by the bank management, through chosen an agent (third party) to act on behalf of the bank, or through having the client as an agent. The last method is what is normally done by the bank, and it is the safest way for the bank to eliminate any risks possible. In this case, the customer purchases the goods on behalf of the bank and takes the ownership of the goods. Then, the payment is made by the bank directly to the supplier. Care should be taken that in the application, it does not lead to a “buy-back”, an act of double sale between borrower and lender that ends up the same as having a loan on interest (Ayub, 2007).

Commodity Murabaha/Organized Tawarruq/Reverse Murabaha

This instrument is originated from the concept of “sharikat al-wujuh” (partnership of good reputations), enabling “the merchants who have lost their capital to re-establich temselves” (Cicakza, 2011:145). It is done by buying a commodity on credit with deferred price and selling it with spot price to “unknown” third party for gaining cash.

Tawarruq operates differently by utilizing two separate contracts, creating “a loophole” to borrow money (Iqbal and Mirakhor, 2007). The trading of commodities at London Metal Exchange uses this concept. It is done by appointing a broker to purchase the commodities and then sell it on deferred payment to any third broker on the same date. It is technically lawful under Islamic law. However, such practice could lead to riba and create no real economic activity (Iqbal and Mirakhor, 2007). The transactions happened so fast that the issue of possession of the commodity is being questionable. However, it is argued that commodity murabaha is allowed on the basis that “time has a share in price” (Cicakza, 2011).

Under murabaha, the financing is linked to a commodity, thus, “ensures the involvement of finance in the productive process” (Iqbal, Ahmad, and Khan, 1998:16). Furthermore, the bank is also exposed on risks, unlike interest based system (Iqbal and Mirakhor, 2007). However, while nobody denies the permissibility of classical murabahah, the modern murabahah and its derivatives are criticized for creating “a back door to interest” (Ayub, 2007:223) and being “a mere disguise for interest lending” (Vogel and Hayes, 1998:143). Many new instruments are being mis-used (Cicakza, 2011) and thus, it can easily be used as “vehicles for riba”, which can be seen in tawarruq scheme through the possibility to have “same-item sale-repurchase” (El-Gamal, 2006:48). The concept of mark-up is also criticized for being similar with riba, especially when LIBOR is used as the benchmark (El-Gamal, 2006).

Overall, murabahah is being favoured as a financing instrument, as it is simple and convenience, providing high liquidity and low risk for the investors (Iqbal, Ahmad, and Khan, 1998). Credit and financial murabaha, for example, is suitable to be utilized by “non-financial firms” to help financing the purchase of commodities by households and business firms (Saadallah, 1999). It is often used especially for working capital financing by help

facilitating the purchase of raw material or trade financing through facilitating imports and exports. The nature of the contracts which involves the purchase of commodities along with the financing activities makes it suitable to be used for that purposes. However, although it is very popular, it is heavily criticized for providing a way that could lead to riba. Many of its form, such as tawarruq, showing the reality that those instruments just adhere with Islamic law, rather than having the substance.

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