An Overview of Murābaḥah & Its Application in Modern Finance

By Mohammed Siddiq Mohiuddin (5th Year ʿĀlim Student, DarusSalam Seminary)

In a society where most homes are financed, it is unfortunate that so many are unaware of the legal rulings governing these transactions. Statistics show that over sixty percent of homeowners are paying mortgages.[1] As deferred payments continue to become the norm, common household items such as furniture, appliances, phones, etc., can now be financed. Thus, we must be aware of the Sacred Law’s standards in the modern marketplace. Scholars, such as Muftī Taqī ʿUthmānī, have contributed monumental amounts of research while trying to bridge the gap between the modern-day financial systems and Islāmic commercial law.

More specifically, he outlined different methods that can be utilized as modes of finance, while at the same time, upholding Islām’s laws. One of these methods utilizes the contractual structure of murābaḥah. This brief essay will summarize what he wrote on the subject.

In its contractual form, murābaḥah is almost identical to a normal transaction. The difference is that in a normal transaction the seller profits from his merchandise without specifying his profit margin to the buyer. And in murābaḥah, the seller informs the buyer how much the commodity cost him and how much profit he will make. The profit may be a lump sum or percentage based. The point nonetheless is that it is not a mode of finance, but rather a method of sale. One of the leading Ḥanafī jurists, Imām al-Qudūrī, defines murābaḥah in his Mukhtaṣar.[2] He mentions that murābaḥah is a transaction in which the seller sells a commodity and states the amount of money that the item cost him and how much profit he is making. This type of transaction is called a “cost plus sale.”

With this understood, one should note that this is not a preferred contract for financing. In fact, this is a method to avoid interest. And, in this way, the contracting parties do not sin.

It should be noted that contracts like mushārakah may be more ideal. However, they may also have some issues. They will only be perfected once they are implemented and we are able observe their flaws. And as these flaws are found, they can be corrected. An ideal system may only be achieved through practical application.

Another aspect that one must consider is the application of the general laws of transactions specific to murābaḥah when it is utilized as a mode of finance. Ergo, I think it appropriate to briefly discuss these rules, which will directly affect murābaḥah-based financing.

Firstly, the commodity must exist and be in the seller’s possession at the time of sale. For example, I cannot sell a 2022 model car because it does not exist yet, nor can I sell a car owned by my neighbor unless I acquire it before the transaction.

Secondly, the item must be in the physical or constructive possession of the seller at the time of sale.  Physical possession means the seller has the item in his possession. Constructive possession means that, although the seller may not have the item physically in his possession, all rights and liabilities are transferred to him.[3] One may promise to sell something he does not own, but this will only be a promise to conduct a sale and is not a sale itself.

Thirdly, the sale must be instant. It cannot be enacted at a future date nor can it be contingent on a future event, even if both parties consent. For example, I cannot say, in the month of October: “I will sell you this phone in November,”  nor can I say that: “I will sell you this phone if so-and-so wins the match.” In both cases, the transaction will be invalid.

Fourthly, the item must be valuable and should not be something that can only be used for ḥarām purposes. An example of this would be an individual selling wine; there is no ḥalāl use for wine and therefore the transaction is impermissible. However, if he were selling a knife, it would be allowed because a knife may be used for permissible actions, such as cooking or it might be used for something impermissible, like murder. In this case, the seller is not responsible for the buyer’s subsequent actions.

Fifthly, the price must be set at the time of the transaction. It cannot be increased after the sale is enacted due to a credit payment. For example, I cannot sell you a car for five thousand dollars and then increase the price to six thousand.

These laws govern all transactions. When an institution wishes to utilize murābaḥah as a financial product, they must abide by the laws specific to a transaction conducted with the stipulation of a deferred payment, which is called “bayʿ muʾajjal.”  These rules are as follows:

– Firstly, the date of sale must be stated. It cannot be contingent on an uncertain future event.

– Secondly, once a time period is set, the time will start when the buyer receives the commodity, unless the parties agreed otherwise.

– Thirdly, the price set for a credit payment may be more than the price of cash payment. At the same time, once the price is set, it cannot be changed based on a late or an early payment. For the sake of brevity, we will suffice with the contract’s essentials.

Keeping the above rules in mind, let us review the proper method of using a murābaḥah-based transaction in order to finance a commodity. I will reiterate what I mentioned. The following phases must be conducted in order and a change in their order could render this transaction ḥarām. In addition, for the sake of simplifying business jargon, I will use the example of an individual trying to purchase a home. Thus, the financier will be the bank, the client will be the buyer, the supplier will be the homeowner selling the house in question, and the commodity will be a house.

Firstly, the buyer and the bank will sign an agreement in which the bank promises to sell and the buyer promises to buy the house in exchange for the price of the house along with an agreed-on profit, which will be added to the overall sale price.

Secondly, the bank will appoint the buyer as its agent to purchase the house on its behalf and both parties will sign an agreement of agency.

Thirdly, the buyer will purchase the house on behalf of the bank and take possession of it on its behalf. At this stage, the bank is liable for the house. Assuming liability is crucial here. Otherwise, the transaction becomes usurious.

Fourthly, the buyer will inform the bank that the house has been purchased on its behalf. And he will make an offer to purchase the house from the bank according to the price promised in step one.

Fifthly, the bank will accept the offer and the sale will be concluded. The ownership and liability of the commodity will be transferred to the client.

If the bank purchases the house directly from the homeowner instead of making the buyer its agent, there will be no need for steps two and three. This method is preferred as it reduces the steps, and thus, reduces the possibility of error that may result in an interest-based transaction.

There are a few concerns regarding common errors that I want to address. The first problem that arises pertains to the financial institutions that loan money and need liquid assets. If it buys a property and the buyer backs out, it is left with the property, which prevents that money from being invested.  Therefore, the bank runs a risk in signing a promissory document with the buyer if the law does not enforce it.

There is a difference of opinion on whether this promise is enforceable. Muftī Taqī says that according to some of the schools it would be.[4] He further mentions that due to need in this situation, fatwā may be given according to that.

Another concern that is brought up is that of delayed payments. In a normal interest-based transaction, a late payment would simply increase the buyer’s debt. However, since in this transaction the price is set in the contract’s initial stages and cannot be changed, buyers take advantage and delay payments to the bank. The best way to resolve this is to have the buyer sign a document that will force him to donate a certain amount of money to a charity, which the bank chooses. For example, the contract may state that the buyer will pay the amount of one hundred dollars for each day the payment is delayed. The bank, under no circumstances, can profit from this. It must be given as charity. This ensures that the buyer does not default on payments.

Banks also make common errors under the name of a murābaḥah transaction, which render the transaction interest-based. One is that many banks refinance previously purchased homes using murābaḥah. This is usually done by having the customer buy their home back. And this is impermissible.

One cannot use murābaḥah to finance something an individual already owns. It is a sale, meaning, it requires a commodity and the transfer of ownership.

Another common error is that many banks roll over the contract in the case that the client is unable to meet the deadline. This is not allowed. Again, it would be contracting a sale for something the client already owns. Instead, as a form of security, the bank can have the client bring a guarantor. Alternatively, the bank can issue a lien or have the client sign a mortgage. In this way, the bank is protected from dishonest clients.

Although the scholars deemed this type of transaction permissible, many people bring up the concern that this method is very similar to a conventional loan. In both cases, the commodity is sold for a price that is higher than the market value in exchange for the time afforded to the client to pay the price of the commodity. The more time that is awarded to pay, the higher the price will be. This appears to be eerily similar to interest, and not surprisingly, many people end up assuming that it is.

This misconception arises due to misunderstanding the rules regulating the prohibition of interest. Our modern-day capitalist theory does not differentiate between currency and commodity. Both are traded and both can be sold at whatever price the parties agree on. An individual may sell one dollar for ten, cash or credit, just as he can sell a commodity for one dollar or ten. The only condition is that there must be mutual consent.

The sharīʿah, however, does not concur with this view. It regards currency and commodity as separate with a different set of rules, based on the following differences. Money has no intrinsic utility. It can only be used to acquire goods and services. Whereas commodities have utility, they can themselves be utilized in for the owner’s benefit. Commodities can be of different qualities, whereas money has no quality other than being a medium of exchange. For example, an old and dirty car is worth less than that same car in better condition. Yet, an old and dirty $100 bill is worth the same as a new one.

Therefore, an excess amount of money charged for a deferred payment is interest, but only in the case of money. Because it has no other qualities except for its trade value. Hence, it cannot be exchanged in unequal amounts.

On the other hand, if a commodity is being sold, different qualities can be factored into the price, including the time of payment. One may charge extra for many reasons. For example, someone selling his store may charge extra if his store is closer to the consumer, the owner himself may be more trustworthy than other vendors, or the atmosphere of his store may be more appealing.

In the same way, one may charge extra for more time given to pay the price of that commodity. This is allowed because commodities have intrinsic utilities and the item’s value is whatever the parties set. The only condition is that the time of purchase must be set. Once the price is set, it is in exchange for the commodity, because all those variables have become a quality of it, including the time of payment. It is not in exchange for the time, but rather in exchange for the commodity itself.

This is proven by the fact that once the item’s value has been set and the transaction carried out, it cannot be changed. If, for some reason, the consumer is unable to pay at the agreed time, the price cannot increase. Had that increase in the original price been against the time given to pay, the price would have gone up due to an excess amount of time provided. The fact that the price did not increase, despite the time increasing, proves that the first price was for the commodity and not the time of payment.

I would like to conclude by first commending the institutions who have proven that it is possible to have Islāmic systems in the modern financial sector. They have silenced many who said it could not be done. At the same time, much improvement is needed. While they are providing a ḥalāl substitute for finance, murābaḥah is not the preferred method considering the ideal Islāmic economic system. The result of interest-based finance and murābaḥah-based finance is one and the same, in that the rich profit off the poor, furthering the financial imbalances that are present in society, especially considering that Islāmic banks use the market’s interest rate as their benchmark for profit margins.

Islām, on the other hand, wants the rich to support the poor. When this imbalance is mitigated it removes injustices from society. As I mentioned, effort should be made to move towards financing using methods that will further Islām’s general economic outlook. This includes methods for financing like mushārakah.

We, as consumers, have a lot of power. And if the ummah strives towards this goal, it is achievable. I strongly believe that establishing such a system would produce more profit for the banks themselves as they would develop a larger consumer base. In this way, everyone benefits. May Allāh give us the ability to uphold His commandments.

 

[1] Kapfidze, Tendayi. “U.S. Mortgage Market Statistics.” Magnify Money. https://www.magnifymoney.com/blog/mortgage/u-s-mortgage-market-statistics-2018/. March 4, 2020.

[2] Mukhtaṣar al-Qudūrī, 86.

[3] Introduction to Islāmic Finance, 67.

[4] Introduction to Islāmic Finance, 87.