Islamic Modes: Murabaha and Salam– Islamic Microfinance Workshop CIBE Training Program

1. Islamic Modes: • Murabaha and Salam– • Islamic Microfinance Workshop • CIBE Training Program • Muhammad Khaleequzzaman • Head Islamic MFIing & Finance • IIU Islamabad

2. Training Workshop – Islamic Microfinance ISLAMIC MODES/INSTRUMENTS: • Sale Contracts: • Murabaha/Murabahah to the Purchase Orderer • Salam/Parallel Salam • Istisna’/Parallel istisna • Participatory Modes: • Mudarabah/Resource Mobilization • Musharakah/Diminishing Musharakah • Rent based Modes: • Operating ijarah • Ijarah wa iqtina’

3. Sale Defined: Exchange of a thing of value with another thing of value with mutual consent OR the sale of a commodity in exchange of cash. Elements of a valid sale: Contract ( Aqd ) Subject matter ( Mabe’e) Price ( Thaman ) Possession or delivery ( Qabza ) Training Workshop – Islamic Microfinance

4. Training Workshop – Islamic Microfinance Rules of Sale: [Sale Defined and Elements of Sale] • Subject must exist at the time of sale • Subject must be in the ownership of seller – Physical or constructive • Sale must be instant and absolute [exception of above rules in Salam and Istisna’] 4. Subject should be halal 5. Subject must be known and identified 6. Sale must be unconditional 7. Delivery of sold item must be certain • Price of subject must be certain Risks and responsibilities attached with the subject must transfer from seller to the purchaser as a result of sale

5. Training Workshop – Islamic Microfinance Types of Islamic Sale • Bai muajjal • Murabaha • Musawama • Salam • Istisna Murabaha: Uses of Murabaha • Sale of raw material • Sale of cart • Sale of equipment • Sale of agricultural inputs • Sale of consumer goods • House material financing

6. Outline: Murabahah – Brief Historical Perspective MFIing Murabahah/Murabahah to the Purchase Orderer Procedural details of Murabahah as practiced by Islamic MFIs Issues in Murabahah Documentation Theory & Practice of Murabahah M. Khaleequzzaman IBF, IIUI

7. Theory & Practice of Murabahah Murabahah – Concept and Shariah Legitimacy Murabahah defined: • Selling a commodity as per cost with a defined and agreed margin of profit (Ribh) • Profit may be a percentage of the selling price or a lump sum. • The transaction may be concluded with or without any promise to purchase by the client: Ordinary Murabahah / MFIing Murabahah or Murabahah to the Purchase Orderer. Shariah Legitimacy of Murabahah: • Qura’an: “It is no crime for you to seek the bounty of your Lord” [Surah Ale Imran: 198] “ Allah has permitted trading and forbidden Riba ” [Surah Al-Baqarah: 275] • Sunnah: The Prophet (PBUH) purchased a she camel from Abu Bakr (RAA) for use as transportation from Medinah... M. Khaleequzzaman IBF, IIUI

8. Theory & Practice of Murabahah Murabahah – Historical perspective Introduced as new form of sale in second half of First Hijrah century as a sale with necessary condition of declaring cost by the seller and agreeing on profit margin by both the seller and the purchaser [Al- Muwatta, Imam Malik] Modifications were made by Imam Shafii’, including an order of the purchaser, who could subsequently exercise the option not to purchase the same, and also included credit transaction He clearly bifurcated two sales’ transactions M. Khaleequzzaman IBF, IIUI

9. Process Flow: Negotiation/Approval of overall limit MOU/Master Murabahah Facility Agreement Requisition + Undertaking + Security Deposit (Hamish jiddiyah - Optional) + Invoice Theory & Practice of Murabahah 2 MOU/Master MFA MFI Client Approval of Limit 1 Requisition, Undertaking, Sec. Dep. 2 M. Khaleequzzaman IBF, IIUI

10. Third party appointed as agent [Optional] – Clint can be appointed agent [case of dire need] Payment to the Supplier – Direct Theory & Practice of Murabahah Payment in Supplier’s Name 2 A Agent (Client) 3 MFI Client MFI Agent (3rd Party) Receipt of Payment 2 1 Agency Agreement Agency Agreement Supplier Supplier Supplier 3 Payment 2 Payment Invoice M. Khaleequzzaman IBF, IIUI

11. Possession Payment to supplier Discount of supplier/benefit to client Title of goods Transfer of risk and responsibilites Theory & Practice of Murabahah Risks and Responsibilities Agent (Client) MFI Supplier Agent (3rd party) Goods Title M. Khaleequzzaman IBF, IIUI

12. Conclusion of Murabahah Theory & Practice of Murabahah 1 Murabahah Price MFI Client Murabahah Terminates 2 Personal/group sec. 4 2 Offer to Purchase MFI Client Acceptance of Offer 3 Receipt , Possession Report 1 Sec. Deposit/Hamish jiddiyah 3 DP Note • Payment of Murabahah Price M. Khaleequzzaman IBF, IIUI

13. Purchase of poultry feed stock Murabahah transaction: Rs. 30,000 Murabahah Facility: 90 Days Payment: Each month Rate of Profit: 15% p.a. Freight: 5% of cost of goods Security: Personal/group guarantee Theory & Practice of Murabahah M. Khaleequzzaman IBF, IIUI

14. Theory & Practice of Murabahah Pricing of Murabahah [Example]: M. Khaleequzzaman IBF, IIUI

15. Theory & Practice of Murabahah Issues in Murabahah: Unilateral promise/undertaking Invoice in the name of MFI Prior contractual relationship (customer and supplier) Vendor being third party/blood relation/wholly owned institution of customer [Buy back (Inah)] Commitment or credit facility fee Documentation charges Hamish Jiddiyah/treatment/timing Timing of promissory note Rollover/Default in payment of price Rebate on early payment M. Khaleequzzaman IBF, IIUI

16. Theory & Practice of Murabahah Documentation: • Murabahah Agreement and Allied Documents: • Parties to the Murabahah • Subject matter • Cost price • Profit Margin • Value Date – Disbursement date of Cost Price • Contract price • Default clause/penalty • Right of set off i.r.o client’s credit balance • Agency agreement as separate contract • Purchase Requisition • Invoice • Receipt of payment to the supplier M. Khaleequzzaman IBF, IIUI

17. Theory & Practice of Murabahah Documentation: • Declaration • Securities as per security documents • Demand Promissory Note • Schedule of payment M. Khaleequzzaman IBF, IIUI

18. Theory & Practice of Murabahah Risks in Murabahah: M. Khaleequzzaman IBF, IIUI

19. Theory & Practice of Murabahah Some Applicable Guidelines from AAOIFI: A. Measurement of asset value At acquisition – Measured and recorded at historical cost. After acquisition – Asset available for sale to client shall be measured at historical cost In case of default in payment of Murabahah price, the asset shall be measured at cash equivalent value (ie. Net realizable value). A provision to be created for decline in the asset value (ie. Difference between acquisition cost and the cash equivalent value). M. Khaleequzzaman IBF, IIUI

20. Theory & Practice of Murabahah Some Applicable Guidelines from AAOIFI: B. Potential discount after acquisition The discount shall not be considered as revenue However it should reduce the cost of goods. C. Profit recognition Profit shall be recognized at the time of executing contract if the term does not exceed the current financial period. Profits of credit sale whose payment is due after the current financial period shall be recognized as per following: Proportionate allocation of profits Profit may also be recognized as and when received. M. Khaleequzzaman IBF, IIUI

21. Theory & Practice of Murabahah Some Applicable Guidelines from AAOIFI: D. Failure to fulfill promise having paid Hamish Jiddiyah Hamish Jiddiyah to be treated as liability on Islamic MFI. Treatment: The amount of actual loss to be deducted from Hamish Jiddiyah E. Penalty – Deposited in Charitable A/C on realization M. Khaleequzzaman IBF, IIUI

22. Salam

23. Islamic Modes – Agricultural Financing Salam: Defined A salam transaction is the purchase of a commodity for deferred delivery in exchange for immediate payment. It is a type of sale in which the price, known as the salam capital, is paid at the time of contracting while the delivery of the item to be sold known as subject matter of salam (al Muslam fihi) is deferred. Salam is also known as Salaf (lit: borrowing) Salam: Purposes Liquidity needs of farm production Working capital/Running Finance Project finance (partial requirements)

24. Islamic Modes – Agricultural Financing Salam: Shariah Legitimacy • Allh says “O ye who believe when you deal with each other, in transactions involving future obligations in a fixed period time, reduce them to writing” [Al Baqara Verse 282] • Ibn Abbas reported, the Prophet (PBUH) came to Medina and found that people were selling dates for deferred delivery (salam) after a duration of one or two years. The Prophet (PBUH) said: “whoever pays for dates on a deferred delivery basis (salam) should do so on the basis of specified scale and weight” [Bukhari and Muslim]

25. Islamic Modes – Agricultural Financing Wisdom of allowing Salam • Farmers, orchard owners, merchants can fulfill their working capital and liquidity needs before the commodity is ready to be sold Three major problems and solutions • Risk of default by seller [personal/group guarantee/ hypothecation] • MFI’s need to liquidate goods after delivery [parallel salam] • Seller’s inabillity to produce or procure commodity [receive back the same price]

26. Islamic Modes – Agricultural Financing Salam: • An exception to the possession • A purchase contract opposite to Murabahah • Benefits both the seller and purchaser • Payment of full price at spot - otherwise selling debt for debt • Allowed in commodities satisfying condition of Dhawatul Amthal - quality and quantity can be specified exactly • Product of a particular field or farm cannot be sold • Quality and quantity decided in un ambiguous terms • Quantity should be agreed in specific terms (by weight, volume or measure)

27. Islamic Modes – Agricultural Financing Salam: • Certain date and place of delivery • The commodity should remain in the market throughout the period of contract [Different opinions] • The time of delivery should be sufficient to allow use of salam capital conveniently and effect prices, preferably be at least 15-30 days from the date of contract [Different opinions] • A security/guarantee or is preferred as safeguard to the risk of default • Only commodity is delivered and not the money

28. Islamic Modes – Agricultural Financing Salam: Alternatives Available to MFIs of Taking Delivery of Commodity: By establishing a subsidiary By appointing the third party or client its agent to sell the commodity The agency agreement should be separate from the salam agreement If agent has been able to sell the commodity at a price more than the one agreed in agency agreement, agent gets the difference 3.By opting for Parallel Salam or Third party sales

29. Payment of Salam Price 1-1-07 1 Salam Contract Wheat 2000 kg. Signed 1-1-07 Delivery 30-6-07 2 MFI Farmer Sale Proceeds Salam Transaction Agent Delivery of Wheat 30-6-07 3 Sale Proceeds less Commission 3C Sale of Wheat 3A Third Party Purchaser Sale Proceeds 3B

30. Salam Sale Contract 1-1-07, Wheat 2000kg. 1 1 2 2 Salam Price Payment 1-1-07 Salam Price Payment 1 June 06 Client Farmer Delivery of Commodity 30-6-07 Delivery of Commodity 20 Dec 06 Purchaser/ Seller MFI Purchaser MFI 5 5 Parallel Salam Payment of Price 15-1-07 3 4 2nd Salam Contract 2nd Salam Contract Payment of Price Third Party 2nd Salam 15 June 06 Third Party 2nd Salam 15-1-07 Delivery of Commodity 5-7-07 Delivery of Commodity 20 Dec 2006 6

31. 1 Salam Sale Contract 1-1-07 2 Salam Price Payment 1-1-07 Farmer Delivery of Commodity 30-6-07 Purchaser Seller MFI 4 Third Party Promise Promise to Purchase 15-1-07 Pays 5-7-07 3 6 5 Third Party Promise and Payment Delivery of Commodity 5-7-07

32. Islamic Modes – Agricultural Financing Rules of Parallel Salam and Third party promise • Both the contracts viz. salam and parallel salam must be independent of each other • Parallel salam is allowed only with third parties. Therefore the original seller cannot be entered into the parallel salam • The third party giving unilateral promise should not pay the price as this is not allowed in Shariah Examples of Products

33. THANKS