ISLAMIC

BANKING
BK5503

PROF. DR. RODNEY WILSON

ASSIGNMENT: MURABAHAH ISSUES

AHMAD PAZIL BIN MD ISA
1400109
31st MARCH 2014

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CONTENTS
1. INTRODUCTION

2. ISLAMIC FINANCIAL INSTITUTIONS

3. MURABAHAH

4. AL-BAI BITHAMAN AJIL (BBA)

5. KEY ISSUES ASSOCIATED WITH MURABAHAH

5.1. Use of interest rate as a benchmark

5.2. Gharar issues

5.3. Securities against Murabahah

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5.4. Guaranteeing the Murabahah

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5.5. Penalty of Default

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5.6. Rollover in Murabahah

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5.7. Rebate on earlier payments

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5.8. Calculation of cost in Murabahah

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5.9. The subject matter of the sale

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6. CONCLUSION
BIBLIOGRAPHY

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1. INTRODUCTION
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Islamic banking is financial services carries out by the Islamic financial institutions based on the
Sharia rules and requirements, designed to meet the needs of Muslim customers in business and
trade. The emergence of Islamic financial institutions in the past few decades within the financial
and monetary organizations around the world have played an important role in financial
transactions, Islamic banks, Islamic financial institutions as important, get more attention than
other institutions. Islamic banks today exist in all parts of the world and is seen as a viable
alternative system, which has many things to offer.
Murabahah is the most popular in Islamic bank financing but the method does not being
favoured by many of the advocates of Islamic banking. Murabahah contract do not defy against
the norms of Sharia' but it has been criticized as a superficial contract, when the Islamic banks
continue without taking actual sales and no real transfer of risk to the buyer of the goods, while
charging the controversial rate of profit as market interest free.

2. ISLAMIC FINANCIAL INSTITUTIONS

Islamic Banking in Islamic economic scenario is based on the most important principle in
Islamic economic philosophy, the prohibition of usury or riba. Technically, riba refers to the
increase in the principal amount of the loan according on time which was loaned and the amount
of loan. In the early days there was intense debate whether riba related to interest or usury,
though now there appears to be a consensus of opinion among Islamic scholars that the term
includes all forms of interest. The prohibition of riba , however has a lot of challenges to scholars
of Islam are not only obliged to remove usury but are also required to present the justice system,
free from exploitation. The key success of the Islamic principles depending on the exact needs of
Sharia' that focuses on justice, risk sharing, physically realized transactions and directly linked to
the business and most importantly addressing the Islamic concept of halal in nature.
Islamic financial institutions in the operation and objectives based on the principles of al-Quran.
Thus it apart from conventional institutions that do not have such religious preoccupations.
Islamic banks provide commercial services that comply with religous Islamic injunctions.
Islamic banks provide to their customers free of interest or usury. Giving and taking of interest is
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prohibited in all transactions. This prohobition makes the Islamic banking system differ
fundamentally from the conventional banking system.
The basic idea of Islamic banking can only be expressed that Islamic financial institutions
operating primarily is based on the principle of Profit Loss Sharing (PLS). An Islamic banks do
not charge interest but instead took part in the outcome resulting from the use of the funds. The
depositors also share in the profits according to a predetermined ratio. Therefore, there is a
partnership between the Islamic bank and the depositor on the side and between the bank and its
investment clients, on the other side, this acts as a resource manager depositors in productive use.
This contrasts with conventional banks, mostly borrowed funds to pay interest and lend funds,
charging interest on the other. The complexity comes from various Islamic banking instruments
employed and in understanding the underpinnings of Islamic law.

3. MURABAHAH
Murabahah is from word ribh which means profits, gain or additional. In English the word is
often translated as mark up or cost-plus financing. In Murabahah, the seller have to disclose the
cost and the contract occurs at an agreed profit margin. This contract was practiced in preIslamic times. Al-Marghinani (1957) has defined Murabahah as a sale of anything for the price at
which it was purchased by the seller and the additional of fixed sum or profit. Therefore, the
seller must disclose capital was involved in the deal or tell the cost to the buyer. This is lawful
without any controversy among the scholars.
According to Imam Malik (1985), Murabahah undertaken and completed by exchanging goods
and the price including a profit margin agreed upon. By definition, therefore, it is the basis for a
valid Murabahah that buyers need to know the original price, additional expenses if any and the
amount of profit. Thus, Murabahah is a contract that can be trusted.
Murabahah is an important and appropriate Islamic product to be used by the Islamic banks to
finance commodity. Financial instruments are often used in exchange transactions in which a
trader buys goods needed by the end user and sell the same to him after adding an agreed profit.
But Murabahah transaction can only be used when the client bank or financial institution wanted
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to buy commodities. Banks or financial institutions buy and sell the commodity at an agreed
profit margin. Shariah compliance is necessary in Murabahah contract, commodities will actually
purchased and taken possession of, physical or constructive, by the bank plus commodity risk as
it remained under the ownership of banks and possession.
In the context of ancient Islamic, Murabahah refers to a simple sales tools and do not have a
direct connection with the financing transaction. But now, Murabahah has recently changed from
sales transactions to means of financing and risk visualized in the adoption of Profit - Loss
Sharing (PLS) Islamic banking system. The bank, at the request of his client, buying items from
the designated third party for a fee. Immediately on the transfer of ownership of goods as well as
getting physically or, in most cases, the building ownership, the bank sells the goods to the
customer at cost plus an agreed fixed profit margin.
The customer then takes physical possession of the goods and promise to pay to the bank either
by installments or in one lump sum, at a later date agreed upon. There are many cases where a
bank customer and the seller of the goods are related parties. In many other cases, the bank
customers buying commodities themselves as the agent bank and then buy back the same
commodity from the bank for the cost plus profit shall be paid at a later date to be mutually
agreed upon.
Tarik M. Yousef (2001) claims that Islamic banks are working under a disadvantage of longterm financing with Mudarabah or Musharakah is far more risky and expensive than long-term or
medium-term loans of conventional banks. It likes Murabahah contract in Islamic banks are
somehow different from equity-based finance theory. By examining syndrome Murabahah in
Islamic finance through the prism of a systematic analysis of the worldwide financial structure,
Tarik M. Yousef (2001) found that Islamic banks, as a specialized provider of capital, not
operating whether differ from conventional banks. It is interesting to note that Murabahah has
come under criticism by many scholars in various forums.

4. AL-BAI BITHAMAN AJIL (BBA)

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Al-Bai Bithaman Ajil (BBA) is a deferred installment sale where bank capitalizes its profit up
front in the sale of property. This financial concept has broadly used for many purposes namely
home financing, vehicles, education financial package, corporate financing and many more. On
the other hand, in the practice, not all of the financing provided by Islamic Bank is well
organized in the process of repayment by customers, since they faced the difficulties in discharge
their obligation, thus it creates customes default payment. These cases lead to the dispute
between Islamic bank and the customers and many of the cases were finally end in the court.
BBA introduced as an alternative to conventional loan with the main objective to ensure the
transaction comply with the teachings of Islam to avoid the practice of usury or riba which is
strictly prohibited by the Shariah.
In Malaysia, the short-term credit Murabahah Murabahah or Murabahah with payment payable
in lump sum. A long-term credit Murabahah is known as al-Bai-Bithaman Ajil (BBA). BBA also
known as Bay' Muajjal and Murabahah in Pakistan and other countries in the Middle East.
Al-Bai Bithaman Ajil (BBA) home financing is the most popular type of financing whether
Islamic bank or conventional banks in Malaysia since the introduction of Islamic banking in
1983 by Bank Islam Malaysia Berhad.
However there are legal issues related to sharia' BBA home financing as practiced in Malaysia.
Argued that BBA as practiced in Malaysia is not based on the original BBA under shariah BBA
but a transaction Islamic banking Bay 'Inah (sell and buy back) which are not accepted as a valid
Islamic contract. Party involved in the BBA contract was never the intention to transfer the
ownership of property. Therefore, it is against main trust of the sales contract in Malaysia
ownerships transfer upon delivery of the subject matter.
The practice of BBA in Malaysia is similar to the concept of debt financing which is often
resulted in high cost. BBA as practiced in Malaysia are not in compliance with Shariah principles
as the bank does not take the risk of ownership and liability on the property and therefore can not
be accepted by international scholars. There is high level of dissatisfaction among the customers
as shown in their low intention to use BBA. They recommended that Islamic banks or Islamic
financing needs to come up with alternatives of Islamic home financing product.
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As a way to achieve human justice and religious purpose, many Islamic instruments are offered
to the customer as a way to avoid activities which prohibited is in the Shariah. As part of Islamic
instrument, many issues rise in the practice of BBA. The issue rise due the customer not
convince when it comes to early redemption or in the event of default, there is default payment,
there is no transfer of ownership, and the price of the asset often exceeds the original price of the
asset compare to other Islamic product like (Musharakah Mutanaqisah).
The problematic arise in BBA cases that lead to the dispute are due to the bank making a claim
for the full sale price as stipulated in the property sale agreement (PSA) because the bank have a
legal right. And for most cases attracted much public attention is that the way how the bank
practitioner calculated the outstanding amount to be repaid by borrower who had defaulted on
their BBA contract.
Malaysia Commodity Murabahah allows lenders to create financing transactions involving
specific assets, that all deals must involve real economic activity. In Malaysia, when the Islamic
bank uses commodity Murabahah financing offers, it will buy assets to then sell it to the
borrower. The borrower then sells the commodity to a third party using the bank as an agent, and
it receives payment and secures the financing it had requested. Commodity Murabahah and some
forms of tawarruq have drawn sharp criticism from some scholars who say the structure fell foul
of the principles of Islam.
In addition, BBA is dependent on market interest rates as the bench mark. This causes problems
in the pricing of products and marketing for Islamic home financing when market interest rates
are low, the amount financed would be more expensive than conventional loans. Therefore, the
customer may withdraw from Islamic banks and transfer facilities for conventional loans.
Therefore, when the market interest rate is higher than the rate of profit BBA, Islamic banks
suffer losses because it can not raise the rate of profit in BBA as fixed selling price. Offer
Murabahah commodity can be scam with no true sales taking place and no real transfer of risk to
the buyer of goods.
The question is then, why such an Islamic financing raise disputes whereas it supposes to
promote fairness between the parties involved. BBA contract always brings the customer to end
up with a higher financing balance at any certain time if compare to the conventional loan with
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the same monthly payment. When there is default payment, the ownership of the asset remained
hold in the bank side as the financier, there are no transfer of ownership by proportionately
percentage according to the amount that have been paid by the customer. The price of the assets,
particularly the balance of financing at any point of time often exceeds the original price of the
asset compare to other Islamic product like MMP (Musharakah Mutanaqisah) which is the
combination between the Partnership and Ijarah. Critically, the global Fuqaha specifically
Shariah scholars in the Middle East diverged of the BBA with regard to the prohibition of
interest contract.
The purpose of the customer deal with Islamic bank though BBA instrument in order to avoid
conventional bank which contain interest and religious purpose and avoid riba which is
prohibited in al-Quran Al-Baqarah. However in the practice of BBA due to less comprehension
in the customer side regarding the agreement in BBA contract, the customer burden by paying
the remaining installment. Further, the customer has less legality to sustain his right.
Furthermore, the BBA practices consists of a few elements of gharar which is prohibited in Islam
(QS : Al Baqarah : 188) and Islamic law is clear on contracts involving non-existing subject
matter (in this case house under construction) referring to many cases of abandoned housing
projects in Peninsular Malaysia. And also the practice of the BBA in Malaysia is conversed to
the teachings of Islam. BBA transaction should be modified and revamped until it is fully able to
protect the interests of the customer.

5. KEY ISSUES ASSOCIATED WITH MURABAHAH

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5.1. Use of interest rate as a benchmark

Many financing institutions using murabahah determine their profit or mark-up on the basis of
the current interest rate, mostly using LIBOR (Inter-bank offered rate in London) as a criteria.
For example, if LIBOR is 6%, they determine their mark-up in murabahah equivalent to LIBOR
or some percentage above LIBOR. This practice is often criticized on the ground that the profit
based on the interest rate is as forbidden as the interest itself.
No doubt, the use of interest rates to determine the halal profit can not be regarded as justified. It
certainly makes the transaction resemble as an interest-based financing, at least in appearance,
and keeping in view of the prohibition of interest, despite this apparent similarity should be
avoided as far as possible. But we should not ignore the fact that the most important requirement
for the validity of the murabahah is that it is a genuine sale with all the ingredients and necessary
consequence. If murabahah transaction meets all the conditions enumerated in this chapter,
merely using the interest rate as a benchmark for determining the non-profit making murabahah
transaction as invalid, haram or prohibited, because the agreement does not contain interest. The
interest rate has been used only as an indicator or as benchmark.
It is, however, true that the Islamic banks and financial institutions need to eliminate this practice
as soon as possible, because, firstly, it takes interest rates ideal for a halal business which is not
desirable, and secondly because it does not advance the basic philosophy of Islamic economy
that has no impact on the distribution system. Therefore, the banks and financial institutions
should strive to develop their own benchmark.

5.2. Gharar issues

The bank or financier cannot enter into actual sales at a time when the customer seeks
Murabahah financing because the commidity did not owned by the bank. Under the rules of
Sharia', one cannot sell a commodity not owned by the potential seller nor can the financier
effect a forward sale. The bank, therefore, bound to purchase the commodity from the supplier.
Then he can sell it to a customer after having the physical or constructive possession of it.

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The problem is that if the customer is not obligated to purchase the commodity after the financier
has purchased from suppliers, financiers may be faced with a situation where he has done great
expenses to acquire the commodity, but the customer refused to buy it. Commodity in question if
such a way that it has no other buyers in the market and buyers can find it very difficult to
dispose of. In this case the financier can suffer unacceptable losses.

5.3. Securities against Murabahah

The payment comes from the sale are receivables and therefore, customers may be asked to
provide a security. It can be in the form of a mortgage or hypothecation or lien or charge.
Murabahah is a transaction that can not be securitiezed to create a negotibale instruments to be
sold and purchased in the secondary market. If the buyers or customers in Murabaha transactions
sign financial documents to prove his indebtedness against the seller or the financiers, the
document will represent a monetary debt receivable. In other words, it is the money of payable.
Therefore, the transfer of commercial paper to a third party will mean the transfer of money .
The commercial paper may not be sold or purchased at a lower price or higher. Therefore, the
commercial paper represents monetary obligations arising from Murabahah transaction, cannot
make negotiable instruments. If the commercial paper is transferred, it must be at par value.

5.4. Guaranteeing the Murabahah

In Murabahah the seller may ask to the buyer or customer to provide a third party guarantee. In
case of negligence on the payment the seller may may have resource to the guarantor who will be
responsible to pay the amount guaranteed to him.
There are two related issues namely the guarantor cannot charge any fee from the original client.
It is because someone charged a fee for making the loan is in the form of usury. Whatever be the
guarantor may charge a fee for any documentation expenses. Nevertheless based on the Sharia
rules regarding guarantees, expressed there are certain rigorous restriction with regard to such
guarantees. This issue should not be viewed easily.
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5.5. Penalty of Default

Murabahah is a sale transaction, regardless of the mode of payment and the sale price is fixed. If
the customer defaults in payment of the price on a specified date, the sale price cannot be
changed nor can charged a penalty fee .
In an interest-based loan, the loan amount continues to increase according to the length of the
default period. However in Murabahah financing, when the price is fixed, it can not be increased.
Sharia' based restriction is sometimes exploited by dishonest customers who deliberately avoid
paying at due date, because they know that they will not have to pay any additional amount on
account of default .
In order to deal with dishonest clients who default in payment deliberately, they should be made
liable to pay compensation to the Islamic Bank for losses incurred due to default .
However this shall be subject to the following conditions:
a) the person who is in default shall be given a grace period of at least one month .
b ) if it is proved beyond doubt that the customers are defaulting without valid excuse then
compensation can be claimed.
Once Murabahah exercised, the Murabahah price becomes a receivable (Dayn) for the Bank.
Therefore, any amount charged in excess of the "dayn" would amount to Riba.
However, it is allowed to have an undertaking from the customer to pay a sum of money or a
percentage of the debt that will be donated to charity in the event of delay in
payment/installment.

5.6. Rollover in Murabahah

In an interest-based financing, where the bank's customers cannot pay on the due date for any
reason, he may ask banks to provide facilities for another term. This facility is known as a roll11

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over. If the bank agrees on that point, at which the newly agreed rate of interest used for the new
term. It actually means that another loan of the same amount is re-advanced to the borrowers.
Murabahah transaction cannot be rolled over to the long contract period as the old contract ends.
Murabahah is not a loan that is based on the sale of commodities, which are deferred to a specific
date. Once the commodity is sale, transfer of ownership from the bank to the customer and thus
it is no more the property of the seller. Now what the seller can claim is only the price agreed
and therefore there is no question of implementing other sales in the same commodity between
the same parties.
Any roll-over in Murabahah, it is argued, would be a mere interest, because it is an agreement to
impose an additional amounts on the debt created by the sale of Murabahah.
Rollover in Murabaha is not allowed as per the Murabaha transaction is for the purchase of an
asset . A new Murabaha is only feasible for the purchase of new assets. It is advisable that once
implemented there must be a gap of 1-2 days between maturity of the previous Murabaha and
disbursement of the new one.

5.7. Rebate on earlier payments

Sometimes the debtor may wants to pay earlier than the specified date. In this case the debtor
usually want to get a discount on the agreed deferred price.
However in Islam, the majority of Islamic scholars including the major schools of thought
consider this to be un-Islamic. However, if the Islamic bank or financial institution to provide a
rebate on its own, it is not objectionable especially if the client is in need.
If the customer makes a payment in advance and there is no commitment from the institution in
respect of any price discounts of Murabahah, than the institutions that have the sole discretion in
allowing them a rebate. It is not advisable to carry out the practice and must be avoided in the
normal course of business. The issue is, if there is, should be brought within the knowledge of
Sharia' advisers.

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5.8. Calculation of cost in Murabahah

The Murabahah can only be implemented when the seller can determine the exact cost he has
incurred in acquiring the commodity he wants to sell. If the exact cost cannot be ascertained then
Murabahah cannot occur. In this case the sale will occur as musawamah the sale without
reference to cost.

5.9. The subject matter of the sale

All commodities should not be the subject matter of Murabahah because certain conditions need
to be fulfilled. The shares of companies that can legally be sold or purchased on Murabahah
basis because according to Islamic principles that represent ownership of shares in the assets of
the company provided all the basic terms of the transaction are fulfilled. A buy back or sell
without taking possession of them is not allowed.
Murabahah is not possible to things that can not be the subject of sale. For example, Murabahah
is not possible in exchange of currencies.
Goods must be in existence at the time of execution of Murabahah. Murabahah can not be done
in all commodities such as currencies, gold, silver. Murabahah can not be used to pay utility
bills, wages, overhead expenses. General rules relating to the sale of the subject matter must be
followed.

6. CONCLUSION
The purpose of Islamic economic and finance is to provide human justice and prevent things
which are prohibited in Shariah namely riba (usury), gharar (uncertainty) and maisir (gambling).
Riba is prohibited because it would lead to injustice and harm to society. However, it is
surprised to see in practice Islamic financial institutions are still practicing riba in Murabahah
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transactions. Eliminating Riba in the banking system is an important part of Islamic business
principles. Management and staff of this system is bound to run their business with adherence to
the principles of Islamic business in addition to the normal objective of maximizing profits.
These principles include honesty, fairness and equity, determined by Allah and practiced by His
Messenger. It is suggested that Islamic banks have Murabahah financing to adopt true
Murabahah to avoid usury in the transaction and to achieve Maqasid Al Shariah (objectives of
Sharia'). The presence if the Islamic benchmark could be the solution for this to replace the
conventional benchmarks which still using interest rates.
Islamic banks have significantly twisted the principles of Murabahah. They have, on the dubious
grounds of Islam, justified behavior contrary to Sharia', for example the allowances of time value
of money and the enforcement of penalty fees on customers who cannot pay. Many scholars now
claim that banks reduce their use of synthetic Murabahah transaction, on the grounds that they
felt very much like an interest-based loan.
In the case of Malaysia, BBA house financing used by Islamic financial institutions and the
profit rate is dependent on market interest rates due to arbitrage activities . Therefore, it is similar
to the conventional mode of financing. The difference between fixed-rate BBA and the
conventional mode is that once the profit rate is fixed in the BBA, said at 7 % per annum , it will
remain the same for the entire duration of the funding. This, in fact, cause problems for the
financier because it is difficult to accurately estimate the cost of funds and profitability in the
long term, due to fluctuations in economic conditions. The conditions encourage customers to
refinance their homes from the BBA house financing to conventional financing during the period
of low interest and vice versa. The above discussion has highlighted some of the features of
Murabahah contributed to discontent or controversy among the customers. Islamic financial
institutions should strive to provide Shariah-compliant financial. It is expected that the main
objective of Islamic banking is not to maximize profits as the interest-based banking system
does, but to provide socio-economic benefits to the Muslims.

BIBLIOGRAPHY
Ayub, M. (2007). Understanding Islamic Finance. England: John Wiley & Sons.
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Karim, A. A. (2005). Islamic Banking. 3rd Edition. Fiqh and Financial Analysis. Jakarta: PT
Rajagrafindo Persada.
Kettel, B. (2008). Introduction to Islamic Banking and Finance. Islamic Banking Training.
Lahsasna, D. A. (2010). Q&A in Islamic Finance. Kuala Lumpur: CERT Publications Sdn. Bhd.
Nurrachmi, R., Mohamed, H., & Nazah, N. (2013). Dispute between bank and customer in Bai
Bithaman Ajil (BBA). Case in Malaysia.
Siddiqui, A. A. Murabaha Documentation & Application of Murabaha. Retrieved 03 10, 2104,
from AlHuda Centre of Islamic Banking & Economics : http://www.alhudacibe.com
Zandi, G., & Ariffin, N. M. Some Issues on Murabahah Practices in Iran and Malaysian Islamic
Banks.

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