Sheikh Mohammad Khater Initiative

For Contribution in the Development of Islamic Banking

Date: 25 March 2015

Version: 1

Restructuring of
Auto Murabaha
Applied Islamic Finance
Basic Steps
Functionality
Requirements
Sharia Rulings

Yousuf Azim Siddiqi

Restructuring of Auto Murabaha

Introduction:
With no doubt, Islamic banking has evolved considerably over the past 3 decades. Although
the over-all size of Islamic banking is much smaller than the conventional (i.e. standard) banking
which is 4 centuries older but the fact cannot be overlooked that application of Islamic jurisprudence
(over fourteen centuries old) in modern banking practices was itself one of the biggest achievements
the legal minds could have thought of.
Despite the solutioning provided by Islamic banks, under the focused guidance of Sharia
scholars sitting on different Sharia Supervisory Boards, it was disheartening to hear and experience
that existing or upcoming Islamic banks are unaware of some of the basic Sharia techniques which
can solve many issues faced on daily basis.
There is no doubt that Sharia Standards published by Accounting and Auditing Organizations
for Islamic Banks (Bahrain), or more commonly known as AAOIFI, were one of the greatest jointefforts to codify Islamic commercial law after the enactment of Al-Mejelle (during the last century of
Ottoman Empire). However a normal banking professional remains at disadvantage to benefit from
these standards due to its complex regulatory flavor. Moreover modern banking pronouncements in
Arabic references are nothing but hidden jewels for English speaking banking professionals.
The efforts made by some contemporary Sharia scholars (especially Mufti Muhammad Taqi
Usmani and Dr. Abdulsattar Abu Guddah) and some training institutions to simplify and demystify the
Islamic banking concepts like Murabaha, Ijarah, Mudaraba Istisna, Musharaka etc. are nothing but
mesmerizing and outstanding. However the need remains to take these steps further through
introduction of concept of Applied Islamic Finance where the banking professional is exposed to
Islamic juristic reasoning and some helpful techniques can be shared with them which can address
some profitability issues or mitigate any minor or major Sharia risks.
To start with, our first paper is on Auto-Murabaha which is undoubtedly, one of the most
common products in Islamic banking. God willingly, we will be releasing more than a dozen papers.
Also new versions will unearth more jewels and endeavor to raise the previous standards. Kindly
ensure that any Sharia rulings mentioned in these papers do not, necessarily, reflect the official
opinion of either AAOIFI or Sharia Boards of my present or past employers.
Sheikh Mohammad Khater (1913-2004): Born in Dakahlia Governorate (Egypt). A
famous and well-respected Egyptian scholar who on different judicial positions in Egypt
starting from 1943 till his appointment as Grand Mufti of Egypt on 31st October 1970.
Post his retirement he guided Faisal Islamic Bank on the Sharia matters and was
among the pioneers in this field. To applause the sincere efforts made by Sheikh
Mohammad Khater in serving the cause of Islamic banking, we are pleased to name
this initiative (of developing of Islamic banking) after him. We pray our efforts further
enhance the knowledge base of Islamic financial jurisprudence and guide the practitioners,
consumers and regulators to the right path.

Restructuring of Auto Murabaha

Restructuring of Auto Murabaha

Background:
As per Auto Murabaha, the Customer who has already entered into Murabaha contract with the
Islamic Bank is obliged to settle a fixed amount of Murabaha Price which includes the cost (i.e.
principal) and the profit (intended to be charged by the Islamic bank).
Now there could be scenarios where the need for restructuring arises. This section deals with
restructuring of Auto Murabaha scenarios.

Basic Steps:

Steps 1 to 4 are dealt with in detail in our previously published post on Auto Murabaha. In this post
we will highlight about the fifth step: Restructuring of Auto Murabaha.

Restructuring of Auto Murabaha

Reasons for Restructuring. Fee for Restructuring

Functionality with Requirements:

Stage 5: Restructuring of Auto Murabaha
Reasons for Restructuring:
The customer who is obliged to settle his dues as per Auto
Murabaha will request for Restructuring of Auto Murabaha
as a result of:
1. Financial Hardship
Always banks follow Central Banks guidelines in
extending credit to retail and corporate clients. For
example if Debt-burden-Ratio is more than 50% then
the Islamic Bank will not extend financing to the
Customer. Although some Islamic Banks follow more
conservative credit policies but this does not mean
that even 20% or 30% are sufficient for the
Customer to manage his monthly expenses so easily.
Sometimes customers face financial hardship
through loss of job or increasing cost of living. In
such scenarios, the customer request to reduce the
monthly installment amount (EMIs). Similarly in the
corporates, the business entity might face sudden
economic downturn. In such a case, the company (as
Auto Murabaha obligor) will not be in a position to
honor settlement of Murabaha Price on time.
2. Early Settlement
Sometimes the Customer save some amount of money and would like to settle the
outstanding Murabaha Price in one-lump-sum. The Customer in such a case expect some
discount to be extended to him due to early settlement of Murabaha dues.
3. Mutual Agreement
In some cases, especially for corporate banking customers, the Customer and the Islamic
Bank are willing to restructure the existing the facility neither to exit the existing relationship
nor to legally pursue the Customer who is subject to Murabaha obligation.

Fee for Restructuring:

Upon signing of Murabaha, the Deferred Murabaha Price becomes a debt. Hence as per Sharia,
Islamic Bank (as a creditor) is not allowed to make a profit out of Restructuring of Auto Murabaha.
This restriction applies directly to Deferred Murabaha Price and indirectly through charging fee. On
the other hand, administrative fee can be charged by the Islamic Bank provided the same is a
nominal amount and in line with market practices. This fee is charged against processing a standard
application.
In
the
UAE,
Islamic
Banks
usually
charge
AED
100/-.

Restructuring of Auto Murabaha

Restructuring the Price of Murabaha

Restructuring the Price of Murabaha

Once the Customer and the Islamic Bank agree to go ahead with Restructuring of Auto Murabaha
then financial obligation due post Restructuring of Auto Murabaha can be any of the following:
1. 100% Waiver of the Outstanding Murabaha Price:
It is possible that in some cases of financial hardship, Islamic Bank waives 100% of the
outstanding unpaid Murabaha Price. This is known as profit write off. Usually in the cases of
customers death and non-recovery of funds from the insurance company, Islamic bank
resorts to this kind of waiver. This will result in liberating the Customer from any future
financial obligation.
2. Reducing the EMIs with Increasing the Tenure:
Sometimes Islamic Banks realize that the Customer is unable to pay the monthly installment
as agreed in the Murabaha contract whereby he is supposed to pay USD 1458.33 for the
coming 48 months.
Hence if the Customer requests for financial relief, then the Islamic Bank has the right to
reduce the monthly installments (i.e. EMIs) provided the sum of amount paid before and post
Restructuring of Auto Murabaha should not exceed the Total Deferred Murabaha Price (in
this example USD 70,000).
Example 1:
If in the 12th Month, the Islamic Bank and the Customer agree to reduce EMIs (in this
example) from USD 1458.33 to USD 1200.00 for the coming 48 months (i.e. 60th month
from the signing of Murabaha) then the Islamic Bank has to look into the following:
Before Restructuring:
Sum of EMIs paid till the 12th Month = 14583.33 x 12 = USD 17,499.96
Post Restructuring:
Sum of EMI to be paid from 13th Month till the next 48 month (60th Month from the
origin) = USD 1200 x 48 = USD 57,600
This means that the aggregate amount paid by the Customer before and post Restructuring
of Auto Murabaha will be USD 75,099.96 which is higher than Deferred Murabaha Price as
agreed initially which was USD 70,000. This means that due to Restructuring of Auto
Murabaha, the Customer will pay more than what he was supposed to pay as per Auto
Murabaha. Hence this arrangement is not acceptable as per Sharia.
Example2:
If in the 12th Month, the Islamic Bank and the Customer agree to reduce EMIs (in this
example) from USD 1458.33 to USD 1200.00 for the coming 43 months (i.e. 53rd month
from the signing of Murabaha) then the Islamic Bank has to look into the following:
Before Restructuring:
Sum of EMIs paid till the 12th Month = 14583.33 x 12 = USD 17499.96
Post Restructuring:
Sum of EMI to be paid from 13th Month till the next 43 month (53rd Month from the origin) =
USD 1200 x 43 = USD 51600

Restructuring of Auto Murabaha

Restructuring the Price of Murabaha

This means that the aggregate amount paid by the Customer before and post Restructuring
of Auto Murabaha will be USD 69099.96 which is less than Deferred Murabaha Price as
agreed initially which was USD 70,000.
This means that due to Restructuring of Auto Murabaha, the Customer will pay an amount
(USD 69099.96) which will be less/equal than what he was supposed to pay as per Auto
Murabaha. Hence this arrangement is acceptable as per Sharia.
The Thumb-rule is that reducing EMIs is not a condition for determining whether
Restructuring of Auto Murabaha is done as per Sharia or not. Rather we need to look
whether the aggregate amount paid before and after the Restructuring is not exceeding the
Murabaha Price agreed initially at the time of sale of Car on Murabaha basis.
3. Increasing the EMIs with Reducing the Tenure:
Sometimes the Customer comes forward (as the case with Mutual Agreement) and asks for
increase in the amount of EMIs. This will be due to customers willingness to settle his
financial obligation in a shorter span of time.
Example 3:
If in the 12th Month, the Islamic Bank and the Customer agree to increase the amount of
EMIs (in this example) from USD 1458.33 to USD 1800 for the coming 29 months (i.e. 41st
month from the signing of Murabaha) then the Islamic Bank has to look into the following:
Before Restructuring:
Sum of EMIs paid till the 12th Month = 14583.33 x 12 = USD 17499.96
Post Restructuring:
Sum of EMI to be paid from 13th Month till the next 29 months (41st Month from the origin) =
USD 1800 x 29 = USD 52200
This means that the aggregate amount paid by the Customer before and post Restructuring
of Auto Murabaha will be USD 69699.96 which is less than Deferred Murabaha Price as
agreed initially which was USD 70,000.
This means that due to Restructuring of Auto Murabaha, the Customer will pay an amount
(USD 69699.96) which will be less/equal than what he was supposed to pay as per Auto
Murabaha. Hence this arrangement is acceptable as per Sharia.
4. Increasing the EMIs with the Same Payment Tenure:
It is a known fact that Islamic Bank as a seller in the Auto Murabaha cannot increase a single
penny over Deferred Murabaha Price so Islamic Bank face the risk of fixing the price over a
long period of time. This risk is a major concern for those financings where Murabaha was
extended against preferential rates of financing.
As a way out Islamic Bank execute Murabaha contracts at the cap rate of profit (i.e. market
rate or standard rate). However internal systems recover EMIs based on preferential rates for
example USD 1300. This means Murabaha is booked at preferential rates. Once any change
takes place in the economic inputs (like loss of job or increasing the rate of funding) then
Islamic Bank restores to the agreed upon Deferred Murabaha Price i.e. EMI of USD 1458.33.
For this purpose the Islamic Bank might rebook the Murabaha in the system or merely
increase the rate of financing to match with legally agreed upon rate of financing. Islamic
Bank does not have a right over the waiver amount for the previous months i.e. USD

Restructuring of Auto Murabaha

Restructuring the Price of Murabaha

1458.33 USD 1300. The way of monthly waiver upto the Event of Change is considered as
the most efficient and suitable way to deal with risk of sudden rate shocks during the shortterm Auto Murabaha.

5. Partial Waiver of the Outstanding Murabaha Price:

In all cases of Early Settlement, the Customer settles the Deferred Murabaha Price (due as
per Auto Murabaha) earlier than the stipulated time. This settlement could be by choice or by
force.
For example in cases where the Customer defaulted in settling his payments so an event of
defaults occurs and settlement of outstanding unpaid Deferred Murabaha Price becomes
due immediately.
Similarly Early Settlement could be by customers choice to relief himself from financial
burden.
In all cases of Early Settlement, the Islamic Bank has the right to decline accepting
Customers request to accept payment of the outstanding unpaid Deferred Murabaha Price.
This is in line with Customers right to refuse acceleration of payment when he has not
defaulted.
Now Early Settlement in conventional banks car loans is quite simple. Conventional banks
have principal amount of loan and accrue interest on daily basis. In case the customer early
settles his car-loan then conventional bank merely stops accruing interest for the remaining
tenure and charges a fee over the loss occurred due to this settlement.
On the other hand - Islamic Banks agree on the entire Deferred Murabaha Price at the time
of signing the Murabaha contract. All the profits (up to the maturity) are due to the Islamic
Bank which is entitled, as per Sharia, to claim such amounts because it took risk of the
underlying asset (i.e. the Car purchased from the Dealer).
Although in the internal accounting systems, Islamic Banks divides the EMI into Principle and
Profit but as per contractual obligation the entire amount of EMI represents Deferred
Murabaha Price. In this case, when the Customer early settles the outstanding Deferred
Murabaha Price so the Islamic Bank has the legal right (as per Sharia) to claim the full
amount without taking into consideration the outstanding profit and principle in the system.
In order to reward the Customer for his good financial behavior, Islamic Banks, usually, waive
a portion of the outstanding Murabaha Profit. Any obligation on the Islamic Bank to reduce
Deferred Murabaha Price is nothing but reverse Riba. Since in standard Riba (Islamic term
for usury) the financial obligor is charged extra amount over the outstanding debt in case he
delays settling the same by end of the agreed upon period. However, in reverse Riba, the
creditor is forced to waive a portion of the debt due to settling the same prior to the agreed
upon date.
Some conventional regulatory bodies (in the UAE) and court of laws (in Malaysia) saw a
sense of injustice where Islamic Banks misusing the Sharia rulings to make the obligor (i.e.
the Customer) suffer through paying more than his financial obligations with conventional
banks. Hence Islamic Banks were required to maintain the percentage of waiver of
outstanding unpaid Deferred Murabaha Profit with the early settlement fee charged by other
conventional banks. Although Islamic Banks, in most of the cases, maintain the same

Restructuring of Auto Murabaha

Restructuring the Price of Murabaha

percentage of profit waiver but it is not stipulated anywhere in the Auto Murabaha
agreements that Islamic Bank are obliged to waive X% of the outstanding Murabaha Profit in
case of early settlement.