Constructing a Murabaha deal
In the majority of cases, a bank client applies for a loan because he wants to buy something. This could be a new car, a house, an office building, a yacht or a new machinery for his factory. These needs and many more, can be accommodated through Murabaha contracts. Such Murabaha can be constructed as follows:
- Client approaches the bank showing his interest in the purchase of say, an airplane. He will present full description and detailed specification including the source of supply.
The bank will run a credit evaluation, the same way this is done in conventional banking.
If he is a good risk, then the Murabahah margin (i.e. bank’s profit or markup) for him will have to be decided. This margin will be quoted, most probably as a per annum flat rate based on the total cost of acquiring the airplane by the bank which includes price paid and all related expenses.
If he is agreeable, he will be asked to sign a pledge agreement, committing to buy such airplane, once it is the ownership under the possession of the bank. If the bank owns it within the agreed-upon time with the exact required specification, then honoring this pledge by the obligatory. However, this obligation does not mean he is going to be forced to buy because this clearly makes the pledge nothing but a de facto sale contract. Rather, it means that, if the client fails to honor his commitment he will be liable for any loss that may accrue to the bank due to such failure. In such cases the bank will sell this airplane to another client. If losses are sustained, bank will have a recourse on that client. If profit were made, it is the right of the bank.
As part of the Murabaha transaction, the client will be asked to present some securities to the bank at the time of signing the pledge. These securities can be in the form of cash or in any other liquid asset, equivalent to about 5% to 10% of the value of the deal. This is called, in Islamic banking Jargon, seriousness Margin i.e. evidencing that the client is serious. This will be used to compensate the bank in case the latter fails to honor his commitment to purchase and loss was sustained by the bank on the goods are sold to third parties. It is to be noted that this is not a down-payment, because the sale contract is yet to be concluded. In Shari’ah no sale is to be made unless the seller actually have the goods to be sold in his ownership.
- Once goods are ready, the client will be asked to sign the sale contract and receive them. There is no need for the bank to actually have these goods in his own warehouse to satisfy Shari’ah requirements. Rather, if they are clearly identifiable and risk of damage is borne by the bank, then this considered satisfactory.
Source: An Introduction To Islamic Banking, Shaykh Dr Mohamed Ali Elgari. Republished with permission.
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