Murabaha in prearranged deals

Islamic banks which are active in international markets, finance many prearranged deals using the Murabaha. This is especially done in commodity markets. This arrangement can be as follows:

Company A, is an industrial firm buying on regular basis Zinc from Company B which is either an actual producer or a trading house. A company usually borrows from the bank to buy from B alternatively, an Islamic bank can extend credit through Murabaha, buying from B on cash basis and selling to A on deferred payment. Usually such deals are concluded as part of a Murabaha agreement. For each transaction, company A will inform the bank, via telex, of its desire to buy from B, giving details of quantities, qualities, price and date of delivery. Bank will then appoint A as Agent, to buy on behalf of the bank and to sell to its own self.

Payment will be transferred by the bank to company B, the seller, once sale is concluded. Company A will defer the payment and pay a profit to the bank (which is the seller here). Warehouse warrants have to be provided to show the actual existence of the commodities sold at the time of sale, and transfer of title. Being part of a prearranged agreement, this transaction is usually concluded in a “few hours” . Usually an L/C or similar type of guarantee is provided by the buyer (company A), which makes this a low-risk type of finance for Islamic banks. It is also a technique used by Islamic bank to invest their short term excess liquidity.

Source: An Introduction To Islamic Banking, Shaykh Dr Mohamed Ali Elgari. Republished with permission.