Making a Profit with Murabaha

Murabaha is derived from the Arabic word Ribh (ربح) which means profit. It is a common type of a contract used by financial institutions in which the buyer and seller agree on a cost-plus price of a product. As you all know that in today’s world ethical financing has grown exponentially and Islam is also based on an ethical model be it in the field of business or finance. Since the time of Prophet (PBUH) this is the main element which has differentiated Islamic Finance from the conventional based system.

Integrity Matters

In a contract of Murabaha, to fulfill the needs of ethical finance, integrity to both the client and monetary institution is required and that is the reason it is important for an institution to inform its client about the product, its cost price, the markup amount and even if it has bought the product on credit. All these details need to be included in a Murabaha contract. In case, during the tenure of the contract, if the client comes to know about the financial institution being dishonest, he has the right to terminate the contract on priority basis.

Interest free Contract

As the Muslim world is in dire need of an alternative system which must be free from interest, contracts such as Murabaha come to rescue them, it is often used by Islamic banks as a mode of finance.

Payment Convenience

Now the question arises that how does an Islamic bank use Murabaha to finance? So, an Islamic bank (Financier) simply buys the product which the client wants or the client can also purchase the product himself (on behalf of the bank). In the second case, the bank will have to transfer the power of attorney (وکالت) to the client. Afterwards, the client would buy the same product at a deferred price from the bank. The client has an option to make the payment to the bank as a whole or in installments as per the Murabaha contract. One should keep in mind that while the client is just an agent to buy the product and he has not paid a penny to the bank, his Shariah status would be of a trustee which means that the ownership would still belong to the bank (along with the risk factors such as theft, fire etc too). However, once the client has paid the deferred price, the ownership will be transferred to him simultaneously and all the risk factors would then be associated with him.

Process Made Easy

Let’s view a Murabaha transaction: Mr X wants to buy 100 vehicles from Company Y, he approaches the bank and the Islamic banking officer recommends him Murabaha, under this transaction the commodity will be bought directly by bank and the cost of equipment and profit (markup) will be known to both the parties i.e Mr. X and financier (bank). The bank would appoint Mr. X an agent (وکیل) to buy the product on behalf of him with the consent of both parties. After the purchase, the product will be in the possession of Mr.X but the ownership would still belong to the bank, Mr. X then may provide the payment of 100 Vehicles (Cost + Markup as agreed) with an option of one-off payment or in instalments. Once the payment is done, the ownership of the equipment would be transferred to Mr X.

Value Added Difference

So how’s that different from conventional system? Differences between them are as follows:

Murabaha is a sale-based contract in which an asset is always involved whereas the conventional system follows an interest % based agreement irrespective of whether an underlying asset exists or not.

Murabaha agreement does not allow profit (to the bank) from late payment fees or burdening customers with others snowboarding interest upon interest charges as the selling price has already been decided.

However, one must also be clear that Murabaha is considered as a borderline transaction among some scholars as it is a debt-based contract and should only be considered when financing through equity-based contracts such as Partnership (مشارکت) or Mudharabah (مضاربت) are difficult. The Murabaha agreement may also allow the bank to keep the mortgage(رھن) against the deferred payment to minimize the risk of fraud. In addition to this, the agreement can also be enforced by law.

Murabaha truly opens avenues for hassle free financing and offers optimum convenience to the client with multiple benefits.


Written by: Jareer Usmani

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Meezan Bank Reaches Rs. 1 Trillion In Deposits Amidst Global Pandemic

Meezan Bank has displayed exceptional financial performance as they cross the benchmark of 1 trillion Rupees in total assets. Meezan bank has also shown a profit after tax of an outstanding 7 billion Rupees which shows a growth of 70% from last year. This growth is immense and signifies the fortification of financial infrastructure in Pakistan. This is a huge milestone for any bank to achieve and Meezan bank has outdone itself. To achieve something as significant as this is a huge achievement in itself but to attain this in the pandemic that we are going through right now where businesses and financial institutions around the world are seeing a major decline and bankruptcy is just extraordinary.

The bank has maintained a smooth payout record, ever since its listing on the Stock Exchange in the year 2000. The banks financing portfolio closed at 484 billion Rupees with an ADR of 57%. The NPL ratio and NPL coverage ratio stood at 1.60% and 130% and The deposits of the bank grew by 7% to reach 842 billion Rupees.

The total operating income of the bank was increased by 55%, primarily due to continuous focus on maintaining the higher volume of earning assets holdings and a rise in the asset shows an agreeable increase in target rate.

The bank’s return on deposits also recorded a double rise. This growth is primarily due to the increase in volumetric growth depositors’ profit rates and. Fees and commission income of the bank grew by 26% fundamentally due to an increase in the trade business amount handled by the bank and other branch’s banking-related income.

The operating expenses and other charges increased by 26%. This is due to the fact that the devaluation of Pakistani Rupee and an increase in costs associated with new branches. The rise in expenses was adequately absorbed by the growth in the bank’s income, resulting in an improvement in the income efficiency ratio by 11%. The bank added 18 new branches to its network during the half-year, which brought the total number of branches from 660 to 678 all across the country.

Usmani and Co would love to extend their warmest congratulation to Meezan bank and their fascinating and adamant financial decisions that have formed them into the financial giant that they are today. The grit and sheer determination to follow principal and advisory fused with their incredible and unrivaled services are one of the main reasons for their success and we hope to see an even bigger increase in their assets and profits in the long run. These are the financial institutions that bring a positive light to our country and show the world that we are evolving and growing into a great and prosperous nation. 

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TIME VALUE OF MONEY IN ISLAMIC PERSPECTIVE

This question often comes to our mind that Why is Usury (Riba) haram when the Creditor is at a loss if we take into account the concept of Time Value of Money I.E The value of money which the creditor is lending would not be the same at the time when he would receive his money back, so why not charge Interest for the amount to cover for the loss of creditor?

First of All, if Allah has forbidden something then we just can’t argue to find its logic as in real life example if we had asked our servant to buy some medicine and he would’ve questioned the logic behind buying a particular medicine, would we’ve been able to bear his attitude? Similarly, if the creator of the mankind has made trade halal and usury haram then we’re no one to question its logic just as we don’t tend to find the logic behind the fact that he has commanded us to pray 5 daily prayers at their particular time and forbidden us to pray at the time of Sunset and Sunrise so the main objective is being a slave to Allah and adhering to his commandments.

(But, as the loan practice has become too often and you can’t convince people without giving logic and the consequences that the economy has suffered because of the interest-based system then there is no harm in providing logic also.)

Secondly, According to shariah if the creditor is lending money then he should decide whether he is doing it under the basis of Donations/Charity or he is doing Musharkat (Partnership) if he is doing these couple of transactions then in the first case, I.E charity he should only receive the principal amount as according to Shariah when you’re lending someone money, you’re doing an act of kindness and voluntary contribution (تبرع، احسان ) towards the debtor so making a profit out of that is haram if the medium of exchange is same between them, so a creditor should only receive the principal amount he has lend (the concept of Takaful in Islamic Banking is based on this rule). However, if he is doing partnership then both the creditor and debtor may divide the return according to the Profit/loss or Capital ratio.

Thirdly, Time value of money is not totally haram if the medium of exchanges are different such as lending Commodity and taking money as its return or either way, for example in ancient times people use to lend goods and in return, they would get the money (with a surplus) after the agreed period of time, it was a common practice but it was permissible as the medium of exchanges were different and that was Money vs Commodity but if the debtor is unable to pay the amount for the goods at the decided time of paying then the creditor cannot take excessive amount over that as the excessive amount (Penalty) then would be against the basis of the same medium (جنس) For example excessive money taken over principle amount of money agreed before and that’s why the concept of interest on late payment is also haram.

In a nutshell, taking Time value of Money into consideration is haram if the gender of both media of exchanges is same I.E money vs Money or Commodity vs Commodity but if the Medium of exchanges is different for example money vs Commodity then it is permissible. plus one should also keep in mind that the condition in which credit sale is allowed (apart from differences in the medium of exchange) is also that whether it is the case of (commodity vs money) or (commodity vs commodity) the weight and volume of both the mediums must be different for example in money vs commodity, money should be measured by weighing and commodity for eg Wheat should be measured by volume.

As The Prophet said, “Sell gold in exchange of equivalent gold, sell silver in exchange of equivalent silver, sell dates in exchange of equivalent dates, sell wheat in exchange of equivalent wheat, sell salt in exchange of equivalent salt, sell barley in exchange of equivalent barley, but if a person transacts in excess, it will be usury (Riba). However, sell gold for silver anyway you please on the condition it is hand-to-hand (spot) and sell barley for a date any way you please on the condition it is hand-to-hand (spot).”

Written by: Jareer Usmani

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The Basics Of Islamic Banking

The Basics of Islamic Banking

Banking and issues related with it:

A bank is an institution which creates current demand deposits or in simple terms money. A refined banking solution is the core backbone of the monetary network of any country. However traditional banking tends to rely heavily on the interest generated from clients through lending money to different types of borrowers like consumers, SME, Corporates, etc. This contradicts Islamic laws as The Holy Prophet said “Islam is a comprehensive guide for all ages to come, till the Day of Judgment. Islam has strictly prohibited taking, giving and even writing down of interest” [Tirmizi: 1206]. Taking of interest is not just a burden on the economics of society, but is considered as war against Allah and His Apostle (PBUH), as mentioned in the Holy Quran: “O yee who believe, fear Allah and give up what remains of your demand for Riba, if you are indeed believers. If you do it not, take notice of war from Allah and His Messenger.” [2:278-279]

What is Islamic Baking?

An Islamic bank is an interest free banking institution that relies on Islamic principles in order to perform the banking operations; hence it is halal (permissible) according to Islam and Shariah. 

 

How Islamic banks work? 

At deposit/liability side, Islamic banks work in one or more of the following ways:

  • Mudarabah: The bank takes an account holder’s deposit on the basis of Mudarabah contract whereby the account holder provides capital/deposit and the other partner (bank) manages it in a Shariah compliant manner. The profit is shared as per pre agreed ratio between customer (rab ul mal) and bank (mudarib) whereas loss is shared by the customer

  • Wadiah (Safe keeping): A non-profit and loss account, where the account holder basically gives an asset for safekeeping on basis of trust to the bank. Bank returns the asset on demand / maturity. Banks usually charge nominal fees as account maintenance fee.

  • Musharakah (joint venture): Where bank and investor(s) mutually provide funds for a project/business and the profit or loss is distributed among all involved shareholders. At asset side, Islamic Banks, in addition to the above modes, uses the following transactions for profit generation:

  • Murabaḥah (Cost-plus): The bank allows a person to buy an asset at an increased price from the bank, and the buyer can then pay back the amount in monthly installments. Since no interest is charged and a set price is taken, it is allowed in Shariah.

  • . Ijarah (leasing): A leasing contract of an asset to a client for a stream of rentals. At the end of ijarah tenure, Islamic Bank gifts the leased asset or sells it against token money through independent contract.

  • Salam: In Salam transactions, Islamic Banks pay the price of the commodity in advance and assets are delivered on a deferred date after the delivery, Islamic Banks sell the commodity in the market against the increased price.

  • Istisna: Istisna contract delivery of assets is deferred like Salam, however price can be paid any time with mutual consent and the underlined asset must require manufacturing in Istisna transaction.

Principles of Islamic banking:

  • Profit and loss sharing: A Muslim is not allowed to earn interest on credit and moneylending, if someone wants to utilize his capital, he must have to bear the risk of his capital in case of loss in business. Similarly rate of return could not be guaranteed for capital provider/deposit holder. Instead, profit of the business will be shared in predetermined profit sharing ratio.

  • Interest-free: Interest or Riba will not be given or taken under any circumstances in the light of Quran and Sunnah "Ibn Mas'ud says that the Prophet (pbuh) cursed the consumer of riba and the 'one who feeds it' and the one who witnesses it and the one who documents it." [Ibn Maja: 2277]

  • Shared risk: In Musharakahh contract’s risk is shared proportionately among all involved parties.

  • No investment or slightest involvement in prohibited businesses or activities: As mentioned in Holy Quran "And, O my people, give full measure and weight justly, and defraud not men of their things, and act not corruptly in the land making mischief. What remains with Allah is better for you, if you are believers" [11: 85-86]

  • Gharar: According to Islamic laws, all parties involved should be completely aware of the transaction they are going to execute and there should not be any ambiguity with regard to any term of the contract or with regard to the capacity of any party in relation to execution of the contract, hence selling of goods without proper possession is forbidden by Allah’s Apostle, as mentioned in Sahih Muslim “He who buys food-grain should not sell it until he has taken possession of it.” [Book 10: 3640]

  • Takaful: Gambling and insurance is prohibited in Islam, Allah (SWT) says, “O who you believe! Intoxicants (e.g. alcohol) and gambling and idols and (lottery by) arrows are an abomination of Satan's work, so avoid them so that you may get salvation” [Quran 2:219] hence Islamic banks instead of conventional insurance, take takaful cover that is free from interest, Gharar, and Gambling, it works on the basis of “Tabarru” (Gift) and Ihsan.

Global Islamic finances:

Global Islamic financial service industry is growing at a steady rate as more Muslims are getting involved in this Halal sector of interest free banking around the world. The industry’s total worth was estimated to be USD 2.05 trillion in 2017, showing a strong 8.3% growth. Whereas buying of Sukuk bonds, globally was raised by an astonishing 25.6% (closing at USD 399.9 billion at the end of 2017) as mentioned in the Global Islamic Finance Market 2019 Industry Research Report.

Financial Crisis: An Islamic Perspective

Financial Crisis: An Islamic Perspective

The Holy Qur’an says:

“so that it may not circulate only between the rich among you.” (59:7)

Mufti Taqi Usmani in his address to the World Economic Forum at Davos 2010, presented a paper, titled “Post-Crisis Reforms: Some Points to Ponder”, referring to the 2007-2008 financial crises that shook the world , in which he highlighted that, “One of the basic principles emphasized by the Holy Qur’an about the objectives of an economic system is that wealth produced in a society must be distributed in a just and fair manner, so that it may not be concentrated in the hands of a few people.

This is the very nature of a debt-based economy. The rich becomes richer and the poor poorer as the above verse highlights. The debt based economic system is based on riba (interest), which unjustly transfers complete risk to the borrower.

One of the lessons that we learn from the epitome of financial crises that took place in 2007-2008 is the element of risk transfer which created a domino effect and affected many with its swift. But do we really understand what risk transfer is and how did it lead to a financial crisis?

By definition, risk transfer when one party completely transfers the risk to another party. In the case of the financial crises, the following is what took place:

All risk was transferred from the financial institutions to the borrower and as the borrowers were mostly subprime in nature it led to defaults of loan and brought the entire financial system down. It started off in the United States and then affected the Asian Markets also such as China, Hongkong, Japan, India and so on.

Subprime lending is lending to those individuals who lack the financial stability to ensure timely repayment of installments. Siddiqi (2008) further adheres to this and says that the root cause of economic crises was ‘a moral failure that leads to exploitation and corruption’. The financial institutions failed ethically, in their eagerness to earn more riba (interest) they resorted to subprime lending.  Chapra (2008) further attributes that lack of profit-loss sharing (equity-based system) modes of financing led to the crises.

As suggested by Shaykh Muhammad Taqi Usmani, in the same paper, a viable solution to counter this unfair system is to restructure the entire financial system and move away from the current risk transfer system (debt-based) towards a risk sharing system (equity-based).