Murabahah & MPO
1- Definitions
In this section, some technical words are defined.
Murabahah: an agreement whereby the bank sells to a customer at acquisition cost plus an agreed profit margin, a specific kind of asset that is already in its possession.
MPO: Murabahah to the Purchase Orderer is an agreement whereby the bank sells to a customer at cost plus an agreed profit margin a specified kind of asset that has been purchased and acquired by the bank based on a Promise to Purchase (PP) by the customer.
Non-binding MPO: the bank acquires an asset in anticipation that the asset will be purchased by the orderer/costumer. The treatment of this case is similar to a normal Murabahah.
Binding MPO: the bank has no long position in the asset that is the subject of the transaction.
Hamish Jiddiyyah: in the case of a binding MPO, the risk of selling at a loss is mitigated by securing a Hamish Jiddiyyah (HJ). It's a security deposit held as collateral upon entering into agreement to purchase or agreement to lease.
Sharia: is the body of Islamic religious law. It is the legal framework within which the public and private aspects of life are regulated for those living in a legal system based on Islamic principles of jurisprudence. Sharia deals with many aspects of day-to-day life, including politics, economics, banking, business, contracts, family, sexuality, hygiene, and social issues.
PSIA: Profit Sharing Investment Account is a financial instrument that is relatively similar to the time deposits of conventional banks. According to the terms and conditions of PSIA, depositors are entitled to receive a share of the bank's profits, but also obliged to bear all potential losses pertaining to their investment in the bank. This profit-sharing principle is core to Islamic finance, according to which investors and entrepreneurs must share the risks and rewards of a given venture.
A PSIA can be further categorised into: Unrestricted PSIA and Restricted PSIA. The Bank has full discretionary power in making investment decisions for unrestricted PSIA, but in the case of the restricted PSIA the placement of funds by the Bank is subject to investment criteria contract or agreed between the investment account holders (IAH) and the Bank at the time of contracting.
2-Murabahah's principle
In this section, some principles which must be respected by a Murabahah & MPO contract are described and an example is presented.
Murabahah or MPO is a mode of financing which allows to the Islamic banks to finance, respecting their principles, as well the needs of working of their customers (supplies, subjects, intermediate products) as their investment.
In a Murabahah or MPO contract, The Bank intervenes as first buyer of the asset. The Bank buys cash the asset or on credit and resells it in cash or on credit to his customer for a profit margin agreed between both parties.
So that a Murabahah and MPO contract complies with Sharia, it is necessary to respect some rules:
§ The object of the Murabahah contract must comply with the prescripts of the Sharia: no financing of products prohibited by Islam like alcohol, weaponry, pork...
§ Acquisition of the asset by the Bank. Indeed, the basic principle of Murabahah is that the profit margin returning to the Bank justifies itself only by the commercial and not financial character of the transaction (the purchase and the resale must be real not fictitious).
§ The cost price, the profit margin of the Bank and the term of payment have to be known beforehand and accepted by both parties.
§ Once the price is fixed, it cannot be decreased in case of earlier payment, nor can it be increased in case of default. Besides, in case of bad faith of the customer, the Bank is entitled to demand a compensation of the not honored terms. In which case, it would be advisable to estimate the damage by referring to objective criteria of the bank and to avoid any reference to the interest rates.
Example:
A company wants to buy a commodity, but it has not enough working capital for that. An alternative solution for asking a loan to a bank, it is a Murabahah contract.
The Bank will purchase 100,000€ of a commodity (provided that the commodity is not forbidden according to Sharia) and then sell this to the company at a profit price: 108,000€. The additional 8000€ 'mark-up' against the original cost of the commodity is the Bank's profit.
The company now have a debt to the Bank of 108,000€ which it have agreed to repay, in instalments, over 3 years.
3- Murabahah stages
A Murabahah & MPO contract can be divided in two stages:
· Stage I: the asset is available for sale.
· Stage II: the asset is sold and delivered to a customer and the selling price is due to the customer.
The calculation and the type of the risk faced by the Bank are different at the various stages of the contract for the two categories.
