Murabaha consumer financing

Murabaha is the most commonly used mode of financing in Islamic banking and finance. Murabaha is derived from the Arabic word “ribh” which means profit. Murabaha is a contract between a seller and a buyer, which requires the seller to disclose its profit to the buyer. This is considered more efficient as compared to an ordinary sale contract in terms of its informational efficiency, especially in the less developed markets that otherwise may not reveal full information on prices. Murabaha has historically been used for trading in goods that may not have well-developed markets in them. One obvious advantage of buying on a murabaha basis is that the buyer knows for sure what additional amount of money he is paying to the seller in the form of profit.
Many people opine that murabaha is not necessarily an ideal mode of financing in Islamic finance, and hence argue for a more suitable financial tool as a replacement for interest-based financing. They view murabaha financing as a stratagem for replicating the economic effects of an interest-based loan. This view is, however, flawed. Murabaha differs from an interest-bearing loan in a number of ways, including but not limited to the following:
1. Interest-bearing loans are purely monetary transactions, ie, a lender gives money to a borrower who is required to return money, with an additional component (interest). Murabaha-based financing, on the other hand, involves trading of real goods and services for disclosed profit.
2. Murabaha-based financing gets the financier involved in the trading of goods and services, which is not a requirement in the case of interest-based lending. Given this nature of murabaha, it cannot be used for rescheduling of debts. Interest-based lending, on the contrary, allows people and businesses to borrow more to pay-off some of their existing loans. Thus, interest-based lending may give rise to spiralling debt.
3. Strictly speaking, there must not be a default penalty in the case of murabaha financing, which makes it more compassionate in nature than an interest-bearing loan that in most cases allows the lenders to impose additional interest payments in case a borrower fails to pay on time. In the actual practice of murabaha financing, a default penalty is imposed by financiers to curb the moral hazard on the part of the party receiving finance, but the amount of penalty is used for contributing to charity.
Some people question the excessive use of murabaha financing in Islamic banking on the grounds that this looks very similar to interest-based lending. This is not a new criticism. In fact, the Quranic verse 2:275 “Allah has permitted trade and prohibited riba (interest)” alludes to this criticism based on the close similarity between riba (interest) and trading. Thus the Holy Quran very clearly endorses (profit-oriented) trading of goods and services while prohibiting interest-based lending, despite the two practices being seemingly similar.
Many people also criticise murabaha-based financing on the grounds that financiers buy an item from the market and immediately sell it on to the party seeking finance. This criticism, however, does not uphold in the eyes of the shari’a, as the shari’a does not put any minimum limit on the period of ownership of an asset by the seller before he may sell it on. Some of the shari’a requirements for trading in goods and services are as follows:
1. It is required that the parties to a transaction are of sound mind and that they decide to enter into a trade by free will, without any coercion.
2. The object of sale must be halal and it must be in existence or ordinarily available in the market at the time of the sale.
3. The seller must own the object of sale before it is sold and delivered to a purchasing party.
4. An unambiguous price must be mutually agreed and paid by the purchaser to conclude the sale.
Considering the above requirements, it is clear that the most important requirement for trading in goods and services is that the seller must own what they sell to another party. Hence, in the above-mentioned murabaha-based financing the real requirement for the financing party is to own and then sell the asset to the customer. The duration of ownership is not a shari’a concern; rather it should be an economic decision. For a trader, the less time an item spends in the inventory, the more efficient the trade.
In addition to trade financing for businesses, there are a number of possible uses of murabaha for consumer financing, including but not limited to:
1. Financing of durable goods like electronics and automobiles;
2. Home financing;
3. Store cards
In a country such as Pakistan, murabaha-based financing can be used to finance a number of activities, including education of children. This can be done by setting up specialised murabaha companies for consumer financing. There are already a number of mudaraba companies and mudarabas set up under the Mudaraba Companies and Mudarabas (Floatation and Control) Ordinance 1980 and subsequent Mudaraba Companies and Mudaraba Rules. Such companies are primarily for business financing. The proposed murabaha companies must primarily focus on consumer financing. It is important that a comprehensive legal framework must be developed to regulate such a business. The requirement of disclosure of profit in murabaha trading can be used for the regulation of profit in consumer financing. This can be used as a policy tool in favour of providing affordable consumer financing to selected social groups. For example, if murabaha is used for financing of education, then the government may impose a profit ceiling in return for offering some tax incentives to the murabaha companies. Similarly, murabaha financing for buying computers can also be regulated to promote computer literacy, especially in the rural areas where still a large proportion of children have no access to computers.
These are only a few examples of the potential role that murabaha can play not only in consumer financing but in promoting a wider socio-economic agenda a government may seek to implement. A real benefit of promoting murabaha financing will be in terms of developing an alternative source of consumer financing on a localised basis. Banks mostly operate nation-wide and hence have credit policies that in general do not favour lower-income families. Murabaha companies can be set up on a local and regional basis to promote a culture of Islamic credit unions, whereby different non-governmental organisations may attempt to join hands with professionals to develop a new model of consumer financing, by combining the rigour of banking and finance with the passion of charity and philanthropy. If done properly, this may pave the way for a more moral society, promoting social responsibility amongst individuals and businesses.

The writer is shari’a advisor to a number of banks and financial institutions and can be contacted at [email protected]