Issues in Murabaha Financing.
A Case of Murabaha Financing
of The Bank Of Khyber
Contents
Chapter: 1: Introduction ..................................................................................................................... 3
1.1: Background ............................................................................................................................. 3
1.2: Problem Statement .................................................................................................................. 4
1.3: Research Question ................................................................................................................... 4
1.4: Objectives of the study ............................................................................................................ 5
1.5: Scope of the study ................................................................................................................... 5
1.6: Significance of the study ......................................................................................................... 5
Chapter: 2: Literature Review ............................................................................................................ 6
2.1: Murabaha in classical Islamic law ......................................................................................... 6
2.2: Murabaha as a modern instrument ......................................................................................... 6
2.3: Problems and criticisms of modern Murabaha ....................................................................... 9
Chapter: 3: Methodology ................................................................................................................. 12
3.1: Research Approach ............................................................................................................... 12
3.2: Data Collection Techniques .................................................................................................. 12
3.3: Data Analysis Technique ...................................................................................................... 12
References ........................................................................................................................................ 14
Chapter: 1: Introduction
1.1: Background
Islamic banks (“Participation banks” in Pakistan) utilize the money they have collected using
various Islamic banking instruments. Although equity contracts and profit-and-loss sharing is
encouraged in Islamic law, fixed return modes of financing rank highest in use by Islamic banks.
According to Sairally (2002), Murabahais the most common method used by Islamic banks to
arrange financing.
The Murabahacontract is a cost-plus-sale contract where an Islamic bank purchases a product for
a client and sells the same goods to him at an agreed mark-up price that is paid in instalments. In
ArabicIslamic finance literature, the phrase used for Murabahatransactions is “al-Murabaha li
al-āmir bi al-shirā” (Murabahato Purchase Orderer). Since a profit margin is added explicitly to
the cost price, it is often referred to as “cost-plus financing” in English. In Malaysia the term
“Bay‘ bithamanājil” (BBA) is used for long-term credit sales. In Turkey, it is also called either
“production
support
(ūretimdesteği)”
or“individual
financing
support
(bireyselfinansmandesteği)”.The contemporary application of Murabahais a product of modern
conditions; hence, there are many different aspects that call for debate. Although modern
Murabahais widely accepted by scholars of Islamic law, there are still several controversies
around its application.
On the other hand, since Murabahamimics the standard debt contract in conventional banking
systems, its predominance represents a challenge to the idea that Islamic finance would provide
an alternative to interestMURĀBAḤAH based conventional financial systems. Therefore,
Murabaha, as applied by Islamic banks today, has generated debate amongst Islamic scholars
and Muslim finance specialists.
Some scholars and nonprofessionals find Islamic banking and Murabahaarrangements artificial
since they see banks as pure financial intermediaries and not traders. On the contrary, many
scholars see Murabahafinancing as valid and suggest that Islamic banks are supposed to be
“non-pure financial intermediaries” meaning that they have to assume some kind of commercial
intermediation. Instead of providing funds directly to investors, Islamic banks are supposed to
transfer assets they purchased to clients through credit sale during Murabaha(Sairally, 2002, p.
80; Saadallah, 2007, pp. 174-175).
This paper offers a discussion about the main criticisms directed at modern Murabaha financing
from the perspective of Islamic law. The Islamic validity of modern Murabahaas practiced by
The Bank of Khyber will be evaluated and any violations of the injunctions will be highlighted.
1.2: Problem Statement
There have been debates among contemporary scholars concerning the modern Murabaha
contract and the conditions it is based on. The questions raised relate to such issues as the value
of time, the binding promise, and avoidance of Islamic banks of risks related to trading and
whether modern Murabaha is a disguised form of interest.
Modern Murabaha has been criticized as being a roundabout way of charging interest by
artificially transforming a financing transaction into a purchase and sale with deferred
payment.The most important theoretical justification for this is the issue of compensation for
value oftime. It is maintained that the increase in the price vis-a-vis the selloff ordered goods on
credit to the client is analogous to interest charged ona loan. This argument is fallacious since it
equates reselling at a higherprice and charging interest. We have to make it clear that Islamic law
allows associating a value to time in case of a sale while it prohibits itin the case of a loan.The
problem of binding promises is actually the core point of the discussion around modern
Murabaha since this issue has a deep impacton the nature of an arrangement. When a client
orders a commodityfrom an Islamic bank, the bank requests the client to sign a “promise to buy
” to ensure that the client eventually buys what he/she ordered.
When the initial theory of Islamic banking was proposed, the bank was supposed to be active
during the search for plausible goods, contactingthe dealer, supplying and transferring it to the
client, whereas in contemporary Murabaha practices at The Bank of Khyber, we see that the bank
try to avoid all risks related to ownership and possession of the object before its final sale to the
client.
1.3: Research Question
The study investigates the contemporary issues in Murabaha Financing and to answer the
following research questions,

Does The Bank of Khyber avoid Risk of Possession and ownership through Murabaha
Financing?

Is Unilateral Promise of The Bank as Binding in Muarbaha Financing Permissible in
Islamic Sharia?

Does the Bank of Khyber uses Murabaha Financing is for artificially transforming a
financing transaction into a sale transaction?
1.4: Objectives of the study

The main objectives of the study are as follow,

To critically evaluate the issues in Murabaha Financing of The Bank of Khyber

To evaluate the Murabaha Financing of The Bank of Khyber against the Interest Based
Loans in Banking Industry

To find out whether The Bank of Khyber avoid the risk of possession and ownership in
Murabaha Financing

To analyze the Status of Unilateral Promise as a binding Islamic Sharia
1.5: Scope of the study
The study analyzes the Theory and Practice of Murabaha Financing at The Bank of Khyber. The
study using a quantitative data analysis approach evaluates the Issues in Murabaha Financing at
The Bank of Khyber. Issues in Murabaha Financing such as the use of Murabha Financing as
Unilateral binding, transformation of possession and ownership to customer for avoiding risk and
to analyze the criticism of transforming Murabaha Financing into a Sale Transaction. Data from
Previous theoretical and empirical research studies and primary data collected from officials of
Islamic banks in Pakistan is used for analyzing the issues in Murabaha Financing.
1.6: Significance of the study
The Murabaha contract, an ordinary contract in classical Islamic law, has played a significant
role in the emergence and development of modern Islamic Banking and Finance.This modern
financing tool has become the subject of intense debates since then and has been subject to
criticism by some scholars. This paper aims at portraying the juristic discussion and debate on
this modern contract and its application by “The Bank of Khyber”. The findings of the study
present some important insights from The Bank of Khyber regarding the criticism and debate on
Murabaha Financing and add some knew knowledge to the existing Body of Knowledge.
Chapter: 2: Literature Review
2.1: Murabaha in classical Islamic law
In classical fiqhliterature, sales (bay‘; pl. buyū‘) are categorized intotwo groups according to how
the price is determined. If the price isdetermined between buyer and seller without referring to
the originalcost of the goods, it is called a musāwamah(bargain) which is thecommon form of
trading. On the other hand, if the seller discloses hiscost and his profit or loss, this is called a
trust sale (bay‘ al-amānah).
Depending on whether the seller discloses a profit or a loss, it is calledmurābahahor waḍī‘ah, not
to be confused with wadīahwhich is asafekeeping agreement]. If the good is sold at its cost, it is
a tawliya(Mawsili, 1937, vol. 2, p. 28).
The word Murabahais derived from the Arabic word ribāthatmeans profit or gain.
Murabahaliterally means doing business on acost-plus-profit basis. As mentioned above,
Murabahais one of the“trust sale” categories. In Murabaha, the seller explicitly reveals
hiscost and specifies his profit margin as percentage of the cost or in definitemoney terms
(AbūZayd, 2004, p. 37; Sairally, 2002, p. 74). This typeof sale makes sense for customers who
do not know the market priceand would like to depend on the declaration of the seller.The most
important condition for this sale to be valid is that bothparties know the cost and selling price of
the goods. Additionally,according to most fiqhschools (except the Shāfi‘īs), the goods must
bemithli(standard) objects, and according to Hanafis the goods must besomething exclusive of
gold and silver. Since this is a trade based ontrust, in case the seller is dishonest in his declaration
of the cost, this isregarded as cheating and a compensation for this is dealt with in detailin
classical fiqh works (AbūZayd, 2004, p. 53).
2.2: Murabahaas a modern instrument
Modern Murabahais based on a bank’s purchase of some goods andreselling them to the
customers who requested them. Eventually this is asale with an agreed profit margin over the
cost price along with deferredpayment (Ayub, 2007, p. 219).
Murabaha, which is an ordinary type of sale in the classical period,seems to have undergone a
significant change and transformationby evolving into a modern contract type and financing
model that isincreasingly located in the center of Islamic banking. Murabahacontracts as
practiced today by Islamic finance institutions have highlydifferentiated shapes and terms
compared to the classical Murabaha.Modern Murabahais a complex and multi-stage process
compared toits classical equivalent/counterpart. The point the modern Murabahahas reached is
quite different from the classic Murabahatransactionin its nature and quality. That is why this
new contract is also calledfinancial Murabaha” (Saadallah, 2007, p. 174). We prefer the
termmodern Murabaha” in our paper.The first introduction of this concept to Islamic banking is
by SamiHasanHammoud in his PhD thesis “Tatwīr al-‘amal al-maṣrafiyyahbimāyattafiquma‘
al-sharī‘ah
al-Islāmiyya”,
meaning
“Developingbanking
products
that
is
in
accordance/consistent with Islamic law”(Hammoud, 1976). He has based his model mainly on
some examplesmentioned by Imam al-Shāfi‘ī. Modern Murabahahelps banks assistclients to
obtain commodities they need, and payments are subsequentlymade to the Islamic bank by
installments. Modern Murabahaconsistsof three components:
i. Promise phase: the bank and the customer promise the buyingand selling of goods or services.
ii. First contract: The bank purchases the requested goods orservices from a third party at the
order of the client.
iii. Second contract: The bank charges a mark-up to the cost andsells the goods or services to the
customer at credit (AbūZayd,2004, pp. 239-243; Sairally, 2002, p. 74).
The first thing we can say about modern Murabahais that it is a compoundcontract and not
directly related to the classical straightforward and simpleMurabaha. When we compare the two
contracts, we see similarities insome aspects but many differences in other aspects. It is clear in
this casethat differences prevail. When we look more closely, it is not possible tomention a
similarity in their natures but only a resemblance of names.
In this sense, giving long lists of similarities and differences between thetwo contracts can be
misleading. Hence, it is important to underline thedifference between the two contracts in their
nature.First, modern Murabahais a complex contract that consists of threestages. The first two
steps have nothing to do with Murabaha. In thefirst stage, the customer promises that if the bank
purchases the propertyhe needs, he/she will repurchase it from the bank; in the second stage,the
Islamic bank acquires the good for the customer and in the thirdstage, the bank sells the property
to the promising customer. Only thethird stage of modern Murabahais identical to classical
Murabaha,since the price of goods in both sales is determined based on theiroriginal costs.
Consequently, only the third stage is subject to classicalrulings about classical Murabaha.
The promise made by the customer to the bank turns this arrangementinto a three party
compound contract. While in classical Murabahathere is neither a request from the customer nor
a promise (wa‘d) orprior agreement between the customer and the bank. This differenceis a
major one that changes the structure and validity of a contractand renders it impossible to see
both contracts as identical. Anotherpoint is that, in classical Murabaha, customers do not know
the cost ofthe goods, so the vendor’s false statement related to the cost seriouslyaffects the
authenticity of the contract. Whereas in modern Murabahathe customer knows the price and the
added mark-up exactly. Manytimes, the customer himself does all the arrangements related to the
saleon behalf of the bank. Therefore, the core idea of classical Murabaha(“a trust sale”) seems
no longer relevant in modern Murabaha.In contrast to classical Murabahain modern Murabaha,
the banktries to sell the goods immediately to the requesting customer and triesto avoid damage
liability. This also forms a major difference in the twocontracts. Another difference is that
theoretically, the payment of theprice in both types can be either by cash or in installments.
However,practically the payment in modern Murabahais always in installments.
Lastly, modern Murabahautilizes views/rulings of different legalschools (madhhabs) to obtain a
permissible contract while classicalMurabahais deemed permissible by all schools of fiqh.
Although it is a common practice to spot similarities in this context,eventually it is very hard to
find significant similarities between classicand modern Murabaha. Depending on whether the
initial promise isregarded binding or not, this difference would be more or less clear.
Mostly, current Islamic banking practices are based on the premisethat promises are binding.
Therefore, it would make more sense to seemodern Murabahaas a new type of contract that
needs to be evaluatedaccording to the general principles of Islamic law. In light of
thisbackground, we see three different approaches to the permissibility ofmodern
Murabahaamong scholars (Cebeci, 2010, pp. 215-219).
Proponents of modern Murabaha: This approach constitutes themajority view. The scholars who
adopt this view mostly base their ideason practical concerns like economic needs of Muslims,
competitionwith interest based banks and permissibility of producing new types ofcontracts in
Islamic law.
Opponents of modern Murabaha: These scholars see the largescaleuse of Murabahaas a
deviation from Islamic banking principlesand criticize the long-term tendency of Islamic banks
to utilize debtlikeinstruments. They demand from Islamic banks to replace them withprofit-andloss based instruments.
Balanced approach to Murabaha: These scholars accept this newinstrument in a general manner
but raise objections to some details ofthe theory and also to the practical application of modern
MurabahabyIslamic banks today. This approach constitutes our stand on this issue.
It seems that the arguments of the supporters of modern Murabahaare more attractively
presented in contemporary scholarship, sincepractical financing needs of the Muslims overrides
many other concerns.
Consequently, when it comes to doing legal reasoning (ijtihād) regardingbanking and finance,
key terms like ḍarurah(necessity) and maslaḥah(social benefit) come up first. Another method
utilized is recourse tocombining views of different legal schools (talfīq) in validating modern
Murabaha. This eclectic method is highly problematic becausewhenever scholars face a
problem, they choose a view from differentlegal schools that solves the problem. This is done
without regard toacademic integrity and consistency of the legal schools.
2.3: Problems and criticisms of modern Murabaha
There
have
been
debates
among
contemporary
scholars
concerningthe
modern
Murabahacontract and the conditions it is based on. Thequestions raised relate to such issues as
the value of time, the bindingpromise, and avoidance of Islamic banks of risks related to trading
andwhether modern Murabahais a disguised form of interest (Sairally,2002, p. 75).
Time value of money: Murabaha vs. interest based loans
Modern Murabahahas been criticized as being a roundabout way ofcharging interest by
artificially transforming a financing transactioninto a purchase and sale with deferred payment.
The most importanttheoretical justification for this is the issue of compensation for value oftime.
It is maintained that the increase in the price vis-a-vis the selloffordered goods on credit to the
client is analogous to interest charged ona loan. This argument is fallacious since it equates
reselling at a higherprice and charging interest. We have to make it clear that Islamic lawallows
associating a value to time in case of a sale while it prohibits itin the case of a loan. Hence, time
can be attributed value when thereis a sale related to real commodities. Similarly, a modern
Murabaha,when carried out properly, involves a credit sale to the client and not aloan to finance
his need. Therefore, its nature is that of a sale and not aconventional loan (Ayub, 2007; Sairally,
2002).
The permissibility of unilateral promises (wa‘d) to be binding
The problem of binding promises is actually the core point of thediscussion around modern
Murabahasince this issue has a deep impacton the nature of an arrangement. When a client
orders a commodityfrom an Islamic bank, the bank requests the client to sign a “promise tobuy
” to ensure that the client eventually buys what he/she ordered. Thebank also promises the
client to sell him the good when it is purchased.
This is because Islamic law does not allow the selling of a good that isnot owned yet since
ownership cannot be immediately transferred to thepurchaser (Sairally, 2002, p. 84).
Islamic scholars are unanimous that promises are ethically binding.The discussion is whether
they are also legally binding and whether lawcan enforce promises. There are differences of
opinion on this subject.Only the Māliki School is of the idea that promises are also
legallybinding (Hattab, 2000, pp. 240-241). On the other hand, classicalscholars have mentioned
some arrangements similar to modernMurabaha. These examples, which are equivalent to “
Murabahatopurchase orderer”, show that most of the classical legal schools see thispractice
valid since they regard promises as non-binding. Accordingto the other three schools of law,
unconditional promises that are notassociated with a cause or condition is non-binding.
Avoidance of banks of the risks related to ownership and possession
When the initial theory of Islamic banking was proposed, the bank wassupposed to be active
during the search for plausible goods, contactingthe dealer, supplying and transferring it to the
client, whereas incontemporary Murabahapractices, we see that banks try to avoid allrisks
related to ownership and possession of the object before its finalsale to the client. This attitude
may comply with conventional bankingprinciples but it is contrary to the legitimate gain theory
of Islamiccontract law. Islamic legal rulings on modern Murabaharequire
Islamic banks to become involved in trade to some degree. In thispoint, the question arises
whether Islamic banks shall stay as financialintermediaries or shall turn into traders. The answer
to this question isthat Islamic banks have to add the latter function to that of
financialintermediation. Therefore, we can call Islamic banks’ status duringmodern
Murabahatransactions as “non-pure financial intermediation”(Ayub, 2007, pp. 444-445;
Saadallah, 2007, p. 174; Sairally, 2002,pp.80-81).
Chapter: 3: Methodology
3.1: Research Approach
The research is be based on qualitative data as the data captured is not numerical in nature.
Viewed from the aspect of purpose, this study is a descriptive research, i.e. the data collected in
the form of words, pictures and not the numbers. While in terms of data collection techniques,
this study is a combination of library research, i.e. research that includes collecting data and
information through the archives and documents the testing method used was analysis of
documents or content analysisand field research by going out and conducting interviews with
The Bank of Khyber officials to obtain important information from the respective banks on the
various issues on Murabaha.
3.2: Data Collection Techniques
The data collection technique consists of a combination of library research and field research. By
using library research, the researcher has adopted documentary analysis to collect data from
research papers, thesis's and articles pertaining to the title that has rendered tremendous help in
achieving the goals of the researcher. Information from internet sources on the establishment and
growth of Islamic Banking and Finance in Pakistan has also been studied. The primary data will
be collected using Interviews and Questionnaires from The bank OF Khyber officials, Sharia
Scholors, customers and Sharia Board members. To be able to gather data that is relevant and
accurate, the primary source for the study will be The Bank of Khyber. Using the library research
method and applying documentary analysis in capturing data.
3.3: Data Analysis Technique
In analyzing the data, the author will use content analysis techniques to analyze the method of
comparative analysis of the contents of the material on Murabaha, concentrating with the
implementation of Murabahain at The Bank of Khyber. The data obtained are derived from
secondary data drawn from reading books and other literature which consists of:
a. Government regulation on banking.
b. Progress Report of Shariahbanks in Pakistan in the blueprint.
c. Text Books about Murabaha which the data is still relevant to be used.
d. Results of research on Murabahaby previous researchers are still relevant.
The data collected through the questionnaire and interviews will be analyzed using descriptive
statistics analysis technique in light of the previous studies.
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