Islamic Debt Financing – Murabaha
The Islamic mode of debt financing known as murabaha is a form of credit agreement that enables a buyer and seller to agree on the cost-plus or markup price for the goods they are buying or selling. However, this form of credit has some risks that must be understood before utilizing it for business purposes. This article will discuss some of the benefits and risks of murabaha. To avoid these risks, be sure to read on.
Islamic mode of debt financing
The Islamic mode of debt financing uses an instrument called Sukuk. Generally, bonds are fixed income securities that promise a specified series of payments over time. An investor lends money to the bond issuer and in return, the issuer promises to pay the bond investor interest, plus the principal, on a pre-determined date. Islamic Sukuk are debt financing instruments structured under the Shariah. Sukuk are term finance certificates that represent undivided ownership of assets.
This type of contract allows Islamic banks to finance capital goods and other assets that are essential for the development of an Islamic economy. Depending on the nature of the asset, this type of contract can be used in a variety of applications, including construction projects, industrial equipment, and machinery. Another example of a contract using Istisna’a is for the purchase of specific goods against a purchase order for deferred delivery. This type of contract may be used in the construction industry, such as in apartment buildings, hotels, and hospitals.
In addition to Tawarruq, another Islamic mode of debt financing involves the sale of saleable goods and assets by an Islamic bank. In this case, the customer sells the goods to a third party in return for cash. Tawarruq is recognized by most Shari’ah scholars as a sale transaction and requires a third party. It allows Islamic banks to finance a wide range of purposes, from working capital financing to asset acquisition.
Buying and selling goods on a deferred payment basis
Buying and selling goods on a deFERRED payment basis can be beneficial for a business owner. For example, the buyer may be interested in purchasing a $1,000 sofa, but cannot afford the payment in full right away. With a deferred payment plan, the buyer can take possession of the sofa now and pay for it later, with the final amount payable at a later date. In some cases, the seller will accept the payment in installments, allowing the buyer to spread the cost over a longer period of time.
A deferred payment plan is different than a layaway plan. With this plan, the buyer purchases goods but does not pay the seller until later. The buyer pays the supplier in installments, usually 30 to 60 days, and the transaction is recorded through an invoice. This type of financing helps the business owner increase its assets and requires no interest during the payment period. However, it is important to understand the terms and conditions of trade credit before signing such a contract.
Risks of using murabaha
Murabaha is a type of sale transaction where the financier purchases goods from the supplier and then resells them to the end-user. This arrangement is permissible because the intermediary is assuming the risk of commercial failure. The principal component of murabaha is possession, which can be either physical or constructive. In general, the bank uses Libor as the reference for its profit margin, which is not interest.
While the bank bears a portion of the risk in a Murabaha transaction, it uses various techniques to reduce the risk. For example, the bank requires the seller to produce an invoice for the goods it purchases at least seven days before the offer is accepted and once it is paid. The bank will also arrange for random physical inspections of the goods to assess if they meet Shari’ah requirements.
Murabaha is not without controversy. The controversy is often related to its legitimacy. Some contemporary jurists have specifically challenged the Murabaha contract. However, not every Murabaha transaction is fraudulent. This risk threatens the image of IBs. And it is possible that the client does not have a legitimate interest in the goods. It is vital for the client to understand the risks associated with murabaha before using it for any transaction.