Inslamic Finance: Commitments to maintain in Murabaha transactions

Today we will discuss some questions which are commonly raised in relation to a Murabaha transaction.

Why do Islamic banks obtain securities against Murabaha financing?

A reader has asked whether it is allowed under Sharia to obtain securities against Murabaha financing and if so, why. The reply to the first part of his question is in the affirmative.

As regards the second part, in order to safeguard his interests, a seller may seek a security or a third party guarantee from the buyer when delivering the goods on a deferred payment basis. This is allowed under Sharia since both the possession and the title pass on to the buyer at the time of delivering the goods, thus leaving the seller with an unsettled debt in his books.

Islamic banks obtain funds from the public in the capacity of Mudareb and deploy these funds in the Murabaha transactions. Therefore, it becomes their primary responsibility to be prudent in order to protect the ultimate interests of their depositors.

As explained last week, a Murabaha transaction in an Islamic bank progresses through various stages. As such, the bank can ask for the security prior to the start of the Murabaha process if the deferred payment mode has been originally agreed to between the bank and the client. This is important where the bank places a revolving Murabaha facility at a customer's disposal.

In the event that the Murabaha goods/asset itself is given to the bank as security (e.g. mortgage over car or house), the purchaser should take physical or constructive delivery of the object and at the same time give it under the bank's mortgage. In this way the sale transaction will stand distinguished from that of mortgage.

What types of securities does an Islamic bank seek from a client?

The security sought by an Islamic bank could be a tangible asset, a third party guarantee, assignment of payment, or any other collateral acceptable to the bank under the Sharia requirements.

An Islamic banker must not overemphasise the aspect of security while considering a Murabaha facility. Security is invariably the second way out and as such, he should evaluate a Murabaha transaction on its merit and take a calculated decision whether he is comfortable with the level of risk with or without the collateral.

What if a customer defaults on a Murabaha payment?

If a customer defaults on timely settlement of the Murabaha amount due to genuine reasons, the Islamic bank should allow him a reasonable period of time to arrange for the payment. In this case, the bank could hold on to the available collateral until the receipt of Murabaha proceeds and release it to the customer immediately thereafter.

In the event of a customer's failure to clear the Murabaha amount owed to the bank even after the lapse of a reasonable period of time, an Islamic bank can proceed with executing the security through the channels available to it. Any excess received from the security proceeds over and above the Murabaha amount must be returned to the customer.

Sharia does not allow Islamic banks to increase the Murabaha amount in case of default by the client on the basis that it is a sale transaction and reopening the sale price is against Sharia principles.

It has been observed that some companies take advantage of this ruling and deliberately default on timely settlement of their Murabaha commitments. Sadly, they take extra care in meeting commitments to conventional banks due to the practice by these banks of levying penalty interest. This is often done at the cost of their commitments to the Islamic banks in the absence of a penalty for late payment.

In order to rid the Islamic banks of this unfair treatment, Sharia scholars have been exploring the possibility of including a penalty clause in the Murabaha agreement whereby the defaulting customer will be forced to donate the penalty amount to a charitable organisation.

It is expected that by introducing this 'deterrent', Islamic banks will be able to discipline their Murabaha customers, thereby curtailing the list of past due Murabahas in their books.

This corrective measure will not violate any Sharia principle since the penalty amount will not be included in the Islamic bank's profit.

Sohail Zubairi is the vice-president of Sharia structuring, documentation and product development of Dubai Islamic Bank.