Modern View on the Commodity Murabaha Islamic Banking

Product
Commodity Murabaha (Commodity Murabaha or Organized Tawarruq) is the most
popular financial product of Islamic banks which they use both for the liquidity management
through interbank transactions and to finance their clients.
Commodity Murabaha (CM) is a derivative product of Murabaha. Murabaha 1 is a special
type of transaction for commodity sale on deferred payment basis and agreed margin when the
seller is obliged to disclose to the buyer all costs included in the price of commodity.
Islamic banks use Murabaha to meet the needs of clients to obtain specific commodities, for
example, when clients of the bank have no available funds, but they need to purchase equipment,
tools or machines for industrial and commercial needs. In this case, the Bank buys on the market
the right commodity from the manufacturer in accordance with the exact client demand and
resells it to the client with a deferred payment at a price agreed which includes the Bank's
margin.
As for CM, the Islamic Bank uses it to provide client liquidity and cash needs. In this
case, the client needs money itself for working capital or urgent payments. In order to provide
the client with cash the Bank adds another step to the Murabaha transaction. Having purchased a
commodity from the Bank on deferred payment basis, the client immediately resells it to a third
party under SPOT terms and receives the money.
The following definition of CM appears from the purpose of a transaction CM is a
transaction where the Bank buys a particular Commodity on the market and sells it at a markup
price and deferred payment basis to the Client, who does not intend to use this Commodity, so
the Client sells Commodity to another Buyer for cash.
Client financing scheme through CM is as follows:
The client applies to the Islamic Bank for financing. The Bank considers and approves
financing. After approval the Bank uses CM as a technical tool to provide to the Client the
requested financing.
Step-by-step description of CM is given below:
1. The Bank buys the Commodity from a Broker A under SPOT terms at current market
price (initial price).
2. The Bank sells to the Client Commodity with margin to the initial price under SPOT
terms and deferred payment terms.
3. The Client sells Commodity to the Broker B (a third party) under SPOT terms at initial
price through the Bank which in this case will be an intermediate party, Clients Agent.
4. Broker B transfers amount for the Commodity to the Client and the Client receives
necessary financing and owes to the Bank the money for the Commodity under deferred
payment terms.
Commodity in CM transactions is generally the liquid commodity traded on stock
exchange such as platinum or palladium. To make settlements more convenient and faster current
accounts of Broker A and Broker B are opened in the Bank, respectively, and cash payments for
all transactions are conducted by the Bank. For the same purpose metal accounts of all the

1 Murabaha (arab.) means selling at a profit.

contracting parties, as a rule, are opened by the Broker A. The latter also performs all operations
on debiting and crediting Commodity between Brokers, the Bank and the Client.
It should be added that Broker A and Broker B closely interact and exchange information
with each other in the process of transactions. This interaction enables the Client to sell the
Commodity to Broker B at the initial price and fix their costs of financing received at a specified
margin (initial price minus price with margin) because Broker B, in turn, may sell Commodity
bought from the Client to Broker A at the same price so that Broker A could close its open
position on the Commodity sold to the Bank.
As you can see from the description, CM process is predefined, organized and designed
to achieve the ultimate goal to finance the Client. This organized nature is the main cause of
criticism expressed by various Islamic scholars in relation to CM. Such scholars as Ahmad Bin
Abdul Aziz Alhadad2 and Nidal A. Alsayed3 even define CM as non-compliant with Shariah.
Modern Islamic scholars - members of the Islamic Fiqh Academy and members of the
AAOIFI Shariah Board differentiate two types of Murabaha transactions, in other words,
Tawarruq4:
1. Tawarruq Fiqhi or classic Tawarruq, defined as the transaction of buying Commodity
with deferred payment from the seller, who is the owner of the Commodity, with the
buyers further sale of the Commodity to a third party (in the market) for the purpose of
cash. Tawarruq Fiqhi has been approved as Shariah compliant by three Muslim
Madhhabs: Hanafi School of Law, Shafi School and Hanbali School; and was prohibited
by Maliki School5. Such Islamic scholars as Umar Ibn Abdul Aziz, Muhammad Ibn alHasan Al-Shaibani representing Hanafi school and later some scholars of Hanbali School
such as Ibn Taymiyyah and Ibn Qaim considered Tawarruq as a prohibited transaction6.
2. Organized Tawarruq where in contrast to the first one (Tawarruq Fiqhi) the buyer sells
the purchased Commodity for liquidity purposes not in the market, but to a predetermined
third party, and appoints the Bank as its agent for the execution of the sales transaction.
There are contradicting opinions among modern scholars of Islam on the compliance of
Commodity Murabaha or Organized Tawarruq with Shariah.
The Council of the International Islamic Fiqh Academy of OIC believes
that CM is a kind of transaction like Organized Tawarruq type, i.e. synthetic,
fictitious or non-compliant with Shariah.
The Council of the International Islamic Fiqh Academy of OIC during its 17th session held on
13-17 December 2003 in the Second Resolution on Tawarruq deals conducted by Islamic banks
defined as follows:
2 Ahmad bin Abdul Aziz Alhadad Tawarruq, Its essence and its types: Mainstream tawarruq and organized tawarruq
3 Nidal A. Alsayyed The Uses and Misuses of Commodity Murabaha: Islamic economic perspective.
4 Tawarruq arab. request for cash comes from Al Varika dirham made of silver or silver money
5 Mahmoud A. El-Gamal Islamic Finance Law, Economics and practice 2006
6

Wahbah Al-Zuhayli Financial Transactions in Islamic Law 1989

First: Tawarruq used by banks is not permissible, due to the following factors and
reasons:
1. The seller's (Clients) commitment in Tawarruq to sell Commodity by
proxy to another buyer or existence of such buyer make the deal
similar to a legally prohibited deal - Inah (sellers re-purchase of
commodity from the buyer).
2. In many cases there is no direct delivery of Commodity from the
Buyer to the Seller in Tawarruq transactions that is very important
term of the purchase transaction and invalidates the deal.
3. Such a transaction is actually based on financing with markup
through sales of commodities, which in the most cases is formal.
The Banks purpose behind such a transaction is to get profit over
its finance deal. In fact, such a transaction is different from the real
Tawarruq (Tawarruq Fiqhi) that is well-known to the Islamic law
schools.
The Council of the International Islamic Fiqh Academy of OIC on its
15th session has already decided about the legality of Tawarruq Fiqhi
transaction, because it is a full-fledged transaction and its conditions are
clearly defined. There are several differences between Tawarruq Fiqhi and
Organized Tawarruq, which the research papers have explained in detail.
Tawarruq Fiqhi (real Tawarruq) is based on real purchase of a commodity
under deferred payment terms. The buyer in the real sense possesses this
Commodity and then he sells it for cash to another person.
Second: The Council of the International Islamic Fiqh Academy of OIC
calls upon all banks to avoid implementing the transactions prohibited in
compliance with commandment of Almighty Allah.
It also appreciates the efforts of the Islamic banks in protecting the
Muslim Ummah (community) from usury, and recommends that the real and
legitimate transactions are carried out without resorting to the superficial
transactions to make them look like real7.

7 The Second Resolution on Tawarruq Deals by Some Banks of The Islamic Fiqh Council of the Muslim World
League during its 17th session December 2003.

Decisions of the Islamic Fiqh Academy are advisory in nature and

strictly speaking Islamic Banks are not required to apply them, but the
opinion of such a prestigious organization is difficult to ignore. It is also
difficult to dispute the findings of the Academy on the application of CM
based on the views of members of the Academy - the greatest modern
scholars of Islam.
Another equally authoritative international organization is the
Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI), in contrast, has approved the application of CM product and issued
a special Standard No 8 Guideline on CM and Standard No 30 Monetization Tawarruq describing the correct order of Tawarruq transaction.
AAOIFI is an independent international organization, supported by its
institutional members, 200 members from 45 countries as of today. If the
decisions of the Islamic Fiqh Academy are advisory in nature, the standards
of AAOIFI are officially introduced as the basic and mandatory for all Islamic
financial institutions in such countries as the Kingdom of Bahrain, Dubai
International Financial Centre, Jordan, Lebanon, Qatar, Sudan and Syria. The
corresponding financial state authorities in Australia, Indonesia, Malaysia,
Pakistan, Saudi Arabia and South Africa have released guidelines and rules
based on the standards and definitions of AAOIFI.
Although AAOIFI definitions and standards No 8 and No 30, describing CM,
give us a sufficient basis to apply CM in the practice of Islamic banking, we
cannot deny the validity of the arguments of the Islamic Fiqh Academy
disapproving the use of CM and ignore the criticism and skepticism voiced by
other contemporary scholars of Islam and our colleagues in the western
banks.
But it is possible to give an explanation to the three observations of
the Academy, as described above:
1. Existence of an agreed buyer - a third party. This condition is
necessary to give a chance to the Client to sell goods at the initial price
and fix his costs at the level agreed with the Bank margin. If the Client
himself has been looking for a buyer of the Commodity, then it would
take some time, and the price could vary significantly from the initial
price. As a result, the Client would have always been in the uncertainty
about the value of money and could not have compared the conditions
offered by Islamic banks with the terms of the financing of

conventional banks. In such a situation, it would have been difficult for

the Islamic banks to attract to their services clients of conventional
banks.
2. There is no physical delivery of Commodity and the possibility to trace
the transfer of ownership in the CM transaction. First, we need to
emphasize here that Commodities in the Modern Trade are divided into
two broad categories, such as Exchange-based, i.e. traded on stock
exchange and over the counter (OTC) traded in the physical markets.
Exchange deals are fully automated and computerized.
During the day trading session Commodity on the exchange is bought
and sold hundreds of times and has a lot of owners. And the only proof
of ownership of Commodities is the exchange contract or a statement
from the exchange account. Therefore, it is almost impossible to carry
out the physical transfer of Commodity from the buyer to the seller in
every transaction. Second, it is convenient for both the Bank and the
Client to simplify and speed up transactions to have to deal with the
electronic format of stock trading, rather than buying and selling
Commodity in the physical market.
I would like to note that Islamic financial institutions are trying
to improve the existing CM transaction mechanism. To eliminate the
remarks of the Academy, Bursa Malaysia has developed and
implemented a trading platform, specially designed to facilitate CM
transactions. This platform provides the control of the full cycle of the
trading process and allows you to track the owner of Commodity at all
stages of the CM transaction. Recently, Dubai Multi Commodities
Centre has launched the Islamic trading platform that also allows you
to track the transfer of ownership of Commodity traded at any given
time, making it possible to confirm the fact of the actual exchange of
Commodities in stock trading instead of the customary exchange of
paper certificates.
3. The basis of CM transaction is the Banks financing of his client with a
gain through the purchase and sale of Commodities. Yes it is to finance
the Client the Bank enters into a CM transaction. And financing is the
intention of the Bank in CM transactions. I think there is no reason and
argument, allowing us to deny this fact. On the contrary, we must
openly admit that CM is a scheme for Islamic banks to finance clients.

This approach will enable us to eliminate the cause for criticism and
even irony, expressed by the conventional western bankers to the
Islamic banks, when we try to imagine CM as a trading transaction.
Western bankers, in turn, call CM a copy or a replica of a conventional
interest rate loan. But the similarity of CM with a commercial loan is
only in one component - the market rate of interest that Islamic banks
use as a benchmark for determining margin to Commodities. I will
explain about significant differences between CM and the conventional
loan below.

In addition to the negative aspects and negative characteristics of CM

it is necessary to pay attention to the positive qualities of this product.
Further, I propose to focus on the positive qualities of CM, which helped to
develop the Islamic banking business and to establish itself as a successful
financial services niche.
Despite the apparent technical disadvantages from the point of view
of Shariah, CM, in my opinion, has the following advantages:
First, the use of CM as a deposit product helped to attract to Islamic
banks a number of new clients and create a stable base of investors as a
source of medium-term financing. As you know, before the use of CM Islamic
Banks offered its clients two types of deposits:
investment, where the client had to bear the risks associated with his money
that the bank has invested in various projects;
and debt deposits such as Qard Hassan, where the bank took clients money
to keep on deposit and had to give the money back to the client on demand,
but it did not charge interest fees on deposit. It is clear that there were not
many people who wanted to risk their money and most of the clients of
Islamic banks used Qard Hassan deposits. This made the deposit base shortterm and unstable, because clients preferred to place deposits up to one
year and enjoyed the opportunity to withdraw their money on demand. This
situation with liabilities made it impossible to Islamic banks to invest
borrowed money in the medium and long-term investments and restricted
the scope of their activities mostly to financing trade transactions. The use of
CM as a deposit for a debt instrument where the Bank is the debtor and
undertakes to pay to the Client the deferred amount with the margin (deposit

rate) at a certain time, gave the Islamic banks an opportunity to attract

depositors of conventional banks through competitive product that is
comparable to conventional deposit on the price and level of risk.
And most importantly - traditional clients of western banks, having
received an alternative deposit product that is similar to the usual deposit,
began to transfer their money in Islamic banks, therefore, were able to
escape from the financing of prohibited transactions and activities (Haram),
practiced by western banks to finance permitted (Halal) in Islamic banks.
Second, the introduction of CM as a tool to manage liquidity helped
Islamic banks to solve the acute problem of low short-term liquidity. Before
that Islamic banks have worked in the interbank market only with each other,
using Islamic investment products such as Wakala and Mudaraba, based on
the principle of sharing risk and profit, as well as debt-free instrument Qard
Hassan. Western banks, of course, did not feel a great desire to put money
in Islamic banks using instruments with high risk or for free, if you have
developed traditional inter-bank bond market. By offering to conventional
banks to put money in Islamic banks through CM, we gave them the
opportunity to broaden their counterparts, using a financial instrument
having a risk level that is comparable with a typical inter-bank deposit.
Third, applying CM as a tool for customer financing has given Islamic banks an
opportunity to attract traditional clients of western banks seeking financing. Islamic banks
have a competitive product of customer financing, as CM is fully comparable with the usual
conventional loan by terms and conditions as well as pricing of funding, and a potential customer
can compare terms of financing between conventional bank and Islamic Bank. Before that,
Islamic banks used to finance clients only through Islamic investment products such as
Mudaraba, Musharaka, Wakala and specific buy and sell transactions such as Istisna'a and
Salaam. It was difficult to offer to a broad client base such banking products were due to their
individual pricing and terms of risk-sharing of investments. Also, not all potential clients wanted
to see an Islamic Bank as their equal business partner or co-investor, when they had to get only
temporary working capital.
Fourth, through the explanation of the scheme, rules and the
mechanism of CM to potential clients attracted from conventional banks, we
are able to explain to them the basic business principles and prohibitions
prescribed by Islam, which became the basis of CM product: 1. It is forbidden
to sell Commodity, if the seller is not the owner of Commodity and does not
have the Commodity physically. 2. Prohibition of sale transactions with
deferred delivery of Commodity and payment (forward transactions). 3.
Either deferred payment or deferral of delivery of Commodities is allowed in

the transaction, but not both conditions at the same time. 4. It is forbidden to
sell Commodities and to borrow money in the same contract. 5. It is
forbidden to sell the Commodity back to the seller (Inah). 6. It is forbidden to
enter into two transactions in the same contract. 7. It is forbidden to
guarantee profit from the transaction.
The potential client having received such information may see how
wise and useful these rules are. For example, the widespread use of the first
three rules would help the world trade to get rid of huge volume of financial
speculation and bring pricing closer to the actual trend. Realizing this, the
Client would be able to join Islam to some degree.
Fifth, CM has a similarity with a commercial loan. But this similarity is
only in pricing, as Islamic banks use rates of the traditional money market
funds to price the client financing. The main difference of CM from
conventional loan is that in the CM transaction the Islamic Bank fixes the
amount of the client's debt, including a margin and does not increase it in
the case of Clients delay or default. This approach is based on the rules of
Islam, which prohibits increasing the amount of debt over time, as the
amount of debt should remain constant regardless the length of delay in
payment. Thus, the difference between CM and interest-based loan is the
absence of compound interest used to calculate the client's indebtedness.
With the help of CM Islamic banks managed in a relatively short period
to increase the client base by attracting new clients who switched from
conventional banks, and thereby increase their assets.
The main question that we should set ourselves is how we could get
qualitative effect of our solid client base, created through CM.
The answer is the following. The developed client base is a
comprehensive source of information about our clients, especially those who
use the services of the Islamic Bank for years. Now we could know our clients
very well: specific of their business, their business and professional
reputation, whether they use aggressive or mild development method, what
their investment needs are, etc. Additionally, we have established personal
relations based on trust with our clients. All this gives us a unique
opportunity to move to a new qualitative cooperation with the Bank's clients,
i.e. start offering pre-selected clients genuine investment products of Islamic
banking such as Mudaraba, Wakala, Musharaka, based on share of risk and
reward, and their possible combinations.

We can also use a new approach to serve our new clients. Islamic Bank
Manager, having heard from a new client a request for financing should not
immediately offer him CM, and must figure out his specific need why he
needs the money. In discussing the type of the client's business and his
plans, it could be found out that Murabaha may be better for him than CM, as
he needs to buy new equipment, or Ijara (Leasing) for rent of vehicles, etc. If
we begin to use this more in-depth approach to meet the needs of our clients
in financing, the number of CM transactions will be gradually reduced and
ultimately reduced to the minimum requirements - ensuring client working
capital. The members of the Fiqh Academy recommend Islamic banks to use
Card Hassan instead of CM to meet the needs of clients in working capital.
But this is unlikely to be acceptable for banks from a commercial point of
view, because money in Card Hassan is free. Nevertheless, we could, for
example, apply Card Hassan to close short term up to 2 weeks cash breaks
of our first-class clients, client-partners who have received money through
investment Musharaka and Murabaha products. Such a service would be a
nice extra bonus, helping to keep the right clients in Islamic banks and an
additional argument emphasizing the Islamic nature of the bank.
I have listed above suggestions which are simple and obvious. So
why Islamic banks do not develop their active operations in this direction but
rather increasingly use CM as the main instrument for financing clients and
do not increase the share of Islamic investment instruments?
I see two main factors that prevent this:
1. Insufficient development of legal and administrative infrastructure
for Islamic finance. State regulators need to pay great attention to the
creation and improvement of Shariah courts, considering economic disputes
and lawsuits. Because all transactions and contracts entered into by Islamic
banks with their clients are based on the rules of Shariah, then only lawyers experts in Shariah, can effectively resolve disputes under such contracts.
Only lawyers who know Shariah are able to understand the peculiarities of
Islamic jurisprudence, especially given the differences in the prescription of
four Islamic law schools, and to make a fair decision on the lawsuit issues.
Developed Islamic judicial system is an integral part of the infrastructure of
Islamic finance, which helps to reduce the risk of the investor - the Islamic
Bank, and thus make investment products more commercially reasonable for
him.

2. Shortage and sometimes even the lack of Islam in Islamic banks.

By that I mean the poor knowledge of Islam and the low level of belief of
employees of Islamic banks, starting with Top Managers and ending with the
clerks at the box office. We often hear criticism from Islamic scholars to the
Islamic financial institutions about their financial instruments that do not
meet Shariah, the types of transactions involving the compromising
conditions, etc., but very little is said about the level of faith of employees of
Islamic banks and about their level of knowledge of Islam. Of course, Islamic
banks have a special independent body Shariah Board, which considers
compliance with Shariah all standard contracts and procedures of the bank,
decides on all non-standard transactions and operations, guided by Shariah
rules. There are also Shariah departments that monitor compliance with
Shariah the operational activities of Islamic banks. There is no reason to
doubt the highest level of knowledge of the rules and regulations of Shariah
Board Members and employees of Shariah departments, as well as the
strength of their faith. But Shariah Board only approves or rejects this or
other financial products for compliance with Shariah. Shariah Board does not
determine the development business strategy of Islamic Bank and its tactics
on Islamic banking products sales. Business strategy is the responsibility of
the major shareholders and top managers of banks. It is these people who
decide what products and which clients the bank will sell to. But it is
precisely these people who have one drawback - the western way of
thinking, that is, they, for the most part, think as the standard western
bankers. Developing the Islamic bank, they are passionate about typical
western criteria: the capture of market share, asset growth, attracting
depositors, retail credit and credit card sales, at the same time, not really
going into details such as if it is in compliance with the model of Islam and
the ultimate goal of every Muslim - the approach to the Almighty Allah.
The solution of the current situation I see in the creation and
increased development of a special Islamic corporate culture in Islamic
banks. Since many of the Top Managers of Islamic banks build their banking
business in a western style, they should pay great attention to the issue of
creating a unique corporate culture in Islamic banks. In other words, to
create a corporate Islamic culture, just as our western colleagues cultivate
western corporate culture in their firms, but only with an emphasis on
Islamic values and the study of Islam, not only Islamic financial products.
I believe that Shariah Board can be identified as the responsible body
for the development of a methodology to study the rules of Islam and its

implementation, especially among the major shareholders and Top Managers

of banks. This individual work with major shareholders and Top Managers can
be organized in the form of regular meetings, where the scholars of Islam members of the Shariah Board could talk in a confidential atmosphere with
the Management of the banks and explain to them the wisdom inherent in
Islam. Such communication may be able to change the outlook of our
managers, and they can begin to perceive the regulations and restrictions of
Islam not as an obstacle for the development of the banking business, but as
the only correct way of doing business.
I understand that this is an extremely difficult task, and that the
introduction of such practices would meet strong opposition by a number of
reasons. But the Islamic banking community must begin to move in that
direction, if it really wants Islamic banking to become genuine alternative to
the western banking.

List of Reference

The Uses and Misuses of Commodity Murabaha: Islamic Economic

Perspective. INCEIF: The Global University in Islamic Finance, Kuala Lumpur.
Nidal A. Alsayyed.
Tawarruq, its essence and its types: Mainstream Tawarruq and Organized
Tawarruq. Dr. Ahmad bin Abdul Aziz Alhadad
Commodity Murabahah: Concerns, Challenges and Market Appetite. Islamic
Finance. February 2010.
Make Purchases with Cost Plus Profit (Murabaha) Contracts by Dr. Faleel
Jamaldeen from Islamic Finance.
Commodity Murabaha by Abdul Samad. alhudacibe.com
Murabaha by Dr. Muhammad Imran Ashraf Usmani.
Commodity Murabahah Programme (CMP): An Innovative Approach to
Liquidity Management. Dr. Asyraf Wajdi Dusuki.
Islamic banks pressed to diversify money market deals. Reuters. Saturday 30
March 2013.
The Second Resolution on Tawarruq Deals by Some Banks. The
Islamic Fiqh Council of the Muslim World League during its 17th session held
between (13-17 December 2003).
Accounting and Audition Organization for Islamic Financial Institution (AAOIFI)
Standard #8 and Standard #30.