Islamic Finance provides a financing mechanism without Riba (interest), Gharar (gross uncertainty) and Maysir (gambling). These three are the key to all economic oppressions, economic imbalances and instability. They give rise to micro and macro risks which impact the overall wellbeing of an economy. Islamic Finance offers alternative structures and products which are free from Riba, Gharar and Maysir. One of these products is Commodity Murabaha.
In minorities where it is difficult to get Shariah compliant working capital financing for SMEs, Commodity Murabaha is an alternative Shariah compliant product and financing mechanism. Commodity Murabaha is the most common Islamic money market tool that is used to provide liquidity in the short-term Islamic money markets. The AAOIFI Shariah Standards, the majority of global Shariah scholars and global Shariah boards approve of Commodity Murabaha if it is implemented correctly with the correct controls to overcome financing challenges. The classical jurists also approved of a Tawarruq or Commodity Murabaha structure. In fact, Mufti Taqi Uthmani has produced a detailed research paper on Commodity Murabaha outlining the views of classical scholars. Ibn Muflih from the Hanbali school, Imam Shafi’i, Ibn al-Humam and Ibn Abidin from the Hanafi schools have all permitted this product and narrate its permissibility from other classical jurists[1].
Working capital financing is used to cover a company's short-term operational needs and not to buy long-term assets or investments. Those needs can include costs such as payroll, rent and inventory and other costs associated with daily operations etc. Practically, business owners who are looking for shariah-compliant working capital financing to cover their short-term operational needs generally prefer entering a Commodity Murabaha Agreement where a fixed profit rate and corresponding deferred sales price instalments is specified in advance. This allows them to finance their growth at a lower cost of capital as compared to for example using profit and loss sharing (PLS) arrangements such as Mudarabah and Musharakah that result in a higher effective cost of capital. PLS arrangements are better suited for business ventures where there is a higher risk of loss. Profit and loss sharing refers to financing whereby parties enter into equity financing arrangements where the financier has a share ownership in the business.Furthermore, a stable business looking to finance their working capital might not want to dilute their ownership through equity financing. Stable businesses will not want to share their upside so would prefer debt-based financing. By doing so, they are happy to protect the financier from the downside and retain exclusivity to the upside. A PLS is favourable where there is greater risk of downside and therefore the business is happy to share the upside.
In the UK, the most direct and common way for a party to obtain working capital is to obtain an interest-bearing loan from a third-party finance provider. Since a conventional loan represents a purely monetary transaction—in essence, the use of money by a party in exchange for the payment of compensation based on the length of usage—this type of loan may not be given or received by Shariah-compliant investors. The Commodity Murabaha product allows Muslims to finance their working capital without being exposed to interest-based financing.
The Commodity Murabaha agreement has been conscripted to fill the void. A customer enters into a Commodity Murabaha transaction not to obtain a physical asset for its use, but to engage in a series of purchase and sale transactions that result in the customer obtaining working capital. In a basic Murabaha transaction, the customer receives assets in return for a deferred payment obligation, and then employs those assets in its business. In a Commodity Murabaha transaction, the customer takes the additional step of selling the assets to a third party for cash, which represents the working capital (or financing for an acquisition, as the case may be) required by the customer. Note that the customer would not necessarily be required to sell the Assets to a third party; it merely is allowed to do so, as owner of the assets. The sale of the assets to a third party is not an element required to make the Commodity Murabaha transaction a valid transaction under Shariah.
To ensure that this product is not a smokescreen for Riba (usury/interest), contemporary Shariah scholars have placed several controls. The AAOIFI Shariah Standard highlights these controls to ensure that Commodity Murabaha aligns with the principles of the classical jurists. These controls are as follows:
By meeting the above principles, the Commodity Murabaha is a Shariah compliant, asset-backed financing mechanism which aligns with the principles of Islamic Finance. From a micro-economic perspective and for a Muslim minority in the UK context, this product provides a valid Shariah compliant alternative in a system where every corner and every offer are interest-based. An overview of the Commodity Murabaha facility used by Qardus for SME business financing can be found here.
You can contact Mufti Faraz Adam on sharia@qardus.com
[1] Uthmani, M.T. (1998), Buhuth Fi Qadhayah Fiqhiyyah Mu’asarah. Dar al-Qalam
In minorities where it is difficult to get Shariah compliant working capital financing for SMEs, Commodity Murabaha is an alternative Shariah compliant product and financing mechanism. Commodity Murabaha is the most common Islamic money market tool that is used to provide liquidity in the short-term Islamic money markets. The AAOIFI Shariah Standards, the majority of global Shariah scholars and global Shariah boards approve of Commodity Murabaha if it is implemented correctly with the correct controls to overcome financing challenges. The classical jurists also approved of a Tawarruq or Commodity Murabaha structure. In fact, Mufti Taqi Uthmani has produced a detailed research paper on Commodity Murabaha outlining the views of classical scholars. Ibn Muflih from the Hanbali school, Imam Shafi’i, Ibn al-Humam and Ibn Abidin from the Hanafi schools have all permitted this product and narrate its permissibility from other classical jurists[1].
Working capital financing is used to cover a company's short-term operational needs and not to buy long-term assets or investments. Those needs can include costs such as payroll, rent and inventory and other costs associated with daily operations etc. Practically, business owners who are looking for shariah-compliant working capital financing to cover their short-term operational needs generally prefer entering a Commodity Murabaha Agreement where a fixed profit rate and corresponding deferred sales price instalments is specified in advance. This allows them to finance their growth at a lower cost of capital as compared to for example using profit and loss sharing (PLS) arrangements such as Mudarabah and Musharakah that result in a higher effective cost of capital. PLS arrangements are better suited for business ventures where there is a higher risk of loss. Profit and loss sharing refers to financing whereby parties enter into equity financing arrangements where the financier has a share ownership in the business.Furthermore, a stable business looking to finance their working capital might not want to dilute their ownership through equity financing. Stable businesses will not want to share their upside so would prefer debt-based financing. By doing so, they are happy to protect the financier from the downside and retain exclusivity to the upside. A PLS is favourable where there is greater risk of downside and therefore the business is happy to share the upside.
In the UK, the most direct and common way for a party to obtain working capital is to obtain an interest-bearing loan from a third-party finance provider. Since a conventional loan represents a purely monetary transaction—in essence, the use of money by a party in exchange for the payment of compensation based on the length of usage—this type of loan may not be given or received by Shariah-compliant investors. The Commodity Murabaha product allows Muslims to finance their working capital without being exposed to interest-based financing.
The Commodity Murabaha agreement has been conscripted to fill the void. A customer enters into a Commodity Murabaha transaction not to obtain a physical asset for its use, but to engage in a series of purchase and sale transactions that result in the customer obtaining working capital. In a basic Murabaha transaction, the customer receives assets in return for a deferred payment obligation, and then employs those assets in its business. In a Commodity Murabaha transaction, the customer takes the additional step of selling the assets to a third party for cash, which represents the working capital (or financing for an acquisition, as the case may be) required by the customer. Note that the customer would not necessarily be required to sell the Assets to a third party; it merely is allowed to do so, as owner of the assets. The sale of the assets to a third party is not an element required to make the Commodity Murabaha transaction a valid transaction under Shariah.
To ensure that this product is not a smokescreen for Riba (usury/interest), contemporary Shariah scholars have placed several controls. The AAOIFI Shariah Standard highlights these controls to ensure that Commodity Murabaha aligns with the principles of the classical jurists. These controls are as follows:
- Different brokers: The trades must involve the market and involve different brokers from the buy and sell side. This ensures that the trades are genuine and that the brokers are selling/buying the asset with an interest in the asset.
- Real asset :The trades must involve a real asset. A fictitious product cannot be sold. The asset transaction must impact the inventory of the seller and the eventual buyer.
- Real trades: All the Shariah requirements for trading must be met in terms of valid offer, acceptance, legal capacities of the parties, agreement on the commodity, agreement on price etc.
- True ownership: The traders should assume true ownership through true sales of the underlying commodity.
- Possession: The traders must assume possession; either physically, constructively or digitally. This possession must allow them to dispose of the asset or redeem the asset.
- Correct Sequence: The Commodity Murabaha must be performed in a correct sequence which further establishes and validates all of the above key elements.
- Discretion to not sell: The traders must have the discretion to not sell and hold. This ensures that the trade is not fictitious.
- Different agents: The financier should not be the sole agent for all the parties involved in the Commodity Murabaha.
By meeting the above principles, the Commodity Murabaha is a Shariah compliant, asset-backed financing mechanism which aligns with the principles of Islamic Finance. From a micro-economic perspective and for a Muslim minority in the UK context, this product provides a valid Shariah compliant alternative in a system where every corner and every offer are interest-based. An overview of the Commodity Murabaha facility used by Qardus for SME business financing can be found here.
You can contact Mufti Faraz Adam on sharia@qardus.com
[1] Uthmani, M.T. (1998), Buhuth Fi Qadhayah Fiqhiyyah Mu’asarah. Dar al-Qalam
