Islamic Banking: the folly of Murabahah Financing

Murabahah is a particular kind of sale where the seller expressly mentions the cost of the sold commodity he has incurred, and sells it to another person by adding some profit thereon.

The following excerpts further clarifies the method of financing taken from the Meezan Bank's Guide to Islamic Banking,DARUL – ISHAAT Karachi, 2002, by Muhammad Imran Ashraf Usmani

"The Bai' Murabahah involves purchase of a commodity by a bank on behalf of a client and its resale to the latter on cost-plus-profit basis. Under this arrangement the bank discloses its cost and profit margin to the client. In other words rather than advancing money to a borrower, which is how the system would work in a conventional banking agreement, the bank will buy the goods from a third party and sell those goods on to the customer for a pre-agreed price."

It is in principle selling of goods/commodities on deferred payment basis or in installments. As such there is no riba component in this transaction if it is applied in full faith.

Now look at what happens in Islamic banking case. In effect, the selling of goods carry on mark-up/riba/interest over the cost of goods sold. This is because the cost of goods sold for a banker given it's the level of financing must be different than the cost of goods sold for its customer. Take for example the case of Murabahah finacing for a Vehicle. The bank has three options to determine the cost of goods sold; first, it could be ex-factory price, second, it could be whole sale price, third, it could be retail price. Pragmatically, the option the bank choses are that of its customers. If the customer is an individual it charges the retail price as its cost of goods sold and if its customer is wholesaler it charges the wholesale rate.


Instead of revealing its true cost of goods, the banker appoints its customer as its agent to purchase the goods for the bank. This is mere a concoction to full fill the requirement to reveal the cost of goods sold however, a closer inspection would reveal that the customer do not act at the capacity of the banker but at his own capacity to purchase the good for the banker with a view to repurchase the same from the banker, albeit with mark-up. And therefore, the cost of goods incurred was that of customer and not the banker.


For the customer, as the cost of goods incurred belong to him and not the banker, if he had cash he would not have purchased the good from the banker using a mark-up over the cost of goods i.e. Murabahah financing. In effect the mark-up is riba/interest/financing cost or cost of not having money to purchase the good or the cost of loan to purchase the good. When does this method of financing will not constitute riba/interest or mark-up? This would occur when the banker reveals its true cost of goods sold. A cursory look would reveal that for Islamic banker with billions of rupees worth of Murabaha and professional financial consultants and marketing and purchase departments, its cost of goods must be less than that of its customer.


Conclusion:


Recent practice of Murabaha financing as the Islamic mode of finance should be considered an Islamic one if the cost of goods sold by the banker actually reflect the cost of goods to the banker and not its customers. Otherwise it's merely a concoction to circumvent traditional method of financing to Islamic method of financing.