Islamic project and infrastructure finance: re-emergence of the Murabaha

‘Even these metallic problems have their melodramatic side.’ (Oscar Wilde, The Importance of Being Earnest (1895, in premier))


The nature of project and infrastructure finance has changed markedly over the past 18 months as a consequence of the global financial crisis. Early prognostications of massive project and infrastructure spending, particularly in the Middle East, have proven incorrect, at least in terms of timing. While some oil-rich nations that invested cautiously in the last decade, such as Saudi Arabia and Abu Dhabi, continue their projects, most countries have severely reduced project and infrastructure spending. Global recession has ensued, liquidity is severely restricted, private commercial financing is tepid and the conventional capital markets are quiescent. Discussions of financing structures in the private commercial realm focus on models that were previously reserved to real estate financings, eg mini-perm financings involving construction loans that extend for a short term beyond completion. Sukuk markets have been dormant, in sharp contrast to the pre-September 2008 patterns, although they have experienced a slight upsurge during 2009. The wide range of Shari’ah-compliant financing devices used prior to September 2008 have disappeared.

What has emerged during this period, where financing is available, is increasing use of murabaha financing structures. The murabaha has long been recognised as the most frequently used, and the most frequently abused, structure in Islamic finance. It has been the staple for short-term investment and working capital transactions, and a primary device for revolving credit facilities. It has been used in some long-term financings. It has also been a significant element of sukuk issuances since the inception of those markets. But, if the anecdotal and experiential observations of practitioners are any indication, the murabaha has never before been as pervasive in sophisticated financing transactions as at the current time.

Many practitioners aver that the murabaha is an easy way to convert an interest-based lending arrangement into a Shari’ah-compliant transaction. They view the murabaha as simplistic, unworthy of rigorous analysis and discussion. Shari’ah scholars do not share that view. They have long warned against excessive use of the murabaha, and, it seems, have foreseen, with some trepidation, the current, rather cavalier, use of the structure.

This article considers this ancient and most modern of structures, the murabaha. It surveys some general murabaha principles and the predominant ‘commodity as vector’ approach to murabaha financings.

General Murabaha Principles

Bai`u al-murabaha is a type of sale, of venerable lineage under the Shari’ah and acceptable to all four of the main orthodox madhahib. It is a trade-based, ‘cost-plus’ sale contract in which the cost is ascertained and expressly disclosed. As originally formulated, it had nothing to do with financing. Current conceptions are overwhelmingly focused on financing transactions. The basic formulation of the murabaha is that the first buyer (also referred to as the seller) purchases an object for some amount (the initial cost) from a third party and then sells that object to the second buyer at that initial cost plus a profit. Payment by the second buyer may be immediate (at spot) or deferred. In financing transactions, deferred payment by the second buyer is the norm.

The murabaha, in any context, is a sale and must conform to the Shari’ah requirements pertaining to sales. Therefore, it is essential to begin with some fundamental sales principles.

The object of the sale must be in existence at the time of the sale. Agreements relating to nonexistent items (an unborn calf, a future harvest, an unmanufactured good) are not valid murabaha transactions. The sale object must be known and clearly specified in a manner that allows precise identification. Of course, the object may not be a haram object (alcohol, pork, impermissible financial instruments). The object must have determinable value at the time of sale.

The object must be owned by the seller at the time of the sale. A sale of a horse that is owned by a third party is not valid, however likely that the third party will sell the horse to the initial buyer so as to allow the sale to the second buyer. The object must be in the actual or constructive possession of the seller at the time of the sale. Constructive possession here means that the seller has assumed all liabilities and obligations of ownership and possession, including in respect of destruction or ‘perishing’, even if the seller does not take physical delivery of the object. Delivery of the object must be certain, not contingent or dependent on conditions, events or circumstances.

The sale must be immediate and not contingent on future conditions, events or circumstances. If not immediate, or if contingent, it is void as a present sale and will have to be renewed and reaffirmed at the specified future date or on the occurrence of the contingency. Certain ‘customary trade usage’ conditions are permissible (eg the validity of a warranty).

The validity of a murabaha, like that of any sale, is dependent on certainty of price. In a murabaha, price is a function of two fully-disclosed and mutually agreed elements:

  1. initial cost; and
  2. profit.

Both elements must be determinable and fixed with certainty. The price, once fixed, may not be increased or decreased, even if payment is early or late (whether by default or voluntarily).

Generally, initial cost disclosure must include disclosure of any financing and deferred payment arrangements pertaining to the object or its initial purchase. Inability to determine the initial price, or unwillingness to fully disclose that price, voids the sale as a murabaha (although it may be enforceable as a musawamah contract). The profit may be a lump sum or a percentage. It may be higher if the date of payment is more distant and the consideration of time in establishing the initial price is permissible. The price need not reflect the current, or any future, market price. It may be different for cash and credit transactions, reflecting the different risk assessments, although one option must be chosen at inception and the price then fixed. Different prices for different maturities or payment dates, leaving an option to the second purchaser as to election of payment date, are impermissible. In deferred payment transactions (bai’ muj’ajjal), including most murabaha transactions, additional rules apply. The due date for payment must also be unambiguously fixed at inception (eg a specific date or specific period). But the date may not be fixed by reference to an unknown or uncertain event. Payment periods commence from the date of delivery of the object, unless otherwise specified.

Most Shari’ah scholars allow for late payment and default payment charges. These are of two types:

  1. actual fees, costs and expenses (actual damages) incurred by the seller resulting from late or default payment, which may be retained by the seller; and
  2. penalty charges, which may not be retained by the seller but must be donated to charity.

The latter are allowed as incentives for timely payment by the second buyer. Acceleration of the entire purchase price on a default is generally permissible. Collateral security for payment and performance obligations is acceptable.

Certain expenses, though not precisely determinable at inception, may be added to the price. Permissible expenses are non-recurring expenses incurred by the first buyer in effecting the transaction, eg freight and transportation charges, customs duties, sales intermediation expenses, feeding costs, and other normal and customary transactional costs. Recurring business costs and expenses of the seller are not permissible additions to the sale price, eg employee salaries, premises rent, normal storage and warehousing, veterinarian’s costs, and the fees of herdsmen. Consultation with the advising Shari’ah scholar is advisable in connection with determinations as to includable expenses.

The murabaha is a trust sale. Disclosure extends beyond the initial cost to all essential transactional elements. For example, and generally stated, any defect in the object arising during the time the object is in the ownership, possession or control (actual or constructive) of the initial buyer, or as a result of third party acts or omissions, must be disclosed. Increases or decreases in the object of sale must also be disclosed.

Murabaha Financings: Commodities As Vectors

The murabaha is increasingly used as a conventional loan substitute. This gives rise to many misunderstandings and instances of outright abuse that have led Shari’ah scholars to disfavour the structure in many circumstances. The murabaha was originally intended to be used in connection with the purchase of commodities, where the commodity was itself the true object of the transaction. In contemporary financing transactions, the commodity is often, if not usually, a vector to other ends, rather than the object of the transaction.

The primary example of the commodity as a transactional vector is the metals murabaha. In this transaction:

a) the first buyer purchases a permissible metal (not gold or silver) from a third party dealer at spot;

b) the first buyer sells the metal to the party desiring financing, the second buyer, on a deferred basis at a variable rate (often London interbank offered rate (LIBOR)-based); and

c) the second buyer sells the metal to a dealer at spot.

The net result is that:

  1. the first buyer has paid, in cash, a cost equal to the amount of the desired financing;
  2. the second buyer owes that same amount, plus profit, to the first buyer, payable on a deferred basis; and
  3. the second buyer receives that same cost amount in cash.

The formalities are observed, but the commodity is not itself the object of the transaction. Compliance is technical, rather than substantive.

This series of transactions is effected each time the second buyer desires to access the financing facility, which, in a revolving credit agreement, may be frequently in a revolver. Almost universally, the first buyer takes collateral security to secure the second buyer’s obligations.

Bank regulators (such as the Comptroller of the Currency in the US), using an ‘economic substance’ analytical methodology, have determined (in 1999) that murabaha transactions of this type are ‘functionally equivalent to conventional financing transactions’, and are thus permissible bank lending transactions under relevant banking laws and regulations. For accounting and tax purposes, the parties treat these murabaha transactions as loans in exactly the same manner as they treat conventional loans in similar circumstances.

Legal, tax and accounting practitioners structure murabaha transactions based on the conventional loan documentation of the bank or other financial institution participant, with modifications being made to the extent necessary to render the agreement compliant with the Shari’ah as determined by the Shari’ah advisers for that specific transaction. Thus, representations and warranties, covenants, events of default, remedies and other provisions in the murabaha agreement are essentially identical to those in the bank’s conventional loan agreement. Significant issues arise in connection with the implementation of some of the standard conventional loan concepts, such as the unilateral promise nature of the structure, use of variable rates (such as LIBOR), collateral security (rahn) arrangements, commitment fees, profit participations and other accruing obligations, loan ‘rollovers’ and late payment, and default interest, among others. These concepts, as conventionally conceived, are incompatible with relevant Shari’ah principles and precepts. However, mechanisms have been developed to allow the inclusion of modified versions of these concepts in compliant murabaha agreements. Significant issues also arise in connection with the ‘enforceability’ or ‘remedies’ opinion, in both ‘purely secular jurisdictions’, which do not incorporate the Shari’ah to any extent in the secular law, and Shari’ah-incorporate jurisdictions, which do incorporate the Shari’ah, to some greater or lesser extent, into the secular law.

Despite its infirmities from the Shari’ah vantage, the metals murabaha has been accepted ‘as a transitory step taken in the process of Islamicisation of the economy’ where other structures, such as the mudarabah and the musharakah, are not practicable.


The use of murabaha transactions is increasing markedly and expanding to more areas of finance, rather than retreating as desired by the Shari’ah scholars. Part of the reason is the unfortunate and inaccurate perception that it is an easy substitute for a conventional loan arrangement, particularly in its ‘commodity as vector’ manifestation. Increasing use has made it apparent that practitioner awareness of murabaha fundamentals and requisites is somewhat deficient. With the re-emergence and resurgence in the use of the murabaha there is an attendant obligation to study this device, in its proper context as a type of sale, in all of its complexities, nuance, purpose and elegance.

By Michael McMillen, partner, Fulbright & Jaworski LLP.