One of the common questions I get with regards to the Murabahah Standards issued by BNM is on the types of Murabahah covered under the standards. Murabahah is essentially a Sale of goods (cost plus profit) where there is a “deferred” element which validates the profit earned arising from the sale transaction. To understand the difference, it is key to analyse the “deferred” elements, and the risks associated to the deferment.
Essentially, there are two types of deferment in a Murabahah i.e.:
1. Deferment arising from future/deferred settlement of Sale Price – This is the most common form of Murabahah where risks to the Seller is minimised by the almost immediate transfer of ownership of the goods.
This is generally used for debt creation where the Seller (usually a Bank in the case of financing products) purchase goods into its ownership and quickly Sells the goods to the Buyer (usually customer) where the Sale Price (inclusive of profit) is concluded with the future settlement terms agreed. Once the debt creation is completed, the ownership transfers from the Seller to the Buyer and the Buyer will start to make payments on the agreed Sale Price.
All risks on the goods (valuation, pricing, ownership) are transferred quickly from Seller to Buyer; the Seller only holds the credit risk of the debt i.e. the risk that the Buyer may not able to pay the Sale price at the future date as agreed.
This category of Murabaha is generally classified as a Debt-Based structure where the Bank only holds the Credit Risks (Valuation Risks is held by the Customer).
2. Deferment arising from future delivery of goods sold – This structure is more riskier than the earlier mentioned deferment of Sale Price settlement. Deferment of delivery of goods means the Seller purchases the goods now but do not enter into a Sale transaction with the Buyer until much later.
Instead, the Seller holds the ownership of the goods for a period of time and enters into a contract at an agreed future date. The Seller will carry the ownership risks and valuation risks until the goods are sold at the Sale Price (inclusive of profit). Once the Buyer enters the contract, the ownership of goods is transferred on settlement of the Sale Price at spot (either a Murabahah arrangement or Musawamah Simple Sale transaction).
Due to the riskier nature of the above, the Buyer is usually required to undertake to enter into the Sale contract (via Letter of Undertaking in favour of the Seller). On then the Seller procure the goods from Supplier, creating a legal obligation on the Buyer to complete the sale at the agreed future delivery date, even if the Buyer decides not to complete the Murabahah transaction (default on the arrangement). By this undertaking, the Buyer takes on the pricing risks as at the date of Sale transaction; the price of goods on the open market may be higher or lower than the contracted Sale Price.
Additionally, with the Letter of Undertaking, the risks on the Seller is mitigated, resulting the credit risk of the Buyer to be similar/equivalent to the “debt” structure of Murabahah arising from deferment of Sale Price.
This arrangement is commonly referred to in the market as “Murabahah Purchase Order” or MPO where the Seller will only proceed to purchase goods to hold it for a period of time with the surety of the Letter of Undertaking as a risk mitigant. This category of Murabaha can be classified as either an Equity-Based structure (if the Bank choose to hold the ownership until sale i.e. open to valuation risks without a Letter of Undertaking) or a Debt-Based structure (where the Bank executes the Letter of Undertaking and effectively transferring the valuation risks to the customer).
Both the structures are sufficiently addressed in the Murabahah Standards issued in 2013.