English
Musawamah is a type of sales contract used in Islamic finance used for trading in goods, assets and commodities, as well as a form of financing of these goods.
It shares many similarities – both in terms of its structure and its function – with Murabaha contracts, except for a key difference: price.
Today, we breakdown the basics of a Musawamah contract, explain its key difference with Murabaha as well as looking at where that difference can come in handy.
Musawamah shares many common attributes with Murabaha contracts. In its most basic form, it is a sales contract for a good, property, commodity or asset. However, when applied to finance, it too, can be a potent form financing.
Just like in Murabaha, a Musawamah is a form of Shariah-compliant financing used by the borrower to purchase a property, good, or asset. In a typical transaction, the bank or institution purchases the asset (usually through a broker) and then sells it to the borrower at a mark-up or cost-plus profit.
The borrower will then pay for the asset over an agreed upon period of time, typically in installments. The lender profits from the marked-up sale of the asset instead of interest on a loan as is typical in non-Islamic banking.
The only key difference between a Musawamah and a Murabaha is in the pricing scheme of the resale. In a Murabaha, the initial cost of the item on sale is known and is disclosed before the contract is signed and first sale is complete. The mark up by the initial buyer (in this case, the bank) is also known to the end-user (or borrower).
This is different in a Musawamah, where the initial cost of the item is unknown to the borrower, or at least not disclosed by the lender. Once the item is bought, the lender can then set a price of their choosing to the end user, who can accept, reject, or renegotiate the price. Once a price is agreed, the end user can then pay it down immediately or in installments.
Another crucial difference is that the concept of Tawaruq does not apply in a Musawamah transaction. When used in financing, Murabaha can be extended further to allow the borrower to obtain cash liquidity through the use of a commodity Murabaha or Tawaruq.
In a Tawaruq, the item can then be sold off again, through the bank’s broker, and cash given to the borrower, who will then pay that amount back to the lender. This does not apply in a Musawamah, which is built entirely on the sale of the item to the borrower.
Read more about: The Basic Guide to Commodity Murabaha
For a Musawamah to be valid it must meet the following conditions:
The item being sold on to the end user must already be in existence at the time of the sale – unlike with Salam and Istisna contracts. The item must be of value and can be used by the end user.
The initial buyer (the bank in this case) must already own and be in possession of the item at the time of the contract.
While the payment for the item in question can be pushed back and paid down in installments, the sale of the item must take place immediately upon signing of the contract.
The good in question must be halal and the sale must adhere to Islamic principles, with no interest payments, and avoiding excessive speculation and gambling.
Due to their similarities and very minimal differences, it is valid to explore why there was a need for a Musawamah if a Murabaha not only achieves the same function, but has the added benefit of having an upfront price quoted to the customer.
For one, a Musawamah gives the lender and the borrower the flexibility in negotiating the price, allowing for the possibility of the borrower’s costs being reduced and the lender’s profit to increase beyond the initial price.
It also allows for the resale of goods whose price is difficult to determine, such as an item that was not initially purchased in its entirety, but needed to be manufactured and other inputs included.
It also helps if the price of the commodity in question is volatile and can fluctuate widely between the initial purchase and the resale. Setting a new independent price when signing the contract would give such an item an element of price stability for the end user and a hedge against price fluctuations for the lender.
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
