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Islamic finance body seeks to update guidance on murabaha contracts

One of the main standard-setting bodies in Islamic finance has issued a draft standard on murabaha, aiming to update guidance on the most common financing tool used by Islamic banks.

The Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) is conducting a wide review of its standards to encourage convergence of industry practices and increase the consumer appeal the sector.

The proposed standard would supercede two earlier ones on murabaha, a sale contract which incorporates a profit markup on the cost of goods sold either on a spot or deferred basis.

It would cover new areas such as the accounting treatment on the liability side of a murabaha transaction, AAOIFI said in a statement.

AAOIFI is seeking industry feedback on the draft until the end of March, aiming to make the final version effective from January 2019 at the earliest.

Significantly, AAOIFI said it intended for the standard to cover all deferred-sale contracts but opted to develop separate guidance on commodity-based murabaha, also known as tawarruq.

Murabaha is common in consumer financing where a markup is known in advance by both parties to help reduce the ambiguity in the transaction, a key concept in Islamic finance.

In tawarruq, however, the buyer often sells the respective commodity immediately in the spot market, an approach widely used by Islamic banks for treasury transactions.

This practice has been criticised by some religious scholars for lacking a strong link to real economic activity and not being sufficiently different from a conventional interest-based loan.

AAOIFI said a separate accounting standard on tawarruq would allow it to address specific accounting and reporting issues, as well as reflect its use by Islamic bank treasuries.

An existing sharia standard on tawarruq allow such transactions in specific situations, often as a last resort technique, but discourages their use on a commercial basis.