Murabaha Monthly, Episode 4: Fees in Commodity Murabaha Agreements

For this month's instalment, Ben Neville, a senior associate in our Islamic Finance team, takes a debut guest slot on Murabaha Monthly to briefly summarise how and why financier fees within commodity murabaha facilities tend to be structured differently to conventional loans.

Fees payable by a borrower to a financier are of course part and parcel of a typical loan agreement and someone with a passing knowledge of conventional facilities will be familiar with a number of these including: arrangement, transaction, commitment & late payment fees.

The purposes of these fees are wide ranging; from covering actual costs incurred by the financier, to encouraging the borrower to avoid default, to allowing the financier to make a profit on aspects of financing above and beyond the interest on the borrowing.

These purposes in Shariah-compliant financing must be carefully balanced with the prohibition under Islamic law against unjust enrichment and unfair exploitation.

Using these common fees as discussion points, we will quickly work through how and why these fees tend to be structured differently between Shariah compliant finance and conventional loans.

Arrangement Fees

In conventional loans, this fee, charged by the financier for the arrangement of the loan, is expressed as a percentage of the loan amount without further reference. In commodity murabaha facilities, such fees are stated in fixed monetary terms and are often based upon management time and resource incurred by the Islamic financier in in arranging the facility, such as terms’ negotiation and credit approval etc.  In addition, stating the fee as a fixed monetary sum helps distinguish the fee as being distinct and unrelated to the facility amount, thereby mitigating arguments of unjust enrichment – a well-known Shariah prohibition.

Transaction Fees

This fee type is one of the simplest to consider as these fees remain valid across both conventional and Islamic finance. In our example of a commodity murabaha secured against a property, the usual fees involved in the due diligence process of surveyors, valuers, solicitors etc. are acceptable and unanimously charged as they are directly and actually incurred costs on behalf of the financier for the purpose of the financing.

Commitment Fees

Fees charged by financiers for making money available in conventional loans are not utilised in commodity murabaha facilities. The Shariah principle of prohibition on unjust enrichment means that fees of this kind are not permitted as, at the simplest level, they are not an actual cost being passed on by the financier. Therefore, it is common in commodity murabaha facilities for the availability periods to be very short to limit exposure.

Late Payment Fees

The effective use of late payment fees in conventional facilities to encourage borrowers to meet their financial obligations, means there is greater market pressure on Shariah-compliant financiers to use equivalent methods in their products. By balancing the prohibition of unjust enrichment with the need to protect the financier against non-payment, it is typical for commodity murabaha facilities to charge late payment fees when customers are in default which the financier will then deduct out of any actual costs it suffers as a result of the default before making a charitable donation of the balance – consequently not enriching itself from the default.

As can be seen, the position on fees in commodity murabaha facilities and other Shariah-compliant products is a nuanced one, with common fees from conventional loans being adopted, adapted and, in some cases, refuted, to ensure compliance with the underlying Shariah principles. A working assumption (or rule of thumb) is that in Islamic finance, financier fees must be linked to actual costs incurred or suffered in servicing the facility to ensure the financier avoids unjust enrichment.

So concludes the latest instalment of Murabaha Monthly – join us next month when we'll look into the rationale and background to shariah-compliance clauses commonly found within commodity murabaha facilities.

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