What is Musawamah?
Musawamah is an Arabic word derived from the word “sawa” which means “equalizing”. Musawamah means “bargaining” or “negotiation”, and in Islamic banking, it represents a type of sale where the seller does not disclose the cost of goods sold. It allows both parties to negotiate a mutually agreeable price, rather than rigid store policies or pricing structures. Using this financial instrument, an Islamic bank or financial institution can sell something for a profit without disclosing its’ initial purchase price.
Understanding Musawamah in Islamic Banking
In Musawamah, the price is flexible! It is a Shariah-compliant approach for banks to profit from overpricing and allow buyers and sellers to agree on prices without disclosing the cost structure. This form of sale is widely applicable, especially in modern Islamic banking, for products like credit cards, where it is assured that transactions remain free of interest or riba. As Islamic finance continues to evolve, Musawama stands as a key tool for facilitating flexible trade in a way that aligns with Islamic values.
However, many Islamic Finance Scholars are against using Musawamah for products like credit cards. The reasons are discussed later in this article.
How Does Musawamah Payment in Credit Card Work?
Shariah-compliant transactions are gaining prominence due to the rise of Islamic banking and financial services. Credit cards offered by Islamic banks must adhere to Shariah principles, meaning they cannot involve interest (riba – forbidden to pay/receive in Islam) or excessive uncertainty (gharar). Musawamah is one of the models through which Islamic banks offer credit card services. This is how it works:
- For Musawamah payment in credit card, the bank profits from selling a good to its clients.
- The clients already know that they are buying at a higher price. The profit is not an interest-based loan.
- The bank then charges the customer based on the agreed price.
- Since interest cannot be charged, Islamic banks often generate profit by charging a fixed fee or predetermined markup instead of applying interest to the outstanding balance.
The Musawamah structure in credit card payments ensures that the transaction remains Shariah-compliant, allowing Muslims to benefit from modern financial instruments while adhering to the Islamic banking and finance principles.
Musawamah VS Murabaha
Musawamah vs Murabaha is about two different Islamic financial products, and highlights two distinct pricing methodologies. Here are the key differences between Musawamah and Murabaha.
Feature | Musawamah | Murabahah |
| Definition | Negotiated price without purchase cost. | Selling at a disclosed profit margin. |
| Pricing Method | Price agreed upon through negotiation. | Price determined through cost plus markup. |
| Transparency | Flexible negotiation between parties. | Clear cost structure and profit disclosure. |
| Application | Can be applied to various asset types. | Mainly used for goods and properties. |
| Interest | No interest is involved. | No interest; profit margin is pre-defined. |
| Shariah Compliance | Yes | Yes |
| Payment Terms | Flexible payment options can be offered. | Usually, it involves a fixed payment structure. |
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Musawamah Example – Credit Card Transaction
To better understand it, let’s consider a practical example in the context of a simple trade:
- An Islamic bank customer opens their bank application to purchase a new laptop with his credit card, issued by the Islamic bank.
- The client agreed to pay $500 for the laptop and pay $100 from his salary every month.
- The Islamic bank sold the laptop at a higher price because the Islamic bank purchased the laptop from the supplier for only $400.
- In this case, the Islamic bank earned 20% profit using the Musawamah contract.
In this case, the Islamic bank acted as the seller, setting a price for the goods or services purchased with the card but without revealing the original cost.
This example illustrates the flexibility of Musawamah in Islamic finance, where the focus is on mutual agreement without the need for detailed cost disclosures.
Conditions of Musawamah
To ensure compliance with Islamic principles, several key conditions must be met in a Musawamah agreement:
- Clarity in Pricing: The price (not the original cost) must be clearly defined and agreed upon by both parties.
- Lack of Interest: The transaction should not involve any form of interest or hidden fees.
- Asset Documentation: The goods being sold must be tangible and properly documented.
- Mutual Consent: Both the seller and buyer must agree to the terms of the sale.
- Free from Deceit: The exchange must be free from any form of deceit or misrepresentation.
Understanding the Musawamah Contract and Agreement
The structure of a Musawamah contract is less formal than other types of Islamic financial agreements. Here are the key features:
- Agreed price,
- Details of the asset,
- Payment terms, and
- Conditions of delivery.
The flexibility of Musawama contracts makes them adaptable to various scenarios. It is essential to note is that the terms must comply with Islamic law, ensuring both parties’ rights and responsibilities are clear and respected.
What is the Musawamah Local Pledge?
The Musawamah Local Pledge is an agreement that reinforces its importance within specific local markets, ensuring that trade transactions adhere to community norms and ethical standards. The Musawamah local pledge emphasizes:
- Commitment to fair negotiation practices,
- Transparency in pricing and,
- Mutual consent between buyers and sellers.
This seeks to protect consumers and businesses alike from deceitful practices and unfair competition to make it align with Islamic economic principles.
Importance of Negotiation in Hadith
The Prophet Muhammad (PBUH) emphasized fair trading practices, where negotiations were encouraged over fixed prices. It is reported in a Hadith in Sahih al-Bukhari,
“The buyer and the seller have the option of canceling or confirming the bargain unless they separate, and the transaction is only based on fair trade”.
- Hanafi School of Jurisprudence recognizes Musawamah as a valid form of transaction, if price is negotiated under the Shariah guidelines.
- Ibn Qudamah in “Al-Mughni” and Al-Ghazali in “Ihya’ Ulum al-Din” illustrate the permissibility of Musawamah as a legitimate form of trade.
Is Musawamah Halal or Haram? Objections of Shariah Scholars
Musawama is considered Halal if Islamic banks and other financial institutions follow Shariah principles and transactions don’t involve uncertainty (Gharar) or interest (Riba). However, below are some of the objections of Shariah Scholars.
1. Ambiguity and Uncertainty
It involves an agreement where the buyer and seller negotiate the price of goods without the buyer knowing the cost price. This can introduce ambiguity and gharar (uncertainty), which is generally discouraged in Islamic finance.
2. Potential for Exploitation
Scholars argue that buyer’s lack of knowledge about the cost price may lead to excessive profits, which is against the principles of fairness and justice in trade.
3. Violation of Trust
Some scholars believe that musawamah could potentially breach trust and honesty, especially if the seller withholds cost information that might impact the buyer’s decision.
4. Detriment to Fair Pricing
An Islamic bank might set prices that deviate significantly from fair market values, adversely affecting fair pricing mechanisms.