What Is Musawamah?
Musawamah is a term used in Islamic finance. It describes a type of transaction in which the buyer does not know the price paid by the seller to create or obtain the good or service being offered.
Under the rules of Islamic finance, various conditions must be met in order for Musawamah transactions to be permitted and to meet the standards required under Sharia law.
- Musawamah transactions are those in which the buyer and seller are permitted to barter over the price, without the seller disclosing the production cost of the product.
- These transactions are regulated under Islamic law; specific conditions must be met in order for a particular transaction to qualify.
- In the financial services sector, various administrative and technical innovations have occurred to accommodate the religious requirements of Muslim investors.
How Musawamah Works
Musawamah describes a transaction where the price of the good or service is not disclosed to the buyer. This differs from murabaha transactions, where a buyer knows the cost of the underlying asset. Since the seller is not obligated to disclose the cost of obtaining or producing the merchandise for sale to the buyer, the agreed selling price is left to the bargaining powers of both the seller and buyer.
In order to comply with Shariah law, a musawamah transaction must abide by various conditions. For instance, musawah transactions must be spot transactions in the sense that the exchange must take place instantaneously; futures contracts therefore do not qualify. Similarly, the good or service in question must be of tangible economic value, such as a consumable product. Musawamah transactions must also be limited to goods or services that existed at the time of sale, meaning that they cannot be used to procure goods that have not yet been manufactured or procured.
In practice, there is substantial variation in the ways in which the rules of Sharia-compliant finance are interpreted and applied throughout the Islamic world. However, common rules in Islamic finance include the prohibition of usury and of investments in proscribed business practices such as the production of weapons, cigarettes, or pork.
To navigate these complexities, financial firms throughout the world have launched investment funds and other financial products designed to provide Sharia-compliant options for Muslim investors. These products are often overseen in a manner similar to the Socially Responsible Investment (SRI) products that have become popular in recent years. Specifically, Sharia-compliant investments are typically overseen by a special board of experts in Sharia law, who advise the investment managers on whether particular investments are suitable candidates.
Real World Example of a Musawamah Transaction
Michaela wishes to purchase a souvenir from a merchant during her travels in Morocco. She settles on a locally made scarf which is being sold by an artisan in a small market.
Because the scarf has clear usefulness and value to the buyer, and because it is currently in the possession of the seller and is being sold at the present time, the sale of the scarf qualifies as a Musawamah transaction under Sharia law. For this reason, the merchant is not obligated to disclose to Michaela the underlying cost of producing the scarf. Therefore, Michaela will not know the seller’s profit margin when negotiating over the price.
For these reasons, Michaela and the merchant are free to barter over the price of the scarf until they reach a mutually acceptable agreement.