Murabaha

Murabaha (also spelled murabahah) is a sale contract in which the seller tells the buyer what the goods cost and adds an agreed profit, or markup, to arrive at the sale price. In modern Islamic banking it is the most widely used financing technique: the bank buys an asset that a customer needs and sells it to the customer at cost plus a disclosed profit, with payment deferred and usually made in installments.

Murabaha allows a bank to earn a return on financing without charging interest, which is prohibited as riba. The return is a trading profit on a sale of a real asset, and once the price is agreed it cannot be increased because the buyer pays late.

In classical Islamic commercial law, fiqh al-mu'amalat, murabaha is one of the "trust sales" (buyu' al-amanah), so called because the buyer relies on the seller's honest statement of cost. The classical form was a simple trading contract with no financing purpose. The modern banking version, often called "murabaha to the purchase orderer," was developed in the second half of the twentieth century as Islamic banks looked for asset-based alternatives to loans.

1. The customer identifies an asset, such as equipment, a vehicle or a shipment of goods, and asks the bank to buy it.
2. The customer gives a promise (wa'd) to buy the asset from the bank once the bank owns it. In most standards this promise binds the customer to compensate actual loss if it backs out, but it is not itself a sale.
3. The bank buys the asset from the supplier and takes ownership and possession, whether physical or constructive, which in Islamic law is known as qabd. The bank carries the risk of the asset during this period.
4. The bank sells the asset to the customer at cost plus the agreed markup, payable on deferred terms. The price is fixed at the moment of sale.

The bank sometimes appoints the customer as its agent under a wakalah to buy the goods on its behalf. Sharia standards, including those of AAOIFI, require that the bank actually acquire ownership before reselling, and the bank's Sharia supervisory board reviews the documentation for this.

A company needs machinery costing 200,000. The bank buys the machinery and sells it to the company for 216,000, disclosing the 200,000 cost and a 16,000 profit, payable in 24 monthly installments of 9,000. If the company later pays an installment late, the bank cannot add to the 216,000 debt. Many contracts instead oblige a late payer to make a donation to charity, which the bank does not keep as income, a practice linked to income purification.

Murabaha is used for consumer goods, vehicle and home financing, working capital, and especially trade finance, where an Islamic bank buys imported goods and sells them on to the importer. A variant known as commodity murabaha, in which the bank buys and sells metals or other commodities through brokers, is used for interbank liquidity management and to provide customers with cash. When the customer immediately sells the commodity to a third party for cash, the arrangement is called tawarruq.

Murabaha has been criticized for replicating the economics of an interest-bearing loan. Banks often price the markup by reference to conventional benchmarks, the bank's ownership of the asset can last only moments, and the customer bears most of the practical risk. Some scholars accept these features as long as the legal steps are followed; others argue that heavy reliance on murabaha, rather than partnership contracts such as mudarabah and musharakah, departs from the aims of Islamic finance, often discussed under maqasid al-Sharia. Defects in the sequence of steps, such as selling before the bank owns the goods, create Sharia non-compliance risk that can make the profit impermissible.

Murabaha differs from ijarah, a lease in which the bank keeps ownership and charges rent, and from bay' al-'inah, a sale and immediate buy-back between the same two parties that most jurisdictions outside Malaysia reject. Unlike salam or istisna', which finance goods to be delivered or manufactured in the future, murabaha involves an asset that already exists and is delivered at the time of sale while the price is paid later.