Murabaha

Murabaha is a Sharia-compliant form of financing commonly described as cost-plus or markup-based financing. Instead of lending money and charging interest (riba), an Islamic bank buys an asset and resells it to the customer at the original cost plus an agreed profit margin. The customer repays the bank in fixed installments, and legal ownership typically transfers once payment is complete.

How it works

• A client asks the bank to acquire a specific asset (e.g., equipment, vehicle, property).
• The bank purchases the asset from the seller.
• The bank sells the asset to the client at cost plus a pre-agreed profit markup.
• The client repays the bank in fixed installments; no interest is charged.
• The contract is structured as a sale rather than a conventional loan, making it compliant with Islamic law.

Key points

• Murabaha substitutes interest-bearing loans with a fixed markup built into the sale price.
• The transaction is considered halal (permissible) because it involves a genuine sale and transfer of ownership (upon full payment).
• Ownership typically does not pass to the buyer until payments are complete, similar in outcome to some hire-purchase or rent-to-own arrangements.

Uses

Murabaha is used across consumer, corporate, and trade finance:
– Consumers: appliances, cars, home purchases (where applicable).
– Businesses: machinery, equipment, raw materials.
– Trade finance: murabaha-based letters of credit, where the bank’s payment guarantee replaces the importer’s creditworthiness; the importer then repays the bank cost plus markup.

Default and enforcement

• Additional penalties or interest for overdue payments are generally prohibited; imposing such charges would conflict with Sharia principles.
• Islamic banks face challenges with defaults. Common approaches include blacklisting repeat defaulters and denying future financing, while Sharia teachings also emphasize relief or respite for debtors in genuine hardship.
• Willful default—intentional refusal to pay despite ability to do so—is treated more severely and can prompt legal or governmental action depending on the jurisdiction.

Example

A customer wants a boat priced at $100,000. The bank buys the boat for $100,000 and immediately sells it to the customer for $109,000, payable in fixed installments over three years. The $9,000 represents the bank’s profit margin, not interest, and no further interest-based penalties are charged.

Comparison with rent-to-own

Both arrangements can result in ownership after payments, but differ in structure:
– Rent-to-own is a lease with an option to buy and typically includes rental payments that may contribute toward purchase.
– Murabaha is a sale: the bank takes title, then sells the asset to the buyer at a markup with deferred payments.

Geographic adoption

Murabaha is widely used in many countries with developed Islamic banking sectors, including Bahrain, Malaysia, Indonesia, Saudi Arabia, Bangladesh, and Pakistan, and is common in both retail and wholesale Islamic finance operations.

Conclusion

Murabaha provides a practical, widely used alternative to interest-based lending that aligns with Sharia principles by replacing interest with a transparent, agreed-upon profit margin embedded in a sale transaction. It is versatile for consumer purchases, corporate procurement, and trade finance, though managing defaults remains an operational and ethical challenge for Islamic financial institutions.

Sources: Institute of Islamic Banking and Insurance; RSIS International (review of challenges in murabaha); Market Business News (definitions of willful default); trade and consumer finance resources.