Murabaha

What is 'Murabaha'

Murabaha is an Islamic financing structure in which an intermediary buys a property with free and clear title. Murabaha is not an interest-bearing loan, which is considered riba (or excess), and is an acceptable form of credit sale under Sharia (Islamic religious law). Similar in structure to a rent-to-own arrangement, the intermediary retains ownership of the property until the loan is paid in full.

BREAKING DOWN 'Murabaha'

In a murabaha contract of sale, the bank buys a specific item from a client for a predetermined profit over the cost of the item, then sells the item back to the client in installments. Because a set fee is charged rather than riba, or interest, this type of loan is legal in Islamic countries. Islamic banks are not authorized to charge interest on loans because of religious beliefs, so banks must charge a flat fee for continuing daily operations.

Requirements for Murabaha

For meeting Islamic standards of a legal sale, murabaha is completed in two stages. In the first stage, the bank purchases a commodity that the client is selling. In the second stage, the client agrees to a payment schedule for repurchasing the good. Because murabaha involves two transactions, two sale contracts are used.

Murabaha and Default

Because additional charges may not be imposed after a due date, murabaha default is an increasing concern for Islamic banks. Many banks believe defaulters should be blacklisted and not allowed future loans from any Islamic bank as a method of decreasing murabaha default. Even if it is not expressly mentioned in the loan agreement, this arrangement is permissible in Shariah, the body of Islamic law. Therefore, if a debtor is facing a genuine hardship and cannot repay a loan on time, respite may be given as described in the Quran. However, the government may take action in cases of willful default.

Examples of Murabaha

The murabaha form of financing is typically used for fulfilling Islamic loan requirements in diverse sectors. For example, consumers use murabaha when purchasing household appliances, cars or real estate. Businesses use this type of financing when purchasing machinery, equipment or raw materials. However, murabaha is most commonly used for short-term trade, such as issuing letters of credit for importers.

A murabaha letter of credit is issued for a beneficiary, the exporter, on behalf of an applicant, the importer. The bank issuing the letter of credit agrees to pay an amount of money in compliance with the terms described in the letter of credit. Because the bank’s creditworthiness replaces that of the applicant, the beneficiary is guaranteed payment. This benefits the exporter because the bank assumes the payment risk.