Murabaha is derived from the Arabic word Ribh (ربح) which means profit. It is a common type of a contract used by financial institutions in which the buyer and seller agree on a cost-plus price of a product. As you all know that in today’s world ethical financing has grown exponentially and Islam is also based on an ethical model be it in the field of business or finance. Since the time of Prophet (PBUH) this is the main element which has differentiated Islamic Finance from the conventional based system.
In a contract of Murabaha, to fulfill the needs of ethical finance, integrity to both the client and monetary institution is required and that is the reason it is important for an institution to inform its client about the product, its cost price, the markup amount and even if it has bought the product on credit. All these details need to be included in a Murabaha contract. In case, during the tenure of the contract, if the client comes to know about the financial institution being dishonest, he has the right to terminate the contract on priority basis.
Interest free Contract
As the Muslim world is in dire need of an alternative system which must be free from interest, contracts such as Murabaha come to rescue them, it is often used by Islamic banks as a mode of finance.
Now the question arises that how does an Islamic bank use Murabaha to finance? So, an Islamic bank (Financier) simply buys the product which the client wants or the client can also purchase the product himself (on behalf of the bank). In the second case, the bank will have to transfer the power of attorney (وکالت) to the client. Afterwards, the client would buy the same product at a deferred price from the bank. The client has an option to make the payment to the bank as a whole or in installments as per the Murabaha contract. One should keep in mind that while the client is just an agent to buy the product and he has not paid a penny to the bank, his Shariah status would be of a trustee which means that the ownership would still belong to the bank (along with the risk factors such as theft, fire etc too). However, once the client has paid the deferred price, the ownership will be transferred to him simultaneously and all the risk factors would then be associated with him.
Process Made Easy
Let’s view a Murabaha transaction: Mr X wants to buy 100 vehicles from Company Y, he approaches the bank and the Islamic banking officer recommends him Murabaha, under this transaction the commodity will be bought directly by bank and the cost of equipment and profit (markup) will be known to both the parties i.e Mr. X and financier (bank). The bank would appoint Mr. X an agent (وکیل) to buy the product on behalf of him with the consent of both parties. After the purchase, the product will be in the possession of Mr.X but the ownership would still belong to the bank, Mr. X then may provide the payment of 100 Vehicles (Cost + Markup as agreed) with an option of one-off payment or in instalments. Once the payment is done, the ownership of the equipment would be transferred to Mr X.
Value Added Difference
So how’s that different from conventional system? Differences between them are as follows:
Murabaha is a sale-based contract in which an asset is always involved whereas the conventional system follows an interest % based agreement irrespective of whether an underlying asset exists or not.
Murabaha agreement does not allow profit (to the bank) from late payment fees or burdening customers with others snowboarding interest upon interest charges as the selling price has already been decided.
However, one must also be clear that Murabaha is considered as a borderline transaction among some scholars as it is a debt-based contract and should only be considered when financing through equity-based contracts such as Partnership (مشارکت) or Mudharabah (مضاربت) are difficult. The Murabaha agreement may also allow the bank to keep the mortgage(رھن) against the deferred payment to minimize the risk of fraud. In addition to this, the agreement can also be enforced by law.
Murabaha truly opens avenues for hassle free financing and offers optimum convenience to the client with multiple benefits.
Written by: Jareer Usmani