Murabaha

Murabaha, derived from the term ‘ribh’ (profit), is a sale contract in which the seller discloses both the cost and the agreed profit margin to the buyer. It is widely used in Islamic banking as an alternative to conventional loans for purchasing items such as cars, real estate, equipment, machinery, raw materials, and imported goods. The contract involves selling a commodity at a deferred price that includes a pre-agreed markup. Unlike interest-based loans, Murabaha is a genuine sale transaction and must meet specific conditions to be valid, including that it is used for an actual purchase of goods. 

Principles of Murbaha

a. Pre-contract procedures:

Before entering into a Murabaha contract, the buyer must indicate their desire to acquire a specific asset through the seller. This expression of interest does not amount to a binding promise or commitment unless it is formally executed. The seller may purchase the asset in its own name, but only in response to the customer’s request and application. A promise to purchase is not an essential element of a Murabaha contract; rather, it serves as a unilateral assurance from the customer. A bilateral promise is not permissible unless it includes an option to revoke, which may be exercised by one or both parties. Where a binding promise exists, the seller may request a security deposit (Hamish Jiddiyyah). If the customer breaches a binding promise, the seller is entitled to recover only the actual loss incurred, deducted from the security deposit.

b. Contracting parties:

A Murabaha contract involves two parties: the seller, who acts as the financier, and the buyer, who is the customer.

c. Subject matter:

The subject matter of a Murabaha contract consists of the asset and its sale price. The asset must be clearly specified in terms of type, quantity, and relevant characteristics, and it must be permissible under Sharia. The seller is required to bear the ownership risk of the asset and must acquire physical or constructive possession before executing the Murabaha sale with the buyer. In international trade, receipt of the Bill of Lading by the seller or its agent is regarded as constructive possession. The Murabaha sale price - comprising both cost and disclosed profit margin - must be clearly communicated to the buyer. Both the selling price and the seller’s profit must be fixed and known at the time the contract is concluded. Payment may be made either on a deferred basis or in installments. The seller is not permitted to charge any commitment fee or fee for granting a credit period.

d. Conclusion of a Murabaha contract:

A Murabaha contract is concluded through a valid offer by one party and acceptance by the other. This may take place in person or through any customary means of modern communication. The contract cannot be concluded automatically or coercively if the buyer chooses not to proceed. Methods of delivery or possession vary depending on the nature of the asset involved.

Delivery and possession of the asset may vary depending on its nature and prevailing trade practices. If the buyer breaches the contract, the seller is entitled to compensation strictly limited to the actual loss suffered as a result of that breach.

e. Guarantees and related arrangements:

The seller may require the buyer to provide permissible forms of security - such as a pledge, third-party guarantee, post-dated cheques, or promissory notes - to safeguard against default on installment payments. However, it is not permissible to stipulate that ownership of the asset remains with the seller until the full sale price has been paid. 

Example of a Murabaha contract

Buyer A wants to purchase a $50,000 car. He approaches an Islamic bank that offers financial services through a Murabaha contract. The bank buys the car from a dealer specified by buyer A, based on the car's specifications, for $50,000 and then resells it to buyer A for $60,000, which can be paid in installments over three years. The amount buyer A pays is fixed in advance to the bank. In a Murabaha contract, unlike a traditional credit contract, the price of the commodity remains fixed. Penalties and fines imposed in some countries by Islamic financial institutions in case of customer payment default are used as a means of discipline and do not go to the Islamic bank or lender but are directed towards charitable purposes, except in cases of intentional non-compliance by the customer, in which the Islamic bank may seek compensation for its losses.

Common Applications of Murabaha

Murabaha is the most widely adopted contract in today's Islamic financial landscape, serving as the basis for products such as:

• Home financing

• Vehicle financing

• Working capital financing

• Project financing

• Goods financing

• Trade financing - LC based on Murabaha

• Murabaha based Sukuk

• Profit rate swaps

• Islamic fund

• Credit card

Penalty in Case of Default

In Murabaha financing, if the buyer fails to settle the sale price on the agreed due date, the price of the asset may not be increased. Unlike interest-based lending, where the outstanding amount grows with the duration of default, the Murabaha price becomes fixed once the contract is concluded and is not subject to any increase.

This restriction may be abused by dishonest buyers who intentionally delay payment, knowing that no additional amount will be imposed due to default. To address this concern, some contemporary scholars have permitted the imposition of compensation on willful defaulters to cover the actual loss incurred by the Islamic bank as a result of the delay.

In certain jurisdictions, such as Malaysia, the regulator has approved the charging of compensation limited to either a fixed percentage of the outstanding amount or the actual loss suffered, whichever is lower. Such compensation may only be imposed once and must not be compounded.

In Middle Eastern practice, the buyer is typically required, at the time of entering into a Murabaha transaction, to undertake that in the event of default, a specified amount will be paid to a charitable fund administered by the bank. It must be ensured that none of this amount is treated as income of the bank. The funds collected must be allocated exclusively to charitable purposes approved by the Sharia, and the bank may extend interest-free loans to needy individuals from this fund. However, some jurisdictions, such as the UAE, prohibit such practices of charging late payment fees. 

This approach is based on the opinion of certain Maliki jurists, who maintain that while Sharia does not permit charging an additional amount to the debtor upon default - since it constitutes riba - it allows the debtor to voluntarily undertake a charitable payment as a means of ensuring timely settlement.

Absence of Rollover in Murabaha

A Murabaha transaction cannot be rolled over or extended for an additional term. In conventional finance, a borrower who is unable to repay at maturity may request an extension, resulting in a rollover of the facility with a revised interest rate applied to the new term. In effect, this constitutes a new loan granted on the same principal amount.

Some Islamic financial institutions have mistakenly treated Murabaha as a financing technique analogous to an interest-based loan and have attempted to apply rollover mechanisms to it. In such cases, when the purchaser requests an extension of the payment period, the institution rolls over the Murabaha by extending the maturity date in return for an additional markup, often by recording a new Murabaha on the same asset.

This practice is contrary to Sharia principles. Murabaha is not a loan It is a sale contract in which ownership of the asset is transferred to the buyer once the sale is executed. After the sale, the asset no longer belongs to the seller. What remains is a debt representing the agreed sale price, payable by the buyer. Consequently, there can be no subsequent sale of the same asset between the same parties. Any rollover that results in charging an additional amount on the outstanding debt is effectively interest and is therefore impermissible.

Rebate for Early Payment

A buyer may wish to settle the Murabaha price earlier than the agreed due date in return for a discount on the deferred price. This issue, known in classical fiqh as daʿ wa taʿajjal (“give a discount and receive payment earlier”), has been extensively discussed by Islamic jurists.

While some early scholars permitted such an arrangement, the majority of jurists - including the four recognized Sunni schools - do not allow it when the rebate is stipulated as a condition for early payment. Those who permit it rely on a narration attributed to Abdullah ibn Masʿud regarding a directive of the Prophet ﷺ to creditors to offer a discount in exchange for early settlement. However, the majority of scholars question the authenticity of this narration, and even if accepted, it relates to a period prior to the prohibition of riba.

Accordingly, the predominant view is that a rebate tied contractually to early payment is not permissible. However, if the creditor grants a rebate voluntarily, without it being stipulated or claimed as a right by the debtor, it is allowed.

This position has been endorsed by the Islamic Fiqh Academy. Therefore, in Murabaha transactions, no rebate for early payment may be included as a contractual condition, nor may the buyer demand it. Nevertheless, the seller or Islamic financial institution may grant a discretionary rebate at its own initiative.

Rescheduling of Murabaha Payments

If the purchaser is unable to meet the agreed installment schedule, they may request the seller or bank to reschedule the payments. Unlike conventional banking practices, where rescheduling is typically accompanied by additional interest, Murabaha payments may be rescheduled only without any increase in the sale price. The total Murabaha amount must remain unchanged and denominated in the same currency.

Some institutions have proposed rescheduling Murabaha obligations by converting the outstanding amount into a different, stronger currency in order to benefit from currency appreciation. Since this benefit arises directly from the act of rescheduling, such an arrangement is not permissible under Sharia.

Rescheduling must always be carried out on the basis of the same amount and the same currency as originally agreed. However, at the time of actual payment, the purchaser may, with the seller’s consent, settle the obligation in a different currency based on the prevailing exchange rate on the date of payment, rather than the rate applicable at the time of the original transaction.

Other similar Islamic contract like Murabaha

There are several types of Islamic sale contracts that are distinct from Murabaha in their legal structure, yet may appear similar in practice. To prevent misunderstanding, these contracts are outlined below.

• Tawliyyah: It is a sale in which the asset is sold to the buyer at its original cost price, without any markup or profit. This type of sale is supported by narrations from the Sunnah of the Prophet Muhammad ﷺ. The key distinction between Murabaha and Tawliyyah lies in the presence of profit. Murabaha involves a clearly identified profit added to the cost, whereas Tawliyyah is concluded strictly at cost, with no profit earned by the seller.

• Wadi‘ah: It refers to a sale in which the asset is sold at a price lower than its cost or purchase price, resulting in a loss to the seller. The primary difference between Murabaha and Wadi‘ah is that Murabaha requires a disclosed profit over cost, while Wadi‘ah involves selling the asset below its cost price, thereby incurring a loss.

Musawamah: It is a sale conducted through price negotiation between the parties without the seller disclosing either the original cost or the profit margin. Although it may be understood as a form of cost-plus sale in substance, the cost and profit are not revealed to the purchaser. The fundamental distinction between Murabaha and Musawamah is that Murabaha requires full disclosure of both the cost and the profit margin, whereas such disclosure is not required in Musawamah.