What is Murabaha Financing?


Finance education is essential for traders, real estate experts, and law experts. On our website, we have a lot of traders from Islamic countries, so we decided to provide one educational article for them and all other finance knowledgeable people.

What is Murabaha Financing?

Murabaha financing, or cost-plus financing, represents the Islamic financing system in which the cost and markup of a property are negotiated between the seller and a buyer. The markup comes about as interest which is not legal and restricted in Islam.

Murabaha financing proccess scheme

Essentially, Murabaha is different from an interest-bearing loan, and it is an allowable type of credit sale under Islamic Law. In the case of a rental-purchase, the purchaser is not the actual owner until they pay the loan entirely.

How does Murabaha Work in Islamic Banks?

Murabaha financing work in the Islamic banks as a sale contract. Murabaha contract of sale is the process in which the customer requests the bank to buy an item on their behalf. The bank complies with the customer’s request and establishes a contract fixing the cost and profit for them on things if the customer repays, typically in installments.

What are the Basic Rules for Murabaha Financing?

The basic rules for Murabaha financing are given as under:

Islamic Shariah prevents interest-bearing loans.
In Islamic finance, Murabaha financing is an alternative for loans.
Murabaha includes the profit markup in the transaction but not interest; therefore, it is also called cost-plus financing.
Both the sellers and buyers negotiate, and when they reach the price, the money is paid in installments.

What is the Difference Between Murabaha and Ijara?

The significant difference between Murabaha and Ijara is that you can register the property in your name straight away with a Murabaha pledge. Still, in the case of an Ijara mortgage, you can just rent the asset from your lender, who complies with the Islamic Shariah Laws.

Murabaha word comes from the Arabic word “Ribh,” which means profit, and Murabaha’s literal meaning is the fixed profit rate. During the Murabaha sale transaction, the seller communicates the profit and cost to the buyer at the time of sale.

The lexical meaning of Ijrah is to give something on rent. In the sense of assets and properties, Ijrah refers to the transfer of usufruct of a specific property to someone in exchange for rent. We can say that the term ‘Ijarah’ is analogous to the English word ‘leasing.’

What is the Difference Between Murabaha and Tawarruq?

Murabaha is the sale contract between the bank and the purchaser, where the bank pays on behalf of its client for buying something like a new home, car, furniture or electronics, etc. Then, the bank fixes a profit, which is necessary for the client to pay within the due date; otherwise, markup is added with time. But, Tawarruq is the modified form of the Murabaha, often referred to as commodity Murabaha or reverse Murabaha. It involves receiving cash through selling the commodity in an actual transaction.

Tawarruq consists of a couple of steps: In the first step, the customer and the bank reach a commodity Murabaha contract-the bank purchases share or commodities on behalf of the client and leases them to the client. The client then owns the property. During the second stage of the Tawarruq process, asset liquidation occurs, and clients choose to either sell or liquidate their property via an agency agreement with the bank.

What is Murabaha Used For?

Murabaha financing is used for purchasing. Murabaha financing is prominent in multiple sectors as a substitute for loans. For example, clients utilize the Murabaha financing while buying home appliances, real estate, or cars. Businesses need this kind of financing to purchase machinery, equipment, or raw materials. Murabaha is also common in short-term trade, such as issuing letters of credit for importers.

A Murabaha letter of credit is sent out on behalf of an importer. The bank issues the letter of credit and concurs to pay. The bank then pays a sufficient amount of money in compliance with its terms and conditions, which are given in detail in the letter of credit.
The bank creditworthiness is interchanged with the applier’s, and the beneficiary(exporter) is promised the payment. This is beneficial for the exporter because the bank has a greater risk of payment loss.
By following the provisions of the Murabaha financing, the importer must repay the bank for the cost of goods and the profit markup amount.

What is a Murabaha Loan?

The Murabaha loan is the amount upon which no interest is applied according to the Islamic Shariah Laws, so we can say this Murabaha loan is entirely different from the conventional loan method.
The banks offer loans to the customers for buying an asset, which we can say that the bank purchases on behalf of the clients and negotiate profits.

Is Murabaha Halal?

This kind of transaction following Murabaha financing is valid (halal) from an Islamic perspective. The interest-based activities such as issuing conventional loans and getting interested are strictly prohibited (haram) in Islam.
A fixed fee is charged instead of interest (riba), so this type of loan is not prohibited in Islamic countries. According to Islamic religious beliefs, money is just a medium of exchange. It has no innate worth; therefore, Islamic banks cannot charge interest on bank loans, but they have permission to set a fixed fee for persisting in their daily operations.

Most people assert that Murabaha financing is another way of getting interested, but the contract structure is a significant difference. In the Murabaha contract, the bank purchase a property and then sells that back to the customers with the profit charge.

Who Invented Murabaha?

Sami Humid invented the concept of Murabaha financing, which has become the most efficient mode of financing in Islamic banking. Murabaha is the sale contract with banks to buy the property based on the credit sale setting.

Why is Murabaha Popular?

Murabaha is so prevalent in Islamic banking because it is the only substitute for interest-bearing loans in Islamic countries. Interest is forbidden in Islam, so the Islamic bank utilizes the Murabaha financing to get a profit. It also assists people in getting a loan from the bank through a Murabaha sale agreement to buy assets.

What is Sukuk Murabahah?

Sukuk Murabaha originates from the Murabaha, which is the subdivision of the Murabaha financing. In Sukuk Murabaha, a group seeks financing and agrees with a particular purpose vehicle(SPV) that aims to manage specific property owned by the SPV. The SPV gets hold of the property to control using the proceeds of a Sukuk issuance.

What is Bai Murabaha?

Bai Murabaha is the sale contract between the buyer and the seller for trade purposes and financing. The client purchases the specific products from the seller by following the tenets of Islam. They agreed on a cost-plus profit which the client pays in cash on the fixed future date in a lump sum or before or sometime in installments. The seller’s gain may be specified in lump sums and vary when the agreement is to pay them in installments. The seller earns more profit if a client makes it too late to pay the installments.

In the case of Bai Murabaha, the Banks acquire the goods as per the customer’s requisition. Retain in its keeping and then sell. The early adjustment may lead to the consideration of a refund on the profit to the client.

What is Murabaha Payment in Adib?

Murabaha payment in Adib is the profit margin added to the total cost of shares. This occurs when a product is prepared under the Murabaha concept, allowing Adib to purchase the shares for its advantage from the financial market as per the customer’s promise to buy the shares. And then, Adib put the claims for sale. The selling of the shares is done under Murabaha, which means offering profit to the net cost of the shares.

What are the Basic Rules of a Valid Murabaha Transaction?

The followings are some basic rules for the valid Murabaha financing:

1- There are two groups; one is the capital owner, often called the investor and the second one is the fund manager(Mudarib).

2- Then, the investor and fund manager, a couple of parties, fix a percent of profit-sharing and then reach an agreement.

3- In case of loss, the investor bears the loss of capital, while it turns out to be a waste of time and endeavor for the fund manager.

4- The fund manager follows the investor’s instructions and never goes against them, and the investor imposes certain pre-planned restrictions. For example, if the investors prevent investing in textile, the fund manager abides by their saying.

5- If fund managers do not abide by the pre-planned restrictions, then they will also suffer a financial loss due to negligence if there is loss.

What is Commodity Murabaha?

Commodity Murabaha buys particular commodities based on profit from the cost-plus (Murabaha financing). There is an agreement between the seller and buyer, and then the commodity is sold to the third party (another commodity trader) to obtain the cash.

Why is Murabaha a Commodity?

Murabaha is a commodity because the subtype concept of Murabaha, Tawarruq, is known as Commodity Murabaha or Reverse Murabaha. This is called so because it involves the trade of commodities in actual transactions to get cash.

What is Murabaha Margin?

Murabaha margin is the gross profit that a customer pays to the bank under an agreement of Murabaha financing sale. More specifically, the monthly Murabaha profit payable by the client to the bank under the Murabaha contract.

What is Murabaha Default?

An increasing concern in Islamic banking is Murabaha default; it results when additional charges do not apply after Murabaha’s due date. Many of the Islamic banks think of blocklist the defaulters and disallowing the future loans from any Islamic bank as a way of overcoming the Murabaha default. Even though banks do not mention the loan agreement, this agreement is permissible in Islamic tenets.

According to the Holy Quran, if a borrower faces serious difficulty paying due to a financial crisis, give respite to the borrower. But, the government may take action against those who commit the default intentionally. The ruins under Murabaha financing agreements are problematic for the companies functioning under Islamic Shariah rules. There is no clear consensus on dealings, except the prevention of taking the extra amount than actual debt from the borrower.

 

Fxigor

Fxigor

Igor has been a trader since 2007. Currently, Igor works for several prop trading companies. He is an expert in financial niche, long-term trading, and weekly technical levels. The primary field of Igor's research is the application of machine learning in algorithmic trading. Education: Computer Engineering and Ph.D. in machine learning. Igor regularly publishes trading-related videos on the Fxigor Youtube channel. To contact Igor write on: igor@forex.in.rs

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