MURABAHA: Best Practices Simplified!! (+ Detailed Guide)

Murabaha

However, banking institutions have to make a profit in order to stay in business. Hence, what course of action is open to the bank? The Murabaha model offers a solution. Therefore, on this topic, you will have more insight into Murabaha mortgage loan practices, types, advantages, and disadvantages. Also, this article contains the application of Murabaha in Islamic banking, with a few pdfs.

Murabaha


Murabaha, also known as cost-plus financing is a structure in Islamic finance. It is a sales contract in which the seller and the buyer agree on the cost-plus price and profit of an asset. Moreover, a number of Islamic banks today have adopted types of Murabaha as a mode of financing. Murabaha on the other hand is a contract sale between the bank and its customers. The bank purchases a good and sale at a price plus a profit margin for the bank to its customers.

Murabaha is quite different from other financial loans, this is because it doesn’t involve interest. The seller and the buyer agree on an asset or good at a price and profit margin or mark-up. However, according to the Islamic religion that money is just a means of exchange. Every Islamic bank is barred from putting interest in a loan. They can only charge a flat fee to continue their daily activities.

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What Is The Purpose Of Murabaha?

The purpose of Murabaha is to finance a purchase without any interest payments. Because issuing conventional loans and charging interest on them are considered interest-based activities.


However, putting interest in murabana is considered haram, which is prohibited according to Islamic shariah. Murabaha has been a default financing structure for Islamic banks.

Types Of Murabaha

Essentially, there are two types of Murabaha which include:

#1. Purchase Orderer Murabaha


This contract involves the bank specifically purchase an asset or goods for their clients. Its client on the other hand agrees to buy the asset from the bank with a sale price based on an agreement with the future settlement terms.

#2. Commodity Murabaha

The commodity Murabaha is an instrument used in Islamic interbank business and activities. Note this, the source of funds for Islamic banks is based on the interbank transaction. basically, we can describe it also as a financial instrument used to fund the Islamic bank’s short-term liquidity requirement.

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Murabaha Loan

The Murabaha loan type of financing is basically used in place of loans in different sectors. Islamic financing in different forms is playing a very increasing vital role in the money markets. In essence, Islamic financing provides financial services in agreement with the sharia law. In sharia law, there is no issuing of receipt or interest payment. Because of this, the sharia board comes in to regulate the activities of Marabaha, so it doesn’t go against the sharia law.

Thus, it is clear that any business transaction having a predominantly speculative nature would not be eligible for any Islamic financial loan. However, consumers use Murabaha loan in buying cars, real estate, and household appliances. Meanwhile, businesses use it in buying equipment and raw materials. For short term transactions, Murabaha is used in issuing credit letters to importers.

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Murabaha Contract


Murabaha contract sale, the bank purchases an asset or good for its clients, and sell it to them at a cost-plus profit. The profit stands as a markup that both the bank and its clients agree on before the transaction. However, the client can make a lump payment when the good is delivered through a deferred payment installment plan.

So, based on this type of contract, a set fee is charged rather than riba (interest), and is legal in Islamic countries. Still, many argue that the Murabaha contract loan is another means of charging interest. But, the differences lie in the contract structure. Murabaha contract allows the bank to purchase an asset and sell it to its client with a profit charge. It’s also a contract of exchange based on sale-and-purchase contracts with a predetermined cost and profit. Murabaha contracts have its controversy with some Islamic scholars argue that it does not share the risk, thus are not sharia complaint. Moreover, experts have estimated that such contracts constitute up to 80 percent of the global Islamic finance volume.

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Example of Murabaha

Mr. William wants to buy a car from Mr. Adam for $100,000 but does not have enough money. Mr. William will contact the Murabaha bank and request they buy the car from Mr.Adam on his behalf. The bank now buys the car for $100,000 and sell it back to Mr. William for $109,000, the $9,000 is the cost-plus profit. Then, based on the installment period, over three years after the car is delivered, Mr. William has to pay back the bank. Before then, both parties have agreed on the profit and cost of the car at the onset. Therefore, there’s no financial uncertainty in the transaction.

Murabaha Mortgage

The Murabaha mortgage is often used in commercial property finance structures by the Islamic banks. This also includes buy-to-let mortgages as well and is only in line with the sharia law in form and not in spirit. Murabaha mortgage required the buyer to finance a percentage of the asset to be purchase upfront, mainly up to 20 percent. Therefore, this option is suitable for people who are starting out with some capital behind them.

The key benefit of Murabaha mortgages is that from day one, the property officially belongs to the buyer, it is registered in their name. But the repayment period and monthly repayment amounts are agreed upon between the buyer and the lender. With repayments plan fixed for the term of the buyer’s mortgage. The maximum repayment term is 15 years, and you can repay the loan in full at any point without penalty.

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Advantages and Disadvantages of Murabaha

One advantage of Murabaha in Islamic banking is that it is used as a mode of financing. Clients who need funds to purchase some commodities are given such loans. The client has to identify the asset he needs to purchase and the bank makes it available via the Murabaha facility.

What are the disadvantages?

You have to take note, not every commercial risk is minus in Islamic finance like Murabaha. So, below are some disadvantages of Murabaha as part of the Islamic finance structure:

  • There is no agreement based on Sharia interpretations of innovative financial products. Therefore, some Murabaha is based on prevailing interest rates rather than economic or profit conditions.
  • Documentation is often tailor-made for the transaction, so high transaction and issue costs.
  • Can be difficult to balance the interests of the financial institution with those of other stakeholders.
  • With no interest, it is still hard for some Islamic instruments as debt. Therefore, losing the tax benefit and increasing the WACC.
  • Some Islamic products may not be compatible with international financial regulation.
  • There is no hedging, all Islamic banks cannot minimize their risks, that’s just one of the disadvantages.
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Application of Murabaha in Islamic Banking

Murabaha also referred to as a cost-plus sale. It is a type of sale whereby the seller is under obligation to reveal the actual cost of an asset to the buyer. The two parties mutually agree on the mark-up (profit) and the repayment terms and conditions. The asset, good, or commodity must exist at the time of sale and the seller must have physical possession thereof.

In general, contracts relating to Murabaha should be a channel in different financial structures which include mortgages, trade finance, major asset financing. Also, in cash management, working capital financing, letters of credit, and syndicated loans.

Know more on: Back to Back Letters of Credits with Examples, Advantages & amp: Alternatives.

Murabaha pdfs

Below are some few pdfs on types of Murabaha you should download to learn more:

Conclusion

Murabaha is not a mode of financing in its origin. It is simply a sale on a cost-plus basis. It should neither be taken as an ideal Islamic mode of financing. Better still, as a universal instrument for all sorts of financing.

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