Murabaha: the sale with a known mark-up

How it works

1. The client chooses an asset (car, home, equipment) and asks the bank to buy it; he promises to buy it back from the bank.
2. The bank buys it in its own name from the seller and becomes its owner: until delivery, any loss falls on the bank.
3. The bank resells it to the client with a disclosed mark-up; the total price is fixed in the contract.
4. The client pays this price in one or several instalments; it can no longer increase.

The conditions set by the International Islamic Fiqh Academy

“Murabaha to the purchase orderer” is a permitted sale when it concerns an asset that has come into the bank’s ownership and possession, with the bank bearing the risk of loss before delivery and liability for hidden defects (resolutions 40-41 (2/5 and 3/5), Kuwait, December 1988). A promise made by one party alone may bind that party; a promise binding both parties is prohibited, because it would amount to selling an asset that one does not yet own (Abu Dawud 3503, al-Tirmidhi 1232).

The price must be single and settled in the contract: one may not leave a choice between several prices depending on the term without deciding (al-Tirmidhi 1231), nor charge separate interest (resolution 51 (2/6)).

Late payment and early repayment

• Nothing is added to the debt in the event of late payment (resolution 51 (2/6)). To discourage late payment, AAOIFI accepts that the client may undertake to make a donation to a charity, from which the bank does not benefit.
• The bank may take security and provide that the remaining instalments become due if the client stops paying without being insolvent (resolution 64 (2/7)).
• A discount for early payment may be granted, provided it was not promised in the contract (resolution 64 (2/7)).

Example

Price of a car: 20,000; deposit: 2,000; the bank finances 18,000 and resells with a total mark-up of 12%, i.e. 2,160. Sale price: 20,160, paid in 48 monthly instalments of 420. The murabaha calculator also gives the equivalent annual rate, which is useful for comparison with a loan.

Criticisms

The mark-up is often calculated with reference to market rates, which produces monthly payments close to those of a loan. For most Shariah boards, this does not change the nature of the contract, which remains a sale; critics nevertheless ask that the bank bear a real risk and not settle for a purchase that is a mere formality. Murabaha must not be used to obtain cash: that would be organised tawarruq, which the Academy prohibits (resolution 179 (5/19)).