The murabaha contract is essentially a contract whereby the Islamic bank is asked by a customer to make a purchase from a third-party supplier or seller and resell it to the customer.
As a form of financing, murabaha is used in many different types of transactions. These can include the purchase of goods for households, real estate, and business equipment.
What murabaha contracts facilitate is a structure whereby an interest free form of financing is available for those who need it.
Murabaha contracts also enable individuals and businesses to have help with making purchases from specialist markets they may not be familiar with.
In the current unpredictable economic market, murabaha arrangements are less risky and more ethical. Customers do not have to worry about fluctuating interest rates.
Murabaha contracts are used to purchase all manner of goods including raw materials, equipment, machinery, real estate, and exported goods.
- the product or subject of the murabaha must be owned by the bank or financial institution when the financial transaction takes place.
- the asset or goods must be of value (classified as property by Islamic finance rules).
- the goods cannot be commodities that are forbidden
- debt cannot be sold via murabaha contracts.
- there must be no interest payment at all, instead a set fee should be agreed.
- there is a requirement that the entire murabaha transaction should complete in two contract stages - the first being when the customer requests the murabaha transaction and promises to buy it from the bank. The second stage is when the bank purchases the commodity and the customer buys it back on agreed repayment terms.
- both contracts should be valid and enforceable.
- As with any Sharia based contract, the terms and conditions should be clear, concise and unambiguous especially when it comes to the terms relating to money and payments.
- the bank assumes the risk when they buy the goods requested
- the purchaser has the right to return the asset if there are any defects.
There are 3 main stages of a murabaha contract:
- Promise: this stage requires the parties to the contract to negotiate the terms and carry out any due diligence or credit checks that they need to. At this contract stage, the customer will promise the bank that they will purchase the goods the bank will acquire on their behalf.
- Acquisition and Possession: at this stage of the transaction, the bank acquires the goods and keeps possession and takes on the risk of ownership.
- The final stage is when the customer purchases the goods from the bank.
These types of contracts are contracts for the sale of commodities.
Instead of any form of loan agreement or loan repayment, murabaha contracts are based on the existence of two purchase contracts or agreements. The first agreement is the one where the bank purchases the asset, and the second relates to the purchaser buying the asset from the bank.
The risk of the ownership rests with the bank when they purchase the item. Murabaha contracts are not interest based. Instead, the parties negotiate the terms and the profit margin which should be based on the cost of the original purchase and a profit margin.
Murabaha contracts are increasing in popularity as they are a viable alternative to traditional contracts which are not compliant with Sharia rules. What this means for individuals and businesses is that they are able to finance their endeavours within the framework of Islamic finance.