Murabahah is the most widely used financing contract in Islamic banking. It is also one of the most frequently criticised, usually because of how it is carried out rather than because of the contract itself. A murabahah done properly is a genuine sale; a murabahah that skips steps can become a loan with interest in disguise. This article walks through the transaction step by step, following AAOIFI Shari'ah Standard No. 8, Murabahah, and highlights the controls at each stage.
It is an educational summary by ifSPACE, not a fatwa. Institutions should follow their own Shari'ah supervisory board's rulings and the published text of the standard.
What murabahah is
Murabahah is a sale at cost plus a known profit. Its defining feature is transparency: the seller discloses what the goods cost and adds an agreed mark-up. In banking it takes the form of murabahah to the purchase orderer: a customer asks the institution to buy specific goods and promises to buy them from it, usually on deferred payment, once the institution owns them.
The institution's profit is legitimate because it genuinely buys, owns and bears the risk of the goods before selling them. Every control in the standard protects that link.
A worked example
Sara runs a small clinic and needs a dental chair costing 40,000. She asks her Islamic bank for murabahah financing over two years. Here is how the transaction should run.
Step 1: The request and the promise
Sara chooses the chair and the supplier and asks the bank to buy it. She signs a promise to purchase the chair from the bank once the bank owns it.
- The standard allows this unilateral promise to be binding on Sara.
- A bilateral promise binding on both sides is not allowed, because it would amount to a sale of goods the bank does not yet own. The bank may be given an option instead.
- The bank may take a security deposit (hamish jiddiyyah) to show Sara is serious. If she breaks her promise, the bank may deduct only its actual loss, for example the difference between its cost and the price it gets when it resells the chair. It may not claim lost profit, and it must return the rest.
- At this stage the bank must not sign the murabahah sale itself or take a down payment as part of the price.
Step 2: The bank buys the chair
The bank buys the chair from the supplier in its own name.
- It can buy directly or through an agent. It may appoint Sara as its agent, but the standard prefers a third party where possible.
- If Sara is the agent, the agency must be documented separately, she deals with the supplier on the bank's behalf, and the chair is at the bank's risk while in her hands.
- The bank must not buy the chair from Sara herself or from anyone acting for her. Buying from the customer and selling back on credit is 'inah, which the standard does not allow.
- The bank may agree with the supplier a right to return the chair within a period, which protects it if Sara does not go ahead.
Step 3: Ownership and possession
Before selling, the bank must own the chair and take possession of it, actually or constructively (for example, by receiving the documents that give it control and risk).
- From this point until delivery to Sara, the bank bears the risk of loss or damage.
- It should insure the chair, through takaful where available, at its own cost. It may include that cost in the cost price.
This step is where weak practice most often appears. If the bank never truly owns or bears the risk of the goods, the profit has no basis.
Step 4: The murabahah sale
Only now does the bank sell the chair to Sara, by an exchange of offer and acceptance, which may be electronic.
- If Sara acted as agent, she first informs the bank that she has bought the chair on its behalf. Then the sale is concluded. Agency and sale must not overlap.
- The cost is the purchase price plus direct expenses customarily added, such as transport and customs. The bank's general overheads and staff salaries are not part of the cost.
- The profit can be a lump sum or a percentage of cost. Suppose the bank's cost is 40,000 and the agreed profit is 4,000. The price is 44,000, payable in 24 monthly instalments.
- Once the sale is concluded, the price is a fixed debt. It cannot be increased if Sara pays late or asks to reschedule.
- If the supplier later gives the bank a discount on the chair, Sara should benefit, because murabahah is a sale based on the true cost.
Step 5: After the sale
Security. The bank may take a pledge, including over the chair itself, a guarantee or post-dated cheques.
Late payment. Sara may undertake to pay a sum to charity if she delays without a valid excuse. These sums go to charitable purposes under the supervision of the Shari'ah board; they are not income for the bank. Actual collection costs may be recovered where permitted.
Early settlement. If Sara pays early, the bank may give her a rebate (ibra') on the remaining profit, but the rebate may not be a condition written into the contract.
Default. The contract may provide that if Sara misses instalments, the remaining instalments fall due at once, provided she is notified.
What murabahah cannot do
- It cannot be used to sell gold, silver or currencies on deferred payment, because these must be exchanged on the spot.
- It cannot refinance an existing debt by selling the customer something they already own.
- It cannot be used to sell goods back to the person who sold them to the institution.
A checklist for practitioners
| Stage | Question to ask |
|---|---|
| Promise | Is only the customer bound? Is any deposit limited to actual loss? |
| Purchase | Did the institution buy in its own name, not from the customer? |
| Agency | Is the agency separately documented, with risk on the institution? |
| Possession | Did the institution own and possess the goods before selling? |
| Sale | Was the sale concluded after possession, with cost and profit disclosed? |
| Price | Is the price fixed, with no increase for delay or rescheduling? |
| Late payment | Do charity undertakings go to charity, not to income? |
| Rebate | Is any early-settlement rebate discretionary? |
Why the steps matter
The difference between murabahah and an interest-bearing loan is not the paperwork; it is the sequence and the risk. The institution must own the goods before it sells them, carry the risk while it owns them, and fix the price when it sells them. Each step in the standard keeps that sequence intact. For bankers, Shari'ah officers and auditors, knowing the steps is the first line of defence against non-compliance.
Key points
- Murabahah to the purchase orderer is a sale at disclosed cost plus profit, governed by SS 8.
- A binding unilateral promise is allowed; a security deposit covers actual loss only.
- The institution buys in its own name, owns, possesses and bears the risk before selling.
- Agency and sale are separate, and the institution never buys from the customer.
- The price is fixed at the sale; late-payment sums go to charity; rebates are discretionary.