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A simple introduction to murabaha (purchase and resale) transactions

A murabaha transaction enables a bank to finance the purchase of an asset by a customer without making an interest bearing loan.

Posted 20 January 2017

Murabaha is the simplest transaction used in Islamic finance, and is very common. It is best explained with a diagram.

In this scenario, Customer wishes to purchase a machine. The open market price of the machine is $1,000 and if Customer had the available funds, it would purchase the machine from Machine Supplier for $1,000.

However Customer does not have the $1,000 required. Accordingly, it approaches Bank for finance.

Bank is willing to provide $1,000 to Customer for two years, but wishes to earn a fixed return of $500 from the transaction. Accordingly, it informs Customer that, if the Customer agrees, the following transactions will be carried out:

  1. Bank will today purchase the machine from Machine Supplier for $1,000.
  2. Bank will today sell the machine to Customer for $1,100. This marking up of the machine's price by $100 is fully disclosed by Bank to Customer.
  3. Customer is not required to pay the $1,100 immediately. Instead, payment of the machine price is deferred for two years.
  4. Customer receives immediate ownership and use of the machine.

This above transaction allows Bank to provide finance to Customer for the purchase of the asset without there being any interest bearing loan.

 

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