Murabaha

From CEOpedia | Management online

The term murabaha is derived from the Arabic word ribh behind which is the term for earning and creating profit by imposing a higher margin to the cost of a marketable good (Rifki, 2014: Bhatti, 2015).

In another view, murabaha is a way to increase sales of a product and reproduce it through the use of an interest-free commercial method. The concept of murabaha is best illustrated using the example of a financial product, which is characterized by high profitability and timeliness of the sales process.

This product is shipped to the consumer in advance on terms previously agreed upon between two parties such as price and many other variables. The Islamic Financial Services Board (IFSB) defines murabaha as a kind of contractual offering sold by an institution to a business customer based on a cost-plus profit margin model (IFSB-Islamic Financial Services Board, 2021).

Murabaha in the law context

In the eyes of the law, according to Article 48 of the Banking Law No. 5411, murabaha is defined as a kind of credit that offers goods in exchange for paying for a series of transactions, documents and financial processes with a movable or immovable substrate (Banking Law No. 5411). The main purpose of the process is to draw up a business contract between the bank and the customer, which obligates the institution to purchase assets selectively chosen by the customer, who undertakes to buy these assets with an additional profit margin. This is nothing more than a service paid to the customer, who may not currently have the capital to purchase such assets on their own.

Modern understanding of the term murabaha

Murabaha is now an extremely popular form of interest-free financing. The term is presented as a kind of financial support for businesses. The contract obligates the buyer to purchase the financing product with the stipulated profit and costs incurred during the product's life.

The phenomenon of the transaction is that the customer may not have the funds at a given time to purchase a certain product or tool needed, for example, to run a business. Here with a helping hand comes the bank, which assists the client in obtaining the desired market commodity in exchange for the fulfillment of the conditions for cooperation set forth by the institution in the contract.

The stages of murabaha agreement

Although the principle of murabaha itself may seem simple in reality it is not so. Due to the oscillation of large sums of money, both parties must be quite prudent towards each other and insure themselves in case of fraud or non-fulfillment of the contract. Therefore, the parties sign a binding contract, which deals with the following details:

  1. The bank and the customer sign a contract that strictly stipulates how much financing is granted to the buyer.
  2. The bank becomes obligated to purchase the product designated by the customer and sell it to him at a pre-agreed margin.
  3. The client undertakes to buy the product from the bank in fulfillment of the pre-agreed plan.
  4. The bank may require the client to make additional representations to insure the transaction against fraud.
  5. The client provides the bank with information on when and what assets are to be purchased by the bank on behalf of the buyer.
  6. The bank purchases the product, which is then resold to the entity with which it has entered into the above resale agreement.

If the two entities come to a formalizing agreement, the process of implementation and assumptions contained in the agreement begins.

Risks of murabaha agreements

The biggest risk of a murabaha transaction is the situation in which the customer does not proceeds to repurchase the product that the bank has already managed to purchase for him. Therefore, a very detailed binding agreement is signed, which must take into account a number of details in order to prevent later refusal by the customer. In this business it is easy to have a situation where one of the parties tries to enrich itself by bending the contract. Both parties, therefore, must be extremely reliable and have not created any credit or earnings problems in the past. In the case of defaulting on contracts, lawsuits are necessary, which can last even years.


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References

Author: Paweł Słomka