WHAT IS THE DIFFERENCE BETWEEN MURABAHA AND CONVENTIONAL LOAN?

INTRODUCTION

Murabaha is one of the most popular financing modes used by Islamic banks and financial institutions. It is type of sale (ba'i) in which the seller reveals to the buyer the cost of the underlying commodity and amount of profit in the form of a mark-up. In this sense, Murabaha is not an interest-bearing loan (conventional loan or in Arabic (qardh ribawi), but rather it is a sale of a commodity for a price equal to its original cost plus a given mark-up. 

A Murabaha transaction is usually executed by the bank purchasing the commodity desired by the client and selling it to him on a cost-plus-profit basis. Under this arrangement, the bank is bound to disclose cost and profit margin to the client. Therefore, the bank, rather than lending money to a borrower, purchases the commodity from a third party and sells it to the customer for a higher price. This financing mechanism has nothing to do with the conventional way of financing.

The key difference lies in the contract structure. Murabaha is a sale contract, while the conventional loan is an interest based lending agreement and transaction.

For example under a Murabaha agreement, the bank sells a commodity for profit where both the original cost and the profit are disclosed to the buyer. On the other hand, advancing loans and credit and charging interest thereupon is pure interest-based transaction which Islamic shari'a outspokenly forbids.

Murabaha is one of the most common modes used by Islamic Banks. It refers to a sale where the seller discloses the cost of the commodity and amount of profit charged. Therefore, Murabaha is not a loan given on interest rather it is a sale of a commodity at profit. The mechanism of Murabaha is that the bank purchases the commodity as per requisition of the client and sells him on cost-plus-profit basis.

Under this arrangement, the bank is bound to disclose cost and profit margin to the client. Therefore, the bank, rather than advancing money to a borrower, buys the goods from a third party and sell those goods to the customer on profit. A question may be raised that selling goods on profit (under Murabaha) and charging interest on the loan (as per the practice of conventional banks) appears to be one of the same things and also produces the same results. The answer to this query is that there is a clear difference between the mechanism/structure of the product.

The basic difference lies in the contract being used. Murabaha is a sale contract whereas the conventional finance overdraft facility is an interest based lending agreement and transaction.

 

In case of Murabaha, the bank sells an asset and charges profit which is a trade activity declared halal (valid) in the Islamic Shariah. Whereas giving loan and charging interest thereupon is pure interest-based transaction declared haram (prohibited) by Islamic Shariah,