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 (ribh). 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. 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.

The following table enlists the key differences between murabaha and interest-based lending: