Islamic banking products: murabaha, ijara and musharaka

What you will learn

• How murabaha (cost-plus sale), ijara (leasing) and musharaka (partnership) work step by step.
• How to calculate instalments for murabaha and diminishing musharaka.
• Where the risks and ownership lie in each contract.
• Why critics say some products resemble interest-based loans, and what to check as a customer.

Explanation

Islamic banks cannot lend money at interest (lesson 1). Instead they finance customers by trading, leasing or partnering. The customer's final cost may look similar to a loan, but the legal steps and risks differ.

Murabaha (cost-plus sale)

In murabaha, the bank buys an asset and sells it to the customer at the purchase price plus a disclosed markup (profit margin). The customer usually pays in instalments. Key conditions:

• The bank must own the asset (and bear its risk) before selling it, even briefly.
• The total sale price is fixed at the start. It cannot rise if the customer pays late; late fees, if any, are typically given to charity rather than kept by the bank.
• The customer often gives a binding promise (wa'd) to buy, so the bank is not left holding the asset.

Ijara (leasing)

In ijara, the bank buys an asset and rents it to the customer for an agreed period. The bank stays the owner and carries ownership risks such as major damage, typically covered by takaful. In ijara muntahia bittamlik (lease ending in ownership), ownership passes to the customer at the end, through a separate sale or gift. Rent may be reset periodically, for example once a year, but only for future periods.

Musharaka (partnership)

In musharaka, bank and customer both contribute capital. Profits are shared by agreed ratios; losses are shared in proportion to capital. For home finance, banks use diminishing musharaka: bank and customer buy a property together, the customer pays rent on the bank's share and gradually buys that share until he owns 100%. A related contract, mudaraba, was introduced in lesson 1.

The criticism

Markups and rents are commonly set with reference to conventional interest benchmarks, so the instalment can be close to a loan's. Many scholars accept this: using an interest rate only as a price reference does not make the contract riba, provided real ownership and risk transfer happen. Critics argue that some products, such as tawarruq (buying a commodity on credit and selling it immediately for cash), mainly create cash debt. As a customer, check: does the bank really own the asset? Who bears the risk if it is destroyed? What happens on late payment?

In Germany, structures in which a bank first buys a property can raise extra questions about property transfer tax, notary costs and land-register entries. These depend on the specific structure, so providers and a Steuerberater must check them.

Worked example

Hypothetical example 1, murabaha car finance: The bank buys a car for €20,000 and sells it with an 8% total markup, payable in 24 equal monthly instalments. Fees, taxes and insurance are excluded.

• Sale price = €20,000 × 1.08 = €21,600.
• Monthly instalment = €21,600 ÷ 24 = €900.
• If the customer pays late, the price stays €21,600.

Hypothetical example 2, diminishing musharaka home finance: Property price €300,000. The customer contributes 20% (€60,000); the bank owns 80% (€240,000). The customer buys €12,000 of the bank's share each year (20 years) and pays rent of 5% per year on the bank's remaining share. Rents are simplified to annual amounts; costs and taxes are excluded.

The rent falls as the customer's ownership grows. Over 20 years total rent is €12,000 + €11,400 + … + €600 = €126,000 (an arithmetic series of 20 terms averaging €6,300).

Common mistake

Practice activity

Hypothetical: A shop owner needs a machine costing €45,000. Offer A is a murabaha with a 10% total markup over 36 months. Offer B is an ijara over 36 months at €1,300 per month, with ownership transferred for a symbolic €100 at the end.

1. Calculate the monthly instalment and total cost of offer A.
2. Calculate the total cost of offer B.
3. Name one risk difference between the offers during the 36 months.

Key takeaways

• Murabaha is a sale at a fixed, disclosed price; the bank must own the asset first.
• Ijara is a lease in which the bank remains owner and bears ownership risk.
• Diminishing musharaka is a partnership in which the customer gradually buys out the bank.
• Judge products by ownership, risk transfer and late-payment terms, not only by the instalment.

Next step

The next lesson shows how these same contracts are packaged into tradable investment certificates called sukuk.