Islamic Banking: Murabaha, Ijara, Musharakah

Islamic banking is a rapidly growing segment: assets exceeded $2 trillion by 2023. Saudi Arabia and Malaysia are the largest markets. In the UAE, the largest Islamic banks are: Dubai Islamic Bank (DIB), Abu Dhabi Islamic Bank (ADIB), Emirates Islamic.

Murabaha — Mark-up Financing

Definition: Sale with a known mark-up. The bank purchases a good and resells it to the client at a higher price, on an installment basis.

Applications:

• Trade finance: The bank purchases raw materials for a factory and resells them to the factory in installments
• Mortgage: The bank buys a house and resells it to the client at a higher price (the difference = the bank’s "profit")
• Auto financing: The bank purchases a car from a dealer and resells it to the client

Critical condition: The bank must actually own the asset, even for a moment (ownership passes through the bank). Otherwise — violation (bai' ma'dum — selling that which you do not own).

Tawarruq/Commodity Murabaha (monetization): A special structure for cash financing via the commodity market. Used for inter-bank lending and personal financing. Considered controversial from the Shariah perspective by some scholars — it is viewed as a mere disguised loan.

Ijara — Leasing

Definition: Leasing of an asset with transfer of the right of use, but not ownership.

Two forms:

Operating Ijara: Simple lease. The bank remains the owner, bears maintenance expenses. At the end, the asset is returned to the bank.

Ijara Muntahia Bittamleek (Ijara wa Iqtina): "Lease with eventual acquisition." At expiry, the client can purchase the asset at a pre-agreed price. The analog of financial leasing.

Applications:

• Ijara mortgage: the bank buys real estate, leases it to the client, and the client gradually buys it out
• Equipment, aviation, vessels

Key principles of Ijara:

• The bank bears ownership risks (insurance, major maintenance) — otherwise, Shariah violation
• Rent payment must be fixed or pegged to an agreed benchmark (LIBOR/SOFR-based — controversial, but widely used)

Musharakah — Joint Partnership

Definition: Partnership with shared ownership of an asset or business. All partners share profit and loss.

Diminishing Musharakah: Most popular for mortgages. The client gradually buys out the bank’s share.

Example:

• Client wants a house for $500 thousand. He/she puts down 20% ($100 thousand)
• The bank puts in 80% ($400 thousand) → joint ownership 20/80%
• The client pays rent for the bank’s 80% + monthly buys out part of the bank’s share
• After 25 years, the client owns 100%, the bank’s debt = 0

Advantage: Theoretically "cleaner" from the Shariah point of view than Murabaha. The client benefits from the growth in asset value.

Other Important Instruments

Qard Hasan (benevolent loan)

Interest-free loan. The bank takes no profit. Used for social programs. In commercial banks — for current accounts (deposits are considered as Qard Hasan from the client to the bank).

Wadiah (safekeeping)

The bank keeps the client’s funds with a guarantee of return. No interest. The bank may use the funds with the client’s consent and, at its own discretion, may pay a "hibah" (gift).

Wakala (agency)

The client hires the bank as an agent to manage investments. The bank charges a management fee (not interest). Profits are shared proportionally or passed to the client.

Comparison of Islamic Products with Conventional Ones

Financial Indicators of Islamic Banks

According to the IMF, Islamic banks overall have shown profitability comparable to conventional ones (ROE 10–15%) with higher capital (CAR). They proved more resilient during the crises of 2008 and COVID due to the asset-backed nature of assets.