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In Islamic finance, a sales contract where the bank buys a product on behalf of a client and resells the product to the same client by clearly mentioning the cost incurred in buying the product and the margin or the mark-up when reselling the product to the client.
Usually the bank pays for the product in full and allows the client to pay the bank back in installments. So, instead of having a classic loan as in conventional finance when the bank lends money to the client to buy products, in the murabaha case, the financial institution buys and resells the product with a mark-up to the client.
Murabaha is a very popular contract in Islamic finance, especially for the buying of commodities involving large sums of money where the client is unable to pay in advance or when the commodities supplier does not trust the client. It is Shariah-compliant because there is no interest rate on a differed payment the financial institution gives to the client.
Since the mark-up is fixed, banks are more comfortable in entering the murabaha arrangement than in profit and loss sharing options where the income for the bank is not guaranteed.