Financial Instruments 85
fi nanced through the murabahah is taken as security, but when no such asset
is available, the fi nancer takes the item itself as security. This may require
additional claims by the fi nancier on the item fi nanced, such as naming the
fi nancier as a benefi ciary in the insurance policy.
(iv) The mark - up rate charged by the fi nancier is infl uenced by the type
of product, the type of security and collateral, the creditworthiness of the
client, and the length of time for which the fi nancing takes place.
(v) Another distinct feature is that the resulting fi nancial claim resem-
bles conventional debt security characterized by a predetermined payoff.
The difference is that Islamic instruments are clearly and closely linked to,
and collateralized against, a real asset and are consummated by a transac-
tional contract. As a result, a fi nancial claim is created against a real asset
with a short - term maturity and relatively low risk.
Although murabahah fi nancing is allowed by the Shari’ah and is very pop-
ular with Islamic banks, there are some misconceptions about the instrument
among those who do not fully understand the contract. The misunderstanding
stems from the question of the difference between the mark - up and interest,
since murabahah results in a fi nancial claim like a zero - coupon bond with a
fi xed rate of interest. This misunderstanding is further compounded when an
outsider observes a close relationship between the mark - up and the prevailing
interest rate in the market, such as LIBOR. Researchers have addressed both
of these questions.
In distinguishing murabahah from a loan, it is pointed out that in the
former no money is loaned but a specifi c asset is purchased for the client
to ensure that the fi nancing is linked to an asset. In addition, whereas in
lending money as a loan the fi nancier is exposed to credit risk only, in a
murabahah, the fi nancier is fi rst exposed to the price risk when the product
is acquired for the client because the client retains an option to decline to
take delivery of the product.^4 Therefore, it is argued that by engaging in
buying and selling the product, the bank is exposing itself to risks other than
simple credit risk, as well as promoting trading (exchange) of a real asset;
hence, a murabahah transaction is different from a simple loan.
The confusion in equating murabahah with a loan is not a new one. As
mentioned earlier, Arab traders posed the same question during the time of
the Prophet (pbuh). The legal difference between a murabahah contract and
an interest - based loan is clear: the former is a sales contract in which the price
is increased for deferment of payment; the latter is an increase in the amount
of a debt for deferment. The fi rst is permitted, but the second is not.
The practice of using an interest - rate index to determine the mark - up
rate has been the source of confusion and the focus of much criticism. Islamic
banks often argue that the mark - up rate is the function of an interest - rate
index because there is no Islamic benchmark that can provide an indication
of the prevailing rate of return in the economy. This necessitates the creation of
an index to track the expected cost of capital and the rate of return which
can be used to price fi nancial instruments.