Murabaha contract is widely used in Islamic banks and modern Islamic financial institutions. They offer a number of products based on the concept of murabaha in order to fulfill the needs of their customers such as home financing, vehicle financing, trade financing, project financing and goods financing etc. However, the ordinary murabaha is not popular in prevalent Islamic financial institutions. They prefer to use murabaha to purchase orderer (MPO). In an ordinary murabaha, there is no prior promise or undertaking is required from customer. The ordinary trader buys a commodity from someone without any prior promise. Then he sells it to anyone on cost plus profit basis. But, the MPO arrangement is based on prior promise or purchase undertaking from potential customer.

This MPO arrangement is more appealing to Islamic banks due to some following factors.

1. Banks are financial intermediaries whether they are conventional or Islamic. Therefore, they generally do not undertake business wherein they need to maintain inventories and goods.

2. It might not be possible for Islamic banks to buy various types of goods in advance and then sell them to customers on murabaha basis. Because, they’re not traders and they may not know what are the specific needs of the clients.

3. The regulators and central banks do not allow banks to undertake trading as core business activity and put themselves in different types of market and commodity risks. Because, it’s not the mandate of banks to involve in real business and trading.

Mechanism of MPO in Islamic banks

1. The customer needs some specific goods and approaches Islamic bank for this purpose.

2. The customer and Islamic bank enter into an agreement where customer promises to buy the commodity form the bank on an agreed profit ratio added to the original price (murabaha).

3. The Islamic bank appoints customer his agent for purchasing the commodity on its behalf through an agency agreement.

4. The customer buys the commodity and takes possession of it as an agent of the Islamic bank.

5. The customer informs Islamic bank that he has purchased the commodity on behalf of it and simultaneously makes an offer to purchase it from the Islamic bank.

6. The Islamic bank accept this offer and executes the sale contract with customer.

Sometimes, the Islamic bank buys commodity directly from the supplier and then sells it to the customers on murabaha basis. In this scenario, there is no need for an agency agreement.

It’s very important to note that the commodity must remain in the risk of the Islamic bank during the period between 4th and 6th stage. Because, if Islamic bank doesn’t take the ownership risk, then the profit would not be legitimized. This is very important and critical condition in modern application of murabaha and this is the main feature which distinguishes the MPO of Islamic banks from interest-based loan transaction. Likewise, it’s also very important condition in MPO that the commodity is purchased from third party. Because, it’s not allowed for Islamic bank to purchase the commodity from customer himself on lower price and then sells back to him on higher price. This type of buy-back transaction is not permissible according to majority of scholars.

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