Islamic finance replaces the interest-bearing loan with contracts in which the financier takes a real risk: he sells, he leases or he becomes a partner. Murabaha is a sale with a known mark-up, payable on deferred terms; ijara, a lease; musharaka and mudaraba, partnerships sharing profit and loss. Added to these are salam and istisna, for goods delivered later, wakala, an agency, and qard hasan, a loan with no excess whatsoever. Each is governed by an AAOIFI Shariah standard. Compliance depends less on the name of the contract than on how it is carried out: a murabaha in which the bank never holds the asset is nothing more than a loan.
Murabaha, ijara, musharaka: these words appear in sukuk prospectuses, Islamic fund reports and offers of compliant home finance. They are rarely explained. Yet they denote precise contracts, codified for centuries and standardised today by AAOIFI, the reference standard-setter for Islamic finance.
This guide presents the contracts you come across most often, what makes each one lawful, and the abuses that empty them of meaning. It serves as the reference glossary for the other articles in our series: when a product calls itself compliant, it is one of these contracts it invokes.
Why does Islamic finance need its own contracts?
Because the interest-bearing loan is closed to it. In Islamic law, any excess stipulated in a loan contract is riba, whatever its form or size; the International Islamic Fiqh Academy confirmed this for bank interest as early as 1985. A financier therefore cannot be paid simply for having advanced money.
He can be if he does something other than lend: sell an asset he has bought, lease an asset he owns, or join an activity whose fortunes he shares. Two legal maxims sum up this logic: al-kharaj bi-d-daman, "the return belongs to the one who bears the liability", and al-ghunm bil-ghurm, "gain goes with risk". Every contract in Islamic finance is a way of applying this principle. Our guide to investing without riba explains the prohibition it stems from.
Murabaha: selling at a known mark-up
Murabaha is a sale in which the seller discloses his purchase cost and the mark-up he adds. In its banking form, "murabaha to the purchase orderer", the client identifies an asset; the bank buys it, becomes its owner, then sells it on to him at a price that includes its mark-up, payable in one or several instalments. Shariah Standard No. 8 of AAOIFI sets out the conditions.
- The bank must own the asset before selling it on, actually or constructively, and bear its risk between purchase and resale.
- The price is fixed once and for all when the sale is concluded. It may not rise if the client pays late: the debt that results earns nothing more.
- The client's promise to buy may bind him, but a binding bilateral promise, amounting to a sale concluded before the bank owns the asset, is not permitted. The International Islamic Fiqh Academy laid down these rules in its Resolutions No. 40 and 41 of 1988.
Murabaha is today the contract most used by Islamic banks, to finance equipment, vehicles or goods. It is often criticised for setting its mark-up by reference to market interest rates. Most scholars accept this method of calculation: what distinguishes murabaha from a loan is not the size of the mark-up, but the fact that the bank has bought, owned and sold an asset. The same reasoning sheds light on buying gold on credit, where gold, as a ribawi asset, imposes stricter rules still.
Ijara: leasing rather than lending
Ijara is the sale of the use of an asset for a set period and rent. The lessor remains the owner and bears the risks of ownership: destruction of the asset through no fault of the lessee, major maintenance, insurance. The rent is lawful because it pays for the use of a real asset, not for a sum advanced. AAOIFI Shariah Standard No. 9 governs ijara and its variant ending in ownership, ijara muntahia bittamleek, provided the final transfer is made under a separate contract or promise.
Ijara underpins the most widespread sukuk, as we explain in our guide to sukuk, and it is the contract against which every lease is measured: our article on halal leasing shows what takes a typical Swiss lease away from it.
Musharaka and diminishing musharaka
Musharaka is a partnership: several partners contribute capital to an activity or an asset, share the profit according to a ratio agreed in advance, and bear losses in proportion to their contribution. No partner may be guaranteed a fixed amount. For many scholars, it is the form most faithful to the spirit of Islamic finance. AAOIFI Shariah Standard No. 12 deals with it.
Its diminishing variant, musharaka mutanaqisa, is used notably for home finance. The bank and the client buy a home together; the client progressively buys out the bank's shares and pays it a rent for the part it still holds. As its share shrinks, the rent falls, until the client is the sole owner. This arrangement, used notably in the United Kingdom, combines three contracts — partnership, lease and successive sales — which must remain separate.
Mudaraba: capital on one side, work on the other
In a mudaraba, an investor provides the capital and a manager, the mudarib, provides his work and expertise. Profit is shared according to an agreed ratio; any loss of capital is borne by the investor alone, unless the manager is at fault or negligent, in which case he loses the fruit of his work. The manager may not guarantee the capital. AAOIFI Shariah Standard No. 13 sets out its rules.
Mudaraba underpins the investment accounts of Islamic banks and some compliant funds: the depositor is not a lender earning interest, but an investor who shares in the result.
Salam, istisna, wakala, qard hasan: the other contracts
- Salam is a forward sale: the price is paid in full at conclusion, and the goods, precisely described, are delivered on a set date. It traditionally finances agriculture. Shariah Standard No. 10.
- Istisna is a manufacturing order: an asset to be produced, a building to be constructed, paid for according to an agreed schedule. It finances infrastructure and new property. Shariah Standard No. 11.
- Wakala is an agency: an agent manages funds or assets on behalf of his principal, for a fee set in advance, with the result going to the principal. It is used in fund management and some sukuk. Shariah Standard No. 23.
- Qard hasan is the "goodly loan": a loan repaid at exactly its amount, with no excess at all. It is the only loan Islamic finance recognises, and it belongs to mutual help, not to investment. Shariah Standard No. 19.
Summary table
The table below sets out, for each contract, what pays the financier and the risk he bears in return. That counterpart is what makes the difference with a loan.
| Contract | Nature · Return · Risk borne · Use |
|---|---|
| Murabaha (Standard No. 8) | Sale at a known mark-up. The financier earns the mark-up and bears the asset's risk until resale. Equipment, vehicles, goods. |
| Ijara (Standard No. 9) | Lease. The lessor earns the rent and bears the risks of ownership. Leasing, property, ijara sukuk. |
| Musharaka (Standard No. 12) | Partnership. Profit by agreed ratio, loss by contribution. Projects, property through diminishing musharaka. |
| Mudaraba (Standard No. 13) | Capital against work. The investor bears the loss of capital, the manager the loss of his work. Investment accounts, funds. |
| Salam (Standard No. 10) | Forward sale, price paid in advance. The buyer bears the delivery risk. Agriculture, commodities. |
| Istisna (Standard No. 11) | Manufacturing order. The manufacturer bears the production risk. Construction, infrastructure. |
| Wakala (Standard No. 23) | Agency for a fixed fee. The result goes to the principal. Fund management, sukuk. |
| Qard hasan (Standard No. 19) | Loan with no excess at all. No return. Mutual help, advances. |
Tawarruq: the most debated boundary
Tawarruq consists of buying an asset on credit, then immediately selling it for cash to a third party, in order to obtain liquidity. The client ends up with money today and a larger debt tomorrow: economically, the result resembles an interest-bearing loan.
In its individual, occasional form, tawarruq is accepted by some scholars. In its organised form, where the bank arranges all the transactions and itself resells the goods on the client's behalf, the International Islamic Fiqh Academy ruled it impermissible in its Resolution No. 179 of 2009, seeing it as a device for obtaining the same result as a loan. AAOIFI regulates it strictly in its Shariah Standard No. 30. Organised tawarruq is nonetheless still used by many Islamic banks, notably for their treasury: it is one of the points where practice strays furthest from principle.
The name of the contract is never enough. A murabaha with no asset genuinely held, an ijara with no risk for the lessor, a musharaka with guaranteed capital are nothing more than loans under another name.
How do you spot a structure that has only the name?
A few questions are enough, faced with a prospectus, a financing offer or a fund report:
- Does the financier really own the asset? A murabaha or an ijara presupposes an identified asset, bought before being sold on or leased.
- Does he bear a risk? If the loss of the asset, the failure of the project or a fall in value falls entirely on the client, the structure departs from its reference contract.
- Are the price or the capital guaranteed? A partner in a musharaka or an investor in a mudaraba may not be promised his capital or a fixed profit.
- What happens on late payment? A debt arising from a sale may not grow over time. Any penalty must go to charity.
- Are the contracts separate? A sale, a lease and a promise merged into a single automatic commitment often betray a loan.
What these contracts mean for an investor in Switzerland
A private individual in Switzerland rarely meets these contracts directly: to our knowledge, no bank there offers Islamic accounts or financing to private clients. He meets them indirectly, through the products he can buy: sukuk rest on ijara, murabaha or musharaka; Islamic funds are often managed as a mudaraba or a wakala; halal ETFs hold shares, that is, partnership interests in the sense of musharaka.
Being able to read these contracts means understanding what you really hold, and asking the right questions before buying. It is the same approach we apply to other everyday decisions, from leasing to bank interest.
The most common confusions
Believing murabaha is a disguised loan by nature
A properly executed murabaha is a sale: the bank buys, owns, then sells on. It is the execution, not the principle, that is sometimes lacking.
Judging a contract by its mark-up
A mark-up close to an interest rate does not make a sale unlawful, and a small mark-up does not make a loan lawful. What counts is the nature of the transaction.
Thinking a label is enough
A product approved by a Shariah board deserves more trust than one that is not, but boards differ, notably on tawarruq. Reading the structure remains worthwhile.
Confusing musharaka and mudaraba
In a musharaka, everyone contributes capital; in a mudaraba, one side provides the capital and the other the work. Losses are not shared in the same way.
Murabaha, ijara, musharaka, mudaraba: these contracts are not magic formulas that make any financing lawful, but demanding structures that force the financier to take a real risk. Understanding them gives you a reading grid for any product that calls itself compliant. To go back to the principles they derive from, our guide to Islamic finance starts from the foundations.
Understanding what you really hold
Sukuk, funds, ETFs, financing: a halal investment expert reads with you the structure of the products you are interested in, within the Swiss framework, and leaves you to decide with full knowledge of the facts.
Speak to an expertThis content is provided for educational purposes by ALG Club. It constitutes neither a fatwa, nor a recommendation to buy a product, nor a financial service within the meaning of the Financial Services Act (LSFin). As questions of compliance involve differences between schools of jurisprudence, it is for each person to refer to a qualified religious authority for their own situation.