Al-Murabahah: Implications on Financial Stability and Islamic Finance Model

Contract of exchange or cuqud al-mucawadat is an important contract in Islam, in line with the fact that Islam encourages business activities that do not involve riba. In Islamic banking system, deferred contracts of exchange are frequently used for financing purposes and they are commonly materialized as the mark-up contracts or al-murabahah contracts. Based on endogenous monetary theory which states that the stock of money is not determined by the central bank but by the banking system as a whole and the people, al-murabahah contracts create money and more importantly money in the amount that is closely related to financing needs of real economic activities. Consequently, al-murabahah contracts create money supply that can warrant better monetary stability than the money created through debt contracts based on riba principles. In reality, funds from al-murabahah contracts are the biggest component in Islamic bank financing. These findings refute the view of majority of Islamic economists who suggest that Islamic financial system should be modelled mainly from the profit and loss sharing principles. In contrast, a model that takes into accounts the al-murabahah principles and methods is more suitable in depicting the Islamic financial system.