Difference Between Murabahah and Interest

The following question and answer by Sheikh Yusuf Talal DeLorenzo attendees of the Dow Jones University Courses on Islamic Investement.

Question:: I am having trouble understanding the difference between murabahah and interest. What isthe difference between buying a car with a fixed rate of profit in installments and paying a carnote that involves riba? Aren't loans that include riba at a fixed rate also? Can the middle personcharge a higher price because the payment is in installments?

Answer: There is in fact a world of difference between the two. Unfortunately, though, because the endresult is the same, people tend to think that the differences are insignificant, and that the changesrequired to bring about the same result are merely cosmetic in nature. This is just not so! On the onehand we have Muslims who want to avail themselves of the opportunities afforded by interest-freefinancing, and on the other we have Muslims who complain that the interest-free financing is "justlike" the financing with interest! I have explained in my answer to another question that theprohibition is very much a moral issue, and that it is closely related to the concept of khilafahor stewardship. I further explained that money lending and financing belong to two entirely differentspheres; one is charity, pure and simple, and the other is business. The repercussions of thisbifurcation range far and wide, and shape much of what is unique about Islamic notions concerningeconomy and society. Equity investing offers Muslims the opportunity to profit, not by lending ata guaranteed rate of return, but by sharing in ownership, and thus committing to share in the risksassociated with ownership. Such a commitment is clearly in consonance with the concept of stewardship,and this, more than anything else, explains how the Islamic prohibition against interest is as much amoral matter as it is a legal one. So, when your Islamic bank arranges for you to have a new car, ora new home, it will do so as your partner. And that means that it will be concerned about you and thebusiness it will be doing with you. This factor, alone, when multiplied by the number of times theIslamic bank does business with someone, whether an individual or a business or an institution, willmake a great difference in the way the economy operates. In recent decades, Muslim economists havemodelled interest-free institutions and economies. You may want to read the work of Dr. Umar Chapraon the subject.