Islamic Finance: Riba, Murabaha, Ijarah, Mudaraba, Sukuk and Musharaka

Millions of businesses and investors, in Nigeria and across the world, will not lend or borrow at interest because their religion forbids it. For them, a bank cannot simply lend money and charge a rate; instead finance must be tied to real assets, trade and shared risk.

Islamic finance has therefore developed its own contracts, which often produce cash flows very similar to conventional loans and leases but are built on a different foundation. In Nigeria the industry is now large: non-interest finance closed 2025 at about ₦5.8 trillion, and the Federal Government has raised more than ₦1.4 trillion by sovereign sukuk since 2017.

This topic explains the principles and prohibitions of Islamic finance, the main contracts (murabaha, ijarah, mudaraba, musharaka) and sukuk, with worked calculations, how to compare them with conventional finance, the role of the Sharia board, and the Nigerian framework. The next topic covers internal finance and dividend policy.

The syllabus asks candidates to explain the principles of Islamic finance and its instruments. Read rights issues first.

Principles and prohibitions

Islamic finance rests on Sharia, which is derived from the Quran and the teachings of the Prophet Muhammad and guides all aspects of life. Its main principles are:

• wealth must be generated from legitimate trade and asset-based investment; making money from money alone is forbidden;
• investment should have a social and ethical benefit beyond return;
• risk should be shared between the provider and the user of finance; and
• harmful activities are to be avoided.

The aim is to avoid injustice, one-sided risk (a lender who is paid whatever happens), moral hazard and unfair enrichment. The following are prohibited:

• Charging and receiving interest (riba), because it rewards the lender without sharing the risk of the venture.
• Uncertainty (gharar) in contracts about the subject matter or the terms, which includes selling what one does not own (short selling).
• Speculation and extreme risk, seen as gambling.
• Investment in businesses in alcohol, gambling or other unlawful activities, and in companies with too much borrowing (commonly, debt above about one third of the market value of the company’s shares, though this is a matter for interpretation).

Permitted: earning a return from profit-sharing investments, trade (a markup on a sale) or fees; where a loan is made for business, the lender takes part in the risk, usually by buying the asset and letting the customer use it for a fee.

The main contracts

Murabaha

A form of trade credit for buying an asset that avoids interest. The bank buys the asset and sells it to the customer on a deferred basis at a price that includes an agreed mark-up. Payment may be by instalments, but the mark-up is fixed in advance and cannot be increased if the customer pays late.

Example: a customer wants equipment costing ₦60m. The bank buys it and sells it for 60 × 1.15 = ₦69m, payable in eight equal quarterly instalments of ₦8.625m over two years. The mark-up is a profit on a sale, not interest.

But the cash flows are those of a loan: the rate that equates ₦60m to eight payments of ₦8.625m is 3.21% a quarter, an effective 13.5% a year (and the “15% mark-up” is about 7.5% a year as a simple figure, which understates the cost because the principal is repaid in instalments).

Ijarah

A lease: the bank buys the asset and leases it to the customer for a period at agreed rentals that recover the cost and give a profit. To recover ₦40m over five years with a return of 12%, the annual rental is 40 ÷ 3.605 = ₦11.10m, a total of ₦55.5m. As in any lease the owner (the bank) bears the risks of ownership, such as damage not caused by the customer.

Mudaraba

The bank provides the capital and the customer the expertise (the bank does not manage the business). Profits are shared in a pre-agreed ratio but are not guaranteed; if there is a loss the capital provider bears it and the manager cannot be made to compensate it (the manager loses the reward of effort). It is like equity finance.

If the bank provides ₦100m for a project and profit is shared 70:30, a profit of ₦40m gives the bank ₦28m and the customer ₦12m.

Musharaka

A joint venture or partnership in which both parties contribute capital. Profits are shared in a pre-agreed ratio (which can reward management skill), and losses are shared in proportion to capital contributed. If the bank puts in ₦60m and the partner ₦40m, and profits are shared 50:50, a profit of ₦30m gives ₦15m to each; a loss of ₦20m is shared 60:40, ₦12m to the bank and ₦8m to the partner.

Sukuk

Sukuk are Sharia-compliant “bonds”, but they cannot pay interest: they are certificates of ownership in an asset (or in the benefits of an asset, its usufruct), and the holders’ return is a share of the income that the asset generates. They resemble securitisations.

A sponsor sets up a special purpose vehicle (SPV) that issues the certificates to investors, uses the cash to acquire the asset, and passes the income to the holders. The main types are:

• Sukuk al-ijarah: a sale and leaseback. The SPV buys an asset from the company and leases it back for agreed rentals, which are paid to the holders. A ₦10bn issue with rentals at 14% pays ₦1.4bn a year, and the company repurchases the asset for ₦10bn at the end.
• Sukuk al-mudaraba: the SPV invests in a project that the company runs for a fee or a share of profit.
• Sukuk al-murabaha: the SPV buys goods (such as a commodity) and sells them to the company at a profit, payable in instalments passed to the holders.
• Sukuk al-musharaka: the SPV enters a joint venture with the company; profits and losses are shared.

The Sharia board

There is no single authority on Sharia compliance. Each Islamic financial institution has a Sharia board that checks that every product and service complies.

Comparison with conventional finance

For decisions, compare Islamic and conventional finance by calculating the effective rate implicit in the payments, as above, and by allowing for the other differences: who bears asset risks, restrictions on use and the cost of Sharia compliance.

Islamic finance in Nigeria

The Central Bank of Nigeria issued the first full non-interest banking licence, to Jaiz Bank, in 2011; the non-interest banks now include Jaiz, TAJBank, Lotus Bank and the Alternative Bank, and there are takaful (Islamic insurance) operators. Non-interest finance closed 2025 at about ₦5.8 trillion, of which non-interest banking assets were about ₦3.8 trillion.

The Securities and Exchange Commission has rules for sukuk and Islamic funds, and the Investments and Securities Act 2025 provides a statutory framework for non-interest instruments.

The Federal Government has issued sovereign sukuk since 2017 (over ₦1.4 trillion, which funded road projects), and sovereign sukuk are about 74% of a non-interest capital market of about ₦1.6 trillion. The corporate market is small, with issues such as TAJBank’s ₦20bn mudaraba sukuk in 2025 and a first non-interest commercial paper programme approved by the FMDQ Securities Exchange in 2024.

The ideas in more depth

Why the cash flows can look like interest

A murabaha fixes the total price in advance, and the instalments repay the cost and a margin, so the payer’s cash flows are those of a loan.

The difference is legal and economic: the bank owns the asset before selling it and takes the risk of the goods in the meantime, the margin is on a sale and cannot be raised, and a late payment cannot add to the price. Critics say some products copy conventional loans too closely; the Sharia board’s role is to judge whether the substance and the form are both compliant.

Why risk sharing matters

In a conventional loan the lender is paid whether or not the project succeeds. In mudaraba and musharaka the financier shares the result, so the financier has a reason to care about the quality of the project. This is the ethical idea behind the ban on interest and also a practical discipline, though it makes the financier’s return less certain.

Sources and references

• The Central Bank of Nigeria’s framework for non-interest financial institutions; the Investments and Securities Act 2025 and the Securities and Exchange Commission rules on sukuk and Islamic funds; the rules of the FMDQ Securities Exchange on non-interest commercial paper.

These points are stated as at 5 November 2026.

Worked examples

1. Price.
   60 × 1.15 = ₦69m.
2. Instalment.
   69 ÷ 8 = ₦8.625m.

1. Rental.
   40 ÷ 3.605 = ₦11.10m.

1. Bank.
   60% × 20 = ₦12m.
2. Partner.
   40% × 20 = ₦8m.

How to answer in the exam

• State the principle (no interest, asset-backed, shared risk) before the contract.
• Name the right contract for the facts and describe who buys, owns and bears risk.
• Calculate the cash flows and the effective rate to compare with a conventional loan.
• Mention the Sharia board and Nigerian regulation where relevant.

Common mistakes in the exam

• Describing a murabaha as a loan with interest.
• Saying that the mark-up can rise if payment is late.
• Making the entrepreneur bear the loss in a mudaraba.
• Sharing musharaka losses by the profit ratio instead of by capital.
• Describing a sukuk as a bond that pays interest.
• Comparing the quoted mark-up with an annual rate without converting it.

Quick revision

• No riba; asset-based; risk shared; avoid haram, gharar and speculation.
• Murabaha = sale at a fixed mark-up; ijarah = lease; mudaraba = capital and skill; musharaka = joint capital.
• Sukuk = ownership certificates paying a share of asset income.
• Sharia board certifies each institution.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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