Concept of Diminishing Musharakah

Presentation Outline

Diminishing Musharakah - Introduction Basic Structure Shariah Principles Illustration DM in trade & business

Diminishing Musharakah-Introduction

Musharakah
Musharakah is a form of partnership (Shirkat) There are two types of Shirkah: 1. Shirkat-ul-Milk Joint ownership of two or more persons in a particular property 2. Shirkat-ul-Aqd A partnership affected by mutual contract. It can also be translated as a joint commercial enterprise

Diminishing Musharakah
In Diminishing Musharakah the financier and the client participate either in joint ownership of a property or an equipment, or in a joint commercial enterprise The share of the financier will be divided into a number of units The client will purchase these units one by one periodically until he is the sole owner of the property

Diminishing Musharakah
However generally Diminishing Musharakah is used in cases of Shirkatul-Milk It involves taking share in the ownership of a specific asset and then gradually transferring complete ownership to the other partner. This concept is based on Declining ownership of the financier Three components
Joint ownership of the Bank and customer Customer as a lessee uses the share of the bank Redemption of the share of the Bank by the customer

Diminishing Musharakah
Mode of Fixed Asset Financing Diminishing Musharakah is commonly used for the purpose of financing of fixed assets by various Islamic banks.
House financing Car Financing Plant and machinery financing All other fixed Assets

Diminishing Musharakah

Concept of Musha Musha means undivided ownership of the asset Lease of Musha It is allowed to lease Musha to other joint owner.

Basic Structure

BANK

Joint Ownership
Rent

CUSTOMER

Musharaka

The customer approaches the Bank with the request for Project/Machinery/House financing The Bank enters into a Musharakah (Joint Ownership) agreement with the customer and both of them pay their respective shares to the seller of the asset. Customer pays rent for the use of banks share in the property

BANK

Gradual Transfer of Ownership

Joint Ownership

CUSTOMER

Musharaka

The customer approaches the Bank with the request for Project/Machinery financing The Bank enters into a Musharakah (Joint Ownership) agreement with the customer and both of them pay their respective shares to the seller of the asset. Customer pays rent for the use of banks share in the property Ownership of the asset is gradually transferred to the customer upon payment of asset price. (with the help of a Sale transaction between bank & customer at the end of each period)

Shariah Principles

Shariah Principles
To create joint ownership in property is called is Shirkat-ul-Milk and is expressly allowed by all schools of Islamic Jurisprudence. All Muslim Jurists agree on the permissibility of the Financier leasing his share in property to client and charging him rent i.e. the permissibility of leasing ones share to his partner. There is difference of opinion among leasing ones share to a third part But there is no difference on permissibility on leasing to a partner.

Shariah Principles
Promise of client to purchase units of share of financier is also allowed. The Transactions cannot be combined in a single arrangements and they have to be executed independently. This is because it is a well settled rule of Islamic Jurisprudence that one transaction cannot be made a condition for another. Instead of making the transactions a pre-condition for one another there can be one-sided promises from one party to another

Shariah Principles
Argument: In the case of promise to sell units of share by financier one might argue that if the promise to sale has been done before entering into actual sale This is practically putting a condition on the sale itself Answer: There is a difference between: Putting a condition on a sale and making a separate promise , without making it a condition. In case of condition, the sale will be valid only if the condition is fulfilled.

Illustration

DM - Illustration
1. Customer request financing for a fixed Asset costing Rs. 300 million. 2. Islamic Bank agrees to provide financing up to 90% of the cost. 3. Joint Ownership Agreement is executed between the bank and the Customer. 4. Bank will purchase 90% share in the asset by paying Rs. 270 million to supplier. 5. Customers pays its share of Rs. 30 million.

DM - Illustration
6. Banks share is divided into five units. 7. Customer agrees to buyout Banks share (units) on yearly basis and the Undertaking is executed by the customer. 8. Customer pays the rent for the usage of the Banks units after . 9. Rental reduces after purchase of each unit by the customer. 10. After five years ownership of the asset is completely transferred to the customer.

DM in Housing Finance
The arrangement is composed of the following transactions 1. To create joint ownership in property 2. Giving share of financier to client on rent 3. Promise of client to purchase units of share of financier 4. Purchase of financiers units 5. Adjustment of rental according of share of financier in property

DM in Housing Finance
Diminishing Musharakah may be used for House financing with the following conditions: The agreements of joint purchase, Lease and selling of units should not be tied-up together At the time of purchase, sale should be effected through offer and acceptance Preferable to purchase each unit on market value, but permissible to purchase at agreed price

Easy Home - Home Buyer

House Cost Price Customer Share Bank Share Profit Rate Tenure in Years 1,000,000 400,000 40% 600,000 60% 8.50% 5 Total Units Unit Sale Price Monthly Rent/Unit 60 10,000 70.83

Calulation Based on the Schedule as f

Months Rent Unit Price Monthly Payment Balance Unit Price Balance Units

0 1 2 3 4 5
56 57 58 59 60

4,250 4,179 4,108 4,038 3,967

354 283 213 142 71 129,625

10,000 10,000 10,000 10,000 10,000

10,000 10,000 10,000 10,000 10,000 600,000

14,250 14,179 14,108 14,038 13,967

10,354 10,283 10,213 10,142 10,071 729,625

600,000 590,000 580,000 570,000 560,000 550,000

40,000 30,000 20,000 10,000 0

60 59 58 57 56 55
4 3 2 1 -

DM - considerations

Consideration
Title Holder Profit Rate Prepayment Allowed Refinance Available Asset Risk Late Payments

Flexibility Available
Joint Title Fixed/Variable Yes Yes Joint Controllable

Diminishing Musharakah based on Shirkat ul Aqd

DM in Business of Services

Creating a joint ownership in an asset e.g. Taxi Musharakah in the income generated through the services of taxi Purchase of different units of the share of the financier by the client at market price or at a price that is agreed at the time of Sale Sale of unit a pre-agreed price is not permissible.

Dim Musharakah in Trade

The arrangement is simply a Musharakah whereby two partners invest different amounts of capital in a joint enterprise Purchase of different units of the share of the financier by the partner at market price or at a price that is agreed at the time of Sale Sale of unit a pre-agreed price is not permissible.

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