Muhammad Khaleequzzaman Head Islamic banking Department Int’l Islamic University Islamabad

Islamic Modes for Agricultural Financing

PRODUCTS – Diminishing Musharakah

Lahore 16 – 17 May, 2008 Al – Huda Training Programme

Muhammad Khaleequzzaman

Head Islamic banking DepartmentInt’l Islamic University Islamabad

Rules of Musharakah • Fulfillment of prerequisites of a contract• Rules of contribution of equity• Rules of profit and loss sharing • Management of Musharakah/Relationship of

parties• Termination of musharakah

Uses of Musharakah:– Agricultural enterprise financing

– Project financing

– Working capital financing, etc.

Islamic Modes – Agricultural Financing

Musharakah • An equity participation contract under which

IB and its client contribute jointly to finance an enterprise.

• Equity is owned according to each party's share in financing.

• Profit is shared in pre-agreed ratio and loss in proportion to the capital contribution.

• It is an ideal alternative to the interest-based financing with far reaching effects on both production and distribution.


Islamic Modes/Instruments – Participatory Modes:

Musharakah:The Concept of Musharakah:Meanings:

– Sharikah Arabic– Shirkah Arabic– Shirkat Urdu– Partnership English

Shirkah Definition : “commingling money or property (that no share can be distinguished) by two or more parties with an objective of sharing profits and contributing losses"


Musharakah:1. Shirkat ul Milk (co-ownership)

– The existence of thing in the joint ownership of two or more persons in an ascertained thing (ayn) or debt (dayn)

• Shirkat ul Jabr• Shirkat al Ikhtiar

2. Shirkat ul Aqd “Partnership through contract” (Partnership referred by law)

– Shirkat ul Amwal (Wealth) – Shirkat ul amal (services)– Shirkat ul Wujuh (liability/ c/w)

Wider definition of Shirkatul Aqd: “Contract between two or more people for participation in capital and its profits” “Participation in profits w/o partnership in capital” (Mudarabah).


Musharakah:Distribution of Profit/Loss

– The proportion of profit to be agreed at the time of effecting the contract

– A partner, on the date of distribution, may surrender his part of profit in favor of other partners

– Fixation of lump sum amount for any partner is not allowed.

– The ratio of profit to be determined in proportion of the actual profit accrued and not necessarily in proportion to the capital invested

– The final distribution cannot be made based on expected profit. However, a partner can be given lump sum amount of profit or any proportion of investment provisionally, but the same has to be adjusted according to the agreed ratio at the time of calculation of actual profit.

Islamic Modes/Instruments – Participatory Modes:Musharakah:Distribution of Profit/Loss

– In constructive liquidation, assets are valued at market rate, receivables at cash after deducting an allowance for doubtful debts

– In above case, if no profit is actually earned or is less than anticipated, the amount drawn by the partner shall have to be returned.

– The ratio of profit may differ from the ratio of investment If a partner has not been declared as sleeping partner, he is entitled to get additional profit above the proportion of his investment, even if he did not work

– However, the share in profit of a sleeping partner cannot exceed from his proportion of investment

Sharing of Loss:– Each partner shall suffer the loss exactly according to the

ratio of his investment. – It is valid that one partner takes the responsibility of loss

at the time when loss occurs, without any such prior condition

Diminishing Musharakah (DM)

Diminishing Musharakah (DM):

A form of Musharakah where the financier and the client participate in a joint commercial enterprise or property. This enterprise is converted into undivided ownership of both the financier and the client. Over certain period the equity of financier, divided into equal value units, is purchased by the client. And ultimately the client becomes the sole owner of the enterprise.

Uses of DM– Agric. Machinery and implements financing– Storage facility construction/sheds– Transport vehicles, etc.


Diminishing Musharakah (DM):Procedural details:

– Client requests the bank for DM

– Appraisal is accorded

– Approval is conveyed.

– bank releases its share to become partner in the asset. And contract of Musharakah is executed. [buying &selling not stipulated]

– This asset becomes undivided ownership of both the bank and the client [Musha] None of the parties can withdraw its equity till DM is terminated

– General rules of partnership apply



Procedural details: (contd..)– At the same time, uni-lateral promise from client

is obtained to purchase the units of bank’s equity.

– The price of one unit of bank’s equity is valued– Ijarah Agreement is signed – In case of Ijarah the rent is realized while in case

of business or services profit and losses are shared

– Expenses connected to asset are borne by the partners proportionately



Procedural details: (contd..)– Equity of bank is periodically purchased by the

client– Bank’s share in the asset decreases while that of

client increases – so happens to the rent or profit– Ultimately the client becomes the sole owner of

the asset [Bank’s share reduces to zero]


DIMINISHING MUSHARAKAH

3. Accruing Rentals

Share in capital

Share in capital

Partner Bank2

4Sell its

share in equity

Pays price of the units of

bank’s equity


Example – Financing Purchase of Tractor:

A client wants to purchase a tractor by sharing of equity of Rs. 40,000 against price of Rs. 400,000. The bank shares rest of the price of tractor ie. Rs. 360,000. How his request can be accommodated by a bank?

Bank agrees to finance the purchase of tractor through DM.


Diminishing Musharakah (DM): – 10% of the cost (Rs. 40,000) is paid by the

client and 90% of the cost (Rs. 460,000) by the bank. [Musharakah Contract is signed]

– The rental of tractor is fixed according to certain reference price [Ijarah for future date is signed]

– The client promises (unilateral promise) to the bank to purchase banks equity divided in to equal value units

– Say, rent is fixed @ 15% p.a. – The DM terminates after 3 years– Installments can vary [Seasonal, quarterly,

monthly]


Diminishing Musharakah (DM): – After acquisition, the client uses tractor and

pays rent to bank for using bank’s share in the property

– At the same time, purchases unit(s) of equity after expiry of each rental period

– The equity of bank diminishes to zero on expiry of three years, the rent as well, client becomes sole owner


Diminishing Musharakah (DM): (Amount in rupees)

Total value of Asset: 600000

Share of client 40000

Share of Bank 360000

No. of units 36

Value of one unit 10000

Rent per month 4500

Rent per unit per month 4500 / 36 = 125


End of Month

Rent Value unit purchased

Total payment

Remaining units

Remaining balance

0 0 0 0 36 460000

1 125 x 36 = 4500

10000 14500 35 450000

2 125 x 35 = 4375

10000 14375 34 440000

3 125 x 34 = 4250

10000 14250 33 430000

35 125 x 2 = 250

10000 10250 1 10000

36 125 x 1 = 125

10000 10125 0 0

Total ?? 460000 ??

Muhammad Khaleequzzaman Head Islamic banking Department Int’l Islamic University Islamabad

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