Diminishing Musharakah

Outline Diminishing Musharakah - Introduction Basic Structure Shariah Principles Illustration

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
Three components of Diminishing Musharaka
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

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 promises to purchase Banks share (units) over the tenure of transaction with the help of Undertaking to Purchase

BANK

Gradual Transfer of Ownership

Joint Ownership

CUSTOMER

Musharaka

Customer promises to purchase Banks share (units) over the tenure of transaction with the help of Undertaking to Purchase Customer pays rent for the use of banks share in the property Customer purchases the units every month via a separate offer & acceptance every month and will eventually become the owner of the property.

BANK

Gradual Transfer of Ownership

Joint Ownership

CUSTOMER

Musharaka

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 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

Illustration I

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 . 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.

Illustration II

1.Client makes the choice of the house

Banker

Customer

18

2. Bank & client enter into a Musharakah agreement

Value of House: Rs.10,000,000 Shirakat-ulmilk 10% ownership is of Customer

90% ownership is of Bank

19

3. Bank & client enter into an Ijarah agreement

Bank rented his part to the client and now client can use the whole house

20

Bank divides its own part of asset into units, which is promised by the client to be purchased on preagreed price.

21

Payment Calculation
Value of House (Rs.) Tenure in years (Quarterly payment) Total Payments Investment by client Total Units Clients Share Banks Share 40 Parts Rs. 1,000,000 100 10 90 <--- [4*10] Rs.10,000,000 10

Contd.
22

Units to be purchased in each quarter (No. of payment / Banks Share) i.e. 40/90

2.25 units

Unit Price = value of house / total units Rs. 100,000 i.e. 10,000,000/100 Value of units of each quarter 2.25 * 100,000 Rs. 225,000

23

Kibor +spread = 14.70%

Installment 0 1 2 3 4 Date 01/01/08 31/03/08 30/06/08 30/09/08 31/12/08

Shirkah Profit (Rs.) value of total outstanding Opening (Rs.) = (Op.*rate) units per Q Installment capital *(1/4) closing
9,000,000 9,000,000 8,775,000 8,550,000 8,325,000 0 33,0750 318,487.5 312,187.5 0 225,000 225,000 225,000 0 555,750 543,487.5 537,187.5 9000000 8775000 8325000 8100000

326,868.75 225,000

551,868.75 8550000

24

Practice Problem
Mr. A is a non Muslim client of an Islamic bank entered into a DM contract of 20 years. For the purchase of a factory building with equipment's. The worth of the factory is about 100 M and the rent of the factory is about 0.5M per month(rental payments will be made once an year). The Client will purchase 20% shares initially at the time of the contract and rest of the share will be purchased on Annual basis. Required: Calculate the payments Mr. A will made to IB each of the 20 Years.
25