Outline • Diminishing Musharakah - Introduction• Basic Structure• Shariah Principles• Illustration

Diminishing Musharakah

Diminishing Musharakah - Introduction

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

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 financingCar FinancingPlant and machinery financingAll other fixed Assets

Diminishing Musharakah

Basic Structure

CUSTOMER

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 Bank’s share (units) over the tenure of transaction with the help of Undertaking to Purchase

The customer approaches the Bank with the request for Project/Machinery/House financing

BANK

Joint Ownersh

ipMusharak

a

Rent

CUSTOMERBANK

Joint Ownersh

ipMusharak

a

Gradual Transfer of Ownership

Customer promises to purchase Bank’s 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.

CUSTOMER

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)

BANK

Joint Ownersh

ipMusharak

a

Gradual Transfer of Ownership

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 one’s share to his partner.

• There is difference of opinion among leasing one’s 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

Illustration I

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. Bank’s share is divided into five units.

7. Customer agrees to buyout Bank’s share (units) on yearly basis and the Undertaking is executed by the customer.

8. Customer pays the rent for the usage of the Bank’s 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.

DM - Illustration

Illustration II

1.Client makes the choice of the house

Banker

Customer

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2. Bank & client enter into a Musharakah agreement

Shirakat-ul-milk

10% ownership

is of Customer

90% ownership is of Bank

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Value of House: Rs.10,000,000

3. Bank & client enter into an Ijarah agreement

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

the whole house

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Bank divides its own part of asset into units, which is promised by the client to

be purchased on pre-agreed price.

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Payment Calculation

Value of House (Rs.) Rs.10,000,000

Tenure in years 10

(Quarterly payment)

Total Payments 40 Parts <--- [4*10] Investment by client Rs. 1,000,000

Total Units 100Client’s Share 10Bank’s Share 90

Contd…….

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

2.25 units

Unit Price = value of house / total unitsi.e. 10,000,000/100

Rs. 100,000

Value of units of each quarter2.25 * 100,000

Rs. 225,000

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Kibor +spread = 14.70%

Installment Date Opening (Rs.)Profit (Rs.)

= (Op.*rate) *(1/4)

value of units per Q

total Installment

Shirkah outstanding

capital closing

0 01/01/08 9,000,000 0 0 0 9000000

1 31/03/08 9,000,000 33,0750 225,000 555,750 8775000

2 30/06/08 8,775,000 326,868.75 225,000 551,868.75 8550000

3 30/09/08 8,550,000 318,487.5 225,000 543,487.5 8325000

4 31/12/08 8,325,000 312,187.5 225,000 537,187.5 8100000

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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.

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