The concept of
musharakah and mudarabah envisaged in the books of Islamic
Fiqh
venture whereby all the partners participate in the business right from it’s
inception and continue to be partners upto the end of the business when all the
assets are liquidated . One can hardly find in the traditional books of Islamic
generally presumes that these contracts are meant for initiating a jointFiqh
the concept of a running business where partners join and leave the enterprise
without affecting in any way the continuity of the business. Obviously, the
classical books of Islamic
scale commercial enterprises were not in vogue and the commercial activities
were not so complex as they are today. Therefore, they did not generally dwell
upon the question of such a running business.
However, it does not mean that the concept of
Fiqh were written in an environment where the largemusharakah and mudarabah
cannot be used for financing a running business. The concept of musharakah
and
are fully complied with, the details of their applications may vary from time to
time. Let us have a look at these basic principles before entering the details:
1. Financing through
advancing of money. It means to participation in the business and in the case
of musharakah, sharing in the assets of the business to the extent of the ratio
of financing.
2. An investor/financier must share the loss incurred by the business to the
extent of his financing.
3. The partners are at liberty to determine, with mutual consent, the ratio of profit
allocated to each one of them, which may differ from the ratio of investment.
However, the partner who has expressly excluded himself from the
responsibility of work for the business cannot claim more than the ratio of his
investment.
4. The loss suffered by each partner must be exactly in the proportion of his
investment.
Keeping these broad principles in view, we proceed to see how
mudarabah is based on some basic principles. As long as these principlesmusharakah and mudarabah does never mean themusharakah and
mudarabah
can be used in different sectors of financing:
Project Financing:
In the case of project financing, the traditional method of
musharakah or
mudarabah
project, the form of
from both sides, the form of
management is the sole responsibility of one party, while the investment comes
from both, a combination of
play according to the rules already discussed.
Since
inception of the project, no problem with regard to the valuation of capital should
rise. Similarly, the distribution of profits according to the normal accounting
standards should not be difficult. However, if the financier wants to withdraw from
the
can purchase the share of the former at an agreed price. In this way the financier
may get back the amount he has invested along with a profit, if the business has
earned a profit. The basis for determining the price of his share shall be
discussed in detail later on (while discussing the financing of the working capital).
On the other hand, the businessman can continue with his project, either on his
own or by selling the first financier’s share to some other person who can
substitute the financier.
Since financial institutions do not normally want to remain partner of a specific
project for good, they can sell their share to other partners of the project as
aforesaid. If the sale of the share on one time basis is not feasible for the lack of
liquidity in the project, the share of the financier can be divided into smaller units
and each unit can be sold after a suitable interval. Whenever a unit is sold, the
share of the financier in the project is reduced to that extent, and when all the
units are sold, the financier comes out of the project totally.
can be easily adopted. If the financier wants to finance the wholemudarabah can come into operation. If investment comesmusharakah can be adopted. In this case, if themusharakah and mudarabah can be brought intomusharakah or mudarabah would have been effected from the verymusharakah, while the other party wants to continue the business, the latter
Securitization of
Musharakah:
M
the case of big projects where huge amounts are required which a limited
number of people cannot afford to subscribe. Every subscriber can be given a
usharakah is a mode of financing which can be securitized easily, especially in
musharakah
assets of the
non-liquid assets, these
instruments and can be bought and sold in the secondary market. However,
trading in these certificates is not allowed when all the assets of the
certificate which represents his proportionate ownership in themusharakah, and after the project is started by acquiring substantialmusharakah certificates can be treated as negotiablemusharakah
are still in liquid form (i.e., in the shape of cash or receivables or advances due
from others).
For proper understanding of this point, it must be noted that subscribing to a
musharakah
has nothing to do with the actual business undertaken with the borrowed money.
The bond stands for a loan repayable to the holder in any case, and mostly with
interest. The
rata ownership of the holder in the assets of the project. If all the assets of the
joint project are in liquid form, the certificate will represent a certain proportion of
money owned by the project. For example, one hundred certificates, having a
value of Rs. one million each, have been issued. It means that the total worth of
the project is Rs. 100 million. If nothing has been purchased by this money, every
certificate will represent Rs. one million. In this case, this certificate cannot be
sold in the market except at par value, because if one certificate is sold for more
than Rs. one million, it will mean that Rs. one million are being sold in exchange
for more than Rs. one million, which is not allowed in Shar’iah, because where
money is exchanged for money, both must be equal. Any excess at their side is
is different from advancing a loan. A bond issued to evidence a loanmusharakah certificate, on the contrary, represents the direct pro
riba
However, when the subscribed money is employed in purchasing non-liquid
assets like land, building, machinery, raw material, furniture etc. the
.musharakah
certificates will represent the holders’ proportionate ownership in these assets .
Thus, in the above example, one certificate will stand for one hundred share in
these assets. In this case it will be allowed by the Shari’iah to sell these
certificates in the secondary market for any price agreed upon in between the
parties which may be more than the fact value of the certificate, because the
subject matter of the sale is a share in the tangible assets and not in the money
only, therefore the certificate may be taken as any other commodities which may
be sold with a profit or at a loss.
In most cases, the assets of the project are a mixture of liquid and non-liquid
assets. This comes to happen when the working partner has converted a part of
the subscribed money into fixed assets or raw material, while rest of the money is
still liquid. Or, the project, after converting all it’s money into non-liquid assets
may have sold some of them and has acquired their sale proceeds in the form of
money. In some cases the price of it’s sales may have become due on it’s
customers but may have not yet been received. These receivable amounts,
being a debt, are also treated as liquid money. The question arises about the rule
of Shar’iah in a situation where the assets of the project are a mixture of liquid
and non-liquid assets, whether the
be traded in? The opinions of the contemporary Muslim jurists are different on
this point. According to the traditional Shafi’i school, this type of certificate cannot
be sold. Their classic view is that whenever there is a combination of liquid and
non-liquid assets, it cannot be sold unless the non-liquid part of the business is
separated and is sold independently.
The Hanafic school, however, is of the opinion that whenever there is a
combination of liquid and non-liquid assets, it can be sold and purchased for an
amount greater than the amount of liquid assets in the combination, in which
case money will be taken as sold at an equal amount and the excess will be
taken as the price of the non-liquid assets owned by the business.
Suppose, the
fixtures, etc. and 60% liquid assets, i.e. cash, and receivables. Now, each
musharakah certificates of such a project canMusharakah project contains 40% non-liquid assets i.e. machinery,
musharakah
worth of liquid assets, and Rs. 40 /- worth of non-liquid assets. This certificate
may be sold at any price more than 60/-. If it is sold at Rs.110/- it will mean that
Rs. 60/- of the price are against Rs. 60/- contained in the certificate and Rs. 50/-
is against the proportionate share in the non-liquid assets. But it will never be
allowed to sell the certificate for a price of Rs. 60/- or less, because in the case of
Rs. 60/- it will not set the amount of Rs. 60/-, let alone the other assets.
According to the Hanafi view, no specific proportion of non-liquid assets in the
whole is prescribed. Therefore, even if the non-liquid assets represent less than
50% in the whole, it’s trading according to the above formula is allowed.
However, most of the contemporary scholars, including those of Shafi’i school
have allowed trading in the units of the whole only if the non-liquid assets of the
business are more than 50%.
Therefore, for a valid trading of the
schools, it is necessary that the portfolio of
assets valuing more than 50% of it’s total worth. However, if Hanafi view is
adopted, trading will be allowed even if the non-liquid assets are less than 50%,
but the size of the non-liquid assets should not be negligible.
certificate having the face value of Rs. 100/- represents Rs. 60/-musharakah certificate acceptable to allMusharakah consists of non-liquid
Financing of a Single Transaction:
M
transaction. Apart from fulfilling the day-to-day needs of small traders, these
instruments can be employed for financing imports and exports. An importer
can approach a financier to finance him for that single transaction of import alone
on the basis of
instruments for import and financing. If the letter of credit has been opened
without any margin, the form of
opened with some margin, the form of
be relevant. After the imported goods are cleared from the port, their sales
proceeds may be shared by the importer and the financier according to a preagreed
ratio.
In this case the ownership of the imported goods shall remain with the financier
to the extent of the ratio of his investment. This
an agreed term, and of the imported goods are not sold in the market up to the
expiry of the term, the importer may himself purchase the share of the financier,
making himself the sole owner of the goods. However, the sale in this case
should take place at the market rate or at a price agreed between the parties on
the date of sale, and not at pre-agreed price at the time of entering into
musharakah. If the price is pre-agreed, the financier cannot compel the client /
importer to purchase it.
Similarly,
exporter has a specific order from abroad. The price on which the goods will be
exported is well-known before hand, and the financier can easily calculate the
expected profit. He may finance him on the basis of
usharakah and mudarabah can be used more easily for financing a singlemusharakah or mudarabah. The banks can also use thesemudarabah can be adopted, and if the L/C ismusharakah or a combination of both willmusharakah can be restricted tomusharakah will be even easier in the case of export financing. Themusharakah and
mudarabah
percentage. In order to secure himself from any negligence on the part of the
exporter, the financier may put a condition that it will be the responsibility of the
exporter to export the goods in full conformity with the conditions of the L/C. In
this case, if some discrepancies are found, the exporter alone shall be
responsible, and the financier shall be immune from any loss due to such
discrepancies , because it is caused by the negligence of the exporter. However,
being a partner of the exporter, the financier will be liable to bear any loss which
may be caused due to any reason other than the negligence or misconduct of the
exporter.
, and may share the amount of export bill on a pre-agreed
Financing of Working Capital:
Where finances are required for the working capital of a running business, the
instrument of
1. The capital of the running business may be evaluated with the mutual
consent. It is already mentioned while discussing the traditional concept of
musharakah may be used in the following manner:
musharakah
of the
form part of the capital on the basis of evaluation. This view can be adopted
here. In this way, the value of the business can be treated as the investment
of the person who seeks finance, while the amount given by the financier can
be treated as his share of investment. The
particular period, like one year or six months or less. Both the parties agree
on a certain percentage of the profit to be given to the financier which should
not exceed the percentage of his investment, because he shall not work for
the business. On the expiry of the term, all liquid and non-liquid assets of the
business are again evaluated and the profit may be distributed on the basis of
this evaluation.
Although, according to the traditional concept, the profit cannot be determined
unless all the assets of the business are liquidated, yet the valuation of the
assets can be treated as “constructive liquidation” with mutual consent of the
parties, because there is no specific prohibition in Shar’iah against it. It can
also mean that the working partner has purchased the share of the financier
in the assets of his business, and the price of his share can be determined on
the basis of valuation, keeping in view the ratio of the profit allocated for him
according to the terms of the
that is not necessary, according to Imam Malik, that the capitalmusharakah is contributed in cash form. Non-liquid assets can alsomusharakah may be effected for amusharakah.
For example, the total business of the value of A is 30 units. B finances
another 20 units, raising the total worth to 50 units; 40% having been
contributed by B, and 60% by A. It is agreed that B shall get 20% of the actual
profit. At the end of the term, the total worth of the business has increased
100 units. Now, if the share of B is purchased by A , he should have paid to
him 40 units, because he owns 40% of the assets of the business. But in
order to reflect the agreed ratio of profit in the price of his share, the formula
of pricing will be different. Any increase in the value of business shall be
divided between the parties in the ratio of 20% and 80%, because this ratio
was determined in the contract for the purpose of distribution of profit.
Since the increase in the value of the business is 50 units , these 50 units are
divided at the ratio of 20-80, meaning thereby that 10 units will have been
earned by B. These 10 units will be added to his original 20 units, and the
price of his share will be 30 units.
In case of loss, however, any decrease in the total value of the assets should
be divided between them exactly in the ratio of their investment, i.e., in the
ratio of 40/60. Therefore, if the value of the business has decreased, in the
above example, by 10 units reducing the total number of units to 40, the loss
of 4 units shall be borne by B (being 40% of the loss.)These 4 units shall be
deducted from it’s original 20 units, and the price of his share shall be
determined as 16 units.
Sharing in the Gross Profit Only:
2. Financing on the basis of
be difficult in a business having a large number of fixed assets, particularly in
a running industry, because the valuation of all its assets and their
depreciation or appreciation may create accounting problems giving rise to
disputes. In such cases,
The major difficulties in these cases arise in the calculation of indirect
expenses, like the depreciation of the machinery, salaries of the staff etc. In
order to solve this problem, the parties may agree on the principle that,
instead of net profit, the gross profit will be distributed between the parties,
that is, the indirect expenses shall not be deducted from the distributable
profit. It will mean that all the indirect expenses shall be borne by the
industrialist voluntarily, and only direct expenses (like those of raw material,
direct labour, electricity etc.) shall be borne by the
industrialist is offering his machinery, building and staff to the
musharakah according to the above procedure maymusharakah may be applied in another way.musharakah. But since themusharakah
voluntarily, the percentage of his profit may be increased to compensate him
to some extent.
This arrangement may be justified on the ground that the clients of financial
institutions do not restrict themselves to the operations for which they seek
finance from the financial institutions. Their machinery and staff etc. is,
therefore, engaged in some other business also which may not be subject to
musharakah
imposed on the
, and in such a case the whole cost of these expenses cannot bemusharakah.
Let us take a practical example. Suppose a ginning factory has a building
worth Rs. 22 million, plant and machinery valuing Rs. 2 million and the staff is
paid Rs. 50,000/- per month . The factory sought finance of Rs. 5,000,000/-
from a bank on the basis of
after one year the
to that point will be distributed between parties according to the agreed ratio.
While determining the profit, all direct expenses will be deducted from the
income. The direct expenses may include the following:
(i) The amount spent on purchasing raw material.
(ii) The wages of the labour directly involved in processing the raw
material.
(iii) The expenses for electricity consumed in the process of ginning.
(iv) The bills for other services directly rendered for the
So far as the building, the machinery and the salary of other staff is
concerned, it is obvious that they are not meant for the business of
musharakah for a term of one year. It means thatmusharakah will be terminated, and the profits accrued upmusharakah.
musharakah
while the building and the machinery are purchased for a much longer term in
which the ginning factory will use them for it’s own business which is not
subject to this one-year
building and the machinery cannot be borne by this short-term
alone, because the musharakah will terminate within one year,musharakah . Therefore , the whole cost of themusharakah.
What can be done at the most is that the depreciation caused to the building
and the machinery during the term of the
expenses. But in practical terms, it will be very difficult to determine the cost
of depreciation, and it may cause disputes also. Therefore, there are two
practical ways to solve this problem.
In the first instance, the parties may agree that the
pay an agreed rent to the client for the use of the machinery and the building
owned by him. This rent will be paid to him from the
irrespective of profit or loss accruing to the business.
The second opinion is that, instead of paying rent to the client, the ratio of his
profit is increased.
From the point of view of Shar’iah, it may be justified on the analogy of
musharakah is included in itsmusharakah portfolio willmusharakah fund
mudarabah
Hanbal.
in services which is allowed in the view of Imam Ahmad bin
Running Musharakah Accounts on the Basis of Daily Products:
3. Many financial institutions finance the working capital of an enterprise by
opening a running account for them from where the clients draw different
amounts at different intervals, but at the same time, they keep returning their
surplus amounts. Thus the process of debit and credit goes on up to the date
of maturity, and the interest is calculated on the basis of daily products.
Can such an arrangement be possible under the
musharakah or mudarabah
modes of financing? Obviously, being a new phenomenon, no express
answer to this question can be found in the classical works of Islamic
However, keeping in view the basic principles of the
procedure may be suggested for this purpose:
i. A certain percentage of the actual profit must be allocated for the
management.
ii. The remaining percentage of the profit must be allocated for the
investors.
iii. The loss, if any, should be borne by the investors only in exact
proportion of their respective investments.
iv. The average balance of the contributions made to the
Fiqh.musharakh the followingmusharakah
account calculated on the basis of daily products shall be treated as
the share capital of the financier.
v. The profit accruing at the end of the term shall be calculated on daily
product basis and shall be distributed accordingly.
If such an arrangement is agreed upon between the parties, it does not seem
to violate any basic principles of the
needs further consideration and research by the experts of Islamic
jurisprudence. Practically, it means that the parties have agreed to the
principle that the profit accrued to the
term will be divided on the capital utilized per day, which will lead to the
average of the profit earned by each rupee per day. The amount of this
average profit per rupee per day will be multiplied by the amount of the days
each investor has put his money into the business, which will determine his
profit entitlement on the daily product basis.
Some contemporary scholars do not allow this method of calculating profits on
the ground that it is just a conjectural method which does not reflect the actual
profits really earned by a partner of the
have earned huge profits during a period when a particular investor had no
money invested in the business at all, or had a very negligible amount invested ,
still, he will be treated at par with other investors who had huge amounts invested
in the business during that period. Conversely, the business may have suffered
a great loss during a period when a particular investor had huge amounts
invested in it. Still, he will pass on some of his loss to other investors who had no
investment in that period or their size of investment was negligible.
This argument can be refuted on the ground that it is not necessary in a
musharakah. However, this suggestionmusharakah portfolio at the end of themusharakah, because the business may
musharakah
musharakah pool comes into existence, the profits accruing to the joint pool are
earned by all the participants, regardless of whether their money is or is not
utilized in a particular transaction . This is particularly true of a Hanafi School
which does not deem it necessary for a valid musharakah that the monetary
contributions of the partners are mixed up together. It means that if A has
entered into a
into the joint pool, he will still be entitled to a share in the profit of the transactions
effected by B for the
entitlement to a share in the profit will be subject to the disbursement of money
undertaken by him, yet the fact remains that the profit of this particular
transaction did not accrue to his money, because the money disbursed by him at
a later stage may be used for another transaction . Suppose, A and B entered
into a
of them shall contribute Rs. 50,000/- and the profits will be distributed by them
equally. A did not yet invest his Rs. 50,000/- into the joint pool. B found a
profitable deal and purchased two air conditioners for the
50,000/- contributed by himself and sold them for Rs. 60,000/-, thus earning a
profit of Rs. 10,000/-. A contributed his share of Rs. 50,000/- after this deal. The
partners purchased two refrigerators through this contribution which could not be
sold at a greater price than Rs. 48,000/- meaning thereby this deal resulted in a
loss of Rs. 2,000/- Although the transactions effected by A’s money brought a
loss of Rs.2,000/- while the profitable deal of air conditioners was financed
entirely by B’s money in which A had no contribution, yet A will be entitled to a
share in the profit of the first deal. The loss of Rs.2,000/- in the second deal will
be set of from the profit of the first deal reducing the aggregate profit to Rs.
8,000/-. This profit of Rs.8,000/- will be shared by both partners equally. It means
that A will get Rs. 4,000/- , even though the transaction effected by his money
has suffered loss.
The reason is that once a
the subsequent transactions effected for
regardless of whose individual money is utilized in them. Each partner is a party
to each transaction by virtue of his entering into the contract of
A possible objection to the above explanation may be that in the above example,
A had undertaken to pay Rs. 50,000/- and it was known before hand that he will
contribute a specified amount to the
account of the
everyday, nobody has undertaken to contribute any specific amount. Therefore,
the capital contributed by each partner is unknown at the time of entering into
that a partner should earn profit on his own money only. Once amusharakah contract with B, but has not yet disbursed his moneymusharakah through his own money. Although hismusharakah to conduct a business of Rs. 100,000/- They agreed that eachmusharakah for Rs.musharakah contract is entered into by the parties , allmusharakah belong to the joint pool,musharakah.musharakah. But in the proposed runningmusharakah where the partners are coming in and going out
musharakah
The answer to the above objection is that the classical scholars of Islamic
, which should render the musharakah invalid.Fiqh
have different views about whether it is necessary for a valid
the capital is pre-known to the partners. The Hanafi scholars are unanimous on
the point that it is not a pre-condition. Al- Kassani, the famous Hanafi jurist,
writes:
“According to our Hanafi School, it is not a condition for the
validity of the
known, while it is a condition according to Imam Shafi’i. Our
argument is that Jahalah (uncertainty) in it self does not
render a contract invalid, unless it leads to disputes. And the
uncertainty in the capital at the time of
lead to disputes, because it is generally known when the
commodities are purchased for the
does not lead to uncertainty in the profit at the time of
distribution.”
It is, therefore, clear from the above that even if the amount of the capital is not
known at the time of
it should not lead to the uncertainity in the profit at the time of distribution.
Distribution of profit on daily product basis fulfills this condition.
It is true that the concept of a running
draw some amounts and at other times inject new money and the profits are
calculated on daily product basis is not found in the classical books of Islamic
musharakah thatmusharakah that the amount of capital ismusharakah does notmusharakah, therefore itmusharakah, the contract is valid. The only condition is thatmusharakah where the partners at times
Fiqh
so far as it does not violate any basic principle of
system, all the partners are treated at par. The profit of each partner is calculated
on the basis of the period for which his money remained in the joint pool. There is
no doubt in the fact that the aggregate profits accrued to the pool are generated
by the joint utilizations of different amounts contributed by the participants at
different times. Therefore if all of them agree with mutual consent to distribute the
profits on a daily basis, there is no injunction of the Shar’iah which makes it
impermissible; rather it is covered under the general guide line given by the Holy
Prophet (PBUH) in his famous hadith quoted in this book more than once:
“Muslims are bound by their mutual agreement unless they hold
a permissible thing as prohibited or a prohibited thing as permissible.”
If distribution on daily products basis is not accepted, it will mean that no partner
can draw any amount from, nor can he inject new amounts to the joint pool.
Similarly, nobody will be able to subscribe to the joint pool accept at the
particular dates of the commencement of a new term. This arrangement is totally
impracticable on the deposit sides of the banks and financial institutions where
the accounts are debited and credited by the depositors many times a day. The
rejection of the concept of the daily products will compel them to wait for months
before they deposit their surplus money in a profitable account. This will hinder
the utilization of savings for development of industry and trade, and will keep the
wheel of financial activities jammed for long periods. There is no other solution
for this problem accept to apply the method of daily products for the calculation of
profits, and since there is no specific injunction of Shar’iah against it, there is no
reason why this method should not be adopted.
. But merely this fact cannot render a new arrangement invalid in Shar’iah,musharakah. In the proposed
Some Objections on
Musharakah Financing:
Let us now examine some objections raised from practical point of view against
using
musharakah as a mode of financing.
1. Risk of Loss:
It is argued that the arrangement of
losses of the business to the financier bank or institution. This loss will be
passed on to depositors also. The depositors, being constantly exposed to
the risk of loss, will not want to deposit their money in the banks and financial
institutions and thus their savings will either remain idle or will be used in
transactions outside of the banking channels, which will not contribute to the
economic development at national level.
This argument is, however, misconceived. Before financing on the basis of
musharakah is more likely to pass on
musharakah
proposed business for which funds are needed. Even in the present system of
the interest-based loans and the banks do not advance loans to each and
every applicant. They study the potentials of the business and if they
apprehend that the business is not profitable, they refuse to advance a loan.
In the case of
depth and precaution.
Moreover, no bank or financial institution can restrict it self to a single
, the banks and financial institutions will study the feasibility of themusharakah, they will have to carry out this study with more
musharakah
bank has financed 100 of its clients on the basis of
studying the feasibility of the proposal of each one of them, it is hardly
conceivable that all of these
in a loss. After taking proper measures and due care, what can happen at the
most is that some of them make a loss. But on the other hand, the profitable
. There will always be a diversified portfolio of musharakah. If amusharakah, aftermusharakahs, or the majority of them will result
musharakahs
because the actual profit is supposed to be distributed between the client and
the bank. Therefore, the
suffer loss, and the possibility of loss to the whole portfolio is merely a
theoretical possibility which should not discourage the depositors. This
theoretical possibility of loss in a financial institution is much less than the
possibility of loss in a joint stock company whose business is restricted to a
limited sector of commercial activities. Still the people purchase its shares
and the possibility of loss does not refrain them from investing in these
shares. The case of the bank and financial institutions is much stronger,
because their
loss in one
in other
are expected to give more return than the interest-based loans,musharakah portfolio, as a whole, is not expected tomusharakah activities will be so diversified that any possiblemusharakah will be more than compensated by the profits earnedmusharakahs.
Apart from this, an Islamic economy must create a mentality which believes
that any profit earned on money is a reward of bearing risks of the business.
This risk may be minimized through expertise and diversifying a portfolio
where it becomes a hypothetical or theoretical risk only. But there is no way to
eliminate this risk totally. The one who wants to earn profit, must accept this
minimal risk. Since this understanding is already there in the case of normal
joint stock companies, nobody has ever raised the objection that the money of
the shareholders is exposed to loss. The problem is created by the system
which separates the banking and financing from the normal trade activities,
which has compelled the people to believe that the banks and financial
institutions deal in money and papers only, and that they have nothing to do
with the actual results emerging in trade and industry. Therefore, it is argued
that they deserve a fixed return in any case. This separation of financing
sector from the sector of trade and industry has brought great harms to the
economy at macro-level. Obviously, when we speak of Islamic banking, we
never mean that it will follow this conventional system in each and every
respect. Islam has its own values and principles which do not believe in
separation of financing from trade and industry . Once this Islamic system is
understood, the people will invest in the financing sector despite the
theoretical risk of loss, more readily than invest in the profitable joint stock
companies.
2. Dishonesty:
Another apprehension against
clients may exploit the instrument of
the financiers. They can always show that the business did not earn any
profit. Indeed, they can claim that it has suffered a loss in which case not only
the profit but also the principle amount will be jeopardized.
It is, no doubt, a valid apprehension, especially in societies where corruption
is the order of the day. However, solution to this problem is not as difficult as
is generally believed or exaggerated.
If all the banks in a country are run on pure Islamic pattern with a careful
support from the Central Bank and the government, the problem of
dishonesty is not hard to overcome. First of all, a well designed system of
auditing should be implemented whereby the accounts of all the clients are
fully maintained and properly controlled. It is already discussed that the profits
may be calculated to the basis of gross margins only. It will reduce the
possibility of disputes and misappropriation. However if any misconduct,
dishonesty or negligence is established against a client, he will be subject to
punitive steps, and may be deprived of availing any facility from any bank in
the country, at least for a specified period.
These steps will serve as strong deterrent against concealing the actual profit
or committing any other act of dishonesty. Otherwise, also the clients of the
banks cannot afford to show artificial losses constantly, because it will be
against their own interest in many respects. It is true that even after taking all
such precautions, there will remain a possibility of some cases where
dishonest clients may succeed in their evil designs, but the punitive steps and
the general atmosphere of the business will gradually reduce the number of
such cases (Even in an interest-based economy, the defaulters have always
been creating the problem of bad debts ) But, it should not be taken as a
justification, or as an excuse, for rejecting the whole system of
musharakah financing is that the dishonestmusharakah by not paying any return tomusharakah.
Undoubtedly, the apprehension of dishonesty is more severe for Islamic
Banks and financial institutions working in isolation from the main stream of
conventional banks. They have not much support from their respective
governments and central Banks. They cannot change the system, nor can
they impose their own laws and regulations. However, they should not forget
that they are not just commercial institutions. They have been established to
introduce a new system of banking which has it’s own philosophy. They are
duty bound to promote this new system, even if they apprehend that it would
reduce the size of their profits to some extent. Therefore, they should start
using the instrument of
every bank has a number of clients whose integrity is beyond all doubts. The
Islamic banks, should at least , start financing them on the basis of true
musharakah, at least on a selective basis. Each and
musharakah
others to follow suit. Moreover, there are some sectors of financing where
. It will help setting good precedents in the market and induce
musharakah
can be used easily. For example, the use of musharakah
instrument in financing exports has not much room for dishonesty. The
exporter has the specific order from abroad. The prices are agreed. The costs
is not difficult to determine. Payments are normally secured by a letter of
credit. The payments are made through the bank itself. There is no reason in
such cases why the
Similarly, financing of imports may also be designed on the basis of
musharakah with some precautions, as explained earlier.
musharakah arrangement should not be adopted.
3. Secrecy of the Business:
Another criticism against
partner in the business of the client, it may disclose the secrets of the
business to the financier, and through him to other traders.
However, the solution to this problem is very easy. The client, while entering
into the musharakah, may put a condition that the financier will not interfere
with the management affairs, and he will not disclose any information about
the business to any person without prior permission of the client. Such
agreements of maintaining secrecy are always honored by the prestigious
institutions, especially by the bank and financial institutions whose entire
business is based on confidentiality.
musharakah is that, by making the financier a
4. Client’s Unwillingness to Share Profits:
Many a time, it is mentioned that the clients are not willing to share with the
banks the actual profits of their business. The reluctance is based on two
reasons:
They think that the bank has no right to share in the actual profit, which may
be substantial, because the bank has nothing to do with the management or
running of the business and why should they (the clients) share the fruit of
their labour with the Bank who merely provides funds .The Clients also argue
that conventional banks are content with a meagre rate of interest and so
should be the Islamic Banks.
Even if the above was not a factor, the Clients are afraid to reveal their true
profits to the Banks, lest the in formation is also passed on to the tax
authorities and Clients’ tax liability increases.
The solution to the first part, though not easy, is not difficult or impossible
either . Such clients need to be convinced and persuaded that borrowing on
interest is a cardinal sin, unless there is a dire necessity for such borrowing.
Mere expansion of business is not a dire need, by any stretch of imagination.
By making a legitimate arrangement for obtaining funds for their business, by
way of
legitimate return for themselves, as well as for the Islamic Banks.
In respect of the second factor, all that can be said is that in some Muslim
countries, rate of taxation are indeed prohibited and unjust. Islamic Banks as
well as their Clients must lobby with the governments and struggle to change
the laws which hamper the progress towards Islamic banking. The
governments should also try to appreciate the fact that if rates of taxation are
reasonable and if tax-payers are convinced that they will benefit by honestly
paying their taxes, this would increase, and not decrease, government
revenues.
Musharakah, not only do they earn Allah’s pleasure but also a
Diminishing
Musharakah:
Another form of
Musharakah, developed in the near past, is ‘Diminishing
Musharakah
either in the joint ownership of a property or an equipment , or in a joint
commercial enterprise. The share of the financier is further divided into a number
of units and it’s understood that the client will purchase the units of the share of
the financier one by one periodically, thus increasing his own share till all the
units of the financier are purchased by him so as to make him the sole owner of
the property , or the commercial enterprise, as the case may be.
The diminishing Musharakah based on the above concept and has taken
different shapes in different transactions. Some examples are given below:
’. According to this concept, a financier and his client participate
1.
client wants to purchase the house for which he does not have adequate
funds. He approaches the financier who agrees to participate with him in
purchasing the required house.20% of the price is paid by the client and 80%
of the price by the financier. Thus the financier owns 80% of the house while
the client owns 20%. After purchasing the property jointly, the client uses the
house for his residential requirement and pays rent to the financier for using
his share in the property. At the same time the share of the financier is further
divided in eight equal units, each unit representing 10% ownership of the
house. The client promises to the financier that he will purchase one unit after
three months. Accordingly, after the first term of three months he purchases
one unit of the share of the financier by paying 1/10
house. It reduces the share of the financier from 80% to 70%. Hence, the rent
payable to the financier is also reduced to that extent. At the end of the
second term, he purchases another unit increasing his share in property to
40% and reducing the share of the financier to 60% and consequentially
reducing the rent to that proportion. This process goes on in the same fashion
until after the end of the two years, the client purchases the whole share of
the financier reducing the share of the financier to ‘zero’ and increasing his
own share to 100%.
This arrangement allows the financier to claim rent according to his proportion
of ownership in the property at the same time allows him periodical return of a
part of his principle through the purchases of the units of his share.
2. ‘A’ wants to purchase a taxi to use it for offering transport services to
passengers and to earn the income through fares recovered from them but he
is short of funds. ‘B’ agrees to participate in the purchase of the taxi,
therefore, both of them purchase a taxi jointly. 80% of the price is paid by ‘B’
and 20% is paid by ‘A’. After the taxi is purchased, it is employed to provide
transport to the passengers where by the net income of Rs. 1000/- is earned
on daily basis. Since ‘B’ has 80% share in the taxi it is agreed that 80% of the
fare will be given to him and the rest of the 20% will be retained by ‘A’ who
has 20% share in the taxi. It means that Rs. 800/- is earned by ‘B’ and Rs.
200 by ‘A’ on a daily basis. At the same time the share of ‘B’ is further divided
into eight units. After three months ‘A’ purchases one unit from the share of
‘B’. Consequently the share of ‘B’ is reduced to 70% and the share of ‘A’ is
increased to 30% meaning thereby that as from the date ‘A’ will be entitled to
Rs. 300/- from the daily income of the taxi and ‘B’ will earn Rs. 700/-. This
process will go on until after the expiry of two years, the whole taxi will be
owned by ‘A’ and ‘B’ will take back his original investment along with income
distributed to him as aforesaid.
3. ‘A’ wishes to start the business of ready-made garments but lacks the
required fund for that business. ’B’ agrees to participate with him for a
specified period, say two years. 40% of the investment is contributed by ‘A’
and 60% by ‘B’. Both start the business on the basis of the
proportion of the profit allocated for each one of them is expressly agreed
upon. But at the same time ‘B’s share in the business is divided into six equal
units and ‘A’ keeps purchasing these units on gradual basis until after the end
of the two years ‘B’ comes out of the business, leaving it’s exclusive
ownership to ‘A’. Apart from periodical profits earned by ‘B’, he gains the price
of the units of his share which, in practical terms, tend to repay him the
original amount invested by him.
Analyzed from the Shar’iah point of view this arrangement is composed of
different transactions which come to pay their role at different stages. Therefore,
each one of the foregoing three forms of diminishing Musharakah is discussed
below in the light of the Islamic principles:
It has been used mostly in house financing. The client wants to purchase theth of the price of theMusharakah. The
House Financing on the Basis of Diminishing
Musharakah:
The proposed arrangement is composed of the following transactions:
1. To create joint ownership in the property (
2. Giving the share of the financier to the client on rent.
3. Promise from the client to purchase the units of share of the financier.
4. Actual purchase of the units at different stages.
5. Adjustment of the rental according to the remaining share of the financier in
the property.
Let me discuss each ingredient of the arrangement in a greater detail:
(i) The first step in above arrangement is to create a joint ownership in the
property. It has already been explained in the beginning of the chapter that
‘
including joint purchase by the parties .This has been expressly allowed
by all schools of Islamic jurisprudence . Therefore no objection can be
raised against creating this joint ownership.
(ii) The second part of this arrangement is that the financier leases his share
in the house to his client and charges rent from him. This arrangement is
also above board because there is no difference of opinion among the
Muslim jurists in the permissibility of leasing one’ s undivided share in a
property to his partner. If the undivided share is leased out to a third party,
its permissibility is a point of difference between the Muslim jurists. Imam
Abu Hanifa and Imam Zufar are of the view that the undivided share
cannot be leased out to a third party while Imam Malik and Imam Shafi’i,
Abu Yusuf and Mohammed Ibn Hasan hold that the undivided share can
be leased out to any person. But so far as the property is leased to the
partner himself all of them are unanimous on the validity of
(iii) The third step in the aforesaid arrangement is that the client purchases
different units of the undivided share of the financier. This transaction is
also allowed. If the undivided share relates to both land and building, the
sale of both is allowed according to all the Islamic schools. Similarly if the
undivided share of the building is intended to be sold to the partner , it is
also allowed unanimously by all the Muslim jurists. However, there is a
difference of opinion if it is sold to the third party.
It is clear from the foregoing three points that each one of the transactions
mentioned here and above is allowed per se, but the question is whether this
transaction may be combined in a single arrangement. The answer is if all these
transactions have been combined by making each of them a condition to the
other, then this is not allowed in the Shar’iah , because it is a well settled rule in
the Islamic legal system that one transaction cannot be made a pre-condition for
another. However, the proposed scheme suggests that instead of making two
transactions conditional to each other , there should be one sided promise from
the client, firstly, to take the share of the financier on lease and pay the agreed
rent , and secondly, to purchase different units of the share of the financier of the
house at different stages. This leads us to the forth issue, which is, the
enforceability of such a promise.
iv. It is generally believed that a promise to do something creates only a moral
obligation on the promisor which cannot be enforced through courts of law.
However, there are a number of Muslim jurists who opine that promises are
enforceable, and the court of law can compel the promisor to fulfill his
promise, especially, in the context of commercial activities. Some Maliki and
Hanifi jurists can be cited in particular, in particular, who have declared that
promises can be enforced through the courts of law in cases of need. The
Hanifi jurists have adopted this view with regard to a particular sale called
‘
whereby the buyer promises to the seller that whenever the latter gives him
back the price of the house, he will resell the house to him . This arrangement
was in vogue in countries of central Asia, and the Hanafi jurists have opined
that if the resale of the house to the original seller is made a condition for the
initial sale, it is not allowed. However, if the first sale is effected without any
condition, but after effecting the sale, the buyer promises to resell the house
whenever the seller offers to him the same price, this promise is acceptable
and it creates not only a moral obligation, but also an enforceable right of the
original seller . The Muslim jurists allowing this arrangement have based their
view on the principle that (the promise can be made enforceable at time of
need).
Even if the promise has been made before effecting the first sale, after which the
sale has been affected without a condition, it is also allowed without certain
Hanafi jurists .
One may raise an objection that if the promise of resale has been taken before
entering into an actual sale , it practically amounts to putting a condition on the
sale itself , because the promise is understood to have been entered into
between the parties at the time of sale, and therefore, even if the sale is without
an express condition , it should be taken as conditional because a promise in an
express term has preceded it.
This objection can be answered by saying that there is a big difference between
putting a condition in the sale and making a separate promise by making it a
condition. If the condition is expressly mentioned at the time of sale, it means that
the sale will be valid only if the condition is fulfilled , meaning thereby that if the
condition is not fulfilled in future, the present sale will become void. This makes
the transaction of the sale contingent on a future event which may or may not
occur. It leads to uncertainty (
in Shar’iah.
Conversely, if the sale is without any condition, but one of the two parties has
promised to do something separately, then the sale cannot be held contingent or
conditional with fulfilling of the promise made. It will take effect irrespective of
whether or not the promisor fulfills his promise. Even if the promisor backs out of
his promise, the sale will remain effective. The most the promisee can do is to
compel the promisor through court of law to fulfill his promise and if the promisor
is unable to fulfill the promise, the promisee can claim actual damages he has
suffered because of the default.
This makes it clear that a separate and independent promise to purchase does
not render the original contract conditional or contingent. Therefore, it can be
enforced.
On the basis of this analysis, diminishing the
Housing Finance with following conditions:
(a) The agreement of joint purchase, leasing and selling different units of the
share of the financier should not be tied-up together in one single contract.
However, the joint purchase and the contract of lease may be joined in
one document whereby the financier agrees to lease his share, after joint
purchase, to the client. This is allowed because, as explained in the
relevant chapter,
the client may sign one-sided promise to purchase different units of the
share of the financier periodically and the financier may undertake that
when the client will purchase a unit of his share, the rent of the remaining
units will be reduced accordingly.
Shirkat-ul-Milk).Shirkat-ul-Milk’ (joint ownership) can come into existence in different ways‘Ijarah’.bai-bilwafa’. This ‘bai-bilwafa’ is a special arrangement of sale of a houseGharar) in the transaction which is totally prohibitedMusharakah may be used forIjarah can be effected for a future date. At the same time
(b)
exchange of offer and acceptance at that particular date.
At the time of the purchase of each unit, sale must be effected by the
(c)
effected on the basis of the market value of the house as prevalent on the
date of purchase of that unit, but it is also permissible that a particular
price is agreed in the promise of purchase signed by the client.
It will be preferable that the purchase of different units by the client is
Diminishing
Musharakah for Carrying Business of Services:
The second example given above for diminishing
purchase of a taxi run for earning income by using it as a hired vehicle. This
arrangement consists of the following ingredients:
(i) Creating joint ownership in a taxi in the form of
stated this is allowed in Shar’iah.
(ii)
allowed as mentioned earlier in this chapter.
Musharakah is the jointShirkat-ul-Milk. As alreadyMusharakah is the income generated through the services of taxi. It is also
(iii)
is again subject to the conditions already detailed in the case of House
financing. However, there is a slight difference between the House
financing and the arrangement suggested in this second example. The
taxi, when used as a hired vehicle, normally depreciates in value overtime,
therefore , depreciation in the value of taxi must be kept in mind while
determining the price of different units of the share of the financier.
Purchase of different units of the share of the financier by the client. This
Diminishing
Musharakah in Trade:
The third example of diminishing
contributes 60% of the capital for launching a business of ready made garments,
for example. This arrangement is composed of two ingredients only:
1. In the first place, the arrangement is simply a
partners invest different amounts of capital in a joint enterprise. This is
obviously permissible subject to the conditions of
out earlier in this chapter.
Musharakah as given above is that the financierMusharakah whereby twoMusharakah already spelled
2.
be in the form of a separate and independent promise by the client. The
requirements of Shar’iah regarding this promise are the same as explained in
the case of House financing with one very important difference. Here the
price of units of the financier cannot be fixed in the promise to purchase,
because if the price is fixed before hand at the time of entering the
Purchase of different units of the share of the financier by the client. This may
Musharakah
invested by the financier with or without profit, which is strictly prohibited in
the case of
about fixing the price of his units to be purchased by the client. One option is
that he agrees to sell the units of the basis of valuation of the business at the
time of the purchase of each unit. If the value of the business has increased,
the price will be higher and if it is decreased the price would be less. Such
valuation may be carried out in accordance with the recognized principles
through the experts, whose identity may be agreed upon between the parties
when the promise is signed. The second option is that the financier allows the
client to sell these units to any body else at whatever price he can, but at the
same time he offers a specific price to the client, meaning thereby that if he
finds a purchaser of that unit at a higher price, he may sell it to him, but if he
wants to sell it to the financier, the latter will be agreeable to purchase it at a
price fixed by him before hand .
Although both these options are available according to the principles of the
Shar’iah, the second option does not seem to be feasible for the financier,
because it would lead to injecting new partners in the
disturb the whole arrangement and defeat the purpose of diminishing
Musharakah in which the financier wants to get his money back within a specified
period. Therefore, in order to implement the objective of diminishing
Musharakah, only the first option is practical.
, it will practically mean that the client has ensured the principleMusharakah. Therefore, there are two options for the financierMusharakah which will
MUSHARAKAH AND MUDARABAH AS MODES OF FINANCING
