Islamic Modes of Financing Diminishing Musharakah.

Islamic Modes of Financing

Diminishing Musharakah

Summary of the Previous Lecture

In previous lecture we discussed certain situations and provided their solutions under the Musharakah and Mudarabah contract.

Learning OutcomesAfter this lecture you will be able to understand;

•The concept of Diminishing Musharakah

•Features and rules of diminishing Musharakah.

•Uses of diminishing Musharakah particularly in House

Financing for four purposes:

1.Purchase of House

2.Construction of House

3.Renovation of House

4.Balance Transfer Facility (BTF)

Diminishing Musharakah

It is a type of Shirkah where one partner promises to purchase the other partner’s share gradually.

Type of Diminishing Musharakah

Like Musharakah contract Diminishing Musharakah is also of two types;

/Diminishing Musharakah

Shirakat-ul-MilkJoint ownership

Shirkat-ul-AqdJoint Venture

Features of Diminishing Musharakah

Shirkat-ul-aqd (joint venture)•Two partners start business in Shirkah to earn profits.•One of the partners undertakes to purchase the share of another partner gradually at regular intervals.

Rules of Diminishing Musharakah in Joint Venture

There will be an agreement of joint venture between both partners where in investment of everyone and ratio of profit will be agreed.

One partner undertakes to purchase the share of other partner, but three conditions should be considered in this undertaking.

a) This promise will not be a part of Shirkah Agreement.b) The price of unit will not be agreed in this promise but

promise to purchase should be on offer and acceptance basis for a valid sale contract (at market value at the time of purchasing).

c) If promise is not fulfilled, then it can be forced by Court of law.

Rules of Diminishing Musharakah in Joint Venture

• At the time of purchase, the price of unit will be

decided on the basis of market value of business.

• Conditions of valid sale transaction must be

observed.

• Unit will be purchased through Offer & Acceptance.

Features of Diminishing Musharakah in Joint Ownership

• Two or more partners purchase any asset

(machinery, property, etc.) and their intention is

that one or both partners will use this asset or

rent out their share and one partner undertakes

to purchase the share of other gradually.

Rules of Diminishing Musharakah in Joint Ownership

• There will be an agreement of Shirkat ul Milk and it will be decided How much investment will be made by each partner.

• Asset will be purchased and everyone will be owner of this asset as per the ratio of his investment and all other rules of Shirkat-ul-Milk will be applicable.


• One Shareek can rent out his share to other partner or to a third party and Ijarah Agreement will be signed.

• Within period of Ijarah, Shariah rulings relating to Ijarah will be applicable.


• One of the partners can promise to purchase the share of another partner and in this promise, the price of unit may be decided.

• Unit can be purchased on the basis of Offer & Acceptance.

• All the above mentioned agreements and undertaking should be independent and not linked up with each other.

Termination of Diminishing Musharakah

1. Subject to agreement or by mutual consent of joint owners, a joint

owner may withdraw his share from the joint asset or property after

serving a due notice to other joint owner(s).

2. The withdrawal can be affected by sale or gift to existing joint

owner(s) or to any other person(s). In case of sale, the parties may

agree on face value, book value, agreed value, or market value.

3. A withdrawal of one or more joint owner(s) shall not lead to the

termination of the joint ownership among remaining joint owner(s).

4. It is also permissible for the joint owners to agree on termination of

the joint ownership before the agreed period.

Use of Diminishing Musharakah in the Present

Islamic Banking System

Use of Diminishing of Musharakah in Banking System

Diminishing Musharakah is usually used for asset

financing and particularly in House Financing for four

purposes:

1. Purchase of House

2. Construction of House

3. Renovation of House

4. Balance Transfer Facility (BTF)

1. Financing for Purchase of House

1. The Client in the approved area of the bank makes

the choice of house.

2. Bank & client enter into Musharakah

agreement. In this agreement it is decided to

purchase the house jointly and ratio of investment

by each other.


3. The property will be in the name of the client.

4. This is Shirkat-ul-Milk.

5. According to the ratio of ownership, each one is

responsible for the loss.

6. Bank divides its own part of asset into units, which is

promised by the client to purchase on pre-agreed

price.


7. After taking possession of house, bank rent out its

share to the client by execution of Ijarah Agreement.

8. Rent may be fixed on prevailing market rate or with

mutual consent.

9. Bank’s monthly profit may also be decided, as monthly

rent of the house and principal amount will be

recovered in the unit price.


10. In Ijarah Agreement, a lump sum amount of rent

is necessary to be fixed for a certain period. Rent

for the rest of the period, may be linked with

agreed Benchmark.

11. Each unit will be purchased on the basis of Offer

& Acceptance.

2. Financing for Purchase of Plot and Construction of House

There are two scenarios in this case:

a.Financing for Purchase of Plot & Construction.

b.Financing only for Construction

2. Financing for Purchase of Plot & Construction

1. Musharakah Agreement will be signed between

bank and client in which investment of everyone

will be agreed. It will also be agreed that client as

working partner will be responsible for

construction.

2. Both partners will be the owners of the property in

same ratio as the ratio of investment.

2 Financing for Purchase of Plot & Construction





6. Bank will divide its own part of assets into units,

7. Which is promised by the client to purchase on

pre-agreed price


7. After completion of house, Ijarah Agreement will be

signed and bank will give its share of house on rent to

the client. Before completion of construction, rent

cannot be charged.

8. Rent may be fixed on prevailing market value or with

mutual consent.





10. In Ijarah Agreement, a lump sum amount of rent is

necessary to be fixed for a certain period. Rent for the

rest of the period, may be linked with agreed Benchmark.

11. Each unit will be purchased on the basis of Offer &

Acceptance.

12. Purchase of unit can be started after Musharakah

Agreement.

2. Financing for Construction Of House

1. Valuation of plot will be made. This value will be

investment of client in Musharakah Agreement and

bank’s financing for construction will be investment of

bank.

2. Musharakah Agreement will be signed between bank

and client in which investment of everyone will be

agreed. It will also be agreed that client as working

partner will be responsible for construction.


3. Both the partners will be owner of the property in same

ratio as the ratio of investment.





7. Bank will divide its own part of asset into units, which is


price.


8. After completion of house, Ijarah Agreement will be

signed and bank will give his share of house on rent.

Before completion of construction, rent cannot be

charged.


mutual consent.







rest of the period, may be linked with agreed

Benchmark.

12. Before one year, client cannot purchase bank’s units.

13. Each unit will be purchased on the basis of Offer &

Acceptance.

3. Financing for Renovation of House

1. Valuation of house will be made and this value will be

treated as investment of client in Musharakah

Agreement and renovation amount will be considered

as bank’s investment.




agreed. It will also be agreed that client as working

partner will be responsible for renovation.

3. Both the partners will be owner of the house in same

ratio as ratio of investment.






7. Bank will divide its own part of asset into units, which is


price.


8. After completion of renovation, Ijarah Agreement will

be signed and bank will give his share of house on

rent. Before completion of renovation, rent cannot be

charged.


mutual consent.





11. In ijarah agreement, a lump sum amount of rent is



benchmark.

12. Each unit will be purchased on the basis of offer &

acceptance.

4. Diminishing Musharakah for Balance Transfer Facility (BTF)

1. This product will be used only in those cases where

someone has obtained interest-based loan for house.

2. Valuation of house will be made and this value will

consist of the investment of client in Musharakah

Agreement and amount of loan paid by bank will be

investment of bank.

4. Diminishing Musharakah for BTF



agreed.

4. Both the partners will be owner of the property in same

ratio as ratio of investment.






8. Bank will divide its own part of asset into units, which

is promised by the client to purchase on pre-agreed

price.


9. Ijarah Agreement will be signed and bank will give its

share of house on rent to the client.


mutual consent.








Benchmark.

13. Before one year, client cannot purchase bank units

14. Each unit will be purchase on the basis of Offer &

Acceptance.

Example

‘A’ wishes to start business of garments but lacks funds, ‘B’ agrees to participate with him for a specified period (2 years). Both invest in the venture 50% each on a Musharakah basis. Both agree on a profit sharing ratio and that B’s share will be purchase by ‘A’. B’s share will be divided into 5 equal units and at the agreed intervals B’s share is purchased by ‘A’ on the prevailing market value or any standard agreed between the partners. Every time a unit is purchase by ‘A’, his share in Musharakah increases and accordingly the profit sharing is fixed. After the units are purchased be ‘A’, the whole property becomes the asset of ‘A’.

Problem

Prepare a schedule of payment by assuming a transaction on December 01, 2013 between the client and the bank for house construction whereby the capital invested by bank and the client is, Rs.5,000,000 (Bank's capital) and Rs.5,000,000 (Client's capital) respectively. Bank’s share is divided in 5 units and will be purchased by the client every six months and rent for the house is fixed at Rs.20,000 per month and it will fixed at the market rates every year during the proposed time period (suppose a 10% increase in rent every year).

Note that the first installment will be due one year after the client moves into the house and that the construction will take about six months and rent will start from July 01, 2014. Installments will be determined on the market value basis; and the value of the property is expected to increase by 5% every six months at the time of installment payment by the client.

Summary of the Lecture

In this lecture we discussed

•The concept of Diminishing Musharakah

•Features and rules of diminishing Musharakah.

•Uses of diminishing Musharakah particularly in House

Financing for four purposes:

1.Purchase of House

2.Construction of House

3.Renovation of House

4.Balance Transfer Facility (BTF)

Islamic Modes of Financing Diminishing Musharakah.

Documents

Transcript of Islamic Modes of Financing Diminishing Musharakah.