Topic ii. participatory modes of islamic finance musharakah and mudarabah(2)
- 1. Participatory Modes of Islamic Finance Contract 1
- 2. Participatory Modes of Finance Contract 2 Musharakah Mudarabah Diminishing Musharakah
- 3. Musharakah 3 Musharakah is a word of Arabic origin which literally means sharing. In the context of business and trade it means a joint enterprise in which all partners share the profit and loss of the joint venture. Musharakah is a partnership wherein all partners provide both capital and work to undertake a business activity, and to share profits according to pre-agreed upon ratios. Ideal alternative for interest based financing. Therefore musharakah can play a vital role in an economy based on Islamic finance. Return is based on actual profit. Justified to both creditor and debtor. According to Islamic principles, a financer must determine whether he is advancing a loan to assist other or he desire to share profit.
- 4. The Concept of Musharakah 4 Shirkah means sharing, shirkah has a much wider sense than the term musharakah as is being used today. Musharakah is modern terminology. There are two kinds of shirkah: 1. Shirkat ul Milk (Joint Ownership): It means joint ownership of two or more persons in particular property. It can be optional or compulsory. 2. Shirkat ul Aqd (Joint Enterprise): This is second type of Shirkah which means “ a partnership effected by a mutual contract” (joint commercial enterprise).
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- 6. The Concept of Musharakah 6 Shirkat ul Aqd divide into three kinds: i. Shirkat ul Amwal where all partners invest some capital into a commercial enterprise. ii. Shirkat ul Amal where all partners jointly undertake to render some services for their customers. iii. Shirkat ul wujooh where partners have no investment at all. All they do is that they purchase the commodities on a deferred price and sell them at spot.
- 7. Basic Rules of Musharakah 7 Musharakah is relationship established by the parties through a mutual contract. It should be valid, parties should be capable of entering into a contract, free consent, without fraud or misrepresentation etc. Distribution of profit 1. The profit sharing ratio for each partner must be determined in proportion to the actual profit accrued to the business and not in proportion to the capital invested by him. For example, if it is agreed between them that 'A' will get 10% of his investment, the contract is not valid. 2. It is not allowed to fix a lump sum amount for anyone of the partners or any rate of profit tied up with his investment. Therefore if 'A' & 'B‘ enter into a partnership and it is agreed between them that 'A' shall be given Rs.10,000/- per month as his share in the profit and the rest will go to 'B', the partnership is invalid. 3. If both partners agree that each will get percentage of profit based on his capital percentage, whether both work or not, it is allowed.
- 8. Basic Rules of Musharakah 8 4. It is also allowed that if an investor is working, his profit share could be higher than his capital contribution irrespective of whether the other partner is working or not. For instance, if 'A' & 'B' have invested Rs.1000/- each in a business and it is agreed that only 'A' will work and will get two third of the profit while 'B' will get one third. Similarly if the condition of work is also imposed on 'B' in the agreement, then also the proportion of profit for 'A' can be more than his investment. 5. If a partner has put an express condition in the agreement that he will not work for the Musharakah and will remain a sleeping partner throughout the term of Musharakah, then his share of profit cannot be more than the ratio of his investment. 6. It is allowed that if a partner is not working, his share of profit can be established at a rate lower than his capital share.
- 9. Basic Rules of Musharakah 9 7. If both are working partners, the share of profit can differ from the ratio of investment. For example, Mr. A and Mr. B both have invested Rs.1000/-each. However, Mr. A gets one third of the total profit and B will get two third, this is allowed. 8. If only a few partners are active and others are only sleeping partners, then the share in the profit of the active partner could be fixed at higher than his ratio of investment e.g.. 'A' & 'B' put in Rs.100 each and it is agreed that only 'A' will work, then 'A' can take more than 50% of the profit as his share. The excess he receives over his investment will be compensation for his services
- 10. Basic Rules of Musharakah 10 The following are the Basic rules of distribution of Loss in case of Musharakah: All scholars are unanimous on the principle of loss sharing in Shariah based on the saying of Syedna Ali ibn Talib that is as follows: "Loss is distributed exactly according to the ratio of investment and the profit is divided according to the agreement of the partners.“ Therefore the loss is always subject to the ratio of investment. For example, if Mr. A has invested 40% of the capital and Mr. B has invested 60%, they must suffer the loss in the same ratio, not more, not less. Any condition contrary to this principle shall render the contract invalid.
- 11. Management of Musharakah 11 Every partner has a right to take part in its management But if one partner is sleeping partner shall be entitled to the profit only to the extent of his investment, and ratio of profit allocated to him should not exceed the ratio of his investment. If all partners agree to work, each one of them shall be treated as the agent of the other.
- 12. Termination of Musharakah 12 Every partner has right to terminate the musharakah at any time after giving his partner a notice. If assets are in cash form all of them will be distributed pro rata between partners. If assets are not in cash, the partners may agree either liquidation or asset distribution. In case of dispute i.e one wants liquidation and other wants distribution then distribution will be preferred. If the assets cannot be separated like machinery then they shall be sold. If one partner die, the contract terminated. His heirs has option to draw the share or continue. If any of partners becomes insane or incapable, the contract stand terminated.
- 13. Mudarabah 13 A form of partnership where one party provides the funds while the other party provides expertise. The people who bring in money are called "the silent partner, investor, or rabb al-mal" while the management and work is an exclusive responsibility of the "entrepreneur or mudarib ". The profit sharing ratio is determined at the time of entering into the Mudarabah agreement whereas in case of loss it is borne by the Rab ul Mal only. In case of Islamic banks, the depositors are called Rabb ul Maal and the bank is called Mudarib.
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- 15. Types of Mudarabah 15 There are two types of Mudarabah: 1. Al-Mudarabah Al Muqayyada: Rab ul Maalmal who, in case of Islamic bank, is depositor specifies a particular business or a particular place for the mudarib (bank), in which case he shall invest the money. This is called Al- Mudarabah Al- Muqayyadah (restricted Mudarabah). 2. Al-Mudarabah Al Mutlaqah: In case where Rab ul maal (depositor) gives full freedom to the Mudarib (bank) to undertake whatever business he deems fit, this is called Al Mudarabah Al Mutlaqah (unrestricted Mudarabah). It is necessary for the validity of Mudarabah that the parties agree on a certain formula of sharing the actual profit right at the beginning of the contract. The Shariah has prescribed no particular proportion of profit sharing rather it has been left to the mutual consent of the parties.
- 16. Distribution of Profit 16 It is necessary for the validity of mudarabah that the parties agree right at the beginning. Profit cannot be fixed amount. Profit cannot be fixed percentage of investment. Different proportions are agree in different situations. Mudarib cannot claim any periodic salary or fee. Imam Ahmad has allowed for mudarib to draw his daily expense. The Hanfi jurists restrict this right of mudarib only to a situation when he is business trip outside his own city. Loss borne by Rab ul Maal only. If business incurred loss due to dishonesty or negligence of mudarib then mudarib shall be liable for loss caused by his negligence or misconduct. If the business has incurred loss in one transaction and profit in other, the profit shall be used to offset the loss then if any shall be distributed. Example:
- 17. Termination of Mudarabah 17 Mudarabah can be terminated any time by either of two parties. Only condition to give notice. If assets are in cash then profit will be distributed according to agreed ratio. If assets are not in cash, then the mudarib shall be given an opportunity to sell and liquidate them, so that actual profit may be determined.
- 18. Musharakah & Mudarabah as Modes of Financing 18 These instruments may be used for purpose of financing in the context of modern trade and industry. The concept of musharakah and mudarabah is based on some basic principles. As long as these principles are fully complied with, the detail of their application may vary time to time 1. It does not mean advancing money, it means participation in business. 2. An investor must share the loss incurred by the business to the extent of financing. 3. Profit ratio is determined by mutual consent. However if partner expressly excluded himself from work, then his claim cannot be more than ratio of investment. 4. Loss must be share according to proportion of investment.
- 19. Project Financing 19 Project financing the traditional method of musharakah and mudarabah can be easily adopted. If financer wants to finance the whole project then its mudarabah. If investment comes from both sides then musharakah can be adopted. Distribution of profit according to normal rule. If the financier wants to withdraw from the musharakah, while the other party wants to continue the business, the latter can purchase the share of the former at an agreed price. The businessman can continue, either on his own or by selling the first financiers share to some other person.
- 20. Securitization of Musharakah 20 Musharakah can be securitized easily especially in the case of big projects. Every subscriber can be given a musharakah certificate, which represent proportionate ownership. Musharakah certificates are negotiable instruments and can bought and sold in the secondary market. Trading in these certificates is not allowed when all the assets of the musharakah are still in liquid forms (cash, receivable, and advances from others). In above case certificate cannot issue in market except at par. Example: If one certificate is issued more than par its not allowed in Shariah if all assets are liquid form.
- 21. Securitization of Musharakah 21 In case of non-liquid assets like land, building, machinery, raw material etc., then musharakah certificates can be sell in secondary market at agreed price between parties which may be more than face value. In case of both liquid and non- liquid assets there are different views. The Hanfi School, combination of assets is allowed, it can be sold and purchased for an amount greater than the amount of liquid assets. Example:
- 22. Financing of a Single Transaction 22 Musharakah and mudarabah can be used for financing a single transaction. It can be for day to day needs of small traders, imports and exports also. If letter of credit has been opened without any margin, the form of mudarabah can be adopted. If letter of credit has been opened with margin, the form of musharakah can be adopted. After imported goods are cleared from port, their sale proceeds may be shared by importer and financer according to pre-agreed ratio.
- 23. Financing of a Single Transaction 23 Musharakah can be restricted to agreed term, if goods are not sold in market, the importer may purchase the share of financer. This sale should take place at market price or at price agreed between the parties on the date of sale. Not at pre agreed price at the time of entering into musharakah. Musharakah can be used for export financing. The price on which goods will be exported is well known before hand and financer can calculate profit. Musharakah or mudarabah can be used for export. Exporter is responsible for export conditions of the
- 24. Financing of the Working Capital 24 Musharakah can be used. According to Imam Malik, capital of musharakah can be cash or non liquid assets. The value of the business can be treated as investment of the person who seeks investment. Musharakah may be for particular period one year or less. Both the parties agreed on percentage of profit. Investors percentage should not exceed percentage of investment. On the expiry all assets are once again evaluated for calculation of profit. The valuation of the assets can be treated as constructive liquidation. Working partner can purchase the share of financer Example: Total value of business of A $30. B finances another $ 20. At the end of the term the total worth of business is $ 100. Calculate profit of A & B if B will share 20% of profit.
- 25. Sharing in Gross Profit Only 25 Musharakah financing is difficult in a business having large number of fixed assets. Due to valuations, depreciation, salaries etc. may create accounting problems. Instead of net profit gross profit can be used for profit distribution. All the indirect expenses shall be born by the industrialist voluntarily. Only direct expense shall be borne by the musharakah. Industrialist percentage of profit may increase in this case. In case of gross profit sharing two options are there financier pay rent to client or the ratio of profit increased.
- 26. Objections on Musharakah Financing 26 Risk of Loss Musharakah more likely to pass on losses of the business to the financier bank or institutions. This loss is pass to depositors Depositors being constantly exposed to the risk of loss. Depositors prefer either remain idle or used amount outside of the banking. Banks and financial institutions study the feasibility before investment. Need more depth and precautions. Bank not invest in single musharakah but there is diversified portfolio of musharakah. Profitable musharakah are expected to give more profit than interest. Its like share of joint stock of company whose business is restricted to limited sector. Need more awareness and mentality to accept.. There is more expertise and diversification, so portfolio become hypothetical or theoretical risk only.
- 27. Diminishing Musharakah 27 According to this concept, a financier and his client participate in the joint ownership of a property or an equipment or in the joint commercial enterprise. The share of the financier is further divided into number of units. It is Understood that the client will purchase the units of the share of the financier one by one periodically. Thus client shares will increase and at end he will become the sole owner.
- 28. 28 By the end of the contract period, the real estate property becomes fully owned by the customer, while the financier has recovered the full invested amount. This financing scheme may look like an ijara financing. However, it is different as the asset is jointly owned by the two partners rather than by the financier (in case of ijara). The financier is compensated for this investment through payments by the customer that add to the return of capital.
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