Islamic Finance

Chapter Four:Musharaka as a Mode of Islamic

Finance

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
 Chapter Four: Musharaka
• Musharaka is a form of partnership between an Islamic bank
and its clients whereby each party contributes to the
partnership capital, in equal or varying degrees, to establish a
new project or share in an existing one, and whereby each of
the parties becomes an owner of the capital on a permanent
or declining basis and is owed its due share of profits.

• however, Losses are shared in proportion to the contributed

capital.

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Types OF MUSHARAKA
• Constant Musharaka

• This is a Musharaka in which the partners’ shares in the capital

remain constant throughout the period, as specified in the contract.
• Diminishing Musharaka

• This is a Musharaka in which an Islamic bank agrees to transfer

gradually to the other partner its (the Islamic bank’s) share in the
Musharaka, with the effect that the Islamic bank’s share declines and
the other partner’s share increases until the latter becomes the sole
proprietor of the venture.

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DEFINITION OF MUSHARAKA

• Musharaka (from the Arabic shirkah) implies partnership

in a venture, and can be defined as a form of partnership
whereby two or more persons combine either their capital
or labour together, to share the profits, enjoying similar
rights and liabilities.
• It can take the form of a mufawada, meaning an unlimited,
unrestricted and equal partnership in which the partners
enjoy complete equality regarding the areas of capital,
management and right of disposition.
• Each partner is both the agent and the guarantor of the
other.

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Shirkah al’inan
• A more limited investment partnership is known as an ‘inan
(shirkah al’inan). This type of partnership occurs when two
or more parties contribute to a capital fund, either with
money, contributions in kind or labour. Each partner is only
the agent and not the guarantor of its partner.
• An ‘inan Musharaka is limited in scope to the specific
undertaking. This version is the most common form of
Musharaka.
• For both versions of Musharaka, the partners share profits
in an agreed manner and bear losses in proportion to their
capital contributions.

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Musharaka Agreement
• Such contractual partnerships are considered
proper because the parties concerned have
willingly entered into a contractual agreement for
joint investment and the sharing of profits and
risks.
• the profits can be shared in any equitably agreed
proportion. The bases for entitlement to the profits
of a Musharaka are capital, active participation in
the Musharaka business and responsibility.

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Profit sharing in musharaka
• Profits are to be distributed among the partners in the
business on the basis of proportions agreed by them in
advance.
• The profit share of every party must be determined as a
proportion or percentage. Losses must, however, be
shared in proportion to the capital contribution. On this
point all Jurists are unanimous.
• The word Musharaka means sharing, and is used to
describe those joint business enterprises in which the
partners share the profit or loss of the venture. Unlike an
interest-based product, there is no guaranteed rate of
return on the investment, because income is based on the
profit earned by the joint venture, and may possibly result
in losses.
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The basic principles of Musharaka
• Financing through Musharaka never implies lending
money; rather it means active participation in the business.
• The investor or financier must share profits and losses
incurred by the business, to the extent of their financing.
• Partners are at liberty to determine the ratio of profit
allocated to each one of them. This may be different from
the ratio of capital investment. However, the partner who
excludes himself from the management of the business
cannot claim more than the ratio of his capital investment.
• Losses suffered by each partner must be exactly in
proportion to his capital contribution.

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WHAT MAKES MUSHARAKA SHARIA’A COMPLIANT?

• As with many of the Islamic modes of finance, it is necessary to turn

to the Ahadith for confirmation of their Sharia’a compliance:
• The legality of partnership is evident from the following quotes:

• “They share in a third”.

An-Nisaa 12

• “Truly many are the partners (in business) who wrong each
other: Not so do those who believe, and work deeds of
righteousness”.

Saad 24

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WHAT MAKES MUSHARAKA SHARIA’A COMPLIANT?

• It was reported in the Hadith from the Prophet:

• I am the third of the two partners, unless either of
them betrays his friend, I withdraw from between
them.

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Application of Diminishing Musharaka
• According to this concept, a financier and his client
participate either in the joint ownership of property or
equipment, or in a joint commercial enterprise. The share
of the financier is further divided into a number of units
and it is understood that the client will purchase the units
of the share of the financier, one by one, periodically. This
process thereby increases the client’s own share until all
the units of the financier are purchased by him thereby
making him the sole owner of the property, or the
commercial enterprise, as the case may be.

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House purchase.
• Diminishing Musharaka has been used
mostly in house financing. Say a client
wants to purchase a house for which he
does not have adequate funds. He
approaches the financier who agrees to
participate with him in purchasing the
designated house. The client pays say a
total of 20% of the price and the financier
pays 80% of the price.

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House purchase.
• 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 requirements 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 into
eight equal units, each unit representing a
10% ownership of the house.

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House purchase.
• The client promises the financier that he
will purchase one unit every three months.
• Accordingly, after the first term of three
months, he purchases one unit of the share
of the financier by paying a tenth of the
price of the house. This reduces the share
of the financier from 80% to 70%. Hence,
the rent payable to the financier is also
reduced to that extent. And so on.

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Thank you

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