Part 2: Individual Effort

Musharakah Mutanaqisah (MM) was relatively new but started to gain popularity
amongst Islamic financial institutions. It regarded to be much convenient and better compliant to
shariah regulations. It was generally argued that MM was closer to the spirit and objectives of
Shariah and should therefore be used more often by Islamic financial institutions. Recent
development in the field has brought a new home financing concept to the fore. Diminishing
partnership (DP) overcomes the main criticism of BBA by forcing banks to take the risk of
ownership and progressively pass the ownership to consumers. The new concept would also
indirectly overcome the concern about utilizing interest rates as a benchmark by replacing it with
rental income. The Shariah validity of the underlying contracts in MM, Musharakah(partnership),
Ijarah(rental) and Bay’(selling) were found in the Quran, the Prophet’s Sunnah and Consensus of
the Muslim scholars (Ijma).

The Shariah compliant of home financing is an investment fund that meets and honors the
demands, requirements and principles based on Shariah. While it also benefiting from the best of
what is available in the modern financial market place. The objective of the Shariah law is to
promote the welfare of the citizens, which lies in safeguarding the faith, life, intellect, future and
property. The principles of Shariah are prohibited income or profit, such as riba (interest) and
gharar (uncertainty). It balances the moral and material needs of a society to achieve socio-
economic justice. Shariah ruling of financial instruments is unable to pay or collect interest from
customers. A Shariah principle of home finance product provides the great confidence because it
is reviewed and approved by Shariah board that comprised of extraordinarily learned scholars
from across the world who take due diligence in supervising and certifying financial products.
Furthermore, Shariah places a great importance on ethical and equitable financing, social welfare
and economic development.

The product that we chose is home equity financing, in Musharakah Mutanaqisah concept,
customer and bank purchase the house jointly. At first, the bank will leases the house to the
customer and rental payments are shared between them based on profit sharing ratio. Then, the
customer will redeem the bank’s share on monthly basis until full payment settlement after
which the asset such as house is transferred to the customer. The DP concept of home financing
product is shariah compliant because it promotes the true spirit of Islamic banking by
emphasizing on the welfare of the people and takes care of the well-being of society. Since the
Musharakah Mutanaqisah is rests on profit and loss sharing and not on debt, hence it seen as not
causing privation and harm to the customers. The bank takes ownership and assumes the
responsibility of the property or asset until the financing amount is fully settled and customer
takes possession of the property. This represents the principle that should be practical in Islamic
sale transaction and therefore, the seller must have possession of the goods and takes liability of
it before it is sold to the buyer.

The concept is handles the issue over the fixed interest with rental rates. The DP is also
flexible and the customer can own the asset in advance by purchasing additional bank’s share.
Debt concept in Islam is based on actual buying and selling and is classified under the contract of
Murabahah and Bai- Baithman Ajil (BBA). Yet, the equity concept is differs from debt as it falls
under the contract of diminishing partnership. Under this arrangement, customer and bank are
sharing their capital to purchase the asset. Besides, profit is not determined upfront as in debt
financing but realized gradually based on the profit sharing ratio agreed between customer and
bank. Therefore, the customer is not indebted to the bank at the onset as in conventional home
financing.

In the situation of DP home financing, rental rate is replaces interest rate as the
benchmark to determine the profit. Rental rate is based upon the actual market value of the
property. The fluctuation of rental price of a house is a terrible problem that MM has to face.
Usually, the rental price increases with the passage of time which places the customers into
difficulties. And also for the locations such as rural, town or city areas and not predetermined
upfront based on interest rate (BLR). For example, customers who wish to purchase a house for
RM250, 000 and paid 10% of the purchase price to the developer as down payment that
amounting to RM25, 000 initially. On the other hand, bank owns the remaining 90% (RM 225,
000). The rental rate agreed was RM 1,744.42, for example 8.37%. The customer pays another
RM 190.17 monthly to redeem the banks share in 20 years. This gives the total monthly payment
as RM 1,934.59 (1744.42+190.17).

MM also faces some challenges and problems in its implementation such as house rent.
The house rent will varies based on the location and time. Another important issue is the promise
(wa`d) from the client to buy the share of the bank gradually until he owns the whole property.
Islamic jurists are divided in determining whether fulfilling this promise is obligatory or
recommended. If the promise is obligatory then the bank has the legal right to impose a fine to
the client if the client does not fulfill his promise. Conversely, if the fulfilment of promise is
recommended, then the client has the freedom to carry it out or terminate it at any time. The bank
should not have any legal right to impose fine on the customer. Furthermore, another significant
issue in this contract is the damage of the property. If the property is damaged by the client
because of his negligence, then he should pay the compensation. Besides, if the damage is due to
natural calamities and so on, then both the partners have to share the loss according to their
proportion as the condition of partnership.

In addition, the current practice of home financing in Malaysia does not truly fall under
the concept of buying and selling required by the Shariah as the banks do not buy the house
directly from the developer and hence do not have possession of the property. Instead, it falls
under the practice of Bai Inah that subjected to Bai Bithaman Ajil(BBA) mode of financing to
criticism from international Shariah scholars. In contrast, the DP home financing does not
involve Bai Inah as in this mode of financing that both the bank and customer are jointly
purchase the house and own the house. Later, bank takes possession and risk of ownership in
meeting the Shariah

DP requires joint ownership and liability by both banks and customers and it uses rental
income as a benchmark in determining the fair pricing. These salient features of DP have led to
the concept being perceived as more Shariah compliant than BBA, a debt-based financing. To
put the concept into use of practice would require a significant departure from banks’ normal
practice, for example using interest rate as a means of fixing income or profit. However, the
move is expected to be welcomed by consumers as it would reduce their financing costs
significantly.
Recommendation

MMP should implement with the variable rental rates of the house. For example, let’s say
if the cost of capital to the bank is based on variable rental rates whereas the MMP rental rate is
using fixed rate for the entire tenor, then the bank may encounter liquidity risk issues. The issue
or difficulty is matching the short duration deposit funds with long duration of the financings.
The MMP can be made for flexible by requiring the review of rental periodically, like every five
years. This would eventually reduce the mismatch problem.

Example of Musharakah Mutanaqisah Partnership (MMP) Financing With Varying

Rental Rate

A customer wishes to buy a house priced at RM300, 000. It assumes that the customer pays 20 %
of the house value (RM60, 000), the banks puts the remaining 80 %(RM240, 000). The customer
wishes to redeem the bank’s share in 20 years. Now assume that the rental is agreed upon to be
RM1, 500 per month for the first 5 years, but would be reviewed to RM1, 800 for the next 5
years and RM2, 000 for the remaining 10 years. According to the MMP formula, if the customer
pays RM1, 500 every month, it would take more than twenty years (exactly 26 years and 11
months) to fully own the house. Therefore, some additional amount is necessary in order to
𝑅 1500
redeem within twenty years. Hence, the rental rate is, x = = 300000 = 0.005 and the additional
𝑃

monthly amount needed is

𝑥 [𝑃−(1+𝑥)𝑛 𝐶0 ] 0.005 [300,000−(1+0.005)240 𝑥 60,000]

A= = = RM219.43
(1+𝑥)𝑛 −1 (1.005)240 −1

Therefore, the total monthly payment = RM1500 + RM219.43 = RM1719.43 for the first 5 years.

Table (appendix 1) provides the schedule for the above MMP contract. At the end of the 5th year,
the balance of financing (financier’s equity) is RM203, 759.35 while the customer’s equity is
RM96, 204.35. Thereafter, the rental would be increased to RM1, 800 per month. The new rental
rate is x = 1800/300000 = 0.6% while the remaining contract period is 15 years or 180 months.
𝑥[𝑃−(1+𝑥)𝑛 𝐶0 ]
The new additional monthly amount can be computed as follows: 𝐴 = (1+𝑥)𝑛 −1

0.006[300,000−(1+0.006)180 ×96,240.35
= = RM54.31
(1.006)180 −1
Therefore, the new total monthly payment = RM1, 800 + RM54.31 = RM1, 854.31 for the next 5
years (60 months). The balance of financing (financier’s equity) at the end of this period is
RM158, 295.35 while the customer’s equity is RM141, 704.65.

For the remaining ten years (120 months), the rental is fixed at RM2, 000 per month, which gives
a rental rate of x = 2000/300000 = 0.6667%. Now, interestingly the new additional amount
needed is a negative amount.

𝑥[𝑃 − (1 + 𝑥)𝑛 𝐶0 ]
𝐴=
(1 + 𝑥)𝑛 − 1
0.006667[300,000 − (1 + 0.006667)120 × 141,704.65
𝐴=
(1.006667)120 − 1

= - RM79.44

Therefore, the new total monthly payment = RM2, 000 – RM79.44 = RM1, 920.56 for the last 10
years (120 months). However, if the customer is willing to pay the RM2,000 rental, then the
remaining duration of the contract can be shortened. In this case it would be 9 years and 5
months, i.e. shortened by 7 months.

In this case, the only change is the rental. If the customer is willing to pay more on the rental
(such as RM 2000 per month) to the bank, which mean it require a shorter period of time to fully
own the asset. To improving, bank should also bear the responsibility if everything happen to the
house and bear the risk of ownership.