CIC2003 ISLAMIC FINANCIAL SYSTEM

Sem. 1, 2018-19

ASSIGNMENT 2
ISLAMIC HOME FINANCING STRUCTURED BASED ON
MUSYARAKAH MUTANAQISAH

Prepared by:

Group 3
AQILAH SYAFIQAH BINTI FARIDUN YUSRI (CIC170006)
Tuesday,
NUR ALLIEYA AINI BINTI AZAHAR (CIC170045)
11 am – 12 pm

ORGANISATION IDEAS (CONTENT) REFERENCES

Introduction Problem Statement
Conclusion Evidence of Support
Logical Flow Provision of Examples Total
Layout Presentation of
Argument
Sentencing
Table of Content
1. Introduction………………………………………………………………………………………...1
2. Musyarakah Mutanaqisah
i. Structured…………………………………………………………………………………….2-3
ii. Contract Issues………………………………………………………………………………4-5
iii. Implication of Musyarakah Mutanaqisah……………………………………………………6

3. Conclusion………………………………………………………………………………………….7

4. References…………………………………………………………………………………………8
 INTRODUCTION

Musyarakah Mutanaqisah (MM) are known in Arabic term for diminishing partnership.
Generally, Musyarakah Mutanaqisah are define as two or more partners join in capital for a
specific business venture, and towards the end of the term of partnership, one partner
gradually acquires the capital shares of the other partner. At the end of the term of
partnership, the partner owns the whole share in the partnership. Hence, one would become
the sole owner of the business venture while another owns zero in partnership. This will end
the partnership between the two parties. However, for home financing, at the end of the
partnership, the client would become the sole owner of the home or house they gradually
bought, while the bank owned zero shares and release full ownership to the client.

Issues regarding Musyarakah Mutanaqisah raise on the shifting from Musyarakah

Mutanaqisah to Commodity Murabahah (CM) due to lower risk in Commodity Murabahah. In
addition, most Islamic Financial Institutions finds that operating commodity Murabahah are
more flexible and are able to set as an alternative to Musyarakah Mutanaqisah. Besides that,
the Islamic banks also in reluctance to offer profit and loss sharing (PLS) contracts with the
clients. However, there are a few Islamic Financial Institution that still offers Musyarakah
Mutanaqisah such as Affin Islamic Bank Berhad. Nevertheless, Islamic Banking product
shall stay in the financial market as there are still demands for the product.

The objectives of this report are to discover the details of the Islamic product that is
Islamic Home Financing based on Musyarakah Mutanaqisah. In addition, this report written
is also to discover the implication of implementing the Islamic Home Financing based on
Musyarakah Mutanaqisah. To summarize the discussion, this report explains the structure
and operation of the Islamic Home Financing based on Musyarakah Mutanaqisah. In
addition, we would also discuss about the contract issue presence in Musyarakah
Mutanaqisah. Along the contract issues, there would be implication of implementing
Musyarakah Mutanaqisah in Home Financing that follows.

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 MUSYARAKAH MUTANAQISAH
Structure

Musyarakah Mutanaqisah is a hybrid financing product structured with 3 stages each

presence of a Syariah contract. Musyarakah Mutanaqisah generally means diminishing
partnership where the client gradually acquires asset, home or house from the bank.

1st stage (Musyarakah Contract)

The first stage starts with the client identifies the asset or house the she/he want to
purchase. After the house was identified, the client approaches the bank for home financing
and enter into Musyarakah Mutanaqisah arrangement where the main objectives are to
acquire the house. After the bank and client reach an agreement, the client is ought to pay
for initial down payment or deposits, considered as her/his contribution to the Musyarakah
Mutanaqisah venture while the bank’s contribution will be the financing amount. The first
stage is where Musyarakah contract, a syariah contract are entered between the client and
bank where the house is owned by the client while the bank participates as a financial
partner and the agreement for the rental payments.

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2nd stage (Ijarah Contract)

Next, the second stage of Musyarakah Mutanaqisah continued where the bank
subsequently leases the acquired house to the client. As agreed, prior during the
Musyarakah contract, the rental paid by the client to the bank at an agreed amount consists
of two types of payments. The sum of the payment for gradual purchase of the shares of the
financier and payment for lease rental make up the monthly payments that the client must
pay to the bank.

3rd stage (Bai’ Contract)

The last stage is where the client purchases the bank’s equity of the jointly acquired
property based on the agreed time intervals throughout the lease tenure. On the bank’s side,
over the financing tenure, the bank’s shares are redeemed and reduced by the purchase
made by the client. Based on figure 3, the purchaser, represented by client, pays 10% as the
initial share to co-own the house while the banks provide the financing for 90%. Then, the
client gradually redeems the financier’s (banks) 90% share at an agreed portion periodically
until the house is fully owned by the client. The banks lease its 90% share under the concept
of ijarah by charging rental fees. Bai’ occurs at the end of the financing agreement where the
ownership title will fully be transferred to the client once the equity portion of the bank has
been fully redeemed. Thus, the partnership between client and bank is then effectively
terminated.
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Contract Issues

a) Event of default

The termination of the Musharakah Mutanaqisah in the event of default could take place
by either of two approaches, without promise and with promise which is also known as
purchase undertaking.

i) Without promise, whereby the underlying property will be sold in the market and
proceed will be shared between the bank and the customer according to the latest
ownership share ratio. If there is a surplus, it will be shared between the parties
based on the profit sharing ratio. If there are losses, it will be shared according to
the capital of each party. For example, the house price RM 10,000.The PSR is
1:9.If the house was selling at RM 9, 00, the bank will get RM 6,300 and the
customer will get RM 2,700.

ii) With promise or purchase undertaking, the customer is required to buy all the
outstanding shares of the banks at once. Majority of the banks are using the wa'd
in their structure. However, if the customer are not able to do so, Musyarakah
Mutanaqisah will be terminated and the underlying property will be sold at an
auction. The selling price of the house could be higher, lower or equal to the
amount claimed.

.
b) Termination of Contract

The bank had recourse to the customer through either a purchase undertaking or trust
deed, in the following termination events:
i) If the customer failed to buy the bank’s entire share of ownership in the property
when the MM agreement was due to terminate
ii) If the customer was unable to make commercial transactions as prescribed by
Shariah, or if the customer died, or was declared to be of unsound mind

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c) Early Settlement

i) Full fledge Islamic Bank allowed customers to ask the bank if they could purchase
the remaining share of ownership at any time during the agreement’s tenure, with
30 days advance notice to the Bank.
ii) Foreign Bank allowed customers to settle the MM if they gave the Bank one
month’s notice in advance and paid the Settlement Amount. Then the Musharakah
Mutanaqisah Arrangement was dissolved.
iii) Local Bank allowed the customer to settle the facility early by paying the
equivalent of the outstanding financing balance and any other amount due and
payable to the bank.

d) Determination of Rental and Share Prices

The majority of Muslim scholars considered that the price of shares as well of rental
prices should be left to market forces, reflective of the true value. This meant adjusting
the payment amounts at every instalment to reflect the market condition at that particular
time. The purchase undertaking (wa’d) granted the bank the right to force the customer to
purchase the bank’s share portion on credit or to purchase the customer’s share at a pre-
determined price. By doing this, the bank will be able to protect itself from the
depreciation in value of its property. BNM’s Shariah Advisory Council allows the customer
to give the wa’d to the bank to purchase the bank’s share either on a lump sum basis or
gradually over an agreed period of time.

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The Implication of Musharakah Mutanaqisah Implementation by Malaysian Islamic
Bank

The implication of Musharakah Mutanaqisah’s implementation by Malaysian Islamic

banks is that there is an increase in the legal documentations. Due to the documentation
issues, there is an increase in the documentation costs that the customers need to pay and
there is also an increase in the risks faced by the Islamic banks in implementing the product.
Besides that, in implementing MM, most of the Islamic banks in Malaysia are using IBR even
though MM has the flexibility in terms of its rental rate. The permissibility of the Wa’ad
(Purchase undertaking) signed by the customers while applying MM financing is still
ambiguous even though it has been allowed by BNM. The issues arose from MM have lead
the banks to seek for other alternatives. Out of the total of 12 banks that offer MM as their
home financing products, 6 of them (50%) stopped offering MM and switched to Commodity
Murabahah, Ijarah Muntahiyah bi al-Tamlik and Istisna’. This finding could be explained by
two main reasons which are Islamic banks’ reluctance to offer profit and loss sharing (PLS)
contracts and the flexibility of other alternative home financing products, specifically with
regards to properties under construction and third party ownership, which could be catered
better by Commodity Murabahah and Ijarah Muntahiyah bi al-Tamlik

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 CONCLUSION

In conclusion, it is as discussed, that Musyarakah Mutanaqisah involved 3 syariah

contract that is Musyarakah contract, Ijarah contract and Bai’ contract subsequently. Each
Syariah contract occur in each stage as explained. Musyarakah Mutanaqisah structured are
used as Islamic Home Financing widely. However, Musyarakah Mutanaqisah are practiced
differently across Malaysia in terms of its documentation, in the event of default, termination
of contract, early settlement and determination of rental and share prices. These approaches
create implication towards the Islamic Banks such as an increased in the documentation and
two others.

Despite having a contract issues or whether it is practiced differently, there are still
few Islamic Banks that offer Musyarakah Mutanaqisah Home Based Financing such as
Maybank Islamic Berhad. It is found that about 50% of banks in Malaysia has stopped
offering Musyarakah Mutanaqisah financing for Home Financing and had shift to commodity
murabahah. The shifting was due to the reluctance of Islamic Financial Institution to offer
profit and loss sharing contract because the financiers bear higher risk especially when client
defaulting from their obligated payment or when the contract are terminated due to client’s
failure to buy the Bank’s entire share of ownership. Apart from that, Islamic Financial
Institution found that there is other flexible alternative that could replace Musyarakah
Mutanaqisah for Home Financing such as commodity murabahah.

One of the challenges that Banks may face when implemented the Musyarakah
Mutanaqisah is that when clients failed to purchase with or without Wa’d, the Bank has to
either sold it in the market or to any third party at auction. Apart from that, the termination of
contract due to the death of client or the client becoming unsound mind would have cause
the bank to bear the risks. To prevent such risks from affecting their operations, some banks
are now shifting towards commodity murabahah. However, if all Islamic Banks are shifting to
commodity murabahah, the challenges in the Islamic Banking Industry is that Musyarakah
Mutanaqisah might not be offered anymore. But, because financial product moves alongside
with demands from society, thus, as long as there are demands from the customer, there are
still some banks that might have offer Musyarakah Mutanaqisah Home based Financing.

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 REFERENCES

Asian Institute of Finance. Musharakah Mutanaqisah Home Financing. Retrieved from

https://www.aif.org.my/clients/aif_d01/assets/multimediaMS/publication/CaseStudy_M
usharakah.pdf

Shofni, A. (n.d.). Musharakah Mutanaqisah Home Financing in Malaysia: A Critical

Appraisal. Retrieved May 22, 2019, from
https://www.academia.edu/3336406/Musharakah_Mutanaqisah_Home_Financing_in_
Malaysia_A_Critical_Appraisal

Subky, Mohd, K. H., Liu, Yuan, J., Abdullah, Muzzammil, M., . . . Ainaz. (2017, February 06).
The Implication of Musharakah Mutanaqisah in Malaysian Islamic Banking Arena: A
Perspective on Legal Documentation. Retrieved May 22, 2019, from
http://www.ijmar.org/v4n1/17-003.html