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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 Outcomes
After 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

Shirkat-ul-Aqd Shirakat-ul-Milk
Joint Venture Joint ownership
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.
Rules of Diminishing Musharakah
in Joint Ownership

• 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.
Rules of Diminishing Musharakah
in Joint Ownership
• 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.


1. Financing for Purchase of House
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.
1. Financing for Purchase of House
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.
1. Financing for Purchase of House

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
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 will divide its own part of assets into units,

7. Which is promised by the client to purchase on


pre-agreed price
2. Financing for Purchase of Plot &
Construction
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.

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.
2. Financing for Purchase of Plot &
Construction
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.
2. Financing for Construction Of
House
3. Both the partners will be owner of the property in same
ratio as the ratio of investment.

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

5. This is Shirkat-ul-Milk.

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


responsible for the loss.

7. Bank will divide its own part of asset into units, which
is promised by the client to purchase on pre-agreed
price.
2. Financing for Construction Of
House
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.

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


mutual consent.

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


rent of the house and principal amount will be
recovered in the unit price.
2. Financing for Construction Of House

11. 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.
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.
3. Financing for Renovation of House

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 renovation.

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


ratio as ratio of investment.
3. Financing for Renovation of House

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

5. This is Shirkat-ul-Milk.

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


responsible for the loss.

7. Bank will divide its own part of asset into units, which
is promised by the client to purchase on pre-agreed
price.
3. Financing for Renovation of House
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.

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


mutual consent.

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


rent of the house and principal amount will be
recovered in the unit price.
3. Financing for Renovation of House

11. 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.

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

3. Musharakah Agreement will be signed between bank


and client in which investment of everyone will be
agreed.

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


ratio as ratio of investment.

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

6. This is Shirkat-ul-Milk.
4. Diminishing Musharakah for BTF

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


responsible for the loss.

8. Bank will divide its own part of asset into units, which
is promised by the client to purchase on pre-agreed
price.
4. Diminishing Musharakah for BTF

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


share of house on rent to the client.

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


mutual consent.

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


rent of the house and principal amount will be
recovered in the unit price.
4. Diminishing Musharakah for BTF

12. 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.

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)