Islamic Modes of Financing

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Islamic Modes of Financing

• Diminishing Musharakah

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Summary of the Previous Lecture

• In previous lecture we discussed certain
  situations and provided their solutions under the
  Musharakah and Mudarabah contract.

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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
• Purchase of House
• Construction of House
• Renovation of House
• Balance Transfer Facility (BTF)

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Diminishing Musharakah

• It is a type of Shirkah where one partner
  promises to purchase the other partners share
  gradually.

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Type of Diminishing Musharakah

• Like Musharakah contract Diminishing Musharakah
  is also of two types

/Diminishing Musharakah
Shirakat-ul-Milk Joint ownership
Shirkat-ul-Aqd Joint Venture
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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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Use of Diminishing Musharakah in the
PresentIslamic Banking System
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Use of Diminishing of Musharakah in Banking
System

• Diminishing Musharakah is usually used for asset
  financing and particularly in House Financing for
  four purposes
• Purchase of House
• Construction of House
• Renovation of House
• Balance Transfer Facility (BTF)

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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.

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1. Financing for Purchase of House

• 3. The property will be in the name of the
  client.
• 4. This is Shirkat-ul-Milk.
• According to the ratio of ownership, each one is
  responsible for the loss.
• Bank divides its own part of asset into units,
  which is promised by the client to purchase on
  pre-agreed price.

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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. Banks monthly profit may also be decided, as
  monthly rent of the house and principal amount
  will be recovered in the unit price.

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1. Financing for Purchase of House

1. 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.
2. Each unit will be purchased on the basis of Offer
   Acceptance.

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2. Financing for Purchase of Plot and
Construction of House

• There are two scenarios in this case
• Financing for Purchase of Plot Construction.
• Financing only for Construction

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2. Financing for Purchase of Plot Construction

• 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.
• Both partners will be the owners of the property
  in same ratio as the ratio of investment.

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2 Financing for Purchase of Plot Construction

• The property will be in the name of the client.
• This is Shirkat-ul-Milk.
• According to the ratio of ownership, each one is
  responsible for the loss.
• Bank will divide its own part of assets into
  units,
• Which is promised by the client to purchase on
  pre-agreed price

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2. Financing for Purchase of Plot Construction

1. 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.
2. Rent may be fixed on prevailing market value or
   with mutual consent.
3. Banks monthly profit may also be decided, as
   monthly rent of the house and principal amount
   will be recovered in the unit price.

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2. Financing for Purchase of Plot Construction

1. 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.
2. Each unit will be purchased on the basis of Offer
   Acceptance.
3. Purchase of unit can be started after Musharakah
   Agreement.

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2. Financing for Construction Of House

1. Valuation of plot will be made. This value will
   be investment of client in Musharakah Agreement
   and banks 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.

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2. Financing for Construction Of House

1. Both the partners will be owner of the property
   in same ratio as the ratio of investment.
2. The property will be in the name of the client.
3. This is Shirkat-ul-Milk.
4. According to the ratio of ownership, each one is
   responsible for the loss.
5. Bank will divide its own part of asset into
   units, which is promised by the client to
   purchase on pre-agreed price.

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2. Financing for Construction Of House

1. 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.
2. Rent may be fixed on prevailing market value or
   with mutual consent.
3. Banks monthly profit may also be decided, as
   monthly rent of the house and principal amount
   will be recovered in the unit price.

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2. Financing for Construction Of House

• 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.
• Before one year, client cannot purchase banks
  units.
• 13. Each unit will be purchased on the basis of
  Offer Acceptance.

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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 banks investment.

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3. Financing for Renovation of House

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
   renovation.
2. Both the partners will be owner of the house in
   same ratio as ratio of investment.

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3. Financing for Renovation of House

1. The property will be in the name of the client.
2. This is Shirkat-ul-Milk.
3. According to the ratio of ownership, each one is
   responsible for the loss.
4. Bank will divide its own part of asset into
   units, which is promised by the client to
   purchase on pre-agreed price.

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3. Financing for Renovation of House

1. 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.
2. Rent may be fixed on prevailing market value or
   with mutual consent.
3. Banks monthly profit may also be decided, as
   monthly rent of the house and principal amount
   will be recovered in the unit price.

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3. Financing for Renovation of House

1. 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.
2. Each unit will be purchased on the basis of offer
   acceptance.

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4. Diminishing Musharakah for Balance Transfer
Facility (BTF)

• 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.

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4. Diminishing Musharakah for BTF

1. Musharakah Agreement will be signed between bank
   and client in which investment of everyone will
   be agreed.
2. Both the partners will be owner of the property
   in same ratio as ratio of investment.
3. The property will be in the name of the client.
4. This is Shirkat-ul-Milk.

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4. Diminishing Musharakah for BTF

1. According to the ratio of ownership, each one is
   responsible for the loss.
2. Bank will divide its own part of asset into
   units, which is promised by the client to
   purchase on pre-agreed price.

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4. Diminishing Musharakah for BTF

1. Ijarah Agreement will be signed and bank will
   give its share of house on rent to the client.
2. Rent may be fixed on prevailing market value or
   with mutual consent.
3. Banks monthly profit may also be decided, as
   monthly rent of the house and principal amount
   will be recovered in the unit price.

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4. Diminishing Musharakah for BTF

1. 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.
2. Before one year, client cannot purchase bank
   units
3. Each unit will be purchase on the basis of Offer
   Acceptance.

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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 Bs
  share will be purchase by A. Bs share will be
  divided into 5 equal units and at the agreed
  intervals Bs 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.

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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.
  Banks 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.

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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
• Purchase of House
• Construction of House
• Renovation of House
• Balance Transfer Facility (BTF)