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Definition

Musharaka is derived from the word ‘sharikah’ which means ‘partnership’. Musharaka is defined as a partnership where profits are shared as per an agreed ratio whereas the losses are shared in proportion to the capital or investment of each partner. All partners must provide capital and may participate in management of business project.

Diminishing Musharakah

It is a Partnership where one partner agrees to gradually purchase the units/stake of ownership of the other partner in a property/asset jointly acquired until full ownership of all units passes to him.

There are three components of DM contract:

  • Joint acquisition by the Bank and customer of asset or property.
  • The customer buys out the share of the Bank in the asset/property.
  • A customer as a lessee uses the share of the bank paying rentals to the bank (financier).

    • Features of Musharakah

  • DM is used for mortgage financing, asset-based financing such as motor vehicles, plant, and machinery.
  • Pricing is normally mirrored against conventional facilities.
  • The profit rate is variable and benchmarked against the bank’s base rate.
  • Unlike conventional loans there is no capitalization.
  • Profit is recognized on an accrual basis based on the outstanding principal amount.

    • Default penalties are charged but not recognized as income-given to charity.

    Profit and Risk sharing: illustration for Musharaka

    Our customer takes an ABF of Kes.8m for a car costing Kes.10m. Two years later when he had repaid Kes 2m of the principal (therefore Kes.6m outstanding balance) the vehicle was involved in an accident and totally written off. Insurance compensation of Kes 7m was paid. Therefore, in the principal of PLS, proceed (insurance compensation) is shared: -.

    Bank: 60% * 7,000,000 = 4,200,000

    Customer: 40% * 7,000,000 = 2,800,000

    Note: The bank will be left with a residual balance of Kes 1.8 million which it will have to write off. If this was a conventional loan the bank would first make good its loan balance, so takes Kes.6m, and gives the balance Kes 1 million to the customer. Therefore, with Islamic finance the customer is better off with Kes 1.8m (2.8 - 1).

    Please note that in the above example, it is assumed the accident was not caused by the customer’s negligence/misconduct.

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