Diminishing Musharakah

Outline
• Diminishing Musharakah - Introduction
• Basic Structure
• Shariah Principles
• Illustration
Diminishing Musharakah - Introduction
 Musharakah

Musharakah is a form of partnership (Shirkat)

There are two types of Shirkah:

1. Shirkat-ul-Milk

Joint ownership of two or more persons in a

particular property

2. Shirkat-ul-Aqd

A partnership affected by mutual contract. It can

also be translated as a joint commercial
enterprise
 Diminishing Musharakah

• In Diminishing Musharakah the financier and the

client participate either in joint ownership of
– a property or an equipment, or in a joint
commercial enterprise

• The share of the financier will be divided into a

number of units

• The client will purchase these units one by one

periodically until he is the sole owner of the
property
 Diminishing Musharakah

Three components of Diminishing Musharaka

 Joint ownership of the Bank and customer

 Customer as a lessee uses the share of the
bank
 Redemption of the share of the Bank by the
customer
 Diminishing Musharakah

Mode of Fixed Asset Financing

Diminishing Musharakah is commonly used for the

purpose of financing of fixed assets by various
Islamic banks.
 House financing
 Car Financing
 Plant and machinery financing
 All other fixed Assets
Basic Structure
 Joint
Ownership
BANK Rent CUSTOMER
Mushara
ka
 The customer approaches the Bank with the
request for Project/Machinery/House financing
 The Bank enters into a Musharakah (Joint
Ownership) agreement with the customer and
both of them pay their respective shares to the
seller of the asset.

 Customer promises to purchase Bank’s share

(units) over the tenure of transaction with the help
of Undertaking to Purchase
 Joint
Ownership
BANK Gradual Transfer of Ownership CUSTOMER
Mushara
ka
 Customer promises to purchase Bank’s share
(units) over the tenure of transaction with the
help of Undertaking to Purchase
 Customer pays rent for the use of banks share
in the property
 Customer purchases the units every month via a
separate offer & acceptance every month and
will eventually become the owner of the
property.
 Joint
Ownership
BANK Gradual Transfer of Ownership CUSTOMER
Mushara
ka

 Ownership of the asset is gradually transferred

to the customer upon payment of asset price.
(with the help of a Sale transaction between
bank & customer at the end of each period)
Shariah Principles
 Shariah Principles

• To create joint ownership in property is called

Shirkat-ul-Milk and is expressly allowed by all schools
of Islamic Jurisprudence.

• All Muslim Jurists agree on the permissibility of the

Financier leasing his share in property to client and
charging him rent i.e. the permissibility of leasing
one’s share to his partner.

• There is difference of opinion among leasing one’s

share to a third part But there is no difference on
permissibility on leasing to a partner.
 Shariah Principles

• Promise of client to purchase units of share of

financier is also allowed.
• The Transactions cannot be combined in a single
arrangements and they have to be executed
independently.
• This is because it is a well settled rule of Islamic
Jurisprudence that one transaction cannot be made a
condition for another.
• Instead of making the transactions a pre-condition
for one another there can be one-sided promises from
one party to another
Illustration I
 DM - Illustration

1. Customer request financing for a fixed Asset

costing Rs. 300 million.
2. Islamic Bank agrees to provide financing up to
90% of the cost.
3. Joint Ownership Agreement is executed between
the bank and the Customer.
4. Bank will purchase 90% share in the asset by
paying Rs. 270 million to supplier.
5. Customers pays its share of Rs. 30 million.
 DM - Illustration

6. Bank’s share is divided into five units.

7. Customer agrees to buyout Bank’s share (units) on
yearly basis and the Undertaking is executed by
the customer.
8. Customer pays the rent for the usage of the
Bank’s units .
9. Rental reduces after purchase of each unit by the
customer.
10.After five years ownership of the asset is
completely transferred to the customer.
Illustration II
1.Client makes the choice of the house

Banker

Customer

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 2. Bank & client enter into a
Musharakah agreement
Value of House:
Rs.10,000,000

Shirakat-ul-
milk

10%
ownership
is of
Customer

90% ownership
is of Bank

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3. Bank & client enter into an Ijarah
agreement

Bank rented his part to the

client and now client can use
the whole house

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Bank divides its own part of
asset into units, which is
promised by the client to
be purchased on pre-
agreed price.

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 Payment Calculation
Value of House (Rs.) Rs.10,000,000
Tenure in years 10
(Quarterly payment)
Total Payments 40 Parts <--- [4*10]
Investment by client Rs. 1,000,000

Total Units 100

Client’s Share 10
Bank’s Share 90

Contd…….

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Units to be purchased in each quarter 2.25 units
(No. of payment / Bank’s Share) i.e.
40/90
Unit Price = value of house / total units Rs. 100,000
i.e. 10,000,000/100
Value of units of each quarter Rs. 225,000
2.25 * 100,000

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 Kibor +spread = 14.70%
Shirkah
Profit (Rs.)
value of total outstanding
Installment Date Opening (Rs.) = (Op.*rate)
units per Q Installment capital
*(1/4)
closing
0 01/01/08 9,000,000 0 0 0 9000000
1 31/03/08 9,000,000 33,0750 225,000 555,750 8775000
2 30/06/08 8,775,000 326,868.75 225,000 551,868.75 8550000
3 30/09/08 8,550,000 318,487.5 225,000 543,487.5 8325000
4 31/12/08 8,325,000 312,187.5 225,000 537,187.5 8100000

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 Practice Problem
• Mr. A is a non Muslim client of an Islamic bank
entered into a DM contract of 20 years. For the
purchase of a factory building with equipment's.
The worth of the factory is about 100 M and the
rent of the factory is about 0.5M per
month(rental payments will be made once an
year). The Client will purchase 20% shares
initially at the time of the contract and rest of
the share will be purchased on Annual basis.
• Required: Calculate the payments Mr. A will
made to IB each of the 20 Years.
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