Islamic Equity Financing and Islamic Assets Financing

 Musharaka is a partnership between two or more persons with a number of fiqh rules to protect the interests of all parties.  Islam leaves many of the details of the partnership to be agreed among the partners but as with all muamalat contracts, there are certain fiqh rules to be applied. Some of the distinguishing features of musharaka are: 1. At least two partners, there is no maximum. 2. All partners can participate in the management, even if not to the same extent. 3. Capital can be equally contributed or in different amounts. 4. Profit sharing ratio must be agreed in advance. 5. Capital cannot be guaranteed by any partner, neither is interest on capital permitted. 6. Losses are shared on the capital ratio, not in the profit sharing ratio. 7. Each partner act as the agent of the other and can by himself decide to take a decision or to undertake a partnership activity, except that he is not allowed to his personal business or expenses under the partnership umbrella. 8. Some partners, especially if they work more than others can have a profit share more than others even if they have contributed lower capital. 9. Musharaka differs from mudaraba, in that all partners must participate in the running of the business and all partners must contribute in capital (except in wujooh and ‘amal partnerships)

 In contrast to the mudaraba, the bank has two advantages: 1. It has a say in the management and running of the musharaka business, this allows for control of agency costs and moral hazard problems. 2. losses are born in the capital contribution ratio, whereas in mudaraba, it is borne by the bank.as the rabbul mal.  The disadvantage is: 1. As a financial intermediary the Islamic bank might not want to get involved in the management of the business due to lack of expertise or regulatory requirements. However, in many jurisdictions, some leeway is given to Islamic banks to be more commercial as opposed to being a strictly financing institution, although this is still a problem with many bank regulators.

 Types of Musharakah Financing  There are at least two types of Musharakah financing. These are:  Constant Musharakah: the partner’s share in Musharakah capital remains (constant) throughout its period.  Musharakah Diminishing to Ownership: one party has the right to purchase a part of the other party’s share, which declines until one becomes the sole proprietor of all capital (Musharakah mutanaqisah).

 The salient feature of Musharakah is on the profit and loss sharing arrangement which is based on fair distribution of risks and efforts.  The need for proper accounting to measure the capital contribution is very important in the case diminishing Musharakah (Musharakah mutanaqisah). This is due to the Shari’ah requirement as in the case of loss, the loss must be fairly distributed based on capital contribution ratio.  The Musharakah financing is an equitable concept that reflects the rights of the partners.  The profit and loss sharing concept encourage partners to effectively contribute in the business.

 The accounting implications indicate that Musharakah financing needs proper accounting recognition, measurement and disclosure to ensure true and fair accounting for repayments of capitals, and profit and loss sharing between partners.  Despite its equitable arrangement, Musharakah financing is not widely offered by Islamic bank due to various factors such as passive risk appetite of the bank, lack of trustworthy.

 The Islamic concept of Musharakah or profit and loss sharing is a partnership arrangement, and normally used in financing projects.  According to AAOIFI FAS 4, Musharakah financing is a partnership between the Islamic bank and its clients, where both parties: contribute equal or varying amounts of capital to establish a new project or share in an existing one; capital can be on permanent or declining (capital) basis and it will have its due share of profits; and, partners share proportionate losses according to the capital contribution.

 In the case of Musharakah mutanaqisah, capital is not permanent and every repayment of capital by the entrepreneur will diminish the total capital ratio for the capital provider.  This will increase the total capital ratio for the entrepreneur until the entrepreneur becomes the sole proprietor for the business.  The repayment period is dependent up on the pre-agreed period.  This scheme is more suitable for the existing business that need new or additional capital for expansion.

 There are three general conditions for Musharakah, namely: i. The principle of Agency (Al-Wakalah)  The partners contracted for in the Musharakah must be capable of accepting the principle of agency or al Wakalah.  It follows that the partners must also be capable of being agents for their colleagues.

ii. The Fixing of the Ratio of Profit-Sharing  The ratio for the distribution of profits must be determined in advance. This is because; the distribution of profit is part of the subject matter of the contract. The ignorance pertaining to the subject matter may render the contract void. Thus, the ratio of profit- sharing must be known by all partners.

iii. The Profit-Sharing must be in Ratio not Fixed Amount  In pre-fixing the profit-sharing, a fixed amount must not be specified. This is because, the expected profit from the Musharakah is still not known. Thus, fixing a certain amount to be given to any of the partners is not compatible with the very nature of al- Musharakah contract. Rather, a ratio for profit distribution should be devised in order to facilitate profit-sharing after the profit has actually been procured.

 Termination of Musharakah  The reasons for the termination of Musharakah contract among others are as follows: 1. The cancellation of the contract of Musharakah by any of the partners. This is because the contract of Musharakah is not a binding contract; hence, any partner may terminate the contract at his will. 2. The death of any partners.