1. Islamic Modes of Financing Diminishing Musharakah

2. Summary of the Previous Lecture In previous lecture we discussed certain situations and provided their solutions under the Musharakah and Mudarabah contract.

3. 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)

4. Diminishing Musharakah It is a type of Shirkah where one partner promises to purchase the other partner’s share gradually.

5. 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

6. 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.

7. 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.

8. 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.

9. 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.

10. 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.

11. 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.

12. 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.

13. 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.

14. Use of Diminishing Musharakah in the Present Islamic Banking System

15. 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)

16. 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.

17. 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.

18. 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.

19. 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.

20. 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

21. 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.

22. 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

23. 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.

24. 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.

25. 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.

26. 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.

27. 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.

28. 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.

29. 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.

30. 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.

31. 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.

32. 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.

33. 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.

34. 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.

35. 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.

36. 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.

37. 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.

38. 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.

39. 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’.

40. 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.

42. 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)