Islamic Modes for Agricultural
Financing
PRODUCTS – Diminishing
Musharakah
Lahore 20 – 21 October, 2008
Al – Huda Training Programme
Muhammad Khaleequzzaman
Head Islamic banking Department
Int’l Islamic University Islamabad
Islamic Modes – Agricultural Financing
Rules of Musharakah
•
•
•
•
Fulfillment of prerequisites of a contract
Rules of contribution of equity
Rules of profit and loss sharing
Management of Musharakah/Relationship of
parties
• Termination of musharakah
Uses of Musharakah:
– Agricultural enterprise financing
– Project financing
– Working capital financing, etc.
Islamic Modes – Agricultural Financing
Musharakah
• An equity participation contract under which
IB and its client contribute jointly to finance an
enterprise.
• Equity is owned according to each party's
share in financing.
• Profit is shared in pre-agreed ratio and loss in
proportion to the capital contribution.
• It is an ideal alternative to the interest-based
financing with far reaching effects on both
production and distribution.
Diminishing
Musharakah (DM)
Islamic Modes – Agricultural Financing
Diminishing Musharakah (DM):
A form of Musharakah where the financier and the
client participate in a joint commercial enterprise
or property. This enterprise is converted into
undivided ownership of both the financier and the
client. Over certain period the equity of financier,
divided into equal value units, is purchased by the
client. And ultimately the client becomes the sole
owner of the enterprise.
Uses of DM
–
–
–
Agric. Machinery and implements financing
Storage facility construction/sheds
Transport vehicles, etc.
Islamic Modes – Agricultural Financing
Diminishing Musharakah (DM):
Procedural details:
–
Client requests the bank for DM
–
Appraisal is accorded
–
Approval is conveyed.
–
bank releases its share to become partner in
the asset. And contract of Musharakah is
executed. [buying &selling not stipulated]
–
This asset becomes undivided ownership of
both the bank and the client [Musha] None of
the parties can withdraw its equity till DM is
terminated
–
General rules of partnership apply
Islamic Modes – Agricultural Financing
Diminishing Musharakah (DM):
Procedural details: (contd..)
– At the same time, uni-lateral promise from client
is obtained to purchase the units of bank’s
equity.
– The price of one unit of bank’s equity is valued
– Ijarah Agreement is signed
– In case of Ijarah the rent is realized while in case
of business or services profit and losses are
shared
– Expenses connected to asset are borne by the
partners proportionately
Islamic Modes – Agricultural Financing
Diminishing Musharakah (DM):
Procedural details: (contd..)
– Equity of bank is periodically purchased by the
client
– Bank’s share in the asset decreases while that of
client increases – so happens to the rent or profit
– Ultimately the client becomes the sole owner of
the asset [Bank’s share reduces to zero]
DIMINISHING MUSHARAKAH
Share in
capital
Share in
capital
2
Partner
Bank
3. Accruing Rentals
Pays price of
the units of
bank’s equity
4
Sell its
share in
equity
Islamic Modes – Agricultural Financing
Diminishing Musharakah (DM):
Examples – Financing Purchase of Tractor:
A client wants to purchase a tractor by sharing of
equity of Rs. 40,000 against price of Rs. 400,000.
The bank shares rest of the price of tractor ie. Rs.
360,000. How his request can be accommodated by
a bank?
Bank agrees to finance the purchase of
tractor through DM.
Islamic Modes – Agricultural Financing
Diminishing Musharakah (DM):
– 10% of the cost (Rs. 40,000) is paid by the
client and 90% of the cost (Rs. 460,000) by
the bank. [Musharakah Contract is signed]
– The rental of tractor is fixed according to
certain reference price [Ijarah for future date
is signed]
– The client promises (unilateral promise) to
the bank to purchase banks equity divided
in to equal value units
– Say, rent is fixed @ 15% p.a.
– The DM terminates after 3 years
– Installments can vary [Seasonal, quarterly,
monthly]
Islamic Modes – Agricultural Financing
Diminishing Musharakah (DM):
– After acquisition, the client uses tractor and
pays rent to bank for using bank’s share in
the property
– At the same time, purchases unit(s) of equity
after expiry of each rental period
– The equity of bank diminishes to zero on
expiry of three years, the rental as well,
client becomes sole owner
Islamic Modes – Agricultural Financing
Diminishing Musharakah (DM):
(Amount in rupees)
Total value of Asset:
60000
Share of client
40000
Share of Bank
360000
No. of units
36
Value of one unit
10000
Rent per month
4500
Rent per unit per month 4500 / 35 = 125
End of
Month
Rent
Value unit Total
purchased payment
Remainin
g units
Remainin
g balance
0
0
0
0
36
460000
1
125 x 36 10000
= 4500
14500
35
450000
2
125 x 35 10000
= 4375
14375
34
440000
3
125 x 34 10000
= 4250
14250
33
430000
35
125 x 2 = 10000
250
10250
1
10000
36
125 x 1 = 10000
125
10125
0
0
Total
??
??
460000
Islamic Modes – Agricultural Financing
THANKS