Diminishing (or Digressive, as it is sometimes known) Musharaka is a special form of Musharaka, which
ultimately culminates in the ownership of the asset, or the project, by the client. It operates in the following
manner. The Islamic bank participates as a financial partner, in full or in part, in a project with a given
income forecast. The partner and the bank sign an agreement that stipulates each party’s share of the profits.
The agreement, however, also provides payment for a portion of the net income of the project as repayment
of the principal financed by the bank. The partner is entitled to keep the rest. In this way, the bank’s share
of the equity is progressively reduced and the partner eventually becomes the full owner. When the bank
enters into a Diminishing Musharaka, its intention is not to stay in the partnership until the company is
dissolved. In this type of partnership, the bank agrees to accept payment on an instalment basis or in one
lump sum of an amount necessary to buy out the bank’s partnership interest. In this way, as the bank
receives payments over and above its share in partnership profits. Its partnership interest diminishes until it
is completely bought out of the partnership. After the discharge, the bank withdraws its claims from the
deal and the property/business becomes the property of the partner. The decreasing partnership arrangement
is an Islamic bank innovation. It differs from the permanent Musharaka partnership only in continuity. The
intent of the project is capital growth. The project may be profitable or may lose money. In the event of loss
each partner bears his share in the loss in the exact proportionate share of capital. If the project is successful,
profits are distributed between the two partners (the bank and the customer) in accordance with the
agreement. There are four steps in a Diminishing Musharaka:
1. The bank tenders part of the capital required for the project in its capacity as a participant and agrees
with the customer/partner on a specific process of gradually selling its share of the capital to the partner.
2. The customer/partner tenders part of the capital required for the project and agrees to pay an agreed-upon
amount in return for the ultimate full ownership of the business/property.
3. The bank progressively sells its share of capital. It expresses its readiness, in accordance with the
agreement, to sell a specific percentage of its share of capital.
4. The customer/partner pays the price of that percentage of capital to the bank and the ownership is
transferred to the customer/partner.
According to the concept of Diminishing Musharaka, a financier and his client participate either in the joint
ownership of a property or equipment, or in a joint commercial enterprise. The financier’s share is further
divided into a number of units and it is understood that the client will purchase these units one by one
periodically, thus increasing his own share until all the units of the financier are purchased, so making the
client the sole owner of the property, or commercial enterprise, as the case may be. Diminishing Musharaka
has been mostly used in house financing. The client wants to purchase a house for which he does not have adequate
funds. He approaches the financier who agrees to participate with him in purchasing the required house. To take an
example, assume 20% of the price is paid by the client and 80% of the price by the financier. Thus the financier owns
80% of the house while the client owns 20%. After purchasing the property jointly, the client uses the house for his
residential requirements and pays rent to the financier for using his share in the property. At the same time the share
of the financier is further divided into eight equal units, each unit representing 10% ownership of the house. Assume
that ‘A’ wants to purchase a taxi and use it for offering transport services to passengers and earning income through
fares recovered from them, but ‘A’ is short of funds. ‘B’ agrees to participate in the purchase of the taxi. Therefore,
both purchase a taxi jointly. ‘B’ pays 80% of the price and ‘A’ pays 20%. After the taxi is purchased, it is employed
to provide taxi rides whereby the net income of say £1000 is earned on a daily basis. Since ‘B’ has an 80% share in
the taxi, it is agreed that 80% of the fare will be given to him and 20% will be retained by ‘A’, who has a 20% share
in the taxi. Therefore, on a daily basis ‘B’ earns £800 and ‘A’ earns £200. At the same time the share of ‘B’ is further
divided into eight units.
In conventional banking, ‘interest’ predetermines a fixed rate of return on a loan advanced by the financier irrespective
of the profit earned or loss suffered by the debtor. As interest is deemed impermissible in Islam, the Musharaka
contract does not envisage a fixed rate of return. Musharaka is a partnership agreement whereby the Islamic bank
provides funds, which are mixed with the funds of the business enterprise and sometimes others. All the providers of
capital are entitled to participate in management but are not necessarily required to do so. Any profit is distributed
among the partners in pre-agreed ratios, whereas any loss is borne strictly in proportion to respective capital
contributions. The literal meaning of the word Musharaka is sharing. Under Sharia’a law, Musharaka refers to a joint
partnership whereby two or more persons combine either their capital or labour, forming a business in which all
partners share the profit according to a specific ratio, whereas the loss is shared according to the ratio of the
contribution made. Musharaka is based on a mutual contract and, therefore, it needs to have the following features to
enable it to be valid under the Sharia’a:
Parties should be capable of entering into a contract (that is, they should be of legal age).
The contract must take place with the free consent of the parties (that is, without any duress).
In Musharaka, every partner has a right to take part in the management, and to work for it. The partners may agree,
however, on a condition in which the management is carried out by one of them, and no other partner works for the
Musharaka. In such a case the ‘sleeping’ (silent) partner is entitled to the profit only to the extent of his investment,
and the ratio of profit allocated to him should not exceed the relative size of his investment in the business. If all the
partners agree to work for the joint venture, however, each one of them should be treated as the agent of the other in
all matters of business. Work done by any of them, in the normal course of business, shall be deemed as being
authorised by all partners. Musharaka can take the form of an unlimited, unrestricted and equal partnership in which
the partners enjoy complete equality in the areas of capital, management and right of disposition. Each partner is both
the agent and guarantor of the other. Another more limited investment partnership is also available. This type of
partnership occurs when two or more parties contribute to a capital fund, with money, contributions in kind or labour.
In this case, each partner is only the agent and not the guarantor of his partner. For both forms, the partners share
profits in an agreed upon manner and bear losses in proportion to the size of their capital contributions.
In conventional banking, ‘interest’ predetermines a fixed rate of return on a loan advanced by the financier irrespective
of the profit earned or loss suffered by the debtor, whereas Musharaka does not envisage a fixed rate of return. Instead,
the return in Musharaka is based on the actual profit earned by the joint venture. The presence of risk in Musharaka
makes it acceptable as an Islamic financing instrument. The finance provider of an interest-bearing loan has many
techniques open to prevent him suffering a loss in the event of failure of the project, whereas the financier in
Musharaka, not having these techniques available, can suffer loss if the joint venture fails to produce fruit.