Diminishing Musharakah

By Mahmood ShafqatSenior Joint Director -Islamic Banking Department - SBPAt AlHuda: Centre of Islamic Banking & Economic WorkshopSheraton Hotel – Karachi.

The views expressed in this presentation are those of the author

and do not necessarily represent State Bank of Pakistan

Presentation Outline

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

Diminishing Musharakah-Introduction

“Shirkah” means “Sharing” in the terminology of Islamic Fiqh.

Musharakah is basically a kind of partnership in which the partners join together with their contributions for the common objective of undertaking business and trade in accordance with the principles of Shari’ah.

Musharakah

It has been divided into two kinds:

SHIRKAT-UL-MILKIt means joint ownership of two or more persons in a particular property.

SHIRKAT-UL-’AQDWhich means “a partnership effected by a mutual contract”.

Types of Shirkat

Based on Shirkat-ul-MilkMeans joint ownership in a property

Three componentsJoint ownership of the Bank and customerCustomer as a lessee uses the share of

the bank Redemption of the share of the Bank by the

customer

Diminishing Musharakah

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 Factory/Building financing Agriculture land financing All other fixed Assets

Mode of Fixed Asset Financing

Musha means undivided ownership of the asset

Lease of Musha

It is allowed to lease Musha to other joint owner.

Musha

Basic Transaction Structure

CUSTOMER

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 pays rent for the use of banks share in the property

The customer approaches the Bank with the request for Project/Machinery/House financing

BANKJoint

Ownership

Musharaka

Rent

CUSTOMER

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.

Ownership of the asset is gradually transferred to the customer upon payment of asset price.

Customer pays rent for the use of banks share in the property

BANKJoint

Ownership

Musharaka

Gradual Transfer of Ownership

The customer approaches the Bank with the request for Project/Machinery financing

The value of Bank’s share in Musharakah property is divided into units, which it sells to the customer. Units will be worked out by dividing Bank’s financed amount by number of months for which finance to be allowed.

With each purchase of unit by the customer, the Bank’s share in the Musharakah property starts diminishing, whereas customer’s share starts increasing, correspondingly.

Finally, the customer becomes the sole owner of the property after having purchased all units from the Bank, along with the rentals thereon.

CUSTOMERBANKJoint

Ownership

Musharaka

Gradual Transfer of Ownership

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

Diminishing Musharakah-Considerations

Joint

 Joint Title

 

 Title Holder

Profit Rate Fixed/VariablePrepayment Allowed Yes

 Refinance Available Yes

 Asset RiskLate Payments Control able

Consideration

Flexibility Available

• The agreements of joint purchase, Lease and selling of units should not be tied-up together

• At the time of purchase, sale should be effected through offer and acceptance

• Preferable to purchase each unit on market value, but permissible to purchase at agreed price

Diminishing Musharakah can be used for financing with the following conditions

1. Diminishing Musharakah Agreement – Islamic Housing Finance Agreement

  Purpose: This is the main agreement that establishes Bank’s share in the Musharakah Property.Components:

- Both parties share     - Musharakah Property detail 2. Monthly Payment Agreement (Rent

Agreement) Purpose: This agreement is signed after Main Musharakah Agreement. Bank gives out its share to the customer via this agreement.

  Components:- Rent Schedule - Formula of calculation

Legal Documentation

Legal Documentation

3. Undertaking to Purchase Musharakah Units

  Purpose: This is an undertaking by the customer to purchase Bank’s Musharakah units.Components:

     - Normal Sale Price- Additional Unit Purchase Price

 4.    Undertaking to Sell Musharakah Units  Purpose: This is an undertaking by the Bank

to sell Bank’s Musharakah units from time to time.Components:

     - Normal Sale Price- Additional Unit Purchase Price

Personal Information• Completed and signed Application

Form• Copy of CNIC• Copy of Co-Applicant's CNIC /

Passport• 2 Passport size photos of Applicant /

Co-Applicant's • Copy of rental docs (if applicable)• Copy of Paid Utility Bills• Borrowers Basic Fact Sheet• Copy of Recent Credit Card Bills

Required Documents

Income Information• Copy of recent Pay Slip / Employer Letter• Employer Certificate for salaried employees

incl. tenor / designation / salary• Last 6 months Bank Statement• Copy of Management Accounts (if applicable)• Bank Statement of Business

Required Documents

In Case of Co-Applicant the Income Related documents will also be required for the Co-Applicant as well.

Business / Professional Information• 3 Years Proof of Business (eg: Tax

Return/Bank Certificate)• Professional Association Membership

Certificate / Practice License• Professional Degree / Certificate

Property Documents• Copy of all related Property Title Documents• Approved Building Plan

Required Documents

• Equitable mortgage of the financed property.

• Any additional security as may be determined by Bank. Such security may be required if the standing of the borrower does not meet the credit underwriting requirements of Bank.

Security

An Illustration

Step by Step GuideStep 1: Application FormSubmit the filled & signed application form & cheque for Processing Fee & External Agency cost Step 2: Required DocumentsAttach all the required document  Step 3: Address Verification Bank will verify the Applicant Residential & Office Addresses and Addresses of the References submitted

Step by Step GuideStep 4: Income Estimation For Businessman / Self Employed Individuals Bank's External Consultant may determine customer’s monthly income.For Salaried IndividualsBank will verify the Income with customer’s employer

Step 5: Legal opinion A legal opinion will be obtained on the property documents

Step 6: Property Valuation Appointed Valuation Agency will evaluate the property to determine its market value.

Step by Step GuideStep 7: Credit Approval & Sanction Letter After customer have fulfilled all Credit requirement satisfactorily, bank will give a conditional Sanction letter Step 8: Account Opening Customer will be required to open an account in bank by submitting a filled account opening form

Step 9: Signing of House Finance AgreementCustomer sign Islamic House Finance Agreement and other legal documents.For Building/Renovation/Replacement of houseOriginal Property documents will be handed over to the bank at this stage.

Step by Step Guide

Step 10: Transfer of Property & Disbursement

In Home Buyer Cases Bank's Sales officer & authorized lawyer will accompany customer & Seller of the property to the Registrar office for Property Transfer.  Original Property documents will be handed over to the Lawyer who, after verification of the document, will handover the Pay Order to the Seller and will complete the legal formalities on Bank's behalf

Common FAQs

What method of Islamic Financing is used in House financing?

What makes Islamic House financing Shariah compliant and how does it differ from a conventional mortgage?

Why is the profit margin charged by Bank correlated to the conventional mortgage market trends?

How much time do you take to approve the case?

Is this rent variable or fixed?

Common FAQs For how many days can I delay my monthly installment?

What would be the Bank’s approach, if I fail to pay my monthly installment?

Do you have any alternative for Insurance?

What is the process for early payment / termination of property?

Key FAQs

What is the difference between the profit Bank charges and the interest charged in conventional mortgages?

In conventional mortgages the interest charged is a mark-up on the money lent. The profit charged by Bank is the utilization payment for the consumer’s use of bank’s share throughout the life of the contract. The profit is predetermined based on market trends.

Ph: 021-9212509, Fax: 021-9212472

Email: mahmood.shafqat@sbp.org.pk

http://www.sbp.org.pk/departments/ibd.htm