Overview of Musharika and Murabaha – Modes of Financing
Musharika – The word Musharika is derived from an Arabic word which means sharing. It is a contract between two parties which is based on profit and loss sharing. These contracts are based on the Quran, and the Sunnah of the Prophet Muhammad (SAW) and the consensus of Muslim jurists. In Quran, it is said that:
“But if they are more than two, they share a third (An Nisa: 12)”.
Our Holy Prophet (PBUH) said that, Allah says:
“I am third of the two partners as long as they don’t betray each other.
When one of them betrays the other, I depart from them” (Sunan Abu Daud).
The partnership based on Musharika contracts has been practiced throughout the history of the Muslims without objection from the jurists. The purpose of Musharika is to provide a reference on the nature and features of the contract to the Islamic financial services industry for various financial instruments including:
- Musharika financing
- Musharika investment
- Musharika Mutanaqisah
There are two basic types of Musharika. Both have further classification as given below:
Sharikat al Milk is joint ownership of two or more persons in a property but Sharikat al ‘Aqd is the partnership effected by a mutual contract and is also called joint commercial enterprise. Musharika contract is applied in:
- Domestic trade
- Importation of goods
- Agriculture
- Letter of credit
The basic rule of Musharika is that it must have all the necessary ingredients of a valid contract in it. Those ingredients are:
- Distribution of profit
- Sharing of loss
- Nature of capital
- Management of Musharakah
- Termination of Musharakah
Murabaha – The word Murabaha is derived from the Arabic word “Ribah” which means profit. It is denoted as “Sale with Profit”. In Quran, it is said that:
“And (in this matter in particular, i.e., lending money on interest) fear the Day when ye shall be brought back to Allah. Then shall every soul be paid what it earned, and none shall be dealt with unjustly” (Al-Baqarah 2:278-281)
Our Holy Prophet (PBUH) said that,
“The best earning is what a man earns with his own hands and from a permissible trade” (Narrated by Hakim, Al-Mustadrak, Hadith no. 2160)
It is a sale where seller mentions the cost of asset to be sold and sells it to another person with profit which is known to buyer. Cost is disclosed to the client in it.For Example: A has purchased a car from B. B has not yet delivered it to A or to his agent. A cannot sell the car to C. If he sells it before taking its delivery from B, the sale is void.
Murabaha finance is not a loan, it is a sale of asset for cash/deferred price. It is used to meet the working capital requirement and for the purchase of fresh assets so it cannot be executed for the assets already purchased. It can be a cash sale, credit sale or combination of both. The payment can be made in lump sum or in instalments or combination of both. There are three models:
- Model 1: Two party relationship (Bank – Client)
- Model 2: Three party relationship (Bank – Vendor) and Customer
- Model 3: Three party relationship Bank and (Vendor – Customer)
Murabaha financing involves the following documents:
- Master Murabaha Financing Agreement (MMFA)
- Agency Agreement
- Draw Down Notice
- Summary Payment Schedule
- Declaration
Murabaha is used in imports and exports. In imports, agency agreement must be signed before opening L/C. All costs and charges must be included in the cost of Murabaha asset. Offer and acceptance must be signed when the assets arrived at port. Offer and acceptance stage is Murabaha execution stage. In exports,there are two cases as:
- Pre-shipment
- Post-shipment
In case of pre-shipment, common procedure as of local Murabaha must be followed. In case of post-shipment, Murabaha cannot be executed for goods already exported. It can only be executed for fresh purchases. Issues in Murabaha contracts are:
- Securities against Murabaha
- Guaranteeing the Murabaha
- Rollover in Murabaha
- Penalty of default
- Rebate on earlier payment
In Murabaha contracts, Vendor and customer must be independent to each other. If both are associated parties then banks are not allowed to enter into a Murabaha transaction. If one party has 33% or more shares in business of other party then the parties are considered to be related parties. Banks can obtain from the customers the following securities:
- Lien in deposits
- Bank guarantees
- Personal guarantees
- Mortgage
- Hypothecation of assets
- Pledge
The writer is a Business Administration Student (Finance) in University of Agriculture, Faisalabad, Pakistan.
