musharakah & mudaraba by hassan kalim

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“Musharakah”

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Hadees-e-Qudsi

“Allah (SWT) has declared that he will become a partner in a business between two Mushariks until they indulge in cheating or breach of trust”

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What is Musharakah?

• Musharakah literally means Sharing

• The word Musharakah has been derived from “Shirkah” which means being a partner

• Musharakah means a joint enterprises formed for conducting some business in which all partners share the profit according to an agreed ratio while the loss is shared as per the ratio of investment

• It is an ideal alternative for the interest based financing withfar reaching effects on the economy

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Types of Shirkah

There are two types of Shirkah:

1. Shirkat-ul-Milk

Joint ownership of two or more persons in a particular property

2. Shirkat-ul-Aqd

A partnership affected by mutual contract. It can also be translated as a joint commercial enterprise

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Shirkat-ul-Milk

It means joint ownership of two or more persons in a particular property.

This kind of Shirkah may come into existence in two differentways:

1. Optional Shirkat-ul-Milk (Ikhtiari)

• If two or more person purchase an equipment, it will be owned jointly by both of them and the relationship between them with regard to that property is called “Shirkat-ul-milk.”

• Here this relationship has come into existence at their own option, as they themselves elected to purchase the equipment jointly.

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Shirkat-ul-Milk

2. Compulsory Shirkat-ul-Milk (Ghair Ikhtiari)

• This comes into existence without any effort/action taken by the parties.

• For example, after the death of a person all his heirs inherit his property, which comes into their joint ownership as a natural consequence of the death of that person

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Shirkat-ul-Aqd

A partnership affected by mutual contract. It can also be translated as a joint commercial enterprise

Shirkat-ul-Aqd is divided into three types:

1. Shirtkat-ul-Amwal

2. Shirtkat-ul-Aamal

3. Shirtkat-ul-Wujooh

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Shirkat-ul-Aqd

1. Shirtkat-ul-Amwal

• All the partners invest some Capital into a Commercial enterprise.

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Shirkat-ul-Aqd

2. Shirtkat-ul-Aamal

• All the partners jointly undertake to render some services for their customers.

• The fee charged from them is distributed among the partners according to an agreed ratio.

• For example: A firm of chartered accountants

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Shirkat-ul-Aqd

3. Shirtkat-ul-Wujooh

• The word Wujooh comes from Wajahat meaning goodwill

• Hence this is a partnership in Goodwill

• Here the partners contribute in the business not through capital but through their goodwill and share profit at an agreed ratio

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Shirkat-ul-Aqd

Each of these three types is further divided into two types:

1. Shirkat-al-Mufawada

• The partners share capital, management, profit, and risk in absolute equals.

• Every partner is a trustee, guarantor and agent on behalf of other partners

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Shirkat-ul-Aqd

Each of these three types is further divided into two types:

2. Shirkat-ul-Ainan

• The partners share capital, management, profit, and risk in unequal proportions.

• It is a more common type of Shirakat

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Musharakah

• All these modes of “Sharing” or partnership are termed as “Shirkah” in the terminology of Islamic Fiqh, while the term “Musharakah” is not found in the books of Fiqh.

• The term Musharakah has been introduced recently by those who have written on the subject of Islamic modes of financing and it generally refers to two particular type of “Shirkah” namely:

- Shirkat-ul-Amwal- Shirkat-ul-Amal

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Basic Rules of Musharakah

Management of Musharakah

• Each partner has a right to take part in Musharakah management.

• The partners may appoint a managing partner by mutual consent

• One or more of the partners may decide not to work for the Musharakah and work as a sleeping partner

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Distribution of Profit

• The ratio of profit distribution must be agreed at the time of execution of the contract

• The ratio must be determined as a proportion of the actual profit earned by the enterprise

- Not as percentage of partner’s investment- Not in lump sum amount

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Distribution of Profit

• The partners may be paid a provisional profit at any rate which will be subject to adjustment from final profit distribution.

• The partners may agree on any ratio of profit distribution provided the ratio of profit of sleeping partner does not exceed his ratio of investment

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Sharing of Loss

• In case the business incurs a loss, all partners will have to share the loss in exact proportion to their investment

• This rule is based on a saying of Hazrat Ali:

“Profit is based on agreement of the parties, but loss is always subject to the ratio of investment”

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Capital

• Share capital in a Musharakah can be contributed either in cash or in the form of commodities. In the latter case, the market value of the commodities shall determine the share of the partner in the capital.

• However, the commodities to be contributed must be evaluated at the time of execution of Musharakah.

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Termination of Musharakah



A Musharakah will be deemed to have terminated in the following events

1. Each partner has the right to terminate the Musharakah at any time after giving prior notice to other partners

• How will the assets be distributed ?

- If the assets are in liquid form, - They will be distributed in proportion of investment

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If the assets are non-liquid, there are 2 scenarios

a) The assets may be liquidated, and the proceeds distributedb) The assets may be distributed in their existing form after

valuation

If the assets cannot be distributed in their existing form e.g. Machinery, They will be liquidated and the proceeds distributed

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2. If any of the partners die during the currency of the Musharakah his heirs will have the option to:

a) Either liquidate their share orb) Continue with the business

3. If any one of the partners becomes insane or otherwise incapable of conducting commercial transactions

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• If one partner wants to terminate the Musharakah but other partners want to continue this can be done by mutual agreement

• Termination of Musharakah with one partner does not mean termination with other partners

• Price of leaving partner’s share must be determined

• If assets are not liquid their valuation must be done to distribute shares

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• If partners cannot arrive at consensus on value the leaving partner can compel others to liquidate business

• However, partners may agree at the start of the project that liquidation will require majority’s consent

• If assets are not liquid their valuation must be done to distribute shares

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Musharakah as a Mode of Financing

Musharakah can be successfully used to in the following areas:

• Project financing• Working capital financing• Import Financing• Export Financing• Running finance• Saving account• Certificates of Investments• Term finance certificates• Treasury Bills• Inter bank lending/borrowing

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“Mudaraba”

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Mudaraba

Mudaraba is a partnership agreement in which one party invests while the other manages the business.

The one who provides capital is called “Rabb-ul-maal”

While the recipient of the funds which provides the know-how towards carrying out the venture is called “ Mudarib

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Mudaraba

Types of Mudaraba

There are 2 types of Mudaraba

1. Restricted Mudaraba (Mudaraba-a;-muqayyada)

2. Unrestricted Mudaraba (Mudaraba-al-mutallaqa)

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Mudaraba

Types of Mudaraba

1. Restricted Mudaraba (Mudaraba-a;-muqayyada)

Rubb-ul-maal may specify a particular business for the Mudarib

Mudarib can invest the money in that particular business only

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Mudaraba

Types of Mudaraba

2. Unrestricted Mudaraba (Mudaraba-al-mutallaqa)

Rubb-ul-mal gives full freedom to Mudarib to undertake

whatever business he deems fit.

Mudarib is authorized to do anything normally done in the

course of business

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Mudaraba

Authority of Rabb-ul-Maal

Rabb-ul-Maal has the authority to:

Oversee the Mudarib’s activities

Work with the Mudarib if the Mudarib consents

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Mudaraba

Different Capacities of Mudarib

1. Ameen (Trustee)The money given by Rabb-ul-maal and the assets required therewith are held by him as a trust.

2. Wakeel (Agent)In purchasing goods for trade, he is an agent of Rabb-ul-maal.

3. Shareek (Partner)In case the enterprise earns a profit, he is a partner of Rabb-ul-maal who shares the profit in agreed ratio.

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Mudaraba

Different Capacities of Mudarib

4. Zamin (Liable)If the business suffers a loss due to his negligence or misconduct he is liable to compensate the loss

2. Ajeer (Employee)If the Mudaraba becomes void due to any reason the Mudarib is entitled to get a fee for his services

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Mudaraba

Capital

The capital in Mudaraba may be either in cash or kind.

If the capital is in kind, its valuation is necessary, without which Mudaraba becomes void

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Mudaraba

Distribution of Profit & Loss

It is necessary for the validity of Mudaraba that the parties agree, right at the beginning, on a definite proportion of the actual profit to which each one of them is entitled.

They can share the profit at any ratio they agree upon.

However, in case the parties have entered into Mudaraba without mentioning the exact proportions of the profit, it will be presumed that they will share the profit in equal ratios.

Some incentives may be given to the Mudarib as bonus.

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Mudaraba

Distribution of Profit & Loss

Apart from the agreed proportion of the profit, the Mudarib cannot claim any periodical salary or a fee or remuneration for the work done by him for the Mudarabah.

The Mudarib & Rabb-ul-Maal cannot allocate a lump sum amount of profit for any party nor can they determine the share of any party at a specific rate tied up with the capital.

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Mudaraba in Banking

ENTREPRENEUR

ISLAMIC BANKINVESTMENT ACCOUNT

HOLDERS

ISLAMIC BANK

RABRAB--ULUL--MAL MAL MUDARIBMUDARIB

DEPOSITSDEPOSITS

INVESTMENTSINVESTMENTS

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Mudaraba in Banking

Deposits - The Bank as Mudarib

• Profit from the Mudaraba activity is shared between the Bank (as Mudarib) and the investment account holder (as Rabb-ul-maal) in a pre-agreed ratio

• The Bank does not bear any loss but remains responsible for negligence

• The Bank may receive from its investors compensation (Mudarib fees) in return for management of their funds

• The Bank is bound to return the capital to the investors after deducting any losses or Mudarib fees at the time of winding up the contract

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Mudaraba in Banking

Investments - The Bank as the Rabb-ul-maal

• Profit from the Mudaraba activity is shared between the Bank (as Rabb-ul-maal) and the Mudarib in a pre-agreed ratio

• The Bank will bear all the loss unless the Mudarib violates the agreement

• The Bank will pay to the Mudarib, compensation (Mudarib fees) in return for management of its funds

• The Mudarib is bound to return the capital to the Bank after deducting any losses or Mudarib fees at the time winding up of the contract

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ASSOCIATED RISKS

• Investment Risks. Banks (as Rabb-ul-maal) do not hold any “tangible” assets as security

• Banks (as Mudarib) bear all the loss from the activity

• Operational Risks. Banks (as Rabb-ul-maal) have a lower degree of control over the management of funds

• Risk of mismanagement of funds by the Entrepreneur (Mudarib)

• Risk of currency rate fluctuations

• Credit Risk. Risk of default due to poor credit standings, lack of experience or lack of commitment

• Market Risk. Risk of price fluctuations specially if the Bank (as Rabb-ul-maal) invests funds in securities

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Musharakah Mudaraba1 Investment comes from all partners Investment sole responsibility of

Rabb-ul-Mal 2 All partners participate in

management Management comes from Mudarib Rabb-ul-Mal has no right to participate in management

3 All partners share loss in ratio of investment

Only Rabb-ul-Mal incurs financial loss Mudarrib loses because there is no return on his effort Provided loss didn’t occur because of Mudarib’s negligence

4 Liability of partners is un-limited Rabb-ul-Mal liable to the extent of his investment

5 All partners can benefit from profit gained through appreciation in value of investment

Gain in appreciation of investment goes to Rabb-ul-Mal

musharakah & mudaraba by hassan kalim

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