Download Modeling Dynamics Of Dividend Policy, Capital Structure And

MBF707: Monetary and Fiscal
Framework in Islamic Finance
COMSATS Institute of Information
Technology (Virtual Campus)
Review of the Last Lecture
Belief in Divine Guidance
The Basic Difference between Capitalist
and Islamic Economy
Asset-backed Financing
Capital and Entrepreneur
Present Practices of Islamic Banks
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Lecture 05
Musharakah
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Topics of Discussion
 Capital and Entrepreneur
 Present Practices of Islamic Banks
Musharakah
 Introduction
 Legality of Musharakah and Mudarabah
 Definition of Musharakah
 Application of Musharakah
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Capital and Entrepreneur
Capital (interest) and entrepreneur (profit) are
two separate factors of production.
Islam, on the contrary, does not recognize
capital and entrepreneur as two separate
factors of production
Who contributes capital (in the form of
money) to a commercial enterprise assumes
the risk of loss and therefore is entitled to a
proportionate share in the actual profit.
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Capital and Entrepreneur
Capital has an intrinsic element of
'entrepreneurship', so far as the risk of the
business is concerned.
Flow of the actual profits earned by the society
may be directed towards the depositors in
equitable proportions which may distribute
wealth in a wider circle and may hamper
concentration of wealth.
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Present Practices of Islamic Banks
Islamic Banks did not bring any visible change
in the economic set-up, not even in the field of
financing
Distributive justice under the umbrella of
Islamic banking are exaggerated.
Islamic banks and financial institutions-small
proportion of the system.
Just three decades as against 300 years.
Not supported by the governments.
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Present Practices of Islamic Banks
whole financing system is not based on the
ideal Islamic principles,
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Introduction
 As many contemporary Muslim scholars and
Islamic economists are advocating for the
implementation of equity-based modes of
financing, the most important contracts in this
regard are Musharakah and Mudarabah.
 These two modes of financing are based on the
concept of profit and loss sharing.
 They are true Islamic products, whereby all
Muslim scholars, classical and contemporary are
unanimous in its validity and permissibility..
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Introduction
Theoretically, much has been discussed about
these two concepts these terms, conditions and
tenets.
 The following sections will discuss the
modern application of these concepts as
financial instruments in Islamic finance and
banking practice
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‫‪Legality of Musharaksh‬‬
‫‪Legality of Musharakah‬‬
‫قال هللا تعالى ‪:‬‬
‫"و إن كثيرا من الخلطاء ليبغي بعضهم على بعض إال‬
‫ءامنوا وعملوا الصالحات وقليل ما هم“الذين‬
‫سورة ص‪ :‬االية‪24 :‬‬
‫‪11‬‬
Legality
Allah SWT says:
“Verily, many partners oppress one another, except those who
believe and do righteous good deeds and they are few” Sad: 24
‫ أنا ثالث الشريكين ما لم يخن‬:‫ قال هللا عز وجل‬:‫وقال رسول هللا صلى هللا عليه وسلم‬
‫أحدهما صاحبه فإذا خانه خرجت من بينهما” رواه أبو داوود‬
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Legality
 The prophets SAW said : “Allah Says: “I am the
third partner of any two partners as long as neither of
them betrays the other. But if one of them betrays the
other I get out of them“”. Abu Daud Hadith No.3383
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Musharakah
‘Musharakah’ is a word of Arabic origin which
literally means sharing. In the context of
business and trade it means a joint enterprise in
which all the partners share the profit or loss of
the joint venture.
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Definition of Musharakah
Technically, Musharakah is a contract between the
partners to contribute capital to an enterprise or a
venture, whether existing or new, or to owner of a
real estate or moveable asset, either on a temporary
or permanent basis. Profits generated by that
venture or real estate or asset are shared in
accordance with the terms of the Musharakah
agreement, while losses are shared in proportion to
each partner’s share of capital.”
Source: (Draft of Shariah parameter reference 4:Musharakah Contract, a
paper published by Bank Negara in 2010 defined Musharakah )
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Application in Modern Finance
Musharakah as equity-based financial instrument
is used in many areas and is applicable to a wide
spectrum of business activities, it can be used in
trade financing, such as import or export, project
financing, syndicated asset financing, stock
markets and issuance of sukuk or certificates
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Application in Trade Financing
(Import)
 Musharakah can be applied in trade finance
without complexities, since the chances of fraud,
negligence and other problems are relatively
lower in international trade than in other
Musharakah-based projects.
 A bank may enter into a Musharakah
arrangement with a client who intends to import;
 the bank may also appoint him as agent for
acquisition and disposal of the goods after the
same are imported;
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Application in Import
An L/C (letter of credit) could be opened in the
bank’s or the client’s name
The net profit out of this limited purpose
Musharakah will be shared between the bank
and the client in an agreed ratio.
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Application in Export
In the case of export finance under L/C, the
goods will be acquired and made ready for
shipment on a Musharakah basis.
The client will prepare the export documents
strictly in accordance with the terms of the L/C
and undertake to indemnify the bank for any
loss in case of his failure to honour his
commitment.
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Application in Export
Export proceeds will be distributed according
to the agreed ratio.
 If there is no L/C involved, the merchandise
will be made ready for export under joint
ownership of the bank and the client.
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Application in Export
The following could be the procedure for export
financing on the basis of Musharakah:
 The exporter receives an order from abroad to
export a specific commodity or goods at a known
price.
 He estimates its expected profit. If he needs
financing for manufacturing or procurement of
the goods, the bank can provide financing on the
basis of Musharakah.
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Application in Export
 Profit would be shared on a pre-agreed percentage.
 The bank can secure itself from any negligence on the
part of the exporter. However, being a partner of the
business, the bank will be liable to bear any loss which
may be caused due to any reason other than the
negligence of the exporter.
 However, in order to undertake such an operation,
banks need to understand the nature of the exporter’s
business and other requirements
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Project Financing
 In the case of project financing, the traditional method
of Musharakah can be easily adopted whereby
investment comes from both sides
 The following may be the flow of transactions in the
case of Musharakah for running business:
1. A running Musharakah Account for the client will be
opened in the books of the financing bank.
2. The client’s proceeds from the sale of finished goods
will be credited in the Running Musharakah Account.
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Project Financing
3. The client’s cash flows generated from
investment activities (for example, sales
proceeds from the disposal of fixed assets) and
cash flows from long-term financing activities
(for example, long-term finance availed for the
project) cannot be credited in the Running
Musharakah Account.
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Project Financing
4. At the end of each quarter or month, as the
case may be, the profit earned by the client in
the Musharakah will be paid to the bank.
5. The profit-sharing will be based on the
computed operating profit for the same period
for which the running Musharakah limit was
awarded.
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Syndicated Asset Financing
A group of banks may join efforts to partially
finance a big enterprise or a large project.
The enterprise contributes its part of the
investment to the project such as building a
new factory for a car manufacturing company
or another giant company.
A group of Islamic banks which join hands
finance the remaining part.
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Syndicated Asset Financing
The enterprise runs the project on behalf of the
banks. The banks and the enterprise share the
profit according to the agreed ratio in the
Musharakah contract and losses are borne in
terms of each investors capital contribution
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Application in Stocks
 Business companies issue shares based
Musharakah concept. The investors buy these
shares and become shareholders in the company.
Like the ordinary partners they are entitled to
profits generated by the company based on the
Musharakah agreements.
Musharakah as a basis of securitization
 Musharakah can easily be adopted as a basis for
securitization, especially in the case of big
projects where huge amounts are required.
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Application in Stocks
Every subscriber can be given a certificate
representing his proportionate ownership in the
assets of the joint business, and after the project
is started by acquiring substantial non-liquid
assets, these Musharakah certificates can be
treated as negotiable instruments and can be
bought and sold in the secondary market.
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Diminishing Musharakah
In a Diminishing Musharakah contract, a party,
after participation in ownership of any
business or project, can liquidate his
investment from the asset or the ongoing
business.
DM contracts contain a sale provision,
according to which, one partner makes a
promise to sell his part of ownership to the
other party periodically.
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Diminishing Musharakah
DM is used in house financing, auto financing,
plant and machinery financing, factory or
building financing and all other fixed asset
financing.
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Summary
 Capital and Entrepreneur
 Present Practices of Islamic Banks
Musharakah
 Introduction
 Legality of Musharakah and Mudarabah
 Definition of Musharakah
 Application of Musharakah
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Thank You
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