You are on page 1of 30

Assignment: Structuring Financial Requirements

Case Study

Muhammad Suhaini Bin Abu (Group B)


Facilitator: Tuan Haji Zainal Abidin Mohd Tahir

This project paper is a partial fulfilment of Module IB 2001 of Part II of

Chartered Islamic Finance Professional (CIFP)
International Centre for Education in Islamic Finance (INCEIF)

January 2011

Table of Contents

1.0 Case Study Question 2

2.0 Answer 1 - Credit/financing assessment of SBBL and its development 4


3.0 Answer 2 – Structuring Musharakah project financing 9

i. Criteria of Shariah principles applied 9
ii. Duties and responsibilities of Musharakah partners 12
iii. Diagrammatic illustration of the Musharakah venture 14
iv. Risks peculiar to Musharakah financing and property 15
development project, and steps to mitigate the risks
v. Basic features, terms and conditions of the Musharakah 22
financing facility

4.0 Answer 3 26
i. Estimated profit amount for both partners 26
ii. Estimated annual rate of return to TBL 26
iii. Actual profit amount for both partners, and actual annual rate of 27
return to TBL
iv. Justification for TBL to provide the Musharakah Project 27

5.0 References 29

1 1000310IB2001CS.docx

1.0 Case Study Question

Solid Base Bukhara Limited (SBBL), a public-listed company which main activity is
property development is seeking Islamic financing to finance the development of its
new mixed development project in Tashkent, Uzbekistan. The development plan
comprised of various types of house that include link-houses, semi-detached houses,
high-rise apartments and commercial complex.

SBBL is an existing customer of Tamwil Bank Limited (TBL), a subsidiary of a

middle-eastern bank whose office is in Tashkent. It has been banking with TBL since
2005 and is enjoying Islamic working capital facility of USD10.0 million. In view of
the substantial amount involved, and to minimize its risk SBBL is willing to discuss
on Musharakah project financing instead of other types of financing. SBBL knows
that by going for Musharakah financing, the bank would be taking a higher risk and
be more committed with the project compared to normal debt financing.

The details about the project venture are as follows:

Total Project Value (TPV) USD500 million 100%

Total Gross Development Cost
USD300 million 60% of TPV
Total Financing Amount Required 50% of GDC or 30%
USD150 million
from the Bank of TPV
SBBL’s contribution in the form of 20.0% of TPV or
USD100 million
development land 33.3% of GDC
Estimated Profit of the Project USD200 million 40% of TPV

Estimated Project Completion Time Three (3) years

For this Musharakah venture, SBBL will contribute only in tangible assets i.e. the
land to be developed which was valued by a renowned property-valuer at USD100
million. After lengthy discussions about the project viability, financial position and
risks involved, TBL and SBBL has agreed that the Profit Sharing Ratio (PSR) of the
venture be fixed at 60:40 i.e. 60% to SBBL and 40% to TBL.

Buyers for the unit of houses and commercial complex will be seeking bank’s
financing, average financing margin given is between 80% and 90% of total purchase
price. The developer will be submitting redemption claims from end financing banks
based on progress of project construction until completion. Therefore amount of
Musharakah capital financing required is only up to 30% of TPV.

2 1000310IB2001CS.docx

TBL has recently appointed you as a Senior Corporate Financing Officer after
completing the CIFP at INCEIF.


1. Explain briefly the factors to be considered in carrying-out credit/financing

assessment of the company, SBBL and its development project.
(5 marks)

2. Structure a package of Musharakah project financing by outlining the


i. Explain the criteria of Shariah principles applied.

ii. Describe the duties and responsibilities of both partners.
iii. Provide diagrammatic illustration of the venture, highlighting the
relationship as well as the capital contribution and profit sharing
iv. Elaborate on the risks peculiar to Musharakah financing and property
development project, and recommend steps to be taken in mitigating
the risks.
v. Outline basic features, terms and condition of the financing facility.
(9 marks)

3. Based on the information given:

i. Compute the estimated profit amount for both partners.

ii. Compute the annual rate of return to TBL from its capital investment
in this project venture.
iii. Assuming that there has been a cost overruns on the project due to
increase in the cost of the building materials, and workers’ demand for
higher wages resulting in the decrease of the actual total profit from the
project to only 35% of TPV, compute the actual profit amount for both
partners. Also compute the actual annual rate of return to TBL from its
iv. Do you think the return is justifiable for TBL to provide the
Musharakah Project Financing?
(6 marks)

3 1000310IB2001CS.docx

2.0 Answer 1

Generally, a possible general model is to assess the basic credit factors of a potential

company or client, in this case SBBL which is based on 5Cs of Credit Assessment

which is Character, Capital, Capacity, Conditions and Collateral.

I. Character

Character is arguably the most important and crucial factor to assess before deciding

to provide financing. Character gets to the issue of people and normally done by

asking questions such as “Are the owner and management of the company honourable

people when it comes to meeting their obligations?” Without SBBL scoring high

marks for character, I should not approve the financing.

How do banks assess character? After all, it is an intangible criterion. It is partly fact-

based and partly “guts feeling”. The fact-based assessment involves a review of credit

reports on the company, and in the case of smaller companies, the personal credit

report of the owner as well. Besides that, the bank’s previous experience with the

client or entrepreneur, a personal interview or conducting discreet market checks, the

reputation of the company in the industry, and possibly the other banks’ experiences

with the customer. The soft side of character assessment will be determined by how

SBBL deal with TBL during the application process and their resultant “gut feeling”.

I will use a combination of both approaches and later make my substantiated


4 1000310IB2001CS.docx

II. Capital

When it comes to capital, the bank is essentially looking for the owner of the

company to have sufficient equity in the company. Capital is important to the bank, in

this case TBL for two reasons. First, having sufficient equity in SBBL provides a

cushion to withstand a blip in the company’s ability to generate cash flow. For

example, if the company were to become unprofitable for any reason, it would begin

to burn through cash to fund operations. The bank should never be interested in

lending money to fund a SBBL’s losses, so I want to be sure that there is enough

equity in the company to weather a storm and to rehabilitate itself. Without sufficient

capital, the company could run out of cash and be forced to file for bankruptcy


When I assess capital, I need to look at the sufficiency of financial commitment of the

shareholders or owners in their business relative to the permanent assets owned by

SBBL. Financial commitment is often measured by the shareholders’ funds in the

business and should also include any subordinated financing to the business and third

party collateral provided by the owners themselves.

There is no precise measure or amount of “enough capital”, but rather it is specific to

the situation and the owner’s financial profile. Commonly, banks will look at the

owner’s investment in the company relative to their total net worth, and they will

compare the amount of the loan to the amount of equity in the company – the

company’s Debt to Equity Ratio. This is a measure of the company’s total liabilities

to shareholder’s equity. I should like to see Debt to Equity Ratios no higher than 2 to

3 times as a Rule of Thumb.

5 1000310IB2001CS.docx

III. Capacity

TBL needs to be certain that SBBL’s business generates enough cash flow to repay

the loan that it is requesting. In order to determine this I will be looking at the

company’s historical and projected cash flow and compare that to the company’s

projected debt service requirements. There are a variety of credit analysis metrics that

can be used to evaluate this, but a commonly used methodology is the “Debt Service

Coverage Ratio”.

Typically the bank will look at the company’s historical ability to service the debt.

This means I should compare the company’s past 3 years free cash flow to projected

debt service, as well as the past twelve months to the extent SBBL is well into its

fiscal year.

Usually projected cash flow figures are higher than historical figures due to expected

growth at the company. However I can view the projected cash flows with scepticism

as they will generally entail some level of execution risk. To the extent that the

historical cash flow is insufficient and I must rely on SBBL’s projections, I shall

check whether future cash flow projections are defended with information that would

give visibility to future performance, such as backlog information.

As mentioned, capacity in credit financing is to measure the ability of the

entrepreneur to pay back his or her financing to meet future obligations from earnings.

In this factor, source of income is essential to gauge the lender’s ability to repay the

financing. Cash flow of SBBL needs to be analyzed in order to ensure the company

meets its obligation of paying debt. Furthermore, identify the source of income of the

client to repay its payment for example by looking at account statement. Apart from

that, I should ensure the source of income is genuine.

6 1000310IB2001CS.docx

IV. Conditions

I am going to assess the conditions surrounding the company and its industry to

determine the key risks facing SBBL, and also, whether or not these risks are

sufficiently mitigated. Even if the company’s historical financial performance is

strong, the bank wants to be sure of the future viability of the company. TBL should

not provide a loan to SBBL if it looks like the viability of the company is threatened

by some unmitigated risk that is not sufficiently addressed.

This factor deals with any external influences that can affect the ability of the owner

of the company’s ability to honour their obligations to the banks. This is to ensure the

conditions surrounding the business do not pose any significant unmitigated risks.

There are 2 matters to look at:

a) Macro issues such as globalization and global economies, foreign currency

markets, economies of major trading partners, legislative and regulatory

framework and finally social trends.

b) Micro issue like local competition.

To summarize this, the common method here is to assess the competitive landscape of

the company, the nature of customer relationships, supply risk and industry issues.

V. Collateral

Collateral is an item of value that is pledged in exchange for a loan or financing.

In most cases, the bank wants the financing amount to be exceeded by the amount of

the company’s collateral. The reason the bank is interested in collateral is as a

secondary source of repayment of the financing. It is common place for borrowers to

think that the bank will finance a dollar for every asset that their company owns. This

is not the case.

7 1000310IB2001CS.docx

If in any circumstances the company is unable to generate sufficient cash flow to

repay the financing at some point in the future, the bank, in this case TBL, wants to be

sure that it will be able to recover its facility by liquidating the collateral and thus

using the proceeds to pay off the financing amount.

This minimizes TBL’s risk by ensuring there is an item of value to recover the

investment from, in the event the customer defaults on the financing. Moreover,

collateral is intended to provide banks with more comfort and security. However,

collateral cannot be the basis for the initial comfort as collateral is the reinforcement

of the foundation on which a bank bases its credit approval and not the foundation


Finally, banks is interested in only certain asset classes as collateral, specifically

accounts receivable, inventory, equipment and real estate since in a liquidation

scenario, these asset classes can be collected or sold to generate funds to repay the

financing or loan. Other asset classes such as goodwill and prepaid amounts shall not

be considered by TBL as collateral since in a liquidation scenario, they would not

fetch any meaningful amounts.

8 1000310IB2001CS.docx

3.0 Answer 2


In this Musharakah project financing, the rules of any valid Islamic contract which

comprise of the three pillars known as subject matter (al-Aqad), contracting parties

(al-Aqidan) and statement of contract (Sighah) also form the pre-requisite of the

financing contract. For example, the parties should be capable of entering into a

contract; the contract must take place with free consent of the parties without any

duress; fraud or misrepresentation; and etc. But there are certain criteria which are

peculiar to the contract of Musharakah. They are as explained below.

Distribution of Profits

The proportion of profit to be distributed among the partners must be determined and

agreed upon at the time of the contract. Otherwise the contract is not valid under


Apart from that, as additional information, there are also some differences in opinion

about how much profit share in terms of for each partner.

According to Imam Malik and Imam Shafi’i, it is necessary that each partner’s share

in the profit is exactly equal to the proportion of initial investment into the

partnership. According to Imam Ahmad, the ratio of profit distribution may vary,

without restriction, from the ratio of investment. According to Imam Abu Hanifah, the

ratio of profit distribution may vary however, for silent partners (non-active partners,

who only contribute capital), as in the case here for TBL, it cannot be any higher than

the ratio of investment.

9 1000310IB2001CS.docx

Distribution of Loss

All the Muslim jurists are unanimous that each partner’s share in loss must be exactly

equal to the ratio of initial investment. Anything to the contrary will render the

contract invalid.

The Nature of Capital

Nature of capital refers to in what form the capital is contributed. There are some

varying opinions on this.

According to Imam Malik and some Hanbali jurists, the nature of capital is not a

restriction in a Musharakah arrangement. Therefore, in-kind (non-cash) contributions

by partners are allowed. The share in partnership will be determined based on the

market value of the commodity contributed. According to Imam Abu Hanifah and

Imam Ahmad, no in-kind contributions are allowed in a Musharakah arrangement.

This is because they believe it poses problems if the partnership needs to be liquidated

or redistributed. Imam Shafi’i makes a distinction between replaceable commodities

and irreplaceable commodities (like cattle).

For the purposes of modern business, the view of Imam Malik has been widely


Management of Musharakah

The norm is for each partner to take part in the management of the partnership, with

each partner acting as an agent of the partnership and any work done by one partner

deemed to be authorized by all partners. However, if the partners wish they can

contract under alternate arrangements for the management of the partnership.

10 1000310IB2001CS.docx

Note on the fact that Musharakah differs from Mudharabah in terms of involvement

of the contracting parties as far as the management of the business is concerned,

where in Mudharabah the Rabbul-Mal remains as only the capital provider and

should not be involved with the management side of the venture, while the Mudharib

will not contribute at all in terms of financial or asset capital, but will contribute in

terms of expertise and management of the business.

In this case, since SBBL is an existing developer, thus have more expertise in

managing property development business, and also is the one who approached the

bank for the Musharakah, SBBL will be involved with building, managing, and then

selling the properties to interested parties. This is also why although SBBL has

contributed less capital, it has bigger share in PSR which is 60% compared to TBL’s

40%, due to its management role. In this case, TBL is considered a sleeping partner

(for the purpose of classification) as explained earlier, although TBL in its role as

financier will be required to actively monitor the progress of the development project

to ensure any potential risk can be mitigated, especially in today’s complex challenges

in banking practice.

Termination of Musharakah

It is agreed upon by the jurists that a partnership (by one the following reasons) is

terminated if:

i. One of the partners terminates the partnership;

ii. One of the partners dies (where the heirs get the choice to continue the

partnership or liquidate it to draw their share from the partnership);

iii. One of the partners becomes insane.

11 1000310IB2001CS.docx

If the remaining partners want to continue the business under any of the above

scenarios, it is achievable with mutual agreement. Thus in this case, the remaining

partners would have to purchase the share of the out-going partner.

For the consideration of this case, if SBBL decides to terminate the partnership, or

becomes bankrupt, or deemed legally unfit by the law under whatever reasons to

continue business, then TBL as the financier may have to find another developer

willing to take-over the role of SBBL as a partner in this Musharakah, and vice versa.

Another question raised is whether the partners can agree, at the time of contracting,

that the partnership will not be terminated unless all partners agree to the termination,

in this case both SBBL and TBL agree to have such a clause. Though the earlier Fiqh

books are silent on the issue, there is nothing in the Shariah that would prohibit such

an arrangement. This clause can help protect both parties from unforeseen unfortunate

circumstances and also major inefficiencies that may cost a huge amount of money,

due from waning desire of either TBL or SBBL to continue and complete such



Both partners, SBBL and TBL have their duties and responsibilities to fulfil the

essential requirement of Musharakah. Every partner has responsibility and right in the

management. As mentioned earlier, each of them is also considered as an agent of the

other in all matters of the business, and as for sleeping partner, its share of profit

should not exceed the ratio of its investment in the partnership business.

I. Both partners contribute a portion of capital which may not necessarily be

equal. The contributed capital can be either in the form of cash or assets with a

12 1000310IB2001CS.docx

recognized monetary value. In this case, TBL contributed financing of

USD150 million, while SBBL contributed development land worth USD100


II. While both partners may undertake the management of the business, if a

partner chooses to withdraw from the management to become a sleeping

partner, such arrangement is allowed. The partner is also allowed to appoint a

third party to manage the business on behalf of the Musharakah partnership;

III. It has been agreed that SBBL will undertake the management side of the

business, namely from building the residences and commercial complex, up

until the sales of the units and submitting redemption claims from end

financing banks.

IV. The project or business must be permissible by Shariah. In this case it is

allowed since it is to build residences and commercial complex for people;

V. The proportion of profit to be distributed between the partners must be

mutually pre-agreed upon inception of the contract. In this case a PSR of

60:40 for SBBL and TBL respectively has been agreed upon; and

VI. Any losses shall be distributed between the partners according to the capital

contribution ratio. In this case the capital contribution ratio is 100:150 or 2:3

to SBBL and TBL respectively. However, if the loss is due to the negligence

of the managing partner or management team, in this case SBBL, then such

losses shall be borne by the respective partner or the management team i.e.


13 1000310IB2001CS.docx


Solid Base
Tamwil Bank
Bukhara Limited
Limited (TBL)

Provide capital of Provide capital of

USD150 million USD100 million
(financing) (development land)

Musharakah Project Financing Agreement

 Project Value: USD500 million
 PSR 60(SBBL):40(TBL)

Musharakah Venture:
Mixed Development Project in Tashkent
 Estimated Cost: USD300 million

40% 60%
USD80 million USD120 million
 Estimated Profit: USD200 million

Diagram: Musharakah venture of TBL and SBBL, showing the relationship,

capital contribution, and profit sharing mechanism.

14 1000310IB2001CS.docx



Let us now examine some risks viewed as peculiar to Musharakah financing and the

steps that can be taken to mitigate them.

Risk of Loss

Of course in business there is always the risk of loss, but here the risk is somewhat

from a different perspective. It is argued that the arrangement of Musharakah is more

likely to pass on losses of the business to the financier bank or institution, in this case,

TBL, especially when the capital contribution portion of the bank is much higher than

the financed partner.

Thus, this loss will be passed on to depositors also. The depositors, being constantly

exposed to the risk of loss, will not want to deposit their money in the banks and

financial institutions like TBL.

Banks like TBL in order to mitigate this type of risk, will study the feasibility of the

proposed business for which funds are needed, before financing on the basis of

Musharakah. TBL study the potentials of the business in a more thorough manner and

if they apprehend that the business is not profitable, they can refuse to advance a

financing. In the case of Musharakah, TBL will have to carry out this study with more

depth and precaution.

Moreover, TBL can have a diversified portfolio of Musharakah and not restrict itself

to only a single Musharakah. As a result, the Musharakah portfolio as a whole is not

expected to suffer loss, and the possibility of loss to the whole portfolio is merely a

15 1000310IB2001CS.docx

theoretical possibility which is not seen as a possibility that can discourage the public

in Islamic banks like TBL.


Dishonesty as a factor of risk can be amplified in Musharakah contracts. Another risk

of Musharakah financing is that the dishonest clients may exploit the instrument of

Musharakah by not paying any return to the financiers. They can always show that

the business did not earn any profit. Indeed, they can claim that it has suffered a loss

in which case not only the profit but also the principle amount will be jeopardized. It

is, no doubt, a valid risk, especially in societies where corruption is the order of the

day. Undoubtedly, the risk of dishonesty is more severe for Islamic banks and

financial institutions like TBL, working in isolation from the main stream of

conventional banks. In some countries, Islamic banks have not much support from

their respective governments and central Banks. However, the solution to mitigate this

problem is not as difficult.

If all the banks in a country are run on pure Islamic pattern with a careful support

from the Central Bank and the government, the problem of dishonesty is not hard to

overcome. First of all, a well designed system of auditing should be implemented

whereby the accounts of all the clients are fully maintained and properly controlled. It

is already discussed that the profits may be calculated to the basis of gross margins

only. It will reduce the possibility of disputes and misappropriation. However if any

misconduct, dishonesty or negligence is established against a client, he will be subject

to punitive steps, and may be deprived of availing any facility from any bank in the

country, at least for a specified period.

16 1000310IB2001CS.docx

These steps will serve as strong deterrent against concealing the actual profit or

committing any other act of dishonesty. Otherwise, also the clients of the banks

cannot afford to show artificial losses constantly, because it will be against their own

interest in many respects. It is true that even after taking all such precautions, there

will remain a possibility of some cases where dishonest clients may succeed in their

evil designs, but the punitive steps and the general atmosphere of the business will

gradually reduce the number of such cases.

Credit Structure/Product Risk

Credit structure/product risk is the risk related to the financing given by the banker.

Poor structuring of the Musharakah financing will cause inherent risk to the

implementation of the credit. To mitigate this risk, TBL would have to really

understand the true financial capability of SBBL and allow as much help especially

financially to ensure the project development from phase to phase will not be affected.

On the other hand, most Islamic banks also are still lacking in their policies and

procedures with regards to exit strategies, valuation methodology and impairment

policies which must be in place to ensure successful implementation of the

Musharakah financing.

To conclude, the distinct risk profile of Musharakah contract which is a form of

equity participation may expose the Islamic banking institutions to various types of

risks, such as counterparty credit risk, equity investment risk, liquidity risk and

reputational risk. These risks require proper, adequate and sound risk management

infrastructure and internal controls.

17 1000310IB2001CS.docx

Apart from the two above, the following are the recommended steps to be taken in

mitigating the risks of Musharakah in general. These risk management activities and

processes require active oversight by the Board and senior management of TBL.

1. Appropriate policies and procedures on Musharakah contracts must be clearly

specified and communicated. There should be a systematic process to

regularly review and update the Musharakah policies, processes and limits to

take into accounts the risk appetite of TBL and changes that take place in the

Islamic banking industry.

2. Based on the materiality or significant involvement of the Islamic banking

institutions in Musharakah, TBL may establish a dedicated committee or unit

to oversee Musharakah exposure. Members of this committee or unit shall

comprise of people with adequate knowledge and understanding on

Musharakah contracts and the risks associated with such exposures. The

committee or unit shall be responsible for the off-site monitoring of the

Musharakah contract exposures that include the identification, measurement

and management of the risks inherent in Musharakah contracts.


Islamic banks including TBL are expected to develop a strong risk management

process to clearly identify, measure, monitor and control the risks associated with

financing of property development project. The risk management process shall take

into account different types of risk profiles arising from property development and

property investment activities undertaken by TBL. The list of functions that are

expected to be conducted by TBL with respect to the exposure to property

development project is provided below.

18 1000310IB2001CS.docx

Equity Risk

TBL shall assess all material risk relating to having equity position in companies

undertaking property development activities. Such assessment would require

appropriate infrastructure to enable the bank making informed investment decision

and having safeguards against excessive risk exposure:

(i) Sound measurement and valuation framework on the equity position held by


(ii) Strong management information system which facilitates monitoring of actual

risk taking against predetermined internal limits and risk tolerance levels;

(iii)Strong monitoring process on the underlying activities of the invested entities,

which is supported by a trigger mechanism and clearly defined action plans in

the event of portfolio deterioration;

(iv) A rigorous stress testing framework that enable periodical assessment on the

invested entities and its implication to the equity position of TBL; and

(v) An appropriate exit strategy/ mechanism in the event of non-favourable

circumstances of SBBL (e.g. prolonged deterioration in financial strength) or

the underlying property development project (e.g. increased likelihood of

project non-completion).

Sectoral Exposure Risk

To avoid excessive sectoral exposure risk, TBL shall institute appropriate and

effective control to continuously assess and conduct stress testing as to whether the

overall exposure to property development project is consistent with the bank’s

19 1000310IB2001CS.docx

business strategies and within the tolerance level defined by the internal policies as

approved by the Board.

In conducting the stress testing exercise, TBL shall take into account plausible

scenarios on real estate or property sector and continuously assess any potential

adverse implications on the exposures based on prevailing market conditions.

Risk of the underlying assets

TBL shall take appropriate measures to mitigate all risks associated with the

underlying asset, which may include:

(i) Proper identification of the properties or land prior to acquisition;

(ii) Ongoing monitoring of the underlying assets based on sound valuation

techniques; and

(iii)Well-defined marketing strategies for the purpose of onward sale or lease of

the properties.

Legal risk

TBL are expected to clearly define and properly document the contractual

relationship, rights and obligations of the respective parties involved in the real estate

business. The documentation shall be consistent with the requirements of the Shariah.

Islamic banks shall execute all legal documentation in the correct flow or sequence to

effectively reflect the underlying Shariah transactions. Any attempt to simplify the

processes or sequence due to practical grounds should not compromise or affect the

sanctity of the Shariah contract. Islamic banks shall ensure that the appointed legal

firms, in-house legal personnel and operations staff have the necessary knowledge,

20 1000310IB2001CS.docx

skills and experience in executing Shariah contracts and transactions involved in the

real estate business.

Market risk

It is defined as the risk of changes in the demand and price of a product as a result of

changes in the factors which are beyond the control of the customer. For example, the

movement of commodity prices, foreign exchange and stock prices in the stock

exchange. Property development project is very sensitive to the economic condition as

it involves a huge volume of amount, and always turns to be the first industry to be

affected when there is a recession. Therefore, TBL should monitor client’s cash flow

capacity as well as the market frequently.

TBL must also identify external factors affecting real estate and to ensure proper

valuation methodology, risk mitigation method and income recognition process. The

joint-venture may not generate projected return or even worse making losses in which

case TBL may end up with unsold properties.

Depending on TBL’s business models and nature of risks to which it is exposed, TBL

is expected to:

(i) Have in-house expertise (such as creation of specialised unit) to provide

technical advice, undertake research, conduct valuation and execute marketing

strategies for the real estate business; or

(ii) Outsource such functions to be conducted by the qualified external parties, in

the event where in-house expertise is not available.

21 1000310IB2001CS.docx

Project/Time Management

One of the risks associating to property development is project completion delays. It

is an inability to complete the project within the time frame originally specified. This

can be caused by internal factors such as management’s poor technical competency

and project inefficiency or by external factors such as the weather or change in

regulatory policies. TBL may mitigate this risk by having the shareholders pumping

in money or extending more money when a real need arise.


Extracted from the Musharakah project financing table provided, and also additional

information, the basic features, terms and conditions of the facility are as follows:

i. The parties in this contract are:

1. Tamwil Bank Limited (TBL), as the financier

2. Solid Base Bukhara Limited (SBBL), as the property developer

i. The Shariah principles applied is Musharakah, and thus the general rules of

Musharakah contract relating but not limited to Distribution of Profits,

Distribution of Loss, The Nature of Capital, Management of Musharakah,

and Termination of Musharakah as mentioned earlier are binding.

ii. The Total Project Value (TPV) is estimated at USD500 million

iii. The Gross Development Cost (GDC) is estimated at USD300 million

iv. The capital provided by both parties are as follows:

1. Tamwil Bank Limited (TBL): Financing amount of USD150 million

over three (3) years

22 1000310IB2001CS.docx

2. Solid Base Bukhara Limited (SBBL): Development land with current

market value of USD100 million

ii. Estimated Profit of the Project: USD200 million

iii. Agreed Profit Sharing Ratio: SBBL:TBL = 60:40

iv. Estimated Project Completion Time: Three (3) years

v. Other mutually agreed covenants:

1. Financing is only for the purpose stipulated, which is to finance the

development of the new mixed project in Tashkent, Uzbekistan.

2. Additional capital may be injected upon mutual agreement of all

partners. In this regard, the partners may agree to vary or revise the

proportion of capital contribution, the profit sharing ratio or change of


3. Musharakah capital comprising of monetary and non-monetary assets

invested by each partner should be commingled representing the

collective rights of each partner.

4. No changes of paid-up capital, accumulated reserves or un-

appropriated profits, or additional borrowing except prior consent from

the bank i.e. TBL & on the basis of annual audited accounts


5. The Projected Rate of Return based on past experience and prudent


6. SBBL to furnish all information which the bank (TBL) may require,

including submission of quarterly report of client’s operations &

statement of financial affairs.

23 1000310IB2001CS.docx

7. Once contributed as capital, the rights, obligation and liabilities of all

assets contributed to the Musharakah venture shall be jointly and

severally assumed by partners. The developer i.e. SBBL however is

responsible in ensuring the shortage of USD50 million in form of

capital from the Total Gross Development Cost will be covered by the

redemption claims from end financing banks based on progress of

project construction until completion. This is derived from buyers for

the unit of houses and commercial complex who will be seeking

bank’s financing, with average financing margin of between 80% and

90% of total purchase price.

8. The capital invested shall not be guaranteed by any of the partners.

9. Any of the partners acting as agents of each other shall be liable for

misconduct or negligence to the partnership as a whole.

10. Any partner acting on his own or as agent who has caused the loss of

capital due to misconduct or negligence shall be liable to refund the

loss of capital to the other partners.

11. Any loss of capital in the course of the venture shall be recognized as

capital impairment. Upon termination of the partnership, capital

impairment loss, if any, shall be borne by both partners proportionate

to capital contribution.

12. A share of a Musharakah capital may be transferred to existing

partners or a third party according to the existing terms and conditions

of the Musharakah contract.

13. The Musharakah contract shall be terminated upon project completion

time i.e. three (3) years.

24 1000310IB2001CS.docx

14. In the case of an actual liquidation, the assets shall be sold at market

value and the proceeds of the sale shall be used as follows:-

1. Payment of liquidation expenses;

2. Payment of financial liabilities that are owing to the

partnership; and

3. Distribution of the remaining assets, if any, among the

partners in proportion to their capital contribution.

25 1000310IB2001CS.docx

4.0 Answer 3

i. Estimated profit amount for partners


Profit Ratio 60% 40%

= USD200 million x 60% = USD200 million x 40%

Profit Amount
= USD120 million = USD80 million

‫؞‬Thus, the estimated profit amount for SBBL and TBL are USD120 million and

USD80 million respectively.

ii. Annual rate of return for TBL


Profit Amount USD80 million

Capital Contribution USD150 million

Rate of Return = USD80 million ÷ USD150 million × 100% ÷ 3 years

Annually = 17.78%

‫؞‬The annual rate of return for TBL from its capital investment in this project

venture is 17.78%.

26 1000310IB2001CS.docx

iii. Actual profit amount for both partners, and actual annual rate of return for


Estimated Profit = USD500 million × 35%

= USD175 million


Profit Ratio 60% 40%

= USD175 million x 60% =USD175 million x 40%

Profit Amount
= USD105 million = USD70 million

= USD70 million ÷ USD150

Rate of Return
N/A million × 100% ÷ 3 years
= 15.56%

‫؞‬Actual profit amount for SBBL and TBL are USD105 million and USD70

million respectively, and actual annual rate of return for TBL is 15.56%.


In my opinion, I would say it is justifiable for TBL to provide this Musharakah

financing if we look at the annual rate of return of 15.56%. This level of annual rate

of return can be considered satisfactory from the viewpoint of most average investors.

The risk in Musharakah financing is a justified concern among banks. This is because

banks are heavily dependent upon the integrity of the partners involved. However, in

this case, as SBBL has been a customer for the bank since 2005 and is also a

27 1000310IB2001CS.docx

subsidiary of a Tashkent-based middle-eastern bank, the risk here is a calculated risk

and the established nature of parent company of SBBL somehow in some ways gave

considerable assurance that SBBL is a good candidate for a workable partnership


The nature of Musharakah contract will also allow TBL to be actively involved in

decision making process, as compared to other equity financing type namely

Mudharabah. This will ensure that the bank’s interest is well taken care of from time

to time, and also will facilitate the bank in monitoring the progress of SBBL’s work


Finally, from my viewpoint, in this Musharakah the capital provided by TBL’s

partner i.e. SBBL is in the form of land with a market value of USD100 million. This

means that if, God forbid, the project turns out to be a failure, the project venture still

has assets worth at least USD100 million (current market value, and may appreciate in

value due its nature as land asset) and therefore TBL will be compensated with around

USD60 million, amount derived based on the capital contribution ratio of 100:150

mentioned earlier. This means a worst case scenario is for the bank to incur a loss of

USD90 million the most.

28 1000310IB2001CS.docx

5.0 References

Bank Negara Malaysia. 2010. Draft of Shariah Parameter Reference 4: Musharakah

Contract. Kuala Lumpur: Bank Negara Malaysia.

Bank Negara Malaysia. 2011. Guidelines on Musharakah and Mudharabah Contracts

for Islamic Banking Institutions. Kuala Lumpur: Bank Negara Malaysia.

Bank Negara Malaysia. 2011. Guidelines on Property Development and Property

Investment Activities by Islamic Banks. Kuala Lumpur: Bank Negara Malaysia.

Usmani, M.M.S.. 2011. Objections on Musharakah Financing. Kuala Lumpur:

Academy for International Modern Studies.

_. 2006. Concepts in Islamic Economics and Finance: Musharakah. WordPress.

Accessed: March 16, 2011. Available online at:

_. 2011. 5 C's of Credit (5 C's of Banking). WikiCFO. Accessed: March 14, 2011.

Available online at:

29 1000310IB2001CS.docx