MUSHARAKAH MUTANAQISAH BASED HOUSE FINANCING LEGAL

ISSUES AND RECOMMENDATIONS

Introduction

In our world nowadays, the contract of Al-Bay‟ Bithaman Ajil (BBA) had always been used for
long time duration of financing. For example, home financing. In Malaysia also, this concept is
popular and it showed that at the Kuala Lumpur High Court alone, 90% of the 3,200 Muamalat
cases registered between 2003 to 2009 concerns BBA1. While the BBA is popular, it has proven
to be quite unsatisfactory to the customers and bankers. That‟s why Musharakah Mutanaqisah
concept is being argued as a better contract than BBA for long time duration.

What is Musharakah Mutanaqisah Concept?

Musharakah Mutanaqisah is based on diminishing partnership concept. It consists of three

contracts which are musharakah, ijarah as well as bay‟(sale). First, the customer enters into a
musharakah under the concept of „Shirkat-al-Milk‟ (joint ownership) agreement with the bank to
co-own the asset being financed. Second, the bank leases its share in the asset ownership to the
customer under the concept of ijarah. This is when the customer pays a% of the asset cost as the
initial share to co-own the asset whilst the bank provides for the balance of b%. Third, the
customer gradually buys the bank‟s b% share at an agreed portion periodically until the asset is
fully owned by the customer.

The periodic rental amounts will be jointly shared between the customer and the bank according
to the percentage share holding at the particular times which keeps changing as the customer
purchases the financier‟s share. The customer‟s share ratio would increase after each rental
payment due to the periodic redemption until eventually fully owned by the customer

1
Zakhiri, M. (2010, June 9). Musharakah Mutanaqisah Financing Facilities Legal Issues and Challenges. Islamic
Finance News.(23)7.
Example of Musharakah:

Financier Customer
80% 20%

Musharakah
100%

Musharakah Businesss

The permissibility of the Musharakah is agreed by the majority of scholars. Most of them argue
that there is no specific evidence in the Quran and Sunnah that prohibit the Musharakah
Mutanaqisah. Allah states that if a person dies without leaving behind any ascendants or
descendants; but he has brothers and sisters more than two in number; then they will share a third
of the property of the mortal2. So, based on this verse the partnership of the property is legal in
the shariah.

Musharakah Mutanaqisah Documents:

1. Promise (Wa‟ad)

2. MM facility agreement (to set terms for the MM and MM business)

3. Sales & Purchase (S&P) (or supplemental S&P, if the customer himself has signed the

S&P with the Vendor before approaching the bank for fi nancing)

4. Ijarah lease agreement

5. Trust deed (if applicable)

2
Surah An-Nisa, 4: 12
 6. Service agency agreement

7. Letter of undertaking

Implementation of Musharakah Mutanaqisah

In regards to the implementation of Musharakah Mutanaqisah, it found that there are some legal
issues pertaining to this concept. It includes issues of rental rate, wa‟ad, damage of property, tax
and land ownership and else (Osmani and Abdullah, 2005). But, there are still many rooms for
improvement to make the Musharakah Mutanaqisah more Shariah compliant otherwise it is just a
replication to the conventional loan.

ISSUES

Interest rate as rental rate

The respective bank uses Islamic Bank Rate (IBR) with adjustment as the profit rate. The profit
rate will be differing according to the financing amount and whether the property is already
completed or under construction. For home financing range between RM 100 thousand to RM
500 thousand, the rate for the completed home will be IBR – 1.70% while for the under
construction home, the rate is IBR – 1.60%. While for the home financing above RM 500
thousand, the adjustment rate is higher by 1% for both completed and under construction. The
same goes to commercial property financing. The rate is different whether the amount of
financing is RM 100 thousand below or above. For the completed property below RM 100
thousand, the rate is IBR – 1.30% while for under construction property, the rate is IBR – 1.20%.
While for the financing amount above the RM 100 thousand, the adjustment rate is higher by 1%
for both completed and under construction property.3 From here it seems that the bank still use
conventional interest rate as a benchmark while if we follow the concept of Musharakah
Mutanaqisah, the bank should use the rental rate. Besides that, as the IBR is based on Overnight
Policy Rate of Bank Negara Malaysia, it may contains element of uncertainty as argued by
Meera and Abdul Razak (2005) because the interest rate is fluctuating everyday and it may

3
Siti Fariha. (2013, March 6). An Evaluation On Musharakah Mutanaqisah Based House Financing By Islamic Banks
In Malaysia. Retrieved 22 November 2013.
burdensome to the customer although the bank states that the profit rate is being capped at
10.25%.4 This benchmark will lead Musharakah Mutanaqisah to be similar with conventional
financing contracts.

Issue of property maintenance

Customer has to bear the cost of maintenance and there is no clause in agreement between the
bank and the customer which specifies the customer to bear the cost of maintenance. It is said to
be done based on the mutual understanding between the customer and the bank. Furthermore, the
bank asserts that since the legal title of the property is possessed by the customer, they are the
ones that should be responsible for the maintenance. Besides that, the bank argues that it would
be impractical for them to be in charge of maintenance works due to the nature of the bank‟s
operation besides at the end of the contract, the customer will own the home or property.

Issue of risk sharing between bank and customer

By analyzing how this respective local Islamic bank implements the Equity Home/ Property
Financing-i, it can be concluded that the bank do not bear any risk regarding the ownership of the
home or property. The legal title of the home or property lies with the customer from the
beginning of the contract and the bank just acts as a trustee. Thus, it can be inferred that the true
concept of Musharakah does not exist here. The true concept of Musharakah acknowledges the
joint ownership by both parties which are the customer and the bank. Secondly, in the case of the
uncompleted home or property, if the home or property is found to be not completed, the bank
will ask the customer to pay back the amount the bank has disbursed on the property. Again, it
does not truly reflect the true concept of Musharakah whereby any loss should be borne by the
both parties according to the capital contribution. Thus, it can be concluded the bank does not
bear any „Iwad in implementation of this contract, merely acts as financier, more or less similar
with conventional financing.

4
Meera, Ahamed Kameel Mydin and Abdul Razak, Dzuljastri (2005) “Islamic Home Financing through Musharakah
Mutanaqisah and Al-Bay’ Bithaman Ajil Contracts: A Comparative Analysis”. Retrieved 22 November 2013.
Issue of charges and fees

Through Non Free Acquisition Cost policy, the bank acquires the customer to pay the legal fees
and all fees related to the acquisition costs upfront before the financing amount is granted. This
is contrast with the concept of Musharakah Mutanaqisah whereby both parties should bear the
legal fees and charges. As a matter of fact, AAOIFI Financial Accounting Standard on
Musharakah Mutannaqisah required the financial expenses arise from the contract are borne by
the partners in proportion to their shares. The same goes to the issue of maintenance as have been
discussed above.

Other issues

In the process of implementing this contract, the respective local Islamic bank faces the problem
in preparing the documentation of the contract due to the lack of the Shariah lawyers that are
experts and well understand the Musharakah Mutanaqisah contract5. Besides that, there are many
comments from their customers regarding the abolishment of Bai Bithaman Ajil and the
replacement with Musharakah Mutanaqisah.

Recommendations

As a newly implemented product, Musharakah Mutanaqisah based contract is not excluded from
having some flaws and limitations. However, there are still some rooms for improvements to
make it a better product. Thus, collaboration from various parties and economic scholars is very
important in improving Musharakah Mutanaqisah based contract to make it more Shariah
compliant and assessable to all type of income group yet maintaining its commercial value

Next, the bank considered as “Islamic” ought to be guided by the philosophies of Islamic
business, which are, firstly, the philosophies will be used by the management or policy makers of
the banks in the process of formulating corporate objectives and policies. Secondly, these
philosophies serve as an indicator as to whether the particular Islamic bank is upholding true
Islamic principles. The representatives should know these philosophies. Other than that, Islamic
banking is a subset of the overall Islamic economic system. They must that strives for a just, fair
and balanced society as envisioned and deeply inscribed in the objectives of Shariah.

5
ibid at 1
We believe that there is a bigger rooms for the Musharakah Mutanaqisah based financing
contract to be further implemented by the banks because currently only nine banks has
implemented Musharakah Mutanaqisah based financing contract which are RHB Islamic Bank,
Kuwait Finance House, OCBC Al Amin, HSBC Amanah, Bank Muamalat Malaysia Berhad,
Citibank, Affin Islamic Bank and Standard Charted Sadiq Islamic Bank. Thus, there is high
opportunity for this Musharakah Mutanaqisah contract to grow and replace Bai Bithaman Ajil
contract since the implementation of Bai Bithaman Ajil contract has been surrounded by many
controversial issues and still being debatable among scholars.

Conclusion

In conclusion, it seems that Musharakah Mutanaqisah contract still in look like in conventional
loan. A truly Islamic financing should avoid interest rates totally as such and let the values and
payments solely be determined by the real economy. There also must be free of uncertainty in
contract to prevent fraud/injustice from incurred.