Musharka Financing

Agreement
By UBL Islamic Banking
Agreement Details
• The customer has applied for a Musharka Financing Facility for
purchase of Musharka Vehicle based on Shirkat-ul-Milk.
• Bank has accepted the offer and agreed to enter into a Musharka with
customer.
• Investment share of both parties will be involved in Musharka but
vehicle will purchased in the name of client and will be used by the
client.
• After making annual payments, the ownership of vehicle will be
transferred to the client.
Recapitulation
Diminishing Musharka
Diminishing Musharakah based on sharing of ownership of an asset
(sharikah al-milk) may not be a good idea for Islamic banking.
• Technical issues may arise in the event of appreciation or depreciation
in the value of the underlying asset.
• What is to be done if market value of the underlying asset falls or
rises sharply and the client calls for final settlement according to the
said market value?
• Bank’s and shareholders interest will be jeopardized.
Detailed Analysis
“It is understood between the parties that regardless of the proportion of each
party in the Musharka, the entire Musharka vehicle will be purchased in the
name of the customer and will be used by the customer”. (Pg 1, 1.2)
• All the transactions including the purchase of capital, are done in the name of
partnership/ joint venture/joint ownership and not in the name of any party
involved.
• A diminishing musharakah financing instrument (DMUFI) based on contractual
partnership, with a subordinate ijarah arrangement, has two components:
1. A diminishing musharakah agreement between the bank and the client, and
2. A lease agreement between the client and the joint venture created in lieu
of the diminishing musharakah.
Detailed Analysis(continued)
“The respective banks…….and the banks investment in the musharka may be made
available to the customer in one or more tranches in accordance with the terms and
conditions of purchase between the customer and the seller (being the owner of the
vehicle)” (Pg 2, 3.1)
“It is agreed that the customer shall…….acquire the Musharka vehicle from the
seller and the bank shall make available the banks investment in the musharka to the
customer or his nominee for the purpose of completing the sale in the name of the
customer on behalf of the Musharka.” (4.1)
• Why is Bank’s investment available to customer for completing the sale? Why the
vehicle is not purchased in joint name.
• This arrangement is giving an impression of the usual and conventional practice of
taking loan to fulfill the need.
Detailed Analysis(continued)
“And whereas the parties have agreed that the customer shall use the
Musharka vehicle and now further hereby it is agreed that to the extent of
the banks Musharka share the customer shall pay a monthly payment to the
bank upon the terms and conditions set out hereunder (Pg 8)
The customer shall pay to the bank the monthly payment in respect of the
use of the Musharka vehicle to the extent represented by the banks share in
the Musharka.” (Pg 9,3.1)
• Division of profits before the ‘payment of rental/ purchase of banks share
is a necessary condition of Musharka and Diminshing Musharka. Here the
rent paid by client for using the car is the source of income for Joint
Venture. No JV is created here so that is the main issue.
Detailed Analysis(continued)
“Without prejudice to any other rights of bank in the event of late payment of any
amounts due under this payment agreement the customer hereby undertakes to pay
charity rs.500/- per month per delayed installment the charity rate is applicable as
per schedule of charges amended from time to time. Such additional amount shall
be utilised by the bank for charitable and religious purposes. The customer hereby
consents to such utilization of the said amount by the shariah board at its absolute
discretion.” (Pg 9,5.4)
• What is the profit / benefit of bank here? A bank is a financial institution not a
social or non-profitable institute.
• Moreover, there is a possibility that bank is using the charity arrangement for its
goodwill (corporate social responsibility). Do the customers know where is all the
charity money going?
Detailed Analysis(continued)
“Appendix B states that the formula for variation of annual payments is
based on KIBOR (Karachi Inter Bank Offer Rate)”(Pg 11)
• Annual payments are collected not the basis of equity stakes but on the
basis of KIBOR (Karachi Inter Bank Offer Rate) , which makes it
questionable.
• Rent should be decided prior to the any and should not be linked to
any varying market rate. It makes it, more or less, the same things as
conventional banks interest rate
Detailed Analysis(continued)
Are the expenses borne on by both the parties on behalf of the join
owneship?
The agreement says,
“The customer shall pay all taxes and expenses except those directly
related to the acquisition/ownership of the Musharka vehicle” (Pg 3,9-
a)
Purchasing the vehicle was the interest of client so all maintenance and
operating expenses will be borne by him excluding the major expenses
Detailed Analysis(continued)
As a principle of Leasing all the risk is to be borne by the lessor, Who
bears the risk of loss in this agreement?
• Similar to conventional banking all kinds of risks, losses or damages
irrespective of the circumstances are to be borne by the Customer.
• If the leased asset is stolen, destroyed or temporarily out of order in
such circumstances rent will continue till the settlement, which is also
similar to conventional baking.
Detailed Analysis(continued)
In case of promise to sell units of share by financier, one might argue
that if the promise to sale has been done before entering into actual
sale, this is practically putting a condition in the sale itself.
• There is a difference between putting a condition on a sale and making
a separate condition on a sale and making separate promise, without
making it a condition. In case of condition, sale will be valid only if
the condition is fulfilled.
Conclusion
• Diminishing Musharka is advisable for contractual partnerships, not for
cases of joint ownership of physical assets like houses. This is because in
the latter case the value of property may change during the tenure of
partnership whereas nominal value of equity in cash-based partnership
does not.
• Diminishing financing by Islamic banks is unique because the source of
income of joint partnership is leasing of jointly owned asset to the client.
• The Current Financial Instruments contains some major flaws which make
its Shariah Compliance questionable. Therefor the practicing Instrument
for Car Financing needs Structural rearrangements. The problems are
identified in this paper which needs to be worked out.