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Islamic Modes Of Financing - Islamic Economics
Islamic Modes Of Financing
Allah Subhan-o-Tallah has declared that He will become a partner in a business between two Mushariks until they indulge in cheating or breach of trust (Khayanah).
Definition and classification of Musharakah
The literal meaning of Musharakah is sharing. The root of the word "Musharakah" in Arabic is Shirkah, which means being a partner. It is used in the same context as the term "shirk" meaning partner to Allah. Under Islamic jurisprudence, Musharakah means a joint enterprise formed for conducting some business in which all partners share the profit according to a specific ratio while the loss is shared according to the ratio of the contribution. It is an ideal alternative for the interest based financing with far reaching effects on both production and distribution. The connotation of this term is little limited than the term "Shirkah" more commonly used in the Islamic jurisprudence. For the purpose of clarity in the basic concepts, it will be pertinent at the outset to explain the meaning of each term, as distinguished from the other. "Shirkah" means "Sharing" and in the terminology of Islamic Fiqh, it has been divided into two kinds:
(1) Shirkat-ul-milk (Partnership by joint ownership):
It means joint ownership of two or more persons in a particular property. This kind of "Shirkah" may come into existence in two different ways:
1. Optional (Ikhtiari):
At the option of the parties e.g., if two or more persons purchase 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 Ikhtiari" Here this relationship has come into existence at their own option, as they themselves elected to purchase the equipment jointly.
b) Compulsory (Ghair Ikhtiari):
This comes into operation automatically 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.
The basic rules of Musharakah
Musharakah or Shirkat-ul-amwal is a relationship established by the parties through a mutual contract. Therefore, it goes without saying that all the necessary ingredients of a valid contract must be present here also. 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, etc.
Basic rules of Capital:
The capital in a Musharakah agreement should be:
a) Quantified (Ma'loom): Meaning how much etc. b) Specified (Muta'aiyan): Meaning specified currency etc. c) Not necessarily be merged: The mixing of capital is not required. d) Not necessarily be in liquid form: Capital share may be contributed either in cash/liquid or in the form of commodities. In case of a commodity, the market value of the commodity shall determine the share of the partner in the capital.
The normal principle of Musharakah is that every partner has a right to take part in its management and to work for it. However, the partners may agree upon a condition that the management shall be carried out by one of them, and no other partner shall work for the Musharakah. But in this case the sleeping partner shall be entitled to the profit only to the extent of his investment, and the ratio of profit allocated to him should not exceed the ratio of his investment, as discussed earlier.
However, if all the partners agree to work for the joint venture, each one of them shall be treated as the agent of the other in all matters of business. Any work done by one of them in the normal course of business shall be deemed as authorized by all partners.
Basic rules of distribution of Profit
1. The ratio of profit for each partner must be determined in proportion to the actual profit accrued to the business and not in proportion to the capital invested by him. E.g. if it is agreed between them that 'A' will get 1% of his investment, the contract is not valid.
2. It is not allowed to fix a lump sum amount for anyone of the partners or any rate of profit tied up with his investment. Therefore if 'A' & 'B' enter into a partnership and it is agreed between them that 'A' shall be given Rs.10,000/- per month as his share in the profit and the rest will go to 'B', the partnership is invalid.
3. If both partners agree that each will get percentage of profit based on his capital percentage, whether both work or not, it is allowed.
4. It is also allowed that if an investor is working, his profit share (%) could be more than his capital base (%) irrespective whether the other partner is working or not. Eg. if 'A' & 'B' have invested Rs.1000/- each in a business and it is agreed that only 'A' will work and will get 2/3rd of the profit while 'B' will get 1/3rd. Similarly if the condition of work is also imposed on 'B' in the agreement, then also the proportion of profit for 'A' can be more than his investment.
5. If a partner has put an express condition in the agreement that he will not work for the Musharakah and will remain a sleeping partner throughout the term of Musharakah, then his share of profit cannot be more than the ratio of his investment. However, Hanbali school of thought considers fixing the sleeping partners share more than his investment to be permissible.
6. It is allowed that if a partner is not working, his profit share can be established as less than his capital share.
7. If both are working partners, the share of profit can differ from the ratio of investment. Eg. Zaid & Bakar both have invested Rs.1000/- each. However Zaid gets 1/3rd of the total profit and Bakar 2/3rd, this is allowed. This opinion of Imam Abu Hanifa is based on the fact that capital is not the only factor for profit but also labours and work. Therefore although the investment of two partners is the same but in some cases quantity and quality of work might differ.
8. If only a few partners are active and others are only sleeping partners, then the share in the profit of the active partner could be fixed at higher than his ratio of investment eg. 'A' & 'B' put in Rs.100 each and it is agreed that only 'A' will work, then 'A' can take more than 50% of the profit as his share. The excess he receives over his investment will be compensation for his services
Basic rules of distribution of Loss
All scholars are unanimous on the principle of loss sharing in Shariah based on the saying of Syedna Ali ibn Talib that is as follows:
"Loss is distributed exactly according to the ratio of investment and the profit is divided according to the agreement of the partners."
Therefore the loss is always subject to the ratio of investment eg. if 'A' has invested 40% of the capital and 'B' 60%, they must suffer the loss in the same ratio, not more, not less. Any condition contrary to this principle shall render the contract invalid.
Powers & Rights of Partners in Musharakah:
After entering into a Musharakah contract, partners have the following rights:
a) The right to sell the mutually owned property since all partners are representing each other in Shirkah and all have the right to buy & sell for business purposes.
b) The right to buy raw material or other stock on cash or credit using funds belonging to Shirkah to put into business.
c) The right to hire people to carry out business if needed.
d) The right to deposit money & goods of the business belonging to Shirkah as depositor trust where and when necessary.
e) The right to use Shirkah's fund or goods in Mudarabah.
f) The right of giving Shirkah's funds as hiba (gift) or loan. If one partner for purpose of investing in the business has taken a Qard-e-Hasana, then paying it becomes liable on both.
This is a kind of partnership where one partner gives money to another for investing in a commercial enterprise. The investment comes from the first partner who is called "Rab-ul-Maal" while the management and work is an exclusive responsibility of the other, who is called "Mudarib" and the profits generated are shared in a predetermined ratio.
Types of Mudarabah
There are 2 types of Mudarabah namely:
1. Al Mudarabah Al Muqayyadah:
Rab-ul-Maal may specify a particular business or a particular place for the mudarib, in which case he shall invest the money in that particular business or place. This is called Al Mudarabah Al Muqayyadah (restricted Mudarabah).
2. Al Mudarabah Al Mutlaqah:
However if Rab-ul-maal gives full freedom to Mudarib to undertake whatever business he deems fit, this is called Al Mudarabah Al Mutlaqah (unrestricted Mudarabah). However Mudarib cannot, without the consent of Rab-ul-Maal, lend money to anyone. Mudarib is authorized to do anything, which is normally done in the course of business. However if they want to have an extraordinary work, which is beyond the normal routine of the traders, he cannot do so without express permission from Rab-ul-Maal. He is also not authorized to:
a) keep another Mudarib or a partner b) mix his own investment in that particular Modarabah without the consent of Rab-ul Maal.
Conditions of Offer & Acceptance are applicable to both. A Rab-ul-Maal can contract Mudarabah with more than one person through a single transaction. It means that he can offer his money to 'A' and 'B' both so that each one of them can act for him as Mudarib and the capital of the Mudarabah shall be utilized by both of them jointly, and the share of the Mudarib.
Difference between Musharakah and Mudarabah
1. All partners invest. Only Rab-ul-Maal invests.
2. All partners participate in the management of the business and can work for it. Rab-ul-maal has no right to participate in the management which is carried out by the Mudarib only.
3. All partners share the loss to the extent of the ratio of their investment. Only Rab-ul-maal suffers loss because the Mudarib does not invest anything. However, this is subject to a condition that the Mudarib has worked with due diligence.
4. The liability of the partners is normally unlimited. If the liabilities of business exceed its assets and the business goes in liquidation, all the exceeding liabilities shall be borne pro rata by all partners. But if the partners agree that no partner shall incur any debt during the course of business, then the exceeding liabilities shall be borne by that partner alone who has incurred a debt on the business in violation of the aforesaid condition. The liability of Rab-ul-maal is limited to his investment unless he has permitted the Mudarib to incur debts on his behalf.
As soon as the partners mix up their capital in a joint pool, all the assets become jointly owned by all of them according to the proportion of their respective investment. All partners benefit from the appreciation in the value of the assets even if profit has not accrued through sales. The goods purchased by the Mudarib are solely owned by Rab-ul-maal and the Mudarib can earn his share in the profit only in case he sells the goods profitably.
Murabaha is one of the most commonly used modes of financing by Islamic Banks and financial institutions.
Murabahah is a particular kind of sale where the seller expressly mentions the cost of the sold commodity he has incurred, and sells it to another person by adding some profit thereon. Thus, Murabahah is not a loan given on interest; it is a sale of a commodity for cash/deferred price.
The Bai' Murabahah involves purchase of a commodity by a bank on behalf of a client and its resale to the latter on cost-plus-profit basis. Under this arrangement the bank discloses its cost and profit margin to the client. In other words rather than advancing money to a borrower, which is how the system would work in a conventional banking agreement, the bank will buy the goods from a third party and sell those goods on to the customer for a pre-agreed price.
Murabahah is a mode of financing as old as Musharakah. Today in Islamic banks world-over 66% of all investment transactions are through Murabahah.
Basic rules for Murabahah
Following are the rules governing a Murabahah transaction:
1. The subject of sale must exist at the time of the sale. Thus anything that may not exist at the time of sale cannot be sold and its non-existence makes the contract void.
2. The subject matter should be in the ownership of the seller at the time of sale. If he sells something that he has not acquired himself then the sale becomes void.
3. The subject of sale must be in physical or constructive possession of the seller when he sells it to another person. Constructive possession means a situation where the possessor has not taken physical delivery of the commodity yet it has come into his control and all rights and liabilities of the commodity are passed on to him including the risk of its destruction.
4. The sale must be instant and absolute. Thus a sale attributed to a future date or a sale contingent on a future event is void. For example, 'A' tells 'B' on 1st January that he will sell his car on 1st February to 'B', the sale is void because it is attributed to a future date.
5. The subject matter should be a property having value. Thus a good having no value cannot be sold or purchased.
6. The subject of sale should not be a thing used for an un-Islamic purpose.
7. The subject of sale must be specifically known and identified to the buyer. For Example, 'A' owner of an apartment building says to 'B' that he will sell an apartment to 'B'. Now the sale is void because the apartment to be sold is not specifically mentioned or pointed to the buyer.
8. The delivery of the sold commodity to the buyer must be certain and should not depend on a contingency or chance.
9. The certainty of price is a necessary condition for the validity of the sale. If the price is uncertain, the sale is void.
10. The sale must be unconditional. A conditional sale is invalid unless the condition is recognized as a part of the transaction according to the usage of the trade.
Uses of Murabahah:
Murabahah can be used in following conditions:
Short / Medium / Long Term Finance for:
* · Raw material
* · Inventory
* · Equipment
* · Asset financing
* · Import financing
* · Export financing (Pre-shipment)
* · Consumer goods financing
* · House financing
* · Vehicle financing
* · Land financing
* · Shop financing
* · PC financing
* · Tour package financing
* · Education package financing
* · All other services that can be sold in the form of package (i.e. services like education, medical etc. as a package)
Bai' Muajjal is the Arabic acronym for "sale on deferred payment basis". The deferred payment becomes a loan payable by the buyer in a lump sum or installment (as agreed between the two parties). In Bai' Muajjal all those items can be sold on deferred payment basis which come under the definition of capital where quality does not make a difference but the intrinsic value does. Those assets do not come under definition of capital where quality can be compensated for by the price and Shariah scholars have an 'ijmah' (consensus) that demanding a high price in deferred payment in such a case is permissible.
Conditions for Bai' Muajjal
1. The price to be paid must be agreed and fixed at the time of the deal. It may include any amount of profit without qualms about riba.
2. Complete/total possession of the object in question must be given to the buyer, while the deferred price is to be treated as debt against him.
3. Once the price is fixed, it cannot be decreased in case of earlier payment nor can it be increased in case of default.
4. In order to secure the payment of price, the seller may ask the buyer to furnish a security either in the form of mortgage or in the form of an item.
5. If the commodity is sold on installments, the seller may put a condition on the buyer that if he fails to pay any installment on its due date, the remaining installments will become due immediately.
Transferring of usufruct not ownership. In leasing an owner transfers its usufruct to another person for an agreed period, at an agreed consideration.
Subject of lessee
Should be valuable, identified and quantified.
All consumable things cannot be leased out.
The corpus of the leased property remains in the ownership of the seller, and only its usufruct is transferred to the lessee. Thus, anything, which cannot be used without consuming, cannot be leased out. For example money, wheat etc.
All liabilities of ownership is borne by lessor
As the corpus of the leased property remains in the ownership of the lessor, all the liabilities emerging from the ownership shall be borne by the lessor.
Period of lease
* The period of lease must be determined in clear terms.
* It is necessary for a valid lease that the leased asset is fully identified by the parties.
Lease for specific purpose
The lessee cannot use the leased asset for any purpose other than the purpose specified in the lease agreement. However, if no such purpose is specified in the agreement, the lessee can use it for whatever purpose it is used in the normal course.
REVOLUTIONARY BANKING STRATEGY
[The bank should provide employment to the person who deposits his money in the bank, at the place where his money is given as a loan. so that, in this way –a check is kept on both & hence both are benefited. the person who needs loan gets the money & the person who deposits money gets the employment.]
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