Musharaka

(Equity partnership)

Mudaraba

(Investment Partnership)

How do you finance

anything?
Equity vs debt?
How to decide?
Availability, cost, tax structure...
Conventional vs Islamic perspective

Trouble with debt

2008 GFC - households borrow more than
they can pay back

2009 Dubai (Nakheel ) debt crisis -

businesses borrow more than they can pay

back

2010/11 Current Debt Crisis governments

borrow more than they can pay back

Next???

Islam and debt

Bukhari,Volume 3, Book 41, Number 582:
"O Allah, I seek refuge with you from all sins, and from being in
debt." Someone said, O Allah's Apostle! (I see you) very often
you seek refuge with Allah from being in debt. He replied, "If a
person is in debt, he tells lies when he speaks, and breaks his
promises when he promises.
Bukhari Volume 4, Book 52, Number 143:
"O Allah! I seek refuge with You from distress and sorrow,
from helplessness and laziness, from miserliness and cowardice,
from being heavily indebtand from being overcome by men."

Narrated by Abu Dawood Book 22, Number

3335 & 3336:
Prophet Muhammad (peace be upon him)
linking debt with being in prison by saying Your
companion has been detained (from entering
Paradise) on account of his debt.
Also, The Prophet (peace be upon him) said:
After the grave sins which Allah has prohibited
the greatest sin is that a man dies while he
has debt due from him and does not leave
anything to pay it off, and meets Him with it.

Whoever dies free from three things

arrogance, cheating and debt will enter
Paradise. Narrated by al-Tirmidhi (1572)
Umar ibn al-Khattaab r.a. said:Beware of debt,
for it starts with worry and it ends with war.
Narrated by Maalik in al-Muwatta (2/770).
Scholars say: It is a disgrace and a humiliation
because it preoccupies the mind and makes
one worried about paying it off. (al-Qurtubi in
al-Jaami li Ahkaam al-Quraan (3/417))

AAOIFI on equity
based financing
the Shari'ah Board advises Islamic Financial
Institutions to decrease their involvements
in debt-related operations and to increase
true partnerships based on profit and loss
sharing in order to achieve the objectives
of the Shari'ah. (AAOIFI's Shari'a Board
Resolutions on Sukuk)

Two basic modes of

Islamic financing
Modes of Islamic Finance

Debt Based Financing

(non-PLS* mode)
Eg. Murabaha, Ijarah, etc.

Equity Based Financing

(PLS* mode)
Eg. Musharaka and
Mudaraba
*profit-and-loss sharing (PLS)

Musharaka

(Equity partnership, Joint Venture)

Derived from
word shirkah or
sharing.

* Slides on Musharaka are based on AAOFI Sharia Standard No. (12) Sharika
(Musharaka) and modern Corporations; and Introduction to Islamic finance by T.
Usmani.

Sharika (partnership)
AAOFI Sharia Standard No. (12) Sharika

(Musharaka) and modern Corporations covers:

Applicable to all forms of traditional fiqhnominated partnerships that operate on the basis
of Sharika al-aqd (contractual partnership,
(excluding ownership partnership sharika al-milk)
All modern forms of partnership including
diminishing Musharaka

Definition
Sharika al-aqd (typical Musharaka)
Sharika al-aqd (contractual partnership) means an
agreement between two or more parties to combine
their assets, labour or liabilities for the purpose of
making profits AAOIF sharia standard 12/2/1
Sharika al-aqd is classified into two main categories:
1. Traditional fiqh-nominated partnership
2. Modern corporations

Musharaka
A
$/20%

B
$/80%

Business Venture
Profit: 20/80 ratio
Or any pre agreed ratio
(eg 30/70)

Loss: 20/80 ratio - Fixed!

(according to capital
contribution)

Musharaka

Calculation example (Pre agreed ratio 30/70)

Investor

Capital
Contribution

$40,000

$60,000

Outcome 1
Profit
$10,000

Outcome 2
Loss
-$10,000

Diminishing Musharaka
Diminishing Musharaka is a form of partnership in

which one of the partners promises to buy the equity

share of the other partner gradually until the title to the
equity is completely transferred to him. AAOIFI 12/5/1

Ownership %
Bank
80%
75%
70%
65%
...
0%

Customer
20%
25%
30%
35%
...
100%

Musharaka example
- A and B invest 50 (Capital contribution A: 30, B: 20)
- It is agreed that A will get 80% and B 20% of actual
profits. (Profit ration 80/20)
- Total worth of the business has Increased to 100
units.
Q1: How will the profit be divided between the
partners?
Q2: What would A have to pay to purchase Bs shares?

Q
If A and B enter into a partnership and it is agreed between them that A
shall be given $10,000/- per month as his share in the profit, and the
rest will go to B, is the partnership valid?

A
It is invalid - The proportion of profit to be distributed between the
partners must be agreed upon at the time of effecting the contract. If no
such proportion has been determined, the contract is not valid in
Shariah.
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. It is not allowed to fix a lump sum amount
for any one of the partners, or any rate of profit tied up with his
investment. The correct basis for distribution would be an agreed
percentage of the actual profit accrued to the business.

What about shares?

What are shares?
Shares represent units of ownership interest or a specific part of
the total capital of a company.
Is it permissible to own shares?
In general there is nothing wrong with buying or selling shares as
part of an investment strategy, as long as they pass Shariah
compliancy test.
What about profits and dividends?
By purchasing shares in a company a person becomes a shareholder
or partner in a business. As such, a shareholder is entitled to
receive proportional profits that result from the companys
economic activities.

Mudaraba

(Investment Partnership)

Mudaraba is a partnership in profit whereby one party

provides capital (rab al-maal) and the other party
provides labour (mudarib)

Mudaraba
Mudari
b
Labour

Investor
(one or group)
Capital

Business Venture
Profit: Any pre agreed
ratio
(eg 20/80)

Loss: Mudarib (labour),

Investor (capital)

Mudaraba

Calculation example (Pre agreed ratio 30/70)

Investor

Capital
Contribution

Manager

$0

Investor

$100,000

Outcome 1
Profit
$10,000

Outcome 2
Loss
-$10,000

Eg. Bank and Mudaraba

Bank - definition and purpose
Take deposits/mobilize funds
Act as financial intermediary between lenders and borrowers
Connects savers to borrowers via various financial products
Islamic banks are less straightforward because Islam prohibits
making money by money and thus all transactions must not
involve any interest (riba). The Qur'anic verse "Allah has
permitted trade and has forbidden interest (usury)" [2:275] is
the main reason why Islamic banking derives its profit from
real economic activities by means of trading, leasing or
investment.

Bank accounts
Deposits

Surplus
units

Deficit
units

Bank
Financing

Q? If the capital is $100000/- can partners in

Mudaraba agree on a condition that $10000/- out
of the profit shall be the share of the mudarib?
NO
Can they say that 20% of the capital shall be
given to rabb-ul-mal.
NO
Can agree on that 40% of the actual profit shall
go to the mudarib and 60% to the rabb-ul-mal or
vice versa.
YES

Is it allowed that different proportions are agreed

in different situations?
For example the rabbul-mal say to mudarib, If you
trade in wheat, you will get 50% of the profit and if
you trade in flour, you will have 33% of the profit.
YES
What about: If you do the business in your town,
you will be entitled to 30% of the profit, and if you
do it in another town, your share will be 50% of
the profit
YES.

Is it allowed that different proportions are agreed in

different situations?
For example the rabbul-mal say to mudarib, If you trade in
wheat, you will get 50% of the profit and if you trade in
flour, you will have 33% of the profit.
YES
What about: If you do the business in your town, you will
be entitled to 30% of the profit, and if you do it in another
town, your share will be 50% of the profit
YES.
Can mudarib claim any periodical salary or a fee or
remuneration for the work done by him for the mudarabah?
NO what is the alternative?

Almir Colan

almir@auscif.com
www.AusCIF.com