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SEPTEMBER 2008

Legal Section

Musharakah Mutanaqisah as an Islamic


Financing Alternative to BBA
By Noreeta Mohd Nor
Islamic finance in Malaysia Hence, MMQ was introduced to imple- the customer enters into a partner-
has been gaining importance in recent ment the relationship of partnership in ship (Musharakah) agreement with the
decades, concentrating on the area of the elements of sharing and ownership. bank.
retail products — the common prod- The customer pays, for exam-
ucts, to name a few, are deposit ac- Comparison of BBA with MMQ ple, 20% of the initial share to co-own
counts, personal financing and home The BBA is basically a deferred the house while the bank provides the
financing. For most of us, a large pro- payment sale contract whereby the balance of 80%. The customer then
portion of our income would go toward buyer is given the benefit of a deferred gradually redeems the bank’s 80%
home financing. payment, and the deferred price of the share at an agreed portion until the
In Malaysia, nearly all the sale object carries an additional profit. house is fully owned by the customer.
Islamic banks adopt the widely used The steps in a BBA transaction are il- Second, the bank leases its 80%
principle of Bai Bithaman Ajil (BBA). lustrated below. to the customer under the concept of
Other Islamic modes of home financ- The underlying transaction Ijarah, i.e. by charging rent. The cus-
ing in the country are Bai Inah, Istisna of the BBA is said to be based on the tomer agrees to pay rental to the bank
and Musharakah Mutanaqisah (MMQ, Murabahah concept of a cost plus con- for using its share of the property.
diminishing partnership). tract, whereby the sale price (with prof- The periodic rental amounts
As the basic features of Islamic it) of the commodity is paid in install- will then be shared between the cus-
financing generally embrace the no- ments over a long period. tomer and the bank according to the
tion or application of the sales concept, The MMQ contract, on the percentage shareholding at the par-
there is a need to explore other inno- other hand, is based on the diminish- ticular time which keeps changing as
vative Islamic financial concepts such ing partnership concept. There are the customer redeems the bank’s share.
as partnership contracts and leasing. two portions to the contract. First, With each payment, the bank’s share in
the property will be reduced while the
The structure of a BBA transaction customer’s share increases.
The structure of the
Vendor Musharakah Mutanaqisah is illustrated
(i) on the following page.

(ii) Operational structure


The BBA assists the customer
Customer Bank in paying the cost of financing during
the tenor of the facility (for example, 10
(iii) years) at a fixed rate determined by the
i. The customer purchases the property from the vendor and the customer intends to bank. The bank buys the property from
settle the purchase price using bank financing. the customer (which is actually the fi-
ii. The bank purchases the property from the customer at the bank’s purchase price, which nancing amount) and sells it back to the
is equivalent to the financing amount. The purchase money (i.e. financing amount) customer, plus its profit margin.
received by the customer will be used to pay the vendor. The Shariah would require the
iii. The bank will immediately sell back the property to the customer on a deferred pay- bank, as the vendor, to hold ownership
ment basis — say, over 10 years — by monthly installments and the amount paid by
of the property and to all liabilities
the customer will be a marked-up price.
arising. However, the BBA documenta-

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tion shows that the bank merely acts as through the purchase agreement with contract” with the bank at the outset,
a financier rather than a vendor. the customer that does not involve thereby leaving the welfare of the peo-
the transfer of the name in the issue ple unprotected.
document of title to the property. The MMQ, on the other hand,
The buying lasts for a few ultimately culminates in ownership
seconds during the signing and, in of the property by the customer. The
At the heart practice, the selling back to the cus- bank participates as a financial partner,
tomer through the asset sale agree- whether in full or in part, and an agree-
of Islamic finance is ment is almost immediate. ment is signed between the customer
It has been argued that this (partner) and the bank that stipulates
the principle of risk ignores the Shariah principle of “al- each party’s share of the profits.
sharing. As such, the Ghorm bin Ghonm” (no reward with- The bank will then lease its
out risk), “Ikhtiar” (value addition or share of the property to the customer
concept of ‘al-bay’ effort) and “al-Kahraj bil Daman” (any under Ijarah. The share will be divided
benefit must be accompanied by liabil- into a number of equal units and the
(trade) is used because ity), thereby subjecting the BBA profit customer promises to buy the individ-
the profit from trading to riba. ual units periodically until all are taken
At the heart of Islamic finance up (the principle of “al-bay” under the
incorporates risk- is the principle of risk sharing. As such, MMQ contract).
the concept of “al-bay” (trade) is used The bank will then agree that
taking, while the because the profit from trading incorpo- the Ijarah rental is reduced in propor-
contractual profit rates risk-taking, while the contractual tion to the units purchased.
profit from loan transactions (riba) is The periodic payment by the
from loan risk-free. customer in this model constitutes
Many have observed that there two parts:
transactions (riba) is no risk-taking in the BBA financing a) a rental payment for the portion
is risk-free. and, hence, does not merit the concept owned by the bank; and
of al-bay. b) a buyout of part of that ownership.
In a BBA financing, the cus- In contrast to the leasing mod-
tomer is saddled with the burden of el, where the ownership of the financed
This is evident from the ac- paying off the property even before it is item remains with the lessor for the en-
quisition of the property by the bank completed as he has engaged in a “debt continued...
The structure of Musharakah Mutanaqisah

(iii)
(ii)
Customer Bank

Co-ownership
(i)

20% 80%

Property

i. The customer identifies the property, with 20% of the purchase price being paid by the customer and 80% by the bank. The customer
and the bank therefore own 20% and 80% of the property respectively.
ii. The customer uses the property as a residence and pays rent to the bank for the use of his share of the property.
iii. The bank’s share of the property is divided into 20 units of 4% each and the customer promises to buy one unit at the end of each year
for the next 20 years — at the end of which the customer fully owns the property and the rent is reduced in proportion to units bought
by the customer.

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SEPTEMBER 2008

article continued...

6. By default, partners in the Musha-


rakah arrangement are free to leave
a partnership anytime. Thus, the
bank has to note this and incorpo-
rate the compensation clause appli-
cable when a customer leaves the
partnership.

7. By default, the lessee in an Ijarah


arrangement will cease to pay rent
once he stops deriving benefit from
the use of the property.

8. By default, any decision relating


to the disposal of the acquired
property must be approved by both
Musharakah partners.

9. The return of the BBA is based on


a fixed selling price. However, under
tire lease period, ownership under the Musharakah and Ijarah into one docu- the MMQ, the bank need not be
MMQ contract is shared between the ment as long as both were concluded tied to a fixed profit rate throughout
customer and the bank. Over a period separately and do not overlap. the financing tenor. This is because
of time, the portion of the property the rental rate can be revised
owned by the customer increases until Differences between BBA and periodically to reflect the current
he owns the entire property and no lon- MMQ contracts market situation.
ger needs to pay rent. At this point, the 1. The MMQ contract is seen as a joint
contract is terminated. ownership structure whereas the 10. The bank can manage the liquidity
The MMQ, nevertheless, has BBA is a debt-type financing. risks better as rental payments can be
its share of operational problems. adjusted at the end of each subcontract
An example is that the rental rate would 2. As a financing structure, the MMQ period. This is not possible under the
be based on the market rental value, is more flexible than the BBA as the current fixed-rate BBA as the profit
which is very much determined by lo- customer can own the property ear- rate is constant throughout the tenor
cation, and in time, the rental value can lier by redeeming faster the principal of the financing.
therefore change; in normal cases, this sum of the bank without the need to In comparison, under the BBA
would increase. compute rebates, as is the case with concept, the customer would most
It would be difficult to keep the BBA. likely end up paying about four times
track of the rising rentals and prove the original cost. This may burden the
cumbersome to the bank and the cus- 3. Many may be of the opinion that lower-income group in particular.
tomer, who would have to pay a higher the BBA is similar to a convention- The MMQ can be seen as more
rental as the years pass. al loan. just as there is no interest charge or
Another issue is whether the “advanced” profit involved. It is based
above transactions can be combined 4. The MMQ is accepted international- on the concept of rental payments and
into one agreement as the Shariah prin- ly as Shariah compliant whereas the redeeming the bank’s shares in the
ciple has made it clear that a combined BBA is recognized predominantly in property.
agreement and made conditional to the east, e.g. in Malaysia and so on.
each other is not permissible.
There has been a proposal 5. Under the BBA, the selling price of the
that the co-purchase and Ijarah can be property by the bank does not reflect
combined into one document and the market value since the mark-up for the
Noreeta Mohd Nor is a senior asso-
purchase of the bank’s share over time deferred payment is quite substantial.
ciate at Azmi & Associates. She can
must be in a separate agreement. In the MMQ model, the value
be contacted at +603 2118 5031 or
However, it has been resolved of the property always reflects mar-
via email at noreeta@azmilaw.com.
that it is permissible for the contracting ket price and rental is determined by
Visit www.azmilaw.com
parties to combine the two contracts of market rental values.

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