Musharakah in Islamic Banking: Theory, Problems, and Application

This report provides an overview of Musharakah, a crucial mode of finance within Islamic banking. It delves into the theoretical underpinnings of Musharakah, defining it as a partnership where individuals contribute labor and capital, sharing profits and losses proportionally. The report explores different types of Musharakah, including Shirkat-ul-Milk and Shirkat-ul-Aqd, and their applications in various financial instruments. It highlights the significance of Musharakah, emphasizing its flexibility and benefits for both banks and customers, particularly in risk-sharing. Furthermore, the report examines the conditions for Musharakah, such as mutual agreement, maturity, and sound mind of partners. It also addresses the challenges associated with its implementation, including issues related to rental rate tax, land ownership, and property damage. The report concludes by emphasizing the importance of adhering to Shariah principles to avoid replicating conventional lending practices.

Musharakah as a mode of finance in Islamic banking: highlights theoretical aspects and its problems
[Document subtitle]

Table of Content
Introduction.................................................................................................................................................1
Musharakah................................................................................................................................................2
Literature review.........................................................................................................................................4
Objectives of the study................................................................................................................................6
Application of Musharakah.........................................................................................................................7
Significance of Musharakah.........................................................................................................................8
Conditions for Musharakah.........................................................................................................................9
Problems regarding Musharakah in Islamic financing...............................................................................10
Musharakah and Islam..............................................................................................................................11
Critical Analysis of Musharakah.................................................................................................................12
Conclusion.................................................................................................................................................13
References.................................................................................................................................................14
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Introduction
Islamic finance is currently practiced round the world. It launches officially in 1970s, since then
Islamic finance departments have observed fast growth worldwide in Islamic and Non-Islamic
countries (Dudley,2001). Though the idea of Islamic finance has present for many centuries, but
it came into practice in last centurial (De Jonge,1996).
The Mit Ghamr Savings Banks of Egypt successfully practiced the Islamic finance for the first
time in 1993 (Algaoud & Lewis, 2001). By 1970s the practice of Islamic finance has increased
rapidly. In an international conference of Muslim countries set to introduced an Islamic
Development Bank, the purpose of which was to increase the progress and economic growth in
the Muslim countries according to the principles of Shariah (Saeed,1996). This show the major
action taken by the governments of Muslim countries in promoting Islamic banking.
Law of Shariah forbid the Muslims to conduct any business which involves interest. It implies
that followers of Islam neither can pay nor can receive interest, so they cannot conduct
businesses by taking money from conventional banking. So, the Islamic banks was established
to service the economy (Jaffe, 2002).
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To compete or participate with the typical modes of finance which is based on interest, Islamic
banking institutions established the product which may fulfill the obligation of Shariah and
provide the values same as the values provided by the conventional banks. The main Islamic
banking products include profit and loss sharing (Musharakah and Mudarabah), and leasing
(Rammal, 2004).
Musharakah
The literal meaning of the word Musharakah is “sharing.” The root of this works, musharakah, is
Shirkah. Meaning of the word Shirkah is being a partner Musharakah is defined as the type of
partnership in which two or more than two people combine or join each other labor and
capital. In this type of business all individual or investors share profit or loss according to their
contributions. One can registered this type of business in the category of partnership with the
limited liabilities and can also registered under the category of companies with the limited
liabilities (Ahmad, 2006).
In this article we will discussed about Musharakah in detail. First, we will discuss that what is
meant by the term Musharakah and its types. Then this article provides the application of
musharakah and problems of Musharakah will also discussed in this study.
Musharakah (partnership) is the type of business which Islam introduced in its early period. The
Holy Quran and Apostle of Allah (S. A. W) approved musharakah or partnership. Last Prophet of
Allah, Muhammad (S. A. W), conducted himself business in the partnership with the others.
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Allah says:
“But if they are more than two, they share a third” (An Nisa:12)
“Many partners oppress one another, except those who believe and do righteous deeds and
very few they are. “
The justification for partnership is clearly provided by the Ahadith given below:
Muhammad (S. A. W) is reported to have said: “Allah Almighty had said that until one partner
plays false to another, I am a third member of their Partnership.” (Abu Dawud, Hakim and
Baihaqi)
The term Shirkah is divided into two kinds according to Fiqh:Shirkat-ul-milk (partnership by joint
ownership), Shirkat-ul-Aqd (partnership by contract). The first kind of Shirkah, “Shirkah-Ul-milk,
“means proprietorship of two or more than two people in a specific business or property. There
are different kinds of this type of Shirkah.
Optional: At the choice of the different parties for instance that if two or more than two
individuals purchase capital or equipment, both of them will possess this jointly. Regarding to
this property the relationship exists between these individuals is known as “Shirkat-ul-Milk
Ikhtiari.” Compulsory: This is automatically come into the options unaccompanied by any action
or step taken by alliance. For instance, when someone die his or her property is automatically
inherited by the heirs of the property. There are also two other types of partnership
 Shirkat-ul-Ain
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 Shirkat-ul-Dain
A property owned jointly and is not divided so far is known as Musha. Such assets are used into
different ways such as “Mushtarik intifa, Muhaya, Taqseem.”
Shirkat-ul-Aqd
Second kind of Shirkah means “a partnership effected by the mutual contract.” We divided
Shirkat-ul-Aqd further in three types given below:
 Shirkat-ul-Amwal
 Shirkat-ul-Aamal
 Shirkat-ul-wujooh
In Musharakah (Partnership) each partner can take part in management and can work.
However, they may concur on the condition in which administration run by one of the all
partners. In this case the profit is allocated accordingly the silent partner receive the profit
according to investment in the business (Rammal,2004).
Literature review
Muhammad and Kashi in 2017 discuss technical problems regarding implementation of
Muranaqisah and Musharakah partnership model (MMP) model from Islamic banks in the
Malaysia. The article used qualitative methods based on the interviews. It finds that MMP
model is converged with BBA (Bay’ Bithaman Ajeel) and also with conventional loans for the
housing.
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Saito and Abdullah (2016) study the issuance or allocation of the Musharakah bonds to finance
the waqf real estate project in 2001 to 2003 in Singapore. In this study a case study was
involved. Documentary and analysis of the content of specific and relevant materials is also
involved in this study. The study finds that bonds in Musharakah do not make certain or assure
the conditions about the lawful income and valid contracts.
Soumare and Hassan in 2014 come with a model to investigate the link and relationship
between the Musharakah and the Mudarabah government and the certificate holders. The
research concluded that the investors or businessman will be ready to take risk if investors
think that at least their capitals are guaranteed by their government.
Smolo and Hassan in 2011 study to indicate the fundamental principles for the implementation
of the Musharakah and Mudarabah and the distinctive properties or features of Musharakah
and Mudarabah compared to the other financial modes based on the deep and broad review of
the literature. The study highlights that the Musharakah and Mudarabah have a significant
advantage for the financiers and for the customers as well as compared to the conventional
lending or loan.
In 2015 a research conducted by Sayim demonstrates that the experiment of the Turkish
participant banks, has four banks for participation; each bank involve in the participation have
on an average two hundred forty two branches in 2013, while thirty two private banks have on
average three hundred forty three branches at the end of year 2013. The profit of these banks
increased by the 67 percent from year 2007 to the year 2013. Even though they were facing
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some problems or issues for example issue of interbank system and the existence of guaranty
system of insurance.
Rani and Mikail in 2016 purpose and advice that two phases of Musharakah and Mudarabah
which are ownership and partnership should be isolate from its own supporting and
fundamental contracts. Which help the organization or company to select right and appropriate
partnership contracts for the Musharakah and Mudarabah and help them to keep away from
the confusion.
A research analyzed that the financing scheme of Musharakah and Mudarabah as the profit loss
sharing method (PLS method) to solve the problem of asymmetric knowledge. It concluded that
the financing by Musharakah and Mudarabah gives a strong and beneficial incentive to the
businesses.
Objectives of the study
This article is aim to analyze the previous study related to the topic. The term Musharakah and
the types and subtypes of Musharakah will be discussed in this article. Application of
Musharakah in the Islamic banks, economy and different sectors of life also take into
consideration. Importance or significance and conditions of Musharakah as a mode of financing
will also be studied in this article. Issues regarding the implementation of the Musharakah will
also be discussed in this study in detail.
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Application of Musharakah
Musharakah can be applied easily or doubtlessly to facilitate or ease the financial requirements
of any industry and trade in short or in long term both. The application of Musharakah are
given below:
 Capital
Capital required for working for example purchase of the material for the manufacturing and
construction of different material can be given or provide by Musharakah.
 Finance for consumers
Finance for the consumers durable can be given on basis of the Musharakah. Individuals can
also use this for the purpose of financing the purchase of the house or for the material for
construction of the building of one’s house. For this case banks use Musharakah called
Diminishing Musharakah.
 Project financing
It can also be used for financing the project based on the participation on equity from the fund
giver and fund sharing as soon as the particular project begin generating the revenue.
 Financing for long term
Long term or medium requirements or needs for the purchase of the building, machinery,
equipments and land can also be financed through Musharakah (Ali & Hussain, 2017).
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Significance of Musharakah
The significance of Musharakah in Islamic banking, economy, industries, businesses and other
sectors or departments of life is given below:
 The financing of economy and businesses by Mudarabah and Musharakah has number
of advantages for their flexibility. This has advantages for the economists and Islamic
Bank. For banks this system provides medium- and long-term investment of the
resources.
 It has a source of a regular profit or income that will make it possible to give its
shareholders and also depositors with appealing remuneration rates.
 Musharakah also come with form of medium- and long-term credit in addition to
finance the short-term participation for acquisition and commercial materials. So,
financing by Musharakah is a very appropriate and effective method of financing the
requirements of any businesses already exists or for start-ups, capitals growth and
formation and investment of the equipment.
 The principles of the risk sharing model Musharakah an appealing source of the
financing for the operators economic. Banks as a partner are obliged to bear loss within
their capacity. This shows the importance of Musharakah as a mode of financing in
Islamic banking.
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 Financing via Musharakah also meets financing requirements of small grants in craft
department, restaurants, hotels and also other kinds of activities rather than
weaknesses with regard to and financial resources and guarantees.
 Financing by Musharakah is a very appropriate and effective method of financing the
requirements of any businesses already exists or for start-ups, capitals growth and
formation and investment of the equipment.
Conditions for Musharakah
 Mutual agreement
According to the Holy Quran mutual agreement is the fundamental condition for the mutual
dealings. So, the mutual agreement is the necessary condition for the Musharakah.
 Maturity of business partners
It is mandatory that the partners should have achieved the age of adulthood or maturity to
enter in the partnership.
 Sound mind
The sound mind ness of partners is also necessary condition or term for proprietorship that
they have the ability to understand the affairs.
 Sharing the profit and loss
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Before starting the business, partners should fix the proportion of the profit and also, they
should share the loss in proportion to their investment.
Problems regarding Musharakah in Islamic financing
In term of implementation of Musharakah and Mudarabah, it is observed that there are some
issues related to this Islamic financing system. It encompasses the issues related to the rental
rate tax, land ownership and damage of property.
But there are many methods and ways to improve the financing of banks through Musharakah
and Mudarabah according to the laws and obligations of Shariah otherwise this is only the
replication of the conventional or traditional lending or loans.
 Maintenance of property
Customers or consumers have to bear or accept the cost of preservation and maintenance and
there is no section in the agreements between banks and customers that specify the consumer
to accept the maintenance cost. It should be done on the mutual agreement between the
banks and the customers.
In addition, banks states that as the legal titles of the properties are possessed by the
consumers, so they should take the responsibility of the maintenance of the property.
 Problems of risk sharing among customers and bank
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The analysis of policies and implementation Islamic Bank for equity home we can conclude that
banks do not take any responsibility and do not bear or accept any kind of risk related to the
ownership of property and house.
The legal titles are possessed by the owners and customers of the house and property, so the
banks only play the role of the trustees. So, we can say that the true or right concept or form of
Musharakah does not present here.
 Issues of fees and charges
By Non-Free Acquisition Cost policy, banks accept that the customers pay not only all legal fees
but also all charges regarding the investment costs before granted the financing amount. This is
opposite with the concept or form of Musharakah in which it is mandatory for the both parties
to bear the legitimate fees and the charges.
 Other issues
In the implementation of the Musharaka in the society, the banks face the issues and difficulties
in the preparation of the documents of contract because of lack of or insufficient lawyers of
Shariah which understand the concept of Musharakah very well.
Musharakah and Islam
There is great importance of Musharakah in Islam. In past it is practiced in Arab countries.
There are number of Ahadiths on Musharakah or partnership. Some of which are given below:
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The last prophet of Allah Almighty l, Muhammad (S. A. W) says: “conduct business on the basis
of equal shares. This brings ample returns.” (Abu Dawud)
A came to the Apostle of Allah (S. A. W) and said: “while I conduct the business in the market,
one of my partners offers prayers in the mosque. “
The holy Prophet (S. A. W) said: “perhaps this is the cause of your thriving business.”
Critical Analysis of Musharakah
Sometimes, Musharakah is criticized as an instrument which is very old and which is not valid
for the modern world. So, it cannot used in this era of science and technology. Nevertheless,
this is not right and not justified. Islam has not suggested a particular procedure and
mechanism for the Musharakah. Instead Islam has introduced some principles that can include
number of different procedures and forms (Usmani, M. T. 1998).
A new type, procedure, mechanism or form of Musharakah that will be suitable for the financial
needs of this modern world cannot be refused just because that it has not practiced in the past.
As a matter of fact, each new procedure can be adopted as long as it is not against the laws and
obligations of Shariah. So, it is not obligatory that it is used only in the traditional form (Usmani,
1998).
Sometimes, Musharkah is criticized for the problem of profit which is guaranteed by the others
financial departments. Although, this is considered as the most important and reliable form and
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type of Islamic financing, risk related to the sharing and losses mean which is not as famous as
the others mode of Islamic banking.
So, in order to make product of Musharakah appealing or attractive to the people or the
customers, some institutions of finance have begun guaranteeing profit in the Musharakah
(Wards, 2000). If the profit is guaranteed then the factor of risk is excluded or eliminating.
Which make the profit similar to the interest? Even though these steps taken by Islamic banks
may help them to grow in short run but in the long term this cost them a lot. Such actions may
also give ammunition and chance to the critics of this system, who already are questioning that
whether this system is nothing than the interest-based system (The Economist, 1994).
Conclusion
Even though Musharakah is not as famous as the others Islamic banking tool, it is still viewed to
be the most authentic and appropriate form of financing approved by the Shariah. It is also
found that there Islamic financing tools used by Islamic banking such as Musharakah and
Mudarabah is not practiced in its true form but are closely resemble with the tools of
conventional or traditional banking which is interest based. The government of Muslim
countries should push or force the banks to follow the true concept of Musharakah for the
growth and development of the economy. The implementation of Islamic modes of financing in
its true form is important for the future survival and growth of the Islamic banking or finance.
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