Musharaka Contract – The Various Types
Musharaka is a form of an Islamic financial contract that gives rise to a joint venture partnership. Specifically, it is a co-ownership clause entered into by two parties—the bank and the customer—who agree to finance a business and share the profits and losses accruing from it. A musharaka contract also lays down the rules for managing the partnership and specifies the basis for sharing the profits and losses.
There are two principal types of Musharaka contracts: Permanent Musharaka and Diminishing Musharaka.
Permanent Musharaka
In this form of Musharaka contract, a bank becomes a partner in financing a project and receives a share of the profits generated, on a pro rata basis. Both the parties can carry on with the contract for as long as they wish and the bank will continue to receive profits, on terms agreed to in the contract, till this time.
This form of co-ownership contract is widely used in projects of long duration with lengthy gestation periods.
Diminishing Musharaka
This is a modern take on the conventional Musharaka contract and may involve equity participation and profit sharing on a pro rata basis. The bank receives dividends on the equity it holds along with its partners in the contract. But what differentiates this form of contract from the other kind is that the financing party or the bank’s share goes on lessening over time, till the borrower buys out the share. So, although at the initial stages of the contract, there is joint ownership of assets, a company, or a project, there is eventually a full transfer of ownership on to the other partners or the borrowers. When the equity held by the bank is finally reduced to nil, it ceases to be a partner in the Musharaka agreement.
This form of Musharakah contract is sometimes entered into in instances of residential mortgages.
The Musharaka partnership contract is generally held as one of the three kinds of Islamic financing utilized in the USA and Canada since it is founded on the basic and sound principle of sharing in the risk and reaping the profits on the basis of undertaking that risk.