Musharaka is one of the basic Islamic financial instruments. Musharaka in literal translation means division. In Islamic finance, the term refers to a company in which all partners take part in the profits and losses of the undertaking undertaken. The musharak contract is a contract in which two or more entities set up a business and each of them puts at its disposal capital, work and takes an active part in the management. Profit is divided between the parties according to the principles agreed in the contract, however, it is not allowed to set a fixed amount of profit for payment. In the event of a loss, it is divided proportionally to the capital invested. The general rule regarding musharak says that all parties to the contract participate in costs, work and management. However, there is a possibility that one of the parties would be excluded from providing work or doing business. In this case, the participation in the profits of the "passive" partner must be proportional to its capital share in the given project. The share of partners does not have to be identical. It can take the form of physical assets, but it can also be intangible, such as knowledge, experience and even good will.
Musharaka in modern Islamic banking
Musharaka as a method of financing, may consist in the transfer of an advance payment by the bank to the customer's account. In this situation, the bank assumes the role of a "passive" partner. Musharaka can also be a form of running investment funds in which buyers of participation units become "passive" partners.
Types of Musharaka
There are several types of musharakah:
- Shirka al'nan - each partner answers for own part (doesn't take financial responsibility for other partners)
- Al Mufawada - equal partnership, where every partner puts the same amount of money and share the same profit
- Permanent - without ending date
- Diminishing - share of one partner is transferred to another until the first partner is paid off.
Muskaraka a mudaraba
In comparison to the mudaraba contract, where the owner of the capital can not interfere in running a business, the musharak contract gives all parties the opportunity to make operational decisions. Mudaraba and musharak are the most popular instruments used to finance all kinds of undertakings. Both contracts played a huge role in the medieval Islamic world, when they were used to mobilize capital for agriculture, fleet, craft or trade with distant countries.
Examples of Musharaka
- Joint Venture: A joint venture is a business arrangement in which two or more parties join together to undertake a project and share in the profits and losses. The parties to the joint venture may provide capital, labour or other resources to the venture. In a joint venture, the parties to the agreement can decide to share the profits and losses in any proportion they agree on.
- Partnership: A partnership is a type of Musharaka in which two or more people or entities join together to undertake a business venture. The partners agree to share the profits and losses of the venture in an agreed-upon proportion. The partners can also decide how to divide the management of the venture.
- Property Investment: Property investment is another form of Musharaka, where two or more partners invest money into a property project. The partners agree to share the profits and losses of the project in an agreed-upon proportion. This type of Musharaka is often used in the real estate industry, where two or more partners purchase a property and agree to share the profits and losses of the venture.
Advantages of Musharaka
Musharaka is a type of contract in which two or more parties share their capital and investments to jointly undertake a project or business. It is a popular Islamic financial instrument and has several advantages:
- It allows parties to share the risks and rewards of a project. As all parties own a share in the project, the potential losses and gains are shared among all the participants. This allows them to more efficiently manage their investments and have a more diversified portfolio.
- Musharaka allows parties to tap into different sources and gain access to funds that they may not have access to individually. This is especially beneficial for small and medium enterprises as they can leverage the collective resources of the partners.
- It ensures that each partner has a say in the management of the project or business, allowing for better decision-making. This helps to ensure that the business is run in the most efficient way possible.
- It encourages collaboration between partners and promotes a spirit of teamwork. This helps to ensure that all parties have an incentive to work together towards the success of the project.
Limitations of Musharaka
- Risk of Loss: The most important limitation of Musharaka is the risk of loss for all partners. The profits and losses of the business are shared among all partners based on the pre-agreed proportions, so if the business incurs a loss each partner will have to bear a proportional amount.
- Uncertainty of Profit: Another limitation of Musharaka is the uncertainty of profit. As the profits of the business are shared among all partners, it is difficult to predict the exact amount each partner will get as profit.
- Limited to Certain Areas: Musharaka is limited to certain areas of business. It cannot be used in the field of finance, insurance, and banking.
- Complexity: Musharaka is a complex business structure, and all the partners have to agree on a fair profit sharing structure and plan. This may become difficult when multiple partners are involved, and the negotiation process can be difficult and time consuming.
- No Security: Since the capital contribution in Musharaka is not secured, there is a risk that one of the partners may not be able to make their contribution or may default on the agreement. This may lead to a delay in the progress of the business.
In addition to the most popular form of Musharaka, there are other approaches related to the application of this Islamic financial instrument. These include:
- Diminishing Musharaka (DM): in this form, the ownership of the venture is transferred gradually to the investor, and the partner gradually withdraws from the business. This form of Musharaka is used for financing and purchasing.
- Fixed Musharaka: in this form, the capital investment of the partner remains unchanged throughout the duration of the contract.
- Modaraba: this is a form of Musharaka in which one party (the investor) provides the capital, while the other party (the manager) is responsible for managing the venture with the investor's capital.
- Combination of Musharaka and Murabaha: this form combines both Musharaka and Murabaha. The partner provides the capital, while the other party provides the goods or services.
In summary, there are several types of Musharaka that can be used in Islamic finance. These types of Musharaka include Diminishing Musharaka, Fixed Musharaka, Modaraba and a combination of Musharaka and Murabaha. Each of these forms has its own unique characteristics and can be used for different purposes.
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- Ahmed, M. (2006). Practice of mudaraba and musharaka in Islamic banking.
- Akram, M., Rafique, M., & Alam, H. M. (2011). Prospects of Islamic banking: reflections from Pakistan. Australian Journal of Business and Management Research, 1(2), 125.