Alhdua CIBE - Islamic modes of agricultural financing by Muhammad Khaleequ

1. Islamic Modes for Agricultural
Financing
PRODUCTS – Diminishing
Musharakah
Lahore 20 – 21 October, 2008
Al – Huda Training Programme
Muhammad Khaleequzzaman
Head Islamic banking Department
Int’l Islamic University Islamabad

2. Rules of Musharakah
• Fulfillment of prerequisites of a contract
• Rules of contribution of equity
• Rules of profit and loss sharing
• Management of Musharakah/Relationship of
parties
• Termination of musharakah
Uses of Musharakah:
– Agricultural enterprise financing
– Project financing
– Working capital financing, etc.
Islamic Modes – Agricultural Financing

3. Musharakah
• An equity participation contract under which
IB and its client contribute jointly to finance an
enterprise.
• Equity is owned according to each party's
share in financing.
• Profit is shared in pre-agreed ratio and loss in
proportion to the capital contribution.
• It is an ideal alternative to the interest-based
financing with far reaching effects on both
production and distribution.
Islamic Modes – Agricultural Financing

4. Diminishing
Musharakah (DM)

5. Diminishing Musharakah (DM):
A form of Musharakah where the
financier and the client participate in a joint
commercial enterprise or property. This enterprise
is converted into undivided ownership of both the
financier and the client. Over certain period the
equity of financier, divided into equal value units,
is purchased by the client. And ultimately the
client becomes the sole owner of the enterprise.
Uses of DM
– Agric. Machinery and implements financing
– Storage facility construction/sheds
– Transport vehicles, etc.
Islamic Modes – Agricultural Financing

6. Diminishing Musharakah (DM):
Procedural details:
– Client requests the bank for DM
– Appraisal is accorded
– Approval is conveyed.
– bank releases its share to become partner in
the asset. And contract of Musharakah is
executed. [buying &selling not stipulated]
– This asset becomes undivided ownership of
both the bank and the client [Musha] None of
the parties can withdraw its equity till DM is
terminated
– General rules of partnership apply
Islamic Modes – Agricultural Financing

7. Diminishing Musharakah (DM):
Procedural details: (contd..)
– At the same time, uni-lateral promise from client
is obtained to purchase the units of bank’s
equity.
– The price of one unit of bank’s equity is valued
– Ijarah Agreement is signed
– In case of Ijarah the rent is realized while in case
of business or services profit and losses are
shared
– Expenses connected to asset are borne by the
partners proportionately
Islamic Modes – Agricultural Financing

8. Diminishing Musharakah (DM):
Procedural details: (contd..)
– Equity of bank is periodically purchased by the
client
– Bank’s share in the asset decreases while that of
client increases – so happens to the rent or profit
– Ultimately the client becomes the sole owner of
the asset [Bank’s share reduces to zero]
Islamic Modes – Agricultural Financing

9. DIMINISHING MUSHARAKAH
3. Accruing Rentals
Share in
capital
Share in
capital
Partner Bank
2
4
Sell its
share in
equity
Pays price of
the units of
bank’s equity

10. Diminishing Musharakah (DM):
Examples – Financing Purchase of Tractor:
A client wants to purchase a tractor
by sharing of equity of Rs. 40,000 against price of
Rs. 400,000. The bank shares rest of the price of
tractor ie. Rs. 360,000. How his request can be
accommodated by a bank?
Bank agrees to finance the
purchase of tractor through DM.
Islamic Modes – Agricultural Financing

11. Diminishing Musharakah (DM):
– 10% of the cost (Rs. 40,000) is paid by the
client and 90% of the cost (Rs. 460,000) by
the bank. [Musharakah Contract is signed]
– The rental of tractor is fixed according to
certain reference price [Ijarah for future date
is signed]
– The client promises (unilateral promise) to
the bank to purchase banks equity divided
in to equal value units
– Say, rent is fixed @ 15% p.a.
– The DM terminates after 3 years
– Installments can vary [Seasonal, quarterly,
monthly]
Islamic Modes – Agricultural Financing

12. Diminishing Musharakah (DM):
– After acquisition, the client uses tractor and
pays rent to bank for using bank’s share in
the property
– At the same time, purchases unit(s) of equity
after expiry of each rental period
– The equity of bank diminishes to zero on
expiry of three years, the rental as well,
client becomes sole owner
Islamic Modes – Agricultural Financing

13. Diminishing Musharakah (DM): (Amount in rupees)
Total value of Asset: 60000
Share of client 40000
Share of Bank 360000
No. of units 36
Value of one unit 10000
Rent per month 4500
Rent per unit per month4500 / 35 = 125
Islamic Modes – Agricultural Financing

14. End of
Month
Rent Value unit
purchased
Total
payment
Remainin
g units
Remainin
g balance
0 0 0 0 36 460000
1 125 x 36
= 4500
10000 14500 35 450000
2 125 x 35
= 4375
10000 14375 34 440000
3 125 x 34
= 4250
10000 14250 33 430000
35 125 x 2 =
250
10000 10250 1 10000
36 125 x 1 =
125
10000 10125 0 0
Total ?? 460000 ??

15. THANKS
Islamic Modes – Agricultural Financing