1.
P Islamic Financial System MIFB - 6013Application of Musharakah and Mudarabah as financial instruments in Islamic Finance and Banking practice A term paper presented by Mohamed ibrahim ismail [Matric No: A1111477M04] 15th Oct 2011

2.
Outline Introduction Legality of Musharakah and Mudarabah Definition of MusharakahApplication of Musharakah Definition of MudarabahApplication of MudarabahConclusionPage  2

3.
IntroductionAs many contemporary Muslim scholars and Islamic economists are advocating for the implementation of equity- based modes of financing, the most important contracts in this regard are Musharakah and Mudarabah.These two modes of financing are based the concept of profit and loss sharing.hey are true Islamic products, whereby all Muslim scholars , classical and contemporary are unanimous in its validity and permissibility..Page  3

4.
INTRODUCTION Theoretically, much has been discussed about these two concepts such the terms ,conditions and tenets The following sections will discuss the modern application of these concepts in the as financial instruments in Islamic finance and banking practicePage  4

5.
Legality of the two productsLegality of Musharakah “Page  5

6.
Cont…..Allah SWT says:“Verily, many partners oppress one another, except those who believe and do righteous good deeds and they are few” Sad: 24Page  6

7.
Cont….The prophets SAW said : “Allah Says: “I am the third partner of any two partners as long as neither of them betrays the other. But if one of them betrays the other I get out of them“”. Abu Daud Hadith No.3383Page  7

8.
Legality of Mudarabah 1 “ ”Ibn Munzir said in his book “Al-Ijma”,“They [Muslim Ulama] unanimously agreed upon each other thatQirad(Mudarabah) in Dinars and Dirhams (Cash) is permissible”Page  8 1.Ibn Mundir (1999) A,l-Ijma, Maktabah Alfurqan, Ras Khaima, p.140

9.
Definition of MusharakahDraft of Shariah parameter reference 4:Musharakah Contract, a paper published by Bank Negara in 2010 defined Musharakah as follows:“Technically, Musharakah is a contract between the partners to contribute capital to an enterprise or a venture, whether existing or new, or to owner of a real estate or moveable asset, either on a temporary or permanent basis. Profits generated by that venture or real estate or asset are shared in accordance with the terms of the Musharakah agreement, while losses are shared in proportion to each partner’s share of capital.”Page  9

10.
How is Musharakah applied in modern finance and Banking Practice?Musharakah as equity-based financial instrument is used in many areas and is applicable to a wide spectrum of business activities, it can be used in trade financing, such as import or export, project financing, syndicated asset financing, stock markets and issuance of sukuk or certificatesPage  10

11.
Musharakah in trade financing: Import Musharakah can be applied in trade finance without complexities, since the chances of fraud, negligence and other problems are relatively lower in international trade than in other Musharakah- based projects. A bank may enter into a Musharakah arrangement with a client who intends to import; the bank may also appoint him as agent for acquisition and disposal of the goods after the same are imported;Page  11

12.
Cont…… an L/C(letter of credit) could be opened in the bank’s or the client’s name The net profit out of this limited purpose Musharakah will be shared between the bank and the client in an agreed ratio.Page  12

13.
Musharakah in trade financing: export In the case of export finance under L/C, the goods will be acquired and made ready for shipment on a Musharakah basis. The client will prepare the export documents strictly in accordance with the terms of the L/C and undertake to indemnify the bank for any loss in case of his failure to honour his commitment.Page  13

14.
Cont……….. Export proceeds will be distributed according to the agreed ratio. If there is no L/C involved, the merchandise will be made ready for export under joint ownership of the bank and the client.Page  14

15.
Cont…. The following could be the procedure for export financing on the basis of Musharakah: the exporter receives an order from abroad to export a specific commodity or goods at a known price. He estimates its expected profit. If he needs financing for manufacturing or procurement of the goods, the bank can provide financing on the basis of Musharakah..Page  15

16.
Cont… Profit would be shared on a pre-agreed percentage. The bank can secure itself from any negligence on the part of the exporter. However, being a partner of the business, the bank will be liable to bear any loss which may be caused due to any reason other than the negligence of the exporter. However, in order to undertake such an operation, banks need to understand the nature of the exporter’s business and other requirementsPage  16

17.
Project FinancingIn the case of project financing, the traditional method of Musharakah can be easily adopted whereby investment comes from both sides The following may be the flow of transactions in the case of Musharakah for running business:1. A running Musharakah Account for the client will be opened in the books of the financing bank. 2. The client’s proceeds from the sale of finished of goods will be credited in the Running Musharakah Account.Page  17

18.
Cont…. 3. The client’s cash flows generated from investment activities (for example, sales proceeds from the disposal of fixed assets) and cash flows from long-term financing activities (for example, long-term finance availed for the project) cannot be credited in the Running Musharakah Account.Page  18

19.
Cont… 5. At the end of each quarter or month, as the case may be, the profit earned by the client in the Musharakah will be paid to the bank. 6. The profit-sharing will be based on the computed operating profit for the same period for which the running Musharakah limit was awarded.Page  19

20.
Syndicated asset financing A group of banks joint efforts to partially finance a big enterprise or a large project.The enterprise contributes its part of the investment to the project such building a new factory for a car manufacturing company or another giant company.A group of Islamic banks which joined hands finance the remaining part.Page  20

21.
Cont…The enterprise runs the project on behave of the banks. The banks and the enterprise share the profit according to the agreed ratio in the Musharakah contract and losses are borne in terms of each investors capital contributionPage  21

22.
Musharakah in stocks Business companies issue shares based Musharakah concept. The investors buy these shares and become shareholders in the company. Like the ordinary partners the are entitled to profits generated by the company generated based on the Musharakah agreements. Musharakah as a basis of securitizationMusharakah can easily be adopted as a basis for securitization, especially in the case of big projects where huge amounts are required.Page  22

23.
Cont… Every subscriber can be given a certificate representing his proportionate ownership in the assets of the joint business, and after the project is started by acquiring substantial non-liquid assets, these Musharakah certificates can be treated as negotiable instruments and can be bought and sold in the secondary marketPage  23

24.
Diminishing Musharakah ( ) In a Diminishing Musharakah contract, a party, after participation in ownership of any business or project, can liquidate his investment from the asset or the ongoing business.DM contracts contain a sale provision, according to which, one partner makes a promise to sell his part of ownership to the other party periodically.Page  24

25.
Cont…..DM is used in house financing, auto financing, plant and machinery financing, factory or building financing and all other fixed asset financing.House financingTrade financingPage  25

26.
MudarabahAccording to Islamic Financial System by ISRA Mudarabah is defined a partnership in profit whereby one party (rabbul mal) provides capital and the other party (mudarib) provides labour.2Page  26 2 ISRA (2011) Islamic financial System, ISRA, Kuala Lumpur p. 249

27.
Application of Mudarabah Mudarabah is used in the following a source of fundSaving Deposit Account- Bank accepts deposits on wadiah yad damanah and utilize it in its financing activitiesCurrent Deposit AccountGeneral Investment AccountSpecial Investment AccountPage  27

28.
Cont….. Mudarabah as a financing instrument can be used in the following:Project financingTrade financing: import/exportMudarabah as applied in takafulMudarabah sukuk-facilitated by SPV or SPMPage  28

29.
Cont… Inter-bank Funds MarketA bank in short of funds enters into a mudarabah contract with a bank with surplus funds. This creates an investee-investor relationship.Government/Public Sector FinancingThe government issues certificates of Mudarabah when it is short in funds, purchases assets or utilities and leases the asset to the public corporations.Page  29

30.
Concluding remarks Musharakah and mudarabah can be applied in a spectrum of areas and the Muslim scholars are unanimous in on their permissibility, however the practitioners in the Islamic banking industry overstate the risks associated with undertaking projects based on PLS concepts. To avoid any future financial crisis, the Islamic banking industry should be more on the equity side in terms of financing modes while at the same time trying their level best to mitigate any possible risks that may arise in adopting equity-based financial instrumentsPage  30

31.
THANK YOU THE END B IPage  31 Application of Musharakah and Mudarabah