Diminishing Musharah is best instrument in my opinion for Housing Finance. With its structure and flexibility it can play very important role in growing the Islamic Finance. There are three possible structures of musharakah partnership in a business venture, namely, permanent musharakah, temporary (redeemable) musharakah and diminishing musharakah. The term Musharakah means joint venture where profits are shared amongst the partners as agreed between them and losses have to be borne by each partner according to their investment. In DM, a financer and a client participate in either ownership of a joint property, or in a joint commercial business, with the understanding that the client partner will buy the equity share of the financier partner over an agreed period of time until the title to the equity is completely transferred to the client by payments of installments to the financier for purchase over the agreed period. The buying and selling of equity is not stipulated in the partnership contract as it is not allowed - one partner is allowed to give only a promise to buy.

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Dr. Zia Ahmed Khan www.ventureart.biz whatsapp: +96567086552
Brief Introduction of Diminishing Musharakah
Brief Introduction
of Diminishing
Musharakah
By Dr. Zia Ahmed
zia@ventureart.biz

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Dr. Zia Ahmed Khan www.ventureart.biz whatsapp: +96567086552
Brief Introduction of Diminishing Musharakah
The Concept of Diminishing Musharakah (DM)
There are three possible structures of musharakah partnership in a business
venture, namely, permanent musharakah, temporary (redeemable)
musharakah and diminishing musharakah. The term Musharakah means
joint venture where profits are shared amongst the partners as agreed
between them and losses
have to be borne by each
partner according to their
investment.
In DM, a financer and a
client participate in either
ownership of a joint
property, or in a joint
commercial business, with
the understanding that
the client partner will buy
the equity share of the
financier partner over an
agreed period of time
until the title to the equity is completely transferred to the client by
payments of installments to the financier for purchase over the agreed
period. The buying and selling of equity is not stipulated in the partnership
contract as it is not allowed - one partner is allowed to give only a promise
to buy.
a) In DM, through contract partnership (shirkah al-aqd) the ratio of profit
distribution for each partner can be disproportionate to the ratio of equity of

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Brief Introduction of Diminishing Musharakah
both parties and has to be stipulated at the time of execution of a
musharakah contract. However, any loss would necessarily have to be
allocated in accordance with the ratio of equity at the time when the loss
was incurred. In partnership by ownership (shirkah al-milk), the major
objective of the relationship between the partners in a shared ownership in a
property is not for the purpose of profit-earning through the business of
buying and selling the property; therefore the ratio of profit distribution need
not be stipulated in the arrangement.
b) In DM through partnership by contract, the lessee partner can promise to
buy periodically the share of the financer partner according to the market
value or at a price to be agreed at the time of sale of ownership Units of the
asset. It is not permitted to stipulate that the ownership Units will be bought
at a pre-agreed price or at their original or fair value, as that would
constitute a guarantee of the share capital of one partner by the other
partner; this is not allowed in a contractual partnership (shirkah al-aqd).
In DM through partnership by ownership (shirkah al-milk), on the other
hand, one partner can purchase the ownership Units representing the share
of the co-partner at a pre-agreed price. This is a very important difference
between the two forms of DM, particularly in respect of Shari´ah compliance
relating to both the procedure and the payment of price for the transfer of
ownership by Islamic banks of their share in an asset to their clients. Islamic
banks that provide housing finance on the basis of DM by way of shirkah al-
milk (partnership by ownership), in order not to breach the Shari’ah rules,
generally obtain a promise from their clients (or make a promise with the
clients) that the clients will purchase the banks’ Units of shares in a
particular property or asset at a pre-agreed price.

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Brief Introduction of Diminishing Musharakah
Composition of the DM Contract
A DM contract may consist of two or three sub-contracts, i.e.
(i) Partnership by ownership between two or more persons,
(ii) One partner leasing its share in the asset to the other partner(s), and
(iii) One partner selling its share to the other partner(s).
Contracts relevant to commercial assets that do not involve leasing involve
two subcontracts – partnership and sale.
All the sub-contracts are considered permissible by the Muslim jurists when
one contract is not dependent on another and particularly when sale/lease
contracts are stipulated among the partners, i.e. where assets are
sold/leased to partners. As regards the price of ownership Units periodically
purchased by one partner from another, if the assets involve leasing, the
purchase price can be pre-agreed. However, if leasing is not involved (as in
the case of commercial activities) and there is a simple partnership in which
two partners start a business, for example, on a 40:60 basis, they can agree
that the share in the ownership as Units of one partner (the financier
partner) will be periodically sold to the other partner, who will keep on
purchasing them until the selling partner is out of the business.
After creating a joint ownership, the bank can sign a promise to sell the
Units of the share of the bank’s ownership periodically to the client and, at
the same time, undertake that when the client purchases a Unit of the
bank’s share, the payments due on the remaining Units of the bank’s share
will accordingly be reduced. Although the entrepreneur partner (the client)
has an inherent motivation to acquire full ownership by purchasing shares
from the financier (the bank), the majority of Shari´ah scholars and the
AAOIFI Standard are not inclined to make the purchase binding on the client.

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Brief Introduction of Diminishing Musharakah
Thus, while an Islamic bank will be making a binding promise to offer a
specific part of its ownership of the project for sale on a specified future
date, at a price that will be determined at the time of the actual sale (in the
case of partnership by contract), the entrepreneur partner (the client) will
voluntarily buy the share of the financing partner (the bank) at the price
prevailing at the time of the sale, in the stock market or at a price
determined by the free consent of the contracting parties.
Relationship between the Parties in DM
The relationship between the parties in a DM arrangement is that of partners
and lessor / lessee in the first stage and seller and buyer at the later stage.
The rules of the each segment of the arrangement must be complied with
independently. The sale has to be kept independent from the first stage
which comprises the partnership and leasing arrangement.
Any arrangement in which three separate agreements of partnership, leasing
and sale are made in such a way that they are not conditional upon one
another and are separately enforceable, will be Shari´ah-compliant.
However, stipulating the three contracts collectively are normally not
approved by Muslim jurists because it is considered to be against the general
principle that one contract should not be entered into as condition of another
contract.

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Brief Introduction of Diminishing Musharakah
Diminishing Musharakah as a Mode of Finance
DM has a huge potential, particularly for financing of assets that can be
leased. Islamic banks can use DM for providing house financing, auto
financing, plants and machinery financing, factory/building financing and
financing of all other fixed assets. As a variable / floating rate of return is
possible in transactions involving leasing, Islamic banks can use DM for long-
term financing even in those economies having an inflationary trend.
For example, in the case of housing finance for purchase of a house, where a
bank may extend finance for over 20 years, a joint ownership in
proportionate shares to the level of their investment in the property to be
purchased is created; a legal mortgage is taken on the client’s beneficial
share to secure the obligation to the bank under the financing arrangement;
the financier partner (the bank) gives its undivided share on lease to the
other partner (the client). The client pays rent to the bank for the usage of
its share of the property until such time as the client has acquired the
complete ownership (the rent payment may be based on the pricing of the
bank’s share in the form of Units of ownership). At that time the ownership
of the property will be transferred to the client as the sole owner. Both the
bank and the client benefit from the joint arrangement.
Financing by the Islamic banks on the basis of DM can take different forms
depending upon the assets involved. For example, in house financing, the
facility can be provided for buying a house for occupation, for the
construction of a house, for the renovation of a house already occupied and
for replacing interest-based housing loans/mortgages with the Shari´ah-
compliant arrangement (balance transfer facility - BTF).

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Brief Introduction of Diminishing Musharakah
The process of an Islamic bank’s financing
through Diminishing Musharakah for:
a) Purchase of a property, and
b) Re-payment of an outstanding interest based mortgage
finance (BTF)
Purchase of a House
I. The client identifies a suitable house to purchase and obtains the
necessary information about its ownership title and the price; the client
approaches an Islamic bank for the purchase of the property and agrees to
invest a certain amount towards the purchase and applies to the bank for
financing the balance amount.
II. The Islamic bank verifies all the information. If the bank is satisfied about
the title to the house and the future cash flow of the client, the bank will
approve a facility to finance the purchase (the bank’s investment) and a
musharakah agreement is created in terms of which the client and the bank
(as partners) become co-owners in the house (the joint property) on the
basis of shirkat almilk. The share in the property belonging to the client and
the financing bank is according to their investment contributions.
III. The client as the eventual owner has immediate rights to occupation;
both parties agree that the bank will lease its undivided share to the client
partner for use by the client against a stipulated rental, to be governed
under the rules of ijarah (leasing). This agreement is signed after the
musharakah agreement. It contains the details about rent, the formula for
its calculation and a schedule for the period of the lease;

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Brief Introduction of Diminishing Musharakah
IV. Undertaking to purchase Units of the bank’s share of ownership in the
joint property: It is a separate unilateral promise binding on the promisor
only. As is the case for shirkah al-milk, either the client or the bank can
make this promise. It may contain a price schedule by which the client has
to purchase the Units of the bank’s share from time to time. It also gives the
details required in the event the client may want at any time to purchase
more Units than provided in the schedule mutually agreed at the time of
entering into the agreement. The arrangement also contains details about
the nature of security / guarantee to be provided by the client and is
normally an equitable mortgage on the financed property (the house) that
encumbers the property as security for the repayment.
V. The bank may require any additional security to secure its interest,
particularly in view of the financial position of the client; this would be
stipulated in the agreement.
Additions / Renovation of a House already in
Ownership of the Client
(i) Renovation of a house owned by the client, or additions to it, would also
involve sale and lease back. Dividing the value of the client’s ownership of
the house into 100 Units the client would sell, say forty Units to the bank to
create a joint ownership. With the proceeds of the sale (the bank’s
financing), the client would renovate the house or make alterations to it.
Because the client is already living in the house, the bank can start taking
rent for occupying the part in the bank’s ownership from the first month
after disbursement of the amount to the client (if bank disburses the amount
financed in stages, then after the first disbursement is made). But the
process of sale back of Units of the bank’s ownership to the client would

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Brief Introduction of Diminishing Musharakah
have to start one year after the disbursement of the last tranche where the
disbursement of the financing amount to the client is made in stages.
The case of BTF (balance transfer facility for an interest-based mortgage
finance to be replaced by a Shari’ah compliant house finance) is also like
that of renovation – the client will sell some Units of the ownership of the
house to an Islamic bank, against which the client had previously availed
interest-based finance; from the proceeds, the client will repay the interest-
based finance to the original lender bank; the Islamic bank will take rent on
its share of the joint ownership; after one year the client will start buying
Units from the bank, which process will continue until the bank’s share of the
ownership title in the house is completely transferred to the client. In all the
above cases, if the client regularly pays the rentals and periodically also
purchases the bank’s Units of ownership by additional payments to the bank,
the rental payment is reduced with the client’s ownership increasing over a
period of time, the bank’s part in ownership title is ultimately transferred to
the client. If the client delays payment, the rental will not decrease and the
bank’s loss in terms of income will be far less than in the case of
murabahah, as in the case of DM the client will go on paying rentals on the
Units owned by the bank whereas in murabahah the bank cannot recover
any compensation from the client for losses arising from the delay in
payments. DM is beneficial for the client who can purchase more Units if the
client’s cash flow allows this and the rent will decrease accordingly.