Diminishing Musharakah

Diminishing Musharakah is a form of partnership, which ends with the

complete ownership of a partner who purchases the share of another partner
in that project by a redeeming mechanism agreed between both of them.
Diminishing Musharakah is used mostly when one party who wants to own an
asset or a commercial business which does not have adequate funds to pay
the full price; and takes the assistance of financing from another party. The
share of the financier is divided into a number of units and it is understood
that the client will purchase the units of the share of the financier one by one
periodically, thus increasing his own share till all the units of the financier are
purchased by the client so as to make him the sole owner of the asset. In this
kind of partnership, all partners are co-owners of each and every part of the
joint property or asset on a pro-rata basis and one partner cannot make a
claim to a specific part of the property or asset leaving the other parts for
other partners.
Diminishing Musharakah can be conducted through shirkah al-aqd; in that
case, the ratio of profit distribution for each partner can be disproportionate
to the ratio of equity of both parties and has to be stipulated at the time of
execution of the contract. In case of loss, it should be necessarily allocated in
accordance with the ratio of equity at the time when the loss was incurred.
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 the sale. The price of share units cannot be fixed in the promise to sell
Diminishing Musharakah can also be conducted through shirkah al-milk, the
ratio of profit distribution doesnt need to be stipulated in the arrangement.
Each partner will own the risk as well as the reward in proportionate to their
individual share in the property or asset. The financing partner can lease its
share to the other party and receive a rental for use of the leased part. The
other party goes on paying the rental and purchasing the share of the
financier partner in the form of ownership units, the rental payments will go
on decreasing. He will also get the benefit of having the use of his part
without paying any rent. One partner cannot purchase the ownership units
representing the share of the co-partner at a pre-agreed price.
A contract of Diminishing Musharakah could take different shapes in different
sub-contracts which come to play their role at different stages: partnership
by ownership between two or more persons, leasing of the share of one
partner in the asset to the other partner, and the sale of the share of one
partner to the others. These sub-contracts are considered permissible in the
Shariah given that one contract is not dependent on another and
particularly when assets are sold or leased to partners. If all these subcontracts have been combined by making each one of them a condition to

the other, then this is not allowed, because it is a well settled rule in Shari
ah that one transaction cannot be made a pre-condition for another. Thus,
the relationship between the parties in a Diminishing Musharakah
arrangement in the first stage is that of lessor and lessee and at the later
stage is that of seller and buyer.

Define Diminishing Musharakah

Diminishing Musharakah is a form of partnership in which the Islamic Bank and the customer
participate in the joint ownership of a property or equipment. The share of the financier is further
divided into a number of units and the client purchases the units of the share of the Islamic Bank
periodically, thus increasing his own share till all the units of the Islamic Bank are purchased by
the customer, making him the sole owner of the property or the equipment.
Diminishing Musharakah is most commonly used for the financing of fixed and movable assets,
long term projects, etc.
You and the Bank participate in joint ownership of a property, equipment or a commercial
enterprise. The share of the Bank is divided into number of units. You purchase these units from
bank one by one with periodic intervals, thereby increasing your share in the undivided
property/asset gradually until you ultimately become sole owner of the property/asset. During the
period of Musharakah bank charges rent for the use of that portion of asset which is owned by
bank. The rent amount of the bank diminishes as its stake in the asset decreases after purchase of
units.

Types of Musharakah
-Shirkat-ul-milk (partnership by joint ownership)
-Shirkat-Ul-Aqd (Partnership by contract)
Shirkat-ul-milk (partnership by joint ownership) is the kind of Musharakah where by two or parts
jointly own the particular property. This kind of partnership can be done optionally(ikhtiar) when
the partners mutually decide to purchase the property to be owned by them for any intention
other than commercial. It can also be compulsory (ghair ikhtiar), i.e. happened automatically
without mutual agreement or any effort done by involved partners. The main case for this kind of
Shirkah is death of a person where by all his heirs inherit his property and become the owners of
this property naturally. It should be It should be noted that the ratio of the share of this property
is calculated according to Islamic laws of inheritance. Shirkat-Ul-Aqd (partnership by contract)
also known as join commercial enterprises, is the kind of Musharakah which come into existence
by a mutual contract for the purpose of being brief in duration where either the partners share
everything equally, i.e., capital, management, profit and risk are shared equally, this situation is
described by the term Shirkat-ul-mufawadameaning capital and labour at par, Or when the
partners share the capital, management, profit and loss unequally, this situation is termed as
Shirkat-ul-ainan Shirkat-Ul-Aqd can come into existence in three states; the first state Shirkatul-amwal (Partnership in commercial) where all partners involved allocates the investment

capital into commercial enterprise. The second state Shirkat-ul-aamal (partnership in services) is
the kind of Shirkat-Ul-Aqd where by all partners mutually commence to provide some service
for their customers, the kind of service provided can be different or linked to each other. The fee
charged from that service is distributed among the partners in agreed ratio irrespective to the
level of workload carried out by the partners. The third state Shirkat-ul-wujooh (partnership in
goodwill), in this state the partners do not have the investment at all, they purchase the products
on deferred price, by getting capital on loan because of their goodwill and sell them at spot and
distribute the earned profit at an agreed ratio.

Diminishing Musharakah Finance (For Shirkat-ul-Milk)

Diminishing Musharakah is a form of partnership in which one of the partners promises to buy
the equity share of the other partner gradually until the title of the equity share is completely
transferred to him. This transaction starts with the formation of a partnership, after which buying
and selling of the equity takes place between the two partners. Diminishing Musharakah can be
used for plant, machinery, equipment, buildings and automobile financing.

Principles of Diminishing Musharakah (Shirkat-ul-Milk):

Diminishing Musharakah (DM) is a form of co-ownership in which the client and the
bank share the ownership of a tangible asset in agreed proportion and the client
undertakes to buy in periodic installments of the proportionate share of the bank until the
title to such tangible asset is completely transferred to the client.
Diminishing Musharakah can be created only in tangible assets. Diminishing Musharakah
shall be limited to the specific asset(s) and not to the whole enterprise or business.

A DM would consist of the following three steps

Creation of joint ownership between the bank and the client.

Renting out by the bank undivided share in the asset owned to the client.
Selling its share in periodic installments by the bank to the client.
All other terms and conditions as are essential to co-ownership, Ijarah and sale shall be
fulfilled in respect of different stages in the process of DM arrangement.
Proportionate share of the client and the bank must be known and defined in terms of
investment.
Loss, if any, shall be borne by the bank and the client in the proportion of their respective
investments.
The amount of periodic payment would go on decreasing with purchase of ownership
units by the client.
Each periodic payment shall constitute a separate transaction of sale.
Separate agreements/contracts shall be entered into at different times in such manner and
in such sequence so that each agreement/contract is independent of the other in order to
ensure that each agreement is a separate transaction.

Following are the documents to be executed in DM Financing;

Diminishing Musharakah Agreement

Rental Agreement for moveable/Immoveable Assets

Agreement for purchase of Musharakah Units

In case a client fails to honor the undertaking, as aforesaid with regard to the periodic payment
and purchase of sale of units as the case may be, the asset may be sold in the open market and the
bank aggrieved by such failure shall be entitled to recover:

Actual loss, defined as the difference between the market price and price mentioned in
the undertaking, if any, not being the opportunity cost.
Any gain on sale of property, shall be shared by the bank and the client in proportion of
their respective investment at the time of such sale.
He banks shall be entitled to recover outstanding periodic payments in respect of the
period for which the client has actually used or possessed the asset which shall be
payable to the bank.

Features of Diminishing Musharakah in Shirkat-Ul-Aqd (Joint Venture)

Two partners start business in shirkah to earn profit one of the partners undertakes to purchase
the share of another partner gradually every month or each year.

Rules of Diminishing Musharakah in Shirkat-Ul-Aqd (Joint Venture)

There will be an agreement of joint venture between both partners where in investment of
everyone and ratio of profit will be agreed.
One partner undertakes to purchase the share of other partner, but three conditions should be
considered in this undertaking.
1. This promise will not be a part of Shirkah Agreement.
2. The price of unit will not be agreed in this promise but promise to purchase should be on
offer and acceptance basis for a valid sale contract (at market value at the time of
purchasing).
3. If promise is not fulfilled, then it can be forced by Court of law.
4. At the time of purchase, the price of unit will be decided on the basis of market value of
business.
5. Conditions of valid sale transaction must be observed.
6. Unit will be purchased through Offer & Acceptance.

Features of Diminishing Musharakah in Joint Ownership

Two or more partners purchase any asset (machinery, property, etc.) and their intention is that
one or both partners will use this asset or rent out their share and one partner undertakes to
purchase the share of other gradually.

Rules of Diminishing Musharakah in Joint Ownership

1. There will be an agreement of Shirkat ul Milk and it will be decided How much
investment will be made by each partner.
2. Asset will be purchased and everyone will be owner of this asset as per the ratio of his
investment and all other rules of Shirkat-ul-Milk will be applicable.
3. One Shareek can rent out his share to other partner or to a third party and Ijarah
Agreement will be signed.
4. Within period of Ijarah, Shariah rulings relating to Ijarah will be applicable.
5. One of the partners can promise to purchase the share of another partner and in this
promise, the price of unit may be decided.
6. Unit can be purchased on the basis of Offer & Acceptance.
7. All the above mentioned agreements and undertaking should be independent and not
linked up with each other.

Termination of Diminishing Musharakah

1. Subject to agreement or by mutual consent of joint owners, a joint owner may withdraw
his share from the joint asset or property after serving a due notice to other joint
owner(s).
2. The withdrawal can be affected by sale or gift to existing joint owner(s) or to any other
person(s). In case of sale, the parties may agree on face value, book value, agreed value,
or market value.
3. A withdrawal of one or more joint owner(s) shall not lead to the termination of the joint
ownership among remaining joint owner(s).
4. It is also permissible for the joint owners to agree on termination of the joint ownership
before the agreed period.

Use of Diminishing Musharakah in Present Islamic Banking

Diminishing Musharakah is usually used for asset financing and particularly in House Financing
for four purposes:

Purchase of House
Construction of House
Renovation of House
Balance Transfer Facility (BTF)

House financing on the basis of diminishing Musharakah

The Client in the approved area of the bank makes the choice of house.
Bank & client enter into Musharakah agreement. In this agreement it is decided to
purchase the house jointly and ratio of investment by each other.
The property will be in the name of the client.

This is Shirkat-ul-Milk.
According to the ratio of ownership, each one is responsible for the loss.
Bank divides its own part of asset into units, which is promised by the client to purchase
on pre-agreed price.
After taking possession of house, bank rent out its share to the client by execution of
Ijarah Agreement.
Rent may be fixed on prevailing market rate or with mutual consent.
Banks monthly profit may also be decided, as monthly rent of the house and principal
amount will be recovered in the unit price.
In Ijarah Agreement, a lump sum amount of rent is necessary to be fixed for a certain
period. Rent for the rest of the period, may be linked with agreed Benchmark.
Each unit will be purchased on the basis of Offer & Acceptance.

Financing for Purchase of Plot and Construction of House

There are two scenarios in this case:
a) Financing for Purchase of Plot & Construction.
b) Financing only for Construction

Financing for Purchase of Plot & Construction

Musharakah Agreement will be signed between bank and client in which investment of everyone
will be agreed. It will also be agreed that client as working partner will be responsible for
construction. Both partners will be the owners of the property in same ratio as the ratio of
investment. After completion of house, Ijarah Agreement will be signed and bank will give its
share of house on rent to the client. Before completion of construction, rent cannot be charged.
Rent may be fixed on prevailing market value or with mutual consent. Banks monthly profit
may also be decided, as monthly rent of the house and principal amount will be recovered in the
unit price. In Ijarah Agreement, a lump sum amount of rent is necessary to be fixed for a certain
period. Rent for the rest of the period, may be linked with agreed Benchmark. Each unit will be
purchased on the basis of Offer & Acceptance. Purchase of unit can be started after Musharakah
Agreement.

Financing for Construction of House

Valuation of plot will be made. This value will be investment of client in Musharakah Agreement
and banks financing for construction will be investment of bank. Musharakah Agreement will be
signed between bank and client in which investment of everyone will be agreed. It will also be
agreed that client as working partner will be responsible for construction. Both the partners will
be owner of the property in same ratio as the ratio of investment. The property will be in the
name of the client. According to the ratio of ownership, each one is responsible for the loss. Bank
will divide its own part of asset into units, which is promised by the client to purchase on preagreed price. After completion of house, Ijarah Agreement will be signed and bank will give his
share of house on rent. Before completion of construction, rent cannot be charged. Rent may be
fixed on prevailing market value or with mutual consent. Banks monthly profit may also be
decided, as monthly rent of the house and principal amount will be recovered in the unit price.

Financing for Renovation of House

Valuation of house will be made and this value will be treated as investment of client in
Musharakah Agreement and renovation amount will be considered as banks investment.
Musharakah Agreement will be signed between bank and client in which investment of everyone
will be agreed. It will also be agreed that client as working partner will be responsible for
renovation. Both the partners will be owner of the house in same ratio as ratio of investment. The
property will be in the name of the client. According to the ratio of ownership, each one is
responsible for the loss. Bank will divide its own part of asset into units, which is promised by
the client to purchase on pre-agreed price.

Diminishing Musharakah for Balance Transfer Facility (BTF)

This product will be used only in those cases where someone has obtained interest-based loan for
house. Valuation of house will be made and this value will consist of the investment of client in
Musharakah Agreement and amount of loan paid by bank will be investment of bank.
Musharakah Agreement will be signed between bank and client in which investment of everyone
will be agreed. Both the partners will be owner of the property in same ratio as ratio of
investment. The property will be in the name of the client. According to the ratio of ownership,
each one is responsible for the loss. Bank will divide its own part of asset into units, which is
promised by the client to purchase on pre-agreed price. Ijarah Agreement will be signed and
bank will give its share of house on rent to the client. Rent may be fixed on prevailing market
value or with mutual agreement. Banks monthly profit may also be decided, as monthly rent of
the house and principal amount will be recovered in the unit price. In Ijarah Agreement, a lump
sum amount of rent is necessary to be fixed for a certain period. Rent for the rest of the period,
may be linked with agreed Benchmark. Before one year, client cannot purchase bank units Each
unit will be purchase on the basis of Offer & Acceptance.

Diminishing Musharakah in Trade

The third example of diminishing Musharakah as given above is that the financier contributes
60% of the capital for launching a business of ready-made garments, for example. This
arrangement is composed of two ingredients only.
In the first place, the arrangement is simply a Musharakah whereby two partners invest different
amounts of capital in a joint enterprise.
Purchase of different units of the share of the financier by the client. This may be in the form of a
separate and independent promise by the client. The requirements of Sharia regarding this
promise are the same as explained in the case of House financing with one very important
difference. Here the price of units of the financier cannot be fixed in the promise to purchase,
because if the price is fixed beforehand at the time of entering into Musharakah, it will
practically mean that the client has ensured the principal invested by the financier with or
without profit, which is strictly prohibited in the case of Musharakah. Therefore, there are two
options for the financier about fixing the price of his units to be purchased by the client. One
option is that he agrees to sell the units on the basis of valuation of the business at the time of the

purchase of each unit. If the value of the business has increased, the price will be higher and if it
has decreased the price will be less. Such valuation may be carried out in accordance with the
recognized principles through the experts, whose identity may be agreed upon between the
parties when the promise is signed. The second option is that the financier allows the client to
sell these units to anybody else at whatever price he can, but at the same time he offers a specific
price to the client, meaning thereby that if he finds a purchaser of that unit at a higher price, he
may sell it to him, but if he wants to sell it to the financier, the latter will be agreeable to
purchase it at the price fixed by him beforehand. Although both these options are available
according to the principles of Shariah, the second option does not seem to be feasible for the
financier, because it would lead to injecting new partners in the Musharakah which will disturb
the whole arrangement and defeat the purpose of Diminishing Musharakah which the financier
wants to get his money back within a specified period. Therefore, in order to implement the
objective of Diminishing Musharakah, only the first option is practical.

Define Demand Finance:

The duration of DF is more than running or Cash Finance. These are made in Lump sum and are
there is a permission to repay the amount in periodic instalment. Upon receipt of documents
negotiated by the seller bank the opening bank makes sure that documents are according to terms
and conditions of the credit. Bank makes the payment to the party against document and upon
expire date, bank receives back money with markup rate.

In other words, Demand Finance

A Demand finance is a loan which is repayable on demand by the bank. In other words, it is
repayable at short-notice. The entire amount of demand finance is disbursed at one time and the
borrower has to pay interest on it. The borrower can repay the loan either in lump sum (one time)
or as agreed with the bank. For example, if it is so agreed the amount of loan may be repaid in
suitable installments. Such loans are normally granted by banks against security. The security
may include materials or goods in stock, shares of companies or any other asset. Demand
finances are raised normally for working capital purpose like purchase of raw materials, making
payment of short-term liabilities.