(Profit and Loss Sharing System)
word Musharaka takes its name from the Arabic work "shiraka"
which means partnership and it is that relationship which subsists
between two or more persons carrying on a business in common with
a view of profit to be divided between themselves in pre-agreed
proportions. It is formed by an agreement whereby the partners agree
to carry on a particular type of business together with a view to
partnership is normally of limited duration, formed to carry out
a specific project. It is therefore similar to a joint venture.
The share of each one of the partners should be stated in terms
of percentage or ratio or fraction of anticipated profits and not
as an absolute fixed amount. Such stipulation or pre-fixing of a
certain sum as profits for any partner will invalidate the contract.
share of each one of the partners may or may not be determined on
pro-rata basis to the capital contributed by each partner. However,
the agreement should earmark a certain portion of the profits for
the active partner in excess of the actual percentage due to him
as a compensation for his entrepreneurship and management. This
portion should be deducted from the profits prior to distribution.
Losses resulting from normal business conditions should be borne
by the partners on pro-rata basis according to each partners contribution
in the capital. The active partner will, however, bear responsibility
for any loss should this be the result of his negligence or willful
act or breach of the Musharaka agreement.
carried according to this mode may vary from weeks to years and
can be classified under two headings:
This is a self-liquidating form of participation whereby the bank
would, in addition to its share of profits, be retrieving from the
other partner certain agreed sums until the bank's share of the
capital is fully repaid and ownership of the project passes over
to the other party. It is usually applicable in medium to long-term
operations and projects.
In this kind of Musharaka, the bank participates in the project
permanently until liquidation of the same or until, by agreement,
the bank sells its share in the project to the other partner or
to any other party.
The Interest-free Banks through these methods of finance (Mudharaba
and Musharaka) play the role of a real partner.
other category of methods of finance, as stated earlier, are the
trade finance or trade related methods. These include:
This method is extensively used by Interest-free Banks to finance
the trade needs of its customers.
It consists of two distinct transactions, purchase and sale, where
the bank adds an agreed amount of mark up as profit over the cost
of the purchase transaction to the sale transaction. This margin
is charged only once at the time of selling the goods to the customer
and is not variable or subject to increase again in the future even
if the customer delays in repayment or fails to repay. The mark-up
principle is justified on the basis of a generally accepted axiom
that time may be valued provided it is incorporated in an actual
The Murabaha method is widely used by Interest-free Banks to finance
international trade and the importation of goods under letters of
This method is used where the customer and the supplier of a product
are stationed in the same locality. Its difference with the Murabaha
(Mark-up sale) is that a lump sum sale price of the goods would
be agreed upon after bargaining between the bank and customer irrespective
of the original cost price of the goods and/or the profit.
This is a post-delivery or forward transaction similar to a future
or a forward-purchase contract. In this arrangement, banks purchase
in advance goods from the owners of productive units who undertake
to deliver the goods at a future date. Through this system the bank
would afford the necessary funds required to meet the working capital
needs of owners of the productive sector of the economy. It is particularly
applicable to seasonal agricultural purchases, but it can also be
used to buy other goods in cases where the seller needs working
capital before he can deliver. The necessary conditions that need
to be met are that the quantity and quality of the commodity, delivery
date and the price should be specified.
Muzara'a is derived from the Arabic work Zira'a which means farming.
This form of finance is largely practised by the Interest-free Banks,
which operate in agricultural countries notably those in Iran and
Sudan. Under such contracts, the banks provide agricultural lands
that they own or that are in their possession as a trust to farmers
for a specified period. The underlying concept of a Muzara'a contract
is that the land provided is a fixed asset put to the use of the
farmer who should share the fruits of its harvest with the bank.
Leasing as practiced by Interest-free Banks is quite similar to
its conventional practice. Under such arrangements, the bank purchases
goods and then leases the same to its clients for specified rentals
for a fixed period of time. Payments may be made by the client monthly
or quarterly and the bank will normally fix rentals which cover
all or most of the original purchase price of the item over the
period of the contract.
the end of the lease period, the bank may either sell the item of
equipment concerned in the market, rent it to another client for
a sum usually less than that agreed for the first contract, or else
sell the item to the original client. If the eventual sale to the
original client was agreed at the time the initial contract was
made, then the contract can be said to incorporate both Ijara and
Murabaha elements. In this case, the rental premiums may be smaller.
This type of mixed contract is quite popular in leasing transactions
undertaken by many Interest-free Banks.
(Lease Purchase Financing)
This is an extended version of leasing method discussed above. In
addition to the regular lease rentals, the client undertakes to
deposit additional agreed amounts of capital payments over a definite
time period into a savings account held in the bank. The bank shall
then invest these additional capital amounts and profits generated
thereof shall further be credited to the account until such time
when an agreed value for the equipment is reached and ownership
is transferred to the client.
of Contemporary Banking Services.
Besides offering alternative forms of financial inter-mediation,
Interest-free Banks also offer comprehensively and competitively
all those services expected of any contemporary bank.
These services are fee-paid retail services that in general do not
involve interest payments. They include, checking accounts, spot
foreign exchange transactions, fund transfers, travellers cheques,
safe deposit boxes, securities safe-keeping, investment management
and advice services, trust services, property management, execution
of wills and testaments and income tax consultancy.