This is a partnership, normally of limited duration, formed to carry out a specific project. It is, therefore, similar to a Western-style joint venture, and is also regarded by some as the purest form of Islamic financial instrument, since it conforms to the underlying partnership principles of sharing in, and benefiting from, risk. Participation in a Musharaka can either be in a new project, or by providing additional funds for an existing one. Profits are divided on a pre-determined basis, and any losses shared in proportion to the capital contribution. In this case, the bank enters into a partnership with a client in which both share the equity capital- and maybe even the management -of a project or deal, and both share in the profits or losses according to their equity shareholding.
There are two basic types of Musharaka:
1. Fixed Musharaka:
It is the partnership where the Bank's share in the joint venture's capital remains as long as the contract’s term remains.
2. Diminishing Musharaka (Ends up with ownership):
It is a partnership, where the bank gives the right to its partner to gradually buy the bank's share in the project. While the share of the bank decreases, the partner's share increases to complete ownership of the project.
Steps for a Musharaka finance
1. The customer submits an application to the bank specifying the asset or project subject of the Musharaka (domestic or imported). The application usually includes the Musharaka capital, the customer's share and how would that share be paid (cash/ in kind) along with the feasibility study and required documentation.
2. The bank study the transaction and having ensured the feasibility of the project would set out the conditions required for approval.
3. A bank account is opened for the Musharaka wherein the capital is deposited and used to pay the asset price or to establish the project.
4. A contract is made between the bank and customer to include the entire agreement and indicate percentage of capital share and profit distribution ratios.
5. Fixed Musharaka is cleared by selling the subject asset while the diminishing Musharaka is cleared by selling the bank share to the customer.
Area of application
Musharaka as a finance instruments, is suitable for participation in the capital share of new or existing project such as industrial facilities, farming and hospitals and any other project of regular income where the bank contributes part of the capital share.