Fundamentals of Islamic Finance and Banking

CHAPTER 6Musharaka

Learning outcomes

Upon completion of this chapter, you should be able to:

1. Define the Musharaka contract and describe the types of Musharaka in modern Islamic finance and banking.
2. Explain Shariah compliance and other principles guiding Musharaka contracts.
3. Discuss the problems related to the use of Musharaka contracts in Islamic banking.
4. Describe the practical uses of Musharaka contracts and their differences from conventional banking and the Mudaraba contract.

INTRODUCTION TO MUSHARAKA

The term Musharaka is derived from the Arabic word Shirkah, and means partnership. Musharaka is a partnership of two or more, who put together their capital and labour based on mutual trust, share in the profit and loss of the joint venture and have similar rights and liabilities. It is the purest form of Islamic finance instrument. In Musharaka the risks and profit or loss are distributed more equitably between the investors, determined by the proportion of the investment of each partner, rather than in a conventional interest-based loan where interest is calculated based on the principal amount, the interest rate applied and the period of the loan, without any link to the risk or profit–loss scenario of the venture.

From the Shariah perspective, Musharaka is a simple partnership. But designing a banking product from it is not easy. Banks prefer to enter into a partnership for a limited period only. Yet Musharaka is considered the most viable Islamic banking product, ...