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Glossary

Musharaka

Category — Islamic Finance
Musharaka is an Islamic mode of financing in the form of a partnership or a joint venture between two partners, “for example the bank and its customer”. Each party contributes to the capital of the partnership in equal or varying degrees.

Characteristics of the Musharaka contract:

1. The Management of the project may be carried out by one or both parties. This is a very flexible partnership arrangement, in that the sharing of profits and management can be negotiated and agreed on by all parties involved.

2. The accrued profit is divided between the partners in a pre-agreed formula, but losses must be shared in proportion to their initial investment.

3. A Musharaka agreement may be entered into for a short- or long-term period.

Types of Musharaka in Islamic banks:

1. Permanent Musharaka: it is the bank’s participation in a specific project without determining a specific deadline for the end of this partnership. For example, the participation of Islamic banks in establishing joint-stock companies.

2. Temporary Musharaka: This is the bank’s participation in a specific project with determining the deadline or the method for ending the bank’s participation in this project in the future. This Musharaka is of two types:

a) Musharaka in financing a specific deal: It is the participation of the Islamic bank with a company in financing a specific deal, provided that they share the profit at a certain percentage. When the deal ends, each party’s share of the profits is calculated and handed over to him after returning their capital.

b) Musharaka ending with ownership: “Diminishing Musharaka”: It is the participation of the Islamic bank with another party in establishing a specific project with a certain capital so that the bank and the partners contribute to the capital of this project at certain rates. Provided that the other party purchases the bank’s share gradually from the profits it obtains until the bank’s share in the project’s capital is transferred in full to the other party so that the other partner becomes the owner of the project and the bank exits this partnership.

Advantages:

1. Exploiting excess liquidity in Islamic banks with high returns.

2. Distribution of risks among the owners of capital and saving efforts due to the distribution of responsibilities among partners.

Disadvantages of Musharaka contracts:

1. Musharaka financing requires a process of supervision and follow-up for the funded projects, and the provision of specialized cadres in the activity of each contract to evaluate it, which leads to an increase in the costs of financing.

2. Risks of non-compliance with the conditions of the Musharaka contract and its mismanagement, resulting in less profit or even a loss.

3. There is no guarantee of profit for any party except in the event of negligence.

Advantages:

1. Exploiting excess liquidity usually in Islamic banks with high returns.

2. Distribution of risks among the owners of capital and saving efforts due to the distribution of responsibilities among partners.

Disadvantages of Musharaka contracts:

1. Musharaka financing requires a process of supervision and follow-up for the funded projects, and the provision of specialized cadres in the activity of each contract to evaluate it, which leads to an increase in the costs of financing.

2. Risks of non-compliance with the conditions of the Musharaka contract and its mismanagement, resulting in less profit or even a loss.

3. There is no guarantee of profit for any party except in the event of negligence.
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