Fiqh of Islamic Finance

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Fiqh of Islamic Finance

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Musharakah

1. Shirkah (partnership) It literally means
   sharing. The sharing may be of money, labor, or
   anything else. The prophet (SAW) said, People
   are partners in three things water, herbage,
   and fire.
2. Shirkah (partnership) is defined as a contract
   between partners on both capital and profit.

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Kinds of Partnerships

• Shirkat ul-milk (partnership of ownership) It
  means joint ownership of two or more persons in a
  particular property.
• This kind of Shirkah may come into existence in
  two different ways.
• By the partners choice means coming into the
  operation at the option of the parties. For
  example, if two partners agree to buy equipment
  it will be owned jointly by both of them.
• Without the partners choice means coming into
  the operation automatically without any action
  taken by the parties. For example, if property is
  inherited.

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Kinds of Partnerships

• Shirakal al-aqd (partnership of a contract)
  which means a partnership effect by a mutual
  contract.
• This kind of Shirkah exists in three types
• Shirkal ul-amwal (financial company) where all
  the partners invest some capital into a
  commercial enterprise.
• Shirkat ul-amal (company of workmanship) where
  all the partners jointly undertake to render some
  services for their customers and the fee charged
  from them is distributed among them according to
  an agreed ratio.

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Kinds of Partnerships

• Shirkal ul-wujooh (partnership with eminent
  people) where the partners have no investment at
  all. All they do is purchase the commodities on a
  deferred price and sell them at that spot. The
  profit so earned is distributed between them at
  an agreed ratio.

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 Basic Rules of Musharakah Distribution of
profit

• The proportion of profit to be distributed
  between the partners must be agreed upon at the
  time of the effecting of the contract.

• The ratio of profit for each partner must be
  determined in proportion to the actual profit
  accrued to the business, and not in proportion to
  the capital invested by him.

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Basic Rules of Musharakah

• Sharing of Loss
• In the case of loss each partner shall suffer
  the loss exactly according to the ratio of his
  investment. If a partner has invested 40 of the
  capital, he must suffer 40 of the loss, not
  more, not less.

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Basic Rules of Musharakah The Nature Of the
Capital

• Most of the Muslim jurists are of the opinion
  that the capital of a joint venture must be in
  monetary form, no part of it can be contributed
  in kind. Except in the opinion of Imam Malik who
  said that it is permissible for a partner to
  contribute to the musharakah in kind.

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Basic Rules of Musharakah Management of
Musharakah

• Every partner has a right to take part in the
  business's management and to work for it.
• However the partners may agree upon a condition
  that the management shall be carried out by only
  one of them and that no other partner shall work
  for the musharakah.
• If all the partners agree to work for the joint
  venture, each one of them shall be treated as an
  agent of the other in all the matters of the
  business.

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Basic Rules of Musharakah Termination of the
Musharakah

• Every partner has a right to terminate the
  musharakah at any time after giving his partner a
  notice to this effect.
• If any one of the partners die during the
  currency of musharakah, his heirs will have the
  option to terminate or to continue with the
  contract of musharakah.
• If any one of the partners becomes insane or
  otherwise becomes incapable of effecting
  commercial transactions, the musharakah can be
  terminated. 

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Diminishing Musharakah

• A financier and his client participate either in
  the joint ownership of a property or an
  equipment, or in a joint commercial enterprise.
• The share of the financier is further divided
  into a number of units. It is understood that the
  client will purchase the units of the financiers
  share, one by one, periodically.

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Mudarabah

• The word mudarabah comes from the Arabic root
  (Dharabahfi al ard), which means going and
  working to obtain livelihood.
• Mudarabah is a special kind of partnership where
  on partner provides work in trade and the other
  side provides the capital.
• The first partner is called mudarib, and the
  second partner is called rabb ul-mal.

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Difference between Musharakah and Mudarabah

1. The investment in musharakha comes form all the
   partners, while in mudarabah the investments
   comes from rabb-ul-mal only. This means that the
   musharakah is a partnership in profit and
   capital, while mudarabah is a partnership in
   profit not in capital.

1. In mushararkah all the partners can participate
   in the management of the business, and can work
   for it. While in musdarabah the rabb ul-mal has
   no right to participate in the management, which
   is carried out by the mudarib only.

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Difference between Musharakah and Mudarabah

• In musharakah all the partners share the loss.
  While in the mudarabah, only rabb-ul-mal suffers
  the loss, while the mudarib suffers the loss of
  his labor.

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Types of Mudarabah

• Al-mudarabah al-muqayyadah (restricted
  mudarabah) where rabb-ul-mal specifies a
  particular business for the mudarib, in which
  case he shall invest the money in that particular
  business only.

• Al mudarabah al muttaqah (unrestricted
  mudarabah) where rabb-ul-mal leaves the door
  open for the mudarib to undertake whatever
  business he whishes, the mudarib shall be
  authorized to invest the money in any business he
  deems fit.

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Distribution of the Profit

• It is necessary for the validity of mudarabah
  that the parties agree right at the beginning on
  a definite proportion of the actual profit to
  which each one of them is entitled. They can
  share the profit in equal proportions, and they
  can also allocate different proportions for the
  rabb-ul-mal and the mudarib.

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Termination of Mudarabah

• The mudarabah contract can be terminated at any
  time by either of the two parties. The only
  condition is for notice to be given to the other
  party.
• If all the assets of the mudarabah are in cash
  form at the time of termination,

• and some profit has been earned on the principal
  amount, it shall be distributed between the
  parties according to the agreed ratio.
• If the assets of the mudarabah are not in cash
  form, the mudarib shall be given an opportunity
  to sell and liquidate them, so that the actual
  profit may be determined.

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Combination of Musharakah and Mudarabah

• A contract of mudarabah normally presumes that
  the mudarib has not invested anything to the
  mudarabah. He is only responsible for the
  management, while all the investment comes from
  the rabb-ul-mal. Sometimes the Mudarib wants to
  invest some of his money into the business of the
  mudarabah, in such case the musharakah and the
  mudarabah are combined together.

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Combination of Musharakha and Mudarabah

• Example
• A gives B 100,000 in a contract of mudarabah.
  B then added 50,000 with the permission of A.
  This type of partnership will be treated as a
  combination of musharakah and mudarabah. The
  mudraib is a sharik, so he gets s a certain
  percentage of profit on account of his investment
  as a sharik and another percentage for his
  management and work as a mudarib.

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Murabahah (Set Profit Sale)

• Definition of Murabahah
• It is a sale contract, with a set increment on
  the original price, agreed upon by the two
  parties.
• It is a particular kind of sale where the seller
  expressly mentions the cost of the sold commodity
  he has incurred, and sells it to another person
  by adding some profit.

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Rules of Murabahah

1. The original price should be made known to the
   second buyer
2. The profit should be made known
3. All the expenses incurred by the seller in
   acquiring the commodity like freight, custom
   duty, etc. Shall be included in the cost price,
   and the mark up can be applied on the aggregate
   cost.
4. No usurious dealing is involved, as the increment
   of money in usurious dealings is prohibited in
   Islam.

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Rules of Murabahah

• The first contract should be legal. This is
  because the second (set profit) sale is based on
  the first contract, so if the first contract is
  illegal the second contract is also illegal.
• The first buyer must own the commodity before he
  sells it to the second buyer.
• The commodity must come into the possession of
  the first buyer whether physical or constructive,
  in the sense that the commodity must be in his
  risk, though for a short period.

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Ijarah (hire)

• Definition of Aqd al-Ijarah
• It is a contract on using the benefits or
  services in return for compensation.

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Ijarah (hire) In the Islamic jurisprudence the
term Ijarah is used for two different situations

• It means to employ the services of a person on
  wages given to him as a consideration for his
  hired services.
• The employer is called Musfajir, the employee is
  called Ajir
• If A has employed B in his office as a manager or
  as a clerk on a monthly salary, A is the mustajir
  and B is an ajir.

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Ijarah (hire) In the Islamic jurisprudence the
term Ijarah is used for two different situations

• Relates to the usufructs of assets and properties
  
•  Ijarah in this sense means to transfer the
  usufruct (using the benefit) of a particular
  property to another person in exchange for a rent
  claimed from him. 
• The term Ijarah is analogous to the English terms
  leasing
• The lesser is called mujir
• The lessee is called Mustajir.
• The rent payable to the lesser is called Ujrah.

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Ijarah (hire)

• The rules of Ijarah in the sense of leasing is
  very mush similar to the rule of sale, because in
  both cases something is transferred to another
  person for a valuable consideration.

• The only difference between Ijarah and sale is
  that in the sale case the corpus of the property
  is transferred to the purchaser. While in the
  case of Ijarah the corpus of the property remains
  in the ownership of the transferor, and only its
  usufruct, the right to use it, is transferred to
  the lessee.

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Basic Rules of Leasing

• Leasing is a contract whereby the owner of
  something transfers its usufruct to another
  person for an agreed period and at an agreed
  consideration.
• The subject of lease must have a valuable use.
  Therefore things having no usufruct at all con
  not be leased.
• It is necessary for a valid contract of lease
  that the corpus of the leased property remains in
  the ownership of the seller, and only its
  usufruct is transferred to the lessee.
• The period of lease must be determined in clear
  terms.  
• The lessee cannot use the leased asset for any
  purpose other the purpose specified in the lease
  agreement

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Basic Rules of Leasing

1. The lessee is liable to compensate the lesser for
   any harm to the leased asset cased by any misuse
   or negligence of the part of the lessee.
2. The leased asset shall remain in the risk of the
   lesser through out the lease period in the sense
   that any harm or loss caused by the factors
   beyond the control of the lessee shall be borne
   by the lesser.
3. It is necessary for a valid lease that the leased
   asset is fully identified by the parties.
4. If the leased property is insured it should be at
   the expense of the lesser and not at the expense
   of the lessee.

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Basic Rules of Leasing

• The Ijarah itself should not contain a condition
  of gift or sale at the end of the lease period,
  because due to the Islamic jurisprudence one
  transaction cannot be tied up with another
  transaction.
• However the lesser may enter into a unilateral
  promise to sell the leased asset to the lessee at
  the end of the lease period.  

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Bai Muajjal (Sale on Deferred Payment Basis)

• A sale in which the parties agree that the
  payment of price shall be deferred.
• The Rules
• Bai Muajjal is valid if the due date of payment
  is fixed in an unambiguous manner.
• The due time of payment can be fixed either with
  reference to a particular date or by specifying a
  period like three months if the time of payment
  is unknown or uncertain, the sale is void.

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Bai Muajjal (Sale on Deferred Payment Basis)

1. The deferred price may be more than the cash
   price, but it must be fixed at the time of sale.
2. Once the price is fixed it cannot be decreased in
   case of earlier payment nor can it be increased
   in case of default.
3. If the commodity is sold on installments, the
   seller may put a condition on the buyer that if
   he fails to pay any installment on its due date,
   the remaining installments will become due
   immediately.

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Bai Muajjal (Sale on Deferred Payment Basis).

1. In order to secure the payment of price the
   seller may ask the buyer to furnish a security
   whether in the form of a mortgage or in the form
   of a lien or a charge on any of his existing
   assets.
2. The buyer can also be asked to sign a promissory
   note or a bill of exchange but the note or the
   bill cannot be sold to a third party at a price
   different from its face value.