192 Ahmad Block, New Garden Town, Lahore - Pakistan.

1. 192 Ahmad Block, New Garden Town, Lahore - Pakistan. Ph: (92-42) 35913096 - 98, Fax: (92-42) 35913056 Email: info@alhudacibe.com www.alhudacibe.com

2. Two Days Specialized Training Workshop On Islamic Microfinance MUSHARAKAH &MUDARABAH Abdul Samad AlHuda CIBE

3. Shirkah

4. Scope of the Presentation • Terminology of Musharaka • Types of Musharaka • Structure of Musharaka • Rules of Musharaka • Capital; • Profit and loss; • Termination • Security / Collateral in Musharaka • Concept of limited liability • Modern partnerships • Case in point

5. MEANING OF SHAIRKAT • The literal meaning of Musharakah is sharing. The root of the word "Musharakah" in Arabic is Shirkah, which means being a partner. • Under Islamic jurisprudence, Musharakah means a joint enterprise formed for conducting some business in which all partners share the profit according to a specific ratio while the loss is shared according to the ratio of the contribution.

6. LEGITIMACY OF SHIRKAT • Allah- Subhana- o-Ta’ala has declared that He becomes a party in a business between two Musharakain until one indulges in cheating or breach of trust (Khayanah) with other in Musharakah.” (Sunan-i-Abi Daud, Kitabul Buyuo)

7. Types of Shirkah Shirkah Shirkat-ul-Milk (Co- ownership) Shirkat-ul-Aaqd (Contractual Partnership)

8. Shirkat-ul-Milk(Joint ownership) • Joint ownership of two or more persons in a particular property/ asset with out any business intention. • This comes into being as a result of joint purchase, joint acceptance of gift or a bequest and inheritance of joint property etc.

9. Types of Shirkat-ul-Milk • Shirkat-ul-Milk Optional (Ikhtiari) • This comes into operation through the act of parties e.g., purchase of asset with mutual consent. • Shirkat-ul-Milk Compulsory (Ghair Ikhtiari) • This comes into operation without any action on the part of parties e.g., ownership of heirs on the inherited property.

10. Shirkat-ul-Aqd(Joint venture/partnership). • Shirkat-ul-Aqd or Contract Partnership is an Agreement between two or more parties to combine their assets or to merge their services or obligations and liabilities with the aim of making profit. • It can also be referred to as a joint commercial enterprise or activity

11. Difference between Shirkat-ul-Aqd and Shirkat-ul-Milk • In Shirkat ul Aqd both parties create partnership for sharing profit earned by Shirkah asset, while in Shirkat ul milk both partners do not intend to earn profit from Shirkah asset. • In Shirkat ul Aqd, each partner is an agent of others while in Shirkat ul Milk each partner is stranger with respect to other’s share.

12. Kinds of Shirkat-ul-Aqd Shirkat-ul-Amwal (Investment /Capital Partnership) Shirkat-ul-Aamal (Work Partnership) Shirkat-ul-Wojooh (Credit Partnership)

13. Shirkat-ul-Amwal Where all the partners invest some capital into a commercial enterprise and share its profits according to agreement.

14. Shirkat-ul-Aamal • 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. • For example, if two persons agree to undertake tailoring services for their customers on the condition that the wages so earned will go to a joint pool which shall be distributed between them

15. Shirkat-ul-Wujooh Where the partners have no investment at all, they purchase commodities on deferred price by their goodwill and sell them on spot. Their capital is their credit worthiness and reputation.

16. Types of Shirkat-ul-Aqd All the three are further divided in to two types: Shirkat-ul-Amwal Shirkat-ul-Aamal Shirkat-ul-Wojooh Shirkat-ul-Mufawadah Shirkat-ul-Inan

17. Subdivision of Shirkat-ul-Aqd • 1-Shirkat-ul-Mufawadah: Where capital, profit, loss and management are equal among the partners. • 2-Shirkat-ul-Inan: Partners’ share capital, management, profit and risk are not equal and may differ for each partner. This is common type of partnership.

19. Rules of Shirkat-ul-Milk • Each partner is a stranger with respect to the share of the others. • The partners are not allowed to undertake any act of disposal with respect to the other’s share except with the latter’s permission. • Each partner can sell his own share without the other partners’ consent, except in cases where share of one partner can not be distinguished from the other.

20. Rules of Shirkat-ul-Milk • Profit & loss will be according the ratio of ownership. • Expenses related to ownership will be borne by all partners according to the ratio of ownership. • Every partner has the right to sale/gift/lease to the extent of his share. • One partner can promise to purchase the share of other partner at any price, may be at face value, market value or pre-agreed price.

21. Shirkat-ul-Ammwal Definition: • It is an agreement between two or more persons to invest a sum of money in a business and share its profits according to agreement. The investment of this partnership consists of capital contributed by the partners.

22. SHIRKAT-UL- AMWAL: Capital of Musharakah • It should be known, ascertained and available at the time of contract. • The value should be agreed upon in case of kinds; • Capital paid in different currencies should be valued into the currency of Shirkah; • Capital advanced by the parties. Should be uniform (currency of partnership). • Share capital in a Musharakah can be contributed either in cash or in the form of commodities • In the letter case the market value of the commodities shall determine the share of the partner in the capital.

23. Capital of Musharakah Capital of partnership is Amanat in the hands of partners. If loss occurred due to negligence, the partner responsible for loss, will compensate the loss.

24. Management of Musharakah • Each partner has right to take part in Musharakah management. • The partner may appoint a managing partner by mutual consent. • One are more of the partners may decide not to work for the Musharakah and work as a sleeping partner. • It is not allowed to specify a fixed remuneration to a partner Musharaka who manages funds or provides some form of other services, such as accounting; • However, it is permissible to give him a greater share of profit than he would receive solely on the basis of his share in the partnership capital;

25. Distribution of Profit • The ratio of profit distribution must be agreed at the time of execution of the contract. • It is not necessary for sharing profit according to proportionate capital contribution; • It is not allowed to defer the determination of profit until realization of profit. • The ratio must be determined as a proportion on the actual profit earned by the enterprise. • Not as percentage of partner’s investment. • Not in lump sum amount. • It is not allowed to defer the determination of profit until realization of profit. • A sleeping partner cannot share in the profit more than the percentage of his capital.

26. Rules of Profit Determination/Distribution • No guarantee can be given by the partners for the payment of profit or capital. • Different partners may be given different weightings according to amount and period of their investment. • Tiered profit sharing ratios can also be agreed. • Profit ratio can either be fixed or variable according to the tiers; • Both partners can agree that first 6-month profit e.g. will be distributed at ratio of 50% : 50% and next 6-month profit will be distributed at ratio of 30% : 70%.

27. Rules of Loss Determination/Distribution • Sharing of Loss: • As a matter of principle the loss has to be shared according to the ratio of capital contribution; • Partners are not allowed to adopt any other mechanism except the mechanism that ensure distribution of loss among partners on pro rata basis; • Any other arrangement, even agreed upon by partners, will be invalid and void. • It is not allowed to hold one partner or group of partners liable for entire loss.

28. Guarantees in Shirkah Contracts - All partners in Shirkah maintain the assets of the partnership as a trust. - No one is liable except in cases of breach of the contract, misconduct or proven negligence. - Negligence will be considered to have occurred in any of the following three cases: (i) A partner does not abide by the terms and conditions of the contract; (ii) A partner works against the norms of the concerned business; and (iii) The established ill-intention of a partner. - The profit or even capital of any partners cannot be guaranteed by the co-partners. - One partner can demand from another partner to provide any surety, security or pledge to cover the case of misconduct and negligence.

29. Rules of Musharakah – termination Musharakah terminates in any of the following event: Death of a partner during the Musharakah; Heirs of the deceased partner have option either to draw the share of the deceased from the business, 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 Musharaka stands terminated. In normal course of business, every partner has a right to terminate the Musharakah at any time after giving notice to other partner; In this case, if all the assets of the Musharakah are in cash form then they will be distributed pro rata between the partners; In case they are mixed assets the partners may agree either on: Physical distribution of the assets among partners; or Liquidation of the assets in open market (market price); or Internal liquidation i.e. purchasing from one partner share of other at any agreed price between them;

30. Rules of Musharakah – termination with one partner • In case a partner wishes termination of the Musharakah, while others do not, this can be achieved by mutual consent; • The partners who wish to run the business may purchase the share of the other partner who wants termination; • The reason is that the termination of Musharakah with one partner does not imply its termination between other partners; • However, in this case, the price of the share of the leaving partner has to be determined by mutual consent; • In case of dispute on the valuation of the share the leaving partner may compel other partners on the distribution of the assets; • However, if they are not divisible then the partner may an arbitrator to solve the dispute;

31. Musharakah – application Musharakah is top preferable mode of financing recommended by Islam; It one of the important factors that help in achieving ‘distribution of wealth’ which is a key feature of Islamic financial and economic system; As Mudarabah, Musharakah is also not a vastly practiced Islamic mode of financing by Islamic IMFs due to certain reasons; However, Musharakah could easily be used as a vast mode of financing for almost every financial need; Below are some fields where this mode can easily be applied: Long-term Finance; Running Finance (limited scope); Investment IMFing; Project Financing; Private Equity Investment; Redeemable capital investment.

32. QUESTIONS??

33. MUDARABAH

34. Scope of the Presentation Definition • Mudaraba Capital • Profit / Loss Distribution • Types of Mudaraba • Capacities of Mudarib • Participation from Mudarib • More than one RabbulMaal • Termination of Mudaraba • Mudaraba Vs Musharakah • Problems and risks

35. Mudaraba Introduction - Definition “Mudaraba” is a kind of partnership where one partner gives money to another for investing in profitable avenues. • The investor (fund supplier) is called “Rabb-ul-Mal” ( رب اﻟﻤﺎﻝ ) while the person who utilizes this fund (the fund manager) is called “Mudarib” (ﻣﻀﺎﺭﺏ) who is exclusively responsible for management of the business.

36. Al Mudarabah Al Muqayyadah (Restricted Mudarabah) • Rab-ul-Maal may specify a particular business or a particular place for the Mudarib. • In which case he shall invest the money in that particular business or place. • Al Mudarabah Al Mutlaqah (Unrestricted Mudarabah) • Rab-ul-Maal gives full freedom to Mudarib to undertake whatever business he deem fit. • Mudarib is authorized to do anything normally done in the course of business. Types of Mudaraba

37. Capacities of Mudarib Mudarib has different capacities for which rules are different. Listed down are his roles: • Ameen (trustee): • Mudarib holds money and assets of Mudarabah as trustee; • Therefore, he is responsible for management of assets honestly; • In case of actual loss he is responsible for nothing; • Wakeel (Agent): • Mudarib manages Mudarabah as an agent of owner; • Therefore his actions are considered as of Rabbul Maal; • Actual loss is born by Rabbul Maal in case it happens; • Shareek (partner): • Mudarib becomes partner in the profit that Mudarabah generates;

38. Capacities of Mudarib • Zamin (liable/guarantor): • In situation of loss due to misconduct / negligence Mudarib has to bear it; • Ajeer (employee): • Mudarib gets a fee if Mudarabah becomes void due to any reason;

39. Mudaraba Introduction – Mudaraba capital • Mudaraba Capital: • The capital of Mudaraba should be in form of known cash as a matter of principle; • However, tangible assets could also be accepted if valued with mutual consent. • In such case the determined value of the assets will be the Mudaraba capital; • The Capital of Mudaraba should be clearly known to the contracting parties and defined in terms of quality and quantity; • The capital should be in hand, therefore, receivables (debt etc.) can not be capital of Mudaraba;

40. Mudaraba Introduction – Mudaraba capital • Mudaraba Capital: • The capital should be handed over to Mudarib; • Simple segregation of funds for Mudaraba is not enough; • Therefore, increase in value of Mudaraba capital before start of Mudaraba will account for increase in Mudaraba capital and will not be treated as Profit;

41. Mudaraba Introduction - profit & loss distribution • Profit and Loss distribution: • The Mudaraba contract should mention profit sharing ratio in defined and clear terms; • The profit sharing ratio should be: • specific; • of the expected profit; • Apart from the agreed proportion of the profit, the Mudarib cannot claim any periodical salary or a fee or remuneration for the work done by him for the Moradabad. •  The Mudarib & Rab-ul-Maal cannot allocate a lump sum amount of profit for any party nor can they determine the share of any party at a specific rate tied up with the capital.

42. Profit & Loss Distribution • Example • If the capital is Rs. 100,000/- they cannot agree on a condition that Rs. 10,000 out of the profit shall be the share of the Mudarib nor can they say that 20% of the capital shall be given to Rab-ul-Maal. However they can agree that 40% of the actual profit shall go to the Mudarib and 60% to the Raab-ul-Maal or vice versa. • If the business has incurred loss in some transactions and has gained profit in some others, the profit shall be used to offset the loss at the first instance, then the remainder profit, if any, shall be distributed between the parties according to the agreed ratio.

43. Mudaraba – participation from Mudrib • Mixing of funds by Mudarib • The basic feature of Mudaraba is that the Mudarib performs only business operations and does not add capital; • The capital is provided by Rabbul Maal and the Mudarib is responsible for the management only; • But the Mudarib may also add capital into the business of Mudaraba with permission of Rabbul Maal; • In such cases Musharaka and Mudaraba are combined; • For example, “A” gave to “B” Rs.100,000/- in a contract of Mudaraba. B added Rs. 50,000/- from his own pocket with the permission of A; • This type of partnership will be treated as a combination of Musharaka and Mudaraba; • Here the Mudarib may allocate for himself certain percentage of profit as partner (Sharik), and at the same time he may allocate another percentage for his management and work as a Mudarib.

44. Mudaraba – more than one Rabbul Maal • Mudaraba can be between two prsons: Rabbul Maal and Mudarib; • But Rabbul Maal may also be more than one; • If a Mudaraba starts by provision of funds from one Rabbul Maal and after the start Mudarib wishes to add some more funds from others, this would be allowd if Rabbul Maal permits; • In such case all funds providers (Rabbul Maals) are partners among themselves; • The share for Rabbul Maal will be divided among them as per their contribution ratio;

45. Mudaraba – termination • Termination of Mudaraba: • The contract of Mudaraba can be terminated at any time by either of the parties; • This termination should be with consent of concerned parties; • A notice to the other party is also sufficient if it was agreed at the time of inception of Mudaraba; • Termination of Mudaraba means that the Mudarib cannot purchase new goods for the Mudaraba. However, he may sell the existing goods that were purchase before termination. • If all assets are in form of cash and some profit has been earned on the principle amount, it shall be distributed between the parties according to the agreed ratio; • If the assets of the Mudaraba are in other form the Mudarib shall be given an opportunity liquidate them and the actual profit may be determined after liquidation: • If there is a profit, it will be distributed between Mudarib and Rab-ul-Maal. • If no profit is left, Mudarib will not get anything.

46. Mudaraba Vs Musharaka

47. Mudaraba – application • Scope of Mudaraba for IMF System: • Mudaraba is second preferable mode of financing recommended by Islam; • It helps in achieving ‘distribution of wealth’ which is a key feature of Islamic financial and economic system; • Mudaraba as a mode of financing used by Islamic IMFs for the following purpose: • Relationship of Islamic IMFs with depositors, depositors provide deposits to IMF as Rabb-ul-Mal, these deposits are to be invested by Islamic IMF as Mudarib; • Islamic IMFs sometimes use Mudaraba with some of their customers; • Islamic IMF provides the adequate finance as a capital owner in exchange of a share in the profit to be agreed upon; • Mudaraba can be easily used for Large Enterprise financing; • Project Finance does have potential for financing on Mudaraba basis;

48. Mudaraba– IMF application • Asset side: • Short / medium / long term financing; • Project financing; • Small and medium enterprise setup financing; • Large enterprises setup financing; • Import financing; • Import bills drawn under import Lcs; • Inland bills drawn under inland Lcs • Bridge financing; • LC without margin; • Export financing; • Working capital financing; • Running accounts financing/ short term advances.

49. Mudaraba & Musharakah on Liability side • Liability side: • All types of saving / investment accounts; • Inter- bank acceptance and placement; • Term Finance certificates; • Certificate of investment; • Special rate deposits; Calculation is attached.

50. Problems and Risks for Islamic IMFs • Problems and Risks for Islamic IMFs: • Since Mudaraba is a profit and loss sharing way of financing, it is considered a high risk financing activity; • Collateral can be asked but could not be used in case of real loss; • IMF’s existing competencies in project evaluation and related techniques are limited; • Dual book keeping trends in market also a threat; • Legal mechanism for treatment with Mudarabah as a mode of financing by Islamic IMFs, is not in place;