Principles of Islamic banking and finance/PIBF202/Islamic banking products/Musharakah Muntanaqisah in house financing

Musharakah mutanaqisah
Musharakah means partnership and mutanaqisah means to diminish. Musharakah mutanaqisah means diminishing partnership. It is a partnership contract between the financial institution and its client. The client begins to purchase the share of the financial institution until he owns the whole property. In addition, the financial institution leases his portion of share to the client at the same time. The client needs to promise that he will buy the share of the bank. Therefore, this contract is a combination of partnership of a business, buying and selling the share of the property and leasing.

For example, a customer wants to buy a house then he proceeds to the bank and fills up an application form. If accepted, the bank and the customer purchase a house and through mutual agreement, the bank pays 90 percent of the total price while customer pay rest of the amount. Based on this, the bank owns 90 percent of the property and the customer owns 10 percent. After the purchase, the rent of the property is determined by the bank and rented to the client. The client, however, is free to sub-let the property to anyone else but must pay the agreed upon rent to the bank. As the client hands over the full rent of the property to the bank including the 10 % of the rent that belongs to her, gradually the share of the client in the property increases while that of bank declines. At the end, the client buys the total share of the bank and the bank transfers the ownership to the client.

Implementation of MM in Malaysia
In Maybank Islamic, a Malaysian bank, the operational features of MM are as follows (Maybank Islamic:
 * 1) The client and the bank make partnership between them to get the capital to buy the property.
 * 2) The customer and the bank become the owner of the property based on the ratio of payment in purchasing the property.
 * 3) The bank leases its share to the client and takes rentals monthly for a predetermined period. The client buys the bank’s share systematically.
 * 4) Finally, the bank’s share ends and the client gets the full ownership of the property.

RHB Islamic bank, Kuwait Finance house and Citibank in Malaysia, also follows the above steps. Kuwait Finance House offers the customers to pay the rental within 30 years tenure or within 65 years of age (whichever is earlier). They finance up to 90 percent of the property. Moreover, the investment is insured by Islamic insurance.

Shari`ah Principles for MM contract
Though most of the Islamic jurists agreed upon the permissibility of MM, some scholars hold different opinions. The majority believes that it is permissible and Shari’ah compliant. Shari`ah scholars generally agreed on the validity of a sale contract which is combined with lease contract. In addition, there is no clear text in the Shari`ah that prohibits MM. Considering the public interests and benefits of MM in the investment, it should be permitted in the Shari’ah. Some scholars however, disagreed to the validity of MM contract. To them, it is invalid as it contains some elements of doubts. They also claim that it is similar to interest as the primary purpose of MM is to give loan to the clients and to derive extra money from the amount of loan. This view of some scholars seems to be shortsighted. It is quite clear from the definition and features of MM that it is a joint ownership plus sale and leasing contract. Both the financier and the client share the profit and loss of the business together. Therefore, the claim that MM is similar to interest based loan is unfounded. Moreover, the International Fiqh Academy of OIC (2004) in its 15th session made resolution that MM is a valid contract in the Shari`ah. Besides, the Shari`ah Advisory Council of Bank Negara Malaysia in its 56th meeting decided that MM is a recognized contract in the Shari`ah and the current practice of the contract is permissible as well. (Bank Negara Malaysia, 2007) Therefore, we could safely infer that MM is a permitted contract in Islamic Shari`ah.

However, scholars suggest some principles and guidelines that are needed to be observed strictly, so that this contract does not exceed the boundary of the Shari’ah and does not get assimilated with the interest based contracts. The principles are as follows:


 * 1) The goods must be present. So, the property which is not present or on loan is not allowed for having a transaction.
 * 2)  The proportion of the profit must be specified and the profit will be in proportion not by amount of money.
 * 3) Both the financier and the client must share the profit and loss of the property.
 * 4) The Shari’ah advisory board must have the right to monitor the contract.
 * 5) The contract of partnership and the contract of sale should be done separately, and not collectively.
 * 6) A binding promise can be taken from one partner to purchase the share of the other partner gradually.

Comparison between BBA and MM
BBA (al-Bay` Bi-thaman Ajil or differed payment sale) is a sale contract which is based on murabahah concept. The bank purchases the house with lump sum price and immediately sells it back to the client with the cost plus profit, which is to be paid back in installments. For example, a client proceeds to the bank and applies to the bank to buy for him a house according to his interest, which costs RM 100,000. Upon acceptance of the application, the bank purchases the house by RM 100,000 with cash price and then sells it back to the client by RM 150,000 with installments of 20 years. So, RM 50,000 is the profit of the bank which will be paid within 20 years. In reality, the profit rate is determined based on the interest rate in conventional banking. Besides, in practice some banks just provide money to the client but do not purchase the house from the very outset. Therefore, BBA has been criticized by many Islamic scholars.

Based on the above, the difference between MM and BBA home financing could be inferred. While MM is a joint ownership of the property, the BBA is a debt type financing which resembles to conventional loan. The return of BBA is fixed selling price, which cannot be changed, but the return of MM is the rent of the property, which can be revised anytime. In MM the customer can withdraw the contract at the middle if he gets difficulties but in BBA the client is obliged to pay the fixed amount. In BBA the client owns the house immediately after the contract, but in MM he becomes owner of the house after the tenure. Therefore, MM should be the better alternative to BBA home financing as it is more flexible for the customers since they can pay the rentals according to the market price. MM is globally accepted contract; but BBA is allowed only in Malaysia and the South Asian countries. MM is closer to the objective of the Shari`ah as the bank and the client become co-owner of the property thus they co-operate each other. Besides, it is argued that MM can prevent the creation of new money if it is implemented by the housing cooperatives. This is because Islamic Banks under the fractional reserve banking system are allowed to create fiat money out of nothing to disburse in the Islamic financing modes which creates a macroeconomic problem.

Problems in Implementing MM Home Financing
With the advantages as mentioned, MM also faces some challenges and problems in its implementation.

The house rent
The house rent varies based on the location and time. The fluctuation of rental price of a house is a terrible problem that MM has to face. Usually, the rental price increases with the passage of time, which places the customers into difficulties.

Tax
This contract also raises the question, who will pay the tax? Some sholars urge that the tax should be paid from the profit added to the bank‟s equity not form the profit added to the customer’s share.

Buying the share of the bank
Another important issue is the promise (wa`d) from the client to buy the share of the bank gradually until he owns the whole property. Islamic jurists are divided in determining whether fulfilling this promise is obligatory or recommended. If the promise is obligatory then the bank has the legal right to impose a fine to the client if the client does not fulfill his promise. Conversely, if the fulfillment of promise is recommended, then the client has the freedom to carry it out or terminate it at any time. The bank should not have any legal right to impose fine on the customer. The International Fiqh Academy under OIC decided that a promise is legally binding. Therefore, compensation must be paid to the bank if the client fails to fulfill the promise except that if there is a valid excuse. (International Fiqh Academy, 1988)

Damage to property
Another significant issue in this contract is the damage of the property. If the client because of his negligence damages the property, then he should pay the compensation. Besides, if the damage is due to natural calamities and so on, then both the partners have to share the loss according to their proportion as the condition of partnership.

Source
With permission and thanks, adapted from Noor Mohammad Osmani & and Md. Faruk Abdullah, "Musharakah Mutanaqisah Home Financing: A Review of Literatures and Practices of Islamic Banks In Malaysia", International Review of Business Research Papers, Volume 6. Number 2. July 2010 Pp. 272 - 282. Available at: https://www.bizresearchpapers.com/21.%20Osmani.pdf