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The Diminishing Musharaka
“Musharakah” is the Arabic word for partnership, and as a consequence the financier and the customer are described as having entered into a partnership in respect of the property in question. The steps involved in a Diminishing Musharaka are outlined below:
Step 1 – the vendor of the property sells the property directly to the financier, in whom the legal title to the property is vested. The financer pays the full purchase price of the property to the vendor.
Step 2 – the financier and the customer enter into a partnership to co-own the property (constituted by a Diminishing Musharaka Agreement). The financier and the customer agree at the start that their respective shares in the property shall be pro-rata, concerning their contributions towards the purchase price paid to the vendor.
Step 3 – the parties also agree that during the course of their partnership, which has an agreed date of termination, the customer will purchase the financier’s share in the property in instalments and for the price that the financier had paid for such share on the initial date of acquisition. As the customer increases its share in the property, the financier’s share correspondingly decreases by the same amount.
Step 4 – in parallel to the Diminishing Musharaka Agreement, the financer grants to the customer a lease in respect of its share in the property. The lease is effective for as long as the financier has a share in the property. The prevailing view of Sharia scholars is that it is acceptable for the rent (payable by the customer) to be a percentage amount of the financier’s capital in the partnership benchmarked against LIBOR. The indexation against LIBOR allows the financier to charge a floating rate of rent.
Step 5 – as security for the customer’s obligations to make payments of rent under the lease and acquire the financier’s share in the property at a fixed price under the Diminishing Musharaka Agreement, the customer charges by way of security in favour of the financier, its interests in the property under the lease and the Diminishing Musharaka Agreement.
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