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Quiz 1 - Solution - Define Musharaka

Musharaka is an Islamic financing method based on partnership and equity sharing. It involves an investor placing capital with another party to jointly invest in a business venture, sharing profits based on a pre-agreed ratio while losses are shared based on capital contribution. Two risks of Musharaka are credit risk if the partner defaults, and operational risk if the partner lacks expertise and the project fails.

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153 views2 pages

Quiz 1 - Solution - Define Musharaka

Musharaka is an Islamic financing method based on partnership and equity sharing. It involves an investor placing capital with another party to jointly invest in a business venture, sharing profits based on a pre-agreed ratio while losses are shared based on capital contribution. Two risks of Musharaka are credit risk if the partner defaults, and operational risk if the partner lacks expertise and the project fails.

Uploaded by

anassaleem
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Define Musharaka? How does it work?

How is it different from the interest based


financing? In what sense is Musharaka an asset-based or equity-based source of finance?
Also describe at least two risks associated with the Musharaka contract

Musharaka
Musharaka means partnership. It involves an investor placing capital with another person and
both sharing the risk and reward (see Figure). The difference between Musharaka arrangements
and conventional banking is that, with Musharaka, you can set any kind of profit sharing ratio,
but losses must be proportionate to the amount invested.
The literal meaning of the word Musharaka is sharing. Under Islamic law, Musharaka refers to a
joint partnership where two or more persons combine either their capital or labour, forming a
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 (meaning amount invested). Musharaka is based
on a mutual contract and, therefore, it needs to have the following features to enable it to be
valid:
Musharaka flow chart

How does it work?


The bank forms a partnership with another party. Both partners contribute capital. Profits are
allocated according to an agreed proportion while allowing for managerial skills to be
remunerated.
How is it different from the interest based financing?

In what sense is Musharaka an asset-based or equity-based source of finance?

Money has no intrinsic utility in Islam; it is only a medium of exchange. Making money from
money is riba and thereby haram. Financing in Islam must be asset based or equity based. As it
says in the Qur’an: ‘ Allah has permitted trade and prohibited riba’. The partnership will use the
funds for the purchase of real assets which result in productive investment and the creation of
wealth. It is thus both equity and asset based.
Describe at least two risks associated with the Musharaka contract

Risk 1 Credit Risk:


The risk that the entrepreneur/partner defaults and goes bankrupt.
Risk 2 Operational Risk:
The risk that the partner lacks technical expertise and the project fails.

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