«Prospects and Challenges in Application of Musharakah Contract» - Free Essay Paper
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Islamic financing refers to financial transactions in Islam based banks. Islam law governs Islam banking services, and since Islam law prohibits interest charges, Islam financing uses different models to gain profits. After all, just like any other business, Islamic banks seek to make profits from their services and products. Islamic financing was developed to satisfy the unmet needs of Muslim clients. However, with time, these banks have drawn clients from all over the world. After all, bank institutions are not religious. Additionally, they offer a wide range of products and services to their clients. The successful growth in the Islamic financing sector has proven that financial intermediation is practical and, in fact, may be more profitable than most models used by conventional financial institutions (Iqbal, 2013). The successful growth in the Islamic financing sector has proven that financial intermediation is practical and, in fact, may be more profitable than most models used by conventional financial institutions. Musharakah is one of the financing options, which Islamic banks offer. This paper will analyze the prospects, as well as challenges in the application of Musharakah contract, as an option of Islamic financing.
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History of Islamic Financing
Islamic financing started officially in 1970 and majorly concentrated its business transactions in the Middle East. Earlier than this, in the 1960s, the Islam financing was operating in the most rural areas in Egypt. However, more than 50 branches were opened all over the world. The industry has, in fact, grown into a multi-billion dollar company with many international banks, giving a room for provision of Islamic financing products and services to their clients. The United Kingdom has taken the lead in western countries in Islamic financing by legalizing Islamic products and services across the country. Many countries that were skeptical about the idea have started changing their minds and Islamic financing may reach its greatest potential, outdoing conventional banking institutions in profitability (Ahmed, 2014).
Principles of Islamic Financing
The basic principles of Islamic finance are founded on the permissibility of various actions by the lawgiver, as stipulated in the Quran. All provisions are guided by the Sharia law, and, as far as terms and conditions of a contract fall within the brackets of whatever is permissible by the law, such a deal is then acceptable in Islamic financing. Ideally, the number of things prohibited by the Sharia law are few and, hence, the degree of freedom is high in those who use Islamic financing. By basing their service provision on these laws, Islamic financing always aims at being fair to all individuals, ensuring that justice prevails and that nobody gets special treatment. By so doing, the interests of the weaker parties, who may not have a say, are protected and mutual benefits are achieved for all parties involved. When all of the above is achieved, social harmony is also achieved and lesser or no conflicts at all arise. This kind of financing, therefore, not only seeks to make profits, but to also promote and, to a greater extent, protect the interest of generations to come. Prohibition of interest charging in Islamic law is not founded on baseless arguments, but on the idea of serving justice to all clients (Iqbal, 2013).
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Several unique factors distinguish Islamic financing from other conservative financing institutions, including: sharing of risks, the worth or value created vs creativity, and the moral basis of the institution. On risk sharing, Islamic financing advocates for and practices risks’ sharing between the institutions lending money and the investor. The advocates understand the uncertainty that investments bear is too much for one party to handle and, by sharing the risk, every stakeholder involved wins (it is a win-win situation). With conventional banking, the contrary happens, whereby the investor carries all the risks and the bank requires him or her to pay the loan and the interest back on time, whether the investment succeeds or not. This is considered unjust in Islam law. On moral dimensions, as much as Islam financing institutions are not religious, they are founded and guided by Sharia laws, which can be found in the Quran. Any project, which conflicts with the Islamic morals and values (e.g. casinos), cannot be financed. On the contrary, conventional financing institutions are not founded on any religious beliefs and will fund any project, which appears to have promising returns. While Islamic financing is more interested in understanding how competent an investor is and how viable their plan is (they are more interested in productivity than the credit worth of their customers), conventional institutions are more interested in having their loans paid in full amount and at the right time (credit worthiness of client). The three reasons could account for why Islamic financing is experiencing rapid growth all over the globe (Zaher & Kabir, Hassan, 2001).
Musharakah Contract Application
Musharakah contract application is among the Islamic financing products, which have been widely utilized by clients, both individual clients, governments, and some corporate organizations. Musharakah simply means sharing or partnerships. When partners engage in Musharakah, it means they have agreed to share the profits and losses of the venture. Therefore, a business in which the owners are in Musharakah contract simply means the business is a joint venture. A bank and a client are partners in Musharakah contract. The venture could have been obtained through contract, inheritance or through purchase. In Musharakah, the partners share an equal amount of capital to invest. However, profits are shared, as per the pre-agreed terms, but losses are shared, depending on the amount of capital invested in the business (Farooq & Ahmed, 2013).
Musharakah is divided into two major categories. Shirkat-al-Milk - this refers to partnership, developed, as a result of ownership. This partnership can further be divided into optional or compulsory partnership. With optional ownership, one decides to become a partner or not, so there is consent. With compulsory partnership, partnership is not optional and partners own assets without their consent. A classic example of compulsory ownership is property, which is inherited from a deceased parent by their children. The other type of Musharakah is Shirkat-al-Aqd. It is a partnership which occurs as a result of contract between the involved parties. Partners agree to share the costs, liabilities, profits and any other costs that may pertain to the business. The mutual contract, between or among the partners, influences this kind of partnership. It is further divided into three types, namely: Shirkat-al-Amwal, Shirkat-al-Aamaal, and Shirkat-al-Wujuh (Farooq & Ahmed, 2013).
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Amwal refers to capital, in Arabic. In this partnership, all members (the client and the bank) involved investing some money into the enterprise. Aamaal in Arabic refers to an action, a service or a labor. In this kind of partnership, each member involved offers some service or labor in the investment. A partner may offer a skill in which they are capable of achieving or even serve functions, like being a butcher man, a tailor or any other service that they can offer. Profits made out of the enterprise are shared among the parties involved, as pre-agreed (Muhammad, 2014).
‘Wujuh’ means ‘face’ in Arabic. It could be expounded to mean the reputation of someone or something. Shirkat-al-Wujuh is also referred to as credit partnerships. In Musharakah, this kind of partnership involves partners, using their goodwill and reputation to do business. They do not rely on capital, skills or services. The partners ensure they have a sense of responsibility and everyone is careful not to tarnish their names. People develop trust in these people, and so they can sell goods to them on credit. The partners then sell the products at a cash price and are able to make money out of this. Profits obtained, just like other partnerships, are shared among the partners, as pre-agreed. As an example of Islamic financing products, Musharakah financing is being adopted. The rate of adoption may be negligible but it is a quite promising venture for people to consider due to its potential for growth. In Pakistan, for instance, the rate of growth between 2007 and 2011 was not pleasing, as compared to total profits made from Islamic banking within the same year (Muhammad, 2014).
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As earlier as alluded to, Musharakah contract involves a partnership between a client(s) and the Islamic bank. The two parties invest money in a venture and the profits from the venture are shared among the parties who invested in the venture. Since Islamic financing does not charge interest rates, the profits acquired from the venture is how banks make money. This kind of partnership is quite risky and not many people would like to invest in such a financing option. This explains the main hurdles Musharakah financing is undergoing. Its unpopularity also stems from the risks associated with the partnership. Various studies were conducted to determine the main hurdles, hindering the growth of Musharakah financing option. One of such studies was done in Pakistan; it found out a number of reasons, as to the negligible growth rate experience and they are as outlined as guided by (Muhammad, 2014).
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Inability of the central banks of different states to provide guidelines and regulations on Musharakah financing. In Pakistan, the state bank of Pakistan has been unable to give provisions, which could increase the popularity of this financing option. This has led to unfamiliarity and, hence, the slow growth rate. Citing that the option is only in baby steps, the bank argues that it may be quite difficult to give guidelines. However, setting up the Islamic banking division by the state bank has made it easier for the division to set up the regulations and changes can be expected (Farooq & Ahmed, 2013).
The lack of interest in Musharakah by the banking staff members. This has also contributed to the low population and, hence, the slow growth rate. Most of the Islamic financing staff members are ignorant of the Sharia laws, which govern Islam finance and in so, they may save themselves the trouble by just being ignorant of the Musharakah, as a financing option. By so choosing, they may not even enlighten their clients about this financing option, leading to slow adoption by clients (Farooq & Ahmed, 2013).
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Most Middle East counties have adopted both conventional and Islamic financing institutions. Studies have shown that government support goes majorly to conventional banking institutions and very little support on Islamic financing. Musharakah, being a financing option in Islamic banking, is bound to get little support from the government. More of this support is required if the hurdles are to be overcome. Additionally, given that Islamic banking is still in its early stages of growth, legal framework is yet to be fully developed for it to guarantee legal support to this banking option (Muhammad, 2014).
Another hindrance is a lack of expertise in Musharakah banking by both staff members and the prospect clients. Given that this Islamic banking just started, not many people have the expertise that is required to increase the Musharakah financing usage by the clients. Experience is of great importance if the popularity of this option and its usage is to be adopted. This is a major setback, and it might take some time before the option is wholly used. Rigorous training on the Musharakah financing and its offers are also required for both staff and clients. Understanding Musharakah financing would require one to have basic understanding of some Sharia laws and not every client has this knowledge. This makes conventional banking a better option for most clients (Farooq & Ahmed, 2013).
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Moreover, risk of loss is high with Musharakah, as compared to other Islamic financing options. Musharakah, just like any other partnerships, calls for investment into a business or enterprise by all the parties involved. Capital skills and services are invested and then profits are made; losses are also shared among people. Chances of making losses are high, as compared to other options due to its unpopularity. Many people have refrained from using it to invest in any enterprise.
Another challenge is conflict due to the use of conventional accounting models to run Islamic financing. This is proving a challenge in growth of Musharakah, given that most conventional models used for accounting are not in harmony with the Sharia laws, which govern Islamic financing. The product can, therefore, be expected not to achieve enormous growth, unless new models are adopted, which are in consonance with Islamic financing guidelines (Kammer et al., 2015).
Moral values upheld by the Islamic financing. Commitment and honesty have always been insisted, when it comes to financial banking. However, very few people are committed and lack honesty in their day-to-day activities. For Musharakah to experience growth, these values have to be highly advocated and upheld by the clients, but this is what lacks in the society today. It is a global challenge (Ahmed, 2014).
Customers are not interested in Musharakah. Musharakah financing is all about partnerships between clients or even between the banking institutions and the clients. Many clients are not willing to risk their money by collaborating with the financing institutions. These clients are not interested in Musharakah contracts and prefer to work with other financing options, which have fewer risks and labor involved. Lack of Musharakah financing balances and check mechanisms. It is ironical how Musharakah is one of the mostly used Islamic financing options, yet such significant processes are lacking. Development of these mechanisms may be sought to see if they would not influence the growth of this option (Kammer et al., 2015).
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The paper has discussed some of the challenges facing the Musharakah contract as an Islamic financing option and much more are yet to be unveiled. However, it is a promising area and stakeholders should keenly work on the challenges and come up with solutions. This will have a great impact on the growth of Musharakah contract. It has indeed been considered one of the most authentic financing options and has the potential for growth, based on this finding. However, for this growth to be seen, stakeholders have to work as a team with prospect and existing clients. This will involve Islamic finance programs introduction in institutions of higher learning, at least to make the young aware of it and to grow accountants who are aware of the various offers of Islam financing. By so doing, problems related to a lack of interest and lack of knowledge in Islamic financing will have been solved. This will have a significant impact on Islamic financing and Musharakah, being a part, thereof. Countries in which Islamic financing institutions exist can also chip in their support to ensure the growth of this sector. They should not be biased on the conventional banks, but should also be flexible enough to offer their support to promote Islamic finance.