Home Financing through the Musharakah Mutanaqisah Contracts: Some Practical Issues

Abstract

Abstract. The authors compare the al-Bay' Bithaman Ajil (BBA) and the Musharakah Mutanaqisah Partnership (MMP) contracts. The BBA, a murabahah contract, was argued to be problematic and even unIslamic for long-duration contracts. The MMP contract which is a combination of musharakah (partnership) and ijarah (rental) contracts was argued to be a more appealing alternative. In the MMP, the equity of the financier diminishes progressively while, in accordance, the equity of the customer grows. Unlike for the BBA contract, scholars are consensus on the Shari'ah permissibility of the MMP contract. A mathematical derivation for the MMP showed that the formula for the MMP to be similar to the formula used in conventional loans but nonetheless with the interest rate replaced with the rental rate. Therefore, one major advantage of MMP was argued to be that it can avoid interest (riba) totally. Also, unlike under the BBA, the balance of financing, at any point in time, never exceeds the original price of the asset. Nevertheless, some practical issues need to be addressed particularly the means of estimating the rental rate, tax issues, defaults and asset value appreciation. This paper discusses these issues. When not profitable for the banks, when rental rates fall short of interest rates, the MMP can be implemented through cooperatives, which can be also an investment avenue for members.

MUSHARAKAH MUTANAQISAH PARTNERSHIP IN MALAYSIA’S ISLAMIC BANK: A COMPARISON BETWEEN THEORY AND PRACTICE

“…In the study done by Meera and Razak (2005), they compared the home financing package between BBA and MMP and they concluded that MMP home financing is a better alternative compare to BBA home financing. They argued that the profit rate of BBA is fixed and it also follows the similar computation in the interest based system.…”

“…She also compares the structures of BBA and MMP, the problems and risks faced in practicing the contracts and also their acceptance in the Shariah. Meera and Razak (2009) further explained the issues encountered in practising MMP contract. They found out that the banks are replacing the rental rate with market interest rate of which interest should be avoided in real Islamic banking and the rental rate supposed to be determined by the market rental of the property divided by the value of property.…”

“…MMP is a contract which is based on a diminishing partnership and considered to be more shariah compliant than the BBA (Meera and Razak, 2005). The customer or client purchase the share of the financier until he purchases all and owns the property.…”

“…Musharakah Mutanaqisah also known as diminishing partnership which is an Islamic method of home or property financing whereby an Islamic Bank and the customer jointly owns the property (Meera and Razak, 2005) and the Islamic Bank leases its share/ownership of the property to the customer in the form of ijarah (lease).…”

“…The price is made up of the cost price and the return/profit on the transaction. This essentially implies that it is a murabaha contract (Meera and Razak, 2005). The market interest rate serves as a bench mark for the rate of return on the BBA transaction, hence its (BBA) dependence on the market interest rate.…”