Musharaka is an Islamic mode of financing in the form of a partnership between the bank and its client whereby each party contributes to the capital of the partnership in equal or varying degrees either to establish a new project or share in an existing project.
The accruing profit is divided between the partners pre-agreed formula, while losses are shared on pro rata basis.
The word Musharakah is derived from the Arabic word Sharikah meaning partnership. Islamic jurists point out that the legality and permissibility of Musharakah is based on the injunctions of the Qur'an, Sunnah, and Ijma (consensus) of the scholars. It may be noted that Shirkah in the Islamic Fiqh is divided into two kinds:
- Shirkat â€“ ul â€“ Milk, defined as joint ownership of this or more person in a property.
- Shirkat â€“ ul â€“ Aqd, defined as partnership effected by a mutual contract. Shirkat â€“ ul â€“ Aqd is also divided into three kinds: Shirkat â€“ ul â€“ Amwal, Shirkat â€“ ul â€“ Amal and Shirtal â€“ ul â€“ Wujoot.
Musharakah agreement may be entered into for a short-term or long-term period. The capital contributed by the bank in a Musharaka may remain constant throughout the contracted period.
This is referred to as constant Musharakah. Otherwise the bank gradually transfers its share in the Musharaka to the Musharik so as to decrease its share in order to transfer the ownership of the venture to the other party. This is a diminishing Musharakah.
Profits are shared in accordance with the Musharakah agreement. Losses are normally shared in proportion to the capital contributed by each Musharik.