The Founding Pillars Of Modern Day Islamic Financing Contracts

Michael McMillen, while working in Saudi Arabia, introduced diminishing Musharaka financings for the first time in Saudi Arabia. The project was centered in the Saudi Arabian electric sector, and was later modified and extended for application in other sectors. His views were appreciated in the Islamic countries and became popular among many Islamic economies. His further work and research on house building finances set the founding pillars of modern day Islamic financing contracts. All of Oman adopted Michael’s designed structure of diminishing musharaka for home financing. The key features that set apart a diminishing Musharaka contract are as follows:

• The bank and client jointly own the property
• The bank gives it’s share to the client and the bank gets rental payments in return
• The client has an obligation to repurchase these shares form the bank with the passage of time
• The rate at which units are repurchased varies from contract to contract
• As more units are purchased, the risk is transferred from the bank to the client.

Therefore, the rent is adjusted. Under such an agreement, the first step involves the purchase of the asset by the Bank’s Client. The property is jointly owned (Shirkat ul Mulk) by the customer and the bank. The bank meets the financing part of the agreement. More than one bank may be involved in the financing. Such type of a transaction is necessary for a diminishing Musharaka to take place and permitted as per Islamic Shariah. Once the property has been jointly acquired in the name of the customer and the bank, the bank will then proceed to lease the entire property to the customer and charge rent on the entire property. Certain scholars have raised concerns about selling the property to a third party. However, jurists have concurred that as along as the undivided property has been sold, it is acceptable. This is to ensure that the possession of asset aspect is satisfied.

On the third stage, the Client starts purchasing the undivided units of the property from the Bank on a timely basis and hence the overall share of the Client in the ownership of the property increases as time passes. Typically, the prices of the undivided units is decided with a mutual consent and the purchases payments are made according to an amortization schedule (used by the financier i.e. Bank). Every month, a payment is made to the Bank by the Client that includes a portion of principal amount as well as the rent of the property as the Client resides in it during the term of the agreement. The amortization schedule is almost identical to a typical loan schedule of a conventional 10 or 15 year mortgage financing. However, the terms are decided in the supervision of renowned Muslim Jurists and the Fatwas of Jurists belonging to different sects are considered and kept in mind.

The main problems that arose in such transactions included the conditions that were put in these agreements which is not allowed in Shariah. Therefore, the promise made to buy the house by the Client in several undivided units is made. The promise made is enforceable according to the majority Muslim Jurists as per the Shariah Law and such type of contract is known as “Bai-Bilwafa”. Therefore, it can be safely said that Michael J. T’s endless efforts and hard work has brought results for numerous matters that were previously unresolved. He has given the Muslim Ummah safe alternatives of the already existing types of transactions and without the elements of anything which can be considered as forbidden according to Shariah.

It is deduced from Michael’s work that after Saudi Arabia, Oman is also likely to offer house building loans to its people and is interested in the benefits that diminishing Musharaka has to offer. It is only a matter of time before other Muslim nations join and decide for themselves as well. According to Michael, he believes that as the Sultanate of Oman brings up the latest regulatory framework applicable to Islamic Banking, the latest trends of the industry will be gaining popularity in the country and the Islamic Finance will become a growing field.

The diminishing Musharaka agreement can be terminated with mutual consent of the Bank and the Client if any or both parties’ interests start to differ after some time into the transaction. There can be two ways through which a diminishing Musharaka is dissolved.In one way, the diminishing Musharaka is dissolved through the selling of the underlying property to a third party and the Bank and the Client both keep the profits in the ratio of the undivided units in their ownership at the time of the dissolution of partnership. In another way, the diminishing Musharaka is dissolved after the Client decides to purchase all the remaining units of the house by paying the total price up-front to the bank. Under this, new prices are decided (equal to the outstanding principal plus accrued profit plus fees, costs and expenses). If the Client fails to make all of the remaining payments for the units, the property is sold at an auction and the amount received Is used to make payments to the Bank and any remaining amount is given to the Client if the total value generated is greater than what was decided in the agreement.