4. Partnership Mode of Finance – Musharaka & Mudaraba | Islamic Finance 101

[Music] asalam alikum and welcome to Islamic Finance 101 today we have very exciting topic we are talking about partnership mode of financing so let's get into [Music] it so when we are talking about modes of financing we have two broad ways of thinking about it and there are a lot of names that you could attach to them but one way to think about way that we Finance something is by either joining as partners in something and therefore we share in profit and loss we are exposed to the Dynamics of business or we structure something as a simple transaction which is either sale or lease and this is nonprofit and loss sharing type of partnership sometimes these two arrangements are referred to as Equity way of financing or debt based financing and this is not your typical conventional way of dividing these but let's today look at this Equity base or profit and loss sharing mode and we are going to look particularly at musharaka and muda as a way of financing something the first mode of financing is musharaka so this is what you could translate as joint venture or Equity partnership it is derived from the word shka or sharing as a partnership sharing and I'll give you scenario let's say you have two parties A and B and they want to engage in a business venture something that will either result in a profit making activity or there might be some kind of a loss at the end so these two parties they are investing let's say 2080 their Capital contribution is party a 20% of the funds needed and party B is putting 80% let's say the business requires $100,000 so the first investment is what we call Capital contribution 2018 now end result of this business Arrangement could be that a there is a profit or that there is a loss now in Islam we are allowed before we start to enter into this partnership we are allowed to negotiate profit ratio so as we are thinking what we want to do we want to put some money together at that point in time we could either leave profit sharing ratio as 2080 which is per capital contribution or whatever it is or we might say look I will work more you might be sleeping partner or you might work less or you might know less your my expertise is higher we could do any kind of arrangement where we negotiate that sort of a a profit sharing ratio the only thing we shouldn't be doing is give more than Capital contribution if the partner is just the passive or a sleeping partner but in any case let's say in this particular Venture we agree that one party will get 30% another party will get 70% what we are normally doing here is that we are incentivizing one party so one partner is giving up share of their profit so that if the this partner Works more they're thinking that entire business venture might be more profitable so we are allowed to incentivize by giving more share in profit to another party now when it comes to the loss the loss is always fixed and it is fixed according to the capital contribution in this case it would be always fixed 20 to 80 so what is the wisdom why we can negotiate profit but we cannot negotiate loss well the reason is very simple what would happen if you could negotiate loss ratio you would have a situ situation where the stronger party would usually push undeserved risk to the weaker Party incentivizing Production is a different story it is a positive outcome where you are giving incentive to the party to work more because at the end of the day you rather would like to have smaller share in a bigger pie then half or much more or entire pie that is small so this way it's a win-win for both parties and this just shows you the wisdom of Islam and that you want to incentivize a wealth creation you want to incentivize people working hard contributing and growing the benefit for both of these Partners now let's uh have a little simple case study of this so let's say you have uh investment where you have two parties Capital contribution is one is giving $40,000 another part is giving $660,000 and in the first outcome you agree that whatever and this is obviously something you have to agree in the beginning you don't agree on the profit ratio at the end or when the profit actually arrives but you say uh we're going to share 50/50 so while you did put 4060 in terms of investment from the partners you say we're going to share 50/50 obviously one partner is contributing more of their time and so on maybe they're managing business business so the profit is $10,000 at the end how do they share it they share it 5K each 5050 if there was a opposite loss of uh 10,000 so in first case profit was 10,000 in second case loss is 10,000 how do they share it it goes according to the capital contribution which is 40 60% which is $44,000 and $6,000 for other party how can we use this today to structure not just business uh Ventures but modes of financing for example homes so diminishing musharaka is one of those forms of partnership it's a derivative from typical musharaka where one uh partner promises to buy equity share of other gradually and they are buying it until the title to the equity is completely transferred to another party so in a simple way person who is a customer would go to let's say Islamic Finance organization and they would agree to buy the house 2080 so their Equity stake ownership stake would be 2080 the 20% of ownership on one side versus 80 on the other side now the customer is renting the part of that house that they don't own from the bank so the bank would charge rent on their portion of the house which is 80% and this would constitute a profit remember interest free finance doesn't mean profit free Arrangement because you now have that 80% which you are renting to the person now this person other than renting and let's say the rent is for example $1,000 so 80% of the property that they are renting that is not theirs would be the $800 for the rent on top of that they might contribute additional sum of money to buy some Equity from this uh Finance institution and so over the time more Equity they buy less they pay for the rent so after a while their Equity increased to 30% they're only paying rent for 70% that other institution owns and that starts declining which is diminishing partnership so institutional ownership diminishes over time until it reaches zero at which point you fully own that property now sometimes when it comes to partnership one party might not have a capital but they might have a some skills often today you see somebody might be developer or coding expert or they have some knowledge and they would like to develop let's say app or something like that and other party might have money so in this case we have very similar way of arrangement it is called investment partnership which is mudaraba mudaraba is partnership in profit where one party provides Capital we call that rabul Mal and the other party provides labor and so if you think about previous example we have two partners now in mudaraba one is manager or mudar another one is investor again similar business venture like before they need $100,000 one party will provide labor another party 100% of the capital same rule apply we can pre- agree how we are going to share the profit so in this case let's say we're developing an app for a phone and we agree that person a who is managing providing labor will get 20% and the rest will go to the investor when it comes to the loss if this doesn't work out how do we divide loss one party invests time another party invest money and that is what they lose 100% of your loss in time goes to the person who invested the time and 100% of the monetary losses go to the person who is investing money so what would be uh simple case study so again we have a business venture manager is investing Time Zero money and the other party is investing zero time 100% in terms of the money and let's say they agree seven uh 3070 split when it comes to the profit in the first case if the Venture is in profit that will be 3,000 versus 7,000 for investor in terms of splitting the profit and if it comes to the loss of 10,000 then manager or person who is putting labor would lose their time but zero money lost which doesn't mean that they didn't lose anything they lose their time opportunity to do something else they still have a bill so there is a loss there very tangible loss an investor would lose $100,000 from their investment so if we think about these two ways of uh doing uh financing when we come to the bank we could then start thinking about how at the bank level we can mobilize the funds take deposits and then do financing you know in conventional sense we see usually Bank as intermediator between a lender and a borrower it connects people who have money and those who need in Islamic Finance industry it's less stride forward you can't just be transactional you can't just deal with money to Money Money must become something then you can benefit from that something so money that cycle money to money must be broken down in asset in between so as we said before for you are allowed to benefit from selling an asset but not from selling the money so Islamic uh let's say bank if they want to finance the home they need to buy the home so they they take that money from depositors for example on mudaraba basis so they go and they say all right we're opening this investment account where we going to be like mudar we're going to do our expertise something with that money and uh depositors open this account and so they might say we as a bank will take 20% whatever profits we made with this money and we'll distribute uh 80% to all of our depositors and then on the other side of the bank when they are financing they deal with the customer who need to buy homes in that case they will go into musharaka let's say where the customer would provide 20% or 10% and they would provide then as a finance here on behalf of the depositors right in the first part they were mudar who is getting the money to do something but as a mudar now they assume the role of investor Raul now who is the partnering with the other customer who needs the home to buy the home and through the diminishing musharaka for example they are financing that and through the rent of their ownership they are making a profit for it so you have deposit mechanism you have the way to finance these operations and that's how we solve this challenge that we have in society now let me ask you some simple question let's say you have a partner who is investing with you $100,000 but this partner is asking you to get get them $10,000 in profit every year as their share in Partnership is this something that is permissible can you take $100,000 from someone and then as their part or share in that partnership as the part of the profit from that that business you say okay here's every let's say 12 months you get $10,000 and this is your return on the money that you invested is that permissible what do you think how do you think about about it what is the rule should partnership return be fixed amount or should it be proportion of the actual profit that comes out from the business let me know what you think and we'll see you in the next episode inshallah Salam alikum [Music] do

In this episode of Islamic Finance 101, we explore the partnership modes of finance. Learn about Musharaka (joint venture) and Mudaraba (investment partnership), how profit and loss are shared, and how these concepts apply to real-world financing, including home financing and business ventures. Learn More! To learn more about Islamic finance and economy and to support Muslim Money Matters in producing future financial literacy videos like this, consider becoming a member of our Muslim Money Matters platform. 🌐 Join us at https://www.muslimmoneymatters.com Playlist of all episodes: https://youtube.com/playlist?list=PL648OdKhWVX_8PeSlT112XSaVtErfX8w2&si=hlQ5vTduS5uB_ngJ 📲 Connect with Almir on social media: 🔗 Links: https://www.almircolan.com/links 📩 Subscribe to Almir's email updates: 🌍 Website - https://www.almircolan.com