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Investment basics: Shari’ah financing contracts

Shari’ah financing contracts are implemented through one of two modes:

This is a joint business venture between the Islamic financial institution and the customer. The customer and the institution act as partners in the venture. Equity based financing requires an agreed upon profit share between the financial institution and the customer. There are two common forms of Islamic equity-based financing contracts: Mudarabah contract and Musharakah contract.

Mudarabah contract

Muḍarabah is a profit sharing financing arrangement where one party provides the capital and the other the business management skills, with profits shared  according to a pre-agreed ratio between the parties. Monetary losses are borne solely by the capital provider, while management incurs losses based on the contribution of time and effort.

A Mudarabah contract is suitable for clients who have a business idea and need funding.

Musharakah contract

Musharakah is partnership by capital. Risk exposure of the partners is proportionate to each partner’s ratio of capital contribution. It is a proit and loss sharing contract where all partners contribute towards capital and profits are shared according to an agreed ratio and losses are borne according to the ratio of capital contribution.

A Musharakah contract is suitable for clients who has some funding for a business idea or who would like to expand their business, but require more.

This is the financing of a credit purchase or lease of an asset. The financier acquires the asset and then either sells or leases it to the customer. There are two common forms of asset-based financing: Murabahah contract and Ijarah contract.

Murabahah contract

It is the sale of goods at cost-plus profit. The financial institution meets the demand for goods by its customer through the purchase of the goods from a third party and sells the goods to its customer for a profit. The cost and the profit are disclosed and the financial institution bears the risk of the goods until delivery to its customer. The customer may order the goods, on behalf of the financial institution from the supplier. The payment period and amount to be paid is  mutually agreed  between the financial institution and customer.

A Murabahah contract is suitable for clients who need to buy goods or assets through credit, with a fixed price in mind.

Ijarah contract

Ijārah financing is a financing arrangement where the financial institution acquires an asset and leases it to the customer. This can either be an operating lease, Ijārah, or a finance lease, with an option to transfer the asset to the lessee. Ijārah is essentially the transfer of rights of use or usufruct to a counter party in exchange for rent. Ijārah does not result in ownership transfer to the lessee. Thus, the lessee has no ownership right over the asset unless the parties mutually enter into a transaction of sale.

A Ijarah contract is suitable for clients who would like to rent/lease assets for short-, medium-, or long-periods without owning the asset or having to pay big capital payments.

Agrarius - Historical Pricing