Musharakah as substitute for regular overdraft

In the early writings on Islamic banking, Musharakah was supposed to be the basic mode of finance in the model of interest free banking. However, in contemporary Islamic banking, Musharakah is almost not existent. The reason for this is obvious, complexity and a relatively higher degree of moral hazards. In Shari’ah, the Musharakah is the simple partnership, where two parties participate in a venture providing capital. Developing “partnership” into a banking mode of finance is not easy. Firstly, it has to be temporary, as bank can not engage in ownership and operation of joint stock companies. Secondly, because Musharakah is the “mixing” of two capitals, whenever the Islamic bank gets into Musharakah by providing capital, it has to engage into an evaluation of the "worth" of the other party. This is because profit at the end of Musharakah are the difference in the value of the Musharakah between the two points. This is extremely complex.

Some Shari’ah aspects of Musharakah

In two parties may provide shares of any size into the partnership. In case of loss, share of each party is based on its share of capital. The case of profit is different. They can be shared differently. This is very suitable to Islamic banks, because they can take a share of profit lower than their share in capital, and hence compete with conventional banks. In Musharakah the two partners may or may not participate in management. However, it is allowed for the one who manages, if he happened to be the partner to charge salary or a higher share of profit.

Musharakah as substitute for regular overdraft

Some Islamic banks succeeded in developing musharakah to be a substitute for regular overdraft. In this case the bank opens an account for the client from which overdraft can be drawn. A musharakah agreement is signed with the client, in which the bank become live partner with the client in the overall operation of his business. Whenever the client has excess cash he can deposit in the account thus reducing the obligation. At the end of the period, which is usually one financial year, the bank will have a share of profit proportion to the bank's equity share and the number of the days in which the account in overdrafted. The agreement for such transaction is quite complicated as it includes many measure to guard against changing the nature, procedures and management of the client's business is adverse way.

Source: An Introduction To Islamic Banking, Shaykh Dr Mohamed Ali Elgari. Republished with permission.