'Musharakah' is a word of Arabic origin which literally means sharing. In the context of business and trade it means a joint enterprise in which all the partners share the profit or loss of the joint venture.
It is an ideal alternative for the interest-based financing with far reaching effects on both production and distribution. In the modern capitalist economy, interest is the sole instrument indiscriminately used in financing of every type. Since Islam has prohibited interest, this instrument cannot be used for providing funds of any kind. Therefore, 'Musharakah' can play a vital role in an economy based on Islamic principles.
The proportion of profit to be distributed between the partners must be agreed upon at the time of affecting the contract. If no such proportion has been determined, the contract is not valid in Shari'ah.
The ratio of profit for each partner must be determined in proportion to the actual profit accrued to the business, and not in proportion to the
Capital invested by him. It is not allowed to fix a lump sum amount for any one of the partners or any rate of profit tied up with his investment.
But in the case of loss, all the Muslim jurists are unanimous on the point that each partner shall suffer the loss exactly according to the ratio of his investment.
In spite of all the benefits, Musharakah is almost nonexistent in the Islamic banking and finance markets due to various complexities.
Risks associated with Musharakah:
- Risk of Loss: It is argued that the arrangement of Musharakah is more likely to pass on losses of the business to the financier bank or institution. This loss will be passed on to depositors also. The depositors, being constantly exposed to the risk of loss, will not want to deposit their money in the banks and financial institutions and thus their savings will either remain idle or will be used in transactions outside of the banking channels, which will not contribute to the economic development at national level.
- Dishonesty: Another apprehension against musharakah financing is that the dishonest clients may exploit the instrument of musharakah by not paying any return to the financiers. They can always show that the business did not earn any profit. Indeed, they can claim that it has suffered a loss in which case not only the profit, but also the principal amount will be jeopardized.
The Shari'ah parameters applicable to Musharakah type of financing are: