Islamic banks can participate in home financing on the basis of diminishing Musharakah. This concept requires the financier and the client to participate in the joint ownership of a property. The share of the financier is further divided into a number of units. The client is then able to purchase those units one by one periodically, thus increasing his own share till all the units of the financier are purchased making the client the sole owner of the property. The proposed arrangement is based on the following transactions:
1. The first step is to create a joint ownership in the property. There is no objection from Islamic scholars against structuring this transaction.
2. The second part of the arrangement is that the financier leases his share in the house to the client and charges rent to him. Islamic scholars also permit this transaction, however where the undivided share is leased out to a third party, its permissibility has been a point of contention between Muslim jurists.
Imam Abu Hanifa and Imam Zufar are of the view that the undivided share cannot be leased out to a third party, while Imam Malik and Imam ShafiT, Abu Yusuf and Muhammad Ibn Hassan hold that the undivided share can be leased out to any person. But so far as the property is leased to the partner himself, all of them are unanimous on the validity of this Tjarah leasing transaction that eventually results in full ownership.
3. The third step in the arrangement is that the client purchases different units of the undivided share of the financier. If the undivided share relates to both land and building, the sale of both is allowed according to all the Islamic schools.
Similarly if the intention is to sell the undivided share of the building to the partner, all the Muslim Jurists also, unanimously, permit it. Again, there is a difference of opinion if it is to be sold to a third party. It is clear from the previous three points that each of the transactions mentioned above are allowed per se, but the question is whether this transaction maybe combined in a single arrangement.
The answer is that if these transactions have been combined by making each one of them a condition to the other, then the Shariah does not permit this. It is a well-established rule of the Islamic legal system that one transaction cannot be made a pre-condition for another. However, the proposed scheme suggests that instead of making two transactions conditional to each other, there should be an undertaking from the client.
Firstly, to take the share of the financier on lease and pay the agreed rent, and secondly, to purchase the units of the share of the financier of the house at different stages. This leads to the fourth transaction, which is the enforce-ability of such an undertaking or promise. It is generally believed that an undertaking or promise to do something creates only a moral obligation on that person, which cannot be enforced through courts of law.
However there are a number of Muslim Jurists who hold the view that promises are enforceable, and the court of law can compel people to fulfill their promise, especially, in the context of commercial activities. Some Maliki and Hanafi jurists have declared that an undertaking or promise can be enforced through courts of law in cases of need. The Hanafi Jurists have adopted this view with regards to a particular sale called bai-bilwafa.
Bai-bilwafa is a special arrangement for the sale of a house where a buyer promises the seller that whenever the seller repays him/her the price of the house, he/she will resell the house hack to the original seller. Hanafi jurists, on the other hand, have argued that if the resale of the house to the original seller is made a condition for the initial sale, it is not permitted.
However, if the first sale is effected without any condition, but alter effecting the sale, the buyer promises to resell the house whenever the seller offers him the same price. Then this promise is acceptable and it creates not only a moral obligation, but also an enforceable right of the original seller. The Muslim jurists allowing this arrangement have based their view on the principle that "the promise can be made enforceable at the time of need".
One may raise an objection that if the promise of resale has been taken before entering into an actual sale, it practically amounts to putting a condition on the sale itself, because the promise is understood to have been entered into between the parties at the time of sale. Therefore, even if the sale is without an express condition, it should he taken as conditional because a promise in an express term has preceded it.
This objection can be answered by saying that there is a big difference between putting a condition in the sale and making a separate promise without making it a condition. If the condition is expressly mentioned at the time of sale, it means that the sale will be valid only il' the condition is fulfilled, meaning that if the condition is not fulfilled in future, the present sale will become void.
This makes the transaction of sale contingent upon a future event that may or may not occur. It leads to uncertainty (Gharar) in the transaction, which is totally prohibited in Shariah. Conversely, if the sale is without any condition, but one of the two parties has promised to do something separately, then the sale cannot be held to be contingent or conditional upon fulfilment of the promise made. It will take effect irrespective of whether or not the promise is fulfilled. Even if the promise is backed out of, the sale will remain effective. The most that the person whom the promise has been made to can do is to compel those undertaking the promise, through the courts of law, to fulfil that promise.
A claim for actual damages suffered resulting from a default can consequently be made. This makes it clear that a separate and independent promise to purchase does not render the original contract conditional or contingent. Therefore it can be enforced.
Conditions of Diminishing Musharaka
On the basis of the above analysis, diminishing Musharakah may be used for House Financing subject to the following conditions:
The agreement of joint purchase, leasing and selling different units of the share of the financier should not be tied up together in one single contract.
However, the joint purchase and the contract of lease may be joined in one document whereby the financier agrees to lease his share, after joint purchase, to the client. This is permitted because Ijara can be effected for a future date. At the same time the client may sign a one-sided promise to purchase different units of the share of the financier periodically and the financier may undertake that when the client purchases a unit of his share, the rent of the remaining units will be reduced accordingly.
At the time of the purchase of each unit, sale must be effected by the exchange of an offer and acceptance at that particular date. It is preferable that the purchase of different units by the client be effected on the basis of the market value of the house as prevalent on the date of purchase of that unit. It is also permissible that a particular price is agreed in the promise of purchase signed by the client.
The Institute of Islamic Banking and Insurance (IIBI - London UK)
"At the heart of the great religions, including Islam, are the common themes of helping the less fortunate, being responsible stewards of the natural world, and demonstrating values in our daily work. I am encouraged to think that these ideals can permeate Islamic banking at its best".
Speech made by The Prince of Wales at the Islamic Financial Services Industry and Global Regulatory Environment Summit, London, 19th May 2004 - 'Multi racial Society'
Mohammed Amin of Price Waterhouse Coopers, has recorded a pod cast on Islamic Finance; Mohamed gave a talk in London last year regarding its taxation (August 2006). To share this with readers, he has recorded the presentation in audio format.
> Click here to download this audio broadcast.
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