68 Islamic Finance in Practice
purpose of the arrangement. By way of example, if a business needs new
machinery, equipment, or durable office supplies (eg. furniture) thenijara
muntahiya bit tamleekmay be used. Clearly, goodsmurabahais also a
candidate here for such transactions; however,ijara extends an added
potential advantage to the bank as compared tomurabaha.Inijara,the
bank has the option of choosing floating rates of rent, which can be adjusted
up or down in line with market fundamentals. This protects the bank’s
position better thanmurabaha, where the bank’s return (cost plus profit)
once determined at the outset remains fixed. The option of variable rental is
particularly useful for longer term leases^1 , where the possibility of
fluctuations in the benchmark or average market rate(s) of return is greater.Musharaka
Musharaka, regarded as embodying the true spirit of Islamic finance,
provides more than one potential solution for WCF needs; one of these is for
specifically for WCF-1 which is considered now; the other is a unique product
classified as WCF-3 (which may fulfil both WCF-1 and WCF-2 needs), and is
considered below.
With regards to obtaining durable assets (eg. tractors, machinery,
equipment, etc.)ijara muntahiya bit tamleekhas already been discussed as
a tool to solve WCF needs. For the same sort of durables, diminishing
musharakacan also be used (also calledmusharaka mutanaqisa).
The arrangement of diminishingmusharakais based on the use of two
separate contracts of lease, and (periodic) sale. Here, the bank and the client
business jointly purchase the asset (eg. an electricity generator) at the
outset. Usually, the bank pays a majority portion of the price (in this
example, say 90 per cent) and this is how the client’s need for finance is met.
The remaining 10 per cent is paid for by the client, with the result that the
client owns 10 per cent of the generator and the bank owns 90 per cent. The
client then rents the 90 per cent bank-owned portion of the generator from
the bank over a certain lease period, for instance three years. Over this lease
period, the client also periodically buys further portions of the bank’s share
of ownership in the generator, such that by the end of the lease period, the
client owns the generator fully. So for example, theclient could (separately)
undertake to purchase 30 per cent at the end of each year of the lease period,
to take its own membership up to a full 100 per cent. It is noted that as the
client’s ownership proportion rises, it would normally pay less rent to the
bank, given that the bank now owns a smaller share of the asset. So for
instance, after one year, the client buys a further 30 per cent share,
increasing its share of ownership to 40 per cent, and now will only have to
pay rent of the remaining bank-owned 60 per cent share (until it purchases
a further share from the bank). The bank makes it profit via the sale of its(^1) corresponding tolonger term periods of finance in murabaha.