Dear readers, I am finally done with the discussion on Musharakah. During this voyage, I have explained to readers the four types of Musharakah contracts viz. Sharikat Al Inan or contractual partnership, Sharikat Al Wujuh or reputational partnership, Sharikat Al Mufawadah or equal partnership (where partners are also agents for each other) and Sharikat Al Abdan or partnership based on skill or expertise.
All of them were discussed with the emphasis on Sharikat Al Inan (contractual partnership) which is relevant to Islamic finance and based on which various products are developed by Islamic financial institutions and Sukuk are launched, either based on a single or hybrid structure.
Today, I would like to write on another kind of partnership which was widely used during the global financial crisis of 2008. It is Sharikat Melk or co-ownership. Usually this type of partnership occurs when the heirs inherit the estate of their father or mother in accordance with the Islamic law of inheritance. The inheritors are the deceased’s offsprings, spouse (wife or husband), parents, blood relatives (siblings), unborn child and also the divorced wife who has not yet completed the Idda (compulsory waiting time to crystalize the divorce).
I remember it was September 2008 when the financial crisis hit UAE shores. Traditionally, this was the time for Dubai to come out from vacation hibernation when people arrive back to resume economic activity and schools are reopened. We were hearing about the crisis and gauging its severity but had no idea how soon and at what intensity it will impact the UAE market.
The meltdown became visible by late September 2008 and the banks (both conventional and Islamic) started experiencing default in import loans and Murabahah financing on the corporate finance side, and in personal loans, car loans, mortgages, etc, and car Murabahah, home financing and credit cards in consumer banking.
While conventional banks offered a quick-fix rescheduling of their lending with increased interest rates, Islamic banks found themselves in a dilemma for the past-due Murabahah transactions mainly comprised of import financing and car financing. This is because, and as also explained earlier, Murabahah represents a fixed price sale contract. The Shariah principles do not allow increasing the price for an item which was sold in the past simply on the ground that the buyer under the contract could not keep up with the agreed deferred payment terms. This is irrelevant if the default in a Murabahah contract is attributable to an unforeseen situation (such as a financial crisis then and COVID-19 nowadays) or in normal circumstances.
Here, the stark divide between conventional and Islamic finance is visible whereby a conventional bank shall not hesitate to extend the repayment terms for a past-due loan at an increased interest rate but an Islamic bank will have to carry on with the past-due Murabahah transactions in its books at the original amount, ie without adding anything even if the transaction becomes past-due. The situation had the potential to cause damage to the ecosystem of Islamic banking.
In close liaison with the Shariah scholars and keeping in view of the market situation, a Sharikat Melk (co-ownership) product was developed by me with my team at that time. By virtue of the product, the Islamic bank was able to purchase a part of the client’s identified physical inventory of the Shariah compliant goods to the extent of the amount of past-due Murabahah transactions through a sale and purchase agreement. Simultaneously, the Islamic bank appointed the customer (seller) as its agent to safeguard the inventory (storage, insurance, etc.) and to sell it at the best available price.
The purchase price paid by the bank into the client’s account was immediately diverted to settle the past-due Murabahah transactions. On the other hand, the Islamic bank was able to not only earn profit on the sale of every item (or quantity) from the identified inventory, but the sale proceeds too were assigned to the Islamic bank which enabled it to claim its share of the ownership in the sale proceeds toward redeeming the bank’s investment, and release the rest to the client.
Let us assume that the aggregate value of a client’s past-due Murabahah transactions comprising the import of cars is US$2 million. The Islamic bank enters into a sale and purchase agreement with the client to purchase a share of its inventory comprised of identified unsold cars aggregating US$10 million. Hence, by virtue of the sale and purchase agreement, the bank shall become a 20% co-owner of each vehicle in the inventory. As and when a vehicle is sold, the Islamic bank’s share in the sale proceeds, in addition to the agreed profit, shall be 20% which it will retain and release the rest of 80% plus the client’s share of profit to the client.
So you see how the hybrid structure of Sharikat Melk and agency rescued Islamic banks which were able to not only square up the past-due Murabahah financing from their books but also resume the earning of profit from the same client. They could not achieve it from the past-due Murabahah transactions that the bank was forced to carry.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Next week: Commencement of the new subject on Wakalah or agency contract.