Ebtihaj's Encyclopedia of Economics Wiki

In Diminishing Musharakah , the customer approaches the bank for joint purchase of an asset/property. Designated valuation agencies are consulted for the valuation of the asset/property. The seller of the property is paid by the bank and the bank and the customer enter into a Musharakah Agreement.

It is referred to as ‘Diminishing Musharakah’ because of the arrangement, the ownership stake of the tenant increases and that of the bank decreases or diminishes with the passage of time. The rent decreases as the ownership stake of tenant increases.

The share of the bank in asset/property is divided into units. These units are purchased by the customer periodically until he has purchased all units and becomes the sole owner of the asset/property. Rent is not charged immediately and is charged at the end of the month for the use of asset/property. Rent for at least one period is fixed. Unit price fixed for a period will not change during that period.

The rent is calculated based on 1 year KIBOR (Karachi Interbank Offered Rate) or any other benchmark. KIBOR is used as there is no other benchmark rate available. The logical argument is that in a society if there is only one merchant who sells prohibited products, and then he starts to sell one legitimate product, he can use the profit rates on prohibited products for pricing and calculating profit margin on the legitimate product.

In Musharakah Agreement, the floor rate (minimum rate) and the ceiling rate (maximum rate) is stated based on which the rent can vary. In Musharakah agreement, it is stated that if payment is made on time, the transfer of ownership will take place accordingly.

The risk of damage to the property is borne by the bank and the customer, according to the stake in the property at the time of disaster. Just like in conventional mortgage, a penalty is charged if a customer withdraws from the contract that is paid to charity. The logical argument presented for such a penalty is that the contract involves a promise/undertaking to pay rent and purchase units of the asset/property and if a customer withdraws from the promise/undertaking, he can be asked to pay a penalty for maintaining financial discipline.