Diminishing Musharaka Product of Islamic Banks: A Sharia’a Compliant Substitute of Term Finance

Abstract

Partnership based business is the fundamental concept of doing commercial activity under Islamic rules and principles. To comply with Sharia’a principles within the boundaries of banking law in Pakistan, Financial Engineering provided the solution for all activities. One of the modes of financing in conventional banking system is Term Finance in which the client repays principle and profit at predefined time intervals. This need can be fulfilled by using Islamic Alternate i.e. “Diminishing Musharaka”. This paper investigates the viability of this financing mode as compare to conventional Term Finance which is being utilized by conventional banking system for the same purpose. The paper also highlights the growth of Diminishing Musharaka in quantitative terms as well as its acceptability by end users and Islamic Financial Institutions in the form of portfolio growth for this mode of financing. To quantify its growth, historical time series data with its quarterly trend is used from Islamic Banking Bulletin issued by State Bank of Pakistan. Some key advantages and disadvantages are also mentioned by analyzing them critically. Related Sharia’a rulings and their linkage to this mode of financing are discussed in this study to further support it in Islamic perspective. Benefits associated with this mode and practical applications are discussed with some recommendations. The study is beneficial for Islamic Financial sector, central banks and students of Islamic Banking & Finance. It also aimed to enhance the knowledge of students and users of this product.