Musharakah Financing as Addressed in IFSB Standard: A Regulatory Perspective

Abstract

Islamic finance has continued to expand and demonstrate its resilience in the current more challenging international financial environment. However, this expansion has been confined in terms of debt-based contracts, rather than employing equity-based contracts such as a Musharakah contract. Principally Islamic finance promotes transactions that are based on profit and risk sharing through Mudarabah (partnership of work and capital) and Musharakah (joint venture) contracts, thus encouraging participatory finance and promoting participation in the risk-reward and financial results. However, statistics suggests that the industry has put more weight on the debt-financing instruments. There are several reasons and rationales put forward by the Islamic banks for the non-existence of the Musharakah contract. The majority of Islamic banks have limited themselves to low-risky trade-financing assets. This research paper analyse the Musharakah financing and reasons why Islamic banks tend to avoid such financing models from mainly two facets: Shari’ah perspective and regulatory perspective. Shari’ah perspective will highlight the main Shari’ah issues and minimum Shari’ah requirements that need to be observed while employing Musharakah contract in Islamic banks, while the regulatory perspective will underscore the significance of risk management dimension, minimum capital adequacy and Shari’ah-compliant securitisation related to Musharakah exposures. Finally the chapter concludes on the role of implementing IFSB standard in solving the risk exposure in Musharakah financing and the role of regulatory authority in implementing equity-based contract (Musharakah financing).