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  • CA-3.6 CA-3.6 Musharakah and Diminishing Musharakah

    • Introduction

      • CA-3.6.1

        This Section sets out the minimum capital adequacy requirement to cover the risk of loss on invested capital arising from entering into contracts or transactions that are based on the Sharia rules and principles of Musharakah and Diminishing Musharakah where the Islamic bank licensee and their customers/partner(s) contribute to the capital of the partnership and shares its profit or loss.

        January 2015

      • CA-3.6.2

        This Section is applicable to both (a) Musharakah in which all the partners' share remains constant throughout the contract period; and (b) Diminishing Musharakah in which the share of the Islamic bank licensee is gradually reduced during the tenure of the contract until it is fully sold to the other partner(s).

        January 2015

      • CA-3.6.3

        Musharakah contracts refer to partnerships in specific transactions or projects. These exclude participation in the share capital (equity) of other enterprises which is covered in Section CA-4.8.

        January 2015

      • CA-3.6.4

        A Musharakah is an agreement between the Islamic bank licensee and a customer to contribute capital in various proportions to an enterprise, whether existing or new, or to ownership of a real estate or moveable asset, either on a permanent basis, or on a diminishing basis where the customer progressively buys out the share of the bank ("Diminishing Musharakah"). Profits generated by that enterprise or real estate/asset are shared in accordance with the terms of Musharakah agreement whilst losses are shared in proportion to the respective contributor's share of capital.

        January 2015

      • CA-3.6.5

        An Islamic bank licensee may enter into a Musharakah contract with a customer as a means of providing a financing to the latter on a profit sharing and loss bearing basis. In this case, the Musharakah is normally of the diminishing type, in which the customer gradually purchases the Islamic bank licensee's partnership share over the life of the contract. This type of financing is one of the Sharia compliant alternatives to avoid a conventional term loan repayable by instalments, and as such it is exposed to credit risk for the customer's purchase payments as well as to the risk attached to the Islamic bank licensee's share of the underlying assets.

        January 2015

    • Musharakah

      • CA-3.6.6

        This Section sets out the minimum capital adequacy requirement to cater for "capital impairment risk", the risk of losing the amount contributed to an enterprise or ownership of an asset. The Islamic bank licensee acts as a partner in a Musharakah contract and is exposed to the risk of losing its capital upon making payment of its share of capital in a Musharakah contract. A Musharakah can expose the Islamic bank licensee either to capital impairment risk or to 'credit risk', depending on the structure and purpose of the Musharakah and the types of asset in which the funds are invested. The invested capital is redeemable either by liquidation of the Musharakah assets at the end of the contract which has a fixed tenure or as mutually agreed by the partners, or upon divestment of partnership in an on-going Musharakah subject to giving a notice to other partners. The amount of capital redemption is represented by the value of a share of capital, which is dependent on the quality of the underlying investments or assets, and ability to generate profits and cash flows from the Musharakah.

        January 2015

      • CA-3.6.7

        As a partner to a Musharakah contract, the Islamic bank licensee is not entitled to a fixed rate of return and is thus exposed to variable profits generated by the partnership which are shared on a basis as agreed in the Musharakah contract, whereas losses are to be borne by the Islamic bank licensee and its partners according to their respective ratio of invested capital. Therefore, the Islamic bank licensee is exposed to entrepreneurial risk of an active partner that manages the partnership and business risks associated with the underlying activities and types of investments or assets of the partnership.

        January 2015

      • CA-3.6.7A

        For the purpose of determining the minimum capital adequacy requirement, this Section makes distinctions between the four main categories of Musharakah as set out below:

        (a) Private commercial enterprise to undertake trading activities in foreign exchange, shares and/or commodities This type of Musharakah exposes the Islamic bank licensee to the risk of underlying activities, namely foreign exchange, equities or commodities;
        (b) Private commercial enterprise to undertake a business venture (other than (a)) This type of Musharakah exposes the Islamic bank licensee to the risk as an equity holder, which is similar to the risk assumed by a partner in venture capital or a joint venture, but not to market risk. As an equity investor, the Islamic bank licensee serves as the first loss position and its rights and entitlements are subordinated to the claims of secured and unsecured creditors. For further explanation of the nature of risk in such ventures, see Paragraphs CA-4.8.4 to CA-4.8.6; and
        (c) Joint ownership of real estate or movable assets (such as cars) is divided into two sub-categories:
        (i) Musharakah in Ijara contract
        Ownership of such assets can produce rental income for the partnership, through leasing the assets to third parties by means of Ijara contracts. In this case, the risk of the Musharakah investment is essentially that of the underlying Ijara contracts — that is, credit risk mitigated by the collateral represented by the leased assets.

        However, in some cases the lessee is not a third party but the Islamic bank licensee's partner as customer. The existence of such an Ijara sub-contract in addition to a Musharakah exposes the Islamic bank licensee to credit risk in respect of the partner's obligation to service the lease rentals and
        (ii) Musharakah in Murabahah contract
        The Islamic bank licensee is entitled to its share of revenue generated from selling the assets to third parties by means of Murabahah contracts that expose the Islamic bank licensee to credit risk in respect of the Murabahah receivables from the buyer/counterparty.
        January 2015

    • Diminishing Musharakah

      • CA-3.6.8

        The Islamic bank licensee's position in a diminishing Musharakah is set out in Paragraphs CA-4.8.12 to CA-4.8.15.

        January 2015

    • Equity Position Risk — Musharakah

      • CA-3.6.9

        For Musharakah, the equity exposure is measured based on the nature of the underlying investments as follows:

        (a) For investments held in the trading book, exposure is equal to the fair value; and
        (b) For investments held to maturity, exposure is equal to the carrying value, which may be the fair value or the historical cost less any provisions for impairment.
        January 2015

      • CA-3.6.10

        For private commercial enterprises undertaking trading activities in foreign exchange, shares or commodities, the Musharakah exposures, net of provisions is measured as follows:

        (a) The RW is based on the applicable underlying assets as set out in the market risk section in Chapter CA-5.
        The investment in foreign exchange and trading in gold/silver is measured according to the treatment as set out in Section CA-5.5, which requires 8% capital charge on the greater of either net long or net short positions in foreign exchange and 8% capital charge on the net long position of gold/silver;
        (b) The RW of a Musharakah that invests in quoted shares is measured according to the equity position risk approach, where positions in assets tradable in markets qualify for treatment as equity position risk in the trading book, which incur a total capital charge of 16% as set out in Section CA-5.3; and
        (c) Investment in commodities is measured according to either the maturity ladder approach or the simplified approach as set out in Section CA-5.6.
        January 2015

      • CA-3.6.11

        For private commercial enterprise undertaking a business venture other than in Paragraph CA-3.6.12), there are two possible methods used to calculate the equity exposures:

        (a) Simple risk-weight method: The RW must be applied to the exposures (net of specific provisions) based on equity exposures in the banking book. The RW under the simple RW method for equity position risk in respect of an equity exposure in a business venture must entail a 400% RW for shares that are not publicly traded less any specific provisions for impairment. If there is a third-party guarantee to make good impairment losses, the RW of the guarantor must be substituted for that of the assets for the amount of any such guarantee; or
        (b) Supervisory slotting method: An Islamic bank licensee is required to map its RW into four supervisory categories as described in Appendix CA-5 (specialised financing) where the RW of each category is as follows:

        Supervisory Categories Strong Good Satisfactory Weak
        Risk weights 90% 110% 135% 270%


        The above RWs under the slotting method for specialised financing include an additional fixed factor of 20% RW to cater for potential decline in the Musharakah's net asset value.

        For further explanation, also see Paragraphs CA-4.8.7–4.8.11.
        January 2015

    • Joint Ownership of Real Estate and Movable Assets (such as cars)

      • CA-3.6.12

        Musharakah in Ijara contract:

        Income-producing Musharakah through leasing to third parties by means of Ijara contracts exposes the capital contributor to the risk of that underlying Ijara contract — that is, counterparty risk mitigated by the value of leased assets. This Musharakah investment is assigned a RW based on the credit standing of the counterparty/lessee, as rated by an ECAI that is approved by the CBB, and a 100% RW on the residual value of an Ijara asset (operating lease). In cases where the counterparty is unrated, a RW of 100% applies. (Please refer to the treatment for Ijara as set out in Paragraph CA-3.5.22.)

        January 2015

      • CA-3.6.13

        Musharakah in Murabahah contract:

        Income-producing Musharakah through selling to third parties by means of Murabahah contracts exposes the capital contributor to the risk of that counterparty/buyer. This Musharakah investment is assigned a RW based on the credit standing of the counterparty /buyer, as rated by an ECAI that is approved by the CBB. In cases where the counterparty is unrated, a RW of 100% applies. (Please refer to the treatment for Murabahah as set out in Section CA-3.2.

        January 2015

    • Equity Position Risk — Diminishing Musharakah

      • CA-3.6.14

        The equity exposure in a Diminishing Musharakah contract, where the Islamic bank licensee has provided funds for the working capital of the partnership and intends to transfer its full ownership in movable assets and working capital to the other partner over the life of the contract, is calculated based on the remaining balance of the amount invested (measured at historical cost including any share of undistributed profits) less any specific provision for impairment. The exposure must be risk weighted according to the nature of the underlying assets as set out in Paragraphs CA-3.6.11 to CA-3.6.14. If a third party guarantee exists, to make good impairment losses, the RW of the guarantor is substituted for that of the assets (if lower) for the amount of any such guarantee. The Islamic bank licensee can use the risk weights under the slotting method (see Paragraph CA-3.6.11) after the required CBB approval, based on the criteria set out in Appendix CA-6.

        January 2015

    • Summary of Capital Requirement at Various Stages of the Contract

      • CA-3.6.15

        The following table sets out the Musharakah categories that attract capital charges:

        Musharakah Category Credit RW Market Risk Capital Charge
        Private commercial enterprise to undertake trading activities in the foreign exchange, share and/or commodity Not applicable. Depends on the underlying asset as set out in the applicable market risk section
        Private commercial enterprise to undertake business venture other than trading activities in the foreign exchange, share and/ or commodity
        (a) Simple RW method 400% RW of the contributed amount* to the business venture less any specific provisions. (If there is a third-party guarantee, the RW of the guarantor is substituted for that of the assets for the amount of any such guarantee)

        Or
        (b) Slotting method Between 90–270% RW of the contributed amount* to the business venture based on the four categories
        		Not applicable
        Joint ownership of real estate and movable assets (Musharakah with Ijara subcontract,

        Musharakah with Murabahah subcontract)                 		Based on lessee's (for Ijara sub-contract) or customer's (for Murabahah subcontract) rating or 100% RW for unrated lessee or customer Please refer to the market risk capital charge requirements as set out under the sub-contracts

        * In the case of Diminishing Musharakah, the contributed amount is based on the remaining balance of the invested amount.

        January 2015