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CA-4.8.12

The Islamic bank licensee's position in a diminishing Musharakah entails two kinds of exposures:

(a) The amounts due from the partner to buy out the agreed shares of the investment on the agreed dates are subject to credit risk in respect of the partner's ability and willingness to pay.33 The Islamic bank licensee's selling price for each share of ownership being transferred is based either on the fair value of that share at the date of the partial transfer of ownership (which exposes the Islamic bank licensee to capital gains or losses and hence to capital impairment risk) or at a price agreed upon at the time of entering into the contract. The Islamic bank licensee's credit risk exposure in respect of the Musharakah investment 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. If there is a third-party guarantee to make good impairment losses, the RW of the guarantor is substituted for that of the outstanding balance of the Musharakah investment for the amount of any such guarantee; and
(b) As a joint-owner, the Islamic bank licensee is entitled to its share of income generated from its share of the underlying assets of the Musharakah, such as Ijara lease rentals (e.g. when a home purchase plan is provided by an Islamic bank licensee on the basis of diminishing Musharakah). The rental payable by the partner/customer as Ijara lessee is adjusted periodically to reflect the Islamic bank licensee's remaining ownership share in the asset. The Islamic bank licensee is exposed to credit risk in respect of non-payment of the rentals receivable from the partner/customer.

33 Diminishing Musharakah contracts typically contain a clause whereby, in the event of a default by the partner in making a due payment, the bank has the right to terminate the contract and to exercise a put option requiring the partner to buy out the whole of the bank's remaining share of the investment. However, a financially distressed partner will most likely be unable to do so.

January 2015