Understanding the mushārakah mutanāqiṣah of Koperasi Pembiayaan Syariah Angkasa (KOPSYA)

Introduction

Mushārakah mutanāqiṣah (MM) or diminishing mushārakah is a combination of the mushārakah (partnership) contract and ijārah (lease) contract. In this structure, the equity of the financier will be gradually reduced as a result of a series of repurchases of share ownership by the customer from the financier through the customer’s monthly payments. MM is usually used to finance the purchase of housing, properties, machinery or any tangible assets that are economically feasible and have the ability to generate returns. Numerous research articles have noted that MM made its first foray into Malaysia’s financial industry in 2005. Nonetheless, the idea of MM for mortgage financing was first mooted by the late Professor Baharum (1990) in his book published in 1990. His passion for finding a solution to housing financing woes in Malaysia led to another publication in 2012 that is currently being used as a reference by employees of Koperasi Pembiayaan Syariah Angkasa (KOPSYA), an Islamic co-operative (IC) based in Malaysia.

Baharum (2012) touched upon the need to have MM financing for the ever-increasing housing problem and the need to structure it in a way that does not cause a burden to customers. He emphasised that for any rental paid by the customer to the financier, the full amount (100 per cent) should not be enjoyed by the financier as profit. Instead, it should be shared between both parties in accordance to their capital contribution. The author echoed the MM structure that is currently being practised by the Islamic and Ansar Co-operative Housing Corporation in Canada. That structure was approved by the renowned scholar Shaykh Muhammad Taqi Usmani. It is important to note that the application of MM in Canada primarily serves to cater for the rising number of immigrant homeowners. This objective is no different from the objective and charter of co-operatives: meeting the economic and social needs of their members.

This research is motivated by the aspiration of late Professor Baharum as expressed in his two books. Its objective is to show a different MM treatment that might shed positive light on MM house financing through ICs. Accordingly, the paper focuses on MM and studies KOPSYA’s practice of it in particular. The authors concurred that it represents an ideal organisation by which to study the matter due to its strong stance in promoting Sharīʿah-compliant financing products. The paper provides an understanding of the application of MM by KOPSYA and identifies the issues surrounding its application. It particularly seeks to highlight approaches to default, pricing of rental rates, profit-sharing method and early settlement, which differ from the practice of MM by Islamic financial institutions (IFIs).

The paper is organised as follows. The next section discusses patterns of use of various Sharīʿah-compliant contracts for Islamic financing in Malaysia, highlighting the uptake of commodity murābaḥah (CM) as compared to MM. Then, an overview of co-operatives, in particular KOPSYA and its financial products, is provided, and some literature on MM financing and challenges in its implementation is reviewed. Thereafter, the research methodology adopted in this paper is described. The next section discusses and analyses the implementation of MM by KOPSYA under four tables: a base-case scenario, a situation where the periodic rental is reinvested, a case where the profit rate is reviewed and a case where the customer makes an extra payment to reduce his principal. Then, some challenges faced by IFIs in MM implementation and the way these are addressed at the level of KOPSYA are examined. The last section concludes the paper and provides some recommendations.

Sharīʿah contracts for house financing

As is commonly known, the Sharīʿah contracts used for house financing are usually bayʿ bi thaman ājil (BBA) (deferred payment sale), MM and CM. MM as an Islamic mortgage contract was introduced into the Malaysian market in 2005 by Kuwait Finance House (Malaysia) Berhad. In 2007, Bank Negara Malaysia (BNM, 2010, 2016, 2017) issued a resolution that the financing structure based on MM is permissible, and this enabled other local and foreign IFIs to start adopting MM. It resulted in a shift from the previous BBA contract, which was deemed controversial but widely practiced in Malaysia. The reason for the preference was due to the consensus that MM is closer to the spirit and objectives of the Sharīʿah (Islamic law). It is also acknowledged that the MM models are favoured over BBA because of the latter’s similarity to a conventional loan due to its bayʿ al-īnah (sale and buy back) features (Meera and Abdul Razak, 2009).

Figure 1 depicts the patterns of Sharīʿah contracts used for Islamic financing in Malaysia. According to the data, BBA is seeing declining usage as explained earlier. MM looks to be consistent, ranging between 5 and 10 per cent of total financing. Over the years, some IFIs, mainly local, have also started to adopt CM as an alternative to MM. The shift was mainly due to prevailing challenges and limitations related to taxation, legal ownership and purchase undertaking. Although BNM continues to work diligently with industry players and relevant authorities to find solutions to the challenges, the issues are still lingering. Therefore, there has been a sharp increase in the use of CM in Sharīʿah financing contracts over the past three years (BNM, 2016). Figure 1 shows that murābaḥah (cost plus mark-up sale), which includes CM, has increased exponentially over a three-year period from a modest 24 per cent of total financing in 2014 to an impressive 36 per cent in 2016. The escalation is also observed to be the highest when comparing the changes in the use of Sharīʿah contracts in Figure 2 whereby murābaḥah recorded an impressive 90 per cent growth as compared to mushārakah (partnership) which stood at 76 per cent. While the percentage of mushārakah may look remarkable, its share in total financing in 2016 stood at a mere 9 per cent (Figure 1).

Although the growth in CM is partly caused by the simplicity of its operations, it is also largely spurred by the existence of commodity trading operations on Bursa Suq Al Sila at Bursa Malaysia. The trading platform of Bursa Suq Al Sila has reduced costs and risks associated with tawarruq-based transactions, thus strengthening the capabilities of IFIs to manage credit and market risks effectively.

Islamic co-operatives and mushārakah mutanāqiṣah financing

Interest in co-operatives, credit unions and co-operative banks is argued to be still minimal in Malaysia. According to Othman et al. (2013), a considerable number of studies have been conducted on other types of enterprises instead, such as the banking industry in Malaysia. It is hoped that this paper will inculcate further interest from industry players that may encourage more research on and understanding of ICs’ operations in adopting Sharīʿah principles.

Mushārakah mutanāqiṣah financing

MM originates from the mushārakah contract. It is a partnership or co-ownership culminating in legal ownership of the underlying asset by one of the partners, which is commonly the customer (Haneef, 2011).

Home financing under MM is a hybrid product that involves multiple contracts, including mushārakah (partnership), ijārah (leasing) and bayʿ (sale), supported by waʿd (promise). As an overview, MM begins with two or three parties (depending on the subject of transaction) who purchase the identified asset as partners. After the purchase, one partner (the financier) will lease its ownership in the mushārakah to the customer. The latter makes a periodic payment (normally monthly) that consists of a rental fee and a redemption payment. The customer will commence using the asset to generate income. Any profits received will be shared between the partner (bank) and the customer according to the prevailing share of the said asset as agreed by each party. As MM is a diminishing partnership, the customer will gradually purchase the bank’s ownership in the said asset. At every subsequent payment, the profits enjoyed by the financier will gradually decrease proportional to the financier’s increased ownership. Once the final payment is made, the MM contract will end and the customer will have full ownership of the asset. The customer will surrender his share in the rental to the bank until the bank’s share is completely liquidated (Hasan, 2011).

Subky et al. (2017) emphasised the challenges of MM implementation, particularly in relation to legal documentation, which may lead to issues that will ultimately have a direct effect on the elements of cost and risk. The authors opined that as Islamic banks are becoming reluctant to provide equity-type financing as a result of the inflexibility of its implementation under current bank regulations, KOPSYA may be a better player in accommodating MM financing.

Meera and Abdul Razak (2005) provided an interesting insight that will also be the basis of this research. The authors suggested that MM is more suitable for house financing under co-operatives since the funds provided by the members are for the benefits of the members only. Under the co-operative structure, MM provides returns to the investing members either in the form of rental or sale of properties. Another eye-opener is indeed their opinion on money creation. The authors opined that MM implementation by co-operatives avoids new money creation because as opposed to the fractional reserve system of banks, contributions by the members of co-operatives are for the members, hence minimising new money creation. Therefore, with profits and losses equally enjoyed and borne by both co-operatives and their members, equity-type transactions may bring a harmonious balance between the monetary sector and the real economy. That would ultimately support the maqaṣīd al-Sharīʿah (objectives of the Sharīʿah).

Meera and Abdul Razak (2009) followed up by identifying issues that need to be addressed in MM implementation that touch upon matters affected by changes in rental rates. Issues of rental review were highlighted, and the authors concluded that changes in rental rates may increase the value of the property. The latter could, in turn, be affected when the property is redeemed either at maturity or in the event of default. Further observation suggests that the rental rate, which should be based on actual value or the rental yield, is seen as lower than the average lending rates. Interestingly, the authors reiterate that while banks may use MM for their Islamic mortgage transactions, mushārakah with the diminishing feature would be more suitable for implementation through co-operatives in addressing the social well-being of their members.

Naim (2011) recommends that the undertaking to purchase should be at market price in the event of default instead of the normal practice of setting it at a pre-determined price or at par value. Nevertheless, in the event an undertaking is imposed in the contract, the mushārakah should not be of a diminishing nature. Instead, it should include the element of ijārah muntahiyah bi al-tamlīk (lease ending with transfer of ownership). Upon maturity, the transfer of assets would be made by way of hibah (gift) upon receipt of the final installment. The author is of the opinion that under the mushārakah structure, if the equity portion is not diminished, the financier can exercise its right over the rental and principal in the event of rental default. This non-diminishing mushārakah can also be used to deal with circumstances arising as a result of property price volatility. Purchase undertaking is one of the much-discussed challenges faced by IFIs. The authors shall later explain the approach undertaken by KOPSYA that may provide a glimpse of the solution to this issue.

Research methodology

To achieve the objective of this research, the qualitative approach was undertaken. One of the methods adopted was a review of available literature on MM in relation to Islamic home financing. In the process, it was found that research materials on Islamic finance issues in Malaysia were abundant with the establishment of several research institutions which have been publishing their research outputs. On the other hand, literature on ICs was quite scarce.

The second method adopted was an interview of a person of authority on Islamic finance in Malaysia to discuss the application of MM by ICs in Malaysia. In particular, the authors had the opportunity to interview the Chief Executive Officer (CEO) of KOPSYA, Dato’ Syed Ghazali Wafa bin Syed Adwam Wafa, to explore the rationale behind the implementation of MM in KOPSYA, MM operations in the co-operative, and how MM benefits the customers. Excerpts from the interview play a pivotal part in achieving the objective of this research, and analyses arising from the said discussion are elaborated further in a later section of this paper.

Discussion and analysis of mushārakah mutanāqiṣah under KOPSYA

In relation to MM as practiced by KOPSYA, the contract has two sections. Once the customer has identified a property to purchase, he will inform KOPSYA. The two parties will then enter into a mushārakah agreement under the concept of shirkat al-milk (joint ownership) whereby both KOPSYA and the customer will contribute a percentage of the purchase price to acquire the property. Usually, the customer will contribute 20 per cent, whereas the balance of 80 per cent will be contributed by KOPSYA. The property identified usually takes the form of tangible assets that can generate returns such as houses, properties or land for development.

KOPSYA and the customer will then enter into an ijārah agreement whereby KOPSYA will lease its portion of the property to the customer and the rentals will be paid on a monthly basis. The rental is calculated as: the principal multiplied by the profit rate (in percentage). The rental will be shared based on the outstanding percentage of ownership of each partner. The percentage of ownership changes after receipt of each rental payment until the outstanding percentage is gradually redeemed. Once the equity portion of KOPSYA is fully redeemed, the full ownership of the property will be transferred to the customer, and by that the MM agreement is terminated.

KOPSYA’s treatment of the rental is different from what is practiced by IFIs. Under IFIs, the principal payment will be used to redeem the ownership percentage, whereas the monthly or periodic rental received is normally captured by the IFI. The differential treatment is simply because IFI’s equity comprises both public and corporate shareholders. On the other hand, the equity holders in KOPSYA are its members, who are also its customers. Therefore, the monthly rentals received are enjoyed by both KOPSYA and the customers.

To illustrate, the following base-case scenario depicts the sharing of profit by both parties (KOPSYA and the customer) and how the shareholding is gradually reduced throughout the financing tenure. The base case shows a typical MM treatment under KOPSYA. For straightforward financing of US$240,000 at the rate of 5 per cent, the customer can obtain a 30-year financing with monthly payment of US$1,667.

Three tables are further illustrated below to describe the effects that these changes may have on the financing tenure. These scenario changes are allowed under KOPSYA’s flexible approach.

Challenges and issues in mushārakah mutanāqiṣah implementation

As previously highlighted in the earlier part of the paper, there are several challenges faced by IFIs for MM implementation. These challenges faced by IFIs are tactically handled by KOPSYA in the following manner.

Conclusion

The paper has highlighted the principles of ownership and willingness to negotiate that are reflected in the concept of partnership in the MM contract. Acknowledging the said principles, co-operatives that are established with the motive of uplifting members’ socio-economic status provide an ideal of fair and equal treatment, both for the co-operatives and for the members. Although the main premise for an organisation is to generate profits, the concept of fairness is still required under the purview of co-operatives and for the sake of achieving the maqaṣīd al-Sharīʿah. Under Sharīʿah, all transactions should be fair, certain and contain no maysir (gambling).

One cannot deny that the government lending full support for the development of Sharīʿah-compliant financing is not merely due to the majority of Malaysians being Muslims but because the Islamic finance industry has proven to bring benefits. It can also be concluded that Sharīʿah-compliant financing has come into existence not only as a complement or alternative but more of a solution (Amin et al., 2004). However, while it is undeniable that KOPSYA’s MM product has received an overwhelming response not only from its members but also from other co-operatives, much-needed awareness must be created at the level of individuals and corporations. It is hoped that this paper will spark further interest in promoting KOPSYA and ICs’ operations, which may directly improve the living standard of the needy.

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