Objections on Musharakah Financing
1. Risk of Loss:
It is contended that the arrangement of Musharakah is more likely to pass on losses of the business to the financier bank or institution. This loss will be passed on to depositors also. The depositors, being constantly exposed to the risk of loss, will not like to deposit their money in the banks and financial institutions and, thus, their savings will either remain idle or will be used in transactions outside the banking channels, which will not ` contribute to the economic development at national level.
This argument is, however, misconceived. Before financing on the basis of Musharkah, the banks and financial institution will study the feasibility of the proposed business for which funds are needed. Even in the present system of interest based loans the banks do not advance loans to each and every applicant. They study not only the financial position of the client, but in some cases they have to examine the potentials of the business and if they apprehend that the business is not profitable, they refuse to advance a loan. In the case of Musharakah, they will have to carry out this study at a wider scale with more depth and precaution, but this extra work will certainly contribute a lot to the betterment of the economy as a whole.
Moreover, no bank or financial institution can restrict itself to a single Musharakah. There will always be a diversified portfolio of Musharakah. If a bank has financed 100 of its clients on the basis of Musharakah, after studying the feasibility of the proposal of each one of them, it is hardly conceivable that all of these Musharakahs, or the majority of them will result in a loss. After taking proper measures and due care, what can happen at the most is that some of them make a loss. But on the other hand, the profitable Musharakahs are expected to give more return than the interest‑based loans, because the actual profit is supposed to be distributed between the client and the bank. Therefore, the Musharakah portfolio, as a whole, is not expected to suffer loss, and the possibility of loss to the whole portfolio is merely a theoretical possibility which should not discourage the depositors. This theoretical possibility of loss in a financial institution is much less than the possibility of loss in a joint stock company whose business is restricted to a limited sector of commercial activities. Still, the people purchase its shares and the possibility of loss does not refrain them from investing in these shares. The case of the bank and financial institutions is much stronger, because their Musharakah activities will be so diversified that any possible loss in one Musharakah is expected to be more than compensated by the profits earned in other Musharakahs. No guarantee even of the principal is provided to the depositors by the banks, and, thus, the liabilities side of our present banks is fully equity‑based. Still, the deposits are being made as before.
Apart from this, an Islamic economy must create a mentality which believes that any profit earned on money is the reward of bearing risks of the business. This risk may be minimized through expertise and diversifying the portfolio where it may become a hypothetical or theoretical risk only. But there is no way to eliminate this risk totally: The one who wants to earn profit, must accept this minimal risk. Since this understanding is already there in the case of normal joint stock companies, nobody has ever raised the objection that the money, of the shareholders is exposed to loss. The problem is created by the system that separates the banking and financing from the normal trade activities, and which has compelled the people to believe that banks and financial institutions deal in money and papers only, and that they have nothing to do with the actual results emerging in trade and industry. It is this basic premise on the basis of which it is argued that they deserve a fixed return in any case. This essential separation of financing sector from the sector of trade , and industry has brought great harms to the economy at macro‑level. Obviously, when we speak of Islamic banking, we never mean that it will follow this conventional system in each and every respect. Islam has its own values and principles which do not believe in separation of financing from trade and industry. Once this Islamic system is understood, the people will invest in the financing sector, despite the theoretical risk of loss, more readily than they invest in the profitable joint stock companies.
Another apprehension against Musharakah financing is that the dishonest clients may exploit the instrument of Musharrakah by not paying any return to the financiers. They can always show that the business did not earn any profit. Indeed, they can claim that it has suffered a loss in which case not only the profit, but also the principal amount will be jeopardized.
It is, no doubt, a valid apprehension, especially in societies where corruption is the order of the day. However, solution to this problem is not as difficult as is generally believed or exaggerated.
If all the banks in a country are run on pure Islamic pattern with a careful support from the Central Bank and the Government, the problem of dishonesty is not hard to overcome. First of all, the system of credit rating will have to be implemented with full force. Every company or corporate body should be compelled by law to subject itself to an independent credit rating. Even the big firms seeking finance above a certain level may also be subjected to the same rule. Secondly, a well designed system of auditing should be implemented whereby the accounts of all the clients are fully maintained and properly controlled. According to some contemporary scholars, profits may be calculated on the basis of gross margins only. It will reduce the possibility of disputes and misappropriation. However, if any misconduct, dishonesty or negligence is established against a client, he will be subjected to punitive steps, and may be deprived of availing any facility from any bank in the country, at least for a specific period.
These steps will serve as strong deterrent against concealing the actual profits or committing any other act of dishonesty. Otherwise also, the clients of the banks cannot afford to show artificial losses constantly, because it will be against their own interest in many respects. It is true that even after taking all such precautions, there will remain a possibility of some cases where dishonest clients may succeed in their evil designs, but the punitive steps and the general atmosphere of the business will gradually reduce the number of such cases. (Even in an interest based economy, the defaulters have always been creating the problem of bad debts). But it should not be taken as a justification, or as an excuse, for rejecting the whole system of Musharakah.