Bank Financing via Partnership

Islamic law prohibits usury and the payment or charging of interest. An alternative method of financing projects and ventures permitted by Islamic law is by means of Partnership. An Islamic bank may act as a Sleeping Partner supplying capital to the customer for the purchase of goods, sharing in the profits or losses (at the agreed ratio) once these goods are sold on. The rules for termination, dissolution and liquidation are the same whether or not a bank a partner.

Diminishing Partnership

An Islamic bank may also participate in investment activity or projects by means of a Diminishing Partnership, under which both it and one or more partners (bank customers) contribute capital. Shares are issued to the bank which the bank may sell back to the other partner(s) (provided they are prepared to and willing to buy them) once the activity or project is under way. The price of the shares is a market price subject to negotiation. The bank shares together with its ownership claim diminishes as the other partner(s)’ increases.

Dissolution & Liquidation of Diminishing Partnership

Diminishing partnerships may be rendered binding by contract for a period of time, in which case they end at expiry of that time. They may be dissolved if no such stipulation is made or under the following circumstances:

  • agreement of the partners
  • incapacity or death of on or more partners the heirs or executors of which choose to discontinue
  • insolvency of one or more partners
  • when the purpose of the partnership is achieved

The rank order of obligations discharged upon dissolution is as follows:

  • obligations of the partnership
  • capital shares
  • profits if any are paid pursuant to the partnership contract
  • loss
    • is first paid out of the profits made
    • if insufficient, the capital of the partnership is used to pay
    • if insufficient, the partners are personally liable to pay in proportion to their shares in the capital

The Diminishing Partnership may also finance the purchase of a house, in a manner functionally equivalent to a mortgage.