THE LEGAL NATURE OF THE MUSHARAKA CONTRACT AND ITS REGULATORY FUNCTION WITHIN ISLAMIC BANKING LAW

Abstract

This article examines the legal nature of the musharaka partnership contract—one of the core Shariah-compliant modes of profit-and-loss sharing (PLS)—and its regulation in modern Islamic banking. Musharaka (from shirkah, “partnership”) is a joint-venture arrangement in which partners contribute capital and share profits according to a pre-agreed ratio, while losses are borne in proportion to capital. Rooted in Qur’anic and Prophetic principles and unanimously accepted by classical Sunni jurists, musharaka historically underpinned commercial partnerships in trade and maritime ventures.

Yet contemporary Islamic banks rely far more on debt-like instruments such as murabaha, while musharaka forms only a modest share of financing—for example, about 22% of Indonesian Islamic bank portfolios versus over 60% in murabaha. This reflects operational complexity, information asymmetry, higher agency and credit risks, and prudential rules that assign very high risk-weights to equity-based financing.

The study outlines key fiqh requirements for musharaka, examines its main structures (including project finance, working-capital partnerships and diminishing musharaka), and evaluates regulatory approaches and international standards (AAOIFI, IFSB, IIFA). It concludes that harmonized regulation, effective risk-mitigation tools and stronger governance are essential to enhance the practical viability of PLS via musharaka in Islamic banking.