What Is Mudaraba in Islamic Finance and Banking?

Types of Mudaraba: There are two types of mudaraba mentioned below:

(1). Al Mudaraba Al-Muqayadah:

Rab’ul-Maal can designate a specific business or place for the Mudaarib, in which case he will invest the money in that specific business or place. This is called Al Mudaraba Al-Muqayadah (Restricted Mudaraba).

(2). Al Mudaraba Al Mutlaqah:

However, when Rab’ul-Maal gives Mudaarib full freedom to engage in whatever business he sees fit, this is called Al Mudaraba Al Mutlaqah (unrestricted Mudaraba). However, Mudaarib cannot lend money to anyone without Rab’ul-Maal’s consent. Mudaarib is authorized to do whatever is normally done in business dealings. However, if they wish to have an exceptional work beyond the normal routine of the traders, he cannot do so without Rab’ul-Maal’s express permission. He is also not authorized:

a) keep another mudarib or partner

b) to shuffle one’s own investment in that particular Modarabah without Rab-ul Maal’s consent.

Offer and acceptance conditions apply to both. A Rab’ul-Maal can assign Mudaraba to more than one person in a single transaction. This means he can offer his money to both ‘A’ and ‘B’, so either of them can trade for him as Mudaarib and the capital of the Mudaraba is shared between both, and the Mudaarib’s share.

Difference between Musharaka and Mudaraba

(1). All partners invest in Musharaka, but only Rab’ul-Maal invests in Mudaraba Finance.

(2). In Musharaka, all partners participate in the management of the company and can work for it. However, in Mudaraba, Rab’ul-Maal has no right to participate in the administration, which is carried out only by the Mudaarib.

(3). In Musharakha, all partners share the loss in proportion to their investment. But in Mudaraba only Rab’ul-Maal suffers losses because the Mudaarib does not invest. The prerequisite for this, however, is that the Mudaarib has worked with due care.

(4). In musharaka, partners’ liability is usually unlimited. If the company’s liabilities exceed its assets and the company goes into liquidation, all the excess liabilities are to be borne proportionately by all shareholders. However, if the shareholders agree that no shareholder should incur debts in business transactions, the additional liabilities are to be borne solely by the shareholder who, contrary to the above condition, has incurred debts from the company. However, in Mudaraba, Rab’ul-Maal’s liability is limited to his investment unless he has allowed the Mudaarib to incur debt on his behalf.

(5). Once the partners pool their capital in a common pool in Musharaka, all assets are jointly owned by all partners according to the proportion of their respective investment. All partners benefit from the increase in the value of the assets, even if no profit has been made from sales. In mudaraba finance, the goods purchased by the mudarib are the sole property of Rab’ul-Maal and the mudarib can only earn his share of the profits by selling the goods for a profit.

Distribution of profit and loss

For mudaraba to be valid, the parties must agree at the outset on a specific share of the actual profits due to each of them. Sharia has not prescribed any particular ratio; rather it was left to their mutual consent. They can share the profit equally and they can also share different shares for Rab’ul-Maal and Mudaarib. However, in the extreme case, when the parties have not predetermined the winning ratio, the winnings are calculated as 50:50.

The Mudaarib & Rab’ul-Maal cannot allocate a lump sum profit amount to any party, nor can they determine a party’s share at a particular rate associated with the capital. For example, if the capital is £10,000 they cannot agree on a condition that £1,000 of the profits shall be the Mudaarib’s share, nor can they say that 20% of the capital goes to Rab’ul-Mal. However, they can agree that 40% of the actual profit should go to the Mudaarib and 60% to the Rab’ul-Maal or vice versa.

It is also permissible for different proportions to be agreed in different situations. For example, the Rab’ul-Maal may say to Mudaarib, “If you trade in wheat, you will receive 50% of the profit and if you trade in flour, you will receive 33% of the profit.” Likewise, he can say, “If you do that If you do business in your city, you are entitled to 30% of the profits, and if you do it in another city, your share is 50% of the profits.”

Apart from the agreed share of profits as determined above, the Mudaarib cannot claim any regular salary or any fee or remuneration for the work he has done for the Mudaraba. All schools of Islamic fiqh agree on this point. However, Imam Ahmad has allowed the Mudaarib to draw his daily food expenses from the Mudaraba account only. The Hanafi jurists limit this right of the Mudaarib to only one situation when he is on a business trip outside of his own city. In this case, he can claim his personal expenses, room, board, etc., but is not entitled to daily allowances if he is in his hometown.

If the company has suffered losses on some transactions and gained profits on others, the profit will first be used to offset the loss, then any remainder will be divided according to the ratio agreed between the parties.

The mudaraba becomes void (fasid) if the win is fixed in any way. In this case, the total amount (profit + capital) is the Rab’ul Maal. The Mudaarib will only be an employee deserving of Ujrat-e-Misl. The remaining amount is called (profit). This profit is shared in the agreed (pre-agreed) ratio.

Use of Musharaka/Mudaraba:

These modes can be used in the following areas (or replace them according to Sharia rules).

Asset-Side Financing

– Any term financing

– Project financing

– Start-up financing for small and medium-sized companies

– Financing large companies

– Import financing

– Import invoices drawn under Import L/C

– Domestic invoices drawn under Domestic L/C

– Bridge financing

– LC without border (for Mudarba)

– LC with border (for musharaka)

– Export financing (pre-shipment financing)

– Working capital financing

– Current account funding/short-term advances

Liability side financing

– For checking/savings/monthly profit/investment accounts (deposit profit based on Musharkah / Mudaraba – with predetermined ratio)

– Interbank lending/borrowing

– Term Finance Certificates and Investment Certificate

– T-Bill and Federal Investment Bonds/Debentures

– Securitization for large projects (based on Musharkah)

– Investment certificate based on Murabahah

– Islamic musharaka bonds (based on projects requiring large sums – profit based on the return on the project)

Thanks to Haris Ahmed | #Mudaraba #Islamic #Finance #Banking