What is Mudaraba in Islamic Finance and Banking?

Types of Mudaraba: There are two types of Mudaraba, and they are mentioned below:

(one). Al-Mudaraba Al-Muqayadah:

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

(two). Al-Mudaraba Al-Mutlaqah:

However, if Rab’ul-Maal gives Mudaarib full freedom to undertake whatever business he sees fit, this is called Al Mudaraba Al Mutlaqah (Unrestricted Mudaraba). However, Mudaarib cannot, without Ra’ul-Maal’s consent, lend money to anyone. Mudaarib is authorized to do anything, which is normally done in the course of business. However, if they want to have an extraordinary job, which is beyond the normal routine of merchants, he cannot do it without the express permission of Rab’ul-Maal. He is also not authorized to:

a) keep another Mudaarib or a partner

b) mix their own investment in that particular Modarabah without the consent of Rab-ul Maal.

The Conditions of Offer and Acceptance are applicable to both. A Rab’ul-Maal can contract Mudaraba with more than one person through a single transaction. It means that he can offer his money to ‘A’ and ‘B’ for each of them to act on his behalf as Mudaarib and the capital of Mudaraba will be used by both jointly, and Mudaarib’s share.

Difference Between Musharaka and Mudaraba

(one). In Musharaka, all partners invest, however, in Mudaraba Finance, only Rab’ul-Maal invests.

(two). At Musharaka, all partners participate in running the business and can work for it. However, in Mudaraba, Rab’ul-Maal does not have the right to participate in management that is carried out solely by Mudaarib.

(3). In Musharakha, all partners share in the loss to the extent of their investment ratio. But in Mudaraba, only Rab’ul-Maal suffers losses because Mudaarib does not invest anything. However, this is subject to the condition that Mudaarib has done due diligence.

(4). In Musharaka, the liability of the partners is normally unlimited. If the company’s liabilities exceed its assets and the company goes into liquidation, all partners will pay all excess liabilities pro rata. But if the partners agree that neither partner will incur any debt during the course of the business, then the excess liabilities will be borne only by the partner who has incurred a debt in the business in violation of the above condition. However, in Mudaraba, Rab’ul-Maal’s liability is limited to his investment unless he has allowed Mudaarib to incur debts on his behalf.

(5). Once the partners pool their capital into a common fund in Musharaka, all assets become jointly owned by all partners, according to their respective investment ratio. All partners benefit from the appreciation in asset value, even if the profit has not increased through sales. In the Mudaraba financing, the goods purchased by Mudaarib are the sole property of Rab’ul-Maal and Mudaarib can earn his share of the profits only in case he sells the goods profitably.

Profit and Loss Distribution

It is necessary for the validity of Mudaraba that the parties agree, from the outset, on a definite proportion of the actual profit to which each of them is entitled. Sharia has not prescribed any particular ratio; rather it has been left to their mutual consent. They can share the profits in equal proportions and can also allocate different proportions for Rab’ul-Maal and Mudaarib. However, in the extreme case where the parties have not predetermined the profit ratio, the profit will be calculated at 50:50.

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

Different ratios are also allowed to be agreed upon in different situations. For example, Rab’ul-Maal may say to Mudaarib: “If you trade in wheat, you will get 50% of the profits, and if you trade in flour, you will get 33% of the profits.” Similarly, he can say “If you do the business in your city, you will be entitled to 30% of the profit and if you do it in another city, your share will be 50% of the profit.”

Apart from the agreed proportion of the profit, as determined in the above manner, the Mudaarib cannot claim any regular salary or fee or remuneration for the work done by him for the Mudaraba. All schools of Islamic Fiqh are unanimous on this point. However, Imam Ahmad has allowed Mudaarib to draw his daily food expenses only from the Mudaraba Account. Hanafi jurists restrict this right of the Mudaarib only to a situation where he is on a business trip outside his own city. In this case he can claim his personal expenses, accommodation, food, etc. but he is not entitled to receive anything like daily allowances when he is in his own city.

If the company has incurred a loss in some operations and has obtained a profit in others, the profit will be used to compensate the loss in the first instance, then the rest, if any, will be distributed among the parties according to the agreed proportion.

The Mudaraba is nullified (Fasid) if the gain is fixed in any way. In this case, the total amount (Profit + Capital) will be from Rab’ul-Maal. The Mudaarib will be just an employee who earns Ujrat-e-Misl. The remaining amount will be called (Benefit). This benefit will be distributed in the agreed proportion (pre-agreed).

Uses of Musharaka/Mudaraba:

These modes can be used in the following areas (or can be replaced according to Shariah rules).

Asset Side Financing

– Financing at any term
– Project financing
– Financing installation of small and medium enterprises
– Financing of large companies
– Financing of imports
– Import invoices drawn under import L/C
– Internal letters drawn under internal letter of credit
– Bridge financing
– LC without margin (for Mudarba)
– LC with margin (for Musharaka)
– Export Financing (Pre-Shipment Financing)
– Financing of working capital
– Financing current accounts / short-term advances

Liability Side Financing

– For checking/savings/monthly benefits/investment accounts (benefits that grant deposits based on Musharkah/Mudaraba – with a predetermined ratio)
– Loans/interbank loans
– Term Financing 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 that require large amounts – profit based on project performance)