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preciate the importance of a clear under- standing of the principles of Islamic finance, which are based on the solid foundation of Islamic contract law. Mudarabah is one of the key Shariah compliant products, and its modalities are explored and discussed in this article.


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The term Mudarabah is derived from the Arabic root word ‘darbun,’ which means jour- ney, and in this case it refers to the journey of seeking a trade or employment. Mudara- bah is an Islamic finance product offering. It is based on a special kind of partnership, whereby one partner (a company or indi- vidual) provides capital to another partner (the beneficiary, entrepreneur or borrower) by way of investing it in a commercial enter- prise.


Mudarabah is a mode of finance commonly used by Islamic banks, and can be used in two different ways. Firstly, the bank can build a relationship with depositors, who provide money for investment by the bank, on the basis of a pre-agreed profit and loss sharing ratio. Alternatively, Islamic banks can also use this mode of Shariah-compliant financing in order to provide capital to a busi- ness. This can be used for practices such as financing for a large enterprise or project, business ventures and private equity.


Parties involved in the Mudarabah con- tract


Essentially, a Mudarabah contract is an agreement between two parties. One of the partners, known as the “Rabb-ul-mal,” pro- vides the capital, and the other partner, known as the “Mudarab,” contributes entre- preneurial skills to the enterprise .


The Rabb-ul-Mal, or capital provider, is usu- ally the sleeping partner, while the Mudarib is the working partner or manager of the enterprise. . The Mudarib’s exclusive re- sponsibility is the investment of his exper- tise in the operation of the venture. Profits generated by the venture are shared in a predetermined ratio. The Rabb-ul-Maal has the authority to oversee Mudarib’s activities, and to work with the Mudarib if the Mudarib provides consent.


If there are more than one Mudaribs in a Mudarabah agreement, the capital invested is to be utilised by both of them jointly. The share of the Mudarib is distributed between them according to a pre-agreed proportion. The Mudaribs involved should run the busi- ness as if they were partners inter se, and


he burgeoning Islamic finance industry offers a range of diversi- fied and innovative Shariah-com- pliant product lines. The current upsurge of demand for Islamic finance options makes one ap-


they are authorised to do anything which is normally done in the regular course of business. However, if they want to take an extraordinary step, which is beyond the normal range of trade, they must gain due permission from the Rabb-ul-mal. In modern Islamic finance, Mudarabah agreements are usually based on a two-tier system. Multiple depositors or investors deposit money into an Islamic bank. The Islamic bank then acts as the investor for a variety of entrepreneurs, and shares profits and losses with the origi- nal first-tier bank depositors.


Islamic banks usually assume a dual role, acting both as Mudarib and as the inves- tor. Islamic banks thereby form a credible intermediary, ideally positioned to build up a formidable risk capital contributed by small, medium or large investors/depositors. Not only that, but they are also privy to many lucrative investment opportunities through which this risk capital could be profitability deployed.


Types of Mudarabah Broadly speaking there are two types of Mudarabah agreements: namely, Restricted Mudarabah (Al Mudarabah Al Muqayyadah), and Unrestricted Mudarabah (Al Mudara- bah Al Mutlaqah). In the case of Restricted Mudarabah, the Rabb-ul-Maal may specify a particular business or a particular place, which binds the Mudarib to invest the money in that particular business or place.


The other type of Mudarabah is the Un- restricted Mudarabah. In this contract, the Rabb-ul-maal gives full freedom to the Mudarib to undertake whatever business s/he deems fit. The only restrictions on the Mudarib’s activities are that s/he is not authorised to keep another Mudarib or a partner, or mix his own investment in that particular Mudarabah without the consent of Rabb-ul Maal.


Investment and profit destribution Capital invested in Mudarabah can either be in cash or in kind. The Shariah law does not prescribe a particular proportion of profit sharing in a Mudarabah agreement, leav- ing the decision up to the mutual consent of parties involved. Profit can be shared in equal proportions, or can be allocated in dif- ferent proportions for the Rubb-ul-mal and the Mudarib.


If the capital is in kind, its previous valua- tion is essential, and without valuation the Mudarabah becomes void. In order to ensure the validity of the Mudarabah contract it is necessary that the parties involved agree, right at the beginning of the contract, on a definite decided proportion of the actual profit to which each one of them is entitled. Profit can be shared at any ratio which the


parties agree upon. In the case that parties enter into a Mudarabah agreement without previously deciding upon the exact propor- tions of the profit, it is presumed that they will share the profit in equal proportion. The direct expenses of the Mudarabah are borne by the Mudarabah pool, and indirect expens- es are borne by the Mudarib.


Under a Mudarabah agreement, it is not pos- sible to pre-determine a lump sum amount of profit allocation, or pre-determined share of any party at a specific rate tied up with the capital. For instance, if the capital is GBP 100,000 and the parties cannot agree on the condition that a given amount of the profit – say, for instance, GBP 10,000 - shall be the Mudarib’s share, parties cannot also say that 20 per cent of the capital shall be given to the Rabb-ul-mal. However, under the Mudarabah agreement they can agree on the terms that 40 per cent of the actual profit shall go to the Mudarib and 60 per cent to the Rabb-ul-mal.


The Shariah law permits previous allocation of different proportions of profit for differ- ent situations. For example, the Rubb-ul-mal may get 50 per cent of a wheat commodity trading profit, and 30 per cent of the flour trading profit. The Mudarib cannot claim any periodical salary, fee or remuneration for the work done.


Furthermore, if the business incurs a loss in one transaction, but has gained profit in another, the profit made in the second trans- action shall be used to offset the losses made in the first. If there is any remainder, it should be distributed between the parties according to the pre-agreed ratio.


Termination of a Mudarabah contract: A Mudarabah agreement is subject to ter- mination at any time, by any of the parties involved, provided that due notice is given to the other party. If all of Mudarabah’s assets are in cash at the time of the termination, any profit earned on the principle amount shall be distributed between the parties according to the pre-determined ratio. How- ever, if at the time of termination the assets of the Mudarabah are not in cash form, the Mudarib is to be given an opportunity to sell or liquidate those assets, so as to objectively determine the distribution of actual profit.


There is disagreement among Islamic schol- ars over the question of whether a Mudara- bah contract can include a limited term. Some jurists say that the contract must be open-ended in order to comply with Islamic law. There seems to be general agreement, however, that contracts cannot come with minimum terms. The restriction of a Mudara- bah contract termination to a particular max- imum term time, such as one or two years, is


2011 February Global Islamic Finance 69


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