Islamic Finance Instruments gif


only takes on responsibility for the manage- ment of the enterprise, while all the financial capital investment comes from Rabb-ul-mal. Under certain situations where the Mudarib wants to invest financial capital into the busi- ness managed by a Mudarabah contract, an innovative new Islamic finance offering can be used.


This is a combination of two Islamic finance products; namely, Mudarabah and Mushar- akah. Musharakah is a Shariah-compliant Islamic investment partnership in which prof- it sharing terms are agreed in advance, and losses are pegged to the amount invested.


When Musharakah and Mudarabah are combined, the investing partner (the Rabb- ul-mal) invests a given amount, and the en- trepreneur adds a contribution from his or her own pocket with the permission of the Rabb-ul-mal. This type of partnership is treated as a combination of Mushar- akah and Mudarabah. Under this part- nership, Mudaribs may allocate them- selves a certain percentage of profit due to investment as a Sharik, and at the same time may allocate another percentage for his or her management and work as a Mudarib. The parties may agree on any other proportion. The only condition is that the sleeping partner should not receive a higher percentage than is proportional to their investment.


Mudarabah’s conventional Counterpart Over the years, Mudara- bah has become a core offering of Islamic financ- ing, and many agree- ments in the Middle East use this practice. Its conventional counter- part - project financing via Mudarabah - is com- monly known as “Angel investment”. The under- lying difference between a Mudarabah and Angel


investment is that a Mudarabah follows Islamic law, which prohibits interest based financing. The modalities of a Mudarabah agreement are quite similar to Angel invest- ment procedures. Both methods are means of Angel financing, and involve a partnership whereby one of the partners provides invest- ment capital for a business.


The partner investing capital is termed an “Angel Investor” rather than a “Rabb-ul-Mal,” and the entrepreneur looking to build a busi- ness is referred to as the Mudarib. In both cases, the investor does not usually partici- pate in the day-to-day management issues.


Similarly to Mudarabah, Angel investment can also include different types of partner- ships. All parties involved must agree, from the commencement of the contract, on the


Figure B: Simple Mudarabah Structure


Rabb al-Maal (Investor)


Mudarib (Manager)


proportion of the profit and the loss that each party is responsible for. The agreement can also contain provision for different returns based on the level of work; for example, set percentages may be different for businesses which operate in multiple regions.


Issues in Mudarabah Mudarabah is among the most preferable modes of financing, and is heavily recom- mended by scholars and Ulema. However, but like all other modes it has its fair share of implementation difficulties. One major is- sue affecting the applicability of this financ- ing mode isits perception as a very high-risk financing activity. In short, from a borrowers perspective, Mudarabah (as opposed to debt or equity financing) is possibly the best finance-related risk-return framework. From a financier’s perspective, on the other hand, Mudarabah financing is not very attractive as expected returns are low and risk is relatively high.


Funds


Mudarabah (Join Venture)


Project Management Source: Junaid Mirza 2008, Islamic Finance Advisory Board


This is because Mudarabah financing re- quires the financier to absorb all losses, while sharing all profits. This inequality in the distribution of risk and returns en- hances the risk profile of Islamic banks. Collateral can be asked for, but cannot be used in the case of real loss. Second- ly, the existing competencies of Islamic banks in project evaluation and related techniques are limited, and no legal mechanism for treatment with Mudara- bah has yet been set out.


Figure C: Relationship of Depositors and Islamic Bank in Mudarabah Agreement


Deposits Depositors


Mudarabah Profit & Loss Sharing


Profit Source: http://www.slideshare.net/ISEConsult/eoif-mudarabah-musharakah References and Further Reading:


• Bacha, Obiyathulla I. (1997): Adapting Mudarabah Financing to Contemporary Realities: A Proposed Financing Structure. Published in: The Journal of Accounting, Commerce & Finance; Islamic Perspective , Vol. 1, No. 1 (1997): pp. 26-54. • Junaid Mirza 2008, Islamic Finance Advisory Board • Azhar Nadeem 2010, Islamic Business Contracts -A Case of Mudaraba, MPRA Paper No. 27194, posted 03. December 2010 / 14:13 • Mufti Taqi Usmani – An Introduction to Islamic Finance • Muhammad Zubair Usmani, Sharia Advisor Muslim Commercial Bank Pakistan, Concept of Mudarabah


2011 February Global Islamic Finance 71 Islamic Bank


Thus, although the Mudarabah form of agreement is a highly recommended, Shari- ah-compliant mode of financing, it must be fur- ther tailored in order to generate an attractive low-risk and high reward mode of Islamic financ- ing.


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