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Mudarabah on Shari'ah Ruling

Q. What is Mudarabah?

1. Mudarabah:

The term refers to a form of business contract in which one party brings capital and the other personal effort. The proportionate share in profit is determined by mutual agreement. But the loss, if any, is borne only by the owner of the capital, in which case the entrepreneur gets nothing for his labour. The financier is known as ‘rabal-maal’ and the entrepreneur as ‘mudarib’. As a financing technique adopted by Islamic banks, it is a contract in which all the capital is provided by the Islamic bank while the business is managed by the other party. The profit is shared in pre-agreed ratios, and loss, if any, unless caused by negligence or violation of terms of the contract by the ‘mudarib’ is borne by the Islamic bank. The bank passes on this loss to the depositors.

2. Mudarabah:

We may act as managing trustee (‘Modareb’) while you are the beneficial owner (Rab El-Maal). It is our responsibility to invest the funds that you provide. Alternatively, our roles may be reversed, when you, as managing trustee, are responsible for investing our funds. In each case, we shall agree on our relative share of any profits.

3. Mudarabah:

In the theoretical model of Islamic banking Mudaraba has been suggested a technique which shall provide the basis for the Islamic re-organisation of commercial banking sector. In actual practice of Islamic banking, Mudaraba has not made much progress on t he asset side of the balance sheet, although on the liability side the Islamic banks on Mudaraba accept the funds in investment accounts. Mudaraba is mostly translated in English as profit and loss sharing.

There is no loss sharing in a Mudaraba contract. Profit and loss sharing is more accurate description of the Musharaka contract. The Mudaraba contract may better be represented by the expression profit sharing Mudaraba is an Islamic contract in which one party supplies the money and the other provides management in order to do a specific trade. The party supplying the capital is called owner of the capital. The other party is referred to as worker or agent who actually runs the business. In the Islamic Jurisprudence, different duties and responsibilities have been assigned to each of these two.

As a matter of principle the owner of the capital does not have a right to interfere in to the management of the business enterprise which is the sole responsibility of the Agent x. However, he has every right to specify such conditions that would ensure better management of his money. That is why sometime Mudaraba is referred as sleeping partnership. An important characteristic of Mudaraba is the arrangement of profit sharing. The profits in a Mudaraba agreement may be shared in any proportion agreed between the parties before hand. However, the loss is to be completely borne by the owner of the capital. In case of loss, the capital owner shall bear the monetary loss and agent shall lose the reward of his effort. Mudaraba could be individual or joint.

Islamic banks practice Mudaraba in its both forms. In case of individual Mudaraba an Islamic bank provides finance to a commercial venture run by a person or a company on the basis of profit sharing. The joint Mudaraba may be between the investors and the bank on a continuing basis. The investors keep their funds in a special fund and share the profits without even the liquidation of those financing operations that have not reached the stage of final settlement. Many Islamic Investment Funds operate on the basis of joint Mudaraba.

4. Mudarabah:

This is an agreement made between two parties: one which provides ‘100 percent of the capital’ for the project and another party known as a ‘Mudarib’ who using his entrepreneurial skills, manages the project. Profits arising from the project are distributed according to a predetermined ratio. Any losses accruing are borne by the provider of capital. The provider of capital has no control over the management of the project.

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Q - Is it lawful for the investor to seek from the contractor (agent-manager) payment of a specific percentage of the contract (for the deal the agent-manager is to undertake as his/her part of the mudarabah operation) in addition to (the agreed upon return from) the capital invested? Regardless of the amount financed, and regardless of whether the operation is profitable or not?

W.Q
Saudi Arabia

A - Such a contract will not be valid because it includes the agent-manager's liability for the capital investment; when the agent-manager is no more than a trustee of the capital and cannot be made liable for it unless he/she has been negligent or incompetent in its use. Secondly, the investor's stipulating that the agent-manager pay a certain amount; when such a condition invalidates the contract because it means that the two partners will not share in the profits.

Q - Where an Islamic Bank owing to its position in the international banking community, undertakes mudarabah operations in partnership with several other banks and financial institutions, some of which are Islamic and some of which are not. And that the bank serves as agent-manager for the group, using the funds they invest to purchase goods and then sells them by means of murabahah, such that the bank authorizes an international firm, as its agent, to purchase goods on behalf of the bank by means of a murabahah sales contract with that company. Is this permitted under the Shariah?

H.Y
Geneva

A - The jurists of all the major legal schools are agreed on the legitimacy of mudarabah transactions. In this regard they cite texts from the Qur'an and the Sunnah. In the Qur'an, the root for the word mudarabah, d-r-b, is used in a verse that clearly indicates the lawfulness of trade: And others who go forth in the earth, seeking the bounty of the Almighty (73:20). In the Sunnah, it is related that Ibn 'Abbas said, "Our tribal leader, al 'Abbas ibn 'Abd al Muttalib, whenever he paid money out in mudarabah, would stipulate to his partner that he must not cross over water with his money, or make camp in a dry riverbed, or buy a fractious mount with it. If his partner did any of those things, he would be held personally responsible. When news of these conditions reached the Prophet of Allah, upon him be peace, he endorsed them."

Given the lawfulness of mudarabah from a Shari'ah perspective, the Board sees no impediment to the bank's purchasing goods on the international market with funds gathered from other Islamic banks and financial institutions in partnership, and then its assuming the responsibility of managing the operation (as agent-manager) as a mudarabah in which it also participates as an investor, regardless of whether its dealings are undertaken on a short or a long-term basis, or take the form of either a sale of trust, such as murabahah, or an ordinary bargained sale.

Q - Is it lawful for the bank to charge its client for consultative services ordered by the bank for the study of a project's feasibility before investing in it with, or for, its client by means of mudarabah?

M.A
Jordan

A - There is no legal impediment to taking payment from a client in return for actual consultation presented to the bank in regard to the study and evaluation of projects for mudarabah, musharakah, ijarah, etc. Services performed after a contract has been signed, however, will be shared equally by the client and the bank; except in regard to interest-free loans in which case all fees will be paid by the client alone after the contract has been signed.
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Q - What is the Shari'ah ruling in regard to the bank's paying zakah on the profits earned by investors in mudarabah operations?

P.Z
Egypt

A - There is no legal impediment to the bank's paying zakah from the accounts of its investors so long as it does so with the approval of investors who have authorized it in writing to deduct their zakah portions from their investment accounts; either from their profits or, if no profits are realized, then from the capital investment itself.

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Q - It is a well-established fact in international economics that the greater the amount of capital invested, the greater the profits that may be expected. Will it be lawful, therefore, to combine the capital from two or more mudarabah operations in a single investment vehicle, especially when the mudarabah operations are managed by a single firm?

A.M
Cayman Islands

A - The Board sees no legal impediment to combining the capital from two or more mudarabah operations in a single account that is maintained in accordance with the Shari'ah of Islam, so long as the profits and losses are distributed in proportion to the percentage of each shareholder's investment in the mudarabah.
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Q - To what extent will it be lawful to include the following condition in a contract for an investment savings account: The minimum daily balance acceptable for participation in investment schemes will be one hundred Dinars. If the balance falls below that amount, the account will become a regular current account, and will no longer be subject to the rules for a mudarabah investment.

R.H
France

 

 

A - There is no legal impediment to placing a minimum on the daily balance in the conditions of the contract. If the balance falls below one hundred, the account will be treated like an ordinary current account because a musharakah may be dissolved by means of such a condition.

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Q - Is it lawful to transfer mudarabah contracts from one agent manager to another, when there is an express or implicit approval for the same, and/or the transfer is agreed to either, individually or collectively by the investing partners in their capacity as the benefiting owners.

M.J
India

 

 

A - It is lawful to transfer mudarabah contracts in the light of the legal principle which states that the agent-partner in mudarabah transactions may be engaged under the following conditions:

a) The investors will not have to pay for the second agent-partner brought in by the first. Rather the two will share in the percentage of the profit specified for the first agent-partner and agreed to by the investor(s).

b) Since the mudarabah contract is not legally binding, it may be dissolved at will by either of the contracting parties.

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Q - Is it lawful for the bank in a mudharabah sale transaction, to invest in one of its accounts, a deposit (representing 5% of the value of the sale transaction) paid in by the purchase pledger as a guarantee of payment.

M.S
USA

A - Such an investment is not lawful, regardless of whether the deposit is kept in a current account or in an investment account. This is because the deposit is a (the client's) guarantee against payment and, if it is to be invested, it should be invested to the benefit of the client.
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Q - Is the practice of the bank lawful, in coming to an agreement with its clients on an amount that will serve as a ceiling for their transactions over a specified period of time. And within the framework of that agreement, dealings are undertaken with the client by means of murabahah in which the amount of profit is specified in advance of purchases, and on a deal to deal basis. Is this practice in accordance with the Shariah?

S.A.O
Switzerland

A - There is no legal impediment of setting limits on the extent the bank is willing to Finance a client in their original agreement, or to specify the percentages of profit for each and every murabahah deal when the bank receives the client's order, in the understanding that the order represents the clients pledge to purchase. A pledge to buy, however, is not the same as a sale, but rather a binding agreement to but at the time the sale is ready to be completed.
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Q - Will it be lawful to distribute monthly or periodical profits to investors in long- term mudarabah operations that will not yield returns until after the passing of several years?

I.M
U.K

 

A - There is no legal impediment to an agent-manager's distribution of profits from long term mudarabah operations to investors, by periodically paying investors in the for of interest free loans guaranteed by their capital investments. The periods for such payments may be determined by the agent manager. Furthermore the loans will be debited at the final accounting of the profits.

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Q - How is the share of profits for each of the parties in a mudarabah operation to be determined?

I.A
Sharjah, UAE

A - It is legally required that whatever is specified as profit for both the bank (the agent-manager) and the investor (the bank's client) be for-mulaled precisely from the joint share, that it be known to both parties, and that it remain intact throughout the mudarabah operation period. Such a determination, moreover, must be included in the mudarabah contract either at the time it is entered into or when it is renewed. If the profit percentage is to be changed in the future, prior notification of such a change must be made, and a period of time must be set, the passing of which will be taken to indicate the investors agreement to the change if he/she has not objected (to it by that lime).
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Q - Is it lawful for the working partner in a mudharabah operation to sell the possessions of the financing partner without seeking the permission of the partner?

I.N
India


A - It is not lawful for the working partner in mudarabah to sell his own possessions in exchange for mudarabah money (that he is administering), regardless of whether those possessions are lar removed from the wealth of the (mudarabah financed) company (operation), or actually considered a part of it. It is likewise unlawful for the partner to buy merchandise from the mudarabah operation for himself. In both cases, however, if the financing partner gives special permission, the sale will be lawful.
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