ISLAMIC FINANCE

Mudarabah

1- Definitions

 In this section, some technical words are defined.

Mudarabah: is a special kind of partnership where one partner gives money to another for investing it in a commercial enterprise. The investment comes from the first partner who is called "Rabb-ul-mal", while the management and work is an exclusive responsibility of the other, who is called "Mudarib".

 

Hamish Jiddiyyah: in the case of a binding MPO, the risk of selling at a loss is mitigated by securing a Hamish Jiddiyyah (HJ). It's a security deposit held as collateral upon entering into agreement to purchase or agreement to lease. 

 

Sharia: is the body of Islamic religious law. It is the legal framework within which the public and private aspects of life are regulated for those living in a legal system based on Islamic principles of jurisprudence. Sharia deals with many aspects of day-to-day life, including politics, economics, banking, business, contracts, family, sexuality, hygiene, and social issues.

 

PSIA: Profit Sharing Investment Account is a financial instrument that is relatively similar to the time deposits of conventional banks. According to the terms and conditions of PSIA, depositors are entitled to receive a share of the bank's profits, but also obliged to bear all potential losses pertaining to their investment in the bank. This profit-sharing principle is core to Islamic finance, according to which investors and entrepreneurs must share the risks and rewards of a given venture.

A PSIA can be further categorised into: Unrestricted PSIA and Restricted PSIA. The Bank has full discretionary power in making investment decisions for unrestricted PSIA, but in the case of the restricted PSIA the placement of funds by the Bank is subject to investment criteria contract or agreed between the investment account holders (IAH) and the Bank at the time of contracting.

 

2-Mudarabah's principle

 

The Rabb-ul-mal may specify a particular business for the Mudarib, in which case he shall invest the money in that particular business only. This is called al-Mudarabah al-muqayyadah (restricted Mudarabah). But if he has left it open for the Mudarib to undertake whatever business he wishes, the Mudarib shall be authorized to invest the money in any business he deems fit. This type of Mudarabah is called 'al-Mudarabah al-mutlaqah" (unrestricted Mudarabah)

A Rabb-ul-mal can contract Mudarabah with more than one person through a single transaction. It means that he can offer his money to A and B both, so that each one of them can act for him as Mudarib and the capital of the Mudarabah shall be utilized by both of them jointly, and the share of the Mudarib shall be distributed between them according to the agreed proportion. In this case both the Mudaribs shall run the business as if they were partners inter se.

The Mudarib or Mudaribs, as the case may be, are authorized to do anything which is normally done in the course of business. However, if they want to do an extraordinary work, which is beyond the normal routine of the traders, they cannot do so without express permission from the Rabb-ul-mal.

 

It is necessary for the validity of Mudarabah that the parties agree, right at the beginning, on a definite proportion of the actual profit to which each one of them is entitled. No particular proportion has been prescribed by the Sharia; rather, it has been left to their mutual consent. They can share the profit in equal proportions, and they can also allocate different proportions for the Rabb-ul-mal and the Mudarib. However, they cannot allocate a lump sum amount of profit for any party, nor can they determine the share of any party at a specific rate tied up with the capital.

 

The contract of Mudarabah can be terminated at any time by either of the two parties. The only condition is to give a notice to the other party. If all the assets of the Mudarabah are in cash form at the time of termination, and some profit has been earned on the principal amount, it shall be distributed between the parties according to the agreed ratio. However, if the assets of the Mudarabah are not in the cash form, the Mudarib shall be given an opportunity to sell and liquidate them, so that the actual profit may be determined.


 


3- Difference between Mudarabah & Musharakah

  
The difference between Musharakah and Mudarabah can be summarized in the following points:

      

-          The investment in Musharakah comes from all the partners, while in Mudarabah, investment is the sole responsibility of Rabb-ul-mal.

 

-          In Musharakah, all the partners can participate in the management of the business and can work for it, while in Mudarabah, the Rabb-ul-mal has no right to participate in the management which is carried out by the Mudarib only.

 

-          In Musharakah all the partners share the loss to the extent of the ratio of their investment while in Mudarabah the loss, if any, is suffered by the Rabb-ul-mal only

 

-          In Musharakah, as soon as the partners mix up their capital in a joint pool, all the assets of the Musharakah become jointly owned by all of them according to the proportion of their respective investment. Therefore, each one of them can benefit from the appreciation in the value of the assets, even if profit has not accrued through sales.
The case of Mudarabah is different. Here all the goods purchased by the Mudarib are solely owned by the Rabb-ul-mal, and the Mudarib can earn his share in the profit only in case he sells the goods profitably. Therefore, he is not entitled to claim his share in the assets themselves, even if their value has increased.


4- Mudarabah stages 

       5- Slotting criteria





19/11/2008
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