Islamic Banking Products – Part 1 – Mudarabah
By Mohammed Waseem
Mudarabah is an equity-based contract offered by Islamic banks, which is based on the Islamic Shari’ah. It is a special kind of partnership, where one partner provides money to another and the latter manages the money by investing it in commercial projects in order to earn profit which is shared among the two in a predetermined ratio. The first partner who provides the money to the second is called “rabb al maal (capital provider)” while the second partner is known as “mudarib (manager)”.
The capital provider may not interfere in the routine transactions of the manager, but may provide general technical advice, and the manager should provide periodic reports to the capital provider. The manager also has a choice to add their own capital to what is provided by the capital provider with their consent, in order to increase profits.
Profits from the venture are shared between the capital provider and the manager in a predetermined ratio, while losses are borne solely by the capital provider, provided such loss is not due to the manager’s negligence or violation of specified conditions. The capital provided by the rabb al maal is returned by the manager/mudarib when the contract ends or is dissolved. The contract can be terminated by either of the parties by issuing a notice. Maximum term of the contract may or may not be specified at the beginning of the contract (there is a difference of opinion in this), but minimum term cannot be specified.
If the contract becomes void due to any reason, the manager’s status becomes that of an employee which means that he receives no share of profit but gets an ordinary pay (Ujrah Misl), a salary according to the market value for the work done by the manager; which cannot exceed the profit share.
No fixed amount, whether profit or wage or commission is settled in favor of either the capital provider or the manager but percentages are specified, which is permitted by the Shari’ah, as it is linked directly with the performance of the business and does not constitute interest.
Mudarabah contracts are of two types. The first one is a contract in which the capital provider specifies which projects to invest his/her money in, and the manager is supposed to restrict the investment to the specified businesses; this type of contract is known as Al Mudarabah al Muqayyadah (Restricted Mudarabah). The other type is where the capital provider does not specify any project for investment and the manager has choice; this type of contract is known as Al Mudarabah al Mutlaqah (Unrestricted Mudarabah). If the manager wants to make an extraordinary investment which is beyond the normal routine of business, this cannot be done without the express permission of the capital provider.
In Islamic banking, capital provider is the depositor who deposits money under a Mudarabah contract, while the manager is the bank. The legitimacy of a Mudarabah contract is proven from Quranic verses and the Sunnah of Prophet Muhammad Peace and Blessings be upon him. Practices of the companions of the Prophet Peace and Blessings be upon him are also cited for emphasizing the permissibility of Mudarabah contracts in Shari’ah.