Mudaraba is a long-term investment instrument that essentially meets the owners of money and expertise, so that the first party offers its money while the second party offers its expertise for the purpose of achieving halal profit, which is divided by agreed ratios. The speculation in Islamic banks is mainly through the provision of money by depositors as the owners of money, to be operated by the Islamic bank, benefiting from its expertise and resources.

1. Definition Of Mudarabah

The term Mudaraba (Venture Capital) is derived from the phrase “al-darb fil al-ard” found in the Holly Quran, which means to make a journey. It is called so because a worker strives and toils in the course of a business, and in most cases, making journeys is an inevitable and indispensable part of this hard work or toil.

Mudaraba is a type of partnership (musharaka) in profit/loss between capital (rab-al-maal) and work/mudarib (labor,entrepreneurship,management efforts).

2. Legitimacy Of Mudarabah

The Mudaraba contract derives its legitimacy from the verse of the Quran in which Allah, Most High says:

Others travelling through the land, seeking of Allah’s Bounty … (Al Quran 73:20).

According to AAOIFI standard, the proof from Sunnah on the legality of Mudaraba can be ascertained from the Hadith that says that alAbbas Ibn Abd. al-Muttalib (May Allah be pleased with him) used to pay money for Mudaraba and to stipulate to the Mudarib that he was not to travel by sea, pass by valleys or trade in livestock, and that the Mudarib would be liable for any losses if he did so. Those conditions were brought before the Prophet Muhammad (Peace be upon Him) and he approved of them.

3. Types Of Mudaraba :

1.3) In terms of multiplicity of the parties to a mudaraba contract

– Single mudaraba : (simple mudaraba /ordinary mudaraba / bilateral mudaraba): it involves a bilateral relationship between one worker (mudarib) and one provider of funds (rab al-mal). This type of mudaraba is not common in the operations of Islamic banks and financial institutions.

– Compound mudaraba : (complex mudaraba / multilateral mudaraba) involves more than two parties to the contract. In practice, it may consist of several workers (mudaribs) and one provider of funds (rab al-mal), one worker (mudarib) and several providers of funds (arbab al-mal), and several workers (mudaribs) and several providers of funds (arbab al-mal).

2.3) From the perspective of the timing to determine profit :

– Limited term mudaraba : mudaraba in which profits are calculated and distributed at the time the venture (fund) is liquidated and the capital (ras al-mal) is given back to the provider of funds (rab al-mal).

– Continuous mudaraba : mudaraba in which the two parties agree that profits are calculated and distributed on a periodical basis over the mudaraba term. In this case, the venture continues as a going concern (i.e., it is not liquidated and the capital is not returned to the provider of funds unless at maturity or end of mudaraba term).

1.3) In terms of ownership of the funds invested in mudaraba venture :

– Non-commingled mudaraba : a mudaraba in which the capital (ras al-mal) is only provided by one party (rab al-mal).

– Commingled mudaraba : a mudaraba in which the capital (ras al-mal) is provided by both parties to the contract. However, the work is only the responsibility of the worker (mudarib), who is also a provider of funds at the same time.

1.4) In terms of the limits on the mudarib’s actions, there are :

– Restricted mudaraba / (mudaraba muqayyada) : whereby the worker (mudarib) is restricted by the provider of funds (rab al-mal) as how and where to invest the funds (capital of mudaraba). In Islamic banks, restricted investment accounts (RIA) are based on this type of mudaraba.

– Unrestricted mudaraba (mudaraba mutlaqa) : mudaraba in which the worker (mudarib) is authorized by the provider of funds (rab al-mal) to invest the funds in the manner and venues the mudarib deems appropriate. In Islamic banks, funds of unrestricted investment accounts (URIA) are mobilized using this type of mudaraba.

4. Principles Of Mudaraba :

Mudaraba Contract Parties:

There are two parties involved in Mudaraba,

1. Rab al maal (capital provider)
2. Mudarib (who provides the management).

In terms of legal capacity of the parties, rab al-maal must be competent to appoint a Mudarib, who in turn must be competent to accept this appointment.

Conclusion of Mudaraba Contract:

Mudaraba is one of the trust based contracts. It can be concluded for a particular sum of money and also within a particular defined duration. The Mudaraba contract should define the intention of the parties, the forms of Mudaraba (i.e. unrestricted or restricted), the profit sharing ratio, the type of guarantees, etc.

Mudaraba Capital:

Only one party contributes the capital to Mudaraba. The capital can be provided in cash or in the form of tangible assets, but in either case it should be clearly defined in the contract. The capital must also be available at the time of concluding the Mudaraba contract. Therefore, debt owed by the mudarib or a third party to Rab-al maal (capital provider) cannot be used as the capital, except in the case where the debt is due and ready for collection. The capital must be put at the disposal of the mudarib. In certain cases, Mudarib is also allowed to contribute in the Mudaraba capital.

Duties and Powers of Mudarib:

The mudarib should employ best efforts to accomplish the objectives of the contract and investment.

Regardless the type of Mudarabah, the capital provider (Rab-al maal) is not permitted to stipulate that he has a right to work with the entrepreneur or mudarib in management.The differentiating feature of Mudaraba is that the mudarib is not entitled to a fee or salary.

Guarantee:

In principle, Mudarib is not supposed to give any guarantee to the capital provider neither for Mudaraba capital nor for any profit. The capital provider, however, can obtain certain guarantees from the mudarib that are adequate and enforceable against the Mudarbi’s misconduct, negligence or breach of contract.

Mudaraba Profit Distribution:

Distribution of profit must be clear and must be on the basis of the sharing ratio (and not on the basis of a lump sum or a percentage of capital) and must be agreed upon when the contract is concluded. The profit sharing ratio can be fixed or can vary, subject to the performance of Mudaraba (ceiling basis). No profit can be realized or claimed unless the capital of the Mudaraba is kept invested or maintained intact. However, in the case of continuing Mudaraba, it is permissible to specify a mutually agreed accounting period for the distribution of profits, treating each period independently. There is no issue if any reserve from profits is built by the mutual consent of the parties to offset possible
upcoming losses.

Mudaraba Loss:

In principle, losses if any shall be borne only by the capital provider (Rab-al Maal) and the mudarib is not liable for any loss unless there is negligence or misconduct on the Mudarib’s part.

Distribution of profit or loss depends on the final result of the operations. If the losses are greater than profits at the time of liquidation, the balance (net loss) must be deducted from the capital. If the parties have adopted the periodical profit distribution in continuing Mudaraba, then whenever a Mudaraba operation incurs losses, such losses stand to be compensated by the profits of future or from the reserves.

Maturity and Liquidation :

A Mudaraba contract is not binding. Therefore, any one party may terminate the contract, except in the case when the business has commenced or the parties have already agreed on the duration of the contract. In addition, the Mudaraba can be liquidated when :

• Funds have been exhausted or suffered loss.
• On the death of mudarib.
• The maturity of Mudaraba.
• At any point in time by the mutual agreement of the parties.

The valuation of assets in case of liquidation should be on actual or constructive or on the basis of fair value. The final distribution of profit should be made based on the selling price of the Mudaraba assets.

Operational Procedure Of Musharah

1. The customer and the Islamic bank initiate a Mudaraba Enterprise. As per the Mudaraba contract, the Islamic bank (as Rab-al-Maal) contributes 100% capital, whereas the customer (the Mudarib) contributes the management or skills.
2. As per the agreement they decide to share the Net Profit in the ratio of 40/60, whereas the loss, if any, shall be borne only by the Islamic bank. If there are any direct expenses of Mudaraba, then it shall be charged to the Mudaraba Enterprise and not to any of the parties.
3. Pursuant to the terms agreed upon in the Mudarabaha contract, the Mudaraba asset is, either periodically or at the end of Mudarba, liquidated to determine the profit or the loss.
4. As agreed earlier, 40% of the realized profit is given to the Islamic Bank (rab al-maal) and 60% is retained by the Mudarib while any loss is borne only by the Islamic Bank.
5. At the expiry of Mudaraba, the Mudarbaha assets are disposed off either by selling them in the market or purchased by the Mudarib on their market value.

5. Application Of Mudarabah In Islamic Finance:

In islamic banking the Mudaraba contract is also applied to various Islamic deposit and finance products. Few of them are mentioned below:

• Saving account
• Investment account
• Project financing
• Takaful products
• Mudaraba Sukuk
• Islamic funds