IB1005IB1005DEPOSITS AND FINANCING PRACTICES DEPOSITS AND FINANCING PRACTICES OF ISLAMIC FINANCIAL INSTITUTIONS OF ISLAMIC FINANCIAL INSTITUTIONS CHAPTER 10 : MUDARABAH CHAPTER 10 : MUDARABAH FINANCINGFINANCING

COMPILED BYHAMDAN HJ IDRIS, BSc Econs, MBA (Islamic Banking & Finance)

Certified Professional Trainer (MIM)Industry Expert

INCEIF

PRESENTED BYHJ MAHMUD HJ BUNTAT, MBA (AUOL, UK), DBM (Swansea Inst., UK), CIL (UIA)

Part-time Lecturer (INCEIF)Former Head of Islamic Banking Division, OCBC Bank (Malaysia) Bhd

Chapter 10 : Chapter 10 : Mudarabah FinancingMudarabah Financing

• The Majallah al-Ahkam al-Adliyyah (Ottoman code of Islamic civil law) defines mudharabah as “a kind of partnership on the condition, that the capital is to be found by one, and the labour and work by the other ” Majallah al-Ahkam al-Adliyyah, Book 10 (Sharikat), Ch.7 (Mudharabah), Sect.1, Article 1404 and that one of the conditions of mudharabah is “that the capital be delivered to the mudarib.” Majallah al-Ahkam al-Adliyyah, Book 10 (Sharikat), Ch.7 (Mudharabah), Sect.2, Article 1410.

The Malaysian Accounting Standards Board (MASB) in its Financial Reporting Standards (FRS) for Islamic Financial Institutions (IFI) defines the mudharabah contract as, “Mudharabah (lit., profit sharing) MASB, FRSi-1 Article 6 thtp://www.masb.org.my/masb FRS/masbstd_FRSi-1c.htm [URL @ Oct.’07] – A form of partnership under which one party, called Rabbul-Mal or principal, provides only capital to a business venture. With or without conditions, while another party, the Mudarib or agent, contributes labour only.

• At the end of the Mudarabah period, profits from the venture are shared between the two parties according to a pre-agreed ratio.

In the case of losses, the losses are borne solely by the capital provider.”

The mudarib, regarded as an entrepreneur, contributes management input, itself viewed as a form of capital.

Widely agreed conditions applied to modern mudarabah contracts are that:-

a) the investor is an investor on a non-executive basis.

b) according to Imam Hanifa, the contribution of capital to the mudarabah is to be made in the form of cash Imam Malik however argues that a non-cash contribution can be made provided that its cash value can be established prior to employment in the partnership. Thus material contributions must first be valued or sold for cash before establishing the contributor's share in the mudarabah.

c) a profit share between mudarib(s) and investor(s) is agreed at the outset. Profits can be shared in any ratio agreed at the outset of the mudarabah.

d) ownership of the invested assets remains with the investor at all times.

e) losses should be shared according to the financing share of each financier. The financier's maximum loss is limited to his share of the financing and the mudarib must not bear any of loss attributable to invested capital.

f) With the permission of the investor, the mudarib may contribute some of his own capital to the project or raise fresh capital from others on the basis of mudarabah.

g) the mudarib may only lend available funds with the permission of the investor.

h) the mudarib is not allowed to draw remuneration in any other form than profit-share.

i) Mudarabah may be enacted as a single-tier agreement in which the investor deals directly with the entrepreneur. In a two-tier mudarabah, investors pool their funds with an intermediary who subsequently deals with entrepreneurs.

j) The mudarib may be required by investors to engage only in strictly defined activities in which case the mudarabah becomes one of mudarabah al-muqayadah. Where no restrictions apply, the mudarabah becomes one of mudarabah al- mutlaqah.

k) Imams Hanifah and Hanbal argue that the term of a mudarabah can be restricted, whilst Shafie and Malik argue against any such restriction.

The Accounting and Audit Organization for Islamic Financial Institutions (AAOIFI) expands on the MASB definition, stating that, “the Mudarib is investing capital on a trust basis in which case the Mudarib is not liable for losses except in case of breach of the requirements of trust, such as misconduct in respect to the Mudharabah fund, negligence and breach of the terms of the Mudharabah contract. In committing any of these, the Mudarib becomes liable for the amount of the Mudharabah capital.”

The Majallah continues, “The mudarib is a person entrusted (amin). The capital in his hands is like the property deposited for safekeeping (wadiah). And as regards his disposing of the capital, he is the agent (wakil) of the owner of the capital. And if he makes a profit he is a partner in it.” Majallah al-Ahkam al-Adliyyah, Book 10 (Sharikat), Ch.7 (Mudharabah), Sect.2, Article 1413

• A profit ratio should be pre-agreed, but if a specific amount of the profit is pre-determined then this invalidates the partnership, Shari’a Standards, as AAOIFI explains (8/3): “The parties should agree on the ratio of profit distribution when the contract is concluded”, and (8/5): “If one of the parties stipulate that he should receive a lump sum of money, the Mudharabah shall be void.

Along with musyarakah, the mudarabah (trustee partnership) is a primary direct equity investment contract in Islamic finance.

It comprises the capital provider (rabul-mal) and the trustee partner (mudarib). It is ideally suitable to micro finance, with one partner providing the capital and the other the labour, for which they have the right to share in any profits.

If there are any losses, the financier loses his capital and the mudarib loses his labour.

Rabbul Mal100%40%

Mudarib0%60%

Capital 100,000 40,000 60,000

SalesExpensesGross IncomeLess CapitalProfit for distribution

250,00(110,000)140,000(100,000)

40,00016,000 24,000

Return on capital invested 16.0% 24.0%

Mudarabah FinancingMudarabah Financing

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