Mudarabah Meaning and Definition:

Mudaraba is derived from the Arabic word ‘daraaba’ which means partnership or profit sharing. Mudarabah is defined as an agreement between two parties where one party provides capital while the other manages the investment activities. Both parties share the profits as well as any potential losses according to their agreed ratio. In a Mudarabah contract, the party providing capital is called ‘Rabb-ul-maal’, the managing party is known as ‘Mudarib’, and the investment is called ‘Raas-ul-Maal’. Mudarabah in Islamic banking is widely used to structure bank deposit accounts, and it is also used in combination with other Islamic financial contracts.

“Two partners plan to open a car show room. The investing partner (Rabb-ul-maal) will be responsible to make the investment for buying the cars, paying the rent, and make other office expenses. Whereas, the working partner (Mudarib) is responsible to provide skill, expertise, and business management.”.

Mudarabha Example!

1. What is the Mudarabah Contract?

Mudarabah contract in Islamic finance is sometimes used by individuals who seek to invest in businesses to make their money work harder for them. Mudaraba can also be used by banks or other large organizations that want to diversify their investment portfolio by investing in small businesses across various countries and sectors. Under the Mudarabah Contract:

  1. Investor and Working Partner decide to enter a business venture.
  2. The investor provides capital to run the business, and the Working Partner is responsible to run and manage the business through his expertise.
  3. Subsequently, if the venture is successful and generates profit, this profit is distributed among both partners, on a pre-determined ratio.

2. Key Principles of Mudarabah in Islamic Banking:


Both parties agree to share the profits and losses of the business. The entrepreneur or manager (mudarib) doesn’t invest any capital, but instead provides their expertise and work, while the investor (rabb-ul-mal) provides the funds.


In the case of a loss, it is borne solely by the rabb-ul-mal, provided that there’s no negligence or violation of the terms of the contract by the mudarib.


All terms and conditions of the Mudaraba contract must be clear and understood by all parties involved. Trust is integral in this relationship.


The ratio of profit distribution can be negotiated and agreed upon by both parties before the initiation of the contract.


The investor is not guaranteed a fixed rate of return and the return depends on the actual profit generated by the business.


The business activities must be halal, meaning they must comply with Islamic law. The activities should not involve any haram (forbidden) elements like interest (riba), uncertainty (gharar), or gambling (maysir).

mudarabah meaning

3. Types of Mudarabah:

It is divided into two types: Restricted and Un-Restricted.


It is a contract, in which an investor restricts the actions of a working partner to a particular location, or to a particular type of business.


In mudarba, the investor permits the working partner to administer the fund, without any restrictions.

4. Mudarabah Examples and Applications:


In Islamic banking, current accounts operate based on the principle of “Qard” or a “Loan” to the bank. This arrangement ensures the guarantee of the principal amount. However, under this structure, the account holders are not entitled to any facility.


  • They are term deposits in a combination of Shirkah and Mudaraba.
  • Constructive liquidation is done every month, or half-yearly.
  • Physical liquidation is usually not possible in the Islamic banking system.
  • While calculating the profit ratio, “Administrative Expenses” are deducted from depositors, and branch or operational expenses are deducted from the total portfolio.


Should the financier opt to fund the entire project, this arrangement is known as Mudarabah. Conversely, when both parties contribute to the investment, it is Musharakah.


5. Profit Distribution in Mudarabah:

Guidelines regarding the distribution of profit in a Mudaraba agreement can be outlined as follows.

  • Parties must agree on the profit ratio, at the beginning.
  • Parties can share the profit, at any ratio they agree upon.
  • In case parties enter into a Mudarbah agreement without mentioning the exact proportions of the profit, it will be assumed that they will share the profit in equal ratios.
  • Apart from the agreed profit, a working partner cannot claim any salary or remuneration.
  • Parties cannot allocate a lump sum amount as profit for any party.
  • Losses shall be only sustained by the Investor; unless it is due to the negligence and willful misconduct of the working partner.

6. How to Terminate a Mudarabah Contract?

The Mudarabah contract is flexible in terms of termination, allowing either the financier or the entrepreneur the liberty to end it at any moment, provided notice is given. During the process of terminating a Mudaraba contract, there are certain key aspects to bear in mind.:

  • If assets are in cash form and some profit has been earned, it will be distributed among parties, according to the agreed ratio.
  • If assets are not in cash form, Working Partner may sell and liquidate them, to determine the actual profit. However, constructive liquidation can also be conducted.
  • If the period of the contract is fixed, all parties are responsible for completing it.
  • The capital of the investor will be returned to the investor, and the remaining amount will be considered a profit. This profit will be distributed according to the agreed ratio.

7. Exploring Mudarabah: A Core Module in the Islamic Banking Studies

The CIB Islamic finance training elucidates the principles and types of Mudarabah, illustrating its role in fostering economic growth within the framework of ethical banking. Such educational initiatives help to demystify the complex world of Islamic finance, making it accessible to a wider audience and paving the way for future innovations in the field. AIMS Institute of Islamic Banking offers an Islamic Banking MBA online, which includes a comprehensive module on Mudarba. This integral aspect of Islamic finance illustrates the shift towards a more equitable, risk-sharing approach to banking.


Combining Mudaraba with Other Islamic Financial Modes:

1. Profit Distribution in Mudarabah: Leveraging Islamic Financing Modes:

  • Under the principle of Mudarabah, the customer is an Investor and the bank is the manager of funds deposited by the customer.
  • The bank allocates those funds to a deposit or investment pool.
  • Pool funds are used to provide financing to customers, under Islamic modes, such as Murabahah financing, Ijarah Islamic lease agreement, Musharakah, Diminishing Musharakah agreement, etc
  • Profits earned through these modes are distributed among the bank and depositors.

2. Difference Between Musharakah and Mudarabah with Example:

While Musharakah and Mudaraba are both key Islamic financing modes, they differ in how capital is contributed and profits are divided. In a Musharakah contract, all partners contribute capital and share in the profits and losses, whereas in a Mudarabah, only the financier provides the capital, and the working partner provides expertise and effort.


As an example, consider a business project that needs $100,000 for start-up. In a Musharakah agreement, two partners might contribute equally, each investing $50,000. They agree upon a profit-sharing ratio, say 50:50, and share equally in the profits and losses.

Contrast this with a Mudharabah agreement for the same project. Here, one partner provides the entire $100,000 while the other provides the entrepreneurial effort. The profit-sharing ratio might be 60:40, with the financier receiving 60% of profits. However, if the venture fails, the financier bears all the financial loss, while the working partner loses the time and effort invested.

3. Combining Musharakah and Mudarabah in Business Partnership:

In Islamic finance, a unique situation arises when working partners choose to invest capital into the business in addition to their expertise and labor. This scenario results in a combination of the Musharakah and Mudarabah principles, creating a hybrid model that leverages the strengths of both.


“Ali” and “Bilal” start a Mudarba business, and it is agreed that “Bilal” will invest $100,000, and “Ali” will share the profit as a working partner, on an agreed ratio. Suppose that after some time, more investment is needed, and “Ali” adds $50,000 with the permission of “Bilal”. So, in that case, “Ali” will take a profit:

  • As an “Investor” against his investment of $50,000; and;
  • As a “Working Partner” for managing the whole business worth $150,000.

4. Musharakah and Mudarabah Hybrid Model in Islamic Banks:

Almost all Islamic Banks are using this Mudaraba-based liability structure, where:

  • Bank first signs an agreement with the depositors, as a Managing Partner of their funds, and;
  • Then the banks sign an agreement with the Entrepreneur, as an Investor.

This model is a hybrid of both Musharakah and Mudaraba. Islamic bank also commingles Islamic Banking Funds, especially when there is a single pool for PLS-based deposit products.

Significance of Mudarabah in Islamic Finance:

In conclusion, the Mudarabah contract is an essential component of Islamic banking and finance. Islamic finance principles reflect fairness, risk-sharing, and ethical investment, adhering strictly to the prohibitions of interest-based transactions as per Shariah law. The flexibility offered by unrestricted and restricted Mudarabah caters to a broad spectrum of investment needs. Moreover, through the application of Mudarabah, Islamic banking provides a viable and ethical financial alternative for project financing, venture capital, and small to medium-sized businesses. Understanding Mudarbah and its applications can pave the way for more informed financial decisions in line with Islamic principles.