What is Mudarabah?

Mudarabah contract is a business partnership contract, and mudarabah in Islamic banking may be defined as: “A partnership, where one partner invests in a business venture, while the other manages the business”. The person investing is called Rabb-ul-maal, the person who manages the business is called Mudharib, and the investment is called “Raas-ul-Maal”.

Types of Mudarabah Contract:

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

Restricted Mudarabah:

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

Unrestricted Mudarabah:

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

Mechanism of the Contract:

  • Investor and Working Partner decide to enter a business venture.
  • Investor provides capital to run the business, and Working Partner is responsible to run and manage the business through his expertise.
  • Subsequently, if the venture is successful and generates profit, this profit is distributed among both partners, on a pre-determined ratio.
mudarabah in Islamic banking

Applications of Mudarabah in Islamic Banking:

Bank Deposit:

Current Account:

In Islamic Bank, current accounts are opened on the basis of “Loan” to bank, so the principal is guaranteed, and no facility can be given to the account holders.

Saving Accounts:

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

Project Financing:

If the Financier wants to finance the whole project, it is Mudarabah. However, if the investment comes from both sides, it is Musharkah.

Working Capital:

Working capital finance could be provided only through Musharkah financing. Amount invested by the Financier, will be treated as its’ share of investment. Financier’s share in profit should not exceed the percentage of its investment.

Combining Musharakah and Mudarabah:

Working Partner may also invest money in the business, and in this case, Mu-shaar-kah and Mudarabah are combined.

Case Study:

“Ali” and “Bilal” starts a Mudarabah 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 profit:

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

Two-Tier Mudarabah in Banking:

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

  • Bank first sign 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 Mudarabah. Islamic bank also commingles Islamic Banking Fund, especially when there is single pool for PLS based deposit products.

Banking Mudarabah for Other Islamic Modes:

  • Under the principle of Mudarabah, customer is an Investor and bank is the manager of funds deposited by the customer.
  • 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, Ijarah, Istisna, Musharakah, Diminishing Musharakah, etc
  • Profits earned through these modes are distributed among the bank and depositors.

It is discussed in more details, in the course title IBF-512, which is one of the Islamic banking courses offered by AIMS. This certification leads to Islamic finance certification and Islamic banking diploma.

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