Mudarabah in Islamic Finance

What is Mudaraba in Islamic Finance?

Islamic finance is popularly known for offering interest free loan products. This is in accordance to the Shariah law under which the financial system operates. However, there are also other products offered by the financial institutions. One such product is Mudaraba. This is a joint venture agreement between a bank (investor) and a customer (entrepreneur). However, as opposed to where both would contribute capital, Mudaraba involves one party providing the labour and the other providing the capital. The investor is referred to as rabb-ul-mal whiles the one who takes the managerial and work responsibility is known as mudarib. Since the latter did not provide the capital, everything that he purchases is owned by the former. Mudarib can only make an earning if he manages to sell the goods at a profit. As such, he is not entitled to claiming his share if he has not sold the assets. This is even if they increase in value.

How is mudarabah is done in islamic finance:-

In Mudarabah, rabb-ul-mal starts by specifying the business to be run by mudarib. It is only in this business that he will invest his money. This is what is referred to as al-mudarabah al –muqayyadah or restricted mudarabah. In other cases, rabb-ul-mal may see mudarib make the choice of business.  As such, he will invest in any business suggested as fit by mudarib. This form of mudarabah is referred to as al-mudarabah al-mutlaqah or unrestricted mudarabah. Rabbul- mal can also invest his money in a mudarabah which has more than one mudarib. In simpler terms, he can provide capital to mudarib A and mudarib B where the two will utilize it jointly. When it comes to the share of mudarib in the mudarsabah, it will be divided between A and B. The business is thus run by the two as if it were a partnership. In a mudarabah, mudarib whether he is one or they are two, has the authority of doing anything considered normal in the course of doing business. If they wish to do anything extra to this, they have to seek permission from rabb-ul-mal.

Distribution of profit in mudarabah is usually agreed between the parties; Sharia has not prescribed this. However, the amount given to any of the parties is not supposed to be a lump sum. For example, a 40% to 50% is acceptable compared to a 20% to 80%. They can also agree to share the profit equally. Profit distribution can also vary with situations such as the type of goods traded on or the location of the business. Also, mudarib is not supposed to claim any form of a fee for his work above the agreed share on the profit.

Reference:

Usmani, T. (2002). An Introduction to Islamic Finance. Berlin: Springer.