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What Is Mudaraba in Islamic Finance and Banking?

Types of Mudaraba: There are two types of Mudaraba, and they are mentioned below:

(1). Al Mudaraba Al-Muqayadah:

Rab’ul-Maal may specify a particular business or a particular place for the Mudaarib, in which case he will invest the money in that particular business or place. This is called Al Mudaraba Al-Muqayadah (restricted Mudaraba).

(2). Al Mudaraba Al Mutlaqah:

However if Rab’ul-Maal gives full freedom to Mudaarib to undertake whatever business he deems fit, this is called Al Mudaraba Al Mutlaqah (unrestricted Mudaraba). However Mudaarib cannot, without the consent of Rab’ul-Maal, lend money to anyone. Mudaarib is authorized to do anything, which is normally done in the course of business. However if they want to have an extraordinary work, which is beyond the normal routine of the traders, he cannot do so without express permission from Rab’ul-Maal. He is also not authorized to:

a) keep another Mudaarib or a partner

b) mix his own investment in that particular Modarabah without the consent of Rab-ul Maal.

Conditions of Offer & Acceptance are applicable to both. A Rab’ul-Maal can contract Mudaraba with more than one person through a single transaction. It means that he can offer his money to ‘A’ and ‘B’ both so that each one of them can act for him as Mudaarib and the capital of the Mudaraba shall be utilized by both of them jointly, and the share of the Mudaarib.

Difference between Musharaka and Mudaraba

(1). In Musharaka, all partners invest, however in Mudaraba Finance, only Rab’ul-Maal invests.

(2). In Musharaka, all partners participate in the management of the business and can work for it. However, in Mudaraba, Rab’ul-Maal has no right to participate in the management which is carried out by the Mudaarib only.

(3). In Musharakha, all partners share the loss to the extent of the ratio of their investment. But in Mudaraba, only Rab’ul-Maal suffers loss because the Mudaarib does not invest anything. However this is subject to a condition that the Mudaarib has worked with due diligence.

(4). In Musharaka, the liability of the partners is normally unlimited. If the liabilities of business exceed its assets and the business goes in liquidation, all the exceeding liabilities shall be borne pro rata by all partners. But if the partners agree that no partner shall incur any debt during the course of business, then the exceeding liabilities shall be borne by that partner alone who has incurred a debt on the business in violation of the aforesaid condition. However in Mudaraba, the liability of Rab’ul-Maal is limited to his investment unless he has permitted the Mudaarib to incur debts on his behalf.

(5). Once the partners mix up their capital in a joint-pool in Musharaka, all the assets become jointly owned by all the partners, according to the proportion of their respective investment. All partners benefit from the appreciation in the value of the assets even if profit has not accrued through sales. In Mudaraba financing, the goods purchased by the Mudaarib are solely owned by Rab’ul-Maal and the Mudaarib can earn his share in the profit only in case he sells the goods profitably.

Distribution of Profit & Loss

It is necessary for the validity of Mudaraba that the parties agree, right at the beginning, on a definite proportion of the actual profit to which each one of them is entitled. The Shariah has prescribed no particular proportion; rather it has been left to their mutual consent. They can share the profit in equal proportions and they can also allocate different proportions for Rab’ul-Maal and Mudaarib. However in extreme case where the parties have not predetermined the ratio of profit, the profit will be calculated at 50:50.

The Mudaarib & Rab’ul-Maal cannot allocate a lump sum amount of profit for any party nor can they determine the share of any party at a specific rate tied up with the capital. For example, if the capital is 10,000 Pound Sterlings, they cannot agree on a condition that 1,000 Pound Sterlings out of the profit shall be the share of the Mudaarib nor can they say that 20% of the capital shall be given to Rab’ul-Maal. However they can agree that 40% of the actual profit shall go to the Mudaarib and 60% to the Rab’ul-Maal or vice versa.

It is also allowed that different proportions are agreed in different situations. For example, the Rab’ul-Maal can say to Mudaarib “If you trade in wheat, you will get 50% of the profit and if you trade in flour, you will have 33% of the profit”. Similarly, he can say “If you do the business in your town, you will be entitled to 30% of the profit and if you do it in another town, your share will be 50% of the profit”.

Apart from the agreed proportion of the profit, as determined in the above manner, the Mudaarib cannot claim any periodical salary or a fee or remuneration for the work done by him for the Mudaraba. All schools of Islamic Fiqh are unanimous on this point. However, Imam Ahmad has allowed for the Mudaarib to draw his daily expenses of food only from the Mudaraba Account. The Hanafi jurists restrict this right of the Mudaarib only to a situation when he is on a business trip outside his own city. In this case he can claim his personal expenses, accommodation, food, etc. but he is not entitled to get anything as daily allowances when he is in his own city.

If the business has incurred loss in some transactions and has gained profit in some others, the profit shall be used to offset the loss at the first instance, then the remainder, if any, shall be distributed between the parties according to the agreed ratio.

The Mudaraba becomes void (Fasid) if the profit is fixed in any way. In this case, the entire amount (Profit + Capital) will be the Rab’ul-Maal’s. The Mudaarib will just be an employee earning Ujrat-e-Misl. The remaining amount will be called (Profit). This profit will be shared in the agreed (pre-agreed) ratio.

Uses Of Musharaka/Mudaraba:

These modes can be used in the following areas (or can replace them according to Shariah rules).

Asset Side Financing

– Any term financing
– Project financing
– Small and medium enterprises setup financing
– Large enterprise financing
– Import financing
– Import bills drawn under import L/C
– Inland bills drawn under inland L/C
– Bridge financing
– LC without margin (for Mudarba)
– LC with margin (for Musharaka)
– Export financing (Pre-shipment financing)
– Working capital financing
– Running accounts financing/short term advances

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Sujoy Dhar is a business and technology and blogger. He is driven by the need to be creative and says that writing for various web properties allows him to stay up to date on one of the most rapidly evolving industries around. Each day provides Dhar with a new opportunity to educate readers about tech news and advances that help change the world for the better.

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