Mudarabah is an Islamic contract where one party provides capital to another party for investing in a commercial enterprise. The capital provider is called rabb-ul-mal and the manager is called mudarib. Profits are shared according to a predetermined ratio, while losses are solely borne by the capital provider except in cases of misconduct or negligence by the mudarib. There are two main types of mudarabah - restricted and unrestricted. The contract can be terminated by either party with notice. Mudarabah is used by Islamic banks to accept deposits and invest funds on behalf of depositors based on profit and loss sharing. However, there are also risks involved for the banks in applying mudarabah.

2. Islamic Banking

3. Asma
Farooq
Mustajab
Zahra

4. Contents
Introduction – Mudarabah;
•Profit / Loss Distribution;
•Kinds of Mudarabah
Termination of Mudarabah
Mudarabah Vs Musharakah
Scope of Mudarabah for Banking System
Risks
Practical examples

5. Mudarabah - Introduction
 “Mudaraba” is a kind of partnership where partner involve in business;
 Mudarabah is partnership between persons in which one partner gives
money to another for investing in profitable avenues.
 The investor (fund provider/supplier) is called “Rabb-ul-Maal while
the person who utilizes this fund (the fund manager) is called
“Mudarib”;
 Mudarib is exclusively responsible for management of the business.
 Rab -ul- Maal (fund supplier) does not have any right to interfere in
business affairs.

6. Mudarabah - Introduction
 Mudarabah Capital:
− In principle, the capital of Mudaraba should be provided in the form
of cash.
− However, it may be presented in the form of kind i.e. tangible assets
which will be valued as per mutual consent;
− The value (in cash) of the assets will be the Mudaraba capital;
− The Capital of Mudaraba should be clearly known to the contracting
parties and defined in terms of quality and quantity in a clear manner;
− Debt (receivable) can not be the capital of Mudarabah.

7. Mudarabah - Introduction
 Mechanism of Profit and Loss distribution:
− The contracting parties should stipulate in the contract the profit
shares (in defined terms) for each one;
− The profit sharing ratio should be:
► Specific; and
► of the profit expected to be earned by the venture;
− Therefore following method is not allowed:
► Unknown ratio;
► A ratio attributed to future settlement;
► A ration linked with the capital (in terms of x% of the capital);
► A lump sum settlement as profit;

8. Mudarabah - Introduction
 Mechanism of Profit and Loss distribution:
− Losses in Mudaraba shall only be born by Rabb-ul-Mal and not by the
Mudarib;
− Mudarib will also suffer loss in shape of not receiving anything as
profit;
− The Mudarib shall only be responsible for losses if the loss happened
due to his negligence and willful misconduct.

9. Mudarabah - Types
 There are two types of Mudarabah:
− Restricted Mudarabah (Mudarabah Muqayyadah):
► It is a kind of Mudarabah in which the capital provider restricts the Mudarib to
perform business with certain restrictions. These restrictions may be for place
(geographical restriction), particular type of investment (sector wise restriction)
or any other restriction provided these restrictions do not unduly constrain the
Mudarib from business operations.
− Unrestricted Mudarabah (Mudarabah Mutlaqah):
► It is a kind of Mudarabah in which the capital provider (Rabbul Maal) does not
put any restriction the Mudarib.

10. Mudarabah - Rules
 Supply of funds:
− The basic feature of Mudaraba is that the the capital is provided by
Rabbul Maal and the Mudarib is responsible for the management
only;
− However, it is allowed for Mudarib to add capital into the business of
Mudaraba if agreed with Mudarabi;
− In such cases Musharaka and Mudaraba are combined.
− For example, “Zuhaib” gave to “Rahman Hayder” Rs.100,000/- for
Mudaraba. R. Hayder added Rs. 50,000/- from his own with the
consent of Zuhaib;
− This type of partnership will be treated as a combination of
Musharaka and Mudaraba;
− Here the Mudarib may allocate for himself a certain percentage of
profit on account of his investment as Sharik, and at the same time he
may allocate another percentage for his management and work as a
Mudarib.

11. Mudarabah - Rules
 Termination of Mudarabah:
− The contract of Mudaraba can be terminated at any time by either of
the two parties after giving a notice to the other party.
− If all assets are in form of cash and some profit has been earned on the
principle amount, it shall be distributed between the parties according
to the agreed ratio.
− If the assets of the Mudaraba are in other form the Mudarib shall be
given an opportunity liquidate them and the actual profit may be
determined.

12. Mudarabah Vs Musharakah
 Mudarabah:
− The contribution comes from
Rabbul Maal (the investor).
− The Rabbul Maal (investor) is
not permitted to manage the
business.
− The Mudarib will only
manage the business.
− The Mudarib can also invest
in the capital of Mudarabah.
 Musharakah:
− The contribution comes from
all partners in form of cash,
commodities, services or
liability in the case of
reputation partnership.
− The work, as a general rule, is
to be done jointly by the
parties.
− A partner or some partners
may be sleeping.

13. Mudarabah - Application
 Scope of Mudarabah for Banking System:
− Mudaraba as a mode of finance used by Islamic Banks for the
following purpose:
− Relationship with depositors;
► The depositors provide moneys to bank as Rabb-ul-Mal to be invested by bank as
Mudarib on the basis of profit and loss sharing on pre agreed specific ratio;
− Islamic bank can also use this mode through providing capital in a
business and sharing in the profit with pre-agreed ratio;
► Large Enterprise financing;
► Project Finance;
► Business ventures;
► Private equity;

14. Mudarabah - Application
 Depositors and Islamic bank relationship:
− Mudaraba is used by Islamic Banks for taking deposit from depositors;
− The depositors provide moneys to bank as Rabb-ul-Mal to be invested
by bank as Mudarib on the basis of profit and loss sharing on pre
agreed specific ratio;
ISLAMIC BANKDEPOSITORS
DEPOSITS
PROFIT
MUDARABAH PROFIT &
LOSS SHARING

15. Mudarabah – Application (Deposit [Liability] management)
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POOL MANAGEMENT
Pools according to (1) size of deposit, (2) Tenure
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P RQ
V XW
Time (tenure)
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16. Issues in Mudarabah
Problems and Risks for Islamic Banks:
− Mudarabah is among the preferable modes of financing
which is also heavily recommended by scholars and
Ulema, but certain difficulties are there in application of
this mode. Some are given below:
► Mudaraba is considered to be very high risk financing activity.
► Collateral can be asked but could not be used in case of real loss.
► Bank’s existing competencies in project evaluation and related techniques
are limited.
► Dual book keeping trends in market.
► No legal mechanism for treatment with Mudarabah.

18. Contents
Introduction;
Types of Musharakah;
Basic Rules in Musharakah;
Termination of Musharakah;
Security / Collateral in Musharakah;
Musharakah Management and Liability;
Profit / Loss Distribution ;
Application of Musharakah As a Mode;

19. Introduction
 The actual term used by Fuqahaa (classical Islamic scholars) was
Shirkah (or Sharikah);
 Lexical meaning of it is sharing/merging;
 Technically: “Commingling by two or more persons either their
capital/money or work or obligations to earn a profit or a benefit or a
yield or appreciation in value and to share the loss according to their
proportionate ownership”;
 Now the term Musharakah is popular;
 There are different types of Shirkah which have been explained by
Fuqaha’;
 See next slide for details:

20. SHIRKAH (Partnership)
Shirkat-ul-Milk (Joint ownership)
Optional Forced
Shirkat-ul-A'qd (Business partnership)
A'amal (partnership in work) Wujooh (reputational partnership)Amwaal (partnership with capital)
Mufawadah
(100% equality
in shares of
partners)
Al Inaan
(Variability in
shares of
partners)
Mufawadah
(100% equality
in shares of
partners)
Al Inaan
(Variability in
shares of
partners)
Mufawadah
(100% equality
in shares of
partners)
Al Inaan
(Variability in
shares of
partners)
Types of Shirkah

21. Basics of Musharakah
 There are some basic features of Musharakah:
− Mixing of Capital (joint ownership);
− Asset or property or anything that can accept partnership;
− Rights and Responsibilities;
− Sharing of profit and loss

22. Basics of Musharakah
 According to the nature of partnership (Musharakah) there are three
possible structures of Musharakah:
− Permanent Musharaka:
► Permanent Musharaka is a partnership of permanent nature i.e. a going
concern;
− Temporary (Redeemable) Musharaka;
► Musharakah can be for a limited time period, after that it will be redeemed;
► Redemption of Musharakah will take place through sale of shares from one
partner to other partner or third person (in market/exchange);
► This type is usually used for business ventures;
− Diminishing/declining Musharaka
► A Musharakah in which a partner buys the share of the other partner gradually
until the ownership of the asset or property is completely transferred to second
partner;
► According to this concept, a financer (bank) and its client participate in a joint
commercial enterprises or property or asset and the client gradually buys bank’s
share.

23. Basics of Musharakah
 Capital of Musharakah should be in cash form;
 It may be in kind;
 In such case the value should be agreed;
 Different currencies should be converted or valued into the currency of
Shirkah;
 Capital should be under the disposal of the manager;
 Debt alone can not be contribution in Shirkah;
 Capital can be varying among the partners;

24. Basics of Musharakah
 Management of Partnership:
− In principle each partner has right of Musharakah management;
− The partners may appoint a managing partner by mutual consent;
− Some of the partners may decide not to work for the Musharakah and
work as sleeping partner;
− It is not allowed to specify a fixed remuneration to a partner
Musharaka who manages funds or provides some form of other
services, such as accounting;
− However, it is permissible to give him a greater share of profit than he
would receive solely on the basis of his share in the partnership capital;
− According to a view it is also permissible to appoint his as an employee
and giving him remuneration for his services;

25. Basics of Musharakah
 Profit Sharing ratio:
− Ratio or the basis for sharing profit should be decided in the beginning
of partnership;
− Profit should be allocated in percentages of earning and not in a sum of
money or a percentage of the capital or investment;
− It is not necessary for sharing profit according to proportionate capital
contribution;
− A sleeping partner cannot share in the profit more than the percentage
of his capital;
− The partner may at the later stage agree to change the profit sharing
ratio, and on the date of distribution, a partner may surrender a part
of his profit to another partner;

26. Basics of Musharakah
 Sharing of Loss:
− As a matter of principle the loss has to be shared according to the ratio
of capital contribution;
− No partner can make his share or portion of share guarabteed from
loss;
− Any such agreement will make the Musharakah void and null
 Guarantee of principle:
− Guarantee from one partner to other partner’s profit or capital or part
of capital is not allowed;
− Security can be asked for misconduct or negligence;
− A third party may provide a guarantee to make up losses of one or all
partners;

27. Basics of Musharakah
 Termination of Musharakah:
− Every partner has a right to terminate the Musharaka at any time
after giving notice to the partner and the Musharaka will come to an
end.
− In this case, if all the assets of the Musharaka are in cash form then
they will be distributed pro rata between the partners.
− In case they are mixed assets the partners may agree either on:
► The liquidation of the assets (market price), or
► On their distribution among the partners as they are; or
► Purchasing from one partner share of other at any agreed price between them.

28. Application of Musharakah
 Musharakah could easily be used as a vast mode of financing for
almost every financial need. Below are some fields where this mode
can easily be applied:
− Long-term Finance
− Running Finance (limited scope)
− Investment Banking
− Project Financing
− Private Equity Placement
− Redeemable capital investment

29. Long-term Finance

As the name suggests, Long term financing is a form of
financing that is provided for a period of more than a year. Long
term financing services are provided to those business entities
that face a shortage of capital.
It is different from short term financing which is normally used
to provide money that has to be paid back within a year. The
period may be shorter than one year as well.
Examples of long-term financing include - a 30 year mortgage
or a 10-year Treasury note.
Equity is another form of long-term financing, such as when a
company issues stock to raise capital for a new project.

30. Running Finance (limited scope)
 The running finance is offered by the financial
companies against the creation of charge on inventory
or debtors which are of short term nature. The charge
can be of any type say 1st charge, Ranking charge,
charge, etc. mortgages . It usually comes under the
heading of the working capital financ
Investment Banking
 An investment bank is a financial institution that assists
individuals, corporations, and governments in raising financial
capital by underwriting or acting as the client's agent in the
issuance of securities (or both). An investment bank may also
assist companies involved in mergers and acquisitions (M&A)
and provide ancillary services such as market making, trading
of derivatives and equity securities, and FICC services (fixed
income instruments, currencies, and commodities).

31. Project Financing
 Project finance is the long-
term financing of infrastructure and industrial projects
based upon the projected cash flows of the project rather
than the balance sheets of its sponsors. Usually, a project
financing structure involves a number of equity investors,
known as 'sponsors', as well as a 'syndicate' of banks or
other lending institutions that provide loans to the
operation. They are most commonly non-recourse loans,
which are secured by the project assets and paid entirely
from project cash flow, rather than from the general assets
or creditworthiness of the project sponsors, a decision in
part supported by financial modeling

32. Private Equity Placement
 The sale of securities to a relatively small number of select
investors as a way of raising capital. Investors involved in private
placements are usually large banks, mutual funds, insurance
companies and pension funds. Private placement is the opposite
of a public issue, in which securities are made available for sale
on the open market.
Redeemable capital investment
The return of an investor's principal in a fixed income security, such as a
preferred stock or bond; or the sale of units in a mutual fund. A
redemption occurs, in a fixed income security at par or at a premium
price, upon maturity or cancellation by the issuer. Redemptions occur
with mutual funds, at the choice of the investor, however limitations by
the issuer may exist, such as minimum holding periods

33. QUESTIONS