12/9/2010

Mudarabah and Musharakah

- Participatory Modes of financing
Mudarabah

Essentials of Islamic Banking and Finance

IRSHAD AHMAD AIJAZ

irshad786@ gm ai l.c om

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Contents Mudarabah - Introduction

 Introduction – Mudarabah;  “Mudaraba” is a kind of partnership where partner involve in

− Profit / Loss Distribution; business;
− Kinds of Mudarabah  Mudarabah is partnership between persons in which one partner
 Termination of Mudarabah gives money to another for investing in profitable avenues.
 Mudarabah Vs Musharakah  The investor (fund provider/supplier) is called “Rabb-ul-Maal
while the person who utilizes this fund (the fund manager) is
 Scope of Mudarabah for Banking System called “Mudarib”;
 Risks  Mudarib is exclusively responsible for management of the
 Practical examples business.
 Rabbul Maal (fund supplier) does not have any right to interfere
in business affairs.

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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.
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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.
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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;
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.
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Mudarabah - Rules Mudarabah - Rules

 Supply of funds:  Termination of Mudarabah:

− The basic feature of Mudaraba is that the the capital is provided − The contract of Mudaraba can be terminated at any time by
by Rabbul Maal and the Mudarib is responsible for the either of the two parties after giving a notice to the other party.
management only; − If all assets are in form of cash and some profit has been
− However, it is allowed for Mudarib to add capital into the earned on the principle amount, it shall be distributed between
business of Mudaraba if agreed with Mudarabi; the parties according to the agreed ratio.
− In such cases Musharaka and Mudaraba are combined. − If the assets of the Mudaraba are in other form the Mudarib
− For example, “Zuhaib” gave to “Rahman Hayder” Rs.100,000/- shall be given an opportunity liquidate them and the actual
for Mudaraba. R. Hayder added Rs. 50,000/- from his own with profit may be determined.
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.

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Mudarabah Vs Musharakah Mudarabah - Application

 Mudarabah:  Musharakah:  Scope of Mudarabah for Banking System:

− 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.
− 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.
− 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;

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Mudarabah – Application (Deposit [Liability]

Mudarabah - Application management)
POOL MANAGEMENT
 Depositors and Islamic bank relationship: Pools according to (1) size of deposit, (2) Tenure
− Mudaraba is used by Islamic Banks for taking deposit from S
depositors; i A B C D E F
− The depositors provide moneys to bank as Rabb-ul-Mal to be z
invested by bank as Mudarib on the basis of profit and loss e
sharing on pre agreed specific ratio;
o G H I J K L
f

D
DEPOSITS e M N O P Q R
p
MUDARABAH PROFIT & o
DEPOSITORS LOSS SHARING ISLAMIC BANK
s
i S T U V W X
PROFIT t

Time (tenure)

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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. Musharakah
► 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.

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Contents Introduction

 Introduction;  Musharakah is a newly invented terms by Ulemaa;

 Types of Musharakah;  The actual term used by Fuqahaa (classical Islamic scholars)
 Basic Rules in Musharakah; was Shirkah (or Sharikah);
 Termination of Musharakah;  Lexical meaning of it is sharing/merging;
 Security / Collateral in Musharakah;  Technically: “Commingling by two or more persons either their
 Musharakah Management and Liability; 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
 Profit / Loss Distribution ; according to their proportionate ownership”;
 Application of Musharakah As a Mode;
 Now the term Musharakah is popular;
 There are different types of Shirkah which have been explained
by Fuqaha’;
 See next slide for details:

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Types of Shirkah Basics of Musharakah

 There are some basic features of Musharakah:

− Mixing of Capital (joint ownership);
SHIRKAH (Partnership)
− Asset or property or anything that can accept partnership;
Shirkat-ul-Milk (Joint ownership)
− Rights and Responsibilities;
− Sharing of profit and loss
Optional Forced
Shirkat-ul-A'qd (Business
partnership)

Amwaal (partnership with A'amal (partnership in Wujooh (reputational

capital) work) partnership)

Mufawadah Al Inaan Mufawadah Al Inaan Mufawadah Al Inaan

(100% (Variability in (100% (Variability in (100% (Variability in
equality in shares of equality in shares of equality in shares of
shares of partners) shares of partners) shares of partners)
partners) partners) partners)

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Basics of Musharakah 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.
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Basics of Musharakah 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;
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 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;
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 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;
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Basics of Musharakah Basics of Musharakah

 Sharing of Loss:  Termination of Musharakah:

− 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;
− 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.

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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 QUESTIONS
− Project Financing
− Private Equity Placement
− Redeemable capital investment

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