Modes of Financing Participatory Modes

Modarabah and Deposit Management

Islamic Modes/Instruments Participatory Modes:

Modarabah: [Shariah Standard N0. 13]

A trustee-type finance contract
Profit sharing is agreed between two parties
Losses are borne by the provider of funds
UNLESS
Parties to Mudaraba:
Rabb-ul-Mal (Bank) Rabb-ul-Mal (Customer)
Mudarib (Customer) Mudarib (Bank)
Types of Mudaraba:
Restricted Mudaraba:
Unrestricted Mudaraba:

Islamic Modes/Instruments Participatory Modes:

Modarabah: Conditions of Mudarabah:

Legal capacity of the two parties to appoint
agent and accept agency
Trust contract Mudarib is not liable for
losses UNLESS negligence/misconduct is
proved [Limited liability of Mudarib]
Nature of Contract Non-binding can be
terminated unilaterally, except when the
Mudarib has already commenced the
business binding up to the date of actual
or constructive liquidation.

Islamic Modes/Instruments Participatory Modes:

Mudarabah: Conditions of Mudarabah:

Management and work - exclusive
responsibility of Mudarib
Capital is invested in broadly defined
activities. [specific conditions can apply if
already provided in the contract]
Capital, preferably in cash.
Terms of profit are pre-agreed and
customized for each investment.

Islamic Modes/Instruments Participatory Modes:

Modarabah: Conditions of Mudaraba:

Bank can contract Mudaraba with more than
one person
Each one of clients act as mudarib.
Capital to be utilized by all of them jointly.
All the mudribs shall run the business as
partners among themselves.
Share of mudarib shall be distributed among
them according to the agreed proportion.

Modarabah More than one Mudarib

Proposal of
work

Provision of
capital

1. The Project
Mudarib
2

Mudarib
Mudarib

Share of
profit

Bank (Rabul Maal)

Share of
profit

3. Accruing Profits

4. Capital

Recovery of
capital

Islamic Modes/Instruments Participatory Modes:

Modarabah: Conditions of Mudaraba:

Rab ul Maals More than one [Deposit
Management Relevance].
Pool their funds.
Within pool All are partners.
Profit distributed as per the tenor and amount
of funds.
A special weightage system is built to
distribute the profit

Modarabah More than one Rab ul Maal

Provision of
capital

Proposal of
Work

1. The Project
Rab Maal
2

Rabul Maal
Rab Maal

Share of
profit

Bank (Mudarib)
Share of
profit

3. Accruing Profits

Recovery of
capital

4. Capital

Islamic Modes/Instruments Participatory Modes:

Distribution of Profit:
Bank and client should agree, right at the conclusion of
contract, on a definite proportion. [However, proportion can
be changed for a further definite period]
No lump sum amount of profit.
Mudaribs share can be tied up with the nature of business eg.
40% if does cloth business, 50% if deal in wheats business,
30% if does at his own [but need to be provided in the
contract]
Distribution of profit depends at the time of physical or
constructive liquidation of business. Reserves can be created
with permission of financier which can be used for meeting
losses.
Mudarib cannot claim any periodical salary or fee if already
being provided share in profit (However, under a separate
contract which can be terminated without affecting the
Mudarabah contract, Mudarib may be compensated for
expenses on business trip [Opinions].

Islamic Modes/Instruments Participatory Modes:

Distribution of the profit:
If losses in one transaction and profit in some other
- the profit shall set aside the losses first and the
balance would be distributed.
At the time of liquidation [Constructive OR Actual]:
If losses > profits, the difference subtracted from capital

If ratio of profit distribution is not decided at the

time of contract, then as per customary practice
One partner can donate a part or whole of his profit
to the other
If no such practice, the Mudarabah contract
becomes void - Mudarib receives remuneration of
his services equivalent to market price

Islamic Modes/Instruments Participatory Modes:

Distribution of the profit:

If provided in contract, one of the parties
may get additional profit if it crosses certain
agreed ceiling, otherwise if within that
ceiling, then as per agreed ratio.

Islamic Modes/Instruments Participatory Modes:

Mudarabah: Mudarabah Financing Agreement

Parties
Description of project (DOP) [/feasibility/cash
flow/revenue projection]
Account opened with Institution in name of
Client
Client asset finance as per DOP means the
sum estimated by the Client as necessary to
acquire the assets required for the Project as
disclosed on the Project Information Form
Exhibit A

Islamic Modes/Instruments Participatory Modes:

Mudarabah: Mudarabah Financing Agreement

Management Services
Profit and participation in profit amount of
gross profit available for distribution after
deduction of permissible expenses as may be
agreed between the client and the Institution
and profit to be distributed as per agreed ratio
and periodicity of profit distribution
Losses by the institution and Mudarib loses
management fee, unless
Clients Information Information disclosed by
the client, Client Financials (Balance Sheet,
P&L), Draw Down Dates
Guarantees to cover the negligence and
misconduct of Mudarib.

Islamic Modes/Instruments Participatory Modes:

Modarabah: Mudarabah Financing Agreement

Project Information Form being a narrative
description of the Project
Cash Flow and Revenue Projection for Project,
and Management Services
Authorized signatories
Accounts to be audited by the CA approved by
the bank
Client Information Form
Duration
Termination date

Islamic Modes/Instruments Participatory Modes:

The following are applicable generally but more
relevant to deposit mgmt:

Mudaribs right to profit arises as soon as

profits are realized
Such entitlement is not absolute till the time
of liquidation due to retention practice.
The practice distribute a part of realized
profits on account as interim profits which
will be revised when actual or constructive
valuation takes place.

Islamic Modes/Instruments Participatory Modes:

The following are more relevant to deposit mgmt:

If Mudarib has mixed his funds with the

funds of Rab-ul-Maal, The Mudarib takes two
positions:
Becomes Mudarib in respect of funds of capital
provider
Becomes partner in respect of his funds

Profit in such case will be distributed as

under:
Mudarabah profit to be distributed as per
agreed ratio.
Partnership remaining profit in proportion to
amounts contributed [Deposit Management
weightage system].

Islamic Modes/Instruments Participatory Modes:

Modarabah:
Termination (Liquidation) of Mudaraba:
Basically, Non-binding nature, except in
circumstances discussed earlier
Otherwise, Agreement of both parties is
required
In practice, prior notice is required to be
served
The funds of Mudaraba have been
exhausted due to losses.
The death of Mudarib or liquidation of the
institution working as Mudarib.

Islamic Modes/Instruments Participatory Modes:

Modarabah:
Termination (Liquidation) of Mudaraba:
If the assets of the Mudaraba are in cash at
the time of termination, these shall be
returned, and profit if any, shall be
distributed between the parties according
to the agreed ratio.
If the assets of the Mudaraba are not in the
cash form, the Mudarib shall be given an
opportunity to sell them to arrive at the
actual profit.

Islamic Modes/Instruments Participatory Modes:

Deposit Management in
Islamic Banking

Distribution of Profit & Loss Among Liability Holders

Bank:
Conventionally, a financial intermediary accepting
deposits and granting loans is known to be a bank
An Islamic Bank, a banking company raising funds
(accepting deposits, etc.) and investing in Shariah
compliant manner to earn profit to be distributed
among managers and fund providers
Resources
Surplus Pockets

B
A
N
K

Investments
Deficient Pockets

Distribution of Profit & Loss Among Liability Holders

Financial Statements of a bank Balance Sheet:

Report of conditions Amount and composition of
fund sources (financial inputs - Liabilities) the bank
has drawn upon to finance its various investing
activities (financial outputs - Assets) at any given
point of time.
Liabilities: Claim of fund providers on bank yield
cost to the bank
Assets: Financial assets owned by a bank yield
income to the bank
Financial Statements of a bank Income Statement:
Report of income Summary of income realized
and expenses incurred during a given time period

Distribution of Profit & Loss Among Liability Holders

Balance Sheet of ABC Bank as on December 2xx35

LIABILITIES

ASSETS

Particulars

(Rs.)

Particulars

(Rs.)

Deposits

5000

Cash in hand

1000

Other banks accounts

2000

Murabahah financing

5000

Total liabilities

7000

Ijarah financing

3000

Equity [paid up capital + 3000

reserves + retained
earnings

Other assets

1000

Liabilities and equity

Total assets

10000

10000

Parties on the liability side and their relationship: Depositors - No voting

rights, Shareholders (Shirkah of JSC) owners of bank, and Management
of bank

Complete Liability side of a Bank

Bank
(Mudarib)

Depositors
Pool (Rabul
Maals)
M
U
S
H
A
R

Mudarabah

Shareholders
Capital

Islamic Modes/Instruments Participatory Modes:

Deposit Management in Islamic Banking
Restricted Vs Unrestricted Accounts

Most of the Islamic Banks are following Profit

Sharing mechanism called Mudarabah +
Musharakah model or simply Mudarabah model.

Following is the process flow of the Mudarabah

model.

Creation of Pool

The Bank will create Depositors Pool.

The Pool will have categories based on the
tenor of the deposit. :

Three Month
Six Month
One Year

Distribution of Profit & Loss Among Liability Holders

Deposit Management in Islamic Banking

Assume that following investment is made by the
depositors;
Three Months
Rs. 4,000
Six Months
Rs. 3,500
One Year
Rs. 2,500
Rs. 10,000
All the funds are kept in the pool of depositors
The customers would be assigned a specific
weights based on the investment category:
Three Month
0.60
Six Month
0.70
One Year
1.00

Distribution of Profit & Loss Among Liability Holders

Deposit Management in Islamic Banking

Assume that Bank deploys Rs. 10,000/- for a period
of one year and earns a profit of Rs. 1,000. Profit
would be shared as follows:
Bank Rs. 500
Pool Rs. 500

Profit Sharing among the Depositors:

Rs. 500 earned by the Pool would be

distributed as per the amounts and weightage
assigned at beginning of the month.
Relationship within the Pool would be
governed by the rules of Musharakah

Distribution of Profit & Loss Among Liability Holders

Deposit Management in Islamic Banking

Deposit
(Rs.)

Weight

Weighted
Average

Profit
(Rs.)

Rate
(%)

4000

0.6

2400

163

4.08

3500

0.7

2450

167

4.76

2500

1.0

2500

170

6.80

7350

500

10000

Islamic Modes/Instruments Participatory Modes:

Deposit Management in Islamic Banking
Islamic bank A joint stock company Owners are
partners through partnership deed.
Account holders are not partners in the company no
voting right or management.
The deposit management - Musharakah - combination
of Shirkah and Mudarabah
Shirkah is the partnership of owners of bank
Mudaraba is the business contract between
depositors and the banks management
Bank therefore is Mudarib as well as partner in the
process.
Summarized: we are looking at the Musharakah of the
depositors pool and the banks equity. [Take note of
both sides of the balance sheet].

Islamic Modes/Instruments Participatory Modes:

Deposit Management in Islamic Banking
Shariah Position Of Deposits recognized by Islamic Banks:

The common misconception regarding deposits Amanah.

Deposits resemble more to qard (loan) than Amanah.
Because,

Amanah cannot be used by the holder.

Therefore any benefit drawn from such deposit is not

permissible.

He cannot be held responsible for any loss or damage

suffered by Amanah without his negligence, in this case
100% return is not guaranteed.

Example of Syedna Zubair bin Awwam (RA) [Reported in AlBukhari and Tabaqaat-e-Ibn-e-Saad]

Pakistan:

Current account on the basis of Qard.

Saving and Investment accounts are taken on the basis of

Mudarabah/Musharakah.

Islamic Modes/Instruments Participatory Modes:

Deposit Management in Islamic Banking
Shariah Position Of Deposits recognized by Islamic Banks:
Malaysia:

Current Account Al-Wadiah Yad Dhamanah (Guaranteed

custody) [Specific permission for use of funds, withdrawal
facility on demand, no payment of profit, etc. allowed]

Saving Account Al-Wadiah Yad Dhamanah (Guaranteed

custody) [Specific permission for use of funds, withdrawal
facility on demand, no payment of profit, saving pass book /
cheque book and clearing etc. allowed, Bank on its discretion
rewards the customers]

General & Special Investment Account Al Mudarabah/

Trustee Profit Sharing [Profit sharing and loss bearing basis,
different tenors, different weightages]

Islamic Modes/Instruments Participatory Modes:

Deposit Management in Islamic Banking

Rules of Loss between the Bank and the

Pool are the same as of Mudarabah, ie all
financial Losses would be borne by the
Pool as Rabul Mal and share holders
according to the investment ratio

Other Conditions

The Bank would cover all expenses from its

own share of profit within the Mudarabah
arrangement.

Weightage can only be amended at the

beginning of the month.

Islamic Modes/Instruments Participatory Modes:

Accounting Treatment in Mudarabah

Recognition of Mudarabah capital at the time of contracting

Recognized when paid to mudarib or placed under his

disposition

If paid in installments, each installment recognized when

paid

It is presented as mudarabah financing. If capital is

provided in the form of non-monetary capital it is reported as
non-monetary asset

Measurement of mudarabah capital at the time of contracting

Capital provided in cash is measured by the amount paid or

amount placed under disposition of mudarib

Capital provided in kind is measured at fair value of asset

and any difference between the fair value and book value is
recognized as profit or loss

Expense incurred is not considered as part of mudarabah

capital unless agreed by all parties

Islamic Modes/Instruments Participatory Modes:

Accounting Treatment in Mudarabah

Measurement at the end of financial period

Same criteria as at the time of reporting. However, any

payment made to the bank is deducted from
mudarabah capital

Any loss at the inception of work shall be borne by the

Islamic bank in its P&L A/c. If loss occurs after the
inception of work, it shall affect the measurement of
mudarabah capital (ie. Amount of mudarabah capital
will be reduced accordingly)

If whole of the capital is lost without any misconduct

or negligence of mudarib, the mudarabah shall be
terminated and Islamic bank shall recognize as loss

If in above situation the mudarib is responsible, then it

shall be recognized as receivable from the mudarib

Islamic Modes/Instruments Participatory Modes:

Accounting Treatment in Mudarabah

Recognition of banks share in profit or loss

Profit or loss on mudarabah transaction which

commence and end during the same financial period is
recognized at the time of liquidation (constructive or
actual)

Share of profit that continues for more than one

financial period is recognized to the extent of profit
distribution and any loss is deducted from mudarabah
capital

Share of profit is recognized as a receivable from

mudarib if mudarib does not pay after liquidation or
settlement of business account has been made

Loss is recognized at the time of liquidation by

reducing the mudarabah capital