The term ‘Mudaraba’ derives from one of the definitions of the Arabic word ‘Mudaraba’, which translates as ‘Travel’. Thus, the term ‘Mudaraba’ refers to ‘Travel’ for the purpose of conducting business.
Mudaraba is a profit-sharing partnership in which one party contributes finance and the other party contributes expertise and labor. The capital supplier is referred to as “Shahib al-maal,” whereas the provider of skill and labor is referred to as “Mudarib.”
Thus, Mudaraba may be defined as a partnership agreement in which the Shahib al-maal distributes capital to the Mudarib in exchange for the Mudarib investing it in a commercial venture through the use of his labor and endeavor. Both parties share profits in accordance with the agreed ratio, with losses, if any, being paid by the fund provider, i.e. Shahib al-maal, unless the loss is the result of a breach of trust, i.e. misconduct, negligence, or violation of the Mudarib’s stipulations. If any loss occurs as a result of the aforementioned factors, Mudarib becomes accountable for such loss.
Bai-Murabaha may be defined as a contract between a buyer and a seller in which the seller sells particular items (permissible under Islamic Shariah and local law) to the buyer at a cost plus stipulated profit payable in cash or in installments at a future determined date. Profit margins can be fixed in terms of a fixed amount or as a percentage of the cost price of the items.
Additionally, Mudaraba is venture capital funding for an entrepreneur who offers work while the bank provides cash, allowing for the sharing of profit and risk. These participatory arrangements between capital and labor reflect the Islamic idea that the borrower should not face the entire risk/cost of a failure, resulting in a more equitable distribution of revenue and preventing the lender from monopolizing the economy.
Muslims say that the Islamic prophet Muhammad’s wife Khadija used a Mudaraba contract with Muhammad in order to finance Muhammad’s trading voyages in northern Arabia – with Khadija giving funds and Muhammad supplying labor/entrepreneurship.
Rules and Principles of Mudaraba Contract:
It is permissible for the Client to place an order with the Bank for the purchase of specified items, specifying the goods and committing to purchase them from the Bank on Murabaha, i.e. cost + agreed upon profit.
It is legal to bind the Client to purchase from the Bank by requiring him to either fulfill the promise or indemnify the Bank for any damages incurred as a result of the pledge being broken without justification. It is permissible to take cash/collateral security to ensure the promise’s fulfillment or to compensate against losses.
Additionally, it is acceptable to document the debt resulting from Bai-Murabaha through a Guarantor, a mortgage, or both. Mortgage / Guarantee / Cash Security may be obtained before to or concurrent with the execution of the Agreement. Stock and availability of commodities are prerequisites for the conclusion of a Bai-Murabaha Agreement. Thus, the Bank must obtain ownership of the commodities specified by the Client before to executing the Bai-Murabaha agreement with the Client.
After purchasing goods, the Bank must bear the risk of those goods until they are sold and delivered to the Client, i.e., after the Bank purchases the goods and before selling them on Bai-Murabaha to the Client buyer, the Bank shall bear the consequences of any damages or defects, unless the Client enters into an agreement absolving the Bank of those defects. This means that if the goods are damaged, the Bank is liable; if the goods are defective, the Bank is liable.
The Bank is responsible for delivering the specified Goods to the Client on the stipulated date and at the specified location as defined in the Contract.
The Bank will profit by selling the commodities at a higher price (Cost + Profit). The cost of items sold and the profit margin on them shall be specified separately and plainly in the Bai-Murabaha Agreement. Profit margins may be expressed as a fixed amount or as a percentage of the purchase/cost price of the items. However, under no circumstances shall the percentage of profit be related to or expressed in terms of time, such as per month, per year, or elsewhere.
Once agreed upon and deferred, the price cannot be increased further. The Bank may permit any third party to purchase and receive items on its behalf. The authorization must be contained in a distinct contract.
Distribution of Profit:
For Mudarabah to be legal, the parties must agree on a specific percentage of the actual profit to which each party is entitled from the start. The Shariah does not specify a certain allocation; rather, it is up to their mutual consent. They can divide the profit equally or they can divide it differently between the Rabb-ul-Mal and the Mudarib. They cannot, however, assign a flat sum of profit to any party, nor can they determine a party’s share at a fixed rate related to the capital. For instance, if the capital is Rs. 100000/-, they cannot agree on the condition that Rs. 10000/- of the profit goes to the Mudarib, nor can they agree on the condition that 20% of the capital goes to Rabb-ul-Mal. They can, however, agree that 40% of the actual profit should be distributed to the Mudarib and 60% to the Rabb-ul-Mal, or vice versa.
Additionally, different proportions may be agreed upon under different circumstances. For instance, the Rabb-ul-Mal may inform Mudarib that “if you trade in wheat, you will receive 50% of the profit; if you trade in flour, you will receive 33% of the profit.” Similarly, he can state, “If you conduct business in your town, you are entitled to 30% of the profit; if you conduct business in another town, you are entitled to 50% of the profit.”
Apart from the agreed-upon share of profit, as established in the preceding method, the Mudarib is not entitled to receive any periodic income, fee, or remuneration for labor performed for the Mudarabah. On this topic, all schools of Islamic Fiqh agree. However, Imam Ahmad has permitted the Mudarib to deduct daily meal expenses from the Mudarabah account. According to Hanafi jurists, this power of the Mudarib is limited to situations in which he is on a business trip outside his home city. In this situation, he may claim personal expenditures such as travel, lodging, and food, but he is not entitled to any daily allowances while in his home city.
If the firm has experienced a loss in some transactions and a profit in others, the profit shall first be utilized to offset the loss, and any remaining profit, if any, shall be allocated amongst the parties in accordance with the agreed ratio.
Mudarabah contracts may be restricted or unrestricted:
The Rabb-ul-Mal may identify a particular business for the Mudarib in an al-Mudarabah al-muqayyadah (limited Mudarabah), in which case he shall invest the money exclusively in that business. For the account holder, a restricted Mudarabah may permit the IIFS (institutions offering Islamic financial services) to invest their funds through Mudarabah or agency contracts that impose particular restrictions on the location, manner, and purpose of investment. They would be held in “Investment Funds” rather than “Investment Accounts” by the bank customer.
In an al-Mudarabah al-mutlaqah (unrestricted Mudarabah), the Rabb-ul-Mal permits the Mudarib to engage in any business he desires and so authorizes him to invest the money in whatever venture he considers fit. The account holder’s funds are invested without restriction pursuant to Mudarabah or wakalah (agency) contracts, and the institution may pool the investors’ funds with their own and invest them in a pooled portfolio, with the funds being referred to as “Investment Accounts” rather than “Investment Funds.”
Profit is shared as per agreement.
Loss beared by client.
Amount can be paid on installment basis.
Usual duration 1-2 year(s).
Rebate may be given on Early Adjustment.
The author if this article is studying at the Department of Arabic, Dhaka University.