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29 May 2014
Islamic Finance Basics part 5: Mudaraba - a proven path for
enterprise
By Mahinaz El Aasser
Mudaraba, which is sometimes known as Muqaradah or qirad [1] , is referred to in English as a profit sharing
agreement/contract. It falls within equity based partnership agreements and is defined as an agreement
whereby one person participates in a project with his or her money as capital, while the other person participates
with his/her knowledge in managing the project.
The first person is known as rab al mal, which is an Arabic word that means the owner of the money. He is more
of an investor in this context and gets his share in the form of profit. The second person, who handles the
management aspect, is known as the mudarib, which refers to an entrepreneur or working partner and also
receives a share of the profit.
General structure mudaraba transaction [2]
To make things clear in a murabaha agreement, some rules [3] should be set, including:
- Both parties should agree on a definite share of the profit for each.
- If the agreement does not specify the exact share, then the profit will be divided equally.
- The agreement should not set the share of profit as a percentage from the capital.
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- The agreement should not set a specific amount of money, lump sum, to be the share of profit.
- The mudarib does not claim a salary for work performed under this agreement.
- The agreement is considered void, or fasid, should it fail to adhere to any of the above rules.
- The mudarib can contribute to capital, subject to the approval of rab al mal.
- The agreement is terminated once the duration lapses, if temporary, or when one of the parties informs the
other, when it is an ongoing arrangement.
- In case of losses, the loss is fully borne by the rab al mal unless it is caused by an act of negligence by the
mudarib, who will then bear part of the loss.
Mudaraba has two types [4] :
- Restricted mudaraba: Known in Arabic as Al Mudaraba Al Muqayadah. This is when the rab al mal sets some
rules or specifics, such as a particular business, place or asset class in which the mudarib shall invest money.
- Unrestricted mudaraba: Known in Arabic as Al Mudaraba Al Mutlaqah. In this type, the rab al mal gives full
freedom to the mudarib to undertake whatever business they deem appropriate in order to maximise profits. Any
procedures or actions outside the context of the routine business shall first be approved by the rab al mal.
Mudaraba transactions in banks have reached $3.5bn to date, including syndicated and bilateral transactions.
In such a transaction, the Islamic bank acts as the rab al mal and provides the required funding to the borrower,
which is acting as a mudarib.
In the case of syndicated loans [5] , there will be several banks that provide the required fund. This is done
through an investment agent which is deemed to be the rab al mal instead of having several lenders or the
arbab al mal (the Arabic plural of rab al mal). The partnership is created between the investment agent, on
behalf of the banks, and the borrower. The agent provides the money whereas the borrower provides the
expertise and both share in the profits as specified in the agreement signed between them.
The mudaraba structure is not widely used in the banking sector due to the concept of partnership in profits.
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Some banks instead refer to the wakala structure, which assigns the borrower a fixed fee in return for his work.
In the sukuk market, mudaraba takes a slightly bigger share, at 5%, with $34.24bn worth to date from 434
sukuk tranches. Mudaraba falls within the category of equity based sukuk, as defined by AAOIFI. [6]
Mudaraba sukuk are investment sukuk, which represent the ownership of units of equal value in the equity of the
mudaraba. Or, in other words, these are certificates representing the proportionate ownership of capital for a
specific project undertaken by an entrepreneur.
The steps [7] of mudaraba sukuk takes place as follows:
1. The special purpose vehicle standing for the borrower issues sukuk
2. Investors purchase these sukuk, paying cash to the SPV. The SPV role now is the trustee of this money,
declaring a trust over proceeds.
3. The issuer as rab al mal, on behalf of the investors, enters a mudaraba agreement with the originator
providing the principal amount of funds required for the mudaraba enterprise.
4. The originator provides expertise and management
5. Both cash and expertise are transferred to the mudaraba enterprise/project.
6. Mudaraba profits/losses occur after the operation of the enterprise.
7. Profits are then transferred to the rab al mal and the mudarib as per their specified shares*
8. The issuer pays periodic returns to investors using mudaraba profits
9. The dissolution amount is paid to investors by the end of the agreement.
* The originator might be entitled to performance fees, in the instance that the profits exceed a certain
benchmark. This is to be calculated and given by the end of the mudaraba agreement, upon liquidation. This
point is controversial among scholars, however, because it mainly applies in wakala arrangements
[1] Ethicas Handbook of Islamic Finance 2013 Edition, Ethica Institute of Islamic Finance, p. 655
6/5/2014 Islamic Finance Basics part 5: Mudaraba - a proven path for enterprise | Islamic Finance Information Service (IFIS)
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[2] Islamic Banking & Finance in the Kingdom of Bahrain, Bahrain Monetary Agency, p.26
[3] Ethicas Handbook of Islamic Finance 2013 Edition, Ethica Institute of Islamic Finance, p. 122-124 AND
http://www.deloitte.com/view/en_XD/xd/glossary/understandingmudaraba/index.htm
[4] Ethicas Handbook of Islamic Finance 2013 Edition, Ethica Institute of Islamic Finance, p. 309 AND
http://www.deloitte.com/view/en_XD/xd/glossary/understandingmudaraba/index.htm
[5] A. Khaleq, Ayman H. & N. Meher, Amar, Islamic Syndicated Financing: An Underdeveloped Method of
Shariah Complaint Financing, Practical Law Company, Vinson & Elkins LLP with PLC Finance, p. 3-4
[6] AAOIFI - Accounting and Auditing Organization for Islamic Financial Institutions. Available at:
http://www.aaoifi.com/
[7] Islamic Banker. Available at: http://www.islamicbanker.com/education/sukuk-al-mudaraba
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