Islamic Modes of

Finance
Mian M. Niaz Shakir
Lecturer
College of Commerce
GC University Faisalabad

What is Finance?

Definition of Finance
Finance can be defined as
that activity which is concerned with the
acquisition and conservation of capital
funds in meeting the financial needs and
overall objectives of business enterprise.

What is Islamic Finance?

Definition of Islamic
Finance
Islamic Finance

that activity which is concerned with the

acquisition and conservation of capital
funds in meeting the financial needs and
overall objectives of business enterprise
according to the Islamic Jurisprudents/
Shariah complaints (According to Quran
and Sunnah).

Islamic Modes of Financ

(1) Sharakat
(Partnership)
(2) Modarbah
(3) Bai Salam
(4) Bai Marabaha
(5) Bai Muajjal
(6) Ajara

Partnership (Shirakah)
Definition:When two or more persons join to do
business with a fixed capital for the
purpose of gaining profit and for sharing
in the profit or loss of business according
to a fixed ratio.

Justification
At the time of Muhammads (SAW) call to Prophethood
various forms of business were in vogue.
The Apostle of Allah (SAW) prescribed wrong modes of
business, or reformed those elements in business,
which were contrary to ethics, justice, and equity.
He forbade all forms of business in which disputes,
conflicts or strife was likely to arise in which the gain
of one party meant loss to the other.

Justification
After a careful study of those modes of industry,
trade and agriculture which were proscribed or
in which amendments were prescribed by the
Holy Prophet (SAW), The Juristic have derived
a standard of good and bad to determine lawful
or unlawful nature of a business. By applying
this standard we can investigate other forms of
business and judge whether they are legal or
illegal.

Ahadith on Partnership
The following Ahadith clearly provide justification
for partnership:
1. The Apostle of Allah (SAW) is reported to have
said:
Allah Almighty Says that untill one partner
plays false to another I am a third member of their
Partnership.
[Abu Dawud / Hakim / Baihaqi]

2.

A man came to the Apostle of Allah

(SAW) and said:
While I conduct business in the market,
one of my partners offers prayers in the
Mosque.
This perhaps is the cause of your thriving
business, said the Holy Prophet (SAW)

3.

The Apostle of Allah (SAW) said: Conduct

business on the basis of equal share. This
brings ample returns.
[Abu Dawud]
4.
The Holy Prophet (SAW) said:
Allahs helping hand is with those partners
who are not dishonest.
[Abu Dawud]

5.

The Apostle of Allah (SAW) had entered

into business partnership with Saib bin
Sharik in Makkah. When He (SAW) met
him in Madina, He (SAW) reminisced
about their partnership with approval.

The Following Rational Arguments

Also Provide Ground For The Justification Of
Partnership:
1. By pooling their resources the two partners
can invest more capital, conduct business on a
wider scale and earn more profit.
Partnership facilitate funding for business on a
high scale.

 2. A man may have capital but lack

business sense or a man may have too vast
a business to look after himself. In these
cases partnership is the best mode of
running business successfully.
3. Partnership makes it possible to work
on the principle of division of labour

Conditions of Partnership
1.
2.
3.
4.
5.
6.

Mutual Agreement
Maturity of the Partners
Sound Mind
The Business must be Lawful
Fixing the Rate of Profit
Liability for Loss (With Capital Ratio)

Partnership
(The Hanafi view)

1.By Agreement
(Shirakah Alkud)

In Goodwill
(Shirakata-al-Wagu)

With Equal Shares

(Shirakata-alMafawada)

With Unequal
Shares
(Shirakata-al-Anan)

In Art
(Shirakata-al-Badan)

2. In Property

In Capital
(Shirakata-bil-Mal)

With Equal Shares

(Shirakata-alMafawada)

With Equal Shares

(Shirakata-alMafawada)

With Unequal
Shares
(Shirakata-al-Anan)

With Unequal
Shares
(Shirakata-al-Anan)

At Will
(Voluntary
Partnership)

Compulsory
(Shares in
Inheritance)

Features Of P/S With Equal Shares

(Shirakata-al-mafawada)
Equal capital Investment
Each Partner represents the other
All partners should be
Sound mind
Adult
Free
Faithful
Accountable to other for his dealings and acts of
ommission and commission.
Profit and Loss shall be equally shared

Features of P/S with Unequal Shares

(Shirakata-al-Anan)

Two or more parties with unequal shares

Capital investment may be different
Parties may be of different faith-Muslims with infidels
A minor and adult can be partners
Agreed rate of profit
Losses will be shared in proportion to their capital
investment
In P/S in ownership the powers and functions of
partners may differ, but it is not essential that their
capital investment should be equal.

P/S In Work, Action, Craft Or Art

In this mode of p/s there are two or more parties.
Craftsmen like two or more carpenters or iron
smith can enter into p/s.
The p/s in work is declared lawful by Hanfi,
Malki and Hanbli jurists, while jurists of the
shafi and Jaffria school of thoughts regarded it
as unlawfull.

Partnership in Goodwill
In this mode of partnership there is no capital
investment, but investment of goodwill of a company
or a firm. A firm on the strength of its goodwill
purchases goods on credit and sells them on cash
basis. Partnership with such a firm or company is
called Partnership in Goodwill.
The p/s in work is declared lawful by Hanfi, Malki and
Hanbli jurists, while jurists of the shafi and Jaffria
school of thoughts regarded it as unlawfull.

Modern Forms of Partnership

1.
2.
3.
4.

Joint Stock Company

Partnership
Limited Companies
Cooperatives

Law of Partnership
Distribution of Profit
a) With the agreed ratio, no amount of profit shall be allocated in
advance
b) In determining rate of profit, capital investment, participation and
responsibility shall be taken into account.
c) Despite equal capital investment the ratio of profit for each
partner may vary.
d) In ongoing business current loss may be offset against future
profits.
e) In the auditing of accounts first the capital shall be set apart.
Next the surplus shall be computed. If there is surplus it shall be
entered as profit. If the capital has diminished it is loss.
f) Those who are entitled to profit shall receive it only when the
capital has been returned to its owner. The owners can receive
capital de facto or de jure.

Modarbah
Meaning of Modarbah:
Modarbah is derived from the word Al-Zarab
which means to travel.
travel
This is related to trade because trade usually
Involves travelling.
Furthermore, it is derived from Zarba Fi Al-Ard
Al-Ard
which implies travelling over the length and
breadth of the earth.
This is related to Modarba because the Zarib
(the person who enters into Modarba) adds
his labour to the capital of the Financier.

Modarbah
In the Hanafi and Hanbali jurisprudence, Modarbah
is known as Modarbaha
while the Shafii and Malki jurists use the term
Qiraad for Modarbah.
The meaning in both cases, however is the same,
that is,
a man receives anothers money or goods, adds
his labour to it and earns profit.
The Rb-al-Mal (the finacier or owner of goods) is
called Maqarz and the worker is called
Muqarad.

Modarbah

The other term used for the

Modarba are Qirrad and
Miqarza which is derived from
Qaraza. Qaraza means to cut. In
relation to Modarbah it means
that the financier (or the
capitalist) accumulates capital by
saving from his income and
invests it in business.

Definition
Two or more persons enter into a deal
in which one party provides capital
and the other party conducts business
with this capital under an agreement
of receiving a fixed share in the
profit.
In this mode of business the Financier
(Rab-al-Mal) provides capital and the
Modarib by adding his labour to
increase it.
The increase is then shared by the
parties in accordance with an agreed
ratio.

Name of Parties Involved

The term Rab-al-Mal is used for the

Finacier and
The person who adds his labour to the
capital of the financier is called
Modarib

Different terms of Modarbah

1- Two persons enter into a contract of
Modarbah: one, the Rab-al Mal the and
other Modarib.
2- More than two persons can also enter into
Modarbah, then the position will be
1. More than one Financer and more than
one Modarib
2. The Financer is one and more than one
Modarib
3. The capital is provided by a cartel of
few persons and one person as Modarib
All the above forms are lawful.

Ahadith on Modarabah
1- The Holly Prophet (PBUH) Observed:
The man who brings up three girls is like a
prisoner. So O men of Allah! Enter into
Modarbah with him, give him loan (AlMabsoot)
2- Abbas bin Muttlab (Allah may pleased with
him) used to enter into modarabah on some
special terms. When this came to the
knowledge of Holly Prophet (PBUH), He
(PBUH) disapproved of it. (Al- Mabsoot)
3- Hakeem bin Hazaam (Allah may pleased with
him) used to enter into modarabah on the
same terms. (Al- Mabsoot)

Ahadith on Modarabah
4- Abu Naeem reported that before His call to
Prophethood (PBUH) , the Apostal of Allah
(PBUH) had conducted business in Syria with the
capital provided by Hazrat Khadija (Allah may
pleased with him) on Terms of Modarbah. (AlMabsoot)
5- The Apostal of Allah (PBUH) is reported to have
said that there is blessing in Modarbah. (Abu
Dawood)
6- Hazrat Uthman (Allah may pleased with him)
used to conduct business on Modarbah.
7- Hazray Ayesha (Allah may pleased with him)
used to invest the money deposited with her by
the people in Modarbah.

Ahadith on Modarabah
8- Hazrat Umar (Allah may pleased with

him) entered into Modaebah with Zaid

bin Khaleeda.
9- Hazrat Umar (Allah may pleased with
him) also extended money from the
Bait-ul-Mal for use in business on the
Principal of Modarbah.
10- Example of Hazrat Abdullah and
Hazrat Ubaiddullah two sons of Hazrat
Umar (Allah may pleased with him) .

Importance
1- Peoples having capital but lack of
capability
can invest through Modarbah.
2- Banks can adopt Modarbah as
alternative
to the interest bearing transactions.
3- Companies engaged in big business
can
build up their capital resources
through Modarbah.

Rules of Modarbah:
So long as the Modarib, having received the capital,
does not invest it in business, the capital remains
with him as trust. It is, therefore, the responsibility of
the Modarib to safeguard this trust. It is also his duty
to return the capital to the Rab-a.-Mal on demand. If
the capital is lost, destroyed or wasted, the Modarib
is not liable to fine.

(ii)
When the Modarib invests the capital in the
business he becomes the agent of the Rab-al-Mal.
(iii)
In the case of the business yielding a profit
the Modarib becomes a party to a financial
agreement in which each party shares in the profit
according to an agreed ratio.

Rules
(iv) if for some reason the contract of Modarbah is
dissolved it vv ill turn into a contract of employment
and the Modarib will become an employee of the
Rab-al-Mal. In this case profit or loss will belong to
the Rab-al-Mal. The Modarib shall receive his pay
only.
(v)
If the Modarib does not accept any term of
the contract of Modarbah, he shall be deemed an
embezzler and shall be held liable to return the
capital.

Rules
(vi) If the contract of Modarbah contains the term that
the whole profit will go to the Modarib, it will not be a
contract of Modarbah, but a contract of debt.
The Modarib will become a debtor. The Modarib will take the
profit and bear the loss. If the capital is lost, the debtor shall
be liable to pay the whole of it to the Rab-al-Mal.

(vii)If the contract of Modarbah contains the term that

the entire profit shall go to the Rab-al-Mal, it will be a
contract of albazaata.

Relationship B/W Rab-al- Mal and

Modarib
1-

Modarib asTrustee:
Before Investment.
asTrustee
Responsible to protect the Investment/
capital.
2- Agent: On investment work as Agent.
3- Party: On yielding profit in the Business
become a party to a agreement.
4- Employee: If the Contract of Modarbah is
dissolved it will turn into a contract of
Employment. Profit and loss will belong to
Rab-al-mal.Modarib shall receive his pay only.
5- Embezzler: If the Modarib does not accept
any term of the contract of Modarbah. Held
responsible to return the capital.

Relationship B/W Rab-al- Mal and

Modarib
6- Debtor: If the whole profit goes to Modarib

under contract, it will not be contract of

Modarbah but a contract of Debt. The
Modarib will be responsible for profit and
losses. If capital is lost, He will have to pay
the capital to the creditor/ Rab-al Mal.
7- If the contract of Modarbah contains the
term that the entire profit shall go to the
Rab-al-Mal,it will be a contract of Al-bazaata.

Articles of Modarabah
Offer
Acceptance
The parties must express their agreement in
formal words like one party says, Take this capital
and use it in Modarabah and if there is a profit we
shall divide it by half.
In reply the Modarib says, I take this capital.
I accept this agreement or Simply
I accept
Agreement may be Written or oral.

Terms of Modarbah
1- Ras-ul-mal (Capital) Should be in the
form of Money, gold or Silver.
Modarabah with traded goods is not valid
Because the price of the trade goods
fluctuate.
Modarbaha requires Proffering (Offer for
acceptance) of money.
2-

Amount of
Ras-ul-mal
(Capital)
proffered Should be clearly stated so
that no dispute may arise on this
account.

Terms of Modarbah
3- Rab-ul-mal should posses ready cash
at the time of entering into contract.
4- Rab-ul-mal should transfer ready
cash to the Modarib at the time of
entering into contract so that he may
use it.
5- The Ratio or percentage of the
Modaribs share in the expected
profit must be fixed at the time of
contract.

Terms of Modarbah
6- The Modaribs share be fixed out of
the profit, not out of the capital.
7- If the Rab-ul-mal holds the goods or
financial assets of the Modarib in
mortgage as guarantee for a loan
advanced to him, no valid contract
of Modarabah be made on the basis
of this capital which is mortgaged.

Right and Duties of

Modarib
1- The Modarib should abide by all the
terms and conditions of Modarbah.
2- The Modarib is free to enter into
Modarbah
contract with any other
party when he has
not been
expressly debarred (Prevent officially
from doing something) from doing so.
3- A third party can extend gratis (free
of charge) help to the Modarbah to run
the
business along the better lines.

Right and Duties of

Modarib
4- Most jurists holds that Rab-ul-mal

can not
take an active part in the business with the
Modarib, his powers are curtailed. However,
some Ulema of Shafi School of jurisprudence
allow the Rab-ul-mal to take active part in the
affairs of the business.
5-In a contract of Modarabah, if the guarantee
is sought for the safe return of the Ras-ul-mal
the contract become void.
Hence, a guarantee may be sought from the
Modarib that he will conduct the business with
due care and a sense of responsibility.

Right and Duties of

Modarib

6- The Modarib has the power of sale

and purchase in
connection with
the business.
He can keep goods in his custody.
He can execute a deed of pledge with
some one.
He can enter into Modarbah with an
other person .

7-The Modarib has no power to lend

or gift the capital of Rab-ul-mal to
any one otherwise with the
concent of Rab-ul-mal.

Right and Duties of

Modarib

8- In a contract of Modarabah, the

financial liability of the Rab-ul-mal is
limited to the amount he has provided
to the Modarib except when he has
premitted to the Modarib to raise a
loan purchase goods on his credit.
9-The Modarib has power to sell goods
on credit except he has been expressly
stopped from doing so by Rab-ul-mal .

Period of Modarbah
1- Modarbah contract can be terminated by
either party at will.
2- If there are more than two parties, they can
keep the contract intact even when one or two
parties have repudiated it.
3- Contract for a specified or Indefinite period.
4- Contract is terminated at the death of one
party. However, If there are more than two
parties, they can keep the contract intact .
5- Contract may be kept in force on the
previously agreed terms.

Rules of profit and loss

sharing
The entire loss will have to be born by the Financer
(Rab-ul- Mal)
Profit sharing according to the fixed Ratio, mentioned
in contract.
No fixed sum shall be allocated to any party in
advance.
According to the Hanfi school of thought, distribution
of profit before return of capital to Rab-ul-Mal is not
valid.
In an ongoing business the losses will be offset
against the profits till the business is wounded up
and final account is settled.

Rules of Profit and Loss Sharin :

The amount of profit and loss accruing to

each party shall be determined at the winding
up of the business.
The parties are entitled to receive profit only
when the capital has been returned to Rab-ulMal.
The profit will enhance the capital, if there is
no real profit, the Modarib is entitled to
compensation for his labour.
All matters are settled by mutual agreement.

Application of Modarbah in Modern

Times:
The working of the modern Banking System and
financial institutions has become very complex. Their
operations and procedures are by and large
inconsistent with the teachings of Islam.
Muslim scholars and economics are now striving to
organize their institutions in accordance with the tenets
of Islam. Their efforts are not confined to the reform of
the Banking System, but extend to the restructuring of
all institutions which use public savings for business
purposes. These institutions may with reference to the
raising of financial resources for investment and
operations be classified into two types.

Joint Stock Companies and

Modarbah

(a) In this business the Modarib can receive capital

from more than one financier. All the jurists allow joint
business of this kind on terms of Modarbah.
For this purpose there are two valid modes of
procuring capital:
(i) Capital for investment should be procured before
the commencement of the business.
(ii) Money in hand should be invested in business
and later the capital may be procured.
It is an essential duty of the Modarib that he should
invest in the joint business with the consent of all the
financiers from whom he has obtained capital.
Secondly he should invest in a proper manner.

Joint Stock Companies and

Modarbah
b)ThesecondmodeofModarbahisthecontinuationofa
runningModarbahbusiness.Inotherwords,abusiness-is
commencedtorunforaspecifiedperiod.Whenthisperiod
expires the business may be continued on the existing
terms.
According to first mode referred to above an individual or
individuals give their capital to a company or institution for
investment. This too would be called Modarbah. The
financialinstitutionscanissuegeneralorspecialinvestment
certificatestoprocurecapital.
The mode in partnership business is that the
company raising the capital either invests it
directly or indirectly through another company.

Banking Companies and

Modarbah
The Banking business runs along the same lines.
Besides deposits which can be ithdrawn on
demand, the Banks provide several kinds of
services. Banking bears resemblance to the
business of the Finance Companies. The Banks
obtain capital by selling shares and from investment
accounts. To procure more capital the Banks can
issue certificates. The Banks can then use this
capital to buy stock and investment certificates or
for direct investment.