Guide to mudarabah contract is a partnership – but in profit only

In-Depth Analysis

Mudarabah can also be defined as a partnership, but only in the case of a desirable outcome or profitable run whereby the profit is shared between the 'partners' in Mudarabah. If the outcome is otherwise (a loss), the entrepreneur does not bear it. The author recounts an interesting situation witnessed during his Islamic banking days: a customer of the bank regularly took Mudarabah finance and each time fruitfully completed the Mudarabah period and shared the profit with the bank at the ratio agreed with the bank. However, due to adverse market conditions, he could not continue with the successful run and one Mudarabah transaction bore loss. Although he offered to share the loss in the same manner as he had shared the profit, the Shariah board of the Islamic bank stopped him from doing so. This was based on the Shariah principle that the loss of capital must be borne by the capital provider. Since the customer did not invest and was acting as the fund manager or Mudarib, the Shariah board absolved him from bearing any losses. To elaborate it further, the Rabb Al Mal or the fund provider owned 100% of the Mudarabah capital and in case of a genuine loss, it will be entirely borne by the Rabb Al Mal whereas the Mudarib shall only be entitled to a share in the Mudarabah profit as per a pre-agreed ratio, and in case of a loss, he will not bear it as well as not be compensated for his efforts. In this backdrop, the Shariah structure of Mudarabah vis-a-vis the protection embedded in it for the fund provider or Rabb Al Mal is that the Mudarib or fund manager shall be limited to share the profit — and only if the deployment of the Mudarabah funds have produced any profit. As such, if despite strenuous efforts, the Mudarib is unable to produce any profit by the end of the Mudarabah period, he or she shall not be entitled to any compensation. The Mudarib shall strive its best to grow the Mudarabah capital to the north so that the profitable run of the Mudarabah investment enables it to claim the share in the profit from Rabb Al Maal. A Mudarabah contract must be drawn based on the following essential Shariah parameters: (a) the purpose of entering into the Mudarabah contract must be explicitly stated and should not be left to the imagination of any parties or for any Shariah repugnant activity; (b) the offer should be clearly stated in the contract, either from the Mudarib or the Rabb Al Mal; (c) acceptance from the counterparty should be on the same terms as related to the offer — otherwise, in the case of a variation in terms and conditions, a counter-offer will be made which will necessitate acceptance by the original offeree.