Exploring risks and their mitigation in a Mudarabah transaction

In-Depth Analysis

Following the logical sequence on the aspects of a Mudarabah transaction, the next stop is very important from the perspective of the Rab Al Maal who provides 100% capital and takes a backseat, and to a lesser extent the Mudarib whose efforts are at stake. Although the matter of 'risk' has been discussed on several occasions in this 'Back to Basics' series, the author believes it is time to gather all of them in one place when it comes to Mudarabah transactions and also add some other risks which have not been discussed in order to be able to fully comprehend the overall risk proposition for both the Rab Al Maal and Mudarib and how either of the parties can mitigate them to safeguard their respective interest. Before hitting the road, it is important to clear our understanding of 'risk and return' through the prism of Islamic finance. In Islamic jurisprudence, risk has been categorized in the following three levels: Essential risks — these are the risks which are essential and obligatory to make a contract or transaction Shariah compliant. A sale agreement requires that the seller must bear all risks related to the commodity until the time that it is sold and delivered to the buyer. A lease agreement requires that the risk of the leased property is borne by the lessor upon delivery. And a Mudarabah agreement requires that the risk of the Mudarabah capital is borne by the Rab Al Maal with respect to the genuine loss, damage, or decrease in the value of the Mudarabah items by the Mudarib. On the other hand, the Mudarib must be exposed to his performance risk. Prohibited risks — these risks make a transaction void from a Shariah perspective and are called 'Gharar Jaseem' (excessive or gross risk or speculation). The author provides illustrations: Risk in existence (the sale of a non-existent object); Risk in possession (the sale of a public domain property or stolen object); Risk in quantity (unknown units or weight in a sale contract); Risk in quality (unknown type, grade, or specifications); and Risk in payment (a deferred sale without fixing the price). The involvement of any of the aforementioned types of risks will make a contract void in the Shariah with the unanimous opinion of jurists, with the exception being the Maliki jurists who say that a risk in a gift agreement is permissible due to the absence of payment consideration.