Guide to risk mitigation through restricted Mudarabah contract

In-Depth Analysis

We are currently deliberating risk mitigation techniques in a Mudarabah transaction which are permissible under the Shariah statute, without requiring the risks to be eliminated from a transaction. So far, we have discussed some aspects on risk mitigation and today we shall add to that knowledge by discussing how the Rab Al Maal can also mitigate the capital risk by confining the Mudarib to a limited area of operation through a restricted Mudarabah contract. So, what is a restricted Mudarabah contract? As per the definition agreed by the Sharia board of AAOIFI in Shariah Standard No 13, Article 5/2, it is defined as follows: "A restricted Mudarabah contract is a contract in which the capital provider (Rab Al Maal) restricts the actions of the Mudarib to a particular location or to a particular type of investment as the capital provider considers appropriate, but not in a manner that would unduly constrain the Mudarib in his operation." It will be in order to understand the opposite of the restricted Mudarabah contract. No prizes for guessing correctly, it is the 'unrestricted' Mudarabah contract. But how does the AAOIFI Shariah board define it? "An unrestricted Mudarabah contract is a contract in which the capital provider (Rab Al Maal) permits the Mudarib to administer a Mudarabah fund (Mudarabah capital) without any restrictions. In this case, the Mudarib has a wide range of trade or business freedom on the basis of trust and the business expertise he has acquired." However, such unrestricted business freedom in an unrestricted Mudarabah must be exercised only in accordance with the interests of the parties and the objectives of the Mudarabah contract, which is making profit. Readers may have grasped from the aforesaid definitions that the restricted Mudarabah contract should always be a preferred option for a capital provider in a Mudarabah transaction. However, what is the market norm if the Mudarabah contract is entered into by an Islamic bank — in its capacity as the licensed deposit taker — with the individual depositors? Although Shariah permits that the Rab Al Maal may restrict the Mudarib to invest the Mudarabah capital in a particular business chosen by the Rab Al Maal, the Islamic banks do not accept the condition of restricted Mudarabah since it is nearly impossible for the bank to segregate the deposits from various customers for investing in different segments of their choice. As such, the Islamic banks accept customer deposits purely on the unrestricted Mudarabah basis. A Rab Al Maal's vista of risks to the Mudarabah capital gets substantially constricted through the restricted Mudarabah transaction since it is easier for it to find out when the Mudarib transgresses the Mudarabah contract. Nonetheless, this foregoing statement is accompanied with a disclaimer that this aspect does not apply to the Islamic banks accepting customer deposits through an unrestricted Mudarabah contract basis. This is considered satisfactory due to the layers of governance and transparency that an Islamic bank is required to observe, follow, and report to the regulatory authorities and the public on a periodic basis.