In this simple guide, we will look at the following:
- What is Mudaraba?
- Key requirements of Mudaraba
- Applications of Mudaraba
1. What is Mudaraba?
Mudaraba is a profit-sharing arrangement between two or more parties. Mudaraba has similarities to a private equity arrangement where a Limited Partner and General Partner form a business partnership. In a Mudaraba, the two parties are called Rabbul Mal and Mudarib. The Rabbul Mal is the capital provider/investor, whilst the Mudarib is the manager and active partner. This is again similar to a private equity where the Limited Partner does not manage the investment, the management is done by the General Partner. One of the key distinctions of Mudaraba is that the Mudarib does not invest any funds, and instead provides technical and operationalise expertise only.
2. Key requirements of Mudaraba
Besides the conditions of sanity, adolescence, freedom and mutual consent of the contracting parties, the following conditions must be met for a Mudaraba contract to be valid:
- It is best to provide the capital in the form of cash. If the capital is a mix of cash and non-cash assets, the non-cash assets should be valued at the start of the Mudaraba.
- The capital of Mudaraba should be clearly known to the contracting parties
- The capital of the Mudaraba cannot be an unpaid debt owed by the Mudarib to the Rabbul Mal.
- The mechanism for distributing profit must be clearly known in a manner that eliminates uncertainty and any possibility of dispute.
- The distribution of profit must be on the basis of an agreed percentage of the profit and not on the basis of a lump sum or a percentage of the capital.
- The manager(s) shall not be liable for any loss of capital unless such loss is due to the manager(s) negligence, dishonesty, misconduct or breach of terms of the contract.
- No profit can be recognised or claimed unless the capital of the Mudaraba is maintained intact
3. Applications of Mudaraba
- Savings accounts
Many Islamic bank accounts are structured on the basis of Mudaraba, where the bank acts as the Mudarib and invests the funds of the depositors who are the Rabbul Mal. These funds are invested into the Shariah compliant money market or the assets’ side of the bank or in other assets if it is an unrestricted Mudaraba. The profits of these investments is shared between the bank and the depositors.
- Islamic Funds
If funds are not modelled on Wakala, they are typically then structured as Mudaraba funds. The investors receive a document certifying their subscription and entitling them to the pro- rata profits actually earned by the Fund.
