To define Mudaraba in one sentence I can say that; “Mudaraba is a specific sort of partnership in which one side provides capital and other side provides labor.” Mudaraba is one of the most popular Islamic Finance instruments. Mudaraba; sometimes referred to as Mudarabah; is basicly a “profit sharing agreement.”
Mudaraba is arguably the best known and the most frequently used finance technique in Islamic societies. In a mudaraba transaction there are two different steps; “transferring fund to Islamic bank” and “retransferring fund to enterpreneur”.
In first step, there are two parties : Islamic bank and capital owner. In other words; there are capital owner who deposits the money to bank and Mudarib who make the use of money and share the profit or loss with capital owners according to a pre – decided ratio. In second step; there are two parties again, Islamic bank; as capital owner here and enterpreneur who puts his labor and use the money that the bank provided.
In other words Islamic bank is Mudarib according to capital owner and capital owner according to enterpreneur.
The main objective of mudaraba transaction is to help enterpreneur who has a project, planning to start a business and has enough level of know how but can’t find money to do that. So, Islamic bank helps him to get the work done; provides financing.
Even if mudaraba is some similar to conventional interest based loans that are issued by conventional banks; however they are much different at all.
In a mudaraba transaction, the capital owner ( Rabb-ul Mal) provides all the necessary money. Enterpreneur doesn’t provide any money; he offers his labor.
At the end of transaction; if there is profit, parties share the profit according to decided ratio. If there is a loss; only the capital owner bears the loss, enterpreneur pays nothing. In short; if there is profit both parties enjoys it; if there is a loss, only the capital owner bears the loss; and all the efforts of enterpreneur goes for nothing but He doesn’t compensate for anything.
– Features of Mudaraba –
– Mudaraba is simply capital – labor partnership.
– In a mudaraba transaction and mudaraba contract everything must be clear. All details should be specified and every possibility should be taken into account.
– Bank puts all the money, enterpreneur puts the labor and they share the administration part. Sometimes; bank can leave all the administration to the enterpreneur but Bank must follow everything in a close way.
– If there is profit it should be shared according to decided ratio. As I stated before; if there is a loss however, only capital owner, Bank, bears the loss.
– Parties can’t decide the exact amount of money at the beginning of process, they can’t decide how much they are going to have for share but they can only decide about ratio. For example; Bank can not say the enterpreneur that ” I am giving you 100.000 USD and you are going to give me 120.000 USD at the end of process” but Bank can say ” I am giving you 100.000 USD and you are going to share 20% of your profit at the end of process.”
– An Example of Mudaraba Transaction –
Suppose that XYZ Inc. is a successful construction company. They have an investment plan; they would like to buy a land and construct a big living area, including apartments, shopping malls etc. They make a business plan and estimates that they need 25 Million USD to complete the project; 20 M for land and 5 M for construction.
However, company doesn’t have that much money. So, they go and consult an Islamic Bank, offers a partnership, profit-loss partnership.
Islamic Bank makes a detailed study and finds the project feasible and approves it. Bank provides 25 Million USD.
Islamic Bank and XYZ Inc. meets and sign a Mudaraba agreement. According to agreement, if there is a profit; 20% or profit will go to XYZ Inc. ( Mudarib) and 80% to Islamic Bank (Capital Owner)
XYZ Inc. start building project and construction. They completes the project in 3 years and after all that, they make a calculation and find out that they made 5 Million USD profit. According to ratio, 1M will go to XYZ Inc. and 4M to Islamic Bank.
Seems like a win – win situation here.
However, suppose that project has failed for some reason and XYZ Inc. couldn’t make any profit or actually has lost everything. Then, all the loss belongs to Islamic Banks, XYZ Inc. will not going too pay anything.