Hello readers. I am back after a short break. People who understand cricket know well that a batsman gets exhausted upon scoring a century and the urge to get back to the pavilion increases. However, I do not feel fatigued by writing the 100 articles for this educative series that IFN started since it is my passion to portray the genuine side of Islamic finance. I may score a double century, insha Allah, given that we have a lot remaining to be covered. So be prepared.
We were almost done with the discussion on the subject of risk management in Mudarabah but an interesting question has been raised by a reader. I would like to discuss it with you today.
The reader wants to know if it will be allowable in a Mudarabah transaction if the investor and entrepreneur agree that both will enter into a Mudarabah agreement with an understanding that the Mudarabah shall be for a period of three years divided into six half-yearly subperiods with the objective to purchase and sell the Shariah compliant listed shares.
Instead of distributing the profit emanating from trading in stocks between the two parties for each subperiod, the parties would like to adopt the mechanism whereby in one subperiod, the entire profit shall be paid to the Rab Al Maal and in the next subperiod it will be the turn of the Mudarib to snap up the total profit.
The reader said that since there is equality for the entitlement of the Mudarabah profit between both parties as the Rab Al Maal shall take away the total profit earned by the Mudarabah in three subperiods and the Mudarib shall also recover the full profit for the same number of subperiods, there should be no Shariah issue in this type of Mudarabah.
Based on our learning of the Mudarabah contract so far, let us try to analyze the situation. The first box we tick is that a Mudarabah contract must have two sane and adult parties, the second box ticked is for the Mudarabah capital, the third one is for the period which is also okay, the fourth check is for the objective or activity of the Mudarabah which is also fine since the Mudarabah capital shall be applied to trade in Shariah compliant listed stocks.
What remains to be checked? It is the condition for the distribution of the Mudarabah profit and the absorption of loss.
We know that the genuine loss of the Mudarabah shall, by default, be borne by the Rab Al Maal. But hang on, let us check the Shariah position for the distribution of profit between the parties.
In the 19 articles I have written so far (before this one) on Mudarabah starting from the 22nd January 2020, the mention of the profit distribution principle was quoted six times in clear terms, which is that the parties will agree at the time of entering into the Mudarabah agreement as to what shall be the ratio of the distribution of profit earned between them.
This is to be noted that the stipulation is for the ratio of any amount of the actual profit earned by the Mudarabah in a given period, and not the amount.
In addition, in AAOIFI Shariah Standard No 13 on Mudarabah, Clause 8/3 requires that the parties shall agree on the ratio of profit distribution when the (Mudarabah) contract is concluded.
This profit distribution ratio shall be applied over the amount of profit earned by the Mudarabah in order to determine the extent of the profit amount the Rab Al Maal and the Mudarib shall be entitled to get.
Coming back to the reader’s question, based on the aforementioned explanation, do you think the Shariah principle on the distribution of profit between the parties in a Mudarabah shall still be fulfilled if one party takes away the entire profit for the first subperiod of six months and the other party shall not get anything in that period?
Let us assume that the second party awaited the completion of the next subperiod so that it can claim the entire profit but unfortunately the Mudarabah suffered a loss due to market circumstances.
In this case, the second party did not get any profit although he was thinking of getting compensated from his subperiod which unfortunately did not happen since the Mudarabah suffered a loss.
In Shariah, there is a principle that you cannot prevent a party from the right of sharing the profit and as such, the Mudarabah where only one party is taking away the entire profit, even if it is for one period, is thus prohibited.
Moreover, such practice borders on speculation or gambling since no party can make out whether during its turn to share the profit, the Mudarabah shall actually result in a profit or loss.
Also, if in one subperiod the profit earned by the Mudarabah is greater than expected, the party that is deprived could develop jealousy which may lead him to commit a harmful act on the other party.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Sohail Zubairi is the senior advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected].
Next week: Stay safe, stay tuned for the last Mudarabah article next week, insha Allah.