Query:
An Islamic bank has approved a Mudarabah facility for a customer based on which the Islamic bank will provide funds (i.e. the Mudarabah Capital) to the customer. The Mudarabah capital will be utilized by the customer to undertake its business project.
The Islamic bank is conscious of the investment risks inherent to Mudarabah facility and is desirous of addressing them prior to release of funds. The bank is seeking guidance from its Shariah Board on the following points:
a. The options available to the Islamic bank to mitigate such risks;
b. The possibility of the Islamic bank to obtain collaterals or guarantee and exercise them in case of the loss of the Mudarabah capital by the customer.
Pronouncement:
An Islamic bank mainly adopts the following structures for undertaking an investment with a customer:
(i) Mudarabah: Islamic bank provides capital to the customer which is then invested by the customer by utilizing its expertise and efforts. The profit earned is distributed as per a pre-agreed ratio;
(ii) Musharakah: Islamic bank and the customer both provide the capital and the profit earned is distributed as per pre-agreed ratio; and
(iii) Wakalah: Islamic bank provides the capital and the customer manages the investment at a certain agreed fee as the agent.
In all types of the above investment structures, the manager, the partner or the agent (i.e. the “customer”) cannot guarantee the profit or safe return of the capital. However, the customer shall be liable for the loss in case of fraud, misconduct or negligence.
From Shariah perspective, eliminating essential risks from the investment structures and shifting them to the customer is not permissible. Traditions of Prophet Muhammed lay down the core Shariah principle in a financial transaction that — it is necessary to bear essential risks to be eligible to earn profit.
However, it is permissible for the Islamic bank to adopt such ways to minimize or mitigate the risks which do not contravene the Shariah principles. Some of them are provided below:
Risk mitigation within the structure and documentation:
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The Islamic bank may ask the customer to submit a comprehensive feasibility study which includes the financial projection for profit based on its past track record and expertise. The customer will be responsible for the accuracy of the projection as well as to act to get the result as per feasibility study. The customer will be deemed to have committed a breach if it appears that the feasibility study was not accurate and based on false assumptions in order to entice the Islamic bank to invest with it. Hence the customer will be deemed to be negligent in case it did not act within the framework of the feasibility study;
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The Islamic bank may oblige the customer to inform the bank immediately if the customer foresees loss situation due to change in the market dynamics, and seek further guidance from the Islamic bank. Customer’s failure to keep the Islamic bank informed in such situation shall be considered as negligence and therefore the customer will be held liable for such loss;
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Agreement between Islamic bank and the customer may provide that in case the customer claims loss in an investment structure, the ‘burden of evidence’ will be on the customer to prove that it has not been caused due to it its negligence and there was no misconduct or fraud committed in the transaction;
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The Islamic bank may also oblige the customer that all accounts management and cash flows shall be conducted through the Islamic bank.
Risk mitigation with a guarantee or collateral:
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With respect to the possibility of obtaining a collateral or guarantee under the investment structures, it is permissible for the Islamic bank to seek from the customer either:
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a voluntary guarantee/collateral from a third party; or
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a guarantee/collateral from the customer itself.
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In case the customer itself provides the guarantee/collateral, the Islamic bank cannot exercise it except in case where the customer was negligent or has committed misconduct or fraud;
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However, Islamic bank may exercise the guarantee or collateral in all cases where such guarantee/collateral is provided on a voluntary basis by a third party.
Dr Hussain Hamed Hassan
Chairman of the DIB Shariah Board,
Managing director, Dar Al Sharia Legal & Financial Consultancy, Dubai, UAE