Today you are reading the 100th Back to Basics article. Thank you to all readers for accompanying me on this stimulating expedition which has taken us to several important stops.
Looking back, we started off with the economic philosophy of Islam, proceeded to compare the core differences between the Islamic and conventional financial systems, headed to cover all of the four sale-based contracts and are now at the fag-end of the debate on the first investment-based contract.
Gauging from the subjects covered so far, we are in the middle of this educative series and I expect to take similar time to complete the cycle insha Allah (God willing).
I was informed by a reader before the coronavirus pandemic that he believes this is the first-of-its kind series he has come across where the practical aspects of transactions are so clearly intertwined with the theory that Islamic finance makes a lot of sense.
I consider myself honored to be given the opportunity to contribute to spreading the knowledge through this esteemed platform.
The first Back to Basics article appeared on the 14th March 2018 so we are in the third year.
During this time, I got tremendous support from the IFN team toward accommodating my late-minute submissions, in addition to the ‘absence without intimation’ on several occasions. Thank you very much IFN for putting up with all of this.
Let us get back to our topic and today I will disclose another aspect of the risk mitigation techniques which usually goes unnoticed by a majority of practitioners in the Islamic finance industry.
When the Rab Al Maal appoints an entrepreneur as its Mudarib, it has a right to add the following conditions in the Mudarabah agreement which serves as the discreet safety valves toward mitigation of risks:
a. The Mudarib shall not buy any merchandise or asset related to the trading or investment in terms of the Mudarabah arrangement over and above the market price at any time. At the same time, the Mudarib shall not sell anything owned by the Mudarabah at lower than the market price. This condition makes it the responsibility of the Mudarib to keep a close watch on the market, thus making it agile.
However, the Shariah scholars have provided a leeway to the Mudarib in carrying out exactly the same, provided by so doing it was working in the best interest of the Mudarabah, and on which reason the Mudarib can convincingly explain to the Rab Al Maal. Such a situation may occur in extraordinary market circumstances, such as the current COVID-19 crisis where it may be wiser to cut losses by selling at lower than the market price or below cost.
b. The Mudarib shall not grant a loan to itself or to anyone out of the Mudarabah capital. Similarly, the Mudarib shall have no right to write off any debt or waive any right or entitlement, or make a donation and accord a gift out of or related to the Mudarabah capital, unless it is approved by the Rab Al Maal.
If the Mudarib commits any of the aforementioned misdemeanors, the entire Mudarabah capital shall be transformed into a debt on the Mudarib, and the debt is fully repayable in Islam.
In order to be transparent in the Mudarabah agreement, the Shariah compliant practice is to attach a list of defaults (legally termed as the ‘events of default’) with the agreement.
Upon the occurrence of any of the agreed events of default, it becomes the prerogative of the Rab Al Maal to decide whether to terminate the Mudarabah agreement or continue with it. If the Rab Al Maal wishes to continue with the Mudarabah, it will be required to issue a waiver letter exempting the default at its own risk and responsibility.
In such a situation, the Rab Al Maal shall not be able to recall the same default which was waived by it at any time going forward.
What is the nature of the events of default that I have mentioned a few times in this article?
Apart from the instances cited previously, there are also the breach of any Mudarabah agreement terms; transfer of the ownership of the Mudarib (if it is an entity) during the Mudarabah tenure; non-payment of any periodic profit to the Rab Al Maal; cross-default, ie non-payment of any due liability by the Mudarib entity to its creditors; misrepresentation on any count; revocation of the license by the authorities to carry out normal business activities and various others in the same genre.
To sum up the 100th article, the Shariah financing and investment principles provide for the mitigation of the investment risk from within the structure, rather than seeking extra collateral and guarantees.
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: It seems I will be able to conclude the Mudarabah debate with another two articles. Stay safe, stay tuned.