In the last article, we had dispensed with the aspect of distribution of the actual profit between the parties in a Mudarabah transaction.
Also, that the Mudarib is not allowed to be paid any fee since it is a known amount but it can only share the actual Mudarabah profit with the Rab Al Maal based on a pre-agreed distribution ratio as stated in the Mudarabah agreement.
However, in addition to sharing the actual profit based on the agreed ratio, it is permissible in Shariah that the Rab Al Maal may voluntarily grant certain incentives to the Mudarib out of the share of its own realized profit.
I shall be able to explain this point much better if I take out a live example from my hat. While managing the corporate banking portfolio in a local Islamic bank in Dubai, like any other wholesale banker, my efforts were aimed at enhancing my portfolio of valuable clients.
I embarked upon reviving my old contacts in the market from the time when I was part of the conventional wholesale banking world in the UAE. My first port of call was an ultra-large local family business house since I knew the chief treasurer well.
After exchanging the usual courtesies, I immediately put the purpose of my visit on the table. “I want to revive my business relations with the group from my new position with the Islamic bank,” I said. Without giving him a chance to respond, I started explaining whatever little Islamic banking I had learned by that time.
I finished my sermon which took about a good 10 minutes during which time the gentleman continued twiddling with his wedding ring and frequently looked at the traffic outside the large window. He did not ask any questions which was quite surprising to me since I had kept the answers ready based on my earlier visits to the market.
He quietly took out a bunch of papers from his drawer and dumped them in front of me. I asked: “What is this Mark?” He said: “Frankly, I should not be showing you all of these but only because of my relationship of years with you from your previous bank.”
He continued: “These are the unsolicited facility offer letters received during the last one month from various banks in the UAE. You can see the large extent of facilities offered at finest rates without any formal demand from the group. My apology for the lack of my interest on how your Islamic bank works differently compared with all of these conventional banks. Nevertheless, I am ready to resume a relationship with you in your new position with the Islamic bank provided that your bank is able to either match or improve the amount of credit lines and the interest rates.” Needless to say that I did not try to ‘correct’ him at the time that my Islamic bank does not apply interest rates.
Back in the office, I was excited that my first effort was fruitful in that Mark had agreed to deal with me; however, the million-dollar question was how to meet his expectation of fine pricing from an Islamic bank’s perspective?
I took this question to the learned chairman of the Shariah board at the first opportunity. Pursuant to explaining the nature of the group business, the in-principle agreement from my bank’s management committee to the total group exposure, explaining the availability of various conventional bank lines to the group, and last but extremely important — the premium pricing demanded by the group, the chairman dictated a brilliant solution which I will explain as follows.
The chairman suggested granting a Mudarabah facility to meet the financing need of a new acquisition project which did not violate Shariah principles. The Mudarabah capital shall be handed over to the client at the time of signing the Mudarabah agreement. There will be a profit distribution ratio entered into the Mudarabah agreement. If my memory has not deserted me, it was 50:50.
However, the chairman advised to insert an incentive clause in the Mudarabah agreement whereby if the Mudarib (ie the client) is able to generate the share of the bank’s actual profit beyond a certain threshold, the profit over and above such limit shall be granted to the Mudarib as a performance incentive. This masterstroke from the chairman helped me to win back this very important client and make my corporate portfolio a qualitative one.
So, what was that masterstroke threshold? In a nutshell:
• The Islamic bank shall accord the Mudarabah capital to the new client pursuant to signing the Mudarabah agreement.
• The Mudarabah agreement shall have the actual profit distribution ratio at 50:50 between the Islamic bank being the Rab Al Maal (or capital provider) and the customer being the Mudarib.
• There will be an incentive clause added to the Mudarabah agreement whereby, although the Rab Al Maal (Islamic bank) is eligible to share half of the profit from the project, it shall be content with the actual profit which is comparable to 25bps over a six-month LIBOR (market interest rate) for the relevant profit payment period.
• Any actual profit amount over and above the said threshold shall be voluntarily granted by the Rab Al Maal (Islamic bank) to the Mudarib (customer).
• If the invested Mudarabah capital is unable to produce any profit for a particular period, the Mudarib (customer) shall not be liable to pay anything to the Islamic bank.
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: Debate on the incentive clause to continue next week.