We ended the last article at the question of whether the adoption of the Mudarabah principles can protect an investor from unscrupulous individuals who are out to fleece the innocent people having wealth but lack ideas for its deployment.
Before we search for the answer, it will be important to gain mastery of Mudarabah principles and their application in both – the desirable outcome (ie profitable conclusion) as well as the adversity (ie a loss situation).
Mudarabah can also be defined as a partnership. Yes, a partnership but only in the case of a desirable outcome or profitable run whereby the profit is shared between the ‘partners’ in Mudarabah. If the outcome is otherwise ie loss, the entrepreneur does not bear it.
An interesting situation I witnessed during my Islamic banking days: a customer of the bank regularly took Mudarabah finance and each time fruitfully completed the Mudarabah period and shared the profit with the bank at the ratio agreed with the bank. However, due to adverse market conditions, he could not continue with the successful run and one Mudarabah transaction bore loss.
Although he offered to share the loss in the same manner as he had shared the profit, the Shariah board of the Islamic bank stopped him from doing so. This was based on the Shariah principle that the loss of capital must be borne by the capital provider. Since the customer did not invest and was acting as the fund manager or Mudarib, the Shariah board absolved him from bearing any losses.
To elaborate it further, the Rabb Al Mal or the fund provider owned 100% of the Mudarabah capital and in case of a genuine loss, it will be entirely borne by the Rabb Al Mal whereas the Mudarib shall only be entitled to a share in the Mudarabah profit as per a pre-agreed ratio and in case of a loss, he will not bear it as well as not be compensated for his efforts.
Risk management is such a vast area and banks and financial institutions spend huge amounts on training their relevant employees on the ways to eliminate or manage risks from a financing transaction, and even then at times they do not get it right.
In this backdrop, you can only marvel at the Shariah structure of Mudarabah viz a viz the protection embedded in it for the fund provider or Rabb Al Mal which is that the Mudarib or fund manager shall be limited to share the profit, if and only if, the deployment of the Mudarabah funds have produced any profit. As such, if despite strenuous efforts, the Mudarib is unable to produce any profit by the end of Mudarabah period, he or she shall not be entitled to any compensation.
I had earlier explained that the definition of profit in Shariah is what exceeds the capital. In this situation, by default the Mudarib shall strive its best to grow the Mudarabah capital to the north so that the profitable run of the Mudarabah investment enables it to claim the share in the profit from Rabb Al Maal.
As such, if the Mudarib fails to register any increase over and above the original capital provided by Rabb Al Mal, he will not be able to receive any compensation for his efforts in managing the Mudarabah affairs.
As per a formal Mudarabah contract drawn between the parties, the investor provides funds (or tangible assets/goods or any other non-monetary asset(s)) – appropriately valued to the satisfaction of the Mudarib in order to ascertain the Mudarabah capital at the commencement of the Mudarabah contract.
The entrepreneur utilizes its skills in investing the Mudarabah capital in order to earn a Halal profit for the Mudarabah. The nature of the Mudarabah capital delivered by Rabb Al Mal, either in cash or kind, must be agreed at the time of the signing of the Mudarabah agreement.
The Mudarabah profit is jointly owned by the Rabb Al Mal and Mudarib and shared between them upon its realization as per a pre-agreed distribution ratio. As explained above, the genuine loss, if any, is only borne out by the Rabb Al Mal since he is the owner of the entire Mudarabah capital.
The investor or provider of the capital is called Rabb Al Mal and the entrepreneur Mudarib. In the case of an Islamic bank, the depositors are Rabb Al Mal whereas the bank is the Mudarib. When it comes to the bank to invest the depositors’ funds by way of Mudarabah, it becomes Rabb Al Mal and the customer receiving funds is termed a Mudarib.
A Mudarabah contract must be drawn based on the following essential Shariah parameters:
a. The purpose of entering into the Mudarabah contract must be explicitly stated, and should not be left to the imagination of any parties or for any Shariah repugnant activity;
b. The offer should be clearly stated in the contract, either from the Mudarib or the Rabb Al Mal;
c. Acceptance from the counterparty (Mudarib or Rabb Al Mal) should be on the same terms as related to the offer. Otherwise, in the case of a variation in terms and conditions, a counter-offer will be made which will necessitate acceptance by the original offeree.
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].