We are currently deliberating risk mitigation techniques in a Mudarabah transaction which are permissible under the Shariah statute, without requiring the risks to be eliminated from a transaction.

So far, we have discussed some aspects on risk mitigation and today we shall add to that knowledge by discussing how the Rab Al Maal can also mitigate the capital risk by confining the Mudarib to a limited area of operation through a restricted Mudarabah contract.

So, what is a restricted Mudarabah contract? As per the definition agreed by the Sharia board of AAOIFI in Shariah Standard No 13, Article 5/2, it is defined as follows:

“A restricted Mudarabah contract is a contract in which the capital provider (Rab Al Maal) restricts the actions of the Mudarib to a particular location or to a particular type of investment as the capital provider considers appropriate, but not in a manner that would unduly constrain the Mudarib in his operation.”

It will be in order to understand the opposite of the restricted Mudarabah contract. No prizes for guessing correctly, it is the ‘unrestricted’ Mudarabah contract. But how does the AAOIFI Shariah board define it? Let us have a look:

“An unrestricted Mudarabah contract is a contract in which the capital provider (Rab Al Maal) permits the Mudarib to administer a Mudarabah fund (Mudarabah capital) without any restrictions. In this case, the Mudarib has a wide range of trade or business freedom on the basis of trust and the business expertise he has acquired. An example of unrestricted Mudarabah is when the capital provider says, ‘do business according to your expertise’. However, such unrestricted business freedom in an unrestricted Mudarabah must be exercised only [in] accordance with the interests of the parties and the objectives of the Mudarabah contract, which is making profit. Therefore, the actions of the Mudarib must be in accordance with the business customs relating to the Mudarabah operations: the subject matter of the contract.”

Readers may have grasped from the aforesaid definitions that the restricted Mudarabah contract should always be a preferred option for a capital provider in a Mudarabah transaction. That is fine if the Mudarabah contract is entered into between the two individuals or entities; however, what is the market norm if the Mudarabah contract is entered into by an Islamic bank — in its capacity as the licensed deposit taker — with the individual depositors? I would like to recall what I had written in article 17 published on the 3rd July 2018:

“Although Shariah permits that the Rab Al Maal may restrict the Mudarib to invest the Mudarabah capital in a particular business chosen by the Rab Al Maal, the Islamic banks do not accept the condition of restricted Mudarabah since it is nearly impossible for the bank to segregate the deposits from various customers for investing in different segments of their choice. As such, the Islamic banks accept customer deposits purely on the unrestricted Mudarabah basis”.

After having understood the diversity between restricted and unrestricted Mudarabah, let us now focus on how a restricted Mudarabah contract can be effectively utilized by the Rab Al Maal as a risk mitigation tool.

There are various ways that a Rab Al Maal can restrict the Mudarib and the Shariah principles do not have any qualms with any of them. These are restrictions on a Mudarib to invest a Rab Al Maal’s capital in a specific commodity or a group of items or in a specified market area or at a particular time of the year.

However, with regards to restricting the Mudarib to a specified commodity or a group thereof, the Shariah principle requires that such a commodity(ies) should be generally available in the market where the Mudarib is required to invest the Mudarabah capital so that the interest of the Mudarib can be safeguarded to benefit from the Mudarabah profit. Also, the commodity should not be seasonal, such as winter clothing or mangoes that are only available in summer, save when the Mudarabah contract tenure too is confined to within that season.

A Rab Al Maal’s vista of risks to the Mudarabah capital gets substantially constricted through the restricted Mudarabah transaction since it is easier for it to find out when the Mudarib transgresses the Mudarabah contract. I may be wrong but compare it with a Rab Al Maal entering into an unrestricted Mudarabah contract with a Mudarib, and certainly it is tantamount to gifting the Rab Al Maal with the recipe for sleepless nights.

Nonetheless, my foregoing statement is accompanied with a disclaimer that this aspect does not apply to the Islamic banks accepting customer deposits through an unrestricted Mudarabah contract basis. This is considered satisfactory due to the layers of governance and transparency that an Islamic bank is required to observe, follow and report to the regulatory authorities and the public on a periodic basis.

Also, as explained by me almost two years ago, it is practically unmanageable for an Islamic bank to accept customer deposits on a restricted Mudarabah basis due to the sheer number of depositors whereby it will be impossible to track the investment of their funds in an array of economic sectors.

On the other hand, depositors are actually mitigating their own risks by entering into an unrestricted Mudarabah contract since the Islamic bank will be in a position to spread their investment to various segments whereby if one does not perform, another shall work as an offsetting element.

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: We continue to pick over the few remaining points on Mudarabah before proceeding to the next subject. Stay safely tuned wherever you are.