In the last few articles, I have described how a commingled investment Wakalah transaction works in which the Islamic bank provides the Wakalah capital with the permission to invest it in the client’s own business. Also, an explanation was provided on how the profit distribution takes place in a commingled investment Wakalah environment.
Having grasped the definition of ‘profit’ in Islamic investment-based contracts, which is what exceeds the originally invested capital, today I will explain what happens if the commingled Wakalah transaction bears a loss. How is the Islamic bank supposed to react and what shall be the consequence on the originally invested Wakalah capital?
I had written not too long ago that the probable agent, ie the Islamic bank’s customer needing funds, shall first submit a business plan to the bank in which it will disclose as to where the bank’s capital shall be invested, what the anticipated profit outcome is and its sharing ratio, and when the Wakalah capital is expected to be redeemed to the bank.
If the bank accepts the plan, it will be made part and parcel of the Wakalah agreement between the bank and the customer. Immediately after the agreement is signed, the bank shall release the Wakalah capital to the agent (customer) and also pay the agreed agency fee to it which is stated in the investment Wakalah agreement.
Some of the modern-day Shariah scholars dealing with Islamic finance were able to turn the table onto the agent while dealing with the plausible loss situation. In connivance with the legal fraternity, they devised a new provision to the effect that in the case of a loss, the agent (client) shall be responsible to prove to the Muwakeel (the bank) beyond doubt that the loss was not caused due to its negligence or deviation from the business plan.
If the agent is unable to do so, it will keep the principal indemnified or, in other words, make good the loss of the Wakalah capital together with the anticipated profit which was projected by the agent in the business plan approved by the Islamic bank.
Needless to say that the typical risk-averse Islamic bankers from wholesale banking were on the moon upon getting hold of this clause and since then, they have been religiously embedding it in all investment-based contracts, ie Mudarabah, Musharakah and Wakalah.
While dissecting the new provision, some quarters alleged that this is tantamount to conventional lending since the Wakeel in the investment Wakalah contract will find it hard to prove its innocence, even in genuine circumstances, hence it will invariably have to cough up the full amount of the Islamic bank’s capital plus estimated profit, similar to a conventional bank’s customer repaying the debt with interest. Also, the new provision conveys the message of ‘guilty unless proved innocent’ which is contrary to the golden Shariah teachings to take everyone at face value, unless proven otherwise.
From the Shariah advisory perspective, I personally felt comfortable and recommended using the ‘creative’ approach in Wakalah, Mudarabah and Musharakah transaction documentation at the time when it was manufactured. My viewpoint was based on the argument that, more than anything else, there is a need to protect the capital and that the provision should not be treated beyond a risk mitigation tool.
Moreover, the provision made it possible for several Islamic financial institutions and investors to opt for the usage of Islamic investment-based contracts since they were sitting on the fence for so long and were merely using the Murabahah and other sale-based contracts with credit risk, and which are devoid of equity risk. The reluctant Islamic bankers feared this — what if the counterparty raises their hands and conveniently declares “sorry guys I lost your capital”?
My other argument was that the provision shall make the counterparty of an investment contract vigilant and keep it on its toes. The Wakeel will be extra cautious when deploying the Wakalah capital and for its timely retrieval on a one-off or recurring basis, depending on the nature of the transaction.
I was also of the opinion that should the Wakeel be able to somehow prove its innocence, it will be perfectly alright for the Islamic bank to bear the dent in the capital and profit. After all, this is Islamic banking and Shariah principles which do not differentiate between the provider of funds and their recipients.
In this situation, the entire genuine loss shall be borne by the Muwakeel (principal) who, on the other hand, will also be liable to pay the Wakalah fee to the agent irrespective of the outcome of investing the Wakalah capital by the Wakeel.
I admire the Shariah justice, no matter how big or small a contracting party may be. Such unbiased principles are the mainstay of Islamic finance and the need is for them to be adequately promoted.
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.
Next week: Discussion on the subject of commingled Wakalah investment to continue.