So far we know Islamic banking purely deals with welfare. This Pure Islamic mode of finance completely depends on the honesty and skill of the person who wants to do business by dealing with others money.
Here the provider of the fund is “Shahib al mal” or “ Rab-ul-mal”and the person who wants to utilize the funds for business purposes is called “Mudarib”.
The main notion is to do welfare for those needy persons who have no funds of their own but have skill and experience to manage a business.
It has no time limit. There is a contract between Sahib al mal and mudarib which concludes the necessary conditions of the operation of the business. Sahib al mal will bear the loss if it is incurred without any intentional negligence of the mudarib. If profit is earned then it will be distributed as per contract. So, it can be called a profit sharing but loss bearing mode of finance. The proportion of profit is dependent on various conditions. Such as the distance of the place where the business will occur. The goods which will be dealt with. The risk involved in
The business. The effort which will be exerted by the Mudarib. The reason, the
geo-political condition, the volatility of the market, the availability of the raw materials, the existing rules of the society is of also a great concern. But the first and foremost condition is the faith of the Shahib al mal and the Mudarib and at the same time the honesty and integrity of the Mudarib.
The best example of this financing mode from history is the Holy prophet (SAW) and Ummul Mu'minin Khadijah Al Kubra (RAW). They performed this great job with utmost honesty and sincerity. They made a historic bondage in their social, financial and family life through their great effort. There are so many talks on Mudaraba Invogue.
But nothing to be worried about executing Mudaraba. If executed it can be the best mode Among all Islamic modes of finance. The essence of Islamic banking does not lie in extending fund for a certain period and earn some profit. It lies within the style of executing it as per shariah requirements which emerged from Islamic economy roots of which is Islamic scriptures. The main motto of Islamic economy is to accelerate and speed up the flow of funds and to make the economy more vibrant than any other economy. But its success lies in the hidden characteristic which people bear in their hearts.
Actually, Mudaraba does not need so many scientific models, formulas, analysis, theorems and corollary. It only requires a solid and valid contract between two parties who are involved in these transactions and operations. Generally a tested person can be selected as Mudarib and a person with proper sense, realization and rationality should be involved with the business.
Definition of Mudaraba:
As per Blom Development Bank-“Mudaraba is a special kind of partnership where one partner gives money to another for investing it in a commercial enterprise. The investment comes from the first partner who is rab-ul-mal, while the management and work is an exclusives possibility of the other, who is called mudarib. It may be add here that mudaraba is a trust financing contract.
Features of Mudarabah:
i. Mudaraba is a partnership where capital is provided in cash or assets (no debt is accepted)by one party the fund provider Sahib-al- mal and labour is provided by the other party mudarib.
ii. Both parties can appoint agents on their behalf.
iii. A mudaraba contract could be terminated, unilaterally except when a term has been agreed by both parties, in which case the mudarab a could only be prematurely terminated by mutual agreement. In addition, if the mudarib has already started the business in the mudaraba contract. It becomes binding until actual or constructive liquidation is a trust based contract.
iv.The mudaribis not liable for losses except in case of branch of the requirements of trustor misconduct. Guarantees against negligible or misconduct could be taken loan the mudarib as long as they are not excessively used by the capital provider.
v. The contract should specify whether the mudaraba instrument is unrestricted or restricted (to specific location or type of investment as agreed between parties). It should also indicate that distributes ratio of profit between both parties (which can not be a lump-sum or a percentage of capital). The distribution could be revised at future dates by agreement of both parties
Types of Mudaraba:
The rab-ul-malmay specify a particular business for the mudarib in which case he shall invest the money in that particular business only. This is called mudarabah al muqayyadah (restricted mudarabah). But if he has left it open for the mudarib to undertake whatever business he wishes, the mudarib shall be authorized to invest the money in any business he deems fit. This type of mudarabah is called al-mudaraba-al-mutla (unrestrict mudaraba).
Use of Mudaraba:
Mudaraba is widely used for equity financing in the form of startup capital, venture capital or a mixture of both.
Condition of validity:
It is necessary for the validity of mudaraba that the parties agree, right at the beginning, on a definite proportion of the actual profit to which each of them is entitled. The Losses however are entirely assumed by Rabul mal and the mudarib loses his time and effort only.
Use of Mudaraba:
Mudaraba is widely used for equity financing in the form of startup capital, venture capital or a mixture of both. Condition of validity:
It is necessary for the validity of mudaraba that the parties agree, right at the beginning, on a definite proportion of the actual profit to which each of them is entitled.The Losses however are entirely assumed by Rabul mal and the mudarib loses his time and effort only.
First tier and Two tier mudaraba:
The mudarabah contract is applied when someone deposits money in an Islamic bank with the expectation of getting a return. In most cases, the contract applied is a first tier (or simple)mudaraba contract, meaning that only the customer and the bank are involved. (The bank serves as fund manager for whatever money is deposited).
However, another type of contract exits: a two-tier (intermediary) mudaraba contract. In This case, the bank acts as an intermediary between the depositor and the bank’s clients to whom it provides money. Islamic scholars promote using this kind of mudarabah model is two scenarios:
The bank on its own does not have the capacity to serve as the investor (the rabb ul mal). This scenario may mean that the bank does not have enough liquidity to enter a mudaraba contact with an entrepreneur or fund manager. The bank lacks the expertise to serve as the land manager (mudarib) for an investment.
Some Special Notes:
● The financier can also be called the investor or silent partner. The person who manages the fund can also be called the fund manager or working partner.
● Mudaraba contracts have three basic factors Capital, labor and entrepreneurship.
● The bank invests the depositors money according to sharia guidelines.
● When a mudarabah contract is used as a source of bank funds (when the customer depositsmoney in the bank), the unrestricted mudaraba is most often used.
●When the contract supports a bank's equity financial product (when the bank supplied funds to a working partner), the restricted mudarabah is most often in play.
●The Mudarib (manager or working partner) also receives a fixed fee for managing the project, in addition to a share of any profits
● If the economic venture results in loss, that loss is absorbed by the investor as the capital provider unless the mudarib (fund manager) has acted negligently or has engaged in misconduct.
● In a two tier mudaraba contract, two contracts must be executed.
● The two-tier method of mudaraba is less frequently applied than the first tier method.That’s because barks usually have the liquidity and/or expertise o enter is to a first tier contract and because the two-tier method is not quite as profitable for the bank as the first tier method.
Examples of different methods of Mudaraba:
One between the depositor as investor (rab al mal) and the bank as a fund manager (mudarib):The depositor signs a contract with the bank for a two-year sharia compliant project. The investor and the bank agree to share the profit in a 60:40 ratio (60 percent of profit goes to the investor and 40 percent to the bank). The investment made by the depositor for this specific project is $1 million.
One between the Islamic bank serving is the capacity of investor (rab ul mal) and the project client as the working(mudarib): This contract initiates that the two parties will share the profit on a basics of 70:30 ratio (with the Islamic Bank getting 70 percent and the client getting 30 percent). Assume that the client is not making any capital contribution but is instead investing time, effort, and expertise in the project.
The project earns $1.5 million by the final contract date. The fund manager and the entrepreneur gets 30 percent of the profit of $1,50,000 based on the second contract. The bank recovers the capital $1 million plus a $ 3,50,000 profit
The $ 1 million principal is returned to the initial investor along with 60 percent of the bank's profit from the second contract. ($3,50,000 60 percent equals $2,10,000). The bank holds on to the receiving 40 percent of $ 3,50,000 on $ 1,40,000. So, the bank earns $ 1,40,000 for serving as intermediary between the depositor and the entrepreneur.
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