1. Mudarabah Presented By: Presented to: Mr. Aziz Adil 1.Majid Aziz 2.Hassan Iqbal 3.Farhan Rao 4.Zain Ul Abideen 5.Asim Faheem Shaikh Zayed Islamic Centre

2. Definition The Mudarabah contract is a form of partnership between one who contributes capital (Rabb-ul-maal) and the other who contributes efforts in the form of managerial skills (Mudarib). Profit from the outcome of the venture is shared between the capital provider and manager according to mutually agreed profit sharing ratio whilst losses are borne solely by the capital provider, provided such loss is not due to the Mudarib’s negligence or violation of specified conditions. 2

3. Types of Mudarabah 1. Al Mudarabah Al Muqayyadah (Restricted Mudarabah) Rabb-ul-Maal may specify a particular business or a particular place for the mudarib, in which case he shall invest the money in that particular business or place. This is called Al Mudarabah Al Muqayyadah (restricted Mudarabah). 3

4. Types of Mudarabah 2. Al Mudarabah Al Mutlaqah (Unrestricted Mudarabah) Rabb-ul-maal gives full freedom to Mudarib to undertake whatever business he deems fit, this is called Al Mudarabah Al Mutlaqah (unrestricted Mudarabah) However, he is not authorized to: a) keep another Mudarib or a partner b) mix his own investment in that particular Mudarabah without the consent of Rabb-ul Maal. 4

5. Layout for Today’s Presentation We will try to cover the following Topics 1.Nature of the Mudarabah contract 2.Mudarabah Capital 3.Management of the Mudarabah 4.Profit and loss sharing mechanism 5.Project Finance 6.Two Tier Mudarabah 7.Risk in Mudarabah 5

6. Nature of the Mudarabah Contract Generally Mudarabah contract allows anyone of the contracting parties to terminate the contract unilaterally. However, the contract shall not be terminated unilaterally if the manager has commenced the work or when both parties have agreed not to terminate the contract during a specified time. 6

7. Mudarabah Capital The capital shall be contributed by the capital provider and shall be managed by the manager to generate income. The capital of Mudarabah may be in the form of monetary or non-monetary assets. Monetary assets of different currencies shall be valued according to an agreed currency at the time of signing the Mudarabah contract. 7

8. Mudarabah Capital Multi Currency Mudarabah Fund The mutually agreed currency shall be applicable throughout the Mudarabah business venture. For example, any capital investments after the initial investment shall be converted into the currency mentioned in the prospectus. 8

9. Mudarabah Capital Capital in the form of non-monetary assets which may include intangible assets shall be valued based on the valuation determined by a third party which may include authoritative bodies, experts, or as agreed upon by the contracting parties at the time of conclusion of contract. Non-monetary Mudarabah capital contributed may be redeemed at its original value invested should it be possible or otherwise at its residual market value upon termination or the expiry of the contract. 9

10. Mudarabah Capital Debts such as account receivables or loans due to a capital provider do not qualify as capital of Mudarabah. The agreed capital shall be made available to the manager to commence the business activities. The capital may be fully or partially disbursed or made available to the manager at the time of the contract or based on terms of the contract. Capital provider and manager may agree for a gradual withdrawal of Mudarabah capital by the capital provider. 10

11. Mudarabah Capital Where the agreement is terminated the manager has to return the outstanding capital (if any). If the Mudarabah expenditure exceeds the actual capital contribution, such liability shall be borne by the capital provider up to the limit of the total amount committed under the contract. 11

12. Mudarabah Capital Upon liquidation or maturity of the Mudarabah contract, all outstanding capital shall be returned to the capital provider. Any outstanding capital including the share of profit shall be deemed as debt due to the capital provider. The manager shall not guarantee the Mudarabah capital. 12

13. Mudarabah Capital The capital provider may require the manager to arrange for an independent third party performance guarantee. The guarantee shall be executed as a separate contract and be utilized to cover for any loss or depletion of capital in the event of misconduct, negligence, dishonesty, fraud or breach of the terms of the contract by the manager. 13

14. Mudarabah Capital The Mudarabah third party guarantee may be in the form of performance guarantee of the Mudarabah transactions or Mudarabah capital itself. For example, capital employed to sell assets or render services may be accompanied by a third party guarantee on payment for such sales and services. 14

15. Management of the Mudarabah Venture Mudarabah capital will be used only for the Sharia compliant activities. Manger/Mudarib will have the exclusive rights to manage the contract. However, the capital provider has the right to information regarding the conduct of the business and manger. Manager shall not be liable for any loss of capital unless it is due to any negligence, dishonesty, misconduct or breach of contract Terms. 15

16. Management of the Mudarabah Venture Breach of Terms According to the terms of Mudarabah venture, the manager should disclose all relevant information that is significant for the capital provider to take a decision to participate in the venture. If the manager concealed important information which is known to the manager to be material to the decision making process. Upon engagement, losses on investment occurred and investigation reveals that such unfavorable information was not disclosed. This tantamount to the manager breaching the terms of engagement for willful non-disclosure and hence shall bear such loss of capital. 16

17. Management of the Mudarabah Venture Authority of Rabb-ul-Maal 1. Oversee the Mudarib’s activities and 2. Work with Mudarib if the Mudarib consents. 17

18. Different Capacities of the Mudarib 1. Ameen (Trustee): The money given by Rabb-ul-maal (investor) and the assets required therewith are held by him as a trust. 2. Wakeel (Agent) : In purchasing goods for trade, he is an agent of Rabb-ul-maal. 3. Shareek (Partner): In case the enterprise earns a profit, he is a partner of Rabb-ul-maal who shares the profit in agreed ratio. 4. Zamin (Liable): If the enterprise suffers a loss due to his negligence or misconduct, he is liable to compensate the loss. 5. Ajeer (Employee): If the Mudarabah becomes Void due to any reason, the Mudarib is entitled to get a fee for his services 18

19. Profit Sharing It is necessary for the validity of Mudarabah that the parties agree, right at the beginning, on a definite proportion of the actual profit to which each one of them is entitled. They can share the profit at any ratio they agree upon. However in case the parties have entered into Mudarabah without mentioning the exact proportions of the profit, it will be presumed that they will share the profit in equal ratios. Some incentives my be given to the Mudarib Apart from the agreed proportion of the profit, the Mudarib cannot claim any periodical salary or a fee or remuneration for the work done by him for the Mudarabah. The Mudarib & Rabb-ul-Maal cannot allocate a lump sum amount of profit for any party nor can they determine the share of any party at a specific rate tied up with the capital. 19

20. Distribution of Profit & Loss If the business has incurred loss in some transactions and has gained profit in some others, the profit shall be used to offset the loss at the first instance, then the remainder, if any, shall be distributed between the parties according to the agreed ratio. Mudarabah Expenses: The Mudarib shares profit of the Mudarabah as per agreed rate with the investor but his expenses like meals, clothing and medical are not borne by Mudarabah. However, if he is traveling on business and is overstaying the night, then the above expenses shall be covered from capital. 20

21. Termination of Mudarabah Mudarabah can be terminated any time by either of the two parties by giving notice. If Mudarabah was for a particular term, it will terminate at the end of the term. Termination of Mudarabah means that the Mudarib cannot purchase new goods for the Mudarabah. However, he may sell the existing goods that were purchased before termination. 21

22. Distribution at Termination If all assets of the Mudarabah are in cash form at the time of termination, and some profit has been earned on the principal amount, it shall be distributed between the parties according to the agreed ratio. If the assets of Mudarabah are not in cash form, they will be sold and liquidated so that the actual profit may be determined. If there is a profit, it will be distributed between Mudarib and Rab-ul-Maal. If no profit is left, Mudarib will not get anything. 22

23. Collective Mudarabah Collective Mudarabah” means a joint Pool created by many investors and handled over to a single Mudarib who is normally a juristic person. Collective Mudarabah creates two different relationships: Relationship between investors, which is Shirkah or Partnership. Relationship of all the investors with Mudarib, which is Mudarabah. 23

24. Practical Aspect Mudarabah as Project Financing In the case of project financing, the traditional method of Mudarabah can be easily adopted. If the financier wants to finance the whole project, the form of Mudarabah can come into operation. In this case, if the management is the sole responsibility of one party, while the investment comes from both, a combination of musharakah and Mudarabah can be designed. 24

25. Practical Aspect Investments - The Bank as the Rabb-ul-Maal Profit from the Mudaraba activity is shared between the Bank (as Rabb-ul-maal) and the Mudarib in a pre-agreed ratio. The Bank will bear all the loss unless the Mudarib violates the agreement. The Bank will pay to the Mudarib, compensation (Mudarib fees) in return for management of its funds. The Mudarib is bound to return the capital to the Bank after deducting any losses or Mudarib fees at the time winding up of the contract. 25

26. Process Flow Diagram Activity: 1: Bank and Client discuss business plan; Bank provides funds to client towards capital investment; 2. Client sets up the business and manages its operations; 3. Business generates positive or negative profits; 4. Profits if positive are shared between Client and Bank as per a pre-agreed ratio; 5. Profits if negative are absorbed by Bank; effectively bringing down the value of the asset created with its investments

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28. Graphical Illustration 28 Loss Borne Totally by Rabb-ul-Maal Profit shared in accordance to pre-agreed proportions (80:20 ) 80% to Rabb- ul- Maal i.e 8Mn 20% to Mudarib i.e 2Mn Bank (Rabb al Mal) 500MBank 500M Company(Mudarib)Company(Mudarib) CAPITAL Project Revenue 10M 10M Contract of Mudarabah Profit Sharing ratio – X:Y

29. Risks in Mudarabah To understand the risks Mudarabah based Financing, we look at: The risks at various stages of the transaction: beginning, during, and at the conclusion. Classify Credit Risk (CR) and Market Risk (MR) according to:  possession time (spot/future)  liquidity of asset/wealth (asset/cash). 29

30. Risk classification according to wealth type and time period 30

31. Mudarabah Risk & Hedging RiskCategoryHedging Capital RiskCredit RiskThis can be mitigated by conducting proper feasibility before entry Sharia Non Compliance Risk Operational Risk Due attention to be given to all Sharia Aspects during the stage of both pre and post approval Liquidity Risk Only Long Terms Deposits Should be invested Cancellation Risk Market RiskCollateral Should be obtained Legal RiskOperational Risk To Secure legal position, the bank shall ensure that all process is properly documented and it is legally enforceable Default RiskCredit RiskA Security in form of guarantee can be obtained Revenue RiskMarket RiskConducting proper feasibility Study of the business before investment in project 31

32. Difference between Musharakah and Mudarabah MusharakahMudarabah All partners invest.Only Rab-ul-Maal invests. All partners participate in the management of the business and can work for it. Rab-ul-maal has no right to participate in the management which is carried out by the Mudarib only. All partners share the loss to the extent of the ratio of their investment. Only Rab-ul-maal suffers loss because the Mudarib does not invest anything. However this is subject to a condition that the Mudarib has worked with due diligence. 32

33. 33 MusharakahMudarabah The liability of the partners is normally unlimited. If the liabilities of business exceed its assets and the business goes in liquidation, all the exceeding liabilities shall be borne pro rata by all partners. But if the partners agree that no partner shall incur any debt during the course of business, then the exceeding liabilities shall be borne by that partner alone who has incurred a debt on the business in violation of the aforesaid condition. The liability of Rab-ul-maal is limited to his investment unless he has permitted the Mudarib to incur debts on his behalf. As soon as the partners mix up their capital in a joint pool, all the assets become jointly owned by all of them according to the proportion of their respective investment. All partners benefit from the appreciation in the value of the assets even if profit has not accrued through sales. The goods purchased by the Mudarib are solely owned by Rab-ul-maal and the Mudarib can earn his share in the profit only in case he sells the goods profitably.

34. Conclusion Risks in Islamic financial instruments are complex and change and evolve during the transaction It is important to know the underlying features of the contracts and risks arising in Mudarabah Financing Risk management would require knowledge of Islamic contracts and also the appropriate skills to mitigate risks arising in them 34