Musharakah and Mudarabah
In the modern economic system, Islamic banks are mostly using the debt-creating modes of trade and leasing for their financing activities, while the main basis for mobilising deposits from the public are the partnership modes of Musharakah and Mudarabah. Both modes belong to profit-and-loss sharing or the risk-sharing techniques involved in partnerships. If the financier wants to finance the whole project, the form of Mudarabah can come into operation. If investment comes from both sides, the form of Musharakah can be adopted.
An Islamic bank arranges Musharakah on the basis of a written agreement with the client for a specific transaction or project for a fixed period of time that can be renewed. It could be used to finance industry, trade, real estate, contracting and almost all legal enterprises through partnership. A Musharakah business or its assets can also be securitised by selling Musharakah Certificates in the market. The Musharakah Certificate represents the ownership of the holder in a proportion of the assets of the project. It could be sold in the marker only if it represents non-liquid assets. If the certificate only represents a proportion of liquid assets of the project; it could not be sold in the market except, as it could be assimilated to a trade of money and thus would be similar to Riba.
In addition, the returns of the Islamic bank in Musharakah have been tied up with the actual profits accrued through the enterprise. Thus the client is required to provide the bank periodically with the results of operations of the business. The bank should also share the losses of the business. And if the enterprise earns enormous profits, all of it cannot be secured by the industrialist exclusively, but they will be shared by the common people as depositors in the bank. And since financial institutions do not normally want to remain partner of a specific project for good, they can sell their share to other partners of the project as aforesaid.
Mudarabah is another agreement between the Islamic bank and an entrepreneur, whereby the entrepreneur can mobilize the funds of the bank for its business activity. It is considered as the basis of Islamic banking in the sense that funds are mobilized by banking and non-banking financial institutions mainly under this kind of partnership. The bank acts as a mudarib for the savers and investors and as financier for the entrepreneurs. If the bank employs the client’s deposits without committing any of its own, it acts as mudarib for the client until the conclusion of the business transaction for which the funds were invested; whereas the entrepreneur provides his expertise, labour and management of the project. Profits made are shared between the bank and the entrepreneur according to predetermined ratio. In case of loss, the bank loses the capital, while the entrepreneur loses his provision of labour. It is this financial risk, according to the Shari’ah, that justifies the bank's claim to part of the profit. The profit-sharing continues until the loan is repaid. The bank is compensated for the time value of its money in the form of a floating rate that is pegged to the debtor's profits. Its liability mudarabah is limited to the amount of capital provided and the creditors of a mudarabah have no recourse to other assets of the Islamic bank.
Financial institutions can also mobilize funds for investment by issuing negotiable investment instruments called Mudarabah Certificates; they represent ownership in the funds collected. It would distribute a percentage of the profit earned from the investment of those funds on Mudarabah principles. Mudarabah Certificates are registered in the name of their owners in proportion to the each one’s share therein. A Mudarabah Sukuk can also be issued on the Mudarabah principle.
In addition, Islamic banks can use Mudarabah to finance import trade on a single transaction or a consignment basis where the whole investment has to be made by the bank. Mudarabah can also be used for the purpose of securitisation. Similarly, Mudarabah can be for the whole business of a company or for any specific project whose expenses and revenues can be set aside from the main business.
And in order to insure a mutual trust in this relationship, the accounts of Mudarabah projects are periodically audited in order to determine the distributable profit, after taking into account all expenses. Furthermore, in cross-border financings, exchange and political risks have to be taken into consideration before contracting any transaction of Mudarabah. The bank may also closely monitor the performance of the mudarib during implementation of the project in order to ensure that the project or the business is managed in accordance with custom and the original agreement. The bank may even appoint its representative to the boards of the financed institution.
An Islamic bank arranges Musharakah on the basis of a written agreement with the client for a specific transaction or project for a fixed period of time that can be renewed. It could be used to finance industry, trade, real estate, contracting and almost all legal enterprises through partnership. A Musharakah business or its assets can also be securitised by selling Musharakah Certificates in the market. The Musharakah Certificate represents the ownership of the holder in a proportion of the assets of the project. It could be sold in the marker only if it represents non-liquid assets. If the certificate only represents a proportion of liquid assets of the project; it could not be sold in the market except, as it could be assimilated to a trade of money and thus would be similar to Riba.
In addition, the returns of the Islamic bank in Musharakah have been tied up with the actual profits accrued through the enterprise. Thus the client is required to provide the bank periodically with the results of operations of the business. The bank should also share the losses of the business. And if the enterprise earns enormous profits, all of it cannot be secured by the industrialist exclusively, but they will be shared by the common people as depositors in the bank. And since financial institutions do not normally want to remain partner of a specific project for good, they can sell their share to other partners of the project as aforesaid.
Mudarabah is another agreement between the Islamic bank and an entrepreneur, whereby the entrepreneur can mobilize the funds of the bank for its business activity. It is considered as the basis of Islamic banking in the sense that funds are mobilized by banking and non-banking financial institutions mainly under this kind of partnership. The bank acts as a mudarib for the savers and investors and as financier for the entrepreneurs. If the bank employs the client’s deposits without committing any of its own, it acts as mudarib for the client until the conclusion of the business transaction for which the funds were invested; whereas the entrepreneur provides his expertise, labour and management of the project. Profits made are shared between the bank and the entrepreneur according to predetermined ratio. In case of loss, the bank loses the capital, while the entrepreneur loses his provision of labour. It is this financial risk, according to the Shari’ah, that justifies the bank's claim to part of the profit. The profit-sharing continues until the loan is repaid. The bank is compensated for the time value of its money in the form of a floating rate that is pegged to the debtor's profits. Its liability mudarabah is limited to the amount of capital provided and the creditors of a mudarabah have no recourse to other assets of the Islamic bank.
Financial institutions can also mobilize funds for investment by issuing negotiable investment instruments called Mudarabah Certificates; they represent ownership in the funds collected. It would distribute a percentage of the profit earned from the investment of those funds on Mudarabah principles. Mudarabah Certificates are registered in the name of their owners in proportion to the each one’s share therein. A Mudarabah Sukuk can also be issued on the Mudarabah principle.
In addition, Islamic banks can use Mudarabah to finance import trade on a single transaction or a consignment basis where the whole investment has to be made by the bank. Mudarabah can also be used for the purpose of securitisation. Similarly, Mudarabah can be for the whole business of a company or for any specific project whose expenses and revenues can be set aside from the main business.
And in order to insure a mutual trust in this relationship, the accounts of Mudarabah projects are periodically audited in order to determine the distributable profit, after taking into account all expenses. Furthermore, in cross-border financings, exchange and political risks have to be taken into consideration before contracting any transaction of Mudarabah. The bank may also closely monitor the performance of the mudarib during implementation of the project in order to ensure that the project or the business is managed in accordance with custom and the original agreement. The bank may even appoint its representative to the boards of the financed institution.
Scope of Musharakah and Mudarabah certificates
Musharakah is a mode of financing which can be securitized easily, especially, in the case of large projects that requires huge amounts which a limited number of individuals cannot afford to collect. A Musharakah certificate represents the proportionate ownership of the client in the assets of the Musharakah project. If all the assets of the joint project are in liquid form, the certificate will represent a certain proportion of money owned by the project.
Trading in Musharakah certificates is not allowed when all the assets are still in liquid form, as an increase would fall under the prohibition of riba. Therefore, after the project is started by acquiring substantial non-liquid assets representing tangible assets, Musharakah certificates can be treated as negotiable instruments and can be bought and sold in the secondary market. In fact, the subject matter of the sale, under the Shari’ah, is a share in the tangible assets and not in money alone; therefore the certificate may be taken as any other commodity which can be sold at a profit or at a loss.
And when the money subscribed in Musharakah is employed in purchasing non-liquid assets like land, building, machinery, raw material etc. the Musharakah certificates will represent the holders' proportionate ownership in these assets. However, in most cases, the assets of the project are a mixture of liquid and non-liquid assets. In such cases, most of Muslim jurists find it acceptable to trade in Musharakah Certificates, when the Musharakah portfolio comprises more than 50% in the form of non liquid assets.
Similarly, Mudarabah Certificates are investment instruments, which mobilize the Mudarabah capital by floating certificates, registered in the name of their owners; they represent shares of equal value. Joint owners of shares in the venture capital or whatever shape it may take, in proportion to the each one’s share therein. Mudarabah is considered as the basis of Islamic banking in the sense that funds are mobilised by financial institutions mainly under this arrangement by issuing negotiable Mudarabah Certificates, representing ownership in the funds collected and providing for the profit earned from the investment of those funds to be distributed on Mudarabah principles. And as it is the case in Musharakah certificates; Mudarabah certificates will not be negotiable in the eye of Shari’ah, if all the assets are in nature of liquid.
In addition, Islamic banks could act as a mudarib for the savers and investors and as financier for the entrepreneurs. If the bank employs the client’s deposits without committing any of its own, it acts as mudarib for the client until the conclusion of the business transaction for which the funds were invested. Finally, the liability of the Islamic bank under Mudarabah is limited to the amount of capital provided by the bank and the creditors of a Mudarabah have no recourse to other assets of the bank.
Trading in Musharakah certificates is not allowed when all the assets are still in liquid form, as an increase would fall under the prohibition of riba. Therefore, after the project is started by acquiring substantial non-liquid assets representing tangible assets, Musharakah certificates can be treated as negotiable instruments and can be bought and sold in the secondary market. In fact, the subject matter of the sale, under the Shari’ah, is a share in the tangible assets and not in money alone; therefore the certificate may be taken as any other commodity which can be sold at a profit or at a loss.
And when the money subscribed in Musharakah is employed in purchasing non-liquid assets like land, building, machinery, raw material etc. the Musharakah certificates will represent the holders' proportionate ownership in these assets. However, in most cases, the assets of the project are a mixture of liquid and non-liquid assets. In such cases, most of Muslim jurists find it acceptable to trade in Musharakah Certificates, when the Musharakah portfolio comprises more than 50% in the form of non liquid assets.
Similarly, Mudarabah Certificates are investment instruments, which mobilize the Mudarabah capital by floating certificates, registered in the name of their owners; they represent shares of equal value. Joint owners of shares in the venture capital or whatever shape it may take, in proportion to the each one’s share therein. Mudarabah is considered as the basis of Islamic banking in the sense that funds are mobilised by financial institutions mainly under this arrangement by issuing negotiable Mudarabah Certificates, representing ownership in the funds collected and providing for the profit earned from the investment of those funds to be distributed on Mudarabah principles. And as it is the case in Musharakah certificates; Mudarabah certificates will not be negotiable in the eye of Shari’ah, if all the assets are in nature of liquid.
In addition, Islamic banks could act as a mudarib for the savers and investors and as financier for the entrepreneurs. If the bank employs the client’s deposits without committing any of its own, it acts as mudarib for the client until the conclusion of the business transaction for which the funds were invested. Finally, the liability of the Islamic bank under Mudarabah is limited to the amount of capital provided by the bank and the creditors of a Mudarabah have no recourse to other assets of the bank.
