Mudarabah and

Musharakah - Participatory
Modes of financing

Essentials of Islamic Banking and Finance

IQRA University, MBA
Talha Saleem Kapadia

Talhasaleemkapadia@gmail.com

Mudarab
ah

Contents
Introduction Mudarabah;
Profit / Loss Distribution;
Kinds of Mudarabah
Termination of Mudarabah
Mudarabah Vs Musharakah
Scope of Mudarabah for Banking System
Risks
Practical examples

Mudarabah - Introduction
Mudaraba is a kind of partnership where partner

involve in business;
Mudarabah is partnership between persons in which one
partner gives money to another for investing in
profitable avenues.
The investor (fund provider/supplier) is called Rabb-ulMaal while the person who utilizes this fund (the fund
manager) is called Mudarib;
Mudarib is exclusively responsible for management of
the business.
Rabbul Maal (fund supplier) does not have any right to
interfere in business affairs.

Mudarabah - Introduction
Mudarabah Capital:
In principle, the capital of Mudaraba should be

provided in the form of cash.

However, it may be presented in the form of kind i.e.
tangible assets which will be valued as per mutual
consent;
The value (in cash) of the assets will be the
Mudaraba capital;
The Capital of Mudaraba should be clearly known to
the contracting parties and defined in terms of
quality and quantity in a clear manner;
Debt (receivable) can not be the capital of
Mudarabah.

Mudarabah - Introduction
Mechanism of Profit and Loss distribution:
The contracting parties should stipulate in the

contract the profit shares (in defined terms) for each

one;
The profit sharing ratio should be:

Specific; and
of the profit expected to be earned by the venture;

Therefore following method is not allowed:

Unknown ratio;
A ratio attributed to future settlement;
A ration linked with the capital (in terms of x% of the capital);
A lump sum settlement as profit;

Mudarabah - Introduction
Mechanism of Profit and Loss distribution:
Losses in Mudaraba shall only be born by Rabb-ul-

Mal and not by the Mudarib;

Mudarib will also suffer loss in shape of not receiving
anything as profit;
The Mudarib shall only be responsible for losses if
the loss happened due to his negligence and willful
misconduct.

Mudarabah - Types
There are two types of Mudarabah:
Restricted Mudarabah (Mudarabah Muqayyadah):

It is a kind of Mudarabah in which the capital provider restricts

the Mudarib to perform business with certain restrictions. These
restrictions may be for place (geographical restriction),
particular type of investment (sector wise restriction) or any
other restriction provided these restrictions do not unduly
constrain the Mudarib from business operations.

Unrestricted Mudarabah (Mudarabah Mutlaqah):

It is a kind of Mudarabah in which the capital provider (Rabbul

Maal) does not put any restriction the Mudarib.

Mudarabah - Rules
Supply of funds:
The basic feature of Mudaraba is that the the capital

is provided by Rabbul Maal and the Mudarib is

responsible for the management only;
However, it is allowed for Mudarib to add capital into
the business of Mudaraba if agreed with Mudarabi;
In such cases Musharaka and Mudaraba are
combined.
For example, Zuhaib gave to Rahman Hayder
Rs.100,000/- for Mudaraba. R. Hayder added Rs.
50,000/- from his own with the consent of Zuhaib;
This type of partnership will be treated as a
combination of Musharaka and Mudaraba;
Here the Mudarib may allocate for himself a certain
percentage of profit on account of his investment as
Sharik, and at the same time he may allocate
another percentage for his management and work as
a Mudarib.

Mudarabah - Rules
Termination of Mudarabah:
The contract of Mudaraba can be terminated at any

time by either of the two parties after giving a notice

to the other party.
If all assets are in form of cash and some profit has
been earned on the principle amount, it shall be
distributed between the parties according to the
agreed ratio.
If the assets of the Mudaraba are in other form the
Mudarib shall be given an opportunity liquidate them
and the actual profit may be determined.

Mudarabah Vs Musharakah
Mudarabah:
The contribution comes

from Rabbul Maal (the

investor).
The Rabbul Maal
(investor) is not
permitted to manage the
business.
The Mudarib will only
manage the business.
The Mudarib can also
invest in the capital of
Mudarabah.

Musharakah:
The contribution comes

from all partners in form

of cash, commodities,
services or liability in the
case of reputation
partnership.
The work, as a general
rule, is to be done jointly
by the parties.
A partner or some
partners may be
sleeping.

Mudarabah - Application
Scope of Mudarabah for Banking System:
Mudaraba as a mode of finance used by Islamic

Banks for the following purpose:

Relationship with depositors;

The depositors provide moneys to bank as Rabb-ul-Mal to be

invested by bank as Mudarib on the basis of profit and loss
sharing on pre agreed specific ratio;

Islamic bank can also use this mode through

providing capital in a business and sharing in the

profit with pre-agreed ratio;

Large Enterprise financing;

Project Finance;
Business ventures;
Private equity;

Mudarabah - Application
Depositors and Islamic bank relationship:
Mudaraba is used by Islamic Banks for taking deposit

from depositors;
The depositors provide moneys to bank as Rabb-ulMal to be invested by bank as Mudarib on the basis
of profit and loss sharing on pre agreed specific
ratio;

DEPOSITS
DEPOSITORS

MUDARABAH PROFIT &

LOSS SHARING

PROFIT

ISLAMIC BANK

Issues in Mudarabah
Problems and Risks for Islamic Banks:
Mudarabah is among the preferable modes of financing which is
also heavily recommended by scholars and Ulema, but certain
difficulties are there in application of this mode. Some are given
below:
Mudaraba is considered to be very high risk financing activity.
Collateral can be asked but could not be used in case of real
loss.
Banks existing competencies in project evaluation and related
techniques are limited.
Dual book keeping trends in market.
No legal mechanism for treatment with Mudarabah.

Musharakah

Contents
Introduction;
Types of Musharakah;
Basic Rules in Musharakah;
Termination of Musharakah;
Security / Collateral in Musharakah;
Musharakah Management and Liability;
Profit / Loss Distribution ;
Application of Musharakah As a Mode;

Introduction
Musharakah is a newly invented terms by Ulemaa;
The actual term used by Fuqahaa (classical Islamic

scholars) was Shirkah (or Sharikah);

Lexical meaning of it is sharing/merging;
Technically: Commingling by two or more persons either
their capital/money or work or obligations to earn a
profit or a benefit or a yield or appreciation in value and
to share the loss according to their proportionate
ownership;
Now the term Musharakah is popular;
There are different types of Shirkah which have been
explained by Fuqaha;
See next slide for details:

Types of Shirkah

SHIRKAH (Partnership)
Shirkat-ul-Milk (Joint ownership)

Optional

Forced
Shirkat-ul-A'qd (Business
partnership)

Amwaal (partnership with

capital)
Mufawadah
(100%
equality in
shares of
partners)

Al Inaan
(Variability in
shares of
partners)

A'amal (partnership in
work)

Mufawadah
(100%
equality in
shares of
partners)

Al Inaan
(Variability in
shares of
partners)

Wujooh (reputational
partnership)

Mufawadah
(100%
equality in
shares of
partners)

Al Inaan
(Variability in
shares of
partners)

Basics of Musharakah
There are some basic features of Musharakah:
Mixing of Capital (joint ownership);
Asset or property or anything that can accept

partnership;
Rights and Responsibilities;
Sharing of profit and loss

Basics of Musharakah
According to the nature of partnership (Musharakah)

there are three possible structures of Musharakah:

Permanent Musharaka:

Permanent Musharaka is a partnership of permanent nature i.e.

a going concern;

Temporary (Redeemable) Musharaka;

Musharakah can be for a limited time period, after that it will be

redeemed;
Redemption of Musharakah will take place through sale of
shares from one partner to other partner or third person (in
market/exchange);
This type is usually used for business ventures;

Diminishing/declining Musharaka

A Musharakah in which a partner buys the share of the other

partner gradually until the ownership of the asset or property is
completely transferred to second partner;
According to this concept, a financer (bank) and its client
participate in a joint commercial enterprises or property or

Basics of Musharakah
Capital of Musharakah should be in cash form;
It may be in kind;
In such case the value should be agreed;
Different currencies should be converted or valued into

the currency of Shirkah;

Capital should be under the disposal of the manager;
Debt alone can not be contribution in Shirkah;
Capital can be varying among the partners;

Basics of Musharakah
Management of Partnership:
In principle each partner has right of Musharakah

management;
The partners may appoint a managing partner by
mutual consent;
Some of the partners may decide not to work for the
Musharakah and work as sleeping partner;
It is not allowed to specify a fixed remuneration to a
partner Musharaka who manages funds or provides
some form of other services, such as accounting;
However, it is permissible to give him a greater
share of profit than he would receive solely on the
basis of his share in the partnership capital;
According to a view it is also permissible to appoint
his as an employee and giving him remuneration for
his services;

Basics of Musharakah
Profit Sharing ratio:
Ratio or the basis for sharing profit should be

decided in the beginning of partnership;

Profit should be allocated in percentages of earning
and not in a sum of money or a percentage of the
capital or investment;
It is not necessary for sharing profit according to
proportionate capital contribution;
A sleeping partner cannot share in the profit more
than the percentage of his capital;
The partner may at the later stage agree to change
the profit sharing ratio, and on the date of
distribution, a partner may surrender a part of his
profit to another partner;

Basics of Musharakah
Sharing of Loss:
As a matter of principle the loss has to be shared

according to the ratio of capital contribution;

No partner can make his share or portion of share
guarabteed from loss;
Any such agreement will make the Musharakah void
and null
Guarantee of principle:
Guarantee from one partner to other partners profit

or capital or part of capital is not allowed;

Security can be asked for misconduct or negligence;
A third party may provide a guarantee to make up
losses of one or all partners;

Basics of Musharakah
Termination of Musharakah:
Every partner has a right to terminate the

Musharaka at any time after giving notice to the

partner and the Musharaka will come to an end.
In this case, if all the assets of the Musharaka are in
cash form then they will be distributed pro rata
between the partners.
In case they are mixed assets the partners may
agree either on:

The liquidation of the assets (market price), or

On their distribution among the partners as they are; or
Purchasing from one partner share of other at any agreed price
between them.

Application of Musharakah
Musharakah could easily be used as a vast mode of

financing for almost every financial need. Below are

some fields where this mode can easily be applied:
Long-term Finance
Running Finance (limited scope)
Investment Banking
Project Financing
Private Equity Placement
Redeemable capital investment

QUESTION
S