mudarbah final report (essentials of islamic finance)

Essentials of Islamic Finance MudarbahSubmitted to:Sir Zeeshan Ali

Essentials of Islamic Finance Mudarbah

TABLE OF CONTENTS

1 DEFINITION................................................................................................................................3

2 TYPES OF MUDARBAH.............................................................................................................3

2.1 al mudarib al muqayaddah...........................................................................................................3

2.2 al mudarib al mutlaqah................................................................................................................3

3 MUDARBAH IN THE LIGHT OF HADITH...............................................................................4

4 ROLES IN MUDARBAH CONTRACT/GLOSSARY.................................................................4

5 ROLES OF MUDARIB:................................................................................................................4

6 MUDARBAH EXPENSE..............................................................................................................5

7 DIFFERENCE BETWEEN MUSHARKAH AND MUDARBAH...............................................5

7.1 Musharkah.............................................................................................................................5

7.2 Mudarbah...............................................................................................................................5

8 COMBINE MUDARBAH.............................................................................................................6

9 COMPONENTS............................................................................................................................7

9.1 Contracting parties.................................................................................................................7

9.2 Offer (ijab) and acceptance (qabul)........................................................................................7

9.3 Management..........................................................................................................................7

9.4 Capital...................................................................................................................................7

9.5 Profit......................................................................................................................................8

9.6 Loss.......................................................................................................................................9

10 DISSOLUTION/TERMINATION OF MUDARBAH...............................................................9

10.1 when Contract terminated......................................................................................................9

11 PROPER DISTRIBUTION OF PROFIT AND LOSS WHEN MUDARIB INJECTS CAPITAL............................................................................................................................................10

12 ASSESSMENT PROCESS FLOW..........................................................................................11

13 BENEFITS OF MUDARBAH.................................................................................................11

14 USES OF MUDARBAH.........................................................................................................12

14.1 Asset Side Financing...........................................................................................................12

14.2 Liability Side Financing.......................................................................................................12

15 LIST OF COMPANIES USING MUDARBAH......................................................................12

16 DIFFERENCES IN THE ROLE OF IFI IN MUDARBAH.....................................................14

16.1 ifi’s role as a rabb-ul-maal...................................................................................................14

16.2 ifi’s role as a mudarib..........................................................................................................14

17 THING TO BE CONSIDERED WHILE DOCUMENTATION.............................................15


1 DEFINITION

Mudarbah is an agreement between a capital supplier (Rabb-ul-Maal) and a business person (Mudarib) under which the Rabb-ul-Maal gives funding to be overseen by the Mudarib and any benefit created from the capital is shared between the Rabb-ul-Maal and the Mudarib as per a commonly concurred benefit sharing proportion (PSR) whilst money related misfortunes are borne by the Rabb-ul-Maal gave that such misfortunes are not because of the Mudarib's unfortunate behavior (ta'ddi), negligence(taqsir) or break of indicated terms (mukhalafa-al-shurut).

OR

A contract that is based of trusted relationship between an investor who is known as Rabb-Ul-Maal and a manager who is known as Mudarib. Under the contract of Mudarbah, the losses are bear by the investor (Rabb-ul-Maal) on the other hand profit is shared between them on the mutual consent

2 TYPES OF MUDARBAH

There are two types of Mudarbah

2.1 AL MUDARIB AL MUQAYADDAH

Rabb-ul-Maal may determine a specific business or a specific spot for the Mudarib, in which case he will put the cash in that specific business or spot. This is called Al Mudarbah Al Muqayaddah (restricted Mudarbah).

2.2 AL MUDARIB AL MUTLAQAH

However in the event that Rabb-ul-Maal gives full flexibility to Mudarib to embrace whatever business he regards fit, this is called Al Mudarbah Al Mutlaqah (unrestricted Mudarbah) Mudarib is approved to do anything, which is typically done over the span of business. However in the event that they need to have an unprecedented work, which is past the ordinary routine of the dealers, he cannot does as such without of the merchants, he cannot does as such without express consent from Rabb-ul-Maal. He is likewise not authorized to:

a) Keep another Mudarib or a partner.b) Mix his own particular venture into that specific Mudarbah without the assent of

Rabb-ul-Maal.


3 MUDARBAH IN THE LIGHT OF HADITH

“Ibnu Abbas (may Allah be pleased with him) reported that: “When AbbasIbn Abd al-Muttalib gave his property to someone for mudarabah, he stipulated conditions for his partner not to bring the capital onto the sea; and not to bring with him the capital crossing a valley; and not to buy livestock with the capital; and if his partner violates the conditions, he should guarantee the loss occurred. These conditions have been brought to the attention of Prophet Muhammad (peace be upon him) and he approved them.” “Suhayb (may Allah be pleased with him) reported that the ProphetMuhammad (peace be upon him) said: Three matters that have the blessing (of Allah): A deferred sale, muqaradah (mudarabah), mixing wheat with barley for domestic use and not for sale.”62

4 ROLES IN MUDARBAH CONTRACT/GLOSSARY

Mudarib: The supervisor with whom the benefits are shared once the work is embraced by the individual contracted in the Mudarbah.

Ras-ul-Maal: Capital. The cash or property which a speculator (Rabb-ul-Maal) puts resources into a benefit looking for endeavor, regularly in an organization (Musharkah, for example, a Mudarbah or Shirkah course of action.

Rabb-ul-Maal: Proprietor of capital. In a Mudarbah contract the individual who contributes the capital (the capital proprietor or lender); the financial specialist in Mudarbah contract.

Wakeel: Any purchasing goods for trade, he is an agent of Rabb-ul-Maal. Ameen: The money given by Rabb-ul-Maal (investor) and the assets required

therewith are held by him as a trust. Kafeel: A Kafeel is the one who joins his accountability to that of the principal

(makful) in argues regarding debts, personal damage or material resources.

5 ROLES OF MUDARIB

Ameen (Trustee): To take care of the investment responsibly, with the exception of natural calamities.

Wakeel (Agent): To buy from the assets gave by Rabb-ul-Maal Shareek (partner): Partaking in any kind of profit. Zamin (Liable): To accommodate the misfortune endured by the Mudarbah because

any act on his part. Ajeer (Employee): At the point when the Mudarbah gets Fasid because of any reason,

the Mudarib is Qualified to only the salary, Ujrat-e-Misl.

Any case of misfortune, the Mudarib will not even get the Ujrat-e-Misl.


6 MUDARBAH EXPENSE

The Mudarib shares profit of the Mudarbah as per agreed rate with the investor but his expenses like meals, clothing, conveyance and medical are not borne by Mudarbah. However, if he is traveling on business and is overstaying the night, then the above expenses shall be covered from capital. If Mudarib goes for a journey which constitutes Safar-e-Sharai (more than 48 miles) but does not overstay the night, his expenses will not be borne by Mudarbah.All expenses which are incidental to the Mudarbah’s function like wages of employees/workers or Commission in buying/selling or stitching, dyeing expenses etc., have to be paid by the Mudarbah. However all expenses will be included in the cost of commodities which Mudarib is selling for eg. if he is selling ready-made garments then the stitching, dyeing, washing expenses etc. can be included by the Mudarib in the total cost of the garments.If the Mudarib manages the Mudarbah within his city, he will not be allowed any expenses, only his profit share. Similarly, if he keeps an employee, this employee will not be allowed any expenses, just his salary.If the Mudarbah agreement becomes Fasid due to any reason, the Mudarib’s status will be like an employee, meaning:a) Whether he is traveling or doing business in his city, will not be entitled to any expense such as meals, conveyance, clothing, medicine etc.b) He will not be sharing any profit and will just get Ujrat-e-Misl (ordinary pay) for his job.

7 DIFFERENCE BETWEEN MUSHARKAH AND MUDARBAH

7.1 MUSHARKAH All partners have to invest in business. All partners are liable to do for business. All partners bear the loss as per agreement their investment in the business. The responsibility of the partners is limitless. If the liability of business increase and its

assets or business goes to end all the responsibility will be bear partners as per agreement. When the partners invest their capital in business, partners are owner as per their

investment in business.

7.2 MUDARBAH In Mudarbah Rabb-ul-Maal invest in business. Rabb-ul-Maal has no right to interfere in business, only Mudarib has right to look after

the business. Only Rabb-ul-Maal bears the loss. Mudarib can't bear any loss because he not a investor. If Rabb-ul-Maal wants to interfere in business he needs Mudarib permission.


8 COMBINE MUDARBAH

9

COMPONENTS

9.1 CONTRACTING PARTIES Rabb-ul-Maal (the investor) and the Mudarib (the manager) are the contracting parties

in a Mudarbah contract Both the parties must be a natural person or a legal entity that shall have legal

capacity to enter into Mudarbah contract. For example, having the capacity to perform agency contact either as a principal or as an agent.

The contracting parties in the Mudarbah contract may involve more than one Mudarib or Rabb-ul-Maal

In the case of the Mudarbah involving more than one Rabb-ul-Maal, an agreement among the Rabb-ul-Maal may be established whereby:


a) An existing Rabb-ul-Maal agrees to relinquish his right over a certain portion of the profit if he withdraws from the Mudarbah prior to its maturity date

b) A new Rabb-ul-Maal agrees to assume liability in respect of the Mudarbah, which is already in operation prior to his participation.

Any terms or conditions in the Mudarbah contract has been mutually agreed between the Rabb-ul-Maal and Mudarib, and does not disobey the Shariah shall be binding on both parties.

9.2 OFFER (IJAB) AND ACCEPTANCE (QABUL) A Mudarbah contract shall be entered into by an offer and acceptance between a

Rabb-ul-Maal and a Mudarib. The offer and acceptance may be expressed verbally, in writing or any other methods

which could be evidenced by appropriate documentation or record.

9.3 MANAGEMENT A Mudarib shall have the right to manage a Mudarbah venture. The Mudarib is responsible to ensure proper management of the Mudarbah venture

and acts in the interests of the rabbul mal. The mudarib’s mandate shall be provided under the terms and conditions of the

contract. A rabbul mal shall not be involved in managing the Mudarbah venture but shall have

a right of access to reasonable information regarding the Mudarbah venture.

9.4 CAPITAL The capital of Mudarbah (the capital) shall be provided by the Rabb-ul-Maal and

managed by the Mudarib. The capital shall be identifiable, readily available and accessible for the Mudarib to

commence business activities. The capital may be in the form of cash or in-kind, including intangible assets. Where the capital is in-kind, it shall be valued in monetary terms either by agreement

between the contracting parties or by a third party, which may include experts, valuers, or any qualified person, at the time of entering into a Mudarbah contract.

Where the capital is denominated in a different currency, it shall be valued based on a specific currency as agreed by the contracting parties at the time of entering into the Mudarbah contract.

All remaining capital shall be returned to the Rabb-ul-Maal, if any, upon dissolution or termination of the Mudarbah contract.

The Mudarbah expenditure shall be direct expenses that are identifiable and measurable with regard to a specific investment activity.

The capital may be fully or partially distributed as per the terms of the Mudarbah contract.

In the case where the defaulting rabbul mal has not paid the capital within the time stipulated in the mudarabah contract, the contracting parties may unilaterally


terminate the contract. If the mudarib has commenced work, the rabbul mal has to compensate the mudarib for any mudarabah expenditure incurred and pay the mudarib fair and reasonable wages or fees.

9.5 PROFIT Profit sharing is the primary motive of a Mudarbah contract and therefore it is a

fundamental component of the contract. A Mudarbah profit (the profit) is the value created over and above the capital which is

determined based on a methodology acceptable by market conventions or practices. A Mudarib shall not guarantee any profit. A rabbul mal and a Mudarib shall share profit based on a ratio mutually agreed

between them. The PSR shall be determined at the time of entering into a Mudarbah contract. The PSR may be revised during the tenure of the Mudarbah contract. The Mudarbah contract shall not specify a pre-determined fixed amount of profit to

one contracting party which deprives the profit share of the other contracting party. The profit shall not be fixed in the form of a certain percentage of the capital. In a multi-tiered Mudarbah, two or more profit sharing arrangements may be agreed

upon. In the first tier, a rabbul mal and a mudarib may agree on a certain psr. Whilst in the second tier, the rabbul mal (mudarib in the first tier mudarabah) and the other Mudarib may agree on another PSR. Such arrangement may apply to the following tier respectively. The profit generated in each tier shall be shared according to the respective PSR.

The PSR may be varied to correspond with different periods of investment, different amount of the capital or pre-mature withdrawal of the capital, provided that the conditions for the variation have been agreed upon by the contracting parties at the time of entering into the Mudarbah contract.

A rabbul mal may commission a Mudarib for a fee to perform works apart from the works integral to a Mudarbah venture.

The parties to the contract may agree to set aside the profit as a reserve or for any other purpose.

9.6 LOSS Loss shall be borne by a rabbul mal up to the capital value. A Mudarib shall not be liable for any impairment of asset unless such loss is due to

the mudarib’s misconduct (ta`addi), negligence (taqsir) or breach of specified terms (mukhalafah al-shurut) of the contract.

In the case of any loss, the mudarib shall provide the reason for the occurrence of the loss.

In the case of multiple rabbul mal in a single Mudarbah, the loss shall be borne by each rabbul mal proportionate to his capital contribution.


In the case where a Mudarib commingles or injects his own fund to a Mudarbah venture, the loss shall be borne based on the proportion of the mudarib’s capital contribution in the commingled fund.

10 DISSOLUTION/TERMINATION OF MUDARBAH

Any of the related party can end Mudarbah contract anytime by giving notice to other parties.

A Mudarbah contract can also be dissolved under the following circumstances:

Unilateral termination by any of the parties due to misconduct (ta’ddi), negligence (taqsir) or breach of specified terms (mukhalafa al-shurut) of contract by the other;

Mutual agreement to terminate the Mudarbah contract between the parties; The Mudarbah contract expires upon the maturity date agreed by the parties; Demise or dissolution of either a Mudarib or a Rabb-ul-Maal; Inaccuracy of the Mudarbah.

10.1 WHEN CONTRACT TERMINATED

At the time of termination, some profit has been earned on principle amount and all assets of Mudarbah are in cash form, it will be distributed according to pre-determined ratio among parties. If assets are not in cash form, then it will be sold and liquidated so that actual profit may be determined. Mudarib will not get anything if no profit is left.

11 PROPER DISTRIBUTION OF PROFIT AND LOSS WHEN MUDARIB INJECTS CAPITAL

Upon the Mudarib injecting his own funds/capital into the business:1. Musharkah is formed between the Mudarib and the Mudarbah venture2. Profit /Loss:


i) For the Musharkah, loss shall be distributed according to the amount of capital contribution i.e. ratio of 90:10 and profit shall be distributedAccording to agreed terms and conditions;ii) Subsequently, for the Mudarbah venture, loss shall be absorbed by the Rabb-ul-Maal and profit is to be calculated as per PSR i.e. ratio of 50:50.

12 ASSESSMENT PROCESS FLOW


13 BENEFITS OF MUDARBAH

Mudarbah is the business model in the financial sector which is based on true Islamic practices duly scrutinized and approved by the members of the Religious Board appointed by the Federal Government. It provides profitable investment opportunities to the stakeholders who are looking for Halal profits on their investments according to Islamic Shariah.

The diversity of the Mudarbah concept provides a unique universe of business opportunities to the sector, including financing, trading, manufacturing, equipment-rental, participation in property development, project management, portfolio management, imports and exports and distribution business. Such a diverse piece of activities is not available to any other entity in the Islamic financial regime.

Tax Benefit: The income earned by the Mudarbah’s, other than the trading Mudarbahs, is fully exempted from income tax provided they distribute 90% of their profits amongst the certificate holders. For trading Mudarbahs, the maximum tax rate is 25 percent.

Maximum Distribution of Profits: As an Investor of a Mudarbah one may expect getting maximum dividends as 90% of the income/profits of the Mudarbah are distributed to the certificate holders in order to avail the benefit of tax exemption.

Funding and financial facilities under the Shariah compliant modes are provided by Mudarbahs, on the pattern similar to Islamic banks to the clients.

14 USES OF MUDARBAH

These modes can be used in the following areas (or can replace them according to Shariah rules).

14.1 ASSET SIDE FINANCING Short/medium/long - term financing Project financing Small & medium enterprises setup financing Large enterprise financing Import financing Import bills drawn under import letters of credit Inland bills drawn under inland letters of credit Bridge financing LC without margin (for Mudarbah) LC with margin (for Musharkah) Export financing (Pre-shipment financing) Working capital financing Running accounts financing / short term advances

14.2 LIABILITY SIDE FINANCING For current /saving/mahana amdani/investment accounts (deposit giving


Profit based on Musharkah / Mudarbah – with predetermined ratio) Inter- Bank lending / borrowing Term Finance Certificates & Certificate of Investment Treasury bill and Federal Investment Bonds / Debenture Securitization for large projects (based on Musharkah) Certificate of Investment based on Mudarbah (Eg: Al Meezan Riba Free) Islamic Musharkah bonds (based on projects requiring large amounts – profit based on

the return from the project)

15 LIST OF COMPANIES USING MUDARBAH

Now the Mudarbah Companies and Mudarbahs are operating in Pakistan for the last over 30 years as a unique model and there is no example of any similar legal entities in rest of the world. Mudarbah Companies and Mudarbah Floatation and Control Ordinance 1980 governs the establishment and operation of Mudarbah Companies. Here is small list of companies involved in Mudarbah, showing their good performance in Mudarbah sector.

Sr. No. Name of Mudarbah Rs in millions

Total assets paid up Equity Cash dividend

For 2012-13

1 Allied Rental Mudarbah 4,440 975 2,353 30%, 5% (Bonus)

2 B.F. Mudarbah 129 75 123 Nil

3 B.R.R. Guardian Mudarbah 3,012 780 802 3.10%

4 Crescent Standard Mudarbah 161 200 125 1.50%

5 First Al-Noor Mudarbah 359 210 324 5.00%

6 Elite Capital Mudarbah 193 113 134 5.50%

7 First Equity Mudarbah 666 524 628 Nil

8 First Fidelity Leasing Mudarbah 374 264 344 Nil

9 First Habib Bank Mudarbah 883 397 716 14.75%

10 First Habib Mudarbah 4,719 1,008 3,053 20.00%

11 First IBLMudarbah 220 202 174 3.35%

12 First Imrooz Mudarbah 309 30 133 100.00%

13 First National Bank Mudarbah 2,004 250 298 Nil


14 First Pak Mudarbah 79 125 73 1.20%

15 First Paramount Mudarbah 267 76 176 11%, 10%(Bonus)

16 First Prudential Mudarbah 585 872 516 2.30%

17 First Punjab Mudarbah 1,569 340 33 Nil

18 First Treet Manufacturing Mudarbah 1,644 1,304 1,519 9.50%

19 First UDL Mudarbah 794 264 551 20.00%

20 KASB Mudarbah 1,516 283 266 Nil

21 Mudarbah Al-Mali 239 184 179 1.25%

22 Standard Chartered Mudarbah 6,840 454 1,003 20.00%

23 Trust Mudarbah 429 298 305 6.00%

Total 31,431 9,228 13,828 Nil

16 DIFFERENCES IN THE ROLE OF IFI IN MUDARBAH

16.1 IFI’S ROLE AS A RABB-UL-MAAL

16.2 IFI’S ROLE AS A MUDARIB


17

THING TO BE CONSIDERED WHILE DOCUMENTATION

The committee/board of IFI (Islamic Financial Institutions) is concerned authority when it comes to documentation of Mudarbah. An IFI shall develop comprehensive and legally enforceable documentation for a Mudarbah venture which are in compliance with Shariah and regulatory requirements. At a minimum, the legal documentations shall clearly mention/stipulate the following:

The purpose of the Mudarbah venture; The contractual relationship between the various parties; The rights, roles and responsibilities of the parties to the Mudarbah venture; the amount of capital contributed by the Rabb-ul-Maal; The Profit Sharing Ratio(PSR) The loss that shall be borne by the relevant contracting parties; The calculation methodologies and timing for profit distribution; The tenure of the Mudarbah venture; The pricing or valuation method of underlying assets; Requirements on the reporting of the Mudarbah venture’s performance which includes

the frequency and the information to be reported; Details on the collateral and guarantees including rights over assets, if any; The terms and mechanism of exit; and The terms, fees and charges to be borne by the relevant contracting parties where

applicable.


The use of Arabic terms in the documents shall be clearly clarified or translated to facilitate easiness in understanding of the contracting parties.

Where there is an arrangement of Mudarbah with other Shariah contracts, the IFI shall ensure that the documentation involved is separated and executed in a sequence that is consistent with Shariah requirements.

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