Contracts and Deals in Islamic Finance: A User s Guide to Cash Flows, Balance Sheets, and Capital Structures

Chapter 14Mudharabah

The contract of mudharabah is considered to be one of the pillars of Islamic finance and yet it is a subject of intense controversy. The contract is basically one of partnership between two parties, where one party is a capital provider and the second party is an entrepreneur. The capital provider does not interfere in the management of the funds provided to the entrepreneur and is compensated by the latter with a share in the returns generated by economic activity or investments initiated by the entrepreneur.

The contract involves two parties, one a rab ul maal or capital provider and the other a mudharib, or entrepreneur. The capital provider transfers capital into the control (not the ownership) of a mudharib, and instructs the mudharib to engage the funds into commercial activity to generate returns. The rab ul maal may specify the kinds of commercial transactions the mudharib may engage in or may leave the contract open ended where the mudharib may engage in any commercial enterprise he or she may find suitable. At this stage, a mudharib behaves like an agent of a rab ul mal, or capital provider (Figure 14.1).

Figure 14.1 Mudharabah Process Flow

The mudharib can charge an upront fee for acting on behalf of the capital provider and managing the latter's funds or assets. The status of a mudharib evolves during the various stages of a contract as the ...