Fundamentals of Islamic Finance and Banking

CHAPTER 5Mudaraba

Learning outcomes

Upon completion of this chapter, you should be able to:

1. Define Mudaraba and elaborate its role in the financial intermediation of Islamic banking.
2. Describe the different Mudaraba contracts available in modern Islamic finance and banking.
3. Explain the Shariah compliance and other regulatory conditions that develop the Mudaraba contract.
4. Discuss the challenges faced by Mudaraba, its practical applications today and its differences from conventional banking.

INTRODUCTION TO MUDARABA

Mudaraba is the first of the two equity-based contracts that are popular in modern Islamic finance and involve some sort of partnership. Mudaraba is a form of trust financing, while Musharaka is a joint-venture partnership (dealt with in Chapter 6). Islamic banks have successfully transformed these partnership contracts into financial instruments. In Mudaraba, one party provides the entire capital while the other provides time and effort in the business venture. The capital provider is called the Rab al Maal while the entrepreneur who manages and runs the business using their time, expertise, management and entrepreneurship skills is called the Mudarib. The Rab al Maal does not interfere in the day-to-day running of the business, but may specify some conditions related to management of the business. Rab al Maal trust their capital with the Mudarib, hence the name of ‘trust financing’. Mudaraba can also be called a passive partnership, since one party is ...