9. MUDARABAH

Unit 5 The Application of Mudarabah
and Issues in Islamic Deposits
SHARIAH RULES AND ISSUES
Dr. Ziyaad Mahomed

The Application of Mudarabah and Issues in Islamic Deposits
Unit 5|2
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Shariah Rules and Issues
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UNIT OUTLINE
Introduction
Concept & Legitimacy of Mudarabah
Mudarabah and Related Concepts
Conditions of Mudarabah
Rights and Responsibilities of the Mudarib
Issues in Implementation
Application of Mudarabah
Shariah Issues in Islamic deposits
Summary
OBJECTIVES
At the end of this unit, you should be able to:
 Describe the nature of mudarabah contracts according to different schools

of Islamic law;
 Distinguish between mudarabah and other related concepts;
 Explain how the mudarabah contract is applied in modern Islamic banking
and finance;
 Determine the juristic of mudarabah together with a basic understanding of
the relevant evidence;
 Evaluate the various conditions that need to be fulfilled for the validity of
mudarabah contract; and
 Determine the modern juristic approaches to the relevant issues on the
implementation of mudarabah in modern times.

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Introduction
A profit-and-loss sharing contract employed by modern Islamic banks is the mudarabah

contract. Although representing a growing market segment, currently, mudarabah,
together with musharakah comprise less than ten percent of all transactions of Islamic
banking and finance world-
wide. Even though numerous
efforts have been made to
promote the usage of
mudarabah in Islamic
banking and finance, the
practice of mudarabah is still
viewed to be extremely risky.
Being a business entity, which is risk-averse in nature, Islamic banks still view these
obstacles to be colossal impediments to its implementation. It is realised that the
successful implementation of this concept requires consolidated efforts from various
quarters, ranging from the regulators, bankers, advisors and the society at large.
This unit will focus more on the concept of mudarabah, its implementation in classical
as well as contemporary practices, the conditions for application and various Shari’ah
issues related to the modern application of mudarabah contract.

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Concept of Mudarabah
The term mudarabah is derived from the phrase: al-darb fi al-ard found in al-Qur’an
which means to make a journey. It is called so because the worker strives and toils in the
course of a business, and in most cases, making journeys is inevitable and an
indispensable part of this strives. The meaning of the word in this sense has been used in
al-Qur’an. For instance, Allah says (al-Muzammil: 20):
“….others travelling through the land seeking of Allah’s bounty.”
The word daraba is used in this verse to indicate travelling to various parts of the world,
to go from place to place, or to make a journey for a trading purpose, seeking for Allah’s
bounties.
Other Arabic terms to designate mudarabah are al-qirad and al-muqaradah. The word
qirad and muqaradah are derived from the word qarada which means to cut off. It is so
called because in practice the contract of mudarabah is formed when the capital provider
cuts off some of his money to be utilised by the mudarib in certain business activities for
the purpose of generating profits to be distributed between them.
Though the two terms (mudarabah and qirad) are argued to have been used to emphasise
two different meanings, as mudarabah emphasises more on the work of the mudarib and
the term qirad emphasises the fact that rab al-mal has given part of his capital and part
of his profit to the mudarib, this difference is only recognised at most, in their literal
meaning. As far as the juristic meaning is concerned, both terms are interchangeable with
no essential differences in meaning of connotation among them. The divergence in
terminology was probably due to geographical factors, as mudarabah is known in the
language of the Iraqis while qirad is known in the language of people of Hijaz.

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Subsequently, this difference was perpetuated by the adherence to the school of fiqh. The
Malikis and the Shafi’is incline more towards adopting the word qirad and to a lesser
extent muqaradah whilst the Hanafis and Hanbalis prefer the word mudarabah.
From the legal perspective, the Malikis define it as an agency for trading in delivered cash
for a part of profits. The Shafi’is define it as an agreement whereby an owner hands over
the capital to a worker who trades with it and the profit is to be shared between them.
Likewise, the Hanbalis define it as a contract in which a person gives his capital to another
for business in order to share the profit according to their stipulation. The most lucid and
comprehensible definition of mudarabah is to be found in the Hanafi School of law. They
define mudarabah as a partnership for participation in profit in which capital is provided
from one side, whereas labour or skill (‘amal) is from the other side.
Similarly, the Majallah (Art. 1404) defines it as: “a type of partnership where one party
supplies the capital and the other the labour. The person who owns the capital is called
the owner of the capital and the person who performs the works is called the workman.”
It is realised that all these definitions give no emphasis on the outcome of the venture.
However, this has been given some consideration in Bidayat al-Mujtahid. Ibn Rushd
defines mudarabah as: “When a party gives his property to another for the purpose of
trading, and if the venture generates profit, the mudarib will share his percentage of profit
in accordance to their agreement, one-third, or one-fourth or one-fifth.”
From among contemporary jurists, a renowned scholar, ‘Ali al-Khafif defines it as a

contract for sharing the profit of a business in which one party contributes with capital
and other with his labour.
A contemporary jurist, Ali Khan Niyazi defines mudarabah as a form of partnership

where one of the contracting parties, called sahib al-mal (the financier) provides a
specified amount of capital and acts like a sleeping or dormant partner, while the other
party called the mudarib, provides the mudaribship and management for carrying on any
venture, trade, industry or service with the objective of earning profit.

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An almost similar definition has been advanced by Mudarabah Companies and
Modarabah (Floatation and Control) Ordinance 1980 (Pakistan). Article 2(2) of the
Ordinance defines mudarabah as: “A business in which a person participates with his
money, and another with his efforts or skills or both, and shall include Unit Trusts and
Funds by whatever name called”.
As one may realise, though defined in different ways by jurists, the meanings of
mudarabah are simply directed to the same issue in question; the act of one party giving
away his property as capital to a person for him to work with that capital. If the venture
makes a profit, it will be shared between them according to a certain ratio that they have
agreed upfront. In case of losses, it will be entirely borne by the rab al-mal and the worker
receives nothing for his efforts.
The only difference is about the depth and breadth of the definitions. While some have
just emphasised the act of contributing capital and labour from the parties, some go
beyond that by explaining the result of the venture in, earning profits or making losses.
Some even go further by stating the form of capital in which the rab al-mal can contribute
and so on and so forth.

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Legitimacy of Mudarabah
Although there is no explicit injunction from the text of al-Qur’an in permitting

mudarabah, some verses from al-Qur’an have been recognised by jurists to indicate the
legality of mudarabah. For instance, Allah says: “Others are travelling through the land
seeking of Allah’s bounty.” Although this verse does not directly address the legality of
mudarabah, they are interpreted to mean those who travel for the purpose of trading and
seeking permissible income, including those who work with another’s capital in exchange
for part of the profits.
Proof from Sunnah on the legality of mudarabah can be divided into two; the first group
of evidence is mainly the act of the Prophet, before or after his prophethood, and the
second group of evidence is mainly from his sayings or endorsements to mudarabah
contracts that were practised during his time. It has been reported that the Prophet
himself worked as a mudarib in this type of contract for Khadijah before he was appointed
as a Prophet. Although this act took place before becoming the Prophet, it is a well-
accepted principle that the Prophet is protected from doing anything sinful, be it before
or after his Prophethood.
From the second group of evidence, there is a saying from the Prophet related to this. It
is reported that Ibn Majah relates from Suhaib, that the Prophet said: “There is blessing
in three transactions: credit sales, muqaradah and mixing wheat and barley for home
consumption, not for trading”. This hadith, however, cannot stand as a solid proof in
legitimising mudarabah due to its weakness in its chain of narrators.
Another hadith on this matter is a tacit approval (taqrir) from the Prophet. It is reported
on the authority of Ibn ‘Abbas, that his father, al-‘Abbas used to stipulate a condition
whenever he gave his money in a mudarabah that the mudarib will not take his money
across the sea, into any valley, or buy any animal with a soft belly, and if the mudarib
were to do any of those actions, then he must guarantee the capital. The Prophet heard of
this practice and permitted it.

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In this case, the Prophet gave his tacit approval to the conditions imposed by al’-Abbas
who used to give money based on mudarabah. The aforesaid tacit approval has also been
reported in the case of Hakim ibn Hizam.
Apart from these, the practices of the Companion on mudarabah are also cited in
supporting mudarabah. One very clear example of such a practice has been narrated from
Abu Musa. It was reported that Abdullah and ‘Ubaydullah, the two sons of Umar, while
traveling with the army of Iraq, visited Abu Musa al-‘Ash’ari, the Governor of Kufah. He
welcomed them and offered to help them. His offer was to give them some public money
to be delivered to the bayt al-mal. Before the money was remitted to the bayt al-mal, they
could trade with it. They could keep the profit and submit the capital (original sum of
money) to the Caliph. They did as he suggested. When they reached Madinah and told the
Caliph, he was upset. He asked them if Abu Musa had given similar capital to all other
soldiers. As their reply was in the negative, ‘Umar got angry and argued that Abu Musa
gave them the money simply because they were the sons of the Caliph. ‘Ubaydullah
responded by saying that the agreement was that, if the money perished, they would have
to guarantee it. However, ‘Umar insisted that the money (profit) must be submitted to the
bayt al-mal and they were not allowed to keep it. When ‘Ubaydullah reiterated his
argument, one of the Companions said: “O Caliph, perhaps you can make it a qirad”, and
‘Umar consented to the arrangement. This practice has been accepted by ‘Umar in the
presence of the Companions of the Prophet and they agreed to treat it as an ex-post facto
mudarabah and took half of the profits earned by the two brothers, in addition to the
public money sent by Abu Musa.
Relying on all such evidence and alike, Muslim

jurists have agreed unanimously that mudarabah
is permitted. As mentioned by Ibn al-Munzir in
his book on ijma’, there is generally consensus
among the jurists with respect to the validity of
mudarabah.

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As far as analogy is concerned, diverse opinions of the jurists are found. This diversity
occurs because some jurists believe that mudarabah defies analogy while others say that
legality of mudarabah is also established by analogy. Al-Kasani, for instance, maintained
that legality of mudabarah is established through reasoning by analogy to share cropping
(muzara’ah). On the other hand, Imam al-Sarakhsi believed that mudarabah is
established by way of juristic preference (istihsan) and not by analogy, since by analogy,
this contract would not be allowed, as it is a contract of hire for unknown wages, in fact
for non-existent wages (during the conclusion of the contract). The exact work is also
unknown. Hence, its permissibility by way of analogy is objectionable. Rather it is
permissible based on istihsan. The opinion of al-Sarakhsi is more acceptable to the
Hanafis. Consequently, the Hanafis limited the scope of mudarabah to trading activities
only, by buying ready-made commodities at a low price and selling it higher to gain profit.
It is not allowed at all to use the capital in mudarabah for industrial as well as agricultural
activities as they involve some sort of work and services before they are ready for sale.
This opinion is also followed by the Shafi’is, the Zaidis and the Imamites.
The Hanbalis on the other hands uphold that mudarabah is a kind of shirkah. Ibn
Taymiyyah, for instance, insists that though mudarabah in some part resembles a
contract of exchange (mu’awadat) its resemblance is more towards musharakah, thus
entitling it to take most of its rulings. As such mudarabah can be effected even on
activities which have no direct involvement with the trading of ready-made commodities.
Realising the peculiarity of mudarabah, Ibn Hazm remarks:
“All chapters of Islamic fiqh have a foundation in al-Qur’an or Sunnah,

except for mudarabah, for which we found no foundation in them. The
contract is, in fact legitimised by consensus of jurists, especially since it did
exist during the Prophet’s time, and he permitted it to continue.”

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It seems that his statement is so contradictory. In the first part, he decided that the legality
of mudarabah is not grounded from al-Qur’an and Sunnah, but in the second part, he
acknowledged that mudarabah was practised during the time of the Prophet which was
endorsed by his tacit approval. This is enough to say that the legality of mudarabah has
been endorsed by Sunnah as the tacit approval (sunah taqririyyah) of the Prophet is an
acceptable evidence, at least to render the practice of mudarabah legitimate (mubah).
This is the opinion of Ibn Taymiyyah, who believed that though there is no explicit text in
al-Qur’an or sayings of the Prophet that legitimise mudarabah, the tacit approval of the
Prophet alone is enough to validate the practice of mudarabah.
Mudarabah and Related Concepts
Although mudarabah stands as a contract on its own, there are other contracts which
share some similar features to that of mudarabah. As such, it is important to distinguish
mudarabah from these contracts.
Mudarabah and Musharakah
Mudarabah and Musharakah are two contracts of partnership, where profits (or losses)
are shared between the parties to the contract.
The Malikis and Hanbalis are of the opinion that mudarabah and musharakah are of
different categories. However, the Hanafis, on the other hand, maintain that musharakah
and mudarabah are the same; in fact, mudarabah is part of musharakah and inherits
most of the musharakah’s features. This is because, to him, both principles are similar in
several aspects. The differences between musharakah and mudarabah are not that
considerable as to warrant another category of contract for mudarabah.
The majority of jurists uphold that there are major differences between these two
principles, which warrant different treatment of mudarabah as a different category of
Islamic nominate contract.
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In mudarabah, one party who has capital but has no skill in managing business
contributes his capital to the party who has
skill to manage the business but has no capital.
As such, only one party provides the capital
and the other party puts his skill and faculty to
manage the business. The party who has no
skill gives his consent to the mudarib, to allow
him to run the business without any
intervention from him (the capital provider).
In musharakah, the capital is provided by both

parties. Hence, both will run the business
together. This does not deny the possibility of
delegating the work to one of them, or even to
another party, but no partner can prevent the
other from managing the business if he wishes so.
But in mudarabah, the capital provider is not allowed to interfere in the management of
the business. He may have the right to oversee, monitor and supervise the way the
business is run, its progress, prospects, etc., but the day-to-day control of the business is
the sole right of the mudarib. Any agreement to allow the capital provider’s intervention
in the management of the business will affect the validity of the contract of mudarabah.
The difference in the way the capital is contributed in mudarabah and musharakah has
also given rise to the way the profits and losses are divided. The division of profit in both
contracts is the same. It must be agreed upon that the profit is divided on a proportional
basis and cannot be a lump sum on a guaranteed return. However, in mudarabah, the
losses must be borne solely by the capital provider. The mudarib who does not partake in
the capital contribution does not share the losses. His loss is in the form of losing out his
time and efforts. On the other hand, in musharakah, profit will be distributed according
to the ratio of capital contribution or according to the agreement and losses will be shared
according to the ratio of capital contribution.

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Mudarabah and Hire
In a contract of hire, a party is obliged to perform work for another and as a consideration
a given sum is to be paid to him. In passing, it may be seen that the contract of hire is
identical to mudarabah. A more in-depth study, however, will reveal the contrary.
Mudarabah is a partnership in the sense that one provides capital whereas the other
provides work and as such they are partners. However, in a contract of hire, the other is
just a worker to the capital owner. As such, in a contract of hire, the worker will get a lump
sum payment, if he did his job according to their agreement, irrespective of whether the
business that he managed generated profit or not, so long as he is not negligent or at
default. In mudarabah, his share of profit depends largely on the success of the business.
If it generates profit, then he will share the profit in accordance to the agreement. The
portion of his profit, unlike in a contract of hire, is not a fixed lump sum.
Mudarabah and Loan
Although mudarabah and loan (qard) share the same features in term of capital
contribution, that is, in both contracts, only one party provides the capital; the nature of
capital contribution is different. In mudarabah, the capital provider gives his capital as a
partner, thus entitling him to a share of the profit. If the venture incurs losses, he will
have to risk his capital as no guarantee is provided by the mudarib to the capital as well
as the profit. On the other hand, in a loan contract, since the capital owner gives his capital
to the borrower as a courtesy from him, he is not entitled to claim any profit, if there is
any, or otherwise the rule of riba’ is triggered. Adversely, if the venture fails, this would
not affect his capital at all as the borrower of the capital is liable to guarantee the return
of the capital, irrespective of the outcome of the venture.

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Elements 0f Mudarabah
The Hanafi’s record only forms (offer and acceptance) as the element of mudarabah. In
this sense, the Majallah stipulates (art. 1405): “The basis of a mudarabah is offer and
acceptance”. The majority of jurists list three elements for the contract of mudarabah:
Parties to the contract (rab al-mal and mudarib), subject matter (capital, work and
profit) and form (offer and acceptance) as shown below.
Conditions of Mudarabah
The jurists have laid down certain conditions for the validity of the contract of
mudarabah. These conditions are basically related to the pillars (arkan) of the
mudarabah contract.
The agreement for mudarabah is concluded by linking the acceptance to the offer. It can
be concluded in various forms if it confers the meaning of mudarabah. The Majallah has
forwarded the general idea on the formation of the agreement by stipulating that:

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“Examples (i.e. for the agreement to be concluded): “A person possessing capital asks
some other person to take the capital and use it to share the profits between them equally,
or in the ratio of two-thirds or one-third. Or says something indicative of an intention to
form a mudarabah contract, as when he asks such a person to take so much money and
use it as capital and share the profits with him in a certain ratio and the latter accepts. A
mudarabah contract has been concluded.”
In terms of legal capacity of the parties, the rab al-mal must be competent to appoint an
agent and the mudarib is competent to accept agency. Therefore, a mudarabah contract
may not be concluded in the absence of two contracting parties with absolute legal
capacity, or their agents, who enjoy legal capacity similar to that of the contracting parties.
The religion of the party is irrelevant according to the majority of schools of law with the
exception of the Malikis, who consider having a partnership with a Christian or a Jew
reprehensible.
The capital must consist of property which can serve as the capital of mudarabah.
Therefore, certain properties are not suitable to function as capital in mudarabah. At the
outset, the majority of jurists believed that only cash money can serve as the capital of
mudarabah. Even the Hanafis and Hanbalis went further by rejecting the use of fungible
non-monetary goods as capital. Hence, merchandise and immovable property cannot
serve as the capital of mudarabah. They argued that capital in the form of commodity
might lead to uncertainty (gharar) regarding the amount of the capital provided, thus
rendering the amount of profit also uncertain.
Ibn Abi Layla and al-Awza’i allow for the use of non-monetary properties as capital. To
value these properties, the prevailing market price will be used as the mechanism of
valuation and the value is considered the contribution from the capital provider. It should
be mentioned at this juncture that according to this opinion, the property itself will be
used as the capital for the venture. An example applicable to modern practices is when a
person has 15 cars and he wants to sell these cars. He concludes a contract of mudarabah
with person B and says to him: “If you sell these cars, you will take 50 % of the profit”. In
this case, the capital of the venture is the cars which are not in monetary form. In this
situation, the cars will be valued, and the value is considered the capital contribution to
the venture.
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This situation is different from the situation in which a person says to someone else: “Take
these cars and sell them. Whatever price that you get from the proceeds of the sale
becomes my contribution to the mudarabah contract.” In this case, the capital is not the
cars, but the cash from the proceeds. Abu Hanifah, Malik and Ahmad Ibn Hanbal allow
the latter practice but not the former one. Al-Shafi’i, declines to accept both types of
capital contribution, arguing that the capital is thus specified as the property’s price,
which is unknown during the conclusion of the contract, and a mudarabah contract
cannot be established with unknown capital.
The Majallah as one may expect follows the opinion of Abu Hanifah, Malik and Ahmad
ibn Hanbal. Hence, it is stated: “…..but if the owner of the capital hands over to the person
supplying the labour, certain merchandise and asks him to sell the same and trade with
the proceeds thereof by way of mudarabah and the person supplying the labour accepts
and takes delivery of the merchandise and sells the same, applying the proceeds thereof
to the capital and trade therewith, the mudarabah is valid.”
It seems that the AAOIFI standard on this matter follows the opinion of Ibn Abi Layla and
al-‘Awza’i, though in the explanation, it is mentioned that the standard is following the
opinion of the Maliki and Hanbalis. The standard mentions: “In principle, the capital of
mudarabah must be provided in the form of cash. However, it may be presented in the
form of tangible assets, in which case the value of the assets is the contribution to the
mudarabah capital. The valuation of the assets may be conducted by experts or as agreed
upon by the contracting parties.”
As one may realise, this standard is far more general than the accepted ruling of the
Hanafi, the Malikis and the Hanbalis. According to their opinion, the asset contributed is
not meant to be used in the contract, rather, it will be sold, and the price of the asset will
be used to fund the venture. The AAOIFI standard, on the other hand, does not specify
this as such. Rather it seems to adopt the opinion of the two jurists who allow the asset
itself to be used as capital of the venture, in which the valuation of the expert or the
agreement of the parties will determine the amount of money contributed in the venture.

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The capital must also be present during the conclusion of the contract. Therefore, it is not
permitted to use debt owed by the mudarib or another party to the rab al-mal as capital
in mudarabah, because it is not considered as an existing asset at the conclusion of the
contract and it is not readily available for mudarabah operations, as it is in the form of
receivables which is unavailable for use when the contract is concluded.
In explaining this, Udovitch writes:
“For a creditor to ask the debtor to use the amount of money owed as a
mudarabah investment is not permissible because a mudarabah cannot
be formed with liable money, that is, money for which the agent has some
liability. Undoubtedly another reason for excluding this type of
arrangement, although not stated in the sources, is the easy abuse to
which it could be put in concealing a usurious loan.”
However, if the rab al-mal instructs the mudarib to collect his debts from a third party
and use them as capital in their mudarabah, the contract is valid, provided the debt is
due (dayn hal) and in fact ready for collection.
The existing capital must be delivered to the mudarib who will supply the labour. The rab
al-mal should not have any control over the capital but may have supervision over the
management of the venture. The capital is also considered to be constructively delivered
if the mudarib is allowed free access to the capital, even though no actual delivery of the
capital has taken place. This capital must be known and certain. Therefore, it must be
definite in terms of its quality and quantity, in a manner that eliminates any possibility of
uncertainty or ambiguity. The basis for this requirement is because recognition of profit
is dependent on the recovery of the capital on the date of liquidation. However, recovery
of the capital cannot be ascertained if its amount was not known earlier and this lack of
knowledge may potentially lead to a dispute.

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The mechanism for distribution of the profit must be made clear and known to both
parties in a manner that eliminates uncertainty and any possibility of dispute. The shares
of the profit of each party must be determined as a percentage and not as a specific or
fixed figure. For instance, it must be one half or one-third, but not a fixed amount such as
RM2,000.00. The jurists are unanimous upon this condition. If the determination of the
profit is made based on a certain fixed amount, this fixation is not valid, and as such, the
mudarabah contract itself is invalid. However, if the mudarib has worked and generated
profit from that venture, the contract will be treated as a regular hire (ijarah). Hence, the
mudarib is considered as a hired person to do the work of the venture and he will be
entitled for an equitable remuneration (ajr mithl) for his work, but thereby disqualifying
him from any share of the profit. The determination of the profit ratio must be made in
advance or at the time of the contract. However, if it appears that the contracting parties
have not fixed any ratio of profit at the time of the contract, the profit will be shared
between them equally as the normal practice of a partnership is for the parties to share
everything equally. Though the ratio of profit must be fixed upfront, the parties may
change the ratio at any time because entitlement to the profit is a right of the parties.
Thus, if they agree to change the ratio of profit distribution, they are in fact, exercising
their own right. This ruling has been adopted by AAOIFI as part of its standard on
mudarabah and is also supported by Dallah al-Barakah Group’s fatwa. In its resolution
and recommendation, it is declared that:
“It is permissible on case of mudarabah to agree to determine the share of the

capital owner by a specific percentage of profit at commencement of
mudarabah, such a ratio is subject to change if profits have reached a specific
percentage of his capital if that is based on accounting based on the
mandatory evaluation, e.g. to agree that the share of the capital owner is 90%
of the profits and mudarib share is just 10% and that if the profits of rab al-
mal reached 5% of his capital, the percentage agreed on by them shall change,
because this agreement will not prevent from the sharing of the profits.”

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It must be reiterated here that the nature of the mudarabah contract itself requires the
profit to be shared among the parties. Hence, if all the profit is stipulated for the mudarib
only, then according to Hanafi and Hanbal jurists, the contract is no longer considered
mudarabah; instead, it becomes a contract of loan. The mudarib would be required to
bear all losses and be responsible to return the entire principal. The Shafi’is disagree and
uphold that in that situation, the contract of mudarabah becomes invalid because
mudarabah requires proportional division of profit, which is lacking in this case. It
cannot be transformed to a loan contract automatically because the contract was not
concluded as such.
If all the profit is stipulated for the investor, then the contract is no longer a contract of
mudarabah. Rather it will become a contract of hire, and as such the mudarib will be
entitled for an equitable remuneration (ajr mithl) for his work. If he foregoes the
remuneration, then the contract becomes an ibda’ agreement and the mudarib is
considered to have done a charitable act for the interest of the investor, in which he gets
nothing from it.
The profit to be divided between the parties is the net profit after all expenses and losses
have been written off and the capital has been fully restored. Any distribution of profits
before the termination of the mudarabah agreement will be considered as an advance
and as such is not allowed. However, in the case of continuing mudarabah, it may be
permissible to specify a mutually agreed accounting period for the distribution of profits,
treating each period independently. In this case, the accounting method based on accrual
basis can be adopted for the purpose of calculating the profit. However, even in this
situation, some jurists stipulate that the net loss in any given accounting period would
need to be written off by charges against profits in future periods unless the mudarabah
agreement has come to its final conclusion. Hence, it is suggested that for continuing
mudarabah, it may be advisable to build reserves from profits to offset the possible
upcoming losses. In Malaysian practice, this reserve is known as Profit Equalization
Reserve (PER).

U n i t 5 | 20
Profit Equalisation Reserve (PER)
The relevant issue is whether the “extra” profit paid under the profit equalisation reserve
(PER) will be tantamount to a fixed return. This profit is paid from the PER to smoothen
the payment of profit at the rate which is competitive to the rate in the market, particularly
the interest rate paid for conventional accounts. This cannot be deemed as interest as the
extra profit is taken from the reserve account and not paid by the bank. What is
prohibited from the Shari’ah perspective is any promised fixed return that is paid by the
bank from their shareholders’ fund. The PER is an account which is created from the
surplus return of the profit to maintain a good and competitive rate of return to Islamic
depositors. Any conditions or modes of profit allocation in any investment contract which
include any clause or condition that may result in the probable violation of the principle
of sharing the profit will not be acceptable. Any condition, term or mode of profit
allocation with such an effect would render a partnership contract void.
The issue of PER has been addressed in the SAC BNM resolution. According to SAC, the
profit rate declared by an Islamic financial institution usually fluctuates due to fluctuation
in income, provisioning and deposits. If the declared profit rate is often fluctuating and
uncertain, it may potentially affect the interest and confidence of investors. Hence, there
was a proposal to introduce the PER to create a more stabilised rate of return to maintain
the competitiveness of Islamic financial institutions.
Profit equalisation reserve is a provision shared by both the depositors/investors and the
Islamic financial institutions. It involves an allocation of a relatively small amount of the
gross income as a reserve, in times when the Islamic financial institution is making a
higher return compared to the market rate. The PER will then be used to top-up the rate
of return in situations where the Islamic financial institution is making a lower return
than the market rate. Under this PER mechanism, the rate of return declared by the
Islamic financial institution will be more stable in the long run.
In this regard, the SAC was referred to on the issue as to whether the PER mechanism
may be implemented in Islamic finance, specifically in the context of mudarabah
investments.

U n i t 5 | 21
Resolution
The SAC, in its 14th meeting dated 8 June 2000, has resolved that the proposal to
implement PER is permissible.
Basis of the Ruling
According to the general method of investment in Islam, distribution of profit between

the Islamic financial institution and the investors shall be based on an agreed ratio.
Notwithstanding that, in order to ensure the sustainability of the Islamic financial system
and market stability, the PER mechanism may be implemented on the condition that
transparency shall be taken into account.
Even though this method may reduce the return to the investors or depositors in times
when the Islamic financial institution is making a higher profit, it generally allows the
rate of return to be stabilised for a long term and ensures a reasonable return to the
investors when the institution is making a relatively lower profit. This is considered a fair
mechanism as both the Islamic financial institution and investors/depositors jointly
contribute and share the benefits of PER.
This is also in line with the concept of the waiving of right (mubara’ah) allowed by the
Shari’ah which means waiving a portion of the right to receive profit for the purpose of
achieving market stability in the future.
From the very nature of a mudarabah contract, the labour of the contract must be
provided by the mudarib. Therefore, any condition that restricts him from doing his
normal work is not allowed. This is applicable in mudarabah mutlaqah (unrestricted
mudarabah). If the mudarabah is restricted mudarabah, then the mudarib is bound to
follow the restrictions imposed upon him. Similarly, the rab al-mal cannot make a
condition that stipulates his involvement in the mudarabah contract.

U n i t 5 | 22
If the contract contains a condition that the rab al-mal is to take part in the management,
the contract will be invalid. An opinion in the Hanbali school, however, allows him to take
part in the management of the partnership.
The Shafi’i school of law is of the view that the labour should only be confined to trade in
its narrowest scope (sell and purchase activities) because the purpose of mudarabah is to
invest in trading activities. Accordingly, the involvement of the capital in other spheres of
activities such as industrial and agricultural projects is not allowed at all. In the words of
Ibn Hazm: “The mudarib has his share of profit coming from sales activity only.”
As such, if the capital provider stipulates that the mudarib is to extend his labour to
sectors other than trading, the mudarabah will become invalid. If, however, the mudarib
works in these sectors on his own will, he will be regarded as a transgressor and will have
to guarantee the capital if there is a loss. However, some schools of law, especially the
Hanbalis and Hanafis have extended this scope to cover also contracts that are
agricultural in nature such as muzara’ah and musaqat as long as the ultimate intention
is the selling of the products. The Hanbalis, in particular, extend the scope of mudarabah
venture to anything that would result in trading and making profit. As such, anything that
can be done under musharakah, can also be done under mudarabah.
It is submitted that the concept of trade in modern times has developed to encompass a
wide range of business that may not be previously considered as trading activities.
Therefore, the scope of activities in which the mudarabah contract can be involved must
also take this into consideration. The least that can be said in this respect is that the
concept of trade is to be widened to cover all activities where the end result of the contract
is production of products to be sold. This view seems to be more convenient, because it
satisfies the needs of modern Islamic banking and finance. The Islamic banks are in fact
investment banks whose activities are not confined to direct trading only. Even in certain
jurisdictions, the banking law of the country prohibits the banks from being involved in
any direct trading activities. This restriction will definitely impose overwhelming
difficulties for Islamic banks.

U n i t 5 | 23
Types of Mudarabah
The mudarabah contract may be restricted or unrestricted. Unrestricted mudarabah

(mudarabah mutlaqah) is a type of mudarabah in which the capital is handed over to the
mudarib without determination of the type of work that is to be done, the location, the
time, method of payment from the client (cash or credit), the quality of work and the
person with whom the mudarib may or have to trade, etc.
The Majallah (Art. 1406) defines it as:
“where there is no limitation as to time or place or any particular type of

business, or any particular vendor or purchaser.”
The above definition imparts that if the mudarabah is free from any restrictions, then the
contract is unrestricted mudarabah.
Then, it is up to the discretion of the mudarib to run the business according to his
expertise and experience. His authority is then absolute, and he can use the capital in the
manner he deems fit. In such a situation, he is permitted to undertake all transactions,
which are normally allowed in commercial usage. Although the capital provider has no
right to intervene, once he believes that the mudarib is not acting for the benefit of the
venture, he may raise his dissatisfaction to that, even to the extent of requesting the court
to prevent the mudarib from further usage of the capital. This is because the absolute
right given to the mudarib is based on trust. The customary practice of the business will
be the general benchmark to determine whether his action is proper or not. This means
his action will be compared with the customary practice of the merchants. If such action
conforms to the practice, then it is legitimate and binding upon the rab al-mal.

U n i t 5 | 24
The mudarib cannot commit the rab al-mal beyond the capital provided in the venture.
Hence, leveraging beyond the amount of the capital is not allowed, except with prior
permission from the rab al-mal. Similarly, he is not permitted to borrow money on behalf
of the mudarabah venture unless he is specifically permitted to do so. Summarising this
situation, al-Sarakhsi writes:
“If the investor says to the agent, “act with it as you see fit”, then he may
practise all of these things except the loan.”
On the other hand, the mudarabah contract is considered to be restricted (mudarabah

muqayyadah) when the liberty of the mudarib in managing the venture is restricted in
terms of kind, time and place. The AAIOFI standard defines restricted mudarabah as:
“a contract in which the capital provider restricts the actions of the mudarib
to a particular location or to a particular type of investment as the capital
provider considers appropriate, but not in a manner that would unduly
constrain the mudarib in his operations.”
The standard does not detail the allowable restriction, but it does mention that this
restriction would not impose any difficulties on the mudarib in carrying out his duties
successfully. In fact, the restrictions imposed by the capital provider upon the mudarib
are not a matter of agreement among the jurists.
The restriction that the mudarib can only work with the capital in certain places such as
certain cities only is valid according to all jurists. This restriction qualifies as a useful
condition in the contract, since prices vary across locations, and travel increases the risk
associated with transported capital. This restriction is applied, not only to the mudarib,
but also to the capital. Therefore, he cannot give the capital to someone else, so that the
person may use the capital to trade in other places. If he did so, he is liable to guarantee
the capital.
The restriction to purchase goods from a particular place only is valid according to the
Hanafis and Hanbalis but invalid according to the Malikis and Shafi’is. The Hanafis argue
U n i t 5 | 25
that this restriction might be valid economically as some goods might be more expensive,
generally in one place compared to the other. The Malikis and Shafi’is on the other hands
place their reservation in permitting this kind of restriction. They argue that this kind of
restriction may cause difficulties to the mudarib as he may only find the thing which is
necessary to the business only in the place in which he is prohibited from dealing with.
The Hanafis and Hanbalis allow the rab al-mal to stipulate that the mudarib has to deal
with specific individuals only. They justify this through the possibility of reducing
business risks by restricting the set of individuals with whom the mudarib deals. The
Malikis and Shafi’is refuse to recognise this restriction as they view this as unnecessary.
Moreover, this may cause harm to the business itself. Say for instance, the mudarib
manages to get a buyer other that those allowed by rab al-mal, who offer a better price
than what they are willing to offer. Acting on the interest of the venture will definitely
encourage him to sell the thing to him rather than them.
But he would not be able to do that if this restriction is imposed on him. Since this may
cause harm to the mudarib as well as to the venture, they rule out the possibility of
accepting this restriction.
The Hanafis and Hanbalis permit the rab al-mal to specify a period after which the
contract becomes void. In the words of al-Kasani: “If the period is determined to be within
one year, the contract is valid according to our (Hanafi) school of law.” The Malikis and
Shafi’is on the other hand consider this kind of restriction to invalidate the contract of
mudarabah. They argue that restricting the contract to a certain period of time only is
inconsistent with the purpose of mudarabah, that is, to generate profit, in view of the fact
that profit might not materialise in that period. It should be noted that according to
classical jurists who allow the fixation of period of a mudarabah contract, determining
the time limit of the mudarabah does not rule out the possibility of early withdrawal
before the period ends. The parties have all the right to withdraw from the contract at all
times. It only means that after the elapse of the time, the mudarib is not entitled to
continue performing the act of mudarib to the venture anymore.

U n i t 5 | 26
This rule has been modified in modern times. Most contemporary jurists allow fixation of
time in which early withdrawal is not allowed at all. The AAOIFI standard also accepts
this practice. Restrictions that the mudarabah venture will deal in certain types of
merchandise or in certain investments only is acceptable by all jurists. Nevertheless, the
Malikis and Shafi’is suggest another condition that such merchandise should be normally
available in the market during the period of mudarabah, or otherwise the condition might
invalidate the contract.
Rights and Responsibilities of the Mudarib
As a trustee to the mudarabah venture, the mudarib is responsible to employ his best
efforts to accomplish the objectives of the contract. He is responsible for assuring the
capital provider that his money will be used in the finest manner to achieve the goals of
the venture.
In general, the right and responsibilities of the mudarib depends largely on the type of
mudarabah contract that has been entered into. In unrestricted mudarabah, the
allowable acts of the mudarib are basically actions that are conventionally undertaken by
mudarib. These actions are permitted whether or not he obtained explicit permission
from the capital provider. These actions can be summarised as follows:
a. To buy and sell all types of merchandise, for cash or credit, as he sees fit. In buying,
the jurists agree that he can buy whatever merchandise provided that the price that he
paid for it is less or equal to the market value of the merchandise. In selling, Abu
Hanifah opines that the mudarib may sell cash or credit even with prices that are
excessively lower that the market value. However, Abu Yusuf, Muhammad al-
Shaybani, the Shafi’is and the Malikis view that he is not allowed to sell at credit, or to
sell it excessively lower than the normal price. He can only sell it at a reasonable price
accepted by the practice of the merchants. The Hanbali allow the mudarib to trade
cash or credit, but within reasonable market prices.

U n i t 5 | 27
b. To give goods as ibda’ (giving a person a sum of property to be used for buying certain
merchandise from other places, but that person would not be compensated as he
undertook the purchasing on a voluntary basis). However, the Malikis only allow this
when permission from the capital provider is obtained.
c. To keep the property as deposit or pledge, the Hanafis permit the mudarib to make
deposits to any person, as he may deem fit, arguing that in certain circumstances, it is
necessary for merchants to do so. The Malikis, on the other hands disagree to this.
They argue that this may jeopardise the contract. Therefore, if he makes such a
deposit, he would have to guarantee the capital. However, jurists have permitted the
act of pledging part of the capital for the business that the mudarib has engaged in or
to take pledge in lieu of debts owed to the venture. The payment for the work done by
a helper or hired person will also depend on the custom of the merchants. If the work
is normally done by the mudarib himself, but he employs another to do that, then the
payment will be made from the personal fund of the mudarib. If, however, the work
is not customarily within the responsibility of the mudarib, such as legal
documentation etc., the mudarib may claim this from the mudarabah funds.
d. To rent or buy animals, vehicle, equipment etc., as a means of transportation for him
or the commodities.
e. To travel with the capital. The Malikis, most of the Hanafis and some of the Hanbalis
allow the mudarib to travel with the capital to seek profit. He is entitled to do that
even without any specific permission from the capital provider, as they consider the
blanket approval to unrestricted mudarabah includes this action. However, the
Shafi’is and most of the Hanbalis rule that specific permission is needed before the
mudarib can travel with the capital.

U n i t 5 | 28
The AAOIFI standard regarding the activities of the mudarib agrees to many of the
abovementioned activities. It states:
9/1 If a mudarabah contract is concluded on an unrestricted basis, the mudarib is

permitted, in general, to do what mudaribs do in his field of activity, including the
following:
9/1/1 Attending to all permissible investment or trading fields that are feasible,
given the amount of the capital at his disposal, and in which he believes that his
expertise and technical and professional qualifications are likely to give him the
ability to compete effectively;
9/1/2 Carrying out the work himself or appointing another person to carry out
some work if necessary, such as buying a commodity or marketing it for him;
9/1/3 Choosing as far as possible appropriate places and markets that are
seemingly free of risks;
9/1/4 Safeguarding the mudarabah funds or depositing them in the custody of a

trustworthy person whenever appropriate;
9/1/5 Selling and buying on a deferred payment basis.
9/1/6 The mudarib may do, whether by permission or appointment of the capital
provider, the following:
a. The mudarib may, at any time, combine a mudarabah contract and a

partnership (sharikah) contract, irrespective of whether this takes place at the
outset of the contract or after the commencement of the mudarabah
operations, and of whether the partnership contribution is from the mudarib
himself of from a third party. The mixture of unrestricted investment deposits
with the institutions’ funds is an example of this kind of combination.

U n i t 5 | 29
b. The mudarib may accept funds from a third party on a mudarabah if this new
contract will not affect his investment and management responsibility in
respect of the first mudarabah contract.”
It seems that the divergence of opinions of the jurists in deciding the allowable acts of the
mudarib in unrestricted mudarabah are largely based on their differences in determining
the meaning and scope of customary practices of the merchants in concluding
mudarabah contracts. In the light of the constant changing of the business needs as well
as its administration, it may be said that the customary practices of the mudarib will
depend largely on the needs and practices of equivalent business in the same
environment. This general endorsement demonstrates the flexibility of mudarabah as a
viable contract especially in modern times.
In terms of expenses, all normal expenses incidental to the mudarabah business like
wages of the employee or commission in buying and selling and other payments for the
mudarabah contract will be paid by the venture. If the mudarib manages the contract
within his city, he will not be allowed to claim for any expenses. However, if the contract
requires travelling, he will be entitled to expenses during the period of travelling. This is
the opinion of the Hanafis. These expenses, however, must be reasonable and in
accordance to the status of the mudarib and the business that he is handling. It is again,
the role of the custom to determine this. The Shafi’is disallow the mudarib to claim any
expenses even during the travelling time. They believe that in the fixation of the ratio of
profits, both parties should understand the nature of the venture and the expected job
specifications of the mudarib, and the fixation of the ratio should factor this as one of the
criteria in fixing the ratio. As such, the expenses of the mudarib in managing the venture
are already considered. Therefore, the mudarib is not entitled to personal expenses
whether he is in his hometown or in journey because this may result in him gaining profit
twice, one in the form of profits and the other in the form of claimed expenses.
In restricted mudarabah, the mudarib is responsible for observing all the restrictions
placed upon him, failure of which will make him liable to compensate the rab al-mal.

U n i t 5 | 30
Issues in Implementation
Normally, the contract of mudarabah will take effect immediately after the contract has
been concluded. However, sometimes the rab al-mal may desire to suspend the execution
of the contract, so as to start at a future date. For example, if the owner of the capital says
to the mudarib:
“Take this money and work on the mudarabah’s terms on condition that you have to
start next week.”
In a modern situation, there is the situation where the rab al-mal who wants to invest in
a business venture has his own opinion that entering into the market at a particular time
is not appropriate. He, however, sees the potential of the mudarib and afraid that he
might lose the opportunity to get a good mudarib if he does not conclude the contract of
mudarabah with him. At the same time, he is convinced that the right time to enter into
the market with this new business is, let say, next year. So he concludes the contract, but
it will only be effective next year.
The jurists differ on that matter. According to the Shafi’is and Malikis, the effect of
mudarabah cannot be suspended or delayed because the nature of the contract itself
requires that the contract must take effect immediately. However, the Hanafis and
Hanbalis are of the opinion that the mudarabah can be suspended so long as it is
agreeable to the parties.
Generally, mudarabah contract is a non-binding contract (‘aqd ghayr lazim). As such, it

may be terminated unilaterally by any of the parties. Abu Hanifah, al-Shafi’i and Ahmad
ibn Hanbal rule that this non-binding situation continues even after the commencement
of the contract. Thus, either party has the right to dissolve the contract at any time. Their
opinion is mainly based on the nature of the mudarabah contract itself.

U n i t 5 | 31
Since mudarabah is a contract in which a party is allowed to deal with another’s property
with permission, it is his right again to withdraw from this permission. As a comparison,
they cite the case of wadi’ah (safekeeping) and wakalah (agency contract). They argue
that these two contracts are also from the same category and withdrawal from them is the
right given to the parties at all times. The same rule should also be applied in the
mudarabah by way of analogy. However, the other party must be notified before any
dissolution is effected on the contract. The Hanafis rule further that the allowance to
dissolve the mudarabah contract is only applicable if the capital is in monetary form. This
restriction is opposed by the Shafi’is and the Hanbalis.
According to the stronger opinion of the Shafi’is and Hanbalis, the dissolution of contract
is also allowed, even if the capital is in non-monetary form, provided that the two parties
agree to sell it or divide it among themselves. They also rule that if the mudarib requests
selling the capital, the rab al-mal is forced to sell so that the mudarib may collect his
rightful share of profits.
On the other hand, Imam Malik ruled that once the work begins, the contract becomes
binding on both parties. Imam Malik argues that dissolving the contract in this situation
may harm the other party and may lead to losses, and preventing harm is the ultimate
objective of Islamic law. The AAOIFI standard on this matter follows the opinion of the
Malikis. It maintains that one of the situations in which the contract becomes binding
upon parties in mudarabah is: “When the mudarib has already commenced the business,
in which case the mudarabah contract becomes binding up to the date of actual or
constructive liquidation”.
The basis for making mudarabah contract binding once the work has commenced,
according to the standard, is that a unilateral termination of the contract at this stage
might frustrate the objective of the parties to make profit and might cause damage to the
mudarib since he might not receive any compensation for his work.

U n i t 5 | 32
The jurists also differ in their opinion in fixing certain duration to the mudarabah
contract. While Malik and Shafi’i disallow any fixation of duration in mudarabah
contracts, this practice is allowed according to Abu Hanifah and Ahmad. Al-Kasani says
in this regard: “If money is taken for mudarabah for one year, we believe it is a
permissible situation.” In the same vein, Ibn Qudamah says: “(Example) I give you this
money to use in mudarabah for one year. If the year elapses, you should neither buy nor
sell.” It is also argued that the unlimited power of the parties to terminate the mudarabah
at their pleasure may create some difficulties in the context of the present circumstances,
because most of the commercial enterprises today need time to bring to fruition.
They also demand constant and complex efforts. Therefore, it may be disastrous to the
project, if the rab al-mal terminates the contract right in the beginning of the enterprise.
Besides, it may also cause severe setbacks to the mudarib who may earn nothing despite
of all his efforts. Hence, it should be upheld that if the parties agree that no party shall
have the right to terminate the contract within a certain period of time, this condition
should be valid and enforceable upon them. Though there is no direct injunction from the
text (nas) to support that, a hadith which states that any conditions that a person has
imposed upon himself is binding, except those which contradict any clear principles of
the Shari’ah or any legal text, can be considered as the basis for this ruling.
The opinion that allows the fixation of period of the mudarabah seems to be more
facilitative in today’s business, especially in modern banking and financial practices.
Realising the unassailability of this opinion, the AAOIFI standard also allows the fixation
of the period for the mudarabah. The basis for allowing a time limit for the operation of
a mudarabah contract is that the mudarabah contract is, in essence, an agency contract,
which is subject to a designated duration. The Academy Fiqh of Jeddah in one of its
resolutions also supports this opinion.

U n i t 5 | 33
If the opinion that allows for the fixation of the duration were to be followed, the contract
of mudarabah cannot be cancelled unless the period elapses. In this regard, the AAOIFI
standard mentions: “When the contracting parties agree to determine a duration for
which the contract will remain in operation, in this case, the contract cannot be
terminated prior to the end of the designated duration, except by mutual agreement of
the contracting parties.”
The majority of jurists hold that the mudarib is not entitled to mix the capital of the
mudarabah with another capital, be it his or a third party’s capital, except when
authorisation of the rab al-mal has been obtained. The Hanafis allow the mudarib to mix
the capital with another’s, even without prior permission from the capital provider if it is
the custom of the merchants.
The Malikis, even allow such mixing, and regulate that in certain circumstances the
mixing is either compulsory (wajib) or recommendable (nadb). Contrary to all these, the
Shafi’is, with the exception of al-Mawardi, disallow the mixing of capital even with the
permission of the rab al-mal. The practice of modern Islamic banks is to allow the mixing
of funds. To avail themselves of this privilege, prior permission of the depositors in
investment accounts is obtained. The commingling of capital can be done among several
capital providers, and the mudarib remains as the mudarib for the venture, or the
mudarib can also contribute his capital to the pool of capital.
If the mudarib has commingled his own capital with the mudarabah capital, the mudarib
becomes a partner (as in musharakah contract) in respect of his capital and a mudarib in
respect of the capital of the rab al-mal. This practice is known as mudarabah
musharakah. The profit earned on the commingled capitals will be divided
proportionately to the amounts of the two capitals, in which case, the mudarib takes profit
attributable to his own capital, while the remaining profit is to be distributed between the
mudarib and the rab al-mal according to the provisions of the mudarabah contract. As
such, the mudarib takes two portions of the share of profit, one as the rab al-mal to the
venture and the other as a mudarib who manages the venture.

U n i t 5 | 34
As has been mentioned elsewhere, the jurists have unanimously agreed that the mudarib
is a trustee in respect of the capital that comes to his hand. Therefore, he cannot bear any
losses unless upon fault or negligence. Likewise, he will be responsible to bear the losses
if he works contrary to the terms and conditions of the mudarabah. For example, if the
rab al-mal instructs the mudarib to trade in a specific commodity, and the mudarib does
not work according to the instructions and trades in another commodity which results in
losses, then he will be liable to cover the loss. According to the Malikis and Shafi’is and
an opinion from Ahmad, the mudarib is not responsible to guarantee the losses as regard
the capital and any condition to do so will invalidate the contract.
The Hanafis and the Hanbalis are of the opinion that the contract is valid, but the
condition is deemed to be void. However, it is permissible for a third party, other than the
mudarib, to undertake voluntarily that he will compensate the mudarabah losses,
provided that this guarantee is not linked in any manner to the mudarabah contract.
The jurists differ widely on the ruling regarding mudarib yudarib (two-tier mudarabah).
Generally speaking, almost every jurist from all schools of law disallows the mudarib to
invest in a two-tier mudarabah and become the rab al-mal to that second mudarabah
without prior approval from the first rab al-mal. In the words of al-Sarakhsi: “It is
impermissible for the mudarib to give the capital to someone else for the purpose of
(second) the mudarabah as this amounts to putting that person on his position as regards
to the rights of others (rab al-mal). And also, this will result in the second person sharing
the profit of the rab al-mal (in the first mudarabah) whilst the rab al-mal has only
consented to share the profits with the mudarib alone.”
If the rab al-mal allows him to enter into the second mudarabah using the capital, the
jurists agree that the second mudarabah is valid. They, however, differ as to the position
of the first mudarib after the conclusion of the second mudarabah contract. The Hanbalis
and the Malikis opine that in this situation, the position of the first mudarib is
transformed to become an agent, but he is not entitled to any profits, because he
contributes nothing (capital or work) to that venture. The Shafi’is, on the other hand, give
some details on this matter.

U n i t 5 | 35
According to them, if the rab al-mal gives the money to the mudarib and stipulates that
he must give the capital to another, then he is considered a mere agent, and as such
entitled to no profit at all. However, if the money is given to him so that he can become
the mudarib, and at the same allowing him to give the money to someone else as capital;
if he works with the money, then he can share the profit according to their agreement, but
if he gives the money to the second person, his position is now transformed to an agent to
the mudarabah contract concluded between the rab al-mal and second mudarib. Hence,
he is not entitled to any profit at all.
The Hanafis opine that if the mudarib enters into a contract of mudarabah with another
partner using the mudarabah capital with the permission from the rab al-mal of the first
tier mudarabah, the contract is valid and he is considered the mudarib to the first tier
mudarabah and rab al-mal to the second tier mudarabah. This opinion is considered
the most suitable one in modern commercial activities. The opinion of the majority that
the first mudarib in a two-tier mudarabah performs no work is simply untrue.
In fact, the mudarib in the first tier mudarabah plays a very significant role especially in
ensuring the credibility of the mudarib in the second tier mudarabah as well as the
viability of the project. This requires skills and expertise which has been apparently
performed by the first mudarib before the capital is submitted to the second mudarib.
Modern jurists advocate the opinion of the Hanafis on this matter, but they differ with
regard to the position of the mudarib in the first tier mudarabah. Sheikh Muhammad
Baqir Sadr upholds that by concluding the second tier mudarabah, the position of the
mudarib is transformed to an agent and intermediary between the rab al-mal and
mudarib. However, contrary to the opinion of the majority, he opines that the mudarib
(who is now an agent) is entitled to a fee based on the concept of ju’alah. On the other
hand, some other jurists such as Sami Hamoud, Muhammad Abdullah al-‘Arabi, etc.
maintain that the mudarib remains as the mudarib in the first tier mudarabah and
becomes the rab al-mal in that the second tier mudarabah.

U n i t 5 | 36
In this situation, the division of the profit will be done at the second tier first, so as to
know the accruing profit of that mudarabah. The profit that he (rab al-mal in the second
tier mudarabah and mudarib in the first tier mudarabah) acquires then will be
distributed in accordance to the agreed ratio in the first mudarabah contract. The latter
opinion seems to be more adoptable in modern practices of Islamic banking and finance.
Application of Mudarabah
Simple Partnership. A party provides capital to a mudarib to work with the capital and
they participate in profits. Any losses will be borne by the capital provider and the
mudarib loses his times and effort. This arrangement fits well with the structure of
venture capital.
In General Investment Account (GIA) and Specific

Investment Account (SIA –0r SID)
General Investment Account
GIA is of an absolute mudarabah and the ratio of profit sharing is more or less uniform /
standard and advertised as a ready package between the bank and the customer, whilst in
SIA, the mudarabah arrangement is of a restricted mudarabah. The ratio of profit
sharing can be negotiated between the client and the bank, and normally a relatively big
amount of investment is needed in this type of investment. In SIA, the funds, either short-
term or long term, are to be managed separately, where the utilisation of the funds is
identified and matched with specific funds. While in GIA, the funds are commingled and
managed on a pool basis. The utilisation of these funds is not identified nor matched with
any specific funds. In SIA, all income and expenses reported in each fund’s financial
statements must be clearly identified and matched with the utilisation of the fund.
However, in GIA, income and expenses arising from the utilisation of the funds shall be
shared between the depositors and the bank.

U n i t 5 | 37
Project Financing
Islamic bank provides financing to the projects and the mudarib acts as the manager to
the project. The bank does not interfere in the day-to-day functioning of the project. The
profit is to be shared between the parties according to an agreed ratio determined ex ante,
but the losses will be completely borne by the bank.
Letter of Credit Based on Mudarabah
The most well-known structures used in the issuance of LC are based-on musharakah,
murabahah or wakalah. It seems that besides these structures, a LC can also be issued
using the Mudarabah contract. At the outset, the client informs the bank of his Letter of
Credit requirements and negotiates terms and conditions of the mudarabah financing for
this LC. The client then places a deposit with the bank under the wadi’ah principles the
full amount of the cost of the goods to be purchased / imported as per mudarabah
agreement. As such, he will appoint the bank as the mudarib. The bank, acting as the
mudarib, establishes the Letter of Credit and pays the proceeds to the negotiating bank
utilising the client’s deposit. After disposing the goods, the bank will share with the client
the profit from the venture according to the terms and agreement of the venture.
Relationship between takaful operator and takaful participants. Modern takaful contracts
can also be devised using the mudarabah model. In Malaysia, Takaful Malaysia and
Takaful Nasional use this model for their operation.
In brief, the contract of takaful will start with the participation made by the takaful
subscribers to certain takaful products. The pool of funds from the participants’
contribution will be credited into two separate accounts, participants’ accounts (PA) and
participants’ special accounts’ (PSA).
The former account will be managed based on the contract of the mudarabah. Based on
this principle, the participants as arbab al-mal (capital providers) appoint the takaful
operator as mudarib to work with the money in investments which are Shariah compliant.

U n i t 5 | 38
According to the mudarabah contract, participants will share with the operator the profit
of the business. The latter account (PSA) is managed based on contract of tabarru’
(charity or donation). According to this principle, the participants agree to jointly
guarantee among themselves against prescribed damage of loss that may be inflicted on
any of them. Section 2 of Takaful Act 1984, defines takaful business as a scheme based on
brotherhood, solidarity and mutual assistance which provides for mutual financial aid
and assistance to participants in case of need whereby the participants mutually agree to
contribute for the purpose. This connotes the meaning that unlike conventional
insurance, under takaful contract, all participants are both the insurers and insured
persons. By so doing, the element of gharar that will invalidate the contract will be
tolerated. Even though uncertainty is still in existence, it is excusable for according to
Maliki school of law, the existence of gharar is tolerable in a contract of charity (‘uqud al-
tabaru’at).
Due to the fact the participants have not been involved in managing the fund (accepting
the contribution and channeling financial aid to the members), they appoint the takaful
operator (based on contract of wakalah) to become their agency in managing the fund.
For the agency work that the takaful operator has performed, he is entitled to take a kind
of fee (ujr). This means that the takaful operator is entitled to two mechanisms of
payment. One by means of sharing profit (or loss) by virtue of the contract of the
mudarabah and the other is in the form of fees for the management of funds that he made.
Nevertheless, the takaful operator has the right to waive his entitlement for the fees of the
agency contract and this is what has actually been done in practice. However, some
takaful institutions do employ the concept of wakalah in their relationship with the
participants such as Takaful Ta’awuni which operates in Saudi Arabia.
Unit trust. The investors provide the capital and the unit trusts company provides
management and any profits and losses are to be shared together, according to the agreed
profit sharing ratio.

U n i t 5 | 39
UNIT SUMMARY
Mudarabah is a form of partnership where one party called the rab al-mal (capital
provider) provides a certain amount of capital and acts as a dormant partner, while
the other party called mudarib provides the entrepreneurship in managing the
venture. This venture though classically was restricted by some jurists to operate
in direct trading activities only, the scope of activities, in modern times, has been
widened to cover all activities including industrial and agricultural as long as the
end result of the venture is for trading purposes. The mudarib in this venture is
considered as a trustee. As such, he is required to act with prudence and in good
faith. Therefore, he is not liable to guarantee neither the capital nor the profit,
unless when he is at fault or is negligent. In lieu of that, the capital provider is not
allowed to take any guarantee from him except for the purpose of compensating
him in those situations only. However, a third party guarantee is allowed provided
that this third party is detached legally from the mudarib. This guarantee, anyway,
is limited to covering the capital only, but not the profit.
The mudarabah agreement could also be consummated between several capital

providers and the mudarib. It is up to the parties to the contract, either to agree
on restricted or unrestricted mudarabah. In the case of restricted mudarabah, the
mudarib must respect the restrictions imposed by the capital provider. In the case
of unrestricted mudarabah, the mudarib has an open mandate and is authorised
to do everything necessitated by the mudarabah contract in the ordinary course of
business. Although the capital provider has no right to intervene in the day-to-day
management of the company, he can exercise adequate supervision to ensure that
the capital is used in accordance with the agreement.

U n i t 5 | 40
In modern times, the classical application of the mudarabah contract has been
extended to cover various businesses. However, full potential mudarabah
technique of financing has not yet been realised. It is understood that various
obstacles and hindrances have impeded the successful implementation of PLS
contracts in general and mudarabah in particular. Moreover, it is also said that the
implementation of mudarabah is much more difficult compared to musharakah,
for in musharakah, the bank may have the right to be involved in the management
of the venture whilst in mudarabah, the management of the venture will be left
solely to the mudarib. The bank does not participate in decision making of the
mudarabah venture. As such, high confidence on the ability of the mudarib to
manage the business is extremely needed. To be able to determine that, the bank
needs technical capability in varied fields to carry out successful project evaluation.
Given the current framework of Islamic banks which still largely play the role of an
intermediary, it will be difficult for the bank to do that effectively.

U n i t 5 | 41
RESOLUTIONS
SAC BNM RESOLUTION ON MUDARABAH
Background
Mudarabah contract is a profit-sharing contract between the entrepreneur and the

capital provider. Mudarabah contract is applied in deposit taking arrangement such as
current account, savings account and investment account. Mudarabah contract is also
applied in inter-banks investment and Islamic bonds. In takaful industry, mudarabah
contract is used as one of the operational model as well as being applied for investing the
takaful funds.
Issue
1. Floating Islamic Negotiable Instrument of Deposit (INID)
Bank Negara Malaysia has introduced floating INID with the following mechanisms:
i. A customer deposits money into a bank;

ii. The bank accepts customer’s deposit and issues INID to the customer as an
evidence of receiving deposit;
iii. INID is tradable in the secondary market;
iv. On maturity, the customer or holder of INID returns it to the bank and receives
the principal value of INID and declared divided; and
v. The declared dividend is the dividend derived from the investment of the
deposit.
vi. The term “floating” refers to the characteristic of product that changes in value
based on the dividend declared by the bank from time to time. The question is
whether the investment mechanism mentioned above is in line with
mudarabah principle.

U n i t 5 | 42
Resolution
The Council in its 3rd meeting held on 28th October 1997/ 26 Jamadil Akhir 1418,
resolved that Floating Islamic Negotiable Instrument of Deposit (INID) using
mudarabah concept is permissible and can be tradable in the secondary market.
2. Mudharabah Current Account
There was a proposal from Islamic banking institution to introduce mudarabah

current account product. This account is different from the wadiah current account
in which the payment of dividend to customers is at the sole discretion of the bank. In
this mudarabah current account, customers have right to share any profits generated
in proportion to a pre-agreed ratio by both parties at the point of opening the current
account. Besides, customers will be in the position to enjoy any additional facilities
offered by the bank such as takaful coverage scheme. The Shariah issue here is
whether mudarabah current account mechanism as mentioned above is in line with
mudarabah contract.
Resolution
The Council in its 4th meeting held on 14th February 1998/ 16th Syawal 1418, resolved
that it is permissible to use mudarabah contract in current account product and the bank
can offer other additional facilities to customers which are attached to the product, such
as takaful scheme.

U n i t 5 | 43
3. Wadiah and Mudarabah Current Account
Islamic banking institution has proposed to offer current account based on wadiah
yad dhamanah and mudarabah concepts. Under these principles, the bank acts as a
trustee and entrepreneur while the customer acts as a depositor and capital provider
respectively. Both parties agree on a ratio of profit sharing which must be disclosed
and agreed upon by both parties at the time of opening the account. The guarantees
on the deposit will only be given if the account’s balance does not satisfy the conditions
of profit sharing. However, if the account balances comply with the conditions of profit
sharing, the customers will have to bear all the risk of financial losses (no guarantees
on deposit) since the contract has now changed to mudarabah. The issue is whether
the current account mechanism of combining two types of contracts, wadiah and
mudarabah is permissible in Shariah.
Resolution
The Council in its 5th meeting held on 30th April 1998/ 3rd Muharram 1419 resolved that
current account product based on the combination of two contacts, wadiah and
mudharabah is permissible in Shariah.
4. Indicative Rate in Islamic Banking
An indicative rate was introduced as an indicator to investors and depositors who want
to invest or deposit their money in Islamic banking institution. The indicative rate
uses profit rate declared by every Islamic banking institution for assets they hold as
the basis of computation. In mudarabah contract, the actual profits distributed will
only be known after the contract has matured based on a pre-agreed profit-sharing
ratio.

U n i t 5 | 44
In the context of Islamic banking in Malaysia, generally, most of the investment
portfolios are in the form of fixed return such as financing based of bai` bithaman ajil
concept and investment in securities based on bai` dayn concept. Hence, the bank
could determine from the very beginning the expected returns for a certain period.
Therefore, for an investor invests his money for certain period of time, the profit
distribution (according to an agreed profit sharing ratio) should appropriately be
made according to the bank’s expected profit.
A proposal was made that the profit rate to be given to investors may be determined
at the time when the contract is executed if the expected profit rate is known based on
the asset portfolios held. The issue raised here is whether it is permissible in Shariah
to indicate profit rate in mudarabah contract.
Resolution
The Council in its 9th meeting held on 25th February 1999/8th Zulkaedah 1419 resolved
that the application of indicative profit in Islamic banking mudarabah contract is
permissible based on the following conditions:
1. The Islamic banking indicative profit rate is only regarded as a reference of the
expected return that will be received; and
2. If the actual profit rate received by Islamic banking at the time the contract
matured is different from the indicative profit rate agreed at the inception of the
contract, the profit rate paid to investor must be based on the actual profit rate.
5. Mudarabah Investment Certificate
The need for collateral in certain financing is common in banking activities whether
the financing is conventional or Islamic based. Asset used as collateral is in various
forms including real asset and financial asset. Therefore, Islamic banking institution
raised an issue whether Shariah compliant financial asset like Mudarabah General
Investment Certificate can be used as collateral in conventional financing.

U n i t 5 | 45
Resolution
The Council in its 9th meeting held on 25th February 1998/ 8th Zulkaedah 1419 resolved
that Mudarabah General Investment Certificate can be used as security (collateral) for
Islamic financing. However, if the certificate is used as collateral for conventional
financing, it is the responsibility of the customers themselves and it is beyond the
jurisdiction of Islamic banking institution.
Basis of the Ruling
The permissibility of the Mudarabah Investment Certificate as security is based on the

justification that mudarabah and rahn contracts are two different and separate contracts.
The utilisation of mudarabah capital by the Islamic financial institution is for investment
and is based on the first contract which is mudarabah and not rahn. Thus, there is no
issue on the need of the Islamic financial institution to guarantee the value of the
mortgaged asset. This situation is seen as similar to the usage of share certificate as
security whereby the mortgagee need not necessarily guarantee the market value of the
share mortgaged to him.
In addition, the Mudarabah Investment Certificate is an asset that has a value. As such,
it may be traded and used as a security based on the following fiqh maxim: “Every asset
that can be sold can be charged/mortgaged.”
6. Administrative Costs in Mudharabah Deposit Account
Mudarabah deposit account is an Islamic financial product offered in the market.

There is a proposal from Islamic banking institution to charge administrative cost on
depositors (sahibul mal) of mudarabah deposit account. The issue is whether the
bank as mudarib can charge administrative cost on depositors from the Shariah
perspective.

U n i t 5 | 46
Resolution
The Council in its 16th meeting held on 11th November 2000/12 Syaàban 1421 resolved
that bank cannot impose administrative cost on depositors (sahibul mal) in mudarabah
deposit account. If the bank requires additional amount to cover the administrative cost,
it should be taken into account when deciding on the profit sharing ratio as agreed by
both parties.
The SAC was referred to on the issue as to whether indirect expenses may be considered
as deductible costs from mudarabah fund. Indirect expenses include overhead expenses,
staff salaries, depreciation of fixed assets, settlement expenses, general administrative
expenses, marketing and IT expenses.
Resolution
The SAC, in its 82nd meeting dated 17 February 2009, has resolved that indirect expenses
shall not be deducted from the mudarabah fund.1
Basis of the Ruling
The aforesaid resolution is based on the consideration of the following arguments:
1. The majority of scholars, such as Imam Abu Hanifah, Imam Malik and Zaidiyyah is of
the opinion that a mudarib is entitled to the cost of long distance travelling (musafir)
expenses and not recurring cost from mudarabah profit (if any), and if there is none,
he may take from the capital just to meet his needs for food, drinks and his clothing;
1
SAC BNM p. 32.
U n i t 5 | 47
2. Imam Shafi’i views that a mudarib is not allowed to charge any cost either direct or
indirect expenses as the mudarib is already entitled to a certain percentage of the
mudarabah profit; and
3. In order to avoid cost manipulation and to safeguard the interest of depositors,

indirect expenses shall not be deducted from the mudarabah fund since such cost
should have been taken into account in the determination of the pre-agreed profit-
sharing ratio.
7. Collateral in Mudharabah
Collateral agreement is one of the products proposals in diversifying the Islamic

Accepted Bill product. The transfer of fund between a funding bank and a receiving
bank is proposed to be done based on mudarabah as follows:
i. The investment from Bank A (fund provider) to Bank B (fund recipient) is done
based on profit sharing arrangement;
ii. The difference between this contract and the normal mudarabah contract is
the existence of security as collateral to be used if receiving bank fails to return
the fund (capital) on maturity;
iii. The total amount of investment is equivalent or less than the market value of
the pledged security; and
iv. The profit ratio is determined at the execution of the contract.
The Shariah issue is whether the collateral on investment capital is permissible in

mudarabah contract.
Resolution
The Council in its 18th meeting held on 12th April 2001/ 22nd Muharram 1422 resolved
that collateral in mudarabah contract is not permissible since it is against the mudarabah
concept.

U n i t 5 | 48
8. Intra-Day Transaction
Intra-day transaction was introduced in Islamic Inter-Bank Money Market. Intra-day

transaction refers to investment of fund based on mudarabah with its maturity and
settlement is done on the same day. The objective of intra-day transaction is to
facilitate the financial needs of market participants so that their position can be
stabilised at certain point of time.
The approach used in intra-day transaction is the same as inter-bank mudarabah

investment. The difference is only in terms of maturity period, whereby the interbank
mudarabah investment’s maturity period is between overnight to one year. On the
other hand, intra-day transaction has a short maturity period between 9.00 a.m. untill
4.00 p.m. on the same day.
The Shariah issue raised is whether the short investment maturity period can affect
the validity of certain mudarabah contract.
Resolution
The Council in its 19th meeting held on 20th August 2001/ 1st Jamadil Akhir 1422
resolved that intra-day transaction which refers to investment of fund based on
mudarabah in Islamic money market is permissible.
Basis of the Ruling
The mudarabah contract in intra-day transaction may be implemented even though its
investment maturity period is short. This is due to the efficiency of the electronic system
and information technology at present. Thus, once a fund is received, it may promptly be
used to generate profits.

U n i t 5 | 49
9. The international fiqh academy resolution on mudarabah resolution no
"22 (10-3) concerning muqaradha bonds and investment and
development certificates
i. The Council of the Islamic Fiqh Academy, holding its Third session in Amman
(Hashemite Kingdom of Jordan), from 8 to 13 Safar 1407 H (1 I to 16 October
1986);
ii. Having taken note of the studies presented on 'Mugaradha bonds and
investment and development certificates";
iii. Having listened to the debates, which have focused on this subject;
iv. In accordance with the Council's plan of action, stressing the necessity of
undertaking a number of studies on a single topic; Having regard to the
significance of this subject and the necessity of examining it in full details,
including all its aspects and getting acquainted with all opinions related to it;
Resolves
To request the General Secretariat of the Academy to entrust experts it deems competent,
with the task of undertaking a number of studies on the subject, to enable the Council to
take an appropriate decision at its Fourth session.
May Allah guide us on the right Path.
10. Assignment of Weightage
In the current practice, some Islamic financial institutions will assign a weightage
(from 0.76 to 1.24) to every type of deposits in determining the amount of profit to
be distributed among the depositors of each type respectively. A weightage higher
than 1.0 means higher profit for the depositors as compared to a profit-sharing
ratio, whereas a weightage which is lower than 1.0 leads to lower profit than the
agreed profit-sharing ratio. Normally, a higher weightage is assigned to deposits
with a longer term of maturity.

U n i t 5 | 50
Such a practice of assigning different weightage for different types of deposit is meant to
facilitate the Islamic financial institution in managing mudarabah deposits with a
standardised profit-sharing ratio.
In this regard, the SAC was referred to on the issue as to whether the assignment of
weightage by Islamic financial institutions is allowed.
Resolution
The SAC, in its 82nd meeting dated 17 February 2009, has resolved that assignment of
weightage by Islamic financial institutions is not allowed.2
Basis of the Ruling
The aforesaid SAC’s resolution on the prohibition of assignment of weightage by Islamic

financial institutions is based on Al-Kasani’s view in Bada’i al-Sana’i fi Tartib al-Syara’i,
which states that a fasid (void) condition that carries an element of uncertainty in relation
to profit distribution will render the contract fasid. In a mudarabah contract, the subject
matter that is contracted upon is profit, hence, uncertain and unknown subject matters
will render the contract fasid.
In addition, based on further observation, it is noted that:
1. The assignment of weightage will affect the calculation of net profit for both the
mudarib and rabbul mal;
2. The assignment of weightage will change the pre-agreed profit sharing ratio to a new
effective profit sharing ratio;
3. The presumption that a long term investment is riskier is inaccurate since risks are
closely related to the type and area of the investment portfolio; and
4. The issue of non-transparency arises since weightage is an internal practice that is not
disclosed to the depositors as the rabbul mal.
2
SAC BNM p. 33.
U n i t 5 | 51
11. Transferring mudarabah investment profit to customer to avoid

Displaced Commercial Risk (DCR)
In a dual banking system, when there is an increase in the current market rate of
return, customers would also expect an increase in the rate of return from Islamic
financial institutions. In the context of a mudarabah investment account, the
institutions will transfer a portion of their profit to the customer to avoid displaced
commercial risk so that the declared rate will be competitive with the prevailing
market rate of return.
In this regard, the SAC was referred to on the issue as to whether the institutions are
allowed to transfer a portion of their profits to customers to avoid displaced
commercial risks in mudarabah investment accounts.
Resolution
The SAC, in its 82nd meeting dated 17 February 2009, has resolved that the practice of
Islamic financial institutions to forgo part of their profits to customer to avoid displaced
commercial risk in the context of mudarabah investment is permissible.3
Basis of the Ruling
The aforesaid decision is based on the following considerations:
1. The profit in a mudarabah contract is an exclusive right of the contracting

parties. Mutual agreement to review the pre-agreed profit sharing ratio will not
affect the entitlement of either the rabbul mal or the mudarib to the profit. In
addition, the profit will remain as the rights shared between them; and
2. The practice of the Islamic financial institution in forgoing part or its entire
share of profits in a mudarabah fund is permissible since it is implemented by
the Islamic financial institution without affecting the customers’ right.
3
SAC BNM p.34.
U n i t 5 | 52
Furthermore, the customers will receive more profit than the pre-agreed profit-
sharing ratio.
12. A mudarib’s counterparty in a mudarabah transaction
Basically, a mudarib shall not guarantee the mudarabah capital. However, the SAC
was referred to on the issue as to whether a third party may guarantee the liability
of any party who deals with the mudarib in a mudarabah transaction.
Resolution
The SAC, in its 90th meeting dated 15 August 2009, has resolved that a third party
guarantee on the liability of any party who deals with the mudarib in a mudarabah
transaction is permissible.4
Basis of the Ruling
A third party guarantee of capital and performance on the liability of the party who deals
with the mudarib in a mudarabah transaction is permissible based on the consideration
that such a third party guarantee is consistent with the permissibility of a kafalah
contract. In a kafalah contract, the third party guarantor shall be the party with no direct
interest in the mudarabah business.
A third party guarantee may be granted in two approaches:
1. Guarantee without recourse: This guarantee is made based on tabarru’ by a third

party who is not involved or related to the mudarib. In this approach, the guarantor
will have no recourse on the mudarib for the guaranteed amount paid to the rabbul
mal. According to the views of contemporary scholars, there are no Shari’ah
impediments for a party to donate a sum of money for tabarru’ purposes. If such a
tabarru’ is contingent upon meeting certain requirements, the tabarru’ shall be
furnished by the donor as soon as the requirements are met; or
4
SAC BNM p. 35.
U n i t 5 | 53
2. Guarantee with recourse: In this approach, a third party will pay the guaranteed
amount and then claim from the mudarib for reimbursement of the amount paid to
the rabbul mal. This amount is deemed as a debt owed by the mudarib to the
guarantor.
13. Mudarib’s Guarantee on the Liability of the counterparty in a

mudarabah Joint Venture
Basically, a mudarib shall not guarantee the mudarabah performance. However,

there is confusion as to whether in a mudarabah joint venture, the mudarib may
guarantee liability of a party, whom he is dealing with, to ensure that the capital
and/or profit is guaranteed. In this regard, the SAC was referred to on the issue of
the mudarib’s guarantee on the liability of his counterparty in the mudarabah joint
venture.
Resolution
The SAC, in its 90th meeting dated 15 August 2009, has resolved that in a mudarabah
joint venture, the mudarib is not allowed to guarantee liability of any party who deals
with him for the purpose of guaranteeing the capital only or capital and profit in a
particular mudarabah contract.5
Basis of the Ruling
The aforesaid SAC’s resolution is based on the following considerations:
1. The mudarib’s guarantee on a third party performance in a mudarabah transaction

in relation to the mudarabah joint venture managed by him will lead to him being the
guarantor for the mudarabah capital; and
5
SAC BNM p. 36.
U n i t 5 | 54
2. The mudarib’s negligence in dealing with a third party related to the mudarabah
capital will cause the mudarib to be responsible for any losses incurred and not the
third party. This is because the mudarib is responsible for his expertise in managing
the mudarabah fund. If it is proven that the losses are due to the negligence of the
mudarib, then he is liable to refund the capital to the rabbul mal. The rabbul mal is
entitled to receive adequate and reasonable guarantee for the capital against the
mudarib. This is permissible provided that the rabbul mal does not claim any
compensation except in cases of misconduct, negligence and breach of terms of
contract by the mudarib.
14. 3rd Party Guarantee for capital and/or profit in Mudarabah
The SAC was referred to on the issue of capital contribution by the mudarib into the
mudarabah joint venture fund that has been contributed by more than one rabbul
mal.
Resolution
The SAC, in its 90th meeting dated 15 August 2009, has resolved that capital contribution
by the mudarib into the mudarabah joint venture fund is permissible. Such contribution
is valid based on musharakah principles. Thus, the profit and loss sharing shall be done
according to musharakah principles and consequently, the profit will be shared in
accordance with the agreed profit-sharing ratio in the mudarabah contract.6
Basis of the Ruling
The aforesaid resolution is based on the following considerations:
1. There is no impediment for a group of rabbul mal to combine their capital amongst
themselves together with mudarib’s capital since such practice is based on their
mutual agreement; and
6
SAC BNM p. 38.
U n i t 5 | 55
2. If the mudarib mixed his own fund with the mudarabah capital, he shall then become
a partner (musyarik) for such contribution and at the same time, he shall be the
mudarib for the capital contributed by the rabbul mal. In sharing the profit, the
mudarib will be entitled to his portion of the profit based on his contributed capital.
On the other hand, the profit from the mudarabah capital contributed by the rabbul
mal will be distributed between the rabbul mal and the mudarib based on the agreed
profit-sharing ratio.

U n i t 5 | 56
Shariah Issues in Other Islamic Deposit Accounts
Qard Account
Qard is used to replace the wadi’ah contract due to its flexibility. In addition to that, most
of the issues in a wadi’ah contract are not present in a qard hasan contract. However, the
issue of qard is related to whether the hibah extended by the bank is permissible or not.
Hibah for Loan Contract (Qard)
A qard contract is one of the contracts used to manage liquidity in Islamic finance. The
contract obliges a borrower to return the loan amount to the lender without contracting
to pay any additional return.
However, in normal practice, a borrower sometimes gives hibah at his own discretion
when paying off the debts. The issue here is whether the practice of giving hibah complies
with Shari’ah.
Resolution
The Shari’ah Advisory Council in its 55th meeting held on 29 December 2005/27th
Zulkaedah 1426 resolved that the practice of giving unconditional hibah in a loan contract
is permissible. Nevertheless, the Council advised that such practices should be
implemented wisely so as to avoid it becoming a norm (urf) which can make it a condition
attached to the loan contract.

U n i t 5 | 57
Basis of the Ruling
Even though the act of giving hibah by the borrower to the lender is recommended in
Islam, it cannot be conditional in the contract as it may amount to riba. Any addition to
the amount of qard upon repayment, whether in terms of amount, attributes, the giving
of an asset or benefit, is permissible as long as it is unconditional.
The ruling on the giving of hibah to a lender is similar to the ruling on giving a loan with
a benefit, which is prohibited if such hibah is conditional in the contract, but it is allowed
if it is not made as a condition.
Qard Hasan Principles in Islamic Finance
The application of the qard hasan concept in a correct manner that fulfils the Shari’ah
requirements would definitely benefit the contracting parties. However, if it is
inappropriately applied, it would potentially tarnish the image of the Islamic financial
system. Among the issues that may arise in Islamic finance relating to the application of
qard hasan are:
1. Whether qard hasan in its true sense implies a gift that does not require repayment
or otherwise. This refers to the situation where an Islamic financial institution decides
to bring a case of a defaulted customer based on qard hasan to court; and
2. Since Islamic financial institutions provide financing by utilising the deposits of

customers who expect returns, financing based on qard hasan does not effectively
serve such a purpose because qard hasan is not meant to generate profits, rather it is
benevolent or tabarru’ by nature.
In this regard, the SAC was referred to on the issue as to whether a financing product
based on qard hasan principles is allowed since the application of this concept in a
financing product may contradict the original meaning of qard hasan according to
Shari’ah. The SAC was also referred to on the issue as to whether the word “hasan” may

U n i t 5 | 58
be taken out from the term “qard hasan” that has generally been accepted in the Islamic
financial system.
Resolution
The SAC, in its 51st meeting dated 28 July 2005, has resolved that financial products based
on the qard hasan principle are permissible. However, the word “hasan” shall be taken
out from the term “qard hasan” to imply that it is an obligation for the borrower to repay
his qard to the lender or financier and such obligation shall be borne by the heirs of the
borrower in the case of his death before the total settlement of his loan obligation.
Basis of the Ruling
The scholars define qard as affectionately giving a property to a party who will benefit
from it and who will subsequently replace it. The scholars have unanimously agreed that
qard is permissible based on Al-Quran, Sunnah and ijma.
The following Quranic verse is regarded as a basis for the permissibility of qard:
“Who is that will grant Allah a goodly (sincere) loan so that He will repay him
many times over? And (remember) it is Allah who decreases and increases
(sustenance), and to Him you shall all return.”
According to scholars of tafsir, the term qard hasan in the context of the above verse
refers to acts of contributing for the sake of Allah (s.w.t.) (infaq). The term qard literally
means loan and not infaq. Nevertheless, the scholars of tafsir stated that the term qard
used in this verse is intended to dignify the status of mankind since Allah (s.w.t.) had
chosen to communicate using common and understandable vocabulary with mankind.
The permissibility of qard in the context of the loans is based on the literal meaning of
the above verse since Allah (s.w.t.) will not probably mention and equate commendable
matters like infaq with forbidden matters. This indicates that qard is permissible.

U n i t 5 | 59
In relation to the recommendation that Islamic financial institutions shall not use the
word “hasan” in the term qard hasan, the SAC justified its decision based on the following
arguments:
1. The fiqh scholars had never elaborated the term qard hasan specifically but only
discussed the concept of qard and its permissibility in Shari’ah. Generally, qard hasan
relates to matters pertaining to contribution for the sake of Allah (s.w.t.) (infaq); and
2. The word “hasan” as used in Al-Quran refers to an infaq that is given sincerely for
rewards from Allah (s.w.t.).
Based on this fact, it is concluded that the use of the term qard hasan to refer to a loan
especially in the muamalat context in Islamic finance is inaccurate. This is because qard
as defined by fiqh scholars is a loan (qard) that must be settled. Thus, the term qard is
seen more appropriate for an interest free loan as practised in the current Islamic finance
industry.
Combination of Advance Profit Payment Based on Qard and Murabahah

Contract
There was a proposal from an Islamic financial institution to offer an Islamic investment
deposit account product with a fixed return. In implementing this product, the Islamic
financial institution proposed to apply a commodity murabahah contract to create
indebtedness of the Islamic financial institution to the depositors or investors. One of the
new features of this product is the advance profit based on qard given to depositors upon
the opening of the account.
In this regard, the SAC was referred to on the issue as to whether the combination of
advance profit payment based on the qard and murabahah contract in the structure of
the proposed product is permissible in Shari’ah.

U n i t 5 | 60
Resolution
The SAC, in its 4th special meeting dated 29 November 2007, has resolved that a
combination of advance profit payment based on the qard and murabahah contract is
not allowed.
Basis of the Ruling
There is a clear prohibition from the sources of Shari’ah in relation to the combination of
qard with any contracts of exchange (‘uqud mu’awadhat). Among others, there is a
hadith of Rasulullah (p.b,u.h.) that prohibits the combination of sale and qard:
“Ismail bin Masùd had told us from Khalid from Hussein al-Muàllim from
Àmru bin Shuaib from his father from his grandfather: ‘Verily Rasulullah
(p.b.u.h.) forbids the combination of salaf (debt) and sale, two conditions
within a sale, and profit without guarantee (without taking a risk).”

U n i t 5 | 61
Acceptance of Funds from Unlawful Sources
Among the main functions of Islamic banking institutions in Malaysia are accepting
deposits, and providing financing facilities and investments. All of these activities are
carried out in accordance with Shari’ah principles. Through Shari’ah compliant activities,
Islamic banking institutions manage to generate profits and the benefits are shared with
the investors and shareholders.
Even though Islamic financial activities have been closely regulated and supervised, the
financial institutions cannot avoid accepting deposits in which the sources may be non-
Shari’ah compliant or a mixture of Shari’ah compliant and non-Shari’ah compliant
activities. The compliance status of the sources may probably be unknown and uncertain.
Sometimes, the institutions may also receive a request from customers who select the
Islamic financing facility but choose to have it insured under conventional insurance.
Customers’ Deposit
In relation to Islamic banking deposits, is it permissible for the Islamic banking

institution to accept every deposit without screening its source?
Resolution
The council, in its 58th meeting held on 27 April 2006/28 Rabiul Awal 1427 resolved that
Islamic banking institutions may, generally, accept any application for the placement of
deposit or investment fund from individuals or corporate customers without the need to
investigate the status of the sources of fund; whether it’s Shari’ah compliant, non-Shariah
compliant or a mixture between the two. But if the IFI knows that the sources of the fund
is not permissible (such as money obtained through gambling), what would its position
be?

U n i t 5 | 62
Views of scholars on dealing with parties who holds haram assets
The scholars have categorised the persons who own haram property into three groups:
1. Those who owns all haram property;

2. Those who owns a mixture of haram and halal property; and
3. Those who owns property which is of unknown status, i.e., whether halal or haram
Those who owns assets which are entirely haram
Some of the scholars have distinguished between the person who acquires haram
property with or without the consent of the original owner. According to Ibn Taymiyyah,
it is not permissible to enter into a transaction or dealing with a person that entirely owns
property by way of stealing, robbery, fraud or other prohibited or unjustified means (the
person is aware that the property was wrongfully acquired). Ibn Rushd held that it is not
permissible for any Muslim to deal with anyone who owns haram property if he knows of
the fact. In such a case, he is considered to be the accomplice of the former.
Those who own assets which is mixed between halal and haram
The classical scholars held different views on the rulings of transactions that are entered
into with a person who owns property that is a combination of halal and haram.
1. The Hanafi school of law and some Maliki scholars view that it is permissible to do
the transaction with the person if the halal property owned is more than the haram
property. Al-Samarqandi, who is a Hanafi scholar, said that a person is not allowed
to receive a gift from another who acquires it (the gift) by way of riba or when the gift
is given by a cruel person, and it is known that the latter owns more haram property
than halal property.
2. The Shafi’i school and Maliki and Hanbali scholars held that it is discouraged
(makruh) for a person to enter into a transaction with another person who owns
property that is mixed between haram and halal, even though the haram property is
less than the halal property.

U n i t 5 | 63
3. Al-Syaukani and al-Muhasibi, on the other hand, allows the transaction with a person
who owns mixed property without looking into the portion of halal or haram
property. The justification forwarded by them is that the Prophet (p.b.u.h.) and his
Companions performed transactions with the non-Muslim Badwi in Madinah despite
the fact that they generally acquired the property or asset through unlawful means
such as riba, robbery and so on.
4. The Maliki school of law and the minority of Hanbali scholars opined that the
transaction entered into with a person who owns mixed property is prohibited
(haram).
Those who owns asset which is not known whether it is halal or haram
The scholars generally held the same view that the transaction entered into with this
category of people is permissible.

U n i t 5 | 64
Shari’ah Concept for The Operation of Islamic Deposit

Insurance
In Malaysia, deposit insurance is a mechanism that enables The Malaysia Deposit

Insurance Corporation (PIDM) to protect depositors against loss of their deposits placed
with banking institutions in the unlikely event of a bank failure. To enable the depositors
of Islamic banking institutions to enjoy the same protection, the SAC was referred to
ascertain the appropriate underlying Shari’ah concepts for the operation of Islamic
deposit insurance.
Resolution
The SAC, in its 80th meeting dated 7 January 2009, has resolved that the application of
kafalah bi al-ujr (guarantee with fee) as the underlying Shari’ah concept for the operation
of PIDM in managing Islamic deposit insurance fund is permissible. Based on the concept
of kafalah bi al-ujr, the premium paid by the member institutions of PIDM offering
Islamic banking services is considered as an ujrah or fee for PIDM and thus, belongs to
PIDM. As the premium is considered as a fee, PIDM may structure it in the form of
absolute or proportionate value.

U n i t 5 | 65
Co-Mingling of Funds Contributed by Islamic and
Conventional Banking Institutions in Deposit Insurance
Under the deposit insurance arrangement, Islamic and conventional banking institutions
are required to be members of PIDM and pay the annual premium that serves as a source
of fund for the deposit insurance scheme. Apart from being utilised to make payments to
the insured depositors in the event of a wind-up of any banking institution, the fund is
also used for investment in Shari’ah compliant instruments as well as to defray the
expenses of PIDM.
In this regard, the SAC was referred to on the issue as to whether the accumulation of
premium contributed by Islamic and conventional banking institutions into one single
fund is allowed by the Shari’ah.
In addition, the SAC was also referred to on the issue as to whether the government may
make it mandatory for all Islamic banking institutions to be members of PIDM.
Resolution
The SAC, in its 26th meeting dated 26 June 2002, has resolved that the premium or fee
contributed by Islamic and conventional banking institutions shall be segregated and
shall not be accumulated into one single fund. In the event of the dissolution of PIDM,
the SAC, in its 29th meeting dated 25 September 2002, has resolved that two separate
liquidation processes for both funds shall be executed. In addition, the SAC, in its 80 th
meeting dated 7 January 2009, has also resolved that the government may make it
mandatory for all Islamic banking institutions to be members of PIDM as there is no
Shari’ah impediment for the imposition of such requirement.

U n i t 5 | 66
Basis of the Ruling
The premium or fee contributed by Islamic and conventional banking institutions shall
be segregated to avoid commingling of funds between Islamic and conventional deposit
insurance schemes. This is also to ensure that the Islamic deposit insurance fund is
invested in Shari’ah compliant instruments.
The commingling of premium funds of Islamic and conventional banking may raise
uncertainties on the Shari’ah compliance status of the Islamic banking premium fund.
Separate liquidation processes shall also be executed in order to ensure that the rights
and priority in the payment of the protection are accorded to the rightful parties.

U n i t 5 | 67
| Validity of the Contract |
Case Study
Realising Yusuf’s potential to
manage big businesses; Omar
concludes a mudarabah contract
with him to import clothes from
various countries like Indonesia,
China, Korea and Philippines for
distribution to various outlets in
Klang Valley.
Omar stipulates that Yusuf is not allowed to import these clothes from
India, even though the price there is cheaper from those countries
mentioned in the agreement. It is further stipulated in the agreement, that
the ratio of profit distribution will be 50:50. However, if Abu manages to
increase the profit more than 70% of the invested amount, Omar is willing
to alter the ratio to 60:40, to him and Yusuf, respectively. Omar then
concluded a contract of mudarabah with Amran, using the capital provided
by Yusuf, and the profit ratio agreed between them is 70:30, to him and
Amran respectively.
Online Forum Discussion

Comment on the validity of these contracts according to various
schools of law. How will the distribution of the profit be made?

U n i t 5 | 68
REFERENCES
Abu Sattar Abu Ghuddah, al-Tanmiyyah bi al-Sanadat al-Mashru’ah li ithtithmar

mutawassait wa Tanwil al-Ajal (Sanadat al-Musharakah, wa al-Mudarabah, wa al-Ta’jir
wa al-Salam wa al-Istisna’, ‘Amal al-Nadwah al-Fiqhiyyah al-Khamisah, Bayt al-Tamwil
al-Kuwaiti, November 1998, pp. 173-206.
Sami Hasan Hamud, al-Tanmiyyah ‘An Tariq al-Adawat al-Tamwiliyyah al-Islamiyyah,

‘Amal al-Nadwah al-Fiqhiyyah al-Khamisah, Bayt al-Tamwil al-Kuwaiti, November 1998,
pp. 207-252.
______________, Tatwir al-‘Amal al-Masrafiyyah Bima Yattafiqu wa al-Shari’ah al-

Islamiyyah, Mtba’at al-Sharq, n.d.
Muhammad ‘Abd al-Ghaffar al-Sharif, al-Tanmiyyah fi al-Masarif al-Islamiyyah ‘an Tariq

al-Ithtithmarat al-Mutawassitah Wa al-Tamwil al-Ajal, ‘Amal al-Nadwah al-Fiqhiyyah al-
Khamisah, Bayt al-Tamwil al-Kuwaiti, November 1998, pp. 273-307.
Muhammad Tahir Mansuri & ‘Abd al-Hayy Ibru, al-Madkhal li al-Fiqh al-Masrafi,
Akademia al-Shariah, al-Jami’ah al-Islamiyyah al’Alamiyyah, Islamabad, 2002.
Abu Sattar Abu Ghuddah, Buhuth fi al-Mu’amalat wa al-Asalib al-Masrafiyah al-
Islamiyyah, Bayt al-Tamwil al-Kuwaiti, 1993.
Muhammad Baqir Sadr, al-Bank al-Laribawi fi al-Islam, Dar al-Ta’aruf li al-Matbu’at,

Beirut, n.d.
Muhammad al-‘Arabi, al-Mu’amalat al-Masrafiyyah al-Islamiyyah wa Ra’y al-Islam fihi,
Matba’at Mukhaimar, 1386AH-1967M.
Ali al-Khafif, al-Sharikat fi al-Fiqh al-Islami, Cairo, 1941.

al-Mawardi, al-Mudarabah Min Kitab al-Hawi al-Kabir, ‘Abd al-Wahhab Hawas, Dar al-
Wafa’ li al-Tiba’at wa al-Nasr, al-Mansurah, n.d.
al-Nawawi, Abu Zakariyya, Muhyiddin, Rawdat al-Tallibin wa ‘Umdast al-Muftin, al-
Maktab al-Islami, Beirut, 1405AH.
al-Kasani, Abu Bakar ibn al-Mas’ud, Bada’i al-Sana’i fi Tartib al-Shara’i, Dar al-Kutub al-
‘Ilmiyyah, Beirut, al-Tab’at al-Thaniyah, 1406AH.
al-Baji, Abu al-Walid Sulaiman ibn Khalaf, al-Muntaqa Sharh al-Muwatta’, Dar al-Kitab
al-‘Arabi, Beirut. n.d.

U n i t 5 | 69
KEY TERMS
Mudarabah
Qirad
Profit Sharing
Mudarib
Mudarabah
Muqayyadah
Musharakah
Muqaradah
Rab al-mal
Mudarabah
Mutlaqah

U n i t 5 | 70


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Unit 5 The Application of Mudarabah

and Issues in Islamic Deposits

SHARIAH RULES AND ISSUES

Dr. Ziyaad Mahomed

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 Describe the nature of mudarabah contracts according to different schools

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A profit-and-loss sharing contract employed by modern Islamic banks is the mudarabah

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“….others travelling through the land seeking of Allah’s bounty.”

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From among contemporary jurists, a renowned scholar, ‘Ali al-Khafif defines it as a

A contemporary jurist, Ali Khan Niyazi defines mudarabah as a form of partnership

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Although there is no explicit injunction from the text of al-Qur’an in permitting

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Relying on all such evidence and alike, Muslim

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Realising the peculiarity of mudarabah, Ibn Hazm remarks:

“All chapters of Islamic fiqh have a foundation in al-Qur’an or Sunnah,

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Mudarabah and Related Concepts

Mudarabah and Musharakah

In musharakah, the capital is provided by both

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Mudarabah and Loan

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In explaining this, Udovitch writes:

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“It is permissible on case of mudarabah to agree to determine the share of the

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Basis of the Ruling

According to the general method of investment in Islam, distribution of profit between

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The mudarabah contract may be restricted or unrestricted. Unrestricted mudarabah

The Majallah (Art. 1406) defines it as:

“where there is no limitation as to time or place or any particular type of

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On the other hand, the mudarabah contract is considered to be restricted (mudarabah

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Rights and Responsibilities of the Mudarib

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9/1 If a mudarabah contract is concluded on an unrestricted basis, the mudarib is

9/1/4 Safeguarding the mudarabah funds or depositing them in the custody of a

9/1/5 Selling and buying on a deferred payment basis.

a. The mudarib may, at any time, combine a mudarabah contract and a

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Generally, mudarabah contract is a non-binding contract (‘aqd ghayr lazim). As such, it

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