MUDHARABAH FINANCING

1. Definition of Mudharabah Financing

- Mudharabah is a concept where the capital provider or the Islamic Bank (Rab al-
mal) and the small entrepreneur (mudharib) become a partner.
- Mudaraba is a partnership in profit whereby one party provides capital and the
other party provides skill and labour.
- Then the profit from the business or the project are shared between them as per
agreed upon ratio.
- For the financial loss will be borne entirely by the capital provider (Islamic Bank).
- This is because the premise that a mudharib invests the mudharabah capital on a
trust basis. So it is not liable for losses except in cases of misconduct.
- If the mudharib breach the contract or terms of mudharabah contract, the
mudharib becomes liable for the amount of capital.
2. Overall

- We want to take a look at the basic principles of Mudharabah financing and also
the accounting implications.
- For the principle of Mudharabah got the unique relationship between capital
provider and the entrepreneur highlighted.
- We will present about the needs for proper distribution profit according the
contractual rights of the capital provider and the entrepreneur.
- We also present and analyst the distribution mechanisms for different types of
mudharabah.
- Last one we will take a look at the accounting issue that arise for the income
recognition for multi period for this Mudharabah Financing.

3. Principles of Mudharabah Financing

- There are three fundamentals for mudharabah financing which is :

- 1) The two contracting parties, i.e. Capital Provider (Rab al Mal) and mudharib
(entrepreneur).
- 2) The subject matter of the mudharabah, i.e. capital, labor and profit.
- 3) The offer and acceptance

- With regards to the conditions for the two contracting parties, i.e. rab al-mal and
mudharib, both of them must have the capacity to enter into a contract of agency
(wakalah). This is because, the authorization by the rab al-mal to the mudharib is
considered to be a form of agency, whereby, the rab al-mal is the principal and the
mudharib is the agent.
- Islam is not a condition
 4.0 The condition of capital

- The capital must be in the form of money and not commodities

- The capital must be specified, determined and known at the time of the contract.
- The capital must be in the form of available cash. Thus, it cannot be in the form of
a pending debt or absent cash. The availability of the capital is relevant at the time
of actual starting of the business, not at the time of the contract
- The Capital must be delivered to the possession of the mudharib entirely. Any
condition made by the rab al- mal as to how the capital is to be managed would
invalidate the contract for should such condition exist the capital could never be
possessed solely by the mudharib, and he would be incapable of managing it; and
this in turn would defeat the object of the mudharabah contract.

Mudharabah Structure

- Could be based on a simple or bilateral arrangement where Islamic bank provides

capital and the entrepreneur uses the capital for approved business venture

ISLAMIC BANK ENTREPRENEURS

- Mudharabah structure may also be based on two-tier structure or (re-mudharabah)

where 3 parties i.e. capital provider (depositors/investors), intermediate mudharib
(Islamic bank) and final mudharib (entrepreneurs)
ISLAMIC BANK Capital Providers

ENTREPRENEURS

- The profit-sharing ratio on mudharahah is pre-determined only as a percentage of

the business profit and not a lump sump payment. The profit allocation ratio must
be clearly stated and must be on the basis of an agreed percentage.
- Profit can only be claimed when the mudharabah operations make a profit. Any
losses must be compensated by profits of future operations. After full settlement
has been made, the business entity will be owned by the entrepreneur. The
entrepreneur will exercise full control over the business without intelligence from
the Islamic bank but of course with monitoring.