Ministry of Rural Rehabilitation and Development Afghanistan Rural Enterprise Development Program Islamic Finance Product Development The Mudhārabah contract prepared by Alberto G Brugnoni – ASSAIF June 2013 ISLAMIC REPUBLIC OF AFGHANISTAN

CONTENTS  DEFINITION  QUR’ANIC EVIDENCE  FEATURES  MUDHĀRABAH MUTLAQAH  MUDHĀRABAH MUQAYYADAH  MUDHĀRABAH V MUSHĀRAKAH  CURRENT APPLICATIONS

DEFINITION  Derived from the expression “dharaba fi ‘l-ard” meaning to make a journey: →it is so called because the agent (entrepreneur) gets profit by virtue of his hard work and efforts in performing long journeys  The transaction of mudhārabah is known in the classical literature as qiradh or muqāradhah. Both terms derived from the word qaradha which means to cut off (al-qat’): →this is simply because the capital provider (rabb al-mal) need to cuts off some of his money to be utilized by the mudhārib in business activities

QUR’ANIC EVIDENCE عَلِمَ أَن سَيَكُونُ مِنكُم مَّرۡضَىٰ‌ۙ وَءَاخَرُونَ يَضۡرِبُونَ فِى ٱلۡأَرۡضِ يَبۡتَغُونَ مِن فَضۡلِ ٱللَّه ِ‌ۙ He knoweth that there are sick folk among you, while others travel in the land in search of Allah's bounty (73:20) فَإِذَا قُضِيَتِ ٱلصَّلَوٰةُ فَٱنتَشِرُواْ فِى ٱلۡأَرۡضِ وَٱبۡتَغُواْ مِن فَضۡلِ ٱللَّهِ وَٱذۡكُرُواْ ٱللَّهَ كَثِيرً۬ا لَّعَلَّكُمۡ تُفۡلِحُونَ And when the prayer is ended, then disperse in the land and seek of Allah's bounty, and remember Allah much, that ye may be successful (62:10).

FEATURES  It is a contract or a partnership where one party (rabb al-mal) provides the capital and the other party (mudhārib) the entrepreneurship/labor: →the profit is shared between the two parties according to the terms of their predetermined conditions →the losses will be borne by the capital provider alone who is the financier →the entrepreneur suffers the frustration of a fruitless effort  Roles of the entrepreneur (mudhārib): → ameen (trustee): the money given by the rabb al-mal and the assets required therewith are held by him/her as a trust → wakeel (agent): in purchasing goods for trade, he is an agent of rabb al-mal → sharik (partner): in case the enterprise earns a profit, he/she is a partner of rabb al- mal who shares the profit in agreed ratio → dhamin (liable): if the enterprise suffers a loss due to his/her negligence or misconduct, he/she is liable to compensate the loss → ajeer (employee): if the mudharabah becomes void due to any reason, the mudhārib is entitled to get a fee for his services

FEATURES SUBJECT MATTER  The work or business venture under the mudhārabah must be conducted solely by the entrepreneur (mudhārib). It is not legal if the capital provider (rabb al-mal) it is also required to conduct the daily operations  The project must be legal and permissible (halal) CAPITAL  Must be in the form of money and not commodities, since commodities fluctuate in price and cause uncertainty and ignorance  The capital must be clearly specified, determined and known at the time of the contract  Must be available cash - present at the conclusion of the contract  Must be delivered to the possession of the mudhārib entirely TERMINATION  Unilateral termination  On the date of maturity, if the two parties had earlier agreed to set the time limit  When the fund of mudhārabah has been exhausted or have suffered losses  The death of the mudhārib or liquidation of institution that acts as mudhārib  Insanity of any parties to the mudhārabah contract

FEATURES PROFITS  The distribution of profit must be determined proportionally between the capital provider and the entrepreneur  The pre-determined profit must be in ratio form or percentage and not in fixed amount  Allowed to be different ratios at different situations  There cannot be a distribution of profits until the losses have been written off and the equity of rabb al-mal has been fully restored  Any distribution of profits before the conclusion of the contract will be considered as an advance  All losses incurred in the ordinary course of business must be charged against profits before they can be charged against the equity of rabb al-mal  If it has been agreed that the entire profit will be taken by the rabb al-mal – the mudhārib will be entitled to the customary remuneration (‘ujr al-mithly)  If it has been agreed that the entire profit will be taken by the mudhārib – the rabb al-mal is a creditor and mudhārib is a debtor  The mudhārib cannot claim any periodical salary /fee or remuneration for the work done by him/her for the mudhārabah

MUDHĀRABAH MUTLAQAH  The entrepreneur (mudhārib) may buy and/or sell all types of merchandise as he sees fit, hire helpers as needed, rent equipment and travel with the equipment etc.  The business is run according to the entrepreneur (mudhārib) expertise and experience based on his/her discretion  The capital provider (rabb al-mal) authorizes the entrepreneur (mudhārib) to act completely at the latter’s discretion in all business matter  The mudhārib’s liberty to transact the capital: →all matters which are commonly practiced in business - the authorization to transact with the capital is unlimited →all matters which are not commonly practiced in business - free to transact with the capital provided with permission from rabb al-mal. Eg: giving the capital as donations or loans

MUDHĀRABAH MUQAYYADAH  The capital provider (rabb al-mal) makes certain limitations to the activities to be conducted by the entrepreneur (mudhārib) with regards to the capital given  The business is subject to capital provider’s (rabb al-mal) instruction in term of type, location, time etc.  The mudhārib’s liberty to transact the capital: →the mudhārib is subjected to certain limitations in the form of territorial limits, or time limitation and limitation in terms of kind of goods or person with whom trade may be conducted

MUDHĀRABAH V MUSHĀRAKAH MUDHĀRABAHMUSHĀRAKAH The capital is financed by one party, which is the capital provider or the owner of the business The capital is financed by all the shareholders according to the proportion agreed upon by all parties The capital must be in the form of cash money Any type of property that could normally be assessed and have certain commercial value could be considered as an acceptable source of capital. Example: intellectual capital The entrepreneur will be the only one that will conduct the actual business. The capital provider is not allowed to jointly work with the entrepreneur All the shareholders have the right to work and contribute their skills, knowledge, experience and expertise in the company The monetary loss will be solely borne by the capital provider while the entrepreneur will only suffer from a fruitless effort without having to bear all the capital losses The monetary loss will be jointly borne by all the shareholders according to the ratio and proportion of their respective share in the partnership

CURRENT APPLICATIONS  Project financing  Import/export financing  Working capital financing  Saving/Current/Investment account  Interbank lending/borrowing  Sukuk