Islamic Finance: Investor and entrepreneur gain from Mudaraba venture

Continuing with our discussion on Mudaraba, let us try to understand how a Mudaraba joint venture can be beneficial to the capital owner (investor) and the Mudareb (entrepreneur).

Mudaraba ventures can be immensely beneficial to both parties for the following reasons:

• The owner of capital may not have the time or the expertise to efficiently utilise the capital and earn halal profits.

• The Mudareb may have the expertise and skills to earn halal profits but lacks the capital.

Credibility Factor

Last week we discussed the vital role of the credibility factor in conducting Mudaraba transactions during the old days in Meccah.

How is credibility determined in concluding a Mudaraba deal in the present day?

It is a pleasure to note that the Islamic banks have successfully filled the much needed credibility gap by assuming the dual role of Mudareb as well as investor.

How do they do that? On the one hand, as an intermediary, the Islamic banks are ideally positioned to build formid-able capital contributed by small, medium and large "investors" (i.e. depositors) and on the other, they are privy to lucrative investment opportunities where this capital can be profitability deployed.

An Islamic bank accepts the investment amounts (deposits) in the capacity of Mudareb whereas when it comes to deploying these funds, the Islamic bank switches its capacity from Mudareb to investor.

Concept Modification

The concept of Mudaraba has undergone some modifications for easy adoption by the Islamic banks.

This has been achieved with the help of extensive work undertaken by the Sharia scholars in order to suit the requirements of present day investors and entrepre-neurs. However, the following modifications are well within the Sharia parameters:

• There are many investors and scores of entrepreneurs.

• An Islamic financial institution acts as an intermediary, enjoying investors' confidence in receiving their funds.

• The intermediary finances the projects put forward by the entrepreneurs — rather than the investors — a change from the olden days.

• Investors (depositors) and the entrepreneurs (customers needing finance) do not have a direct relationship and have no responsibility or obligation towards each other.

• Whilst the ratio of profit sharing is pre-agreed between the intermediary and the entrepreneur, no such agreement takes place between the investor and intermediary.

Passive Investor

It is interesting to note that in this investor-intermediary-entrepreneur triangle, the investor continues to remain a passive partner, as was originally practised in Makkah.

He provides capital and then shares the profit or absorbs genuine losses. However, as described earlier, the investor will not be responsible for bearing the loss if caused by a Mudareb's negligence.

Responsibility of an Islamic bank

As the intermediary (an Islamic financial institution) plays the dual role of entrepreneur and investor, it becomes his primary responsibility to hire experienced staff for a thorough examination of the business propositions submitted by the entrepreneurs seeking funds and to invest the trusted funds in a judicious and prudent manner.

He is also responsible for maintaining proper books of accounts and conducting periodical audits in order to maintain high credibility.

This becomes all the more important since the investor does not know which project is being financed through his capital. Similarly, the entrepreneur does not know whose funds are being deployed for the development of his business.

When it comes to profit sharing, it is the net profit from all the avenues that is distributed by the intermediary to the investors after having netted out his operating expenses and retaining his share of profit.

However, it is important to note that the entrepreneurs share the profit generated by their business with the bank at an agreed ratio.

It is appropriate to clarify at this point that the investors (depositors) operate purely on the basis of mudaraba while the bank is free to structure any mode of financing such as murabaha, ijara, salam, istisna, etc., suitable for safe deployment of funds and also keeping in view clients' business needs.

The author is the vice-president for Sharia structuring, documentation and product development at Dubai Islamic Bank.