TOPIC 6. APPLICATION MUDARABAHA FINANCING.pptx

None

1. Chapter 6 APPLICATION OF MUDARABAH FINANCING (capital venture financing) Lecturer by: Khalid Abdi Nur

2. Introduction Mudarabah is a kind of partnership between the two parties:- where one partner contributes capital and the other one contributes efforts as manager or entrepreneur. The profit of the venture is share at an agreed ratio while the losses are borne by the capital provider. The investment comes from “Rabb-ul-Maal ” (Investor) while the management and work is an exclusive responsibility of the working partner, who is called Mudarib . 2

3. Principles of Mudharabah Financing There are three fundamentals for mudharabah financing, namely: The two contracting parties, i.e. rab al-mal (capital provider) and mudharib (entrepreneur) The subject matter of the mudharabah , i.e. capital, labour and profit; and The offer and acceptance. 3

4. Continued………….. the two contracting parties, i.e. rabul -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 rabul -mal to the mudharib is considered to be a form of agency , whereby, the rabul -mal is the principal and the mudharib is the agent. 4

5. MODE OF MUDARABAH FINANCING

6. Financing Model of Mudaraba Profit sharing between rabul -mal and mudharib will depend on the forms of mudharaba transactions. At least there are three forms of mudharabah financing: i. Two-sided Mudharabah (Simple Mudharabah ): One party of capital provider and another party of entrepreneur. ii. Many-sided Mudharabah : Several parties of capital provider and one party of entrepreneur. iii. Re- Mudharabah (Two Tier Mudharabah ): Three parties that includes capital provider, intermediate mudharib (entrepreneur) and final mudharib (entrepreneur) 6

7. Two-sided Mudaraba Two-sided Mudaraba , where there is one capital provider and one entrepreneur (can be an organization such as an Islamic bank. The distinguishing feature of any Mudaraba is that; the profit sharing ratio between the rabul mal and the mudarib (Islamic bank) is agreed beforehand. Any losses, other than those incurred due to negligence or mismanagement of the mudarib is borne by the rabul mal, the mudarib looses his labour as he is not paid any salaries or fee. 7

8. Example 1: If, as in the above diagram, Rabbul Maal invested $200, 000 with Mudarib (the Islamic Bank) in the profit sharing ratio of 70:30 (70% to Rabbul Maal and 30% to the bank). Find the profit distributable among the rabbul - maal and mudarib according to profit sharing ratio? 8

9. Solution 1:- if the investment results in a profit of $80,000, then the bank will get 30% i.e. $24,000 (30%x $80,000) and the Rab al Mal will get $56,000 (70% x $80,000). However, if the investment resulted in a loss of $80,000 instead, then all this loss of $80,000 will be borne by the rab al mal, unless the mudarib was negligent.

10. Two-sided Mudaraba 10

11. Many-sided Mudarabaha Many-sided mudarabaha , where there are at least two capital providers and one entrepreneur. In this case, where there are profits, after the bank gets its share, the depositors are allocated the profits in according to their capital. In the case of Islamic banks, there are many investment account holders and profit allocation can become complex especially when the depositors do not have co-terminus contracts with the bank i.e they invest for different periods of time. 11

12. Example 2: In the chart below, two depositors (RM1 and RM2) invest $100,000 with (Islamic Bank) who invests it, under a mudaraba contract. Let the profit-sharing ratio between the depositors and the mudarib being 70:30 respectively. If the ventures returns a profit of $80,000, then the mudarib (Islamic Bank) gets (30%x$80,000), $24,000 and the rabs al mal share $56,000. This amount is agreed between RM1 and RM2 in proportion to their capital investment i.e 1:1 in this case, therefore they each get $28,000. If the loss is $40,000, then RM1 bears $20,000 and RM2 bears $20,000, since they contributed equal amounts of capital. The Islamic Bank loses its labour (efforts) but does not bear any losses, if it has NOT been negligent. 12

13. Many-sided Mudaraba 13

14. Re- Mudaraba 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). Re mudaraba where, the entrepreneur sources and hires another mudarib under another mudaraba contract 14

15. Example: This is the Rabbul Mal (RM) provides $100,000 capital to Mudarib (MU1) with PSR 70:30. This is in turn handed over to Mudarib 2 (MU2) with profit sharing ratio 60:40. If the venture earns a profit of $50,000, then MU2 gets 40% of $50,000= $20,000, M1 gets 30%x60%x$50,000=$9,000 and the rab al mal gets 70%x60%x$50,000=$21,000. However, if the investment results in a loss of $30,000, this loss is borne by the rab al mal, MU2 and MU1 just passes on their loss to rabbul maal (RM). 15

16. Re- Mudaraba 16

17. Legal documentation Mudarabah agreement Undertaking to responsibility fund manager ( mudarib ). Undertaking to responsibility capital provider ( rabbu-maal ).

18. END