A Mudarabah contract is a profit sharing contract. Under a Mudarabah
contract, the capital provider agrees to share the profits between
themselves and the entrepreneur at an agreed ratio or percentage. (1) As
a source of capital for a business venture, a businessman might consider
undertaking a commercial project financed by funds from a bank under a
Mudarabah contract. If agreeable, the bank supplies the finance to
the businessman on the understanding that both parties will share the
profits of the venture. (2) As a deposit taking activity, money deposited
in a bank by an individual or institution under a Mudarabah contract
is treated as an investment in the bank by the individual or institution.
The bank will use this investment to help make profits from its trading
activities, i.e. financing of individuals and businessmen. Under
the Mudarabah contract, the bank will have agreed to give the depositor a
share of its profits in return for the investment, based on a pre-agreed
Investment financing through Mudarabah is a commitment to participate in
the risk associated with business ventures, with the aim of sharing the
profit generated from a given business venture. Parties to the Mudarabah
contract will only benefit if the venture is successful. Should the
project fail, the financier will lose his investment, whereas the
businessman will only lose the time and effort expended on the project.
In general, conditions imposed and agreed on by both parties limit the
mobilisation of the funds raise dunder a Mudarabah contract, such as
pooling with other funds, types of business venture or investment,as
well as profit and loss sharing among the funds. In the case of a
savings account, a Mudarabah contract without conditions and restrictions
is usually adopted, which is intended for public and retail investors.
Mudarabah, unlike Musharakah, does not entitle the capital provider to
an executive function in the management of the business venture.
Key principles of Mudarabah
- Profit sharing contract.
- Returns depend on a profit being earned.
- Conditions could apply to what the investment can be used for.
- Requires a commitment to participate in the risk associated with business venture.
- The businessman only loses the time and effort expended on the project, where the financier assumes the financial loss.
- Does not entitle the financier to any say in the running of the venture.