a) General Mudharabah (Mudharabah Mutlaqah): is a Mudharabah agreement between the Bank and the customer for a business cooperation which is very broad that is not limited by the specifications of the type of business, time, and area of businesses.
b) Restricted Mudharabah (Mudharabah Muqayyadah): is a Mudharabah agreement between the Bank and the customer for specified type of business, time, or place of business.
Mudharabah Financing
Mudharabah financing is a kind of partnership wherein the bank (Rabbul Mal) extends money to a customer (Mudharib) investing in a business project while utilizing his business skills. The bank provides the capital, and the customer uses and manages the fund in the project until completed.
The aim is to provide or to enhance capital of the customer either in the short term (Working Capital) or in the long term.
The revenue will be collected and returned to the bank while the profit generated will be shared between the bank and the customer at an agreed profit (normally not less than 70:30 for the bank and the customer respectively). The loss, if any, is borne only by the bank, in which case the customer gets nothing for his labour.
For this reason, Mudharabah is considered a very high risk mode of financing hence it is mostly extended to government projects which have assurance of returns or to good analysed private projects which are well secured and undertaken by reputable creditworthy customers.
Mudharabah contracts are limited by a specific time period and once they mature they are closed.
The bank undertakes all necessary credit analysis of the customer including his existing businesses, creditworthiness, repayment history (if any), and security though the security cannot be used unless there is a default caused by the customers negligence or bad intention.
Types of Mudharabah
Types of Mudharabah:
Risk associated with Mudharabah Financing
As earlier mentioned, Mudharabah is a high risk mode of financing. Additional risks associated with this product, apart from other financing risks are:
i) Asymmetric Information
This occurs as the customer may possess greater or better material knowledge about the undertaken business than the bank. This asymmetry creates an imbalance of power and control in the business, which may cause the business to go awry, hence benefit the client at the expense of the bank.
ii) Moral Hazard
This is the risk that a customer has not entered into the contract in good faith, has provided misleading information about his assets, liabilities or credit capacity. Moral hazard may also lead a customer to have an incentive to take unusual risks in a desperate attempt to earn more profits from the contract as the capital is not originating from him.
iii) Fiduciary Risk
This is a risk which is directly related to the nature of the Mudharabah contract and it can be described as objective possibility for losses on the Mudharib (agent) in the case of negligence, malfeasance or breach of contract on the part of management of Mudharabah.
iv) Displaced Commercial Risk
It is a risk related to “smoothing” the financial returns to investment account holders by varying the percentage of profit taken as the Mudharib share, which can be compared to an arrangement or agency fee.
Risk Management in Mudharabah Financing
TRisk Management in Mudharabah Financing:
In a Mudharabah contract, effective risk management is pivotal in reducing all controllable risks to ensure the success of the venture and to protect investors. In order to manage those risks, the bank among other shall engage in four (4) vital processes:
1. Performing intensive vetting on the viability of individual and the projects through our internal project screening mechanism.
2. Partnering with credible project developers that possess a near-perfect track record (that’s why government projects are recommended).
3. Holding collateral on landed property for every project as protection in the event of default by the customer.
Termination of Mudharabah Financing
Under the following terms Mudharabah financing can be terminated:
1) Mudharabah is terminated when it is cancelled or when a Mudharib is prevented from using the fund or when he is dismissed. In this case, the Mudharib is entitled to his claim in the profit. If capital is in the form of goods cancellation of Mudharabah, prevention of Mudharib, or his dismissal can only take place after the goods are sold.
2) When Mudharabah which is for the fixed period of time expires.
3) If either party loses its legal capacity.
4) If one of the conditions in restricted Mudharabah is violated.
5) If Mudharib fails in his duties due to his negligence or deliberate loss.
6) If the capital is destroyed in the hands of Mudharib.
7) If either party dies and if the investor dies the Mudharib has no right to continue Mudharabah.
Required documents for Mudharabah
The following are the documents integral to Mudharabah contract:
• All KYC documents as per the bank’s Operations Manual and the bank’s Lending Policy
• Business plan of the project,
• Building Permit or any other document equivalent to Building Permit (if the project involves construction/production),
• Bill of Quantity or any document equivalent to Bill of Quantity (if the project involves construction/production),
• Mudharabah agreement between the bank and the client
• Security documents as listed in the Bank’s Lending Policy for commercial financing or employer’s guarantee for salaried financing.
