Mudaraba is a contract between an investor and a bank. The investor provides capital in cash or assets and the bank invest the funds and manages its operations. The profit is distributed between the investor and the bank at a pre agreed ratio. The loss is absorbed by the asset so the value of the deposit decreases.
The loss is defined by Sharia to be only on the asset, not on the investor. This is due to what Abdurrazaq narrated in Al-Jam’I from ‘Ali (ra):
“The loss is on the property and the profit is according to what they stipulated”.
Here the example in the Mudaraba is property as the asset but the same principle applies to capital assets.
The mudaraba can either be restricted where the investor specifies a particular business or industry or unrestricted where it is left up to the bank (mudarib). The mudarib cannot claim a fee for the work done rather it is the pre agreed proportion of profits that are for the bank.
The contract can be terminated at any time by either party on the condition that notice is given. If not all assets at the time of termination are in cash form, the mudarib must liquidate them so that profit can be determined and distributed as pre agreed. There is a difference of opinion about whether the contract can be for a specific period after which is terminates automatically. The Hanafi and Hanbali schools of thought are of the view that they can be restricted whereas the Shafi and Maliki schools say the mudaraba cannot be restricted.
Guaranteed Return in Mudaraba:
The investor is exposed to both profit and loss and the possibility of guaranteeing a minimum rate of return does not exist because in a conventional system this is based on interest and inflation return values. However local law may mandate a guarantee. There have been many views on the issue of guaranteed return. One view asserts that a guarantee could be provided by the state as a third party. Another view calls for a special “parental” treatment of “small depositors”. There is yet to be a consensus on such concessions for a deposit modelled after mudaraba. A general guarantee on all investment deposits seems too susceptible to interest (riba) to gain acceptance.