English
Mudarabah contracts have been gaining in popularity and It is easy to see why when looking at the details. Because while mudarabah does offer advantages and disadvantages to all parties involved,
it is one of the contracts that seems to favor the recipient of financing (Mudreb) more than the financier (Ras Al Mal), with the latter assuming the majority of the risk.
Today, we analyze the advantages and disadvantages to both the recipient and the financier and see who is the real winner in mudarabah contracts.
The caveat: Mudarabah contracts can be structured in a variety of ways to mitigate risk for the parties involved. Our analysis will look at them from a more general perspective.
Read more about: The basic guide to mudarabah
The primary advantage to the Mudreb is that they bear no financial responsibility for the failure of the project, barring any misconduct or negligence. A Mudreb isn’t obligated to provide any funding to the business or project, thus, the entire financial risk of the project falls on the Ras Al Mal.
The Mudreb stands to gain a share of the profit from the success of the project or business, while risking none of their own capital.
Mudarabah allows the mudreb to gain access to capital to start or grow a business, without giving up any collateral, or bearing interest. These make mudarabah contracts an attractive proposition for budding entrepreneurs and startup founders.
The Mudreb’s role in a mudarabah is to manage the business. This gives them relative autonomy and control. This can be limited by a restricted mudarabah (or Mudarabah Muqayadah) but even then, they have some form of autonomy in the day-to-day running of the business.
In an unrestricted Mudarabah (Mudarabah Mutlaqah), the Rab Al Mal gives no restrictions (beyond the investment being Shariah-compliant) to the Mudareb, giving the latter the freedom to invest the funds as they see fit.
while the Mudreb does not bear any risk of financial loss, they must expend time and effort in managing the business, which would all go unrewarded if the business does not generate a profit.
While the Mudreb does most of the work, in most cases the Ras Al Mal receives the majority of the financial rewards.
The Mudreb only gets paid based on the profits generated by the business and does not receive a salary. This means all financial rewards must wait until the business starts generating a profit.
Read more: Strategies for financiers to mitigate the disadvantages of a Mudarabah
One of the main advantages of a mudabarah contract for a financier is that it ensures the investment will go towards ethical and shariah-compliant businesses.
The investor in a mudarabah contract reaps the majority of the financial rewards in a successful business as compensation for bearing the entirety of the financial risk.
The Ras Al Mal’s role is simply to provide the investment and leave the managing of the project to the Mudreb. This offers an investor the ability to generate a profit with very little effort.
As a passive investor, the investor can afford to allocate their investment in a variety of different businesses, helping to minimize the risk of financial losses and increasing the chances of landing on a successful business.
Read more about: How can investors benfit from diversification?
Barring any misconduct or negligence by the Mudreb, the financier bears the entire financial risk of the business or project failing. Depending on the project or business, these losses can be massive.
No fixed returns
The Ras Al Mal does not receive any fixed returns, and can only recoup their investment only when the business generates a profit. This usually takes a long time if it occurs at all.
This is the primary disadvantage mudarbah has when compared to non-Islamic financing such as interest-bearing loans.
Lack of control
The Ras Al Mal has to rely entirely on the Mudreb in the day-to-day management of the business, with limited (if any) ability to exert control.
While they can exert some influence in the case of Mudarabah Muqayadah, management decisions must be taken by the Mudreb.
Moral hazard
As they bear no financial responsibility in the event of the business failing, the Mudreb may be incentivized to not work as hard to achieve success.
A lack of transparency
One of the most common complaints in mudarabah contracts is a lack of transparency between the Ras Al Mal and the Mudreb. A potential lack of transparency and accountability by the Mudreb may lead to disagreements and legal disputes, if not the failure of the entire business.
Conclusion
As we can see, the disadvantages are skewed more towards the Ras Al Mal than the Mudreb.
While both stand to gain from a successful business – with Ras Al Mal standing to gain more – they also have the most to lose in this equation.
And with minimal management control, they have very little recourse to steer the ship in a proper direction if the business is failing.
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
