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Muḍārabah
Muḍārabah is a form of profit– loss-sharing joint-venture between two parties, one being the financial-capital provider (ṣāḥib al-māl or rabb al-māl) and the other, the entrepreneur or the investment manager (muḍārib). In this sense, it is a specific form of partnership (shirkah or mushārakah) that allows those who have financial capital but are unable to involve themselves directly in trading or business activity to receive a share of the profit from the activities of entrepreneurs who have the skills but may ynot have the financial capital. (The muḍārabah is sometimes called muqaraḍah [loan].)
In short, Islamic banks allow depositors to provide capital for borrowers to invest. Depositors may earn a share of either the bank’s profit or the profit of a specified investment. If the investment or bank incurs a loss, no profit is paid to the depositors.
Historically, muḍārabah was practiced by the Arabs as a form of trading venture, and even the Prophet Muḥammad, before assuming the role of Prophet, traded as a muḍārib with others’ merchandise on the basis of muḍārabah. In early Muslim society, the practice of muzāraʿah (sharecropping) was based on the principle of joint venture between the landowner and the worker of the land, although there may not have been industrial applications. Both Jewish and Byzantine traditions had equivalent forms of muḍārabah and contributed to the evolution of the commenda of the West, especially as employed by medieval Venetian traders. The muḍārabah was adapted to the requirements of the changing environment and the evolving needs of society while remaining subject to the requirements and guidelines of the sharīʿah. In addition, muḍārabah business ventures have evolved to include joint ventures involving multiple investors and entrepreneurs, the modern-day joint stock company being seen as a modified form of muḍārabah involving shareholders (financial providers) and the company (investment manager).
In today’s finance-dominated economics, muḍārabah (together with mushārakah) has also been presented as an alternative to riban-based finance that charges fixed interest on loans and other transactions. Due to their potential involvement in equity transactions, Islamic banks are said to be closer to universal banking than to commercial banking because the former can use both equity and debt-financing instruments more readily than the latter. Through the practice of two-tier muḍārabah, in which the financial institution plays a dual role as the investment-manager on the liabilities side (with depositors who are the financial-capital providers), and financial-capital provider on the assets side (to entrepreneurs who use the financing for their business activities), Islamic economists since the 1960s have put forward muḍārabah as the preferred alternative to interest-based finance. Central to this practice is the principle in muḍārabah that financial-capital providers are entitled to a share of the profits only if they share in the risks of doing business. Only profit-sharing ratios are determined between the parties, and should the entrepreneurs suffer losses, the financial burden is borne by the bank. While prudent management and the diversification of investments limit the possibility of losses, some form of deposit insurance is also proposed to protect depositors. Despite the theoretical work and some empirical evidence that has shown the viability of muḍārabah-based practices, practitioners have not followed this prescription, choosing instead the “safer” and ostensibly more familiar debt-based instruments such as markup sales (murābaḥah) and other fee-earning services, citing many reasons including the potential agency problems in muḍārabah.
Muḍārabah
410 – 004
https://discerning-Islam.org
Last Update: 02/2021
