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Principles of Islamic Finance

Mudarabah: the most popular contract used by Arab banks to finance companies

Principles of Islamic Finance

 

 

 

 

 

 

 

 

The Mudarabah is an Islamic Law contract whereby two parties create a partnership where one of them, called rabb-ul-mal, provides for the entire capital investment, while the other one, called the mudarib , provides for labor and necessary tools and technical knowledges. The profits generated will be divided between the parties as stipulated in the contract, while the losses will be paid only by the rabb-ul-mal.

The Mudarabah differs from Musharakah for the following reasons:

- the capital is supplied only by the rabb-ul-mal, while in the Musharakah by all members.

- in the Musharakah, all parties may participate in the management of the investment, while in the Mudarabah only the mudarib manages it.

- in the Musharakah all parties partecipate to the losses in proportion to the invested capital, while in the Mudarabah, due to the absence of monetary investment by the mudarib, he will not suffer any loss (except the work done).

We can distinguish two kinds of Mudarabah: restricted or unrestricted. The Mudarabah is restricted when the rabb-ul-mal binds the capital to a specific business, while it is unrestricted when the mudarib is free about the managment of the investment.

More than two parts can form a Mudarabah, so the rabb-ul-mal may provide capital to two different mudarib for the same project.

Mr. Luca Santaniello
Lawyer at Santaniello & Partners

Note: see also Islamic Finance and Musharakah 

Published on 25 July 2012

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