Definition of mudaraba
In Islamic finance, mudaraba is a trust financing contract.
Mudaraba may be conducted between investment account holders as fund providers and the Islamic bank as a mudarib. It may also be conducted between the Islamic bank, as fund provider, on behalf of itself or on behalf of investment account holders, and business owners and other craftsmen or traders etc.
Mudaraba is a partnership where capital is provided, in cash or assets (no debt is accepted) by one party - the fund provider - and labour is provided by the other party - mudarib.
Both parties can appoint agents on their behalf. A mudaraba contract could be terminated unilaterally except when a term has been agreed by both parties, in which case the mudaraba could only be prematurely terminated by mutual agreement. In addition, if the mudarib has already started the business, in the mudaraba contract, it becomes binding until actual or constructive liquidation.
As mudaraba is a trust-based contracts, the mudarib is not liable for losses except in case of breach of the requirements of trust or misconduct. Guarantees against negligence or misconduct could be taken from the mudarib as long as they are not excessively used by the capital provider. The contract should specify whether the mudaraba instrument is unrestricted or restricted (to specific location or type of investment as agreed between parties). It should also indicate the distribution ratio of profit between both parties (which cannot be a lump sum or a percentage of capital). The distribution ratio could be revised at future dates by agreement of both parties.