What is MODARABA in Islamic banking ?
“Modaraba” is a kind of partnership where one partner gives money to another for investing in profitable avenues.
The investor (fund supplier / capital provider) is called “Rabb-ul-Mal”. The person who utilizes the fund (the fund manager) is called “Modarib” who is exclusively responsible for management of the business.
Type of Modaraba in Islamic Banking
What is RESTRICTED MODARABA ?
Restricted Modaraba contract is a kind of Modaraba in which the capital provider restricts the Modarib to perform business as per limitation imposed by him.
These restrictions may be for place (geographical restriction), particular type of investment (sector wise restriction) or any other restriction.
WHAT IS UNRESTRICTED MODARABA ?
- Unrestricted Modaraba contract is a kind of Modaraba in which the capital provider (Rab-ul-Mal) does not restrict the Modarib;
- In this type of Modaraba, Modarib has more freedom in doing business in different sectors.
- and General Modaraba and Investment Modaraba are examples of this type.
USE OF MODARABA FOR OBTAINING DEPOSITS
Islamic banks generally use Modaraba based products for obtaining deposits.
These deposits are based on the Shariah principles of profit and loss sharing, and the Bank uses them in avenues which are compliant with the Shariah requirements.
At times, Bank commingles its own funds with Modaraba funds.
What is Authority of Rab-Ul-Maal ?
Rab-ul-Maal has authority to:
a) Oversee the Mudarib’s activities and
b) Work with Mudarib with the Mudarib consent
Capacities of Modarib
- Ameen(Trustee): The money given by Rab-ul-Maal (investor) and the assets required therewith are held by him as a trust.
2. Wakeel(Agent): In purchasing goods for trade, he is an agent of Rab-ul-Maal.
3. Shareek(Partner): In case the enterprise earns a profit, he is a partner of Rab-ul-Maal who shares the profit in agreed ratio.
4. Zamin (Liable): If the enterprise suffers a loss due to his negligence or misconduct, he is liable to compensate the loss.
5. Ajeer (Employee): If the Mudarabah becomes void due to any reason, the Mudarib is entitled to get a fee for his services.
Whats is Distribution of Profit & Loss ?
In MODARABA in Islamic banking – It is necessary for the validity of Mudarabah that the parties agree, right at the beginning, on a definite proportion of the actual profit to which each one of them is entitled.
They can share the profit at any ratio they agree upon.
However in case the parties have entered into Mudarabah without mentioning the exact proportions of the profit, it will be presumed that they will share the profit as per customs, if there is no custom Mudarabah will be void.
Some incentives my be given to the Mudarib.
Apart from the agreed proportion of the profit, the Mudarib cannot claim any periodical salary or a fee or remuneration for the work done by him for the Mudarabah.
The Mudarib & Rab-ul-Maal cannot allocate a lump sum amount of profit for any party nor can they determine the share of any party at a specific rate tied up with the capital.
EXAMPLE OF Distribution of Profit & Loss
If the capital is Rs.100,000/-, they cannot agree on a condition that Rs.10,000 out of the profit shall be the share of the Mudarib nor can they say that 20% of the capital shall be given to Rab-ul-Maal. However they can agree that 40% of the actual profit shall go to the Mudarib and 60% to the Rab-ul-Maal or vice versa. (MODARABA in Islamic banking)
If the business has incurred loss in some transactions and has gained profit in some others, the profit shall be used to offset the loss at the first instance, then the remainder, if any, shall be distributed between the parties according to the agreed ratio.
Concept of General Pool
General Pool is a virtual enterprise having its own assets, liabilities, expenses and income.
All the deposits from customers of Savings account, Al-Irtifa, Al-Mukhtar, Al-Samarat etc. are tagged to the general pool except for those depositors who were assigned special weightages or higher rates.
Most of the deposits in any Islamic Bank belongs o their general modaraba pool.
Why Islamic Banks do not distribute losses?
This is due to the fact that all the deposits are accumulated and combined in a single pool just like a mutual fund and this huge money is then used for financing of SME, Corporate, Commercial and Consumer sectors.
If, there is some defaults / losses from few customers then still a large number of financing customers pay on time therefore the depositor’s principal stays secure while their profit varies from month to month.
Concept of Special Pool Under MODARABA in Islamic banking
The average return of general pool is usually low since it has a huge number of financings which yield higher as well as lower returns.
While high net worth customers expect to have a higher return, therefore, high yield assets / financings are carved out from general pool to satisfy expectations of special customers.
But, one thing should be remembered that the risk is much higher in special pools due to limited number of depositors and limited number of assets tagged. If one customer defaults, the depositors may loose their principal.
Concept of Profit Sharing Ratio
A Profit Sharing Ratio (PRS) is announced monthly with the weightages to inform depositors regarding distribution ratio for the next month.
PSR is actually a distribution ratio between Bank and depositors.
Example: PSR and weightages for the month of February will be announced at least 3 days before the start of February i.e. on 28th January at maximum due to regulatory requirement.
Concept of Weight-ages Under MODARABA in Islamic banking
Weight ages is a profit distribution mechanism among depositors / rab-ul-maal.
Weight-ages are not for Bank/ Mudarib its only for depositors
Weight-ages shows the rupee value of investment at the time of distribution of profit
Weight-ages are different from Profit rates.
Different weight-ages are assigned to different types of depositors, the two main factors for deciding weight-ages are;
1. Investment Amount
Weight-ages are not applicable in case of loss
Difference between Islamic & Conventional Profit Rate Sheets
The Profit rate sheet announced by Global Operations for conventional banking shows the rate of profit to be given to the depositors in future i.e. guaranteed profit.
On the other hand the Profit rate sheet announced by Global Operations for Islamic Banking only shows the history of performance i.e. the profit rate earned by the depositors in previous months only to facilitate decision making.
Islamic concept of Early Termination in TDRs Under MODARABA in Islamic banking
Unlike the conventional TDRs, Islamic TDRs do not have penalties while early termination. It seems as if the same treatment is followed while there is a huge difference among them.
In Islamic TDR’s the depositor is a partner and if one partner wishes to terminate modaraba and sell off its share then Bank has to purchase it. Since, bank has not forced the depositor to leave in between therefore, the price of partnership share paid to the depositor is usually lower then its principal.
Termination of Mudarabah in Islamic Banking
- Each partner can terminate Mudarabah at any time.
2. If a time period is fixed in Mudarabah, then, all partners will be responsible for the completion of this period.
3. Physical liquidation is not necessary. Constructive liquidation can also be conducted
4. Mudarib will bear all those expenses, which are normally considered the responsibility of Mudarib (in direct expenses . Although, the expenses, which are not considered the responsibility of Mudarib (direct expenses) will be deducted from the total capital.
SAVINGS / FIXED DEPOSIT ACCOUNTS IN CONVENTIONAL BANKING
Conventional saving & fixed deposit accounts offer following benefits to the customer:
Repayment of principal is guaranteed;
Return on principal is also guaranteed; and
Regular interest payments are made or these are compounded.
SAVINGS / FIXED DEPOSIT ACCOUNTS IN ISLAMIC BANKING
In Islamic Banks, these accounts are based on profit and loss sharing mechanism based on Musharaka, Modaraba or a combination of Musharaka and Modaraba
In such accounts: ¨Repayment of principal can not be guaranteed by the Bank; ¨Actual profit enters on the investment shared between Bank and deposit holders;
¨In case of loss, both parties will share the loss; and ¨Profit payment is not fixed and is not guaranteed.