Financial Instruments 89
guarantees of fi nancial performance between economic agents. These con-
tracts play a critical role in that they provide stability and mitigate risk in
the fi nancial system.
Intermediation contracts based on the principles of partnership include
both mudarabah (a trustee fi nance contract) and musharakah (equity partner-
ship). In a mudarabah contract, an economic agent with capital (rabbal - mal)
can develop a partnership with another agent (mudarib) with the skills to
form a partnership, with the agreement being to share the profi ts. Although
losses are borne by the capital owner only, the mudarib may be liable for
any loss arising from misconduct or negligence on his part.
Both mudarabah and musharakah are cornerstones of fi nancial inter-
mediation for mobilizing resources, and are akin to an agent who develops
expertise and knowledge of different markets and acts as an intermediary to
screen and monitor investment opportunities for the deployment of funds
placed with it. In this respect, mudarabah and musharakah contracts
have existed as instruments of fi nancial intermediation from the early peri-
ods of Islam. Both were able to mobilize the entire reservoir of the mon-
etary resources of the medieval Islamic world for fi nancing agriculture,
crafts, manufacturing and long - distance trade. These instruments were used
not only by Muslims but were also acceptable and practiced by Jews and
Christians to the extent that interest - bearing loans and other usurious prac-
tices were not in common use.
There is evidence that these two contracts spread rapidly through-
out the Middle East and then to the other corners of the globe wherever
Muslim traders were active in business and trade. In the Arabian Peninsula,
the second caliph is known to have invested the money of orphans with
merchants who traded between Medina and Iraq. Similarly, as early as the
seventh century AD, tax revenues from Iraq were sent across the desert to
Medina (Saudi Arabia) on the basis of mudarabah. It has been documented,
too, that the trade between Egypt and Tunisia took place on this basis. The
practice of musharakah is known to have existed in the north–south trade
between Egypt and Syria as well as between Egypt and Saudi Arabia, during
the eleventh century.
With the encouragement and blessing of early Muslim jurists,
partnership- based intermediation contracts were promoted, which led
to the evolution of mudarabah and musharakah contracts as standard-
ized, well - documented and well - established fi nancial instruments. However,
around the eleventh and twelfth centuries, further advancements in these
contracts slowed, with the result that further innovation of fi nancial
instruments became limited. However, the concept was expanded further
in Europe, where the business community constantly expanded its part-
nerships and invented larger and larger enterprises. The increasing size of
European partnerships meant that the savings of the small investors were
effectively channeled into large investment projects. The concept of the
joint - stock company or the modern - day corporation grew out of the con-
cept of partnership, but on a larger scale.