Financial Instruments 91
powers and, therefore, by virtue of the trust that was placed in him, to be
liable for any resulting loss or damage.
Profi t/loss sharing One of the most signifi cant features of mudarabah is
that while the profi ts are shared between the investor and the agent, any loss
in the investment or business is borne solely by the capital - owner, unless such
loss is caused by the misconduct or negligence of the mudarib. In cases where
the agent acts in good faith and prudently, but still the investment results
in a loss, the capital owner loses a portion of the capital, but the agent loses
the time and effort deployed during the business venture. The capital - owner
suffers a fi nancial loss from the loss of capital, while the agent/entrepreneur
does not make any fi nancial gains and loses the potential reward for his
skills. The mudarib is not a guarantor of the capital, except where there is
misconduct or negligence on his part.
Profi t distribution In the mudarabah agreement, the partners enjoy abso-
lute freedom to determine the division of profi ts. The following are some of
the rules applicable to the determination and distribution of profi t and loss
under a mudarabah:
■ (^) The most critical requirement is that the division of profi ts between the
investor and mudarib must be in the form of proportions and ratios,
rather than in absolute numbers.
■ (^) The profi t - sharing formula itself must be made specifi c beforehand and
must be clearly indicated in the agreement for profi t distribution. Nei-
ther party can have preferential rights over the profi ts to the exclusion
of the other.
■ (^) The profi t distribution ratio may differ from that of capital contribu-
tion.
■ (^) The distribution of profi ts in a mudarabah can only take place after
the capital - owner has retrieved his capital. Any interim or periodic dis-
tribution before the closing of the accounts is considered tentative and
subject to fi nal review and revision and has to be made good on any
loss of capital. In other words, if any periodic return was paid based
on expected profi ts or interim proceeds, it is to be treated as a partial
return before the conclusion of the contract, when the fi nal profi t or loss
will be determined after adjusting for any interim profi ts paid.
Multiple tiers Early Shari’ah scholars played an important role in the
development of complex intermediation structures by granting the neces-
sary freedom to the mudarib to form other partnerships with third parties.
On the one hand, this allowed the mudarib to expand the partnership to
create a large pool of capital providers as passive partners and, on the other,
it allowed a mudarib to engage entrepreneurs on the basis of mudarabah to
invest the capital entrusted to the mudarib. This fl exible structure of differ-
ent tiers has become the basis of modern Islamic banks.