92 AN INTRODUCTION TO ISLAMIC FINANCE
Credit risk and defaults Since there may not be any tangible assets that can
be used as collateral against potential losses, managing the credit risk and
defaults often becomes an issue. To minimize such risk, the capital - owner
or investor should perform due diligence in respect of the past performance
and reputation of the mudarib. By the same token, the mudarib entrusted
with investing funds should perform adequate screening and monitoring of
potential projects worthy of good investment opportunities. In cases where
an Islamic bank is acting as the mudarib, it may ask for a guarantee, pledge
or collateral of a property from the business.
Trust
Wikala The contract of wikala entails designating a person or legal entity to
act on one’s behalf or as one’s representative. It has been a common practice
to appoint an agent (wakil) to facilitate trade operations. A wikala contract
gives power of attorney or an agency assignment to a fi nancial intermedi-
ary to perform a certain task. On the surface, there does not appear to be
much difference between a mudarabah and a wikala contract, since both
are principal–agent contracts. However, under a mudarabah, the mudarib
has full control and freedom to utilize the funds entrusted. In the case of a
wikala, the wakil acts only as a representative to execute a particular task
according to the instructions given.
Amanah, Ariya and Wadia Amanah (trust), ariya (gratuitous lending) and
wadia (deposits) contracts are all concerned with placing assets in trust.
These contracts are utilized in facilitating a custodial relationship between
investors and the fi nancial institutions.
Wadia arises when a person keeps his/her property with another person
for safe keeping and allows the trustee to use it without the intention of
receiving any return from it. The wadia assets delivered for safe keeping are
a trust in the hands of the person who accepts them. Liability arising out of
the wadia contract depends on the nature of the agreement. For example,
if the trustee does not charge a fee for the safe keeping services, the trustee
is not liable for the losses other than those arising from his/her negligence.
However, if a fee is involved as part of the contract, then the trustee is liable
to compensate in the event of loss. The trustee can, with the owner’s prior
permission, let the asset on hire, lend it for use, pledge the asset or use it
him/herself, but must return it on demand.
The term “amanah” (trust deposit) is a broad term where one party is
entrusted with the custody or safekeeping of someone else’s property. For
example, when an employer hands over a property to an employee, it comes
under the contract of trust. However, in the context of intermediation, ama-
nah refers to a contract where a party deposits its assets with another for the
sole purpose of safekeeping. Unlike wadia, where the keeper of the asset is
allowed to use the asset, an amanah deposit is purely for safe keeping and
the keeper cannot use the asset. Demand deposits of an Islamic bank are