Dissertation On

Financial Performance Of Mudarabah

Financial performance of Mudarabah

Chapter 01

Introduction Of Mudarabah
Definition:
This is a kind of partnership where one partner gives money to another for investing in a
commercial enterprise. The investment comes from the first partner who is called "Rab-ul-Maal"
while the management and work is an exclusive responsibility of the other, who is called
"Mudarib" and the profits generated are shared in a predetermined ratio.

Types of Mudarabah
There are 2 types of Mudarabah namely:

Al Mudarabah Al Muqayyadah:
Rab-ul-Maal may specify a particular business or a particular place for the mudarib, in which
case he shall invest the money in that particular business or place. This is called Al Mudarabah
Al Muqayyadah (restricted Mudarabah).

Al Mudarabah Al Mutlaqah:
However if Rab-ul-maal gives full freedom to Mudarib to undertake whatever business he deems
fit, this is called Al Mudarabah Al Mutlaqah (unrestricted Mudarabah). However Mudarib
cannot, without the consent of Rab-ul-Maal, lend money to anyone. Mudarib is authorized to do
anything, which is normally done in the course of business. However if they want to have an
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extraordinary work, which is beyond the normal routine of the traders, he cannot do so without
express permission from Rab-ul-Maal. He is also not authorized to:
a) keep another Mudarib or a partner
b) mix his own investment in that particular Modarabah without the consent of Rab-ul Maal.
Conditions of Offer & Acceptance are applicable to both. A Rab-ul-Maal can contract
Mudarabah with more than one person through a single transaction. It means that he can offer his
money to 'A' and 'B' both so that each one of them can act for him as Mudarib and the capital of
the Mudarabah shall be utilized by both of them jointly, and the share of the Mudarib.

Investment
In Mudarabah, Rab-ul-maal provides the investment and Mudarib the management therefore the
Rab-ul-maal should hand over the agreed investment to Mudarib and leaves everything to
Mudarib with no interference from his side but he has the authority to:
a) Oversee the Mudarib's activities and
b) Work with Mudarib if the Mudarib consents.
In what form should the capital be? Should it be liquid or non-liquid assets like equipment, land
etc. can these form a capital?
The basic principle is that the capital in Mudarabah is valid just the way as it is in Shirkah which
according to Hanafi fiqh should be in liquid form but according to other scholars equipment, land
etc can also be included as capital. However all agree on the following:
Assets other than cash can be used as an intermediate step, meaning:

However this is subject to the determination of exact amount of the assets before it is used for
Mudarabah. If the assets are not correctly evaluated, the Mudarabah is not valid.

Dissertation On

Financial Performance Of Mudarabah

Mudarabah Expenses
The Mudarib shares profit of the Mudarabah as per agreed rate with the investor but his expenses
like meals, clothing, conveyance and medical are not borne by Mudarabah. However, if he is
traveling on business and is overstaying the night, then the above expenses shall be covered from
capital. If Mudarib goes for a journey which constitutes Safar-e-Sharai (more than 48 miles) but
does not overstay the night, his expenses will not be borne by Mudarabah.
All expenses which are incidental to the Mudarabah's function like wages of employees/workers
or Commission in buying/selling or stitching, dyeing expenses etc have to be paid by the
Mudarabah. However all expenses will be included in the cost of commodities which Mudarib is
selling for eg. if he is selling ready made garments then the stitching, dyeing, washing expenses
etc. can be included by the Mudarib in the total cost of the garments.
If the Mudarib manages the Mudarabah within his city , he will not be allowed any expenses,
only his profit share. Similarly, if he keeps an employee, this employee will not be allowed any
expenses, just his salary.
If the Mudarabah agreement becomes Fasid due to any reason, the Mudarib's status will be like
an employee, meaning:
a) Whether he is traveling or doing business in his city, will not be entitled to any expense
such as meals, conveyance, clothing, medicine etc.
b) He will not be sharing any profit and will just get Ujrat-e-Misl (ordinary pay) for his job.

Distribution of Profit & Loss

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. The Shariah has
prescribed no particular proportion; rather it has been left to their mutual consent. They can share
the profit in equal proportions and they can also allocate different proportions for Rab-ul-Maal
and Mudarib. However in extreme case where the parties have not predetermined the ratio of
profit, the profit will be calculated at 50:50.
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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. For example, 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-ulMaal. 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.
It is also allowed that different proportions are agreed in different situations. For example, the
Rab-ul-Maal can say to Mudarib "If you trade in wheat, you will get 50% of the profit and if you
trade in flour, you will have 33% of the profit". Similarly, he can say "If you do the business in
your town, you will be entitled to 30% of the profit and if you do it in another town, your share
will be 50% of the profit".
Apart from the agreed proportion of the profit, as determined in the above manner, the Mudarib
cannot claim any periodical salary or a fee or remuneration for the work done by him for the
Mudarabah.
All schools of Islamic Fiqh are unanimous on this point. However, Imam Ahmad has allowed for
the Mudarib to draw his daily expenses of food only from the Mudarabah Account. The Hanafi
jurists restrict this right of the Mudarib only to a situation when he is on a business trip outside
his own city. In this case he can claim his personal expenses, accommodation, food, etc. but he is
not entitled to get anything as daily allowances when he is in his own city.
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.
The Mudarabah becomes void (Fasid) if the profit is fixed in any way. In this case, the entire
amount (Profit + Capital) will be the Rab-ul-Maal's. The Mudarib will just be an employee
earning Ujrat-e-Misl.
The remaining amount will be called (Profit).
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This profit will be shared in the agreed (pre-agreed) ratio.

Roles of the Mudarib:

Ameen (Trustee): To look after the investment responsibly, except in case of natural calamities.
Wakeel (Agent) : To purchase from the funds provided by Rab-ul-Maal
Shareek (Partner): Sharing in any profit
Zamin (Liable): To provide for the loss suffered by the Mudarabah due to any act on his part.
Ajeer (Employee): When the Mudarabah gets Fasid due to any reason, the Mudarib is entitled to
only the salary, Ujrat-e-Misl.
In case there is a loss, the Mudarib will not even get the Ujrat-e-Misl.

Termination of Mudarabah
The Mudarabah will stand terminated when the period specified in the contract expires. It can
also be terminated any time by either of the two parties by giving notice. In case Rab-ul-Maal
has terminated services of Mudarib, he will continue to act as Mudarib until he is informed of the
same and all his acts will form part of Mudarabah.
If all assets of the Mudarabah are in cash form at the time of termination, and some profit has
been earned on the principal amount, it shall be distributed between the parties according to the
agreed ratio. However, if the assets of Mudarabah are not in cash form, it will be sold and
liquidated so that the actual profit may be determined. All loans and payables of Mudarabah will
be recovered. The provisional profit earned by Mudarib and Rab-ul-Maal will also be taken into
account and when total capital is drawn, the principal amount invested by Rab-ul-Maal will be
given to him, balance will be called profit which will be distributed between Mudarib and Rabul-Maal at the agreed ratio. If no balance is left, Mudarib will not get anything. If the principal
amount is not recovered fully, then the profit shared by Mudarib and Rab-ul-Maal during the
term of Mudarabah will be withdrawn to pay the principal amount to Rab-ul-Maal. The balance
will be profit, which will be distributed between Mudarib and Rab-ul-Maal. In this case too if no
balance is left, Mudarib will not get anything.
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Explanation:
In any economy, private investment occurs in two different ways: active investment, where one
or more persons put their own capital into a project, manage it themselves and enjoy the fruits of
their labour and capital themselves; and passive investment, where the investor provides the
capital and receives a return but takes no further part in the project. Broadly speaking, a passive
investor has three options: one, buy shares in a company and receive a dividend; two, buy bonds
or securities and receive interest; three, deposit in a bank and receive interest. In an Islamic
economy, active investment and the first option are permissible while the last two options would
be regarded as riba (interest) income and therefore prohibited. On the entrepreneur side, he may
finance his project using his own capital, by selling shares in his enterprise, or by borrowing on
interest (from a bank or by issuing bonds/securities). In an Islamic setting, the first two methods
are permissible while the last is not. For clarity the scenarios are depicted in Tables 1 and 2.

Table 1. Investment options for capital-holders

Type of investment

Active investment

Mode of investment

Type of return on capital

Islamic position

In own enterprise

Profit or loss from the

Allowed

enterprise
Passive investment

Shares in a company

Dividend (profit or loss) from

Allowed

the company

Bonds/securities

Fixed positive return ( riba )

Prohibited

Bank deposit

Fixed positive return ( riba )

Prohibited

Dissertation On

Financial Performance Of Mudarabah

Table 2. Financing options for entrepreneurs

Type of financing

Mode of financing

Type of return on capital

Islamic position

Own funds

Profit or loss from the

Allowed

Active finance

Passive finance

enterprise

Share capital

Dividend (profit or loss) from

Allowed

the company

Bonds/securities

Fixed positive return ( riba )

Prohibited

Bank loans

Fixed positive return ( riba )

Prohibited

Both conventional and Islamic systems permit and encourage active investment, which rewards
labour and capital from realised profits. Both also permit and encourage passive investment in
shareholder companies, which too reward capital from realised profits in the form of
dividends. In both cases any realised loss is borne by the capital-providers. But any investment
that brings in riba income or financing that involves the payment of riba is prohibited in an
Islamic system. This leaves the Muslim passive investors who cannot or will not buy shares in a
company and Muslim entrepreneurs who do not have their own capital or cannot raise share
capital but need seed capital and/or additional funds in a difficult situation. If not for their
religious convictions, they would resort to bonds and securities or fixed deposits and bank
loans. Since this category of investors and entrepreneurs form a large section of the Muslim
investor-entrepreneur community, it is necessary to address their difficulty. This essay explores
the options available to this group within an Islamic setting. Participatory Financing explained
in the following paragraphs is a system developed to address this special concern of Muslims. It
is based on the ancient concept of mudaraba .

Dissertation On

Financial Performance Of Mudarabah

Brief history
Mudaraba is an ancient form of financing practised by the Arabs since long before the advent of
Islam. It suited the Meccan Arabs because of their location at the cross roads of the ancient
trade caravans. They themselves were merchants carrying goods north to Syria in the summer
and south to the Yemen in winter. They took goods from their homeport to sell at their
destination, and with the proceeds bought other goods and brought them back to sell at home
and/or to re-export to another destination. When a trading caravan is organised it was the
practice of the Meccans either to join it with their own goods and money or to send such through
agents who did the business on their behalf. When a caravan returned home and the goods were
all sold, the mission was complete and it was time to prepare the balance sheet and calculate
the profit/loss.
Traders who took their own money and goods assessed the success of the mission by the
profit/loss they made and enjoyed the fruits of their labour or mourned their loss on their
own. Those who combined their fortunes with that of one or more of their colleagues and
undertook the project together had to go one step further and divide the fortune or loss among the
partners, according to a pre-agreed pattern. The rules of this pattern had long been established
by custom and had been known by the namemusharaka.

The agents who carried others goods

and/or money had to give accounts to their principals and claim their share of the profit/loss
according to a pre-arranged pattern. This too had rules assigned by custom and was known by
the name mudaraba.
When Muhammad (Peace be upon him) began his prophetic mission he did one of three things
with regard to the practices of the Arabs: 1) if it involved the denial of the existence or the
uniqueness the one God (Allah) or associating anything or anyone with Him or was against any
command of God, he prohibited it outright; 2) if it did not involve any such action he did not
interfere with it; 3) if some useful or essential practice involved some elements of the first, and
if that could be removed, he removed the offending elements and allowed the modified version
to be practised. Mudarabaand musharaka belonged to the second group.

Dissertation On

Financial Performance Of Mudarabah

Nabil A. Saleh in his authoritative and very readable book, Unlawful Gain and Legitimate Profit
in

Islamic

Law (1986),

gives

detailed

descriptions

of

the

rules

relating

to mudarabaand musharaka , including the differences of opinion in the interpretation of these

rules by the later schools of Islamic Law. A recent (1999) publication by Justice Taqi Usmani is
a very useful contribution to Islamic finance. It is useful to students and teachers of Islamic
banking and finance on account of the authoritative definitions given of the terms and concepts
used in the field, and because of the detailed explanations and background information
provided. It also describes how these concepts are currently implemented, and points out the
shortcomings and gives suggestions for improvements. Though the present author does not,
with all respects, agree with all the suggestions, the book is perhaps a must in the library of every
student of Islamic banking and finance. In it he singles out mudaraba and musharaka as the
only true modes of financing. The others such as murabaha, ijara, salam, istisna are modes of
trade which are presently being used as modes of financing.
Islamic financial institutions assume the role of traders and use the modes of trade but remain
financiers. This metamorphosis is achieved by legal documentation and some selfpersuasion. It does not, however, convince many; and the root of the problems faced by Islamic
banking and finance today lies in this split personality. The theme of this article is: let the
financiers be financiers, and the traders and entrepreneurs be traders and entrepreneurs.

Islamic banking
Mudaraba is essentially an agreement between a financier and an entrepreneur the
principals. However, taking account of the modern social structure and context, the pioneers of
Islamic banking brought in an intermediary between the principals and created a twotier mudaraba. This modified form of mudaraba was introduced into conventional commercial
banking in the form of profit-and-loss-sharing (PLS) investment accounts and financing
arrangements. The earned profit (which is an uncertain and unpredictable return on capital) was
to replace the interest (a pre-determined fixed return) in the conventional setting. This,
however, was not acceptable to the conventional banking authorities. Therefore, except in a few
countries where rules were relaxed or special banking laws were enacted, it was not possible to
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establish and operate Islamic banks in most countries of the world. In such countries Islamic
financial institutions, which did not come under deposit bank regulations, were introduced. In
both cases, while the deposit/investment side worked on mudaraba basis, mudaraba was only
one of several modes used for financing. Though a preferred one in theory, in practice it became
one of the least used. The most used forms are modes of trade, and this has led to questions of
morality and ethics. In addition, Islamic banks are unable to provide all the financing services
expected of a commercial bank.
One of the very serious consequences of using modes of trade as modes of financing is that
Islamic financial institutions are confined to financing short-term trade, and are unable to finance
long-term projects in industries, agriculture, services, etc. The latter are equally important, if
not more, to any country except perhaps for some few raw materials exporting countries which
import all other products. But this situation too cannot continue for long. Many, including Dr.
Ali Yasseri in a recent (August 2000) article, cry out for a new approach. The question is: is
there a viable alternative methodology?

A comprehensive new methodology has been

developed in a series of three books published in the last few years, and an overview of the
salient features of the new approach is given in a recent publication.
The author argues that, In Islam, there is a clear difference between lending and
investing lending can be done only on the basis of zero interest and capital guarantee, and
investing only on the basis of mudaraba . Conventional banking does not and need not make
this differentiation. But a system catering to Muslims has to take this into consideration and
provide for two sub-systems one to cater to those who would lend and another for those
who wish to invest. The first sub-system would cater to those who wish to put their money into
a bank for safety and transaction convenience; and the bank would provide all current account
facilities and short-term loans and advances. This is explained in a 1995 publication Interest-free
Commercial Banking. The 1996 publication Participatory Financing through Investment Banks
and Commercial Banks describes the second sub-system, where both investment and financing
are strictly on the basis of mudaraba. Though the title mentions only banks, the methodology can
be used by investment companies as well. In this article we propose to bring out the salient
features of the second sub-system.
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Introduction Of Three Islamic Banks in Pakistan

1) Meezan Bank
2) Al Baraka Bank
3) Bank Islami

Meezan Bank - The Premier Islamic Bank

Meezan Bank Limited, a publicly listed company, is the first and largest Islamic Bank in
Pakistan and one of the fastest growing banks in the history of the banking sector of the
Country. Having the largest branch network and product range, Meezan Bank bears the critical
responsibility of leading the way forward in establishing a stable and dynamic Islamic banking
system replete with dynamic and cutting-edge products and services. Meezan Bank aims to fulfil
its prime objective of providing customers accessibility and convenience, within an atmosphere
and culture of dedicated service and recognition of their needs.

Meezan Bank has developed an extraordinary research and development capability by combining
investment bankers, commercial bankers, Shariah scholars and legal experts to develop
innovative, viable, and competitive value propositions that not only meet the requirements of
todays complex financial world, but do so with world-class service excellence which our
customers demand; all within the bounds of Shariah.

Al-Meezan Investment Bank is established with a mandate to pursue Islamic Banking.Mr. Irfan
Siddiqui appointed as first and founding Chief Executive Officer.
The Shariat Appellate Bench of the Supreme Court of Pakistan rejects the appeals anddirects all
laws on markup banking to cease. The government sets up a high levelcommission, task forces
and committees to institute and promote Islamic banking on parallel basis with conventional
system.

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The Shariah Supervisory Board is established at Al-Meezan Investment Bank led byJustice
(Retd.) Muhammad Taqi Usmani as chairman. State Bank of Pakistan sets criteriafor
establishment of Islamic commercial banks in private sector and subsidiaries andstand-alone
branches by existing commercial banks to conduct Islamic banking in thecountry.
Meezan Bank acquires the Pakistan operations of Societe Generale and concurrently AlMeezan
Investment Bank converts itself into a full fledged Islamic commercial bank. Thefirst Islamic
banking license is issued to the Bank and it is renamed Meezan Bank.President General Pervez
Musharraf inaugurates the new Islamic Commercial Bank at aformal ceremony in Karachi.
Meezan Bank establishes itself as the pioneer of Islamic Banking in Pakistan and
quicklyestablishes branches in all major cities of the country. A wide range of products
aredeveloped and launched consolidating the Banks position as the premier Islamic Bank of the
country Al Meezan Investment Management Limited (AMIM), the asset managementarm of
Meezan Bank, introduces Meezan Islamic Fund (MIF), the countrys first open-end Islamic
Mutual Fund.
The State Bank establishes a dedicated Islamic Banking Department (IBD) by mergingthe
Islamic Economics Division of the Research Department with the Islamic BankingDivision of
the Banking Policy Department. A Shariah Board has been appointed toregulate and approve
guidelines for the emerging Islamic Banking industry. TheGovernment of Pakistan awards the
mandate for debut of international Sukuk (Bond)offering for USD 500 million. The offering is a
success and establishes a benchmark for Pakistan. Meezan Bank acts as the Shariah Structuring
Advisor for this historictransaction.
Meezan Bank becomes the first customer of Islamic Insurance (Takaful) by signing thefirst
Memorandum of Understanding MoU with Pak-Kuwait Takaful Company Limited(PKTCL).
The signing of this MoU has ushered Pakistan into a new era of IslamicInsurance (Takaful).
A number of new dedicated Islamic Banks, namely Bank Islami and Dubai Islamic
Bank,commence operations in Pakistan.Meezan continues its leadership position in the industry
by more than doubling it branch network to a total of 62 branches in 21 cities, clearly

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establishing itself as the largest Islamic Bank of the country. Meezan Bank, becomes thefirst
Islamic bank to introduce 8 am to 8 pm banking at selected branches in Karachi.
Meezan Bank opens up its 100th branch. Two new dedicated Islamic Banks startoperations in
Pakistan, namely Emirates Global Islamic Bank and Dawood Islamic Bank. With 166 Branches
(including 35 sub-branches) in 40 cities across Pakistan, MeezanBank is clearly positioned as the
leading Islamic Bank in the country. Work starts on theconstruction of Meezan Banks new Head
Office building.The financing and investment portfolio of local Islamic banks reached Rs. 185
billion in December 2008 compared toRs. 137.6 billion in December 2007. Market share in the
overall banking increased to five per cent at end December 2008 compared with four per cent at
end December 2007. Totalassets of Islamic banking reached Rs. 271.1 billion in December 2008
compared to Rs.205.2 billion in December 2007.8

Nature of the Organization

Meezan Bank is a commercial bank which receives deposits from the people who have it
spareand invests it with those who are in need of them. It has got the license of commercial
bankingfrom the State Bank of Pakistan and is registered under the legislation of Banking
CompaniesOrdinance 1962. It has dedicated itself to do business of banking according to islamic
rules andregulations and is supervised by a Shariah Board who keeps an eye on the operations of
the bank and ensures that the same must be in accordance with the teachings of islam and
theremust be no element of Riba in it.

The Meezan Team

Meezan Bank is managed by a team of professional bankers committed to the cause of
IslamicBanking. This single unifying factor unleashes the tremendous power of a dedicated
andmotivated team committed to fulfilling the Vision and Mission of this Bank.

Business Segments of the Bank

Corporate and Investment Banking

Commercial and SME

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Consumer Finance

Treasury & Financial Institutions

Asset Management (managed through a subsidiary Al Meezan InvestmentManagement

Limited.)Retail Banking is organized in three Regions across Pakistan, namely South Region,
CentralRegion and North Region.

VISION
Establish Islamic banking as banking of first choice to facilitate theimplementation of an
equitable economic system, providing a strong foundation for establishing a fair and just society
for mankind.

MISSION
To be a premier Islamic bank, offering a one-stop shop for innovative value added products and
services to our customers within the bounds of Shariah, while optimizingthe stakeholders value
through an organizational culture based on learning, fairness,respect for individual enterprise and
performance.10

SERVICE MISSION
To develop a committed service culture which ensures the consistent delivery of our products
and services within the highest quality service parameters, promoting Islamic values and
ensuring recognition and a quality banking experience to our customers.

Strategy
By implementing robust and aggressive strategic and tactical initiatives on the side of consumer
banking, Meezan Bank aims to fulfill its prime objective of providing customers accessibility

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and convenience, within an atmosphere and culture of dedicated service and recognition of their
needs.

Since its inception as an Islamic commercial bank in 2002, Meezan Bank has been one of the
fastest growing banks in the history of the countrys banking sector. The Banks deposits grew at
an average rate of 46% p.a. from December 2002 to December 2012 while its branch network
grew from 6 branches in 2002 to 328 branches in October 2013, an average growth rate of 48%
p.a. The Bank has established a strong and credible management team comprising of
experienced professionals that has achieved a strong balance sheet with excellent operating
profitability and strong ratios. The JCR-VIS Credit Rating Company Limited has upgraded the
Banks long-term entity rating to AA (Double A) from AA- (Double A minus) and short term
rating at A1+ (A One Plus) with stable outlook. The short term rating of A1+ is the highest
standard in short term rating. Meezan Bank is the only Islamic bank with AA credit rating in the
Islamic banking industry in Pakistan.

Shareholders & Shariah Board

The Banks main shareholders are leading financial institutions of the Region namely, Noor
Financial Investment Company, Pak-Kuwait Investment Company, and the Islamic
Development Bank of Jeddah. The established position, reputation, strength and stability, of
these institutions add significant value to the Bank through Board representation and applied
synergies.

The Bank has an internationally renowned Shariah Supervisory Board Chaired by Justice
(Retd.) Maulana Muhammad Taqi Usmani, an internationally renowned figure in the field of
Shariah, particularly Islamic Finance. He holds the position of Deputy Chairman at the
Islamic Fiqh Academy, Jeddah and in his long and illustrious career has also served as a Judge
in the Shariat Appellate Bench, Supreme Court of Pakistan. The Board also includes Sheikh
Essam M. Ishaq (Bahrain), Dr. Abdul Sattar Abu Ghuddah (Saudi Arabia) and Dr. Imran Usmani
who is also the resident Shariah Advisor of the Bank. Dr. Imran is assisted by a team of
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professionals who strictly monitor the regular transactions of the Bank and are also responsible
for Product Development.

Al Baraka Bank
Introduction
Al Baraka Banking Group (B.S.C) is licensed as an Islamic wholesale bank by the Central Bank
of Bahrain, listed on Bahrain Bourse and Nasdaq Dubai stock exchanges. It is a leading
international Islamic banking group providing its unique services in countries with a population
totaling around one billion and is rated by Standard & Poor's at BB+ (long term) / B (short term).
Al Baraka offers retail, corporate, treasury and investment banking services, strictly in
accordance with the principles of the Islamic Shari'a. The authorized capital of Al Baraka is US$
1.5 billion, while total equity is at about US$ 2 billion.
The Group has a wide geographical presence in the form of subsidiary banking units and
representative offices in fifteen countries, which in turn provide their services through over 500
branches. Al Baraka currently has a strong presence in Jordan, Tunisia, Sudan, Turkey, Bahrain,
Egypt, Algeria, Pakistan, South Africa, Lebanon, Syria, Iraq and Saudi Arabia, including two
representative offices in Indonesia and Libya.
Although the Al Baraka Banking Group (ABG or the Group) is about 10 years old, its
antecedents go back almost 36 years - when one of the oldest Islamic banks in the world, Jordan
Islamic Bank was formed in 1978. The Group came about as a result of a consolidation of
various interests of Shaikh Saleh Abdullah Kamel in 10 Islamic banks, with the object of adding
strength and purpose to his vision of creating a global Islamic banking group.
Following its establishment in 2002, and having established a strong centralized corporate
governance and management infrastructure, the Group achieved in 2006 a combined private
placement and public issue, designed to bring its name to the attention of investors and the
market at large and to raise additional capital to strengthen its subsidiaries and position them for
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expansion in their home territories, as well as to enable the Group to commence its wider
geographical expansion. The successful flotation on the Nasdaq Dubai Stock Exchange and the
Bahrain Bourse set the stage as a precursor to further expansion worldwide.
Since 2006, Al Baraka Banking Group has witnessed an impressive and steady growth- even
through the recent crises of a few years- strengthening its presence in its existing markets
through organic development as well as venturing into new markets such as Indonesia and Libya
by way of representative offices as a prelude to further expansion. The Group established a
strong presence in Syria by commencing retail operations under the name Al Baraka Bank Syria,
and enhanced the capital resources of Al Baraka Turk Participation Bank in 2007 followed by a
sukuk issue and a syndicated morabaha financing that served to give it considerable impetus for
business growth. The operations in Pakistan saw a substantial increase when Emirates Global
Islamic Bank was acquired in 2010.
Based on an edifice of a strong strategy and governance culture, Al Baraka Banking Group has
over the years established for itself niches in key markets that are non-correlative and therefore
present it with a natural risk diversification, a phenomenon that few banks in the region possess.
With group strategic direction and management being articulated at the group headquarters in
Bahrain, the individual components of the Group have all developed into significant contributors
to its overall success.
The brand of Al Baraka was introduced in its present form in 2009 - 2010, to be welcomed well
by the markets and resulted in a new, stronger position across the world. "Partnership" is one of
the key drivers of our business ethos that is well-embodied in our vision which is
We believe society needs a fair and equitable financial system: one which rewards effort and
contributes to the development of the community'
Our approach is to serve society and engage in business in a socially responsible manner that
serves the needs of the community at large while at the same time adhering to the ethical
principles of the Sharia which is aptly described in our mission statement as follows

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To meet the financial needs of communities across the world by conducting business ethically in
accordance with our beliefs, practicing the highest professional standards and sharing the mutual
benefits with the customers, staff and shareholders who participate in our business success
Our core values are a reflection of the business philosophies with which we work: Partnership,
Driven, Neighborly, Peace of mind and Social Contribution.
Looking forward, we anticipate a healthy growth of Islamic banking in the world, thus enabling
us to view the future with optimism for which we shall position ourselves competitively and seek
opportunities to expand into newer markets, strengthen our existing ones and continually
maintain our high standards of corporate governance and Sharia principles.
Al Baraka Business Plus is based on the Islamic concept of Mudarabah. Under this arrangement
the customer is Rab-ul-Maal (Investor) and the bank is Mudarib (Fund Manager). Customer
deposit is invested in profitable business ventures which are legal and Shariah compliant. The
profit/loss is shared on a pre determined ratios. As Fund Manager, the bank is entitled to a part of
the profit, whereas profit distribution amongst the depositors and shareholders is made according
to the weightages assigned to their investment at the beginning of each month.

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BankIslami
INTRODUCTION Of BANKISLAMI
The epochal idea of BankIslami was conceptualized by Jahangir Siddiqui & Company Limited
and Randeree family in late 2003. Mr. Hasan A. Bilgrami was appointed as Adviser to the
sponsors on March 16, 2004 to formalize the idea. He presented the concept paper of BankIslami
to sponsors on March 24, 2004. A detailed business plan was then prepared and a formal
application was submitted to the State Bank of Pakistan on May 26, 2004. On September 26,
2005, Dubai Bank joined the Sponsors and became one of the founding shareholders of
BankIslami by investing 18.75% in the total Capital.
The State Bank of Pakistan issued a No Objection Certificate in no time on August 19, 2004 and
BankIslami Pakistan Limited, the second full-fledge Islamic Commercial Bank in Pakistan, was
incorporated on October 18, 2004 in Pakistan.
BankIslami Pakistan Limited was the first Bank to receive the Islamic Banking license under the
Islamic Banking policy of 2003 on March 31, 2005. The Bank envisioned to focus primarily on
Wealth Management as the core area of business in addition to Shariah compliant Retail Banking
products, Proprietary and Third party products, and Integrated financial planning services.
BankIslami Pakistan Limited made a public offering of Rs. 400 Million, at par, from 6th to 8th
March 2006. This was the first primary issue by a Bank in over a decade in Pakistan. The Initial
public offering (IPO) of BankIslami received overwhelming response from the general public as
the applications received were 9 times higher than offered, fetching nearly Rs. 3.5 Billion,
against the demand of Rs. 400 Million.
The State Bank of Pakistan declared BankIslami Pakistan Limited as a Scheduled Bank with
effect from March 17, 2006. BankIslami started its Banking operations on 7th April 2006 with its
first branch in SITE, Karachi. By the end of 2006, the Bank had 10 branches, nine in Karachi and
one in Quetta. The Bank further concentrated in building a nationwide network and by the end of
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year 2007, its branch network grew to 36 branches in 23 cities. In 2008, the Bank opened 66 new
branches nationwide which expanded its network to 102 branches in 49 cites. By the end of
2013, the Bank has achieved the target of 201 branches in 77 cities nationwide This gives
BankIslami the distinction of having the fastest expanding network in Pakistan as well as
offering the widest network by any Islamic Bank in Pakistan
BankIslami Pakistan Limited is a dedicated Islamic commercial bank operational in Pakistan
since April 7th, 2006. The Bank offers a full range of Shariah compliant commercial banking
products and services. The Bank's growing nationwide network consists of 36 branches.
BankIslami is sponsored by three financially sound and reputable groups which are: The DCD
Group, Dubai Bank and Jahangir Siddiqui & Company Limited.
THE DCD GROUP is a UK based group which has played a pioneering role in setting up of
institutions such as the Islamic Bank of Britain and European Islamic Investment Bank aside
from partnering with Dallah Al-Baraka Bank in South Africa.

DUBAI BANK is an Islamic bank in the UAE, owned by Dubai Holdings, the investment arm of
Government of Dubai and Emaar Properties, which is the largest real estate company in terms of
capitalization in the region.

JAHANGIR SIDDIQUI & CO. LTD is the largest and most diversified financial services group
in Pakistan with a track record of innovation and success. It has the distinction of sponsoring the
first and largest asset management company, ABAMCO Limited and the first Islamic Fund in
Pakistan.
The Shariah Board of BankIslami consists of three renowned and distinguished Shariah scholars
namely Justice (Retd) Muhammad Taqi Usmani, Prof Dr Fazlur Rahman and Mufti Irshad
Ahmad Aijaz. Mufti Irshad Ahmad is also the Shariah Adviser of the bank who works full-time
with the management and guides them in issues pertaining to the Shariah.

The business philosophy of BankIslami focuses on providing Shariah compliant products at par
with better service and technology standards viz-a-viz conventional banks. In pursuit of these
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traditions BankIslami is the first commercial bank in Pakistan as well as in the region to deploy
Biometric ATMs for its customers to ensure better security and service. Also, BankIslami is the
first bank in Pakistan to start Internet banking for all its customer from the day it started
operations.

Currently our Shariah Compliant products menu includes Working Capital Finance, Medium and
Long Term Finance, Ijarah (Islamic Leasing), Islamic Export Refinance, Structured Finance,
Letter of Credit (Sight and Usance), Letter of Guarantees, Forward Cover, Bill Purchases, Islami
Current Account, Islami Bachat Account, Islami Mahana Munafa Account, Islami Amdani
Certificate, Auto Ijarah, Muskun (Home) Financing e.t.c.

BankIslami envisages being the first Islamic Financial institution in Pakistan to focus on Wealth
Management as its core area of business. BankIslami aspires to be recognized as the leading
authentic Islamic bank and hopes to set standards which will take the industry to greater heights.

Vision:
The Vision of BankIslami is to be recognized as the leading Authentic Islamic Bank.

Mission:
The Mission of BankIslami is to create value for our stakeholders by offering Authentic, Shariah
Compliant and technologically advanced product and services. We differentiate ourselves
through:

Authenticity

Innovation

Understanding our client's needs

Commitment to excellence, and

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Fast, efficient and seamless delivery of solution. As a growing institution, the foundation for our
performance lies on our human capital and BankIslami remains committed to becoming an
employer of choice, attracting, nurturing and developing talent in a transparent and performance
driven culture.

Core Values:
BankIslami is strongly committed towards its core values of:

Product authenticity

Customer focus

Meritocracy

Integrity

Team work

Humility

Innovation

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Chapter 2

Literature Review
Introduction
Riba in Islamic Shariah refers to Anything paid/charged over and above the principal amount on
a loan. Allah in Quran said Do not do wrong nor be wronged (Al Baqarah: 279). It means that
interest either results in injustice to the borrower or sometimes, it could result in injustice to the
lender. That is why, lending or borrowing and taking or giving interest both are prohibited in
Islam. Furthermore, interest is prohibited due to its discouraging effects on enterprise. If one
wants to invest money to earn profit, Islam has allowed trade over lending for interest. If one
does not want to invest money for profit, but has some surplus funds, Islam has encouraged
spending in charity over lending for interest.
Islamic Finance is a growing industry which is constantly evolving and has been competitive to
reach and sustain its growth momentum in the midst of even the Great Recession and beyond.
Assets of the global Islamic finance industry are estimated to grow to around $1.6 trillion by
2012 (Source: Reuters). Lately, the Vatican said that banks should look at the rules of Islamic
finance to restore confidence amongst their clients at a time of global economic crisis. Some
reports suggest that assets held by Islamic financial institutions may rise five-fold to more than
$5 trillion.
The market share of Islamic Banking Industry to overall Banking Industry, increased to 12.1% in
2013 from 9.7% in 2012. He pointed out that the State Bank of Pakistan (SBP) has granted
permission to conventional banks to open Islamic branches and windows that put too much
pressure and burden on newly established Islamic banks to compete with them.
The idea of Islamic banking is flourishing day by day not only in the Muslim world but also in
the western and non-Muslim countries. Schmith writes that the prospects for the growth of
Islamic banks is high because 1.5 billion Muslims in the world need an alternative to interest
based banking system. Besides, Islamic banking has also attracted non-Muslims and got
popularity in Europe and America with a growth rate of 15 to 20 percent each year.

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In Pakistan, the market share of the Islamic banks in the banking industry is 12.1 percent with
1300 branches and 23,000 borrowers, while there are 7,700 branches of the conventional banks
with five million borrowers. He is of the opinion that if Islamic banks improve their services and
provide innovative quality products to the
Analysis of the Performance of Islamic and Conventional Banks in Pakistan Zahoor, Farooq,
Fawad customers, they will be able to compete with conventional banks by increasing the market
share up-to 15 percent in near future.
However, there are some difficulties facing the customers of Islamic banks. Khattak and Rahman
(2010) reported that the customers of Islamic banks are less satisfied comparatively to
conventional banks. There are two main reasons, according to them. First, people are not fully
aware about the different products offering by the Islamic banks and secondly, Islamic banks do
not provide highly efficient products as conventional banks do. Moreover, people are a little bit
reluctant to invest in Islamic banking sector due to, one, they are accustomed to conventional
banking and secondly a low experience of the Islamic banks in the banking industry.
Regarding the performance of Islamic banks are better than conventional banks. They took a
sample of five conventional banks and five Islamic banks to measure the performance. The study
found that Islamic banks performed better than conventional banks in terms of adequate capital
while conventional banks did well in terms of management quality. However, in terms of
management quality and earnings ability, the conventional banks excelled. Moreover, in terms of
profitability and liquidity there was no major difference between the Islamic banks and
conventional banks. He is of the opinion that the concept of Islamic banking is new but still is
performing as better as conventional banks.
There is no big difference between Islamic banks and conventional banks in utilizing its
resources. They argued that Islamic banks are better than conventional banks in profit efficiency
than conventional but in cost and revenue side conventional banks are performing better. Using
six financial ratios, Islamic banks are less cost effective and more profit and revenue effective
than conventional banks. On the other hand, using Data Envelopment Analysis, they found that
total efficiency in conventional banks is significantly higher than Islamic banks.
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The instruments of leasing and Mudaraba are sometimes criticized on the ground that their net
result is often the same as the net result of an interest-based borrowing. This criticism is justified
to some extent, and that is why, the Shariah supervisory Boards are unanimous on the point that
they are not ideal modes of financing and they should be used only in cases of need with full
observation of the conditions prescribed by Shariah.

Problem Statement
Islam prohibits interest, but the practiced Islamic finance contracts link cash flows with an
interest based benchmark; hence, there is a need to study whether the preferable equity mode of
Mudarabah is usable in Islamic finance and what contractual arrangements could be needed to
make it usable.

Objectives of the Study

The study sets forth following important objectives:
1. To explore how far equity modes could be used in Islamic finance that are not only legal
solutions to the prohibition of Riba, but are also in line with Islamic egalitarian
philosophy.
2. To recommend contractual covenants to solve the principal agent problem and the
problem of moral hazard and adverse selection in Mudarabah financing.

Importance of the Study

Islamic finance industry mostly uses LIBOR linked financial contracts which are based to debt
financing (dayn) than the more preferable participatory modes of Mudarabah and Musharakah.
As per the current orthodox understanding and practice of Islamic finance, the often quoted
preferable modes like Mudarabah and Musharakah are incapable even in a simple model
economy with them as the only mode of financing. Hence, there is a need to examine the reasons
for their lack of use and to suggest important changes in their features if the problem lies in
contract mechanics.

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Scope of the Study

The study discusses the problems in preferable Islamic modes of Islamic finance and goes on to
discuss the alternate arrangements which could serve as need-fulfillment mechanisms in an
Islamic economy.

Limits of the Study

Since the preferable modes of Islamic Finance i.e. Musharakah and Mudarabah are not used by
Islamic Financial institutions (IFIs), empirical analysis of performance is not possible since they
are rarely used. However, since they are regarded as preferable modes by Islamic scholars and
are well suited to Islamic egalitarian philosophy, a study on how they can be applied is
mandatory.

Research Methodology
In this study, extensive literature review on Islamic economics has been done from books,
monographs, research articles and reports/bulletins. In discussing the efficacy of proposed
changes in plain vanilla equity modes of financing and contractual arrangements, an extensive
use of economic theory and analysis through scenario based models has been used to substantiate
analysis. Simulation model is used to explain the limitations in current structure of Mudarabah.

Critical Analysis of Mudarabah

Mudarabah is considered to be one of the most preferable modes of Islamic Finance both by
earlier and contemporary jurists and Islamic scholars. "One who deliberates on the basic
principles would easily conclude that Musaqat, Muzaraah and Mudarabah are nearer to justice
than hire."
Maulana Taqi Usmani (2004) in his book Introduction to Islamic Finance stated at least 5
times that Mudarabah and Musharakah are ideal mode of financing. His comments on Murabaha
which is the most prevalent mode of financing also deserve serious thinking:

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It should never be overlooked that, originally, Murabaha is not a mode of financing. It is only a
device to escape from interest and not an ideal instrument for carrying out the real economic
objectives of Islam.
Therefore, this instrument should be used as a transitory step taken in the process of the
Islamization of the economy, and its use should be restricted only to those cases where
Mudarabah or Musharakah are not practicable.
Preferable nature of Mudarabah as follows:
Even though in practice the role of profit-sharing and partnership is very small at present, they
continue to dominate the theory of' Islamic banking. They are regarded as the norms towards
which practice should and would, eventually gravitate.
One of the major hurdles in the use of Mudarabah on the asset side of a bank i.e. for financing is
that only Rabb-ul-Maal is considered to bear all the financial losses. Therefore, if an Islamic
bank enters into the Mudarabah contract as a Rabb-ul-Maal, only the Islamic bank would have to
bear all the losses. Mudarib (Fund manager) bears no loss while he has the complete authority in
running the affairs of the business. The Rabb-ul-maal (investor) is not allowed to participate in
the affairs of the business. When a loss occurs, the Mudarib acts like an employee of the business
and when the profit occurs, he shares in the profit as if he was the only reason behind the profits.
Bacha highlighted serious agency problems in Mudarabah and argued that it lacks the bonding
effect of debt financing and can induce perverse incentives. Using scenario analysis, he showed
that for a borrower faced with the alternative of using Mudarabah, debt or equity financing,
Mudarabah would be best in a risk-return framework. For a financier faced with the same three
alternatives however,
Mudarabah financing would be the worst. Likewise, Khalil et al. also highlighted the structurally
chronic agency problem in Mudarabah.
State Bank of Pakistan in its report Financial Stability Review for 2007-08 commented on the
issue in following words:

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In fact, the agency problem is one of the major factors for the reluctance on the part of banks to
undertake equity based modes of financing, as it gives entrepreneurs the incentive to understate
profits.
To overcome agency problems, several researchers gave their solutions. Bacha proposed that the
Mudarib must reimburse' the Rabb-ul-Maal in the event of certain outcomes. This
reimbursement will be in form of the Mudarib giving up part of his equity to the financier. Sarker
(n.d) favored incentives for honesty like providing stake in the ownership, linking transfer of
ownership through granting bonus shares on the performances, build reserve scheme to induce to
hold company shares and provision for profitrelated pay linking with the declaration of profits
etc. to reduce the agency problem.
Now, we analyze these proposals and see how effective they could be in solving the agency
problem in Mudarabah. The proposal by Bacha is only applicable while the Mudarib is a
corporation having its own paid up capital. His proposal tries to solve the problem after it has
occurred rather than preventing it beforehand. Another possible problem with this proposal is the
fact that market value of shares of the Mudaribs corporation could be anything at the time loss
occurs in the joint venture of Mudarabah.
Sarkers proposal is also focused on incentivizing than preventing the problem beforehand. It
also fails to solve the problem of adverse selection which requires a preventive measure than just
incentives. Tier wise profit sharing structure is not completely agreed upon by scholars
worldwide.
The problem is in the disparity in payoffs if loss occurs in Mudarabah. In Mudarabah, to be
willing to take higher risk, the financier would demand higher returns reflected in demand for
higher PSR (Profit Sharing Ratio). But, with higher, PSR, the Mudaribs motivation and
incentive diminishes especially if the Mudarib requires bearing no financial losses and already
having means of sustenance with another business line.
Now, we present our analysis on the issue. The principle that loss sharing should be based upon
and limited to the amount of capital invested is not a condition mentioned in Quran or authentic
Hadith. This juristic viewpoint didnt create much problem during early Islamic era when mostly
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the Mudarib was a poor and resource-less person in financial need with limited incentive and
authority to enter in corruption and no capacity to participate in loss sharing if the loss was
caused by any reason other than negligence on his part. This could be appreciated by looking at
the specific rules in Mudarabah highlighting the rights and duties of Mudarib. Mostly, the
Mudarib was a skillful, but a poor and resource-starved person in those times.
In Musharakah, loss participation by all partners across the board is justifiable because all
partners are also allowed to work. But, due to the fact that in Mudarabah, the working partner is
the sole authority to do the business, making Rabb-ul-Maal completely responsible for sharing
all losses is unjustified in the first place.
Consider an Islamic economy with Mudarabah on asset and liability side and there is no other
instrument used, Mudarib (usually blue chip companies) with no liability to share loss can obtain
financing from banks who would be Rabb-ul-Maal in asset side use of Mudarabah. On liability
side, bank will be Mudarib and the small savers and investors will be Rabb-ul-Maal. So, any loss
incurred by blue chip companies is ultimately paid by small savers and investors who have all
the liability to share losses without having a say in the affairs of the business!
Restricted Mudarabah and clause of willful negligence is insufficient to protect them from losses
strictly due to business cycle fluctuations. This example shows that with current structure, even
Mudarabah used alone in an economy is insufficient to bring about any egalitarian change.
Let us analyze trust deficit and documentation problems which are cited as reasons why
Mudarabah is not being used widely. Relax these assumptions and now consider there is no trust
deficit and documentation problem in the economy. If a loss occurs due to business cycle
fluctuations, no part of the loss is borne by the business that had all the authority to run the
business. The loss is borne not by the bank as well because bank is Mudarib on liability side. All
loss is borne by the small savers and investors.
Now consider the government prohibits interest based lending and borrowing too. Will the
people want to be Rabb-ul-Maal in Mudarabah with bank or the shareholder in a blue chip
company which can take all the money, invest it, earn from it and if loss occurs, pass it onto the
small savers! Mudarabah (with current structure) even when assumptions of trust deficit and
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documentation problems are relaxed and even when there is no competing conventional banking
system is ineffective to say the least.

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Bibliography And References

References
Bacha, O. I. (1996). Conventional versus Mudarabah financing: An agency cost perspective.
International Journal of Economics, Management and Accounting,4(1&2).
Bacha, O. I. (1997). Adapting Mudarabah financing to contemporary realities: A proposed
financing structure.
Bank, M. (2013). Meezan Bank Annual Report 2013.
Iqbal, M., & Llewellyn, D. T. (Eds.). (2002). Islamic banking and finance: new perspectives on
profit sharing and risk. Edward Elgar Publishing.
Iqbal, M., & Molyneux, P. (2005). Thirty Years of Islamic Banking: History, Performance, and
Prospects.
Islami, B. (2013). Bank Islami Annual Report 2013.
KHAN, M. S. (1997). Islamic interest-free banking: a theoretical analysis.Islamic Economics,
9(1), 3-36.
Lewis, M., & Algaoud, L. M. (2001). Islamic banking (p. 167). Cheltenham: Edward Elgar.
Muslehuddin, M. (1976). Interest-Free Banking and the Feasibility of Mudarabah. In First
International Conference on Islamic Economics, Makkah.
Nagaoka, S. (2009). Reconsidering Mudaraba Contracts in Islamic Finance: What is the
Economic Wisdom (Hikma) of Partnership-based Instruments?.Kyoto Working Papers on Area
Studies: G-COE Series, 40, 1-16.
Rab, H. (2004). Impact of inflation on Mudarabah profits: some observations.Islamic Economics,
17(2), 21-25.
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Shaikh, S. A. (2011). A critical analysis of Mudarabah & a new approach to equity financing in
Islamic finance.
Siddiqi, M. N. (1985). Partnership and Profit-Sharing in Islamic Law (Vol. 9). Islamic
Foundation.

Websites
https://www.scribd.com/doc/52509263/internship-report-Bank-islamic
http://www.academia.edu
https://bazarbuzz.wordpress.com/2011/07/18/bank-meezan-bank-limited-analysis-of-financialstatements-financial-year-2003-1q-financial-year-2011/
http://www.bankislami.com.pk/about_us/
http://www.albaraka.com.pk/
http://www.meezanbank.com/
http://www.albaraka.com.pk/investor-relations/financial-statements/
http://www.bankislami.com.pk/investor_relation/

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