What is Modaraba:
Also known as mudarabah, modarabah and modaraba. An Islamic finance technique in which a lender or investor (rab al maal) and a borrower or investment manager (mudareb) establish a profit-sharing partnership to undertake a business or investment activity. Under this structure, the rab al maal provides the financing or funds and the mudareb provides the professional, managerial and technical know-how to carry out the business or manage the investment. The mudareb must invest the funds on a Sharia-compliant basis (for example, the funds cannot be invested in prohibited (haram) products or activities such as tobacco, alcohol or gambling). The mudareb earns a fee that is deducted from any profits for managing the funds or business, and the parties share in any profits according to a pre-agreed ratio. In a mudaraba, the mudareb:
Puts only its time and effort at risk and does not contribute any capital.
Is not responsible for any losses of the venture. Losses, however, are borne entirely by the rab al maal.
The Modaraba structure is used:
To manage investment accounts. In this case, the institution is the mudareb and the depositor is the rab al maal. The bank manages the funds on deposit in exchange for a fee and is not liable for any losses that may occur (other than for negligence). At the end of the contract, the bank is obligated to return the capital (plus the depositor’s share of any profits) to the depositor minus any losses (if any) and fees.
As a financing mechanism. In this case, the institution is the rab al maal and the borrower is the mudareb. The borrower manages the funds in exchange for a fee and is not liable for losses that may occur (other than for breaches of the agreement and negligence). The borrower is obligated to return the capital to the bank minus losses and fees.