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Subject: Essentials for Islamic Finance Submitted to: Yousuf Ibnul Hasan Submitted By : Zain Akhtar Date of submission: 25th Dec 2010 Registration #: 13563 REPORT# : 1 Program : MBA Morning Timings : 12:00 p.m to 3:00 p.m(Monday) Date of repot : 29th Nov 2010 Topic of report The concept of Modaraba in 2000 century application and viability. Minimum 2000 words maimum 6000 words. introduction Islam, being a complete religion, has prohibited "riba" or "interest", in all forms and manifestations in the absence of any blueprint or a workable model of interest free economic system, utmost care with collected gradualness will have to be exercised to bring about a smooth switchover without disrupting the process of capital formation.  Basically, the task of Islamising the financial system revolves around, institutional arrangements, which, on the other hand, reconcile the freedom of the individual with the optimum use of total resources and on the other, do not conflict with the Islamic tenets of equity and fairness. It appears that financial system is based on principles of profit and loss sharing may meet these requirements. While this may cleanse the financial system from the evil of "riba". Its total elimination will be possible only when the savers earn their income out of "halal" activity and the entrepreneurs do not cross the limits of "halal" business and "halal" profits. Again, an Islamic system would be as much in need of optimum capital formation as any other economic system, be it capitalist or socialist or mixed economy.  As an Islamic state, Pakistan has embarked on the task of building a socio-economic order based on the principles of equity and justice enshrined in the Islamic concept of "Al-Adl-Wal-Ahsan". A beginning in this direction has been made by introducing Zakat and Ushr in the personal level and eliminating interest from financial transactions at the institutional level. Modaraba Modaraba is a form of contract a subscriber (Rabulmal) participates with his money and the manager (Modarib) with his efforts and skills, after setting aside the agreed share of Modarib the profits earned on investments are distributed among the subscribers.  In simple words Modaraba means a business in which a subscriber participates with his money and the manager, as "Modarib" participates with his efforts and skills and profits on investment made out of the Modaraba Funds are distributed among the subscribers. Thus, it is a concept of Islamic finance through which one partner or more participate with funds and another with his skill and efforts in some trade, business and industry permitted by Islam. They are who participates with his efforts assumes the role of manager, while the provider of funds becomes the beneficial owner. In modern terminology, a"modaraba" is akin to the concept of mutual finds minus its unIslamic features. The concept of mutual fund has gained widespread acceptance in the country as is evidenced by the success of N.I.T units and I.C.P Mutual Funds.  Characteristics of Modaraba 1. Under Modaraba Capital of one is combined with the labour of the other to earn something.  2. Both Muslim and non-Muslim can carry business under Modaraba.  3. A special contract is executed for a particular business under Modaraba.  4. A contract for Modaraba may also be verbal.  5. Islam has provided more safety and security to the invested capital in Modaraba as compared to the modern partnership business.  6. Distribution of profit is decided mutually by the subscriber (Rab-ul-Mal) and the manager (Mubarib) that what would be the principle for distributing the profit between themselves.  Types of Modaraba  Modaraba can be broadly classified into two types:  1. Multiple Modaraba  A Modaraba having more than one specific purpose or objective. A company for instance, may float a multipurpose modaraba e.g., for finding a transport service, operating an automobile factory or workship and providing services as packers.  2. Specific Purpose Modaraba  A Modaraba for a specific purpose such as getting up cement plant or building and selling houses, or commercial buildings or industrial structures etc.  For the purpose of regulating the floating and operations of modaraba, a law known as Modaraba Companies and Modaraba (Floatation and Control) Ordinance, 1980, has already been promulgated by the Federal Government. Modaraba as a Financing Institution A Modaraba is a financing technique through partnership. One partner provides capital investment and the other contributes through management skills to run the business. Profit is shared between the two in a predetermined ratio, and losses shared strictly in accordance with the contribution to equity. Investment The investment should mainly be in liquid form. However, assets other than cash can be used as an intermediate step towards the final investment in the Modaraba. In such cases, the exact market value of the assets at the time of investment has to be correctly determined. To avoid the liquidation of the Musharika due to one person leaving the joint venture, a clause can be added at the onset of the contract stating that the Musharika cannot be liquidated unless unanimously agreed upon by all partners. Management and Control The Investors’ role in Management is restricted to overseeing the Management’s activities. However, Investors may participate in operations and control if Management consents. Modaraba Expenses Non-business expenses of the Management are not borne by the Modaraba. It is only entitled to its share of the profits. However, all expenses related to business activities are borne by the Modaraba. Distribution of Profit and Loss The proportion of profit allocated to the Investors and Management has to be determined at the inception of the Modaraba. Islamic law has not prescribed a certain proportion, therefore the partners have the flexibility to determine their own agreed ratio. Profit sharing is strictly on the basis of percentage of net profit, i.e. profit cannot be a specific rate tied with capital, or be a specified amount payable to any one or more party. It should be noted that the proportion of profit can be different for various transactions. For example, if the Management is set up for trading, then it can be determined that profits from Item A will be shared on a 50:50 ratio while profits from Item B will be shared on a 60:40 ratio. In case a loss is suffered in one part of the business and a profit in another, the profit is utilized to offset the loss before it is distributed between the parties. Basis Permission and Ristriction of Modaraba * Liabilities cannot be the capital. * Return on capital is not guaranteed. * The capital of Modaraba should be deposited in cash with the Modarib in full trust and confidence * Modaraba becomes invalid if the return of finance is guaranteed/ or fixed. It should be of known in quality and quantity. * Ignorance lead to differences and disputes. * Profit Sharing should be at maturity of transaction. * It should not be paid in parts before the maturity of the transaction because payment might exceed the share and any one of the two partners might devour all the profit. * Modaraba is only achieved through participation because of profit & loss sharing contract, based on justice and trust among the partners. * It is not justice that all profit goes to one and other suffers. Summary * Profits are divided on a pre-determined ratio. * Losses are borne by the provider of capital and Modarib loose its credibility, time and efforts. * Financing is made with absolute trust on the skills, experience, reputation, capability and feasibility of Modaraba transaction or project. * Modaraba agreeA profit-sharing agreement between two parties, in which one provides the finance, and the other provides entrepreneurial and management skills. * It is made only to the transaction purely free from all the classifications and categories of the Riba.