CTU351 - Group Assignment PDF

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FACULTY OF BUSINESS MANAGEMENTMARA UNIVERSITY OF TECHNOLOGYDIPLOMA IN BANKING STUDIESBA119 - MBA1194KSEMESTER:MAC - JULY 2020COURSE:CTU 351 – FUNDAMENTALS OF ISLAMIC BANKINGTITLE:APPLICATION OF AL-MUDHARABAH CONCEPT IN PROJECT FINANCING(INVESTMENT)MEMBERS/PREPARED BY:MEMBERS MATRICS NUMBERSHAHIRA NA...

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FACULTY OF BUSINESS MANAGEMENT MARA UNIVERSITY OF TECHNOLOGY DIPLOMA IN BANKING STUDIES BA119 - MBA1194K SEMESTER: MAC - JULY 2020 COURSE: CTU 351 – FUNDAMENTALS OF ISLAMIC BANKING TITLE: APPLICATION OF AL-MUDHARABAH CONCEPT IN PROJECT FINANCING (INVESTMENT) MEMBERS/PREPARED BY: MEMBERS SHAHIRA NADIA BINTI ABDUL HALIM FATINAH BINTI ZULKIFLI NUR NAZIHAH SYASYA BINTI MOHAMAD HASRIN

MATRICS NUMBER 2018252612 2018691624 2018295264

LECTURER NAME/PREPARED FOR: DR. MOHD ZAID BIN MUSTAFAR SUBMISSION DATE: 23rd MAY 2020

TABLE OF CONTENT

NO

CONTENT

PAGES

1

Acknowledgement

ii

2

1.0 – Introduction to Al-Mudharabah Concept

1

3

Al-Mudharabah Concept in Project Financing (Investment Account) 2.1 – Mudharabah Al Mutlaqah – Unrestricted Investment Account

2

2.2 – Mudharabah Al Muqayyadah – Restricted Investment Account

2

2.3 – Investment Process of Al Mudharabah

3 4-5

2.4 – Distribution of Profit and Loss

3.0 – Suggestion and Conclusion

6

5

4.0 – References/ Bibliography

7

6

Appendix

iii - v

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ACKNOWLEDGEMENT In the name of Allah, The Most Gracious, The Most Merciful.

Praise be to Allah, Lord of the universe who gives the blessings and strength to complete this project paper for our group assignment. Peace and prayers upon His Final Prophet and Messenger, the ideal role model for human beings.

We would like to take this opportunity to thank our lecturer of Fundamental of Islamic Banking CTU 351, Dr. Mohd Zaid bin Mustafar for his support and advice in complete this group assignment. We appreciated what he has done to explain about this assignment. May Allah reward him for all the efforts.

On a personal note, we would also like to thank our group members for their effort, hard work and determination to get this project done within the time given. Not forgetting our parents and friends for being our source of inspiration, encouragement, and support.

We would like to extend our deepest gratitude and special thanks to all who directly and indirectly guided us in the writing report paper. We express our gratitude to our parents, families, friends, and classmates for their continuous support are greatly appreciated.

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1.0 – INTRODUCTION TO AL-MUDHARABAH CONCEPT Mudharabah is a profit sharing. Mudharabah also known an arrangement or agreement between an investor and a project entrepreneur where a project entrepreneur can use the funds to carry out business activities. Profit earned will be shared between 2 parties which is the lenders and the project owners. It is according to agreed ratios while the losses will bear entirely by the lenders (Wikipedia, 2020).

The concept of the Mudharabah contract worked because it made good sense. People need money, need to perform work, or make goods for money, and they cannot engage in that business except by obtaining money to start it. After all, money grows in each society through circulation and trade and investment. Mudharabah is a type of trading partnership in which capital is contributed by the capital provider (rabb al-mal) and labour from the entrepreneur(mudarib). The profit is shared between this 2 parties in the pre agreed contract. In case of loss, it will be bear by the capital provider. The entrepreneur only suffers from the fruitless efforts.

A Mudharabah arrangement could also be concluded between the Islamic banks, as the funds providers, on behalf of itself or on behalf of investment account holders, and the businessmen as well as other craftsmen, like farmers, traders and so forth. The significant relevance of a Mudharabah arrangement may be actualized in the combination of financial and managerial assets between the parties. Mudharabah is applicable to the general of specific investment, project funding, bridge financing, working capital and small and medium financing, interbank investment, structured products, investment deposits, and so on (Research Gate, 2018).

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2.0 – AL-MUDHARABAH CONCEPT IN PROJECT FINANCING TYPES OF MUDHARABAH INVESTMENT ACCOUNT 2.1 - MUDHARABAH AL MUTLAQAH (UNRESTRICTED INVESTMENT ACCOUNT) Unrestrictive Mudharabah mean that a provider of capital or the investor has allowed the working partner the right to undertake in any Shari’ah compliant or legitimate investment. In addition, the working partner has the right to invest in any suitable investment that is realistically estimated to generate profits. It is responsibility of the working partner to prevent illegal and high-risk investments and the working partner shall be liable for any losses caused by these investments. Hence, Al-Mudharabah al-Mutlaqah specifies which party earns what portion of the profit but leaves all other things to the working partner’s discretion.

To clarify that with this type of account, the Investment Account Holder authorises the Islamic Bank to invest the account holder’s funds in a manner which the Islamic Bank deems appropriate without laying down any restrictions as to where, how and for what purpose the funds should be invested. Under this arrangement the Islamic Bank can commingle the Investment Account Holder’s funds with its own funds or with other funds that the Islamic Bank has the right to use (e.g. Current Accounts). The Investment Account Holders and the Islamic Bank generally participate in returns on the invested funds. (AAOIFI 2008)

2.2 - MUDHARABAH AL MUQAYYADAH (RESTRICTED INVESTMENT ACCOUNT) Restricted Mudharabah means that the investor has specified the details of the investment in the mudharabah contract and has restricted the working partner within the scope of that specification. Furthermore, the funds will be deposited in a specific investment account where the working partner will invest the funds into instruments identified by the investor as instructed or outlined in an investment agreement. Moreover, the working partner must take due care and precaution in order to comply with restrictions imposed by the investor.

For example, with this type of account, the Investment Account Holder imposes certain restrictions as to where, how and for what purpose his funds are to be invested. Further, the Islamic Bank may be restricted from commingling its own funds with the restricted Investment Account funds for purposes of investment. In addition, there may be other restrictions which investment account holders may impose. For example, Investment Account Holders may require the Islamic Bank not to invest their funds in instalment sales transactions or without guarantor or collateral or require that the Islamic Bank itself carry out the investment rather than through a third party. (AAOIFI 2008)

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2.3 – INVESTMENT PROCESS OF AL MUDHARABAH

For the beginning, Mudharabah Investment Account also known as Mudharabah Current Account and Saving Account. Mudharabah Investment Account also carry own risk profile reliant to the portfolio of investment account. They categorised the account into three (3) which is low risk investment account, medium risk investment account and high-risk investment account.

Low risk investment account is suitable for short term arrangement with a low return. While medium risk investment account suit for a varied portfolio and high-risk investment account suitable for targeted investment expecting high return. Islamic banks and investors enter a mudarabah deal for mudarabah investment financing. In the mudarabah investment, Islamic bank commits 100 per cent money. The investor serves as fund manager and uses his expertise in management and labour.

The bank also known as a Mudharib has responsibility to prudently invest the deposited funds to the investment account according to the low or medium risk investment to moderate the investment risk. Customer comes in as an investor and willing to see the previous return on the investment in the selected company chosen. The customer will be informed about where the investment will be invested into and will be explain about the potential and the risk of the investment. The Mudarib will make a clear explanation, so that the investor has no doubtful to invest. For example, the investor funds will be invested based on Shariah compliant investment such as Islamic unit trust funds, Islamic real estate investment trust (REITs), Sukuk, Islamic venture capital and many more.

After the investor has agreed and satisfied with the explanation, the investor will decide the specific amount of money will be invest into the account and the duration of the investment. Both parties which is the investor and the Bank (Mudarib) will agree about Profit Sharing Ratio and sign the contract. The amount of funds may not be changed once invested has made. After the maturity date, the Mudarib will distribute the funds and make the investment available to the investor.

The Bank (Mudarib) will declare the profit for the investment at quarterly investment cycles. The distribution to the investor is based on the Profit-Sharing Ratio that has been agreed early. The Mudarib also will calculated the deducting cost and expenses related to the investment before the profit distribute. In the other case, if the company suffered loss, the losses will be bear by the Mudarib (Bank) entirely.

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2.4 – DISTRIBUTION OF PROFIT AND LOSS IN MUDHARABAH CONCEPT According to Bank Negara Malaysia, profit sharing is the main purpose of Mudharabah concept. Moreover, BNM stated that profit shall be based on revenue after deducting all operating costs of the venture and taxes. Other than that, BNM mentions that profit sharing may be based on a ratio or percentage that agreed by all partners. The profit sharing also need to be determined at the time of the conclusion of contract and may be revised from time to time during the contract subject mutual agreement (Bank Negara Malaysia, 2009). Besides that, it is important for Mudharabah 's legitimacy that the parties agree, right at the beginning, on a definite proportion of the actual profit to which each one of them is entitled. Other than that, no proportion has been prescribed by the Shari’ah principle rather; it has been left to their mutual consent. Moreover, both parties can share profit in equal proportions for the rabb-ul-mal and the mudarib. (Usmani, 1998). Mufti Muhammad Taqi Usmani also mentions that it is also allowed that different amounts are accepted. For example, the rabb-ul-mal can say to mudarib, "if you're trading in wheat, you’re going to get 50 percent of the profit and if you're trading flour, you’re going to get 33 percent of the profit” likewise, he can say, "if you're doing business in your town, you’re going to get 30 percent of the profit, and if you're doing it in another town, you’re going to get your share 50 per cent of the profit. Besides the accepted proportion of the benefit as calculated in the above manner, the mudarib cannot demand any periodic salary or compensation or remuneration for the mudarabah's work performed by him. Besides that, Bank Negara Malaysia stated that capital contributed by the manager (Mudarib) as part of the Mudarabah fund shall determine the profit due to or loss suffered by the partner based on the percentage of capital contribution. This is determined prior to profit allocation (if any) to the partner as manager (Mudarib) of the capital provider fund. For example, a manager (Mudarib) in a Mudarabah contract contributed additional capital that becomes 20% of the total fund. In the Mudarabah contract, the manager agrees with the capital provider to share 40% of profits generated by the capital provider fund. The total fund generated RM 100,000 profit. Based on the capital contribution of 20%, the manager earns a profit of RM 20,000. The remaining RM 80,000 profit is then shared between manager and capital provider at RM 32,000 (40%) and RM 48,000 (60%) respectively. If a loss of RM 50,000 is recorded from the total fund, the manager will share the loss of RM 10,000 based on the capital contribution at 20%.

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Other than that, most commonly every investment there must be loss happen and as for that, loss can be recognized when the liability exceeds the value of the assets at a point in time from a balance sheet perspective. In this case, when expenses exceed revenue, an operating loss shall be recorded. Mudharabah operating loss which is measure during the operating period may be offset against prior or future profits. For instance, due to decline in market prices sale of goods by Mudarabah venture is much lower than cost of purchase. As a result, the asset value decreases with given amount of outstanding liability and Mudarabah capital. Hence, the Mudarabah venture reports a loss for the net decrease in capital. Mudarib decides to offset the loss against undistributed profit from previous period. (Bank Negara Malaysia, 2009).

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3.0 – SUGGESTION/CONCLUSION Mudarabah has through various evolutionary changes and transformations since its practice in the pre-Islamic era. The improvement on existing mudarabah conditions in modern mudarabah is acceptable if it does not conflict with the provisions in the al-Quran and Sunnah. The intention of this development is to fulfil the needs of the modern communities and the fastgrowing Islamic financial market. However, mudarabah has many benefits such as higher levels of investment, make sure financial are stable and generate distribution of income (Islamic Market, 2016).

These models support the natural point that relative to a debt structure, both under deterministic and probabilistic system, mudarabah financing resulted in higher investment rated as new venture continued to be pursued if there was the positive. . For financial stability, is further emphasized, how an economy based on the institution of interest is inherently unstable and how the Islamic techniques of finance based on profit and loss sharing has the potential to provide financial stability.

Other than that, although the advantages of Mudharabah financing are widely recognized, they are several problems in mudarabah concept. Several users have clarified the difficulties faced in running Islamic banks and other financial institutions. First, there are no fixed annual payments that are due since they distribute profit equally. Second, Islamic banks cannot take legal action if there are no profits and therefore nothing to be shared to the investor. In the terms of equity, using Mudarabah financing does not rise a firm's risk as debt financing does through increased financial leverage.

Moreover, the problem is not such a big thing because in Mudarabah financing, a Mudarib has every incentive to increase those costs which gain to him as benefits. Similarly, in case of financing a new project or to establish a new subsidiary, a Mudarib will have all the incentives to allocate as much operating cost and other costs of his basis company, to the Mudarabah financed project or subsidiary. The gains from one entity to another will not occur in traditional equity funding, since equity has an unrestricted and continuous claim on all the properties of the company (Islamic Market, 2016).

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4.0 – REFERENCES

Alfatakh, A. (2016). Islamic Bankers Resource Centre - Mudarabah. https://Islamic Bankers

Resource

Centreislamicbankers.me/islamic-banking-islamic-

contracts/deposits-term-deposits/. Bakar,

M.

A.

(2018).

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in

Islamic

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Institutions

.

https://blossomfinance.com/press/17-applications-of-mudarabah-in-islamicfinancial-institutions0. Farlex,

T.

F.

(2003).

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dictionary.thefreedictionary.com/Al-Mudharabah+al-Mutlaqah. Farlex,

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(2020).

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https://financial-

dictionary.thefreedictionary.com/Al-Mudarabah+al-Muqayyadah. Market,

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(2018). Mudharabah.

https://islamicmarkets.com/education/types-of-

mudarabah. Rahman, M. H. (2018). Mudarabah and Its Applications in Islamic Finance. https://www.researchgate.net/publication/328630287_Mudarabah_and_Its_Ap plications_in_Islamic_Finance. Usmani,

D.

M.

(2020).

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https://islamicmarkets.com/education/types-of-mudarabah . Usmani,

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https://islamicmarkets.com/education/mudarabah-distribution-of-profit. Wikipedia. (2020). Mudharabah. https://ms.wikipedia.org/wiki/Mudharabah.

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APPENDIX

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