Issued on: 20 April 2015

Mudarabah

BNM/RH/STD 028-8 Islamic Banking and Takaful
Department

Mudarabah

Table of Contents

PART A     OVERVIEW.............................................................................................. 1

1. Introduction ............................................................................................... 1

2. Policy objectives ....................................................................................... 2

3. Scope of policy document ........................................................................ 2

4. Applicability .............................................................................................. 2

5. Legal provisions ....................................................................................... 3

6. Effective date ............................................................................................ 3

7. Interpretation ............................................................................................ 3

8. Related Shariah rulings and policy documents ......................................... 4

9. Policy documents superseded .................................................................. 4

PART B     SHARIAH REQUIREMENTS AND OPTIONAL PRACTICES ................. 5

10. Definition .................................................................................................. 5

11. Nature....................................................................................................... 5

12. Contracting parties ................................................................................... 6

13. Offer (ijab) and acceptence (qabul) .......................................................... 7

14. Management ............................................................................................ 7

15. Capital ...................................................................................................... 8

16. Profit ....................................................................................................... 11

17. Loss ........................................................................................................ 14

18. Arrangement for guarantee .................................................................... 15

19. Arrangement of a mudarabah with a wadiah, a wakalah or a musyarakah

 ............................................................................................................... 15

20. Arrangement of a mudarabah with a hibah............................................. 16

21. Arrangement of a mudarabah with a promise (wa’d) .............................. 16

22. Dissolution of mudarabah ....................................................................... 17

PART C     OPERATIONAL REQUIREMENTS ....................................................... 18

23. Background ............................................................................................ 18

24. Governance and oversight ..................................................................... 18

25. Structuring .............................................................................................. 21

26. Risk management .................................................................................. 28

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27. Financial disclosure ................................................................................ 29

28. Business and market conduct ................................................................ 30

PART D SPECIFIC OPERATIONAL REQUIREMENTS FOR IFI AS CAPITAL
PROVIDER .............................................................................................................. 32

29. Background ............................................................................................ 32

30. Governance and oversight ..................................................................... 32

31. Structuring .............................................................................................. 38

32. Risk management .................................................................................. 44

33. Financial disclosure ................................................................................ 51

34. Business and market conduct ................................................................ 51

APPENDICES .......................................................................................................... 52

Appendix 1 Legitimacy of mudarabah ........................................................... 52

Appendix 2 Glossary ..................................................................................... 54

Appendix 3 Related Shariah rulings and policy documents ........................... 55

Appendix 4 Differences in the role of IFI in mudarabah ................................. 56

Appendix 5 Mudarabah venture (providing capital via cash) ......................... 57

Appendix 6 Mudarabah involving multiple rabbul-mal ................................... 58

Appendix 7 Proper distribution of profit and loss when mudarib injects capital

.................................................................................................... 59

Appendix 8  Dedicated structure .................................................................... 60

Appendix 9 An example of complex structure in mudarabah ......................... 61

Appendix 10 Prudential limits and requirements based on sources of funds ... 62

Appendix 11 Distress assessment process flow .............................................. 63

Appendix 12 Illustration of additional financial disclosure for mudarabah

venture ........................................................................................ 64

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PART A     OVERVIEW

1. Introduction

 1.1 Compliance with Shariah requirement is a prerequisite in ensuring the

legitimacy and integrity of Islamic financial products and services. In meeting

this expectation, it is essential for an Islamic financial institution (IFI) to

establish the necessary operational framework and infrastructure to ensure

that the conduct of Islamic financial transactions is consistent with Shariah.

 1.2 The Shariah contract-based regulatory policy is intended to promote

transparency and consistency of Shariah contract application which  would

enhance the contracts’ certainty and strengthen Shariah compliance by IFIs.

 1.3 The Shariah contract-based regulatory policy consists of two components,

namely the Shariah and the operational requirements. The Shariah

requirements highlight the salient features and essential conditions of a

specific contract. The latter outlines the core principles underpinning good

governance and oversight, proper product structuring, effective risk

management, sound financial disclosure and fair business and market

conduct. The operational requirements aim to complement and promote sound

application of the Shariah principles.

 1.4 Mudarabah is a contract based on a fiduciary relationship between a capital

provider (rabbul mal) and an entrepreneur (mudarib). Under a mudarabah, any

profit generated from the capital is shared while financial losses are borne by

the rabbul mal.

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2. Policy objectives

 2.1 This policy document aims to:

(a) provide reference on the Shariah rulings associated with mudarabah;

(b) set out key operational requirements with regard to the implementation of

mudarabah; and

(c) promote end-to-end compliance with Shariah requirements which include

adherence to sound banking practices and safeguarding customers’

interest.

3. Scope of policy document

 3.1 Part B provides mandatory Shariah requirements to ensure the validity of

mudarabah and its optional practices.

3.2 Parts C and D provide operational requirements on governance and oversight,

structuring, risk management, financial reporting and business and market

conduct. Part C provides the operational requirements on the mudarabah

where the IFI is a mudarib and/or the rabbul mal of the mudarabah venture,

while Part D provides specific operational requirements where the IFI is the

rabbul mal.

4. Applicability

 4.1 This policy document is applicable to:

(a) all IFIs as defined in paragraph 7.2. Notwithstanding this, licensed

takaful operators under the Islamic Financial Services Act 2013 (IFSA)

shall only apply Part B of this policy document.

(b) all financial products and services structured on mudarabah, except for:

(i) sukuk, collective investment schemes and equities; and

(ii) interbank investments1, which are excluded from Part D.

1  Islamic Negotiable Instruments (INIs) based on mudarabah are also excluded.

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5. Legal provisions

 5.1 The requirements in this policy document are:

(a) specified pursuant to sections 29(1) and (2), 57(1), 135(1) and 277 of the

Islamic Financial Services Act 2013 (IFSA); and

(b) specified pursuant to sections 41(1) and 126 and issued as a direction

pursuant to section 129(3) of the Development Financial Institutions Act

2002 (DFIA).

6. Effective date

 6.1 This policy document comes into effect as follows:

(a) Part B, immediately upon issuance of this policy document; and

(b) Part C and D, on 1 June 2016.

7. Interpretation

 7.1 The terms and expressions used in this policy document shall have the same

meanings as assigned under the Financial Services Act 2013 (FSA), IFSA and

DFIA, as the case may be, unless otherwise defined in this policy document.

 7.2 For the purpose of this policy document:

“S”  denotes a standard, requirement or specification that must be complied

with. Failure to comply may result in one or more enforcement actions;

“G”  denotes guidance which consist information, advice or

recommendation intended to promote common understanding and

sound industry practices which are encouraged to be adopted;

“Islamic financial institution” or “IFI” means:

(a) a licensed Islamic bank under the IFSA;

(b) a licensed takaful operator under the IFSA;

(c) a licensed bank and licensed investment bank under the FSA approved

under section 15(1)(a) of the FSA to carry on Islamic banking business;

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and

(d) a prescribed institution under the DFIA approved under section 129(1) of

the DFIA to carry on Islamic banking business or Islamic financial

business.

 7.3 A glossary of terms used in the policy document is set out in Appendix 2.

8. Related Shariah rulings and policy documents

 8.1 This policy document must be read together with but not limited to such

Shariah rulings and policy documents as specified in Appendix 3.

9. Policy documents superseded

 9.1 This policy document supersedes the requirements for mudarabah in the:

(a) Guidelines on Musharakah and Mudarabah contracts for Islamic Banking

Institutions issued on 15 September 2007 as at the effective date of part

C and D of this policy document; and

(b) Shariah Standard on Mudarabah issued on 22 October 2012.

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PART B     SHARIAH REQUIREMENTS AND OPTIONAL PRACTICES

10.     Definition

S 10.1 Mudarabah2 is a contract between a capital provider (rabbul mal) and an

entrepreneur (mudarib) under which the rabbul mal provides capital to be

managed by the mudarib and any profit generated from the capital is shared

between the rabbul mal and the mudarib according to a mutually agreed

profit sharing ratio (PSR) whilst financial losses are borne by the rabbul mal

provided that such losses are not due to the mudarib’s misconduct (ta`addi),

negligence (taqsir) or breach of specified terms (mukhalafah al-shurut).

11.     Nature

S 11.1 Mudarabah is a contract based on a fiduciary relationship (aqd al-amanah).

Under this principle, a mudarib manages the mudarabah asset in trust and

is not liable for the impairment of the asset except for impairment which is a

result of the mudarib’s misconduct (ta`addi), negligence (taqsir) or breach of

specified terms (mukhalafah al-shurut).

S 11.2 Any of the contracting parties has the right to terminate the contract

unilaterally except in the following conditions:

(a) the mudarib has commenced the work relating to the management of

the capital of the rabbul mal; or

(b) the contracting parties have agreed to enter into a mudarabah contract

for a specified time; or

(c) the contracting parties have agreed not to terminate the mudarabah

contract within a specified time.

2    The terms muqaradah and qirad are synonymous to mudarabah.

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G

11.3 A mudarabah is categorized into two types:

(a) Unrestricted Mudarabah (Mudarabah Mutlaqah).

An unrestricted mudarabah is a contract in which the rabbul mal

permits the mudarib to manage the mudarabah capital without any

specific restriction.

(b) Restricted Mudarabah (Mudarabah Muqayyadah)

A restricted mudarabah is a contract in which the rabbul mal imposes

specific restrictions on the mudarabah terms. The rabbul mal may

specify conditions restricting the mudarib such as the determination of

location, period for investment, type of project and commingling of

funds.

G 11.4 The contracting parties may mutually agree to change the type of

mudarabah they have entered into to another type of mudarabah at any

point in time.

COMPONENTS OF MUDARABAH

12.     Contracting parties

S 12.1 The contracting parties in a mudarabah are a rabbul mal and a mudarib.

S 12.2 Both the rabbul mal and the mudarib must be a natural person or a legal

entity who shall have legal capacity3 to enter into the mudarabah contract

including the capacity to perform agency (wakalah) contract either as a

principal or as an agent.

G 12.3 The contracting parties in the mudarabah contract may involve more than

one mudarib or rabbul mal.

3  The legal capacity of a person, from Shariah perspective, is defined as capacity to assume rights and

responsibilities; and capacity to give legal effect to his action. Among the important conditions are that the
person must possess sound mind and the capacity to distinguish between what is harmful or beneficial to one’s
interests. Legal capacity of a legal entity is defined as eligibility of an entity to acquire rights and assume
responsibilities. In Malaysia, the legal capacity is governed under the Contracts Act 1950 and the Age of
Majority Act 1971.

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G 12.4 In the case of the mudarabah involving more than one rabbul mal, an

agreement among the rabbul mal may be established whereby:

(a) an existing rabbul mal agrees to relinquish his right over a certain

portion of the profit if he withdraws from the mudarabah prior to its

maturity date; and

(b) a new rabbul mal agrees to assume liability in respect of the

mudarabah which is already in operation prior to his participation.

S 12.5 Any terms or conditions in the mudarabah contract has been mutually

agreed between the rabbul mal and mudarib, and does not contravene the

Shariah shall be binding on both parties.

13.     Offer (ijab) and acceptence (qabul)

S 13.1 A mudarabah contract shall be entered into by an offer and acceptance

between a rabbul mal and a mudarib.

G 13.2 The offer and acceptance may be expressed verbally, in writing or any other

methods which could be evidenced by appropriate documentation or record.

14.     Management

S 14.1 A mudarib shall have the right to manage a mudarabah venture.

S

14.2 The mudarib is responsible to ensure proper management of the mudarabah

venture and acts in the interests of the rabbul mal.

S 14.3 The mudarib’s mandate shall be provided under the terms and conditions of

the contract.

G 14.4 The mudarib may assign the mudarabah capital under his management to

another mudarib in another mudarabah (mudarib yudarib) or to an agent

(wakil) subject to the condition that the consent of the rabbul mal is

obtained.

S 14.5 A rabbul mal shall not be involved in managing the mudarabah venture but

shall have a right of access to reasonable information regarding the

mudarabah venture.

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15.     Capital

S 15.1 Capital is an asset provided by a rabbul mal to a mudarib for the purpose of

a mudarabah venture.

S 15.2 The capital of mudarabah (the capital) shall be provided by the rabbul mal

and managed by the mudarib.

S 15.3 The capital shall be identifiable, readily available and accessible for the

mudarib to commence business activities.

G 15.4 The capital may be in the form of cash or in-kind, including intangible assets.

S 15.5 Where the capital is in-kind, it shall be valued in monetary terms either by

agreement between the contracting parties or by a third party, which may

include experts, valuers, or any qualified person, at the time of entering into

a mudarabah contract.

S 15.6 Where the capital is denominated in a different currency, it shall be valued

based on a specific currency as agreed by the contracting parties at the time

of entering into the mudarabah contract.

S 15.7 All forms of debts shall not qualify as capital, including all account

receivables and payments due to the rabbul mal either from the mudarib or

a third party.

S 15.8 All remaining capital shall be returned to the rabbul mal, if any, upon

dissolution or termination of the mudarabah contract.

S 15.9 Any amount of capital due to the rabbul mal under paragraph 15.8 and

profit, if any, shall be deemed as a liability due to the rabbul mal.

S 15.10 The mudarib shall not guarantee the capital except in the case of his

misconduct (ta`addi), negligence (taqsir) or breach of specified terms

(mukhalafah al-shurut).

G 15.11 The mudarabah contract may provide for the gradual withdrawal of capital

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by the rabbul mal during the tenure of the mudarabah contract unless stated

otherwise.

G 15.12 Subject to paragraph 15.13, the mudarib may with the consent of the rabbul

mal commingle the capital with other investment funds

S 15.13 The mudarib shall observe the agreed terms and conditions of the

respective contract.

G 15.14 The mudarib may inject his own funds into the capital subject to the consent

of the rabbul mal and hence a musyarakah contract is formed between the

mudarib (as partner under musyarakah) and the mudarabah venture.

G 15.15 The mudarabah expenditure may be charged to the capital.

S 15.16 The mudarabah expenditure shall be direct expenses that are identifiable

and measurable with regard to a specific investment activity4.

G 15.17 The capital may be fully or partially disbursed as per the terms of the

mudarabah contract.

G 15.18 Where a rabbul mal fails to provide capital as agreed under a mudarabah

contract (defaulting rabbul mal) –

(a) In the case where the defaulting rabbul mal has not paid the capital

within the time stipulated in the mudarabah contract, the contracting

parties may unilaterally terminate the contract. If the mudarib has

commenced work, the rabbul mal has to reimburse the mudarib for any

mudarabah expenditure incurred and pay the mudarib fair and

reasonable wages or fees;

(b) In the case of the mudarabah contract involves one mudarib and one

rabbul mal with staggered capital payment which the defaulting rabbul

mal has made partial capital payment, the contracting parties may,

4  Investment activity in the context of this paragraph refers to Shariah compliant profit generating activities which

may include Shariah compliant provision of finance provided by mudarib using mudarabah fund.

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subject to the terms and conditions of the mudarabah contract, -

(i) revise the mudarabah contract based on the actual capital paid by

the defaulting rabbul mal; or

(ii) terminate the mudarabah contract and consequently:

(a) the mudarib shall return the capital contributed to the

defaulting rabbul mal if any and  share the profits with the

defaulting rabbul mal, if any; and

(b) the defaulting rabbul mal shall bear the mudarabah

expenditure incurred by the mudarib. If the justified

mudarabah expenditure5 incurred exceeds the actual capital

contribution, such liability shall be borne by the defaulting

rabbul mal up to the limit of the total capital amount

committed under the mudarabah contract.

(c) in the case of the mudarabah contract involves one mudarib and

multiple rabbul mal with single capital payment by each rabbul mal,

and where one or more rabbul mal failed to pay, the mudarib may

terminate the mudarabah contract with the defaulting rabbul mal who

failed to pay and may based on agreed terms impose on him to

indemnify the mudarabah venture for any expenses incurred due to his

default.

(d) in the case of the mudarabah contract involves one mudarib and

multiple rabbul mal with staggered capital payment by each or some of

the rabbul mal and where one or more rabbul mal failed to make the

subsequent capital payment, the non-defaulting contracting parties

shall have the following remedies including:

(i) requiring the defaulting rabbul mal to sell his interest to the other

5    Explanation on mudarabah expenditure is provided under paragraph 15.16.

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rabbul mal or to a third party;

(ii) the non-defaulting contracting parties may agree to revise the

mudarabah contract based on actual capital paid; or

(iii) the non-defaulting contracting parties may terminate the

mudarabah contract with the defaulting rabbul mal and may,

based on agreed terms, require him to indemnify the mudarabah

venture for any expenses incurred due to his default.

16.     Profit

S 16.1 Profit sharing is the primary motive of a mudarabah contract and therefore it

is a fundamental component of the contract.

G 16.2 A mudarabah profit (the profit) is the value created over and above the

capital which is determined based on a methodology acceptable by market

conventions or practices.

S 16.3 A mudarib shall not guarantee any profit.

S 16.4 A rabbul mal and a mudarib shall share profit based on a ratio mutually

agreed between them.

S 16.5 The PSR shall be determined at the time of entering into a mudarabah

contract.

G 16.6 The PSR may be revised during the tenure of the mudarabah contract.

S 16.7 Subject to paragraph 16.6, a revision of the PSR shall be mutually agreed

by the rabbul mal and the mudarib.

S 16.8 The mudarabah contract shall not stipulate a pre-determined fixed amount

of profit to one contracting party which deprives the profit share of the other

contracting party.

S 16.9 The profit shall not be fixed in the form of a certain percentage of the capital.

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G 16.10 Notwithstanding paragraph 16.9, the ex-post performance profit amount

(based on the PSR which had been mutually agreed upon between the

rabbul mal and the mudarib) may be translated into a fixed percentage yield

of the capital.

G 16.11 In a multi-tiered mudarabah, two or more profit sharing arrangements may

be agreed upon. In the first tier, a rabbul mal and a mudarib may agree on a

certain PSR. Whilst in the second tier, the rabbul mal (mudarib in the first

tier mudarabah) and the other mudarib may agree on another PSR. Such

arrangement may apply to the following tier respectively. The profit

generated in each tier shall be shared according to the respective PSR.

S 16.12 Pursuant to paragraph 15.14, where a mudarib commingles or injects his

own fund to a mudarabah venture, the mudarib is entitled to the profit based

on his capital contribution in the commingled fund and the remaining profit

shall then be distributed based on PSR in the mudarabah contract.

G 16.13 The rabbul mal and the mudarib may agree on a PSR based on a specified

profit threshold. In the event that:

(a) the actual profit is equivalent or below the threshold, the profit shall be

shared based on the agreed PSR.

(b) the actual profit exceeds the threshold, the excess amount may be:

(i) distributed based on a different PSR agreed by the parties; or

(ii) paid to any of the contracting parties as agreed

G 16.14 The PSR may be varied to correspond with different periods of investment,

different amount of the capital or pre-mature withdrawal of the capital,

provided that the conditions for the variation have been agreed upon by the

contracting parties at the time of entering into the mudarabah contract.

S 16.15 In a single mudarabah contract involving more than one mudarib, a common

PSR is agreed between the rabbul mal and all the mudarib. All mudarib shall

share the mudarib’s profit portion as per the agreed terms.

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S 16.16 Profit  shall  be  recognized based on  the following methodology:

(a) realized basis by actual liquidation of assets of the mudarabah

partnership (al-tandid al-haqiqi); or

(b) constructive basis according to acceptable profit recognition method

which may include valuation according to acceptable market

methodology, independent valuation or valuation based on estimated

figures (al-tandid al-hukmi).

G 16.17 In the case of the profit recognized based on constructive basis, a profit

reserve may be created.

S 16.18 In the case of the profit recognized based on constructive basis, a final

consolidation and adjustment shall be undertaken to determine the actual

profit, either:

(a) at the end of a certain period; or

(b) at the point of actual profit realization.

S 16.19 The profit shall be distributed upon the maturity of a mudarabah venture or

at an agreed period.

S 16.20 Unrealized gains recognized during the mudarabah tenure shall be

recognized as the profit and be included in the profit and loss calculation for

the mudarabah.

S 16.21 A mudarib is only entitled to the profit for works which are integral to the

mudarabah venture and shall not earn any additional fee for such works.

G 16.22 A rabbul mal may commission a mudarib for a fee to perform works apart

from the works integral to a mudarabah venture.

G 16.23 The parties to the contract may agree to set aside the profit as a reserve or

for any other purpose.

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S 16.24 In relation to paragraph 16.23, the reserve shall only be created from the

profit.

S 16.25 In the case where profit reserved is utilised to cover depletion of the capital,

only the profit portion of a rabbul mal in the reserve shall be utilised6.

G 16.26 The contracting parties may agree to a condition whereby a rabbul mal may

be subject to lower or no profit payment if the capital is withdrawn before the

maturity of the mudarabah venture.

17.     Loss

S 17.1 Loss7 shall be borne by a rabbul mal up to the capital value.

S 17.2 A mudarib shall not be liable for any impairment of asset unless such loss is

due to the mudarib’s misconduct (ta`addi), negligence (taqsir) or breach of

specified terms (mukhalafah al-shurut) of the contract.

S 17.3 Notwithstanding paragraph 17.2, in the case of any loss, the mudarib shall

furnish the reason for the occurrence of the loss.

S 17.4 In the case of multiple rabbul mal in a single mudarabah, the loss shall be

borne by each rabbul mal proportionate to his capital contribution.

S 17.5 In the case where a mudarib commingles or injects his own fund to a

mudarabah venture, the loss shall be borne based on the proportion of the

mudarib’s capital contribution in the commingled fund.

6  This requirement is specified to prevent implication of capital guarantee by mudarib.
7  A loss is depletion from the value of capital.

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ARRANGEMENT OF MUDARABAH WITH OTHER CONTRACTS OR CONCEPTS

18.     Arrangement for guarantee

S 18.1 Subject to paragraph 15.10, a mudarib shall not guarantee the capital and/or

profit.

G 18.2 Notwithstanding paragraph 18.1, the following measures may be exercised:

(a) a rabbul mal may take a collateral from the mudarib, provided that the

collateral could only be liquidated in the event of a misconduct

(ta`addi) or negligence (taqsir) or breach of terms (mukhalafah al-

shurut) of a contract by the mudarib; or

(b) the rabbul mal may require the mudarib to arrange for an independent

third party guarantee.

S

18.3 Pursuant to paragraph 18.2(b), the following requirements shall be

observed:

(a) the guarantee shall be executed in a separate contract;

(b) the guarantee shall be utilised to cover any loss or depletion of the

capital; and

(c) the third party guarantor shall be independent from the mudarib such

that it shall not be a related party where:

(i) the mudarib has majority ownership and/or has control over the

third party guarantor; or

(ii) the third party guarantor owns or has control over the mudarib.

19.     Arrangement of a mudarabah with a wadiah, a wakalah or a musyarakah

G 19.1 Contracting parties may agree to an arrangement whereby a certain amount

of fund is assigned as a mudarabah capital and another portion of the fund

is assigned under wadi’ah, wakalah or musyarakah contracts.

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S 19.2 Pursuant to paragraph 19.1, the contracting parties shall observe the

requirements of the mudarabah on the part of fund assigned under the

mudarabah and shall observe the requirements of the wadiah, wakalah or

musyarakah on the part of fund assigned under the respective contract.

20.     Arrangement of a mudarabah with a hibah

G 20.1 A mudarib may provide a hibah to a rabbul mal.

S 20.2 Pursuant to paragraph 20.1, provision of a hibah shall observe the following

conditions:

(a) the hibah shall not be sourced from the capital or the rabbul mal’s

portion of profit; and

(b) provision of the hibah shall not amount to a guarantee of capital and/or

profit by the mudarib.

21.     Arrangement of a mudarabah with a promise (wa’d)

G 21.1 A mudarabah contract may be arranged with a promise (wa`d) where:

(a) a mudarib undertakes to purchase a mudarabah asset upon the

occurrence of a specified event as stipulated in the mudarabah

contract; or

(b) an agent (wakil) appointed by a mudarib undertakes to purchase a

mudarabah asset upon the occurrence of a specified event as

stipulated in the mudarabah contract.

G 21.2 The rabbul mal may request the mudarib to give a promise (wa`d) to

purchase the mudarabah asset over an agreed period of time at market

value, fair value or any price to be agreed by the parties at the time of

purchase.

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DISSOLUTION
22.     Dissolution of mudarabah

S 22.1 A mudarabah contract is dissolved under the following circumstances:

(a) unilateral termination by any of the parties in the absence of any

prohibitive circumstances as per paragraph 11.2;

(b) unilateral termination by any of the parties due to misconduct (ta`addi),

negligence (taqsir) or breach of specified terms (mukhalafah al-shurut)

of contract by the other;

(c) mutual agreement to terminate the mudarabah contract between the

parties;

(d) the mudarabah contract expires upon the maturity date agreed by the

parties;

(e) demise or dissolution of either a mudarib or a rabbul mal;

(f) loss of legal capacity; or

(g) invalidity of the mudarabah.

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PART C     OPERATIONAL REQUIREMENTS

23.     Background

 23.1 Part C outlines the expectations for the establishments of policies and

procedures for a mudarabah venture where an IFI8 is the rabbul mal and/or

the mudarib. It covers requirements to enable effective governance and

oversight, sound risk management, proper product structuring and

appropriate financial disclosure and reporting of a mudarabah venture. It

also highlights expectations on IFIs’ business and market conduct. The

policy intent of these operational requirements is to provide adequate

safeguards for stakeholders’ interests, promote effective implementation of

business and risk management strategies and drive the development and

establishment of the necessary systems, processes and control measures.

24.     Governance and oversight

Principle 1: The IFI shall establish sound governance and oversight structure to
ensure that mudarabah ventures are conducted based on sound practices and
comply with Shariah requirements.

S 24.1 This policy document complements the Guidelines on Corporate

Governance for Licensed Islamic Banks and Guidelines on Corporate

Governance for Development Financial Institutions.

S 24.2 While the broad governance and oversight principles can be applied,

specific requirements are needed to manage the distinct risks and the

unique nature of a mudarabah venture. An IFI shall have sufficient

understanding of its risk profile and availability of resources with the

appropriate knowledge and skill set.

8  Illustration on the differences in the role of IFI is given in the Appendix 4.

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S 24.3 The IFI shall identify areas for further enhancements which include the

establishment of additional roles of the board of directors, board committee,

Shariah committee, senior management and the dedicated function or unit9.

Board of Directors

S 24.4 The board of directors (the Board) shall establish a sound governance

structure to facilitate an effective oversight function on the management of a

mudarabah venture. The adequacy of governance structure shall

commensurate with the nature, complexity and risk profile of the mudarabah

venture.

S 24.5 The roles and responsibilities of the Board with respect to the mudarabah

venture shall include the following:

(a) setting the IFI’s business strategy and risk appetite with regard to the

mudarabah venture;

(b) approving and overseeing policies and procedures for effective risk

management to ensure compliance with the relevant law and

regulations;

(c) ensuring that a comprehensive and effective Shariah governance

framework is in place;

(d) ensuring that the IFI has adequate and qualified personnel with

sufficient knowledge and competency on the concept, application and

risks associated with the mudarabah venture; and

(e) ensuring that independent reviews are conducted regularly to assess

compliance with the policy documents issued by the Bank and internal

policies established by the IFI.

Board Committee

S 24.6 Key responsibilities of the board committee shall include conducting

oversight  to ensure that a mudarabah venture is managed effectively,

9  Dedicated function or unit as per paragraph 30.2.

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assisting the Board in performing its oversight function and providing

recommendations in respect of the management, operations and

performance of the mudarabah venture.

S 24.7 The board committee shall consist of members who are qualified with

sufficient knowledge, competency and understanding of the risks associated

with the mudarabah venture.

Shariah Committee

S 24.8 The Shariah committee shall perform the following to ensure that all

activities associated with a mudarabah venture undertaken by the IFI are

conducted in line with Shariah requirements:

(a) endorse that the Shariah requirements are appropriately applied in the

relevant policies and procedures governing the mudarabah venture;

(b) deliberate and endorse that the terms and conditions stipulated in legal

documentation and other documents10 are in compliance with Shariah;

(c) ensure Shariah review and Shariah audit are conducted, identify

issues and propose appropriate corrective measures; and

(d) advise and provide clarification on relevant Shariah rulings, decisions

or guidelines on Shariah matters issued by the Bank and, if relevant,

any other authorities.

Senior Management

S 24.9 The roles and responsibilities of the senior management with regards to the

mudarabah venture shall include the following:

(a) developing and implementing business strategies, internal control and

risk management requirements in line with IFI’s business objectives;

(b) establishing policies, processes and procedures with regard to proper

management of the mudarabah venture;

(c) implementing relevant internal systems, infrastructure and adequate

10  Such as information published in promotional materials, product manuals or other publications.

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mechanisms to identify, measure, control and monitor risk inherent in

the mudarabah venture;

(d) ensuring that the IFI monitors and has proper and adequate reporting

of the mudarabah venture operations and performance;

(e) identifying, assigning and training of key personnel with the

appropriate skill set for the mudarabah venture and ensuring that the

roles and responsibilities are properly delegated to the relevant

functions within the IFI;

(f) undertaking regular reviews and monitoring compliance with the

approved policies; and

(g) ensuring timely disclosure of relevant information to the Board and the

Shariah committee.

25.     Structuring

Principle 2: The IFI shall ensure that structuring and implementation of
mudarabah venture is supported by comprehensive policies and procedures,
processes, adequate infrastructure and robust documentation.

Principle 3: The IFI shall ensure a sound structuring of mudarabah venture which
includes conducting end-to-end process to match the risk and reward profile
between sources and usage of funds.

Shariah Compliance

S 25.1 An IFI shall be responsible for ensuring:
(a) the overall operations a of mudarabah venture are in compliance with

Shariah requirements;
(b) the product structure, strategies, terms of agreement, asset portfolio11

and type of business involved 12  are endorsed by the Shariah

committee; and
(c) the opinion of the Shariah Advisory Council (SAC) of the Bank is

11  Such as the underlying asset portfolio for a Mudarabah Investment Account.
12  Such as the business or services conducted by the customer as mudarib in a mudarabah venture.

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sought to resolve issues pertaining to Shariah matters as outlined in

the Shariah Governance Framework for Islamic Financial Institutions.

S 25.2 The IFI shall establish an effective framework that is supported by adequate

policies and procedures and competent personnel to ensure that the

mudarabah venture continues to adhere to Shariah requirements.

Contracting Parties13

S 25.3 An IFI shall undertake an assessment on the suitability of the contracting

parties before entering into a mudarabah venture.

S 25.4 The contracting parties' roles and responsibilities shall be stipulated clearly

in the legal documentations.

G 25.5 The contracting parties in a mudarabah venture may involve more than one

rabbul mal which could exist under the following structures:

(a) a “single” PSR structure which creates a mudarabah venture between

a group of rabbul mal with a mudarib; or

(b) a “multiple” PSR structure which creates a mudarabah venture

between each rabbul mal with a mudarib.

Illustration of these structures is given in Appendix 6.

Management of mudarabah venture

S 25.6 As per paragraph 14.5, a mudarabah venture shall only be managed by the

mudarib while the rabbul mal shall have access to information. In this

regard, the rabbul mal shall not:

(a) be involved in the decision making in respect of the mudarabah

venture;

(b) influence decision making in core business areas of the mudarabah

venture14; and

13  Refer to the rabbul mal and the mudarib unless defined otherwise.
14  E.g. a rabbul mal providing advisory services directly contributing to major decision making for the mudarabah

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(c) be involved in the day-to-day management of the mudarabah venture.

Capital

S 25.7 An IFI shall determine the value of capital 15  upon the execution of a

mudarabah contract.

S 25.8 Notwithstanding the type of capital allowed under paragraph 15.4, the

capital shall only be in the form of cash. The capital shall be identifiable,

readily available and accessible at the date of commencement of the

mudarabah venture. The capital shall not be in the following forms:

(a) debt or receivables owing to the rabbul mal; and

(b) encumbered assets16.

S 25.9 Upon disbursement of the capital, the rabbul mal shall assume its rights and

liabilities of the mudarabah venture up to the limit of the amount of capital

disbursed or contributed.

S 25.10 In the event where there is commingling of funds by a mudarib as mentioned

in paragraph 15.12, the IFI shall ensure the following:

(a) identification of funding purpose and assets is clearly stated in the

terms and conditions;

(b) proper tagging of assets (either dedicated or proportionate) at all times

using an appropriate mechanism by the mudarib such as separate

record keeping;

(c) proper valuation of underlying assets under the mudarabah venture is

carried out periodically; and

(d) the rabbul mal has the rights17 on the underlying assets funded by the

rabbul-mal at all times, including upon exit and upon the mudarib’s

winding-up.

venture.

15  To be received by the IFI as a mudarib or to be contributed by the IFI as a rabbul mal.
16  E.g. assets pledged as collateral.
17   Rights as stipulated in the legal documentations.

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S 25.11 Any subsequent commingling of funds arising from the injection of the

mudarib’s own funds into the mudarabah venture shall:

(a) not nullify the mudarabah contract between the rabbul mal and the

mudarib;

(b) continue to cause application of this policy document for the

mudarabah contract;

(c) cause requirements of the musyarakah to apply for the musyarakah

between the mudarib and the mudarabah venture; and

(d) require proper distribution of profit and loss. This is illustrated in

Appendix 7.

S 25.12 The IFI shall observe the applicable prudential limits and requirements

based on the type of mudarabah funds used as specified in the relevant

policy documents as per Appendix 10.

Profit

S 25.13 The PSR shall be mutually agreed between a rabbul mal and a mudarib and

stipulated clearly in a mudarabah contract at the time of entering into the

contract.

G 25.14 In determining the appropriate PSR, the IFI may consider the following

factors:

(a) estimated return on the mudarabah venture;

(b) benchmark rate of return of equivalent product, underlying asset or

business segment; and

(c) estimated management or operational costs incurred by the mudarib in

managing the mudarabah venture.

S 25.15 Notwithstanding the requirements in paragraph 16.16, the profit shall be

recognized and measured based on the applicable Malaysian Financial

Reporting Standards (MFRS).

S 25.16 As required under paragraph 16.18, an IFI shall conduct and, in the case

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where the IFI is the rabbul mal, ensure that the mudarib conducts an

assessment at the end of a certain period of the mudarabah venture or upon

actual realisation of profit to arrive at the actual amount of profit. A final

adjustment in accordance with MFRS shall be undertaken to the amounts

already recognized, to reflect the actual profit of the mudarabah venture.

S 25.17 The methodology used for determining the profit distribution shall be

objective, transparent and acceptable to all contracting parties. Only direct

expenses shall be deducted in calculating the profit, defined18 as expenses

which are:

(a) identifiable and measurable; and

(b) compulsory and incurred in order to complete specific activities in the

mudarabah venture.

S 25.18 The contracting parties shall determine the time period or date for the profit

distribution of the mudarabah venture.

Loss

S 25.19 Pursuant to paragraph 17.1, any loss shall be recognized and measured

based on the applicable MFRS.

S 25.20 Expectations and requirements on the mudarib shall be sufficiently provided

in the terms and conditions to ensure proper conduct of the mudarib and to

protect the interests of the rabbul mal in the event of loss.

S 25.21 The mudarib shall be fully liable if it is proven that the loss is due to his

misconduct (ta’addi), negligence (taqsir) or breach of specified terms

(mukhalafah al-shurut).

S 25.22 If the loss is not attributed to misconduct, negligence or breach of specified

18   As per definition under the policy document on Rate of Return.

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terms of the mudarib, the loss shall be borne by the rabbul mal up to the

amount of capital contributed.

S 25.23 Application of any mechanism which will effectively cause the mudarib to

guarantee the principal amount upfront19 is prohibited.

Guarantee or Collateral
S 25.24 For the purpose of paragraph 18.2 (b), an  independent third party

guarantee shall exclude the following parties:

(a) for corporate guarantors:

(i) entities20 with control over the mudarib; or

(ii) entities controlled by the mudarib

as defined in the MFRS21.

(b) for individual guarantors:

(i) employee (and his close relatives) of the mudarib; or

(ii) controlling shareholder (and his close relatives) of the mudarib.

Exit22 from venture

S 25.25 An IFI shall clearly stipulate the terms and  conditions of an exit of a

mudarabah venture, which includes the:

(a) tenure of the mudarabah venture;

(b) time or intervals allowed for the purpose of withdrawal or redemption;

(c) qualifying criteria for an exit before maturity;

(d) methodology for valuation of underlying assets and calculation of profit

and loss upon the exit;

(e) potential amount payable or to be received, including compensation or

damages incurred; and

(f) operational procedures for the exit including submission of relevant

19  E.g. upfront waiver on loss absorption or wa’d to purchase assets or rights at price equivalent to capital

provided.
20  E.g. parent company.
21  Namely, MFRS 127 Separate Financial Statements.
22  May be in the form of dissolution, termination, withdrawal or redemption of the mudarabah capital.

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documents, notice period, number of days taken to process the

transaction and settlement period.

Documentation

S 25.26 An IFI shall develop comprehensive and legally enforceable documentation

for a mudarabah venture which are in compliance with Shariah and

regulatory requirements.

S 25.27 At a minimum, the legal documentations shall clearly stipulate the following:

(a) the purpose of the mudarabah venture;

(b) the contractual relationship between the various parties;

(c) the rights, roles and responsibilities of the parties to the mudarabah

venture;

(d) the amount of capital contributed by the rabbul mal;

(e) the PSR;

(f) the loss that shall be borne by the relevant contracting parties;

(g) the calculation methodologies and timing for profit distribution;

(h) the tenure of the mudarabah venture;

(i) the pricing or valuation method of underlying assets;

(j) requirements on the reporting of the mudarabah venture’s

performance which includes the frequency and the information to be

reported;

(k) details on the collateral and guarantees including rights over assets, if

any;

(l) the terms and mechanism of  exit; and

(m) the terms, fees and charges to be borne by the relevant contracting

parties where applicable.

S 25.28 The use of Arabic terminology in the documents shall be sufficiently clarified

or translated to facilitate understanding of the contracting parties.

S 25.29 Where there is an arrangement of mudarabah with other Shariah contracts,

the IFI shall ensure that the documentation involved is separated and

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executed in a sequence that is consistent with Shariah requirements.

26.     Risk management

Principle 4: The IFI shall institute and implement sound and integrated risk
management system to effectively manage risks throughout the life cycle of the
mudarabah ventures.

G 26.1 A mudarabah venture may expose a rabbul mal to various types of risks,

such as equity, market, liquidity, credit and operational risks. These risks,

which appear at various stages of transactions, may change in nature and

may necessitate a comprehensive and sound risk management

infrastructure, reporting and control framework.

S 26.2 An IFI shall establish comprehensive risk management policies and

procedures, systems and internal control to address risks in line with its risk

appetite, throughout the life cycle of a mudarabah venture and shall include

the following:

(a) the identification and monitoring of risks;
(b) the appropriate valuation and calculation methodology for underlying

assets and distribution of profit;

(c) the risk exposure limits;

(d) the risk mitigation techniques; and

(e) the monitoring and reporting mechanisms.

S 26.3 Internally, the IFI shall clearly specify and communicate the policies,

procedures and limits to all its relevant functions.

S 26.4 The IFI shall establish a systematic process to review and update its

policies, procedures, internal limits and shall ensure consistency with the

risk appetite of the IFI and material changes within the industry.

S 26.5 The IFI shall have in place a rigorous stress testing framework on the

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mudarabah venture.

S 26.6 In structuring the products based on mudarabah contract, the IFI shall

ensure appropriateness of product structure against the intended risk and

reward profile23,24.

27.     Financial disclosure

Principle 5: The IFI shall provide adequate disclosure and transparency to
facilitate stakeholders’ understanding and assessment of mudarabah ventures.

S 27.1 An IFI shall maintain accounting records and other records in a timely

manner which will sufficiently enable the preparation and reporting of

financial statements that give a true and fair view.

S 27.2 Requirements stipulated in the Guidelines on Financial Reporting for Islamic

Banking Institutions, Guidelines on Financial Reporting for Development

Financial Institutions, Capital Adequacy Framework for Islamic Banks –

Disclosure Requirements (Pillar 3) issued by the Bank and all applicable

MFRS shall be observed by the IFI.

S 27.3 Specific governance and oversight function 25  in place for a mudarabah

venture, if any, shall be disclosed.

23  For example, IFI as a mudarib shall structure an Investment Account product which is commensurate with the

objective as well as targeted risk and return profile of the particular investment account.
24  For example, IFI as rabbul mal shall consider, among other matters, whether the mudarabah requires a Special

Purpose Vehicle or any other specific arrangements.
25  E.g. board observer in respective mudarabah venture and their roles

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28.     Business and market conduct

Principle 6: The IFI shall undertake mudarabah ventures in a fair and transparent
manner in line with Shariah to protect stakeholders’ interests.

S 28.1 An IFI shall give due regard to the interests of contracting parties26 in its

policies and procedures to ensure that a mudarabah venture is conducted in

a fair, transparent, responsible and professional manner.

Fair dealings

S 28.2 The internal policies and procedures of an IFI on business and market

conduct for a mudarabah venture shall reflect fair dealing practices to the

contracting parties, including:

(a) the suitability assessment;

(b) the information provided which shall be accurate, clear and not

misleading;

(c) the fees and charges (if any); and

(d) reasonable care is taken to ensure suitability of advice and

recommendations, if any.

S 28.3 All conflicts of interests including those that will potentially occur under a

mudarabah venture shall be disclosed to the contracting parties by the IFI.

S 28.4 The IFI shall ensure fairness in the terms of the mudarabah contract

including in any amendments to the mudarabah contract during

renegotiation or extension of tenure.

Disclosure of information

S 28.5 At the pre-contractual stage, an IFI shall provide adequate and relevant

information to the potential contracting parties in the marketing and

promotional materials, product disclosure sheet and any other relevant

26  For purposes of paragraph 28, contracting parties refer to the rabbul mal when the IFI is the mudarib or the

mudarib when the IFI is the rabbul mal.

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materials with regard to a mudarabah venture. The information shall include:

(a) a comprehensive description of the mudarabah venture, which

includes;

(i) the contractual relationship between the mudarib and the rabbul

mal;

(ii) the concept of profit sharing between the mudarib and the rabbul

mal and loss bearing by the rabbul mal;

(b) an overview of the transaction’s structure;

(c) the roles, responsibilities, rights and obligations of the contracting

parties;

(d) the key terms and conditions of the mudarabah contract; and

(e) the requirements, if any, for guarantee and/or collateral (including the

rights and obligation of contracting parties on the collateral pledged).

In relation to the product disclosure sheet, the IFI is also required to observe

the minimum information to be disclosed in the product disclosure sheet as

prescribed in the Guidelines on Product Transparency and Disclosure.

S 28.6 The IFI shall facilitate the contracting parties’ understanding of the concept

of a mudarabah contract.

S 28.7 At the point of entering into the contract, the IFI shall disclose the salient

features of the mudarabah venture in the legal documentation to facilitate

the contracting parties’ understanding of the terms and conditions of the

mudarabah contract.

S 28.8 The IFI shall provide appropriate disclosure to the contracting parties during

the tenure of the mudarabah venture such as providing timely notice of

changes to terms and conditions, features, rights and obligations as well as

fees and charges (if applicable).

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PART D SPECIFIC OPERATIONAL REQUIREMENTS FOR IFI AS CAPITAL PROVIDER

29.     Background

S 29.1 In addition to the general operational requirements in Part C, an IFI is

subject to the specific operational requirements under this Part D for a

mudarabah venture which consists of products or services structured using

a mudarabah contract where the IFI is the rabbul mal27. The IFI shall refer to

the Investment Account policy document for specific operational

requirements for a mudarabah contract where the IFI is the mudarib.

30.     Governance and oversight

S 30.1 Sound governance and oversight function requirements for mudarabah

ventures shall reside within both the IFI and the mudarabah venture.

IFI’s level
Dedicated function or unit at operational level

S 30.2 An IFI shall set up a dedicated function or unit specifically for mudarabah

ventures within the IFI with the relevant skills and expertise to provide

oversight on the mudarabah ventures.

S 30.3 The roles and responsibilities of the dedicated function or unit include:

(a) conducting appraisal of proposals received from a potential mudarib

and recommending a mudarabah venture to the relevant management

committee if it is deemed viable;

(b) monitoring the progress of the mudarabah venture, regular on-site28

visits, on-going collection of relevant information and conducting

analysis on impact to the mudarabah venture;

(c) ensuring that risk management policies and internal control to manage

exposures are adhered to; and

27  Recorded as assets in the books of the IFI.
28  Includes on-site visit for Shariah compliance purposes.

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(d) promptly alerting the senior management if abnormalities are detected

and preparing progress reports to the management on a periodical

basis.

S 30.4 The dedicated function or unit shall consist of personnel with the appropriate

expertise, knowledge and competencies in the mudarabah venture.

G 30.5 The IFI may appoint an external party to complement the operations of the

dedicated function or unit29  in areas or business activities where the IFI

does not possess such expertise.

S 30.6 For such appointment under  paragraph 30.5, the IFI must ensure that:

(a) the external party has the credibility, capacity, sufficient knowledge

and expertise in the areas or business activities involved;

(b) there is no conflict of interest between the external party and the IFI;

(c) there is no conflict of interest between the external party and the

mudarib; and

(d) appropriate legal documentation governing the transactions between

the IFI and  the external party to ensure enforceability of provisions

such as liabilities, roles and responsibilities and confidentiality.

Dedicated Structure at Board and Senior Management level

S 30.7 Where the exposure30  to mudarabah ventures reaches 25% of the total

capital31, an IFI shall establish dedicated oversight committees as follows to

enable higher level of focus and in-depth deliberation;

(a) Board Investment Risk Committee (BIRC) at board level; and

(b) Investment Committee (IC) at management level.

S 30.8 The BIRC shall oversee the senior management’s activities in managing

29  Includes advisory, assessment, monitoring, review or any other processes necessary in managing the

mudarabah venture.
30  Includes non-sale based contracts where IFIs may be exposed to capital loss e.g. Musharakah venture.
31  As defined under the Capital Adequacy Framework for Islamic Banks (Capital Components).

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risks related to mudarabah ventures and to ensure that the risk

management processes are in place and functioning effectively. The roles

and responsibilities of the BIRC includes:

(a) reviewing and ensuring the effectiveness of policies and the risk

management framework;

(b) recommending to the Board for new or a change in investment

strategy;

(c) setting an authorisation limit  for investments; and

(d) overseeing the IC.

S 30.9 The IC shall be responsible to oversee the performance and ensure

effective management of mudarabah ventures. The roles and

responsibilities of the IC includes:

(a) overseeing the progress of investment activities;

(b) approving investment application;

(c) recommending investment  proposals and strategies to BIRC; and

(d) performing an oversight function and approving investment to ensure

that the investment is within the IFI’s limit or strategy set.

The dedicated structure and details of the respective roles and

responsibilities are given in Appendix 8.

S 30.10 The membership of the BIRC is limited to non-executive directors with at

least three members and chaired by an independent director.

S 30.11 The IFI shall ensure that at least one member in the BIRC and the IC has

the expertise and experience32 in the main business segments33 relating to

mudarabah ventures.

32  For example, if the IFI is involved mainly in properties, there must be at least a committee member who has

experience in the real estate industry such as involvement in property development companies. In this regard,
experience merely as a banker in real estate or mortgage financing may not be adequate.

33  If the IFI is involved in more than one business segment at a time, the IFI shall apply judgment in identifying the
main business segments that require the existence of a specific committee member with the relevant expertise.

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G 30.12 Notwithstanding the requirements to establish a BIRC under subparagraph

30.7(a), the IFI may leverage on the existing board committee such as

Board Risk Management Committee (BRMC) to undertake the functions of

the BIRC.

S 30.13 If the approach under paragraph 30.12 is adopted, the IFI shall ensure that:

(a) mechanisms are in place to enhance the competency and credibility of

the board committee members, including ensuring that at least one

member in the existing board committee has the expertise and

knowledge in the main business segments relating to the mudarabah

venture; and

(b) the amount of losses or impairment of  the mudarabah venture is low

or insignificant34 at all times.

Mudarabah Venture’s level

Observer

S 30.14 For an IFI as a rabbul mal, the IFI shall ensure that effective mechanisms

are in place to monitor and assess whether the mudarib is executing his

duties effectively, diligently and in accordance with the stipulated terms and

conditions of the mudarabah contract.

S 30.15 The IFI shall establish appropriate safeguard measures to ensure effective

governance and oversight at the venture level.

G 30.16 The safeguard measures may include the appointment of a suitable

observer with the necessary skills and experience at the mudarabah

venture’s board, management or project level. This is to ensure that the IFI

has access to timely information, enhanced understanding of issues and is

able to closely monitor the mudarib’s conduct in executing fiduciary duties

both at the highest as well as at the working level in the mudarabah venture.

34  For example, losses or impairment is not more than 5% of total mudarabah venture exposure.

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S 30.17 Where an observer is appointed for a complex structure such as a

mudarabah venture involving multi-tiered SPV or indirect exposures, such

appointment shall be made at the entity that conducts the actual business

activity and/or the entity which has control over the actual business activity.

Illustration of a complex structure is given in Appendix 9.

S 30.18 The IFI shall establish policies and procedures on the appointment of the

observers which includes the eligibility criteria, conduct, roles and

responsibilities and the review mechanism to enable the observer to

discharge his duties effectively.

S 30.19 The appointed observer shall:

(a) possess skill and in-depth knowledge of the nature of the business of

the mudarabah venture;

(b) possess the necessary qualifications, experience and qualities that

enable him to discharge his duties effectively;

(c) possess the maturity to understand the deliberations carried on in the

mudarabah venture, especially those appointed at the Board level; and

(d) must be “fit and proper” to hold the post which encompass:

(i) his probity, diligence, competence and soundness of judgment;

(ii) his reputation, character, integrity and honesty; and

(iii) any history of offence(s) involving fraud, dishonesty, violence,

incompetence or malpractice, including any engagement in

deceitful, oppressive or improper business practices or any

practices which would discredit him.

G 30.20 The appointed observer may be an employee of the IFI, an employee of an

entity within the IFI’s group of companies or an external party as the subject

matter expert from the relevant industry.

S 30.21 The appointment of the observer shall be subject to the following conditions:

(a) no conflict of interest between the observer and the IFI that may

jeopardize the IFI’s interest. In particular, the IFI is not allowed to

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appoint its Board member as a board observer in the mudarabah

venture;

(b) no conflict of interest between the observer and the mudarib which

may cause the oversight function to be ineffective;

(c) the appointment terms shall define the  rights and responsibilities of

the observer including duties to the IFI, the prohibited conduct and the

disclosure requirements;

(d) if the observer is an external party to the IFI:

(i) the IFI must have in place an assessment process in appointing

an external party as an observer to ensure that he has the

credibility, knowledge and expertise in the areas or business

activities involved; and

(ii) the external party shall provide a written undertaking to the IFI on

the obligation to comply with the secrecy provision stipulated in

section 145 of IFSA, section 133 of FSA or section 119 of DFIA,

as the case may be.

S 30.22 The roles and responsibilities of the observer shall include the following:

(a) reporting the progress and performance of the mudarabah venture to

the IFI in a timely manner;

(b) safeguarding the IFI’s interest;

(c) obtaining necessary information in order to validate any issues faced

by the mudarib; and

(d) maintaining a high level of integrity and avoiding any transactions with

the mudarib or any other parties for personal benefit or gain.

S 30.23 The IFI shall have the following policy in place to ensure the effectiveness of

the observer’s function:

(a) the mudarabah venture is recognized as one of his core job functions;

(b) establish an internal limit on the number of invested entities for which

each individual is allowed to be an observer e.g. each observer is

limited to only two ventures at any time;

(c) any assignment of an alternate observer shall be limited to only one

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other specified35 person, who shall also be subject to the terms and

conditions of the appointment of an observer; and

(d) any fees or remuneration payable to the observer for conducting this

function cannot be sourced from the mudarib.

S 30.24 The IFI shall immediately relinquish the observer’s function upon disposal of

the IFI’s interest in the mudarabah venture.

S 30.25 The IFI shall ensure the independence of all functions at the IFI and venture

level are preserved at all times to enable checks and balances e.g. the

board and project level observer shall not be the same person and the head

of the dedicated unit or function shall not be the board observer.

31.     Structuring

Sources of funds

S 31.1 An IFI’s capital contribution under a mudarabah venture shall be subjected

to the following requirements:

(a) funding from Unrestricted Investment Account (UA)36 and Restricted

Investment Account (RA) are allowed provided that the requirements

as per the policy document on Investment Account37 are adhered to. In

addition, any utilization of UA fund shall be subject to conditions that

would significantly mitigate38 liquidity risks;

(b) funding from shareholders’ funds are allowed subject to the following:

(i) the IFI maintains adequate capital as required under the Capital

Adequacy Framework for Islamic Banks (Capital Components);

and

(ii) the IFI clearly establishes its risk appetite for mudarabah

35  Specified means an alternate observer who shall be made permanent throughout the assignment and not be

replaced by any other person.
36  For the purpose of funding real estate business, UA is eligible as source of fund subject to conditions specified

in paragraph 7.6 of Guidelines on Property Development and Property Investment Activities by Islamic Banks.
37  UA and RA refer to URIA and RIA, respectively in the policy document on Investment Account
38  This may include mechanisms such as matching of tenure between source and usage of funds, allowing

redemptions only upon liquidation of underlying assets or replacement of investors other than the IFI.

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ventures and establishes an internal limit on the use of

shareholders’ funds which commensurate with its risk appetite;

and

(c) funding from deposits are not allowed.

S 31.2 Where the mechanism of matching tenure under subparagraph 31.1(a) is

used to significantly mitigate liquidity risk, any extension to the tenure of the

mudarabah venture shall also be supported by an extension of redemption

period for the UA and RA funds.

Usage of funds

S 31.3 In utilising funds for purposes of a mudarabah venture, an IFI shall assess

the business venture viability and risk profile i.e. cash flow and risk and

reward, in line with the IFI’s risk appetite and sources of funds.

Contracting parties

S 31.4 The terms and conditions for the appointment of a mudarib shall include

clarification of the liabilities to be borne by the mudarib.

S

31.5 An IFI shall assess the need for safety measures to ensure that any

assignment of a mudarabah venture bya mudarib to another mudarib i.e.

second mudarib will not impose additional risk to the mudarabah venture.

S 31.6 For purposes of paragraph 31.5, the IFI shall:

(a) stipulate criteria or conditions of the mudarib in the agreement to

ensure proper selection, effective management and proper conduct of

the second mudarib;

(b) have mechanisms in place to ensure that there is no conflict of interest

between the mudarib and the second mudarib;

(c) ensure that the following mudarabah contracts are executed

separately and shall not negate individual responsibility under each

contract:

(i) the mudarabah contract between the IFI and the mudarib; and

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(ii) the mudarabah contract between the mudarib and the second

mudarib;

(d) ensure that the terms in the contract between the mudarib and the

second mudarib includes:

(i) the roles and responsibilities of the second mudarib including

reporting obligation, frequency and furnishing detailed reports on

any occurrence of loss;

(ii) the liabilities to be held by the second mudarib; and

(e) assess areas where expectations or requirements as imposed by the

IFI on the mudarib should be similarly imposed on the second mudarib.

S 31.7 The IFI shall have a mechanism in place to ensure that there is no conflict of

interest between the mudarib and any parties appointed for business

dealings.

Capital

S 31.8 An IFI shall provide capital only in cash39 to a mudarib. In addition, the

capital provided shall not be via acquisition of shares40 of the mudarib or the

mudarabah venture.

S 31.9 In addition to the requirements in paragraph 25.10, when there is

commingling of the mudarabah capital with the mudarib‘s other funds, the

IFI shall ensure that the terms and conditions as well as any other measures

taken are legally enforceable and effective in ensuring the IFI’s rights on the

underlying assets under the mudarabah venture.

G 31.10 The capital may be fully or partially disbursed as per the terms of a

mudarabah contract and additional capital injection is allowed within the

tenure of the mudarabah venture, subject to mutual agreement between the

IFI and the mudarib.

39  Capital in-kind is not allowed.
40  Where IFI subscribes to the shares issued by the mudarib.

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Profit

S 31.11 The methodology used for determining the calculation and distribution of

profit shall be objective, transparent and acceptable to all contracting

parties.

G 31.12 With regard to the final adjustment to the profit or loss calculation of a

mudarabah venture as mentioned in paragraph 25.16, an IFI may wish to

identify measures to prevent complications of the profit being over-

distributed, before such adjustments are made between the IFI and the

mudarib.

Loss

S 31.13 An IFI shall have effective processes in place to ensure that the mudarib

provides justification and a detailed report on any occurrence of loss,

underperformance against projected returns or derailment from expected

performance in a timely manner to the IFI.

S 31.14 In order to mitigate risks, the IFI shall only provide restricted mudarabah

funding to the mudarib. Under this arrangement, the IFI shall identify specific

requirements such as details on the business scope, specific assets

involved, milestones and deliverables by the mudarib.

G 31.15 The IFI may set criteria41 on misconduct and negligence in the mudarabah

venture terms and conditions to provide clarity, encourage proper conduct of

the mudarib and to protect the interests of the IFI in the event of loss.

S 31.16 The mudarabah venture shall be separated from the mudarib’s other

businesses.  The venture shall be structured via a separate entity e.g. an

SPV if the business falls under the following circumstances:

(a) existence of high-risk activities; where the mudarib has other high-risk

41  Such as setting expectations on maintaining proper books and records, transparency, disclosure of information.

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business activities which may affect the mudarabah venture. Examples

of ventures that are considered as high-risk are:

(i) products that are still at the exploratory or prototype stage e.g.

pharmaceuticals; or

(ii) industries with a high rate of obsolescence e.g. technology

sector; or

(b) inability to practise effective management; where the IFI is unable to

appoint observer(s) or unable to operationalize the use of the

designated account42 under the non-SPV set-up.

S

31.17 The IFI shall assess whether the mudarabah venture should be segregated

from the IFI and structured under a separate entity such as an SPV. The

factors to be considered include:

(a) activities and level of risk involved such as the examples in

subparagraph 31.16(a); and

(b) the need to limit risks or claims on the IFI or potential legal impact to

the IFI.

S 31.18 If the mudarabah venture is structured in the form of a separate entity, it

shall be:

(a) a limited liability entity (e.g. established under the Companies Act

1965); and

(b) for single-purpose only, which shall be determined by the IFI.

G 31.19 While requirements in paragraphs 14.5 and 25.6 limit the IFI’s involvement

in the mudarabah venture, the IFI may identify covenants necessary to

protect the IFI’s interest to be included in the legal documentation and

agreed at the time of entering into the contract. For example:

(a) negative covenants preventing certain actions and conduct  by the

mudarib or positive covenants that requires the mudarib to conduct

42  As per paragraph 32.7.

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specified actions; and/or

(b) prior notification needed to be given to the IFI on specific decisions or

actions taken by the mudarib.

Tenure

S 31.20 An IFI shall determine a fixed tenure 43  for a mudarabah venture. Any

decision to extend the tenure of the mudarabah venture shall be supported

by justifiable reasons such as delay in construction or significant change in

market conditions and after conducting appropriate renegotiation and

reassessment such as the cost benefit analysis.

Guarantee or collateral

S 31.21 For purposes of meeting the requirements under paragraph 18.2, an IFI

shall conduct assessment on:

(a) the need for collateral or guarantee and its intended purpose44;

(b) the value of assets acceptable as collateral;

(c) acceptability of collateral and eligibility of guarantors, which includes:

(i) existing  legal impediments on collateral such as encumbered

assets;

(ii) financial strength of the guarantors; and

(iii) third parties’ eligibility as guarantors  as per paragraph 25.26.

S 31.22 The IFI shall ensure legal enforceability of any collateral or guarantee

documentation.

Exit45 from venture

S 31.23 As part of the measures to mitigate risks, an IFI shall identify potential exit

options in order to immediately cut loss, taking into consideration the overall

impact to the IFI which may include potential compensation or damages

43  Takes into consideration the appropriate tenure to maximise returns.
44  To cover losses due to misconduct, breach of contract or negligence or to cover losses due to any other

reasons.
45  May be in the form of dissolution, termination, redemption or withdrawal of the mudarabah capital.

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payable to a mudarib.

32.     Risk management

S 32.1 An  effective risk management framework shall consist of three main stages

prevalent in a mudarabah venture:

(a) the pre-contractual stage;

(b) the during or on-going stage; and

(c) the exit stage.

Pre-contractual stage

G 32.2 At the pre-contractual stage, the risk management objective is to enable

sufficiency of information for decision making purposes before embarking on

a mudarabah venture.

Feasibility assessment

S 32.3 An IFI shall ensure that the objectives and criteria of potential mudarabah

ventures are in line with the IFI’s investment strategy.

S 32.4 The IFI shall ensure that a comprehensive and robust feasibility and due-

diligence framework is in place to facilitate effective decision making, which

includes the following:

(a) the assessment methodologies employed are suitable for the type of

products, services and business segments under the mudarabah

venture e.g. the use of an assessment framework under a similar

business segment for sale-based financing 46  may not be exactly

suitable for a mudarabah venture due to differences in the nature of

funding;

(b) the assessment shall be based on empirical evidence based on both

quantitative and qualitative analysis. Should there be any data

limitations, the IFI shall identify other means to support the

46 Such as murabahah financing.

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assessment such as using relevant data as proxies. Where judgment

is significantly involved, the IFI shall have in place the parameters for

the application of judgment in the assessment process e.g. identifying

appropriate personnel or committee that can exercise such judgment;

(c) salient risks and important features affecting the prospects of the

mudarabah venture have been taken into consideration. Salient risks

such as investment, market, operational (which includes legal risk and

Shariah non-compliance risk), liquidity and credit risks shall be

assessed appropriately. All relevant factors affecting these risks shall

be identified and assessed including:

(i) the credibility, capability, track record47  and experience of the

mudarib including any other parties involved in the mudarabah

venture such as a second mudarib, agents, contractors and

suppliers. This also includes assessment of potential conflict of

interest amongst the parties involved;

(ii) the transaction or venture characteristics such as marketability of

products or services which are influenced by several factors

including the type and design of the products or services,

consumer demand, location, promotional strategies and

competition;

(iii) the expected selling price, costs involved, expected cash-flow

and any potential changes affecting the mudarabah venture; and

(iv) the enforceability of legal requirements, Shariah-compliance of

the business activities as well as economic and regulatory

changes;

(d) robust methodologies are applied in assessing projection of returns,

costs involved and cash-flows, taking into consideration stressed

conditions such as potential changes in the costs of materials, delay in

sales, increase in labour costs or delay in delivery. For this purpose,

the IFI shall ensure that sound assumptions based on objective

47 Such as performance and financial track record.

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evidence are used in arriving at the projections. In addition, the IFI

shall be more conservative in their projection of returns when the

actual cash-in flow is based on bullet projection of repayments due to

uncertainty in business and market conditions;

(e) the information used for assessment purposes are current, relevant

and obtained from reliable sources; and

(f) the assessment process is conducted by parties48  with appropriate

knowledge and expertise in the relevant business activity and no

conflict of interest with the potential mudarib. Where external parties

are involved, the IFI shall also have in place the policies and

procedures which includes the criteria on the selection of suitable

external parties.

G 32.5 In addition to the assessment usually applied for sale-based financing, the

IFI may wish to apply an appropriate business courtship49 arrangement with

the potential mudarib before embarking in a mudarabah venture. This will

involve arrangement for getting to know the mudarib more thoroughly over a

certain period of time involving close monitoring, information collection and

familiarisation process before entering into the mudarabah venture.

S 32.6 The IFI shall ensure that the rights to fully access the books and records of

the mudarib and any information that would potentially affect the mudarabah

venture shall be clearly stipulated by the terms and conditions.

S 32.7 The IFI shall establish designated account(s) for the mudarabah venture

where all financial transactions shall be maintained to enable close

monitoring and supervision of transactions made by the mudarabah venture.

S 32.8 Any credit facilities other than the capital contributions made under the

48  The party conducting the assessment may be internal or external party.
49  A period of time where an IFI engages and seeks for more information to better understand the business e.g.

request for periodic performance overtime without any obligation.

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mudarabah venture, extended by the IFI shall be made on an arm’s length

basis whereby the terms and conditions for these facilities should not be

more favourable than those granted to other obligors with similar

background and creditworthiness.

S 32.9 The IFI shall assess potential exit strategies for the proposed mudarabah

venture and potential compensation or damages of all contracting parties.

S 32.10 The legal mechanism on exit strategies shall be specifically and

appropriately documented in the mudarabah contract to ensure a smooth

exit.

S 32.11 The IFI shall classify the mudarabah venture as impaired or loss-making in

accordance with the applicable MFRS.

G

32.12 For the purposes of internal assessment, the IFI may use relevant

indicators50 to monitor and classify a mudarabah venture according to its

level of performance.

During or on-going stage
Active monitoring and continued assessment
G 32.13 The risk management objectives at this stage are intended to ensure

continuous monitoring in achieving long term strategy and value creation.

S 32.14 An IFI shall ensure continuous monitoring on a mudarabah venture through

adequate and robust risk reporting, risk monitoring and risk control

framework with the aim to reduce the IFI’s overall risk exposure and

safeguard the IFI’s investment portfolio. Any gaps or inappropriate risk

exposures must be reported immediately.

50  E.g. specified series of reduction or significant percentage of reduction in returns projection.

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S 32.15 The IFI shall have in place early-warning mechanism with pre-identified

trigger events to facilitate prompt decision making upon any alarming

performance of the mudarabah venture.

S 32.16 In respect of the mudarabah venture’s performance reporting, the IFI shall

conduct the following:

(a) identify information required from the mudarib or other contracting

parties, if any, including:

(i) periodical management and financial accounts of the mudarabah

venture;

(ii) key performance indicators;

(iii) risk management practices;

(iv) minutes of the board of director’s meetings; and

(v) significant activities or changes51 that have material effect on the

performance of the mudarabah venture;

(b) mudarib provides periodical reports in a timely manner; and

(c) validate the reports received to mitigate the risk of potential

manipulation on the performance results leading to understatements of

mudarabah earnings. This may include validation of the reported

earnings or losses, calculation of profits and valuation of underlying

assets.

S 32.17 The IFI shall conduct assessment periodically on the projected returns of the

mudarabah venture or upon the occurrence of material changes affecting

the mudarabah venture. The frequency for such periodic assessment shall

commensurate with the level of risk and complexity of the mudarabah

venture.

S 32.18 The IFI shall have in place a sound valuation methodology that provides the

51  Such as change in management (e.g. resignation or election of new board of directors), change in key

contractual parties (e.g. change of agent, contractor, supplier or other outsourcing party), and regulatory
changes in business requirements (e.g. health and safety regulations and product bans).

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possible loss estimates for the mudarabah venture.

S 32.19 The IFI shall establish a process to collect and analyse data and information

on the mudarabah venture.

S 32.20 If a third party is appointed to conduct any activity52 for the mudarabah

venture, the IFI shall ensure that the mudarib conducts the following:

(a) undertake proper selection process;

(b) monitor the effectiveness of functions and conduct of the third party;

(c) disclose information53 about the third party; and

(d) ensure an exit mechanism is in place54.

G 32.21 Legal documentation may contain clauses that will enable the IFI to take

actions against the mudarib’s failure to prepare timely periodical reports

within a reasonable period.

S 32.22 An effective asset-liability management shall be established to manage

mismatch in returns and cash flows of the mudarabah venture and the IFI’s

source of funding.

G 32.23 The contracting parties may appoint an independent third party to carry out

valuations on the mudarabah venture to ensure transparency and objectivity

in the valuation and distribution of the profits.

Underperforming mudarabah venture

S 32.24 If a mudarabah venture is or is expected to be underperforming, the IFI shall

conduct a detailed assessment on whether the mudarabah venture would

continue to be viable.

52  E.g. sub-contracting, management of inventories.
53  E.g. performance history, financial strength and company reputation.
54  E.g. able to replace third party should the arrangement fail to deliver results.

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S 32.25 The viability assessment shall take into consideration the following;

(a) the possibilities for improvement on the issues and factors that lead to

the underperformance;

(b) the feasibility of improvement plans proposed by the mudarib, such as

change in the management, operational processes and period for

turnaround;

(c) the appropriateness of the revised projection of returns and

assumptions used to support such projection;

(d) the additional funding required; and

(e) whether the mudarabah venture’s level of risk and reward are still

within the IFI’s risk appetite.

S 32.26 After conducting the viability assessment of the mudarabah venture, any

decision not to exit shall be:

(a) based on plausible grounds, such as to minimise losses or high

potential to recover the profits and capital;

(b) time-barred, whereby the IFI shall identify a fixed period for the

mudarib to turnaround the mudarabah venture; and

(c) followed by the identification of clear strategies, measures and action

plans55 by the IFI.

S 32.27 Risk monitoring, assessment and control functions shall be strengthened56 if

the underperforming mudarabah venture is to be continued.

Exit Stage

S 32.28 Processes and procedures on the exit mechanism shall be clearly stipulated

and communicated to the relevant functions or departments in an IFI in

order to ensure effective and efficient execution of exit.

S 32.29 An assessment on the impact of each exit options shall be conducted by the

55  Which may include renegotiating the terms of the mudarabah venture.
56  An example of a turnaround process flow for a musyarakah venture is stipulated in Appendix 11.

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IFI to determine the best value realisation.

S 32.30 The IFI shall obtain legal opinion that the exit mechanism can be executed

without any legal impediments.

S 32.31 In the event the IFI exits from the mudarabah venture, an assessment on

any potential damages payable to the mudarib or any other parties involved

shall be conducted.

33.     Financial disclosure

S 33.1 The financial disclosure 57  for a mudarabah venture shall include the

following:

(a) the value of the mudarabah venture:

(i) the initial capital contribution;

(ii) the outstanding or recoverable value58 by sector including any

losses incurred or provisions made during the period; and

(b) the composition of aggregate sources of funds.

S 33.2 Any potential consolidation59 in the financial statements of an IFI arising

from the mudarabah venture shall be notified to the Bank in advance.

34.     Business and market conduct

S 34.1 An IFI shall not disclose any material information, for example trade secrets,

of the mudarabah venture to any third party without authorisation from the

mudarib.

57  Illustration of the disclosure requirements is given in Appendix 12.
58  Exposure value as per MFRS.
59  Refers to line-by-line consolidation.

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APPENDICES

Appendix 1  Legitimacy of mudarabah

1. The legitimacy of the mudarabah contract is derived from the Quran, and

founded on the Sunnah of the Prophet Muhammad (peace be upon him), and

the consensus of Muslim jurists (Ijma’).

The Quran
2. The following verse of the Quran implies the general permissibility of

commercial venture including mudarabah.

(i)  وَن ِيف ُ َْضِرب وَن ي َآَخرُ ْن فَْضِل اللَّهِ اوَ غُوَن مِ تـَ بْ َ ِض يـ َألرْ

“…and others travelling in the earth in quest of Allah’s bounty...”60

The word ( َُون َْضِرب  in the verse implies permissibility to travel in managing (ي

wealth to seek the bounty of Allah SWT which may take the form of

mudarabah.

The Sunnah of The Prophet Muhammad (peace be upon him)

 صاحبه على اشرتط مضاربة ماال دفع إذا املطلب عبد بن العباس كان قال: عباس ابن عن .3

 فهو فعل فإن رطبة، كبد ذات به يشرتي وال ديا،وا به ينزل وال حبرا، به يسلك ال أن

.فأجازه وسلم عليه اهللا صلى اهللا رسول إىل شرطه فرفع ضامن،

“Ibnu Abbas (may Allah be pleased with him) reported that: “When Abbas

Ibn Abd al-Muttalib gave his property to someone for mudarabah, he

stipulated conditions for his partner not to bring the capital onto the sea;

and not to bring with him the capital crossing a valley; and not to buy

60 Surah al-Muzzammil, verse 20.

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livestock with the capital; and if his partner violates the conditions, he

should guarantee the loss occurred. These conditions have been brought

to the attention of Prophet Muhammad (peace be upon him) and he

approved them.”61

            ثالث(  :وسلم عليه اهللا صلى اهللا رسول قال :قال أبيه عن صهيب بن صاحل عن .4

)ال للبيع  للبيت بالشعري الرب وأخالط واملقارضة أجل إىل الربكة: البيع فيهن

“Suhayb (may Allah be pleased with him) reported that the Prophet

Muhammad (peace be upon him) said: Three matters that have the

blessing (of Allah): A deferred sale, muqaradah (mudarabah), mixing wheat

with barley for domestic use and not for sale.”62

Consensus of The Muslim Jurists (Ijma’)
5. The Muslim jurists have reached Ijma’ among them on the permissibility of the

mudarabah contract.

61 Al-Bayhaqi, Al-Sunan al-Kubra, v. 6, p. 111.
62 Ibn Majah, Sunan Ibn Majah, hadith no. 2289.

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Appendix 2 Glossary

Terms Definition

Hibah A transfer of ownership of an asset from a donor to a donee
without any consideration.

Mudarabah asset Asset created under a mudarabah venture.

Mudarabah venture Business or profit generating activities undertaken by
mudarib in managing capital provided by the rabbul mal.

Mudarib Entrepreneur of a mudarabah venture.

Mudarib yudarib Mudarabah contract where the rabbul mal invests his capital
with a mudarib who subsequently invests the fund with
another mudarib.

Musyarakah A partnership between two or more parties, whereby all
parties will share the profit and bear the loss from the
partnership.

Profit sharing ratio  The ratio in which the profits are shared between the rabbul
mal and mudarib.

Rabbul mal Capital provider.

Wa`d A promise or undertaking which refers to an expression of
commitment given by one party to another to perform certain
action(s) in the future.

Wadi`ah A contract by which an asset is placed with another party for
safekeeping.

Wakalah A contract in which a party as principal authorizes another
party as his agent to perform a particular task in matters that
may be delegated, with or without imposition of a fee.

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Appendix 3 Related Shariah rulings and policy documents

1. Investment Account

2. Shariah Advisory Council (SAC) rulings published by the Bank63;

3. Guidelines on Corporate Governance for Licensed Islamic Bank;

4. Guidelines on Corporate Governance for Development Financial Institutions;

5. Shariah Governance Framework for Islamic Financial Institutions;

6. Rate of Return;

7. Musyarakah;

8. Guidelines on Financial Reporting for Islamic Banking Institutions;

9. Guidelines on Financial Reporting for Development Financial Institutions;

10. Capital Adequacy Framework for Islamic Banks – Disclosure Requirements

(Pillar 3);

11. Guidelines on Product Transparency and Disclosure;

12. Capital Adequacy Framework for Islamic Banks (Capital Components);

13. Guidelines on Property Development and Property Investment Activities by

Islamic Banks;

14. Guidelines on Investment in Shares and Interest-in-Shares and Collective

Investment Schemes for Islamic Banks;

15. Single Counterparty Exposure Limit; and

16. Applicable Malaysian Financial Reporting Standards (MFRS).

63  Including Shariah resolutions in Islamic Finance, standards, circulars or any directive pertaining to Shariah

matters issued by the Bank.

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Appendix 4 Differences in the role of IFI in mudarabah

 1. IFI’s role as a rabbul mal

 2.  IFI’s role as a mudarib

Restricted Investment Account (RA) – capital provided by investor

is invested into specific assets as determined by investor.

Unrestricted Investment Account (UA) – capital provided is

invested into assets determined by the IFI.

P/L P/L

RA UA

Asset Asset

1 2

1

2

Investor as
Rabbul Mal

• Investor places fund to IFI
• Investor shares profit with IFI

IFI as Mudarib

IFI as
Rabbul Mal

Mudarib

 can be an existing
entity or an SPV

 uses funds for
business activities

• IFI provides
capital to mudarib

• IFI shares profit
with mudarib

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Appendix 5 Mudarabah venture (providing capital via cash)

Diagram 1:  Provide funding for a specific purpose in a company

IFI Specific
business
segment

Provide
capital

Company (ie. the Mudarib) with
various business segments

Diagram 2:  Provide funding for a special purpose vehicle (SPV)

IFI
Provide capital

Entity (ie. the
Mudarib such as

SPV)

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Appendix 6 Mudarabah involving multiple rabbul-mal

Mudarabah venture
• Mudarib manage

business

Rabbul Mal
A

Rabbul Mal
B

Rabbul Mal
C

Single PSR
50:50

PSR 60:40

PSR 70:30

PSR 50:50

Different PSR

Single PSR structure

Multiple PSR structure

Rabbul Mal
A

Rabbul Mal
B

Rabbul Mal
C

Mudarabah venture
• Mudarib manage

business

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Appendix 7 Proper distribution of profit and loss when mudarib injects capital

Example:

Upon the mudarib injecting his own funds/capital into the business:

1. Musharakah is formed between the mudarib and the mudarabah venture

2. Profit /Loss:

i) For the musharakah, loss shall  be distributed according to the amount

of capital contribution i.e. ratio of 90:10 and profit shall be distributed

according to agreed terms and conditions;

ii) Subsequently, for the mudarabah venture, loss shall be absorbed by

the rabbul-mal and profit is to be calculated as per PSR i.e. ratio of

50:50.

Mudarib IFI

10% capital  90% capital

Musharakah between mudarib
& mudarabah venture

Mudarabah venture
funded under
mudarabah
PSR 50:50

Funds injected by
mudarib

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Appendix 8  Dedicated structure

•

Board
Investment

Risk
Committee

(BIRC)

Material
Board Risk

Management
Committee

(BRMC)

• Review and ensure the
effectiveness of policies and
risk management framework

• Provide recommendation to
the Board for new or change
in investment strategy

• Set authorisation limit  for
investments

• Oversight role to Investment
Committee

• Oversee  the progress of
investment activities

• Approval of investment
application

• Provide recommendation
related to investment
proposal & strategy to BIRC

• Oversight function &
approval of investment
within limit /strategy set

Investment
Committee

(IC)

Credit
Committee

(CC)

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Appendix 9 An example of complex structure in mudarabah

Appoint observer
(board/management/project) at the
entity/entities that:
• Conducts the actual business

activity; and/or
• Has control over the actual

business activity

Project/
Construction

IFI
Capital

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Appendix 10 Prudential limits and requirements64 based on sources of funds

Policy

Document

Sources

of funds

Guidelines on Property Development and

Property Investment Activities by Islamic Banks

Guidelines on

Investment in Shares

and Interest-in-

Shares and

Collective Investment

Schemes for Islamic

Banks

Single

Counterparty

Exposure

Limit (SCEL)

for Islamic

Banking

Institutions

 Use of

General

Investment

Account

(GIA) is

limited up to

15% of total

GIA  fund of

IFI for

funding real

estate

business

Permissible

structure to

participate in

property

development

activities

 Must be

through joint-

venture or

equity

participation

with reputable

property

development

companies

that are not

subsidiaries

of the IFI

Investment

in each real

estate

business

shall not

exceed 25%

of IFI’s total

capital65

 Aggregate book

value of

investment in

shares, interest-

in-shares, CIS

and immovable

properties shall

not exceed 50%

of IFI’s total

capital65

 Aggregate book

value of

investment in

shares & interest-

in-shares shall not

exceed 25% of

IFI’s total capital65

Treatment of

exposures

funded by

RA and UA

as per para

8.5 and 8.6

of the policy

document

RA Not

applicable

Exempted66 Exempted Exempted Excluded67

for IFI as

mudarib

UA Applicable Applicable Applicable Exempted Excluded67

for IFI as

mudarib

64  Subject to changes in respective policy documents.
65  Total capital as per defined in the Capital Adequacy Framework for Islamic Banks (Capital Components)
66  RA funds which are off-balance sheet.
67  For IFI which places RA/UA to another IFI, look-through approach shall apply.

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Appendix 11 Distress assessment process flow

Monitoring of
mudarabah venture

Performance matches
expectation

Performance below
expectation

Normal monitoring
requirements Perform distress

assessment

Exit Retain
mudarabah

venture

Exit
 (Cut loss

limit)

Implement
turnaround strategy
and more vigorous

monitoring
requirements

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Appendix 12 Illustration of additional financial disclosure for mudarabah
venture

Notes to Account

Amount funded by:

  Unrestricted Investment Accounts (UA) x
Restricted Investment Accounts (RA) x
Shareholders' fund x
  xxx

Mudarabah

Sector Initial capital
(RM’000)

Losses/Impairment
Provisions
(RM’000)

Amount as at
 31 Dec 20XX

(RM’000)
Property xxx xxx xxx

Manufacturing xxx xxx xxx
Total xxx xxx xxx

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