Mudarabah is a form of sharakah (partnership) in profit (ribh) whereby one party (rab al-mal) provides capital and the other (mudarib) provides labor (including management skills, efforts and time, etc.). Mudarabah financing refers to an agreement between an Islamic bank (or in general an Islamic financial institution– IFI) and a customer, whereby the former contributes capital (ras al-mal) to a venture or activity that will be managed by the customer as mudarib.
It is permissible by shari’ah (Islamic law) to execute a series of mudarabah transactions through a memorandum of understanding in which the amount of mudarabah funds and the duration of investment for each contract are preset and well defined. Furthermore, the memorandum of understanding outlines the general framework (master agreement) for the contract, including the desired form of mudarabah (restricted mudarabah/ mudarabah muqayyadah or unrestricted mudarabah/ mudarabah mutlaqah), either through revolving or separate transactions. It also sets out the profit ratio and the type of securities (daman) that mudarib will provide in order to cover risks (makhater) of negligence (ihmal), misconduct (taqseer), or breach of contractual terms and conditions (ikhlal).
The memorandum of understanding is considered an integral part of future mudarabah transactions between the two parties involved, unless the parties agree otherwise.
