Risk Management in
Islamic Financial Instruments
16
Mudaraba is a trustee finance contract, typically utilized under the framework of an Islamic
partnership between an economic agent called rabbul-mal, who is the capital contributor, and
another economic agent, mudarub, who does not make any capital contributions, but, instead,
provides expertise in the deployment of the rabbul-mal’s monies. Amana and kifala (a third
party) become the surety, or guarantor, for the payment of a debt, (if the person originally
liable does not pay) and also act to supplement financial intermediation functions, allowing for
brokerage, custodial services, insurance design, and consulting to take place. Wakala contracts,
which operate on the basis of the agent receiving a fixed fee, do not share in profits, like in the
mudaraba, along with Amanah (an entity representing the idea of safekeeping, in depository
terms, and more generally, trust), are perceived as being practically less effective, and, as a
result, are used with less frequency. Ju’ala, often utilized to offer consultations, fund
placements, trusts, and other professional services, deals with offering a service for a pre-
determined fee or commission as dictated in contractual terms. In said contract, one party pays
another party a specified amount of money as a fee for rendering a specified service in
accordance with the terms of the stipulated contract between the two parties. According to
Vogel and Hayes (1998), due to the fact that ju'ala allows contracting on an object that may not
exist (or come under a party’s control), it can be used to construct novel Islamic financing
structures. Lastly, Takaful, a term being more frequently heard in the Islamic finance space, is a
cooperative financial mechanism in which participants contribute funds (to be invested solely
in interest free, Shari’ah compliant investments) into a Takaful pool, the source of the monies
they will receive in the event of an insurance claim. Unlike traditional insurance mechanisms
in which there is a naturally adversarial relationship between the insurer and the insured, in
takaful pools, the insurer does not profit from higher premiums, but rather, often receives a
fixed rate as compensation for properly allocating/compliantly investing funds over the course
of the life of the pool.4
Transaction and Asset-Based Contracts
Qard el-hasan, a benevolent loan, is, like zakat, a method of social welfare promotion. The
contract’s most notable feature is its unilateral transactional framework. By that, it is meant
that the recipient of the loan monies from the giving party is not obligated by contractual
terms to pay the loan back. On the other hand, murabaha* 5 (mark-up transactions) and bay
salaam (sale contract with deferred delivery, e.g. farmers selling prior to their crop’s yield) are
trade-based agreements and are typically utilized in the context of commodities. Due to the
constraints regarding liabilities in Islamic banking, the asset side of the industry allows for
more expansive diversification of asset classes, i.e. greater variance among risk and maturity
profiles. Examples of these assets include risk adverse, short-maturity investments derived
from trade activities, like murabaha, bay mua’jal, and bay salaam.6 Typically, asset-backed
4 *In Western countries, in particular, takaful companies usually act as subsidiaries of larger non-compliant entities, meaning that sometimes
non-compliant companies dictate compliant investing on behalf of the pool in order to maximize the life of pool.
5 *Cost plus transactions in which a buyer and intermediary agree upon a to-be-paid price by the buyer, following the intermediary’s purchase
of the entity for sale
6 Hawary, Dahlia El, Wafik Grais, and Zamir Iqbal. "Regulating Islamic Financial Institutions: The Nature of the Regulated." International
Conference on Islamic Banking: Risk Management, Regulation and Supervision, Aug. 2003. Web.