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A Modaraba company is a unique and prime mode of non-interest Islamic financial system. It is a form of financial contract in which one party, the investor (Rab-ul-mal), entrusts money to another party, the financial manager (Mudarib), for the purpose of carrying out a business (Modaraba). Modaraba is defined in The Modaraba Companies & Modaraba (Floatation & Control) Ordinance, 1980 (hereinafter referred to as the Ordinance) as a business in which a person participates with his money and another with his efforts or skills or both. It shall also include Unit Trusts and mutual funds by whatever name called.
The most common example of a Modaraba can be found in Islamic history when Hazrat Khadijah provided capital for the business of the Holy Prophet Muhammad (Sal-Allahu Alaihe Waalahi Wassalam). The profits and losses in a Modaraba are shared between the investor and financial manager in an agreed proportion.
In Pakistan, the concept of Modaraba was introduced in 1980 when the government realized the need for the Islamization of the economy.
S.7 of the Ordinance, 1980 explains the types of Modaraba Companies:
Mudarabah Al Muqayyadah means a restricted Modaraba where the investor specifies a particular business or a particular place for the financial manager, in which case the manager shall invest the money according to the instructions provided by the investor.
Modaraba Al Mutlaqah means an unrestricted Modaraba where the investor gives liberty and independence to the manager to undertake whatever business he deems fit. However, the manager is not authorized to: keep another manager or a partner, or mix his own investment in that particular Modaraba without the consent of the investor.
In the case of Unrestricted Mudarabah, the manager is authorized to do anything that is normally done in the course of business. However, if they wish to perform any extraordinary work beyond the normal routine of traders, they cannot do so without the express approval of the investor.
A Modaraba may be either for a fixed period or for an indefinite period.
According to Sec. 4 of the Ordinance, the party shall apply to the Securities & Exchange Commission of Pakistan (SECP). When a Modaraba Company is registered with SECP, another application is made for initiating the operation—the floatation of the Modaraba. This application is accompanied by a prospectus related to the nature and conduct of business, Modaraba Certificates, debentures, etc.
An application for the Floatation of Modaraba shall be accompanied by a prospectus which shall contain, inter alia, the following information:
The application, the prospectus, and the documents filed therewith shall be authenticated by all the directors of the Company.
To ensure the compliance of the application with the Shariah, the documents are evaluated by the Religious Supervisory Board (RSB). After clearance from the board, the Company applies to the controller of Capital Issues and Stock Exchange for the floatation of the Modarabas.
The registrar, if he is satisfied after such inquiry and after obtaining such further information as he may consider necessary that the applicant is eligible for registration and that it is in the public interest so to do, may grant registration and that it is in the public interest so to do, may grant registration to such company on such conditions as he may deem fit.
The State Bank has no specific regulations related to Modaraba Companies. These companies are treated as non-banking financial institutions. The instructions of the State Bank of Pakistan for the floatation of the Modaraba by such institutions are given in the Prudential Regulations for non-banking financial institutions. Following are the salient features of these regulations which also apply to the Modaraba Companies.
Each Modaraba will establish with the SBP a reserve fund equivalent to its own paid-up capital. The reserve fund will be established by an annual contribution of at least 20% of the after-tax profits of each Modaraba floated. Once the reserve fund equals the paid-up capital, the annual contribution will be decreased up to 5% of after-tax profits. Stock dividends are considered as an appropriation for this purpose.
The prospectus of the Modaraba should be approved by the Registrar Modaraba, Securities and Exchange Commission of Pakistan, after obtaining a certificate from the Religious Board for the business of the Modaraba.