TWO-TIER MUDHARABAH

Two-Tier Mudharabah

Two-Tier Mudharabah

Introduction

The Islamic financial scholars and practitioners alike advocate that Islamic economics has a built-in mechanism that enables the global financial system to perform in an orderly manner and avoid such systemic collapse. They further argue that the current global financial crisis would not have occurred if the Islamic principles of finance were implemented in international financial markets. Others, on the other hand, claim that 'immaturity' of the Islamic financial industry has, at least in part, prevented Islamic banking from facing the same destiny faced by conventional banking. They argue that Islamic banking can no longer claim immunity from the global financial crisis and maintain that Islamic financial system still needs to validate its substance and demonstrate its resilience - considering the fact that this emerging industry comprises a modest proportion of the global financial industry.

The opportunities for Islamic finance are enormous, so are the challenges. Islamic finance is being concurrently challenged on three different fronts: theoretical, operational, and appliance, and that each of these challenges has profound implications for the development and the future direction of the Islamic financial industry. The distinguishing characteristic of Islamic finance is the absence of riba (interest), gharar (uncertainty), maysir (gambling) and haram (prohibitive activities). Being equity-based, the Islamic financial system has a built-in mechanism that, if it does not totally prevent, it certainly minimizes the negative implications and potential risks associated with the international financial market instability. A number of investors may view the Islamic financial products as prohibition-driven; the authors after reviewing Islamic finance rules and regulations demonstrate that Islamic finance puts a well-established system for dealing with financial risk and protecting the economy from unforeseen circumstances and unpleasant events. (Iqbal and Mirakhor, 2007)

Two-Tier Mudharabah

The view of protecting the interest of demand depositors in terms of a theoretical IFI (international financial institutions) model and the case for introducing regulation to protect depositors underlies in the “two-tier 'Mudharabah' model, which does not envisage any reserve requirement. The essence of Islamic financial intermediation being symmetrical risk as well as profit and loss sharing, introducing a guarantee on the downside would run counter to the core objective.

Investment depositors should however expect to be informed on the features of the contract they enter into and have recourse if it is breached. Hence regulation promoting the integrity of fiduciary contracts would be consistent with the theoretical IFI model. Two-tier Mudharabah model seeks to protect depositors, public resources and fiduciary contract integrity. The protection of demand depositors is envisaged in this “two-tier” Mudharabah and can be justified through any of the perspectives discussed below: (Iqbal and Mirakhor, 1999)

Profit Rates Equality: Untenable (unjustified)

1. In two-tier Mudharabah the bank cannot offer the same rate of profit to the depositors as it earns on investing their deposits.

2. Not even if the bank incurs no transaction-costs or the bank does not mix its own capital with the depositors' in the investment.

3. A bank in any case will retain a portion of profit earned for the entrepreneurial service it renders to ...