Contrasting Mudaraba, Musharaka and Istisnaa Certificates

Mudaraba, Musharaka and Istisnaa are three of the more common types of investment contracts found in Islamic banking.  Each investor involved gets a certificate that signifies they are entitled to the portion of the profits generated from those investments. Each certificate has their own unique features that offer a number of advantages and potential pitfalls. Furthermore, profit and loss is handled differently in those investment contracts that it would in the investment contracts found in other forms of banking. This leaves a direct impact on the investor's bottom line.

Understanding Islamic Banking

Like other aspects of Islamic banking, Mudaraba, Musharaka and Istisnaa certificates must follow Shariah--a set of religious laws based on sacred Islamic texts. Among other things, this means that risk of losses is deliberately minimized and certain forms of investments are off-limits. Investors who hold the certificates will not earn any profits from interest payments, since charging interest is not allowed in Islamic banking.

Mudaraba Certificates

Mudaraba is an investment partnership in which the investor provides funds to the investment manager so that the business manager can invest those funds on the investor's behalf. The investor and the investment manager split the profits based on an agreed-upon ratio, but the investor is the one who has to bear all the losses.

There are two types of certificates investors can get from when they invest through Mudaraba--Mudaraba Project Certificates and Muidaraba Certificates. With Mudaraba project certificates, the returns are not fixed - rather, they are determined at the end of every accounting period. These certificates are non-transferable and last for a certain finite period of time. Once that period ends, the investor can extend them if for another finite period of time if he or she so chooses. The Mudaraba certificates, on the other hand, can be held indefinitely. They give the investor stake in the assets of whatever projects the investor chose to invest in.

Musharaka Certificates

Musharaka is an investment contract geared towards small group of investors. The profits are split between investors involved according to a ratio they agree upon ahead of time. The losses are distributed in proportion to how much capital each investor invested. This is designed to make sure that none of the investors suffer an excessive loss.

Musharaka certificates work similar to the Mudaraba certificates. They can be held indefinitely and traded in the secondary markets. The only difference is investors who hold Musharaka certificates will have to suffer some loss.

Istisnaa Certificates

Istisnaa is an investment contract where the investor's capital is used to finance construction and manufacturing projects. The investor earns profit from the profits generated by the end result of such projects. For example, if the investor invested in a the construction of a residential building, theyh will get the portion of the profits generated from sale/rent of the resulting real estate.

Istisnaa certificates all carry equal value, and each gives the investor that holds it an ownership stake in the product produced through the project it finances. Since the investor profits from the product, rather than the project, they do not receive any profit until the project is complete. This means that the investors are more vulnerable to loss than they would be with other investment contracts.