Profit-sharing investment accounts in islamic banks or mutualization, accounting perspective

Abstract

Purpose Islamic banks use Mudarabah contract to replace the interest-bearing deposits with profit-sharing investment accounts. The purpose of this paper is to explore the challenges and problems associated with the employment of Mudarabah contract by Islamic banks. Design/methodology/approach The study critically analyzes the Mudarabah contract used by Islamic banks. It reviews the evolution of the contract from its traditional type to more complicated types such as compound, unrestricted, commingled and continuous Mudarabah. The paper investigates the problems that have emerged from implementing such types in current business settings. Findings The paper proves that implementing the Mudarabah contract by banks imposes several problems among which are the following: difficulty in the determination of total profit resulting from Mudarabah and in allocating this profit to the multiple parties involved in Mudarabah; usage of reserves to cater against future losses may undermine the concept of Mudarabah profit-loss sharing and lead to earnings management; corporate governance is also a major problem in Mudarabah contract, as the depositors are exposed to risks but have no governance rights; and Mudarabah may also lessen the fair presentation of financial reporting. Research limitations/implications The paper examines the evolving Mudarabah contract and its implementation challenges, based on available literature (no empirical analysis was conducted). Practical implications The implications are significant for the future development of Islamic contracts and Islamic accounting treatments. Originality/value Many studies explored the Mudarabah contract from a Shariah or law perspective. However, this paper investigates the Mudarabah contract with a focus on the implication on accounting and financial reporting because of the lack of studies in this area. Furthermore, it demonstrates the persistent flaws in the Mudarabah contract, and it proposes a new model for mobilizing funds, i.e. mutual fund.