A Mudarabah contract is based on a partnership in which one partner is the financier (the investor, or rabb-ul-mal) and the other partner (the fund manager, or “mudarib”) manages the financier’s investment in a business activity. Both parties agree in advance to a profit sharing ratio.
With Human Capital Mudarabah, the mudarib receives a lump sum of money today and commits to sharing with rabb-ul-mal a portion of whatever income they earn for a fixed period of time in which they are fully employed.
An example of Human Capital Mudarabah in action can be found here.
From a macro-perspective, societies who use HCM agreements benefit through:
1. Increased societal cohesion.
HCM agreements align the well-being of the financier with the financed. The only way the financier in an HCM agreement will do well is if the financed is doing well. Conversely the financed cannot cause the financier to do poorly without reducing their own income.This dynamic is absent with interest-bearing debt; often lenders will wish default on borrowers in order to foreclose on the collateral or borrowers will purposefully default on their obligations if the asset they purchased becomes worth less than what they owe.
2. Financing the most productive members of society.
By making returns fluctuate based on performance, HCMs guarantee financing will be provided to the most productive members of society first.
If Adam and Kareem have historically produced returns of 8% and 9% respectively, and the rate of interest is currently at 7%, neither person has a decided advantage over the other in the eyes of a lender. A lender is only interested in knowing that the financed will be able to make the 7% interest payments and both Adam and Kareem can. On the other hand, an HCM investor would be more inclined to invest in Kareem since they would share in his success.
3. Reducing societal stress.
The burden of financial stress harms people’s health, relationships and destroys families.
Substituting debt with a product that is designed to provide affordable payments will reduce the burden of financial stress on society. This means less money spent on divorce, marriage counseling, and family services along with lower rates of theft, illness and crime.