RM-3.1.1

This Chapter sets out the principles and rules pertaining to the management of risks inherent in the holding of equity instruments for investment purposes. In particular, for Islamic bank licensees, the relevant instruments are typically those based on the Mudarabah and Musharakah contracts. This Chapter focuses on such instruments. The risks entailed by holding equity instruments for trading or liquidity purposes are dealt with under market risk in Chapter RM-4. While investments made via Mudarabah and Musharakah instruments may contribute substantially to Islamic bank licensees' earnings, they entail significant market, liquidity, credit⁸ and other risks, potentially giving rise to volatility in earnings and capital.

⁸ One example of credit risk exposure arises from the Mudarib's obligation to pay the agreed share of profit to the Islamic bank licensee as Rabb al-mal when such payment falls due. Failure to meet this obligation constitutes a case of misconduct and negligence in the part of the Mudarib.

RM-3.1.2

The capital invested through Mudarabah and Musharakah may be used to purchase shares in a publicly traded company or privately held equity or invested in a specific project, portfolio or through a pooled investment vehicle. In the case of a specific project, Islamic bank licensees may invest at different investment stages.

RM-3.1.3

One distinct difference between Mudarabah and Musharakah financings is in terms of Islamic bank licensee's involvement in the investments during the contract period. In Mudarabah, the Islamic bank licensee invests its money as a silent partner and, the management is the exclusive responsibility of the other party, namely the Mudarib. In contrast, in Musharakah financing the Islamic bank licensee invests funds with partners, and the Islamic bank licensee may be a silent partner, or may participate in management. Regardless of the authority under which the profit sharing instruments are used, both Musharakah and Mudarabah are profit-sharing financings, under which the capital invested by the provider of finance does not constitute a fixed return, but is explicitly exposed to impairment in the event of losses (capital impairment risk).