Islamic Finance

Human Capital Mudarabah – an Islamic answer to Student Loans?

Author: Rakaan Kayali

Rakaan Kayali is the author @ Practical Islamic Finance ( and founder @ BFF Income Share Funding ( He was the only student in his graduating class to receive the honor “With Distinction in Finance” for research he did and published at The Ohio State University entitled “The viability of Islamic finance as a substitute for interest-based banking”. He holds degrees in Computer Science & Engineering as well as Finance from The Ohio State University.  

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.

If the investor (rabb-ul-mal) leaves it open for the mudarib to undertake whatever business he/she wishes, the mudarib has the liberty to invest the money as they see fit. This type of mudarabah is called “al-mudarabah al-mutlaqah” (unrestricted mudarabah)

Most people who earn income are engaged in business activity; they are trading in their time and skilled labor in order to receive an income. Whether the person is a doctor, engineer, teacher, mechanic etc. they are all selling their time and skilled labor in order to generate an income.

Typically, Mudarabah implementations have been limited to only certain types of business activity e.g. trading in material goods. However, based on the fact that most income earners are engaged in business activity, I believe the applications of Mudarabah are far more versatile than current implementations suggest. Specifically, I am recommending Mudarabah contracts be used for financing consumer needs. I call the product “Human Capital Mudarabah” or HCM.

With Human Capital Mudarabah, an individual receives a lump sum of money (the mudarib) and commits to sharing with their financier (rabb-ul-mal) a portion of whatever income they earn (profit sharing ratio) for a fixed period of time in which they are fully employed.

Take the following example:

Adam just graduated college and needs $25,000 in financing to buy his first car.

An investor estimates Adam will earn $60,000 annually over the next five years.

Adam and the investor agree to an HCM agreement wherein Adam commits 10% of his income over the next 5 years he is fully employed in return for $25,000 in financing today.

The investor’s return depends on how much income Adam actually earns for the duration of the funding agreement.

Consider the following possible outcomes:

If the investor’s prediction that Adam will earn a $60,000 average annual income is correct, an investment of $25,000 today will yield the investor a 6.4% annualized return.

If Adam earns more than $60,000 annually, the investor’s average return will be more than 6.4%.

If Adam earns less than $60,000 annually, the investor’s return will be less than 6.4%.

If Adam is unemployed for a year during the life of the contract (so the duration of the contract is 6 calendar years) and Adam earns $60,000 annually when he is working, then the investor’s return will be 4.7%

Regardless of how much the investor’s return is, Adam will not be in default so long as he paid the agreed upon 10% of his income for 5 years in which he was fully employed.

There are a number of terms that need to be included in any HCM agreement in order to guarantee the rights of the investor and investee. For instance:

The term “fully employed” needs to be clearly defined in the contract.

Another stipulation is that there must be a limit on the total percentage of income a mudarib can commit to investors. If the percentage of committed income is too high, the mudarib may decide that it’s not worth it to work anymore. However, if the percentage is reasonably low, the mudarib will always be incentivized to work towards maximizing their income because not doing so would mean they have less income to spend on themselves.

For example, a mudarib should not be allowed to commit 50% of their income. Perhaps a reasonable limit is somewhere around the 15% mark for any one mudarib.

Financing this way guarantees affordable payments for the financed (since payments are a fixed percentage of income rather than a fixed dollar amount) and allows investors to invest in a more stable asset class than equity i.e. wages.

When adopted in mass, Human Capital Mudarabah will form the foundation of an economy more equitable than its debt-based counterparts; an economy where human capital is valued more than monetary capital and where opportunity is based on the merit of the individual rather than the social class they belong to.

As I’ve illustrated in other posts, Human Capital Mudarabah agreements are better for the financed, the financier and the economy as a whole.

If you’re interested in receiving financing using Human Capital Mudarabah, and live in the United States, or would simply like to learn more about how the product works, visit:

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  • There are several issues with this.
    One is it incentives students to chase money, whereas an education is about a lot more than this.
    Another is that it puts pressure on the student to graduate, whereas they might want to do a PhD. Or cease studies and pursue another degree altogether.
    A third is that the investor is taking a risk that nobody is ever willing to take. It’s another incarnation of ‘lets educate our community through charity!’ which has proven itself already to be wishful thinking.
    Fourthly the temptation is too great to put into this contract clauses which turn it into an interest based repayment scheme. Else the poor graduate might have not enough to live on (graduate salaries in the UK are appalling and I invite the author to try realistically thinking about this in GBP!)
    Fifthly nobody will opt for this if it is less convenient than state backed traditional student loans. So even if designed perfectly, uptake will be negligible, and we haven’t solved the problem at hand.
    Sixthly, it is a clear ‘legal ploy’ as they say in Islamic jurisprudence; nobody ever thinks of an eighteen year old going to university as a business person, because this simply isn’t the case. Employees are a terrible way to get a return on investment, even if the student decides to go and work at all, in the same country, etc.
    Seventhly, this is only even useful if the lump sum covers all fees, plus food transport rent bills etc. University in the UK is incredibly inflexible and I don’t know if the author appreciates this coming from the US.

    The state exists for a reason. Almost no countries in the first world put their young people through what the US and England are doing. This is firmly the domain of the state and the only real solution is to vote Labour. We can afford to educate people as a society.


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