Depositis
Deposits from savers are an important source of financial strength for the Islamic banks. They use it to increase their capacity for financing operations and thereby increase profit for the shareholders. Islamic Banks raise funds generally based on Amanah or Wadiah arrangements, on Mudarabah and on Wakalah for Fund Management. There are two main bases of mobilisation of deposits by Islamic banks that are Current account deposits and Savings deposits. Banks may also get permanent or redeemable equity capital through investment deposits that practically take the form of a running partnership between the depositors. Depositors in Islamic finance can be compared with investors/shareholders in companies, who earn dividends when the investment makes a profit or lose part of their capital if the investment posts a loss. The contractual agreement between depositors and Islamic banks does not pre-determine any rates of return, it only sets the ratio according to which profits and losses are distributed between the parties to the deposit contract.
In Islamic banks, Current Account deposits are based on the principle of Amanah / Wadiah or that of Qard. In the first type, interest-free deposits are held by the banks either in trust (Amanah), or in safe-keeping (Wadiah). Under Amanah arrangement, the Islamic bank treats the funds as a trust and cannot use these funds for its operations; it does not guarantee the refund of the deposit in case of any damage or loss to the Amanah resulting from circumstances beyond its control. In Wadiah, the bank is deemed as a keeper and trustee of funds and has the depositors’ permission to use the funds for its operations in a Shari´ah compliant manner. Deposits under Wadiah take the form of loans from depositors to Islamic banks and the bank guarantees refund of the entire amount of the deposit. While these deposits can be withdrawn at any time, the depositors have no right to any return/profit on such deposits. However, depositors, at the bank's discretion, may be rewarded with a Hibah provided such gifts do not become a custom or a permanent practice. In the second type, the client gives the bank authority to use current accounts funds to invest in its operations, in that case, the deposit amount is considered as a non-interest loan by the depositor to the bank. The bank has the obligation of to return the credit balance upon demand clients who have no right to receive any profit on their balances. The liability to return a Qard deposit is not affected by the bank’s solvency or otherwise.
Savings deposit accounts operate in a different way. The depositors allow the banks to use their money invested in profitable business ventures which are legal and Shari´ah compliant. Generally, deposits in savings accounts are accepted by Islamic banks on the basis of Mudarabah where the depositor is rabb-ul-mal (investor) and the bank is the Mudarib (fund manager). The profit will be shared as per a pre-determined ratio upon, while loss will be borne by the rabb-ul-mal. Profit distribution amongst the depositors and the shareholders will be made according to the weightage assigned usually at the beginning of each month to their investments. Savings deposits are generally paced in a joint investment pool with other deposits mobilised by the Islamic banks.
Investment deposits are accepted for a fixed period of time or term and are governed by the Mudarabah contract with the bank. When deposits are for an agreed fixed term no withdrawal is normally allowed until the end of the deposit term. However, some banks are allowing early withdrawals in an agreed notice period. Term deposits are arrangement where depositors seek some return on their investments; they are taken on a Mudarabah basis. These deposits are allocated to a number of investment pools and the Islamic banks invest the pooled amount in Shari´ah-compliant businesses. All direct expenses are charged to the respective pools; the net proceeds are distributed between the bank and the pools and then among the depositors represented by the pool. The profits from the assets are shared between the depositors and the bank according to a pre-determined ratio agreed upon at the outset. The profit sharing weightages are assigned based on the various tenures and the amount invested under the arrangement. And as required under Mudarabah, depositors have to be informed in advance of the formula used for sharing the net earnings of the investment pool with the bank. In case of the unlikely event of loss, the depositors have to bear the loss on a pro-rata basis while bank goes un-rewarded for all its efforts. If a bank contributes its equity capital in a pool at the time of setting up an investment pool, the relationship will be a combination of Musharakah and Mudarabah, and the bank would be entitled to a proportionate profit on its own investment in relation to the total Mudarabah investment pool. Islamic banks can also open may announce Murabaha and leasing funds in which the risk-averse investors may purchase units and be treated as rabb-ul-mal and get the quasi fixed-return from profits or rentals earned by the respective funds from the trading and leasing activities.
In Islamic banks, Current Account deposits are based on the principle of Amanah / Wadiah or that of Qard. In the first type, interest-free deposits are held by the banks either in trust (Amanah), or in safe-keeping (Wadiah). Under Amanah arrangement, the Islamic bank treats the funds as a trust and cannot use these funds for its operations; it does not guarantee the refund of the deposit in case of any damage or loss to the Amanah resulting from circumstances beyond its control. In Wadiah, the bank is deemed as a keeper and trustee of funds and has the depositors’ permission to use the funds for its operations in a Shari´ah compliant manner. Deposits under Wadiah take the form of loans from depositors to Islamic banks and the bank guarantees refund of the entire amount of the deposit. While these deposits can be withdrawn at any time, the depositors have no right to any return/profit on such deposits. However, depositors, at the bank's discretion, may be rewarded with a Hibah provided such gifts do not become a custom or a permanent practice. In the second type, the client gives the bank authority to use current accounts funds to invest in its operations, in that case, the deposit amount is considered as a non-interest loan by the depositor to the bank. The bank has the obligation of to return the credit balance upon demand clients who have no right to receive any profit on their balances. The liability to return a Qard deposit is not affected by the bank’s solvency or otherwise.
Savings deposit accounts operate in a different way. The depositors allow the banks to use their money invested in profitable business ventures which are legal and Shari´ah compliant. Generally, deposits in savings accounts are accepted by Islamic banks on the basis of Mudarabah where the depositor is rabb-ul-mal (investor) and the bank is the Mudarib (fund manager). The profit will be shared as per a pre-determined ratio upon, while loss will be borne by the rabb-ul-mal. Profit distribution amongst the depositors and the shareholders will be made according to the weightage assigned usually at the beginning of each month to their investments. Savings deposits are generally paced in a joint investment pool with other deposits mobilised by the Islamic banks.
Investment deposits are accepted for a fixed period of time or term and are governed by the Mudarabah contract with the bank. When deposits are for an agreed fixed term no withdrawal is normally allowed until the end of the deposit term. However, some banks are allowing early withdrawals in an agreed notice period. Term deposits are arrangement where depositors seek some return on their investments; they are taken on a Mudarabah basis. These deposits are allocated to a number of investment pools and the Islamic banks invest the pooled amount in Shari´ah-compliant businesses. All direct expenses are charged to the respective pools; the net proceeds are distributed between the bank and the pools and then among the depositors represented by the pool. The profits from the assets are shared between the depositors and the bank according to a pre-determined ratio agreed upon at the outset. The profit sharing weightages are assigned based on the various tenures and the amount invested under the arrangement. And as required under Mudarabah, depositors have to be informed in advance of the formula used for sharing the net earnings of the investment pool with the bank. In case of the unlikely event of loss, the depositors have to bear the loss on a pro-rata basis while bank goes un-rewarded for all its efforts. If a bank contributes its equity capital in a pool at the time of setting up an investment pool, the relationship will be a combination of Musharakah and Mudarabah, and the bank would be entitled to a proportionate profit on its own investment in relation to the total Mudarabah investment pool. Islamic banks can also open may announce Murabaha and leasing funds in which the risk-averse investors may purchase units and be treated as rabb-ul-mal and get the quasi fixed-return from profits or rentals earned by the respective funds from the trading and leasing activities.
Current account deposits
There are two main types of account which are commonly known in the Islamic Banks that are: Current Account and Investment account. Current account deposits are regarded as trusts or safe-keeping and offer the depositors safety of their money against the bank’s guarantee to return their funds on demand.
Similarly, the current account, as operated by conventional banks, is essentially a safekeeping arrangement between the depositors and the bank, which allows the depositors to withdraw their money at any time and permits the bank to use the depositors' money. However, deposits in these banks have their principal guaranteed, and they may agree to pay a return on the deposits that is either fixed or floating, but not linked with the outcome of their economic activities. The mobilised funds are freely used by the banks and are totally liable for their repayment even if the banks incur a loss.
In the case of Islamic banks, current account deposits can be categorised as loans. In fact, the bank guarantees the full return of these deposits on demand to the depositors, who in turn, authorize the bank to utilize their funds for any purpose permitted by the Shari’ah at the bank's own risk. Hence, if there is any profit resulting from the employment of these funds, it accrues to the bank and if there is any loss, it is also borne by the bank. Loans accounts are not eligible for a share in profits, as they are not subject to risk and there shall be no return or mark-up payable on them. Therefore, Islamic banks that have ruled current accounts may be eligible for payment of gifts, but not profits.
Current Account deposits with Islamic banks follow the principle of Amanah, where they cannot be guaranteed or Wadiah where their principle amount is treated as loan and therefore guaranteed, in that case the Islamic bank has the permission the deposits in their own operations. The depositors have no right to any return or profit on such deposits. However, gifts to such depositors can be given entirely at the discretion of the Islamic banks. And as the banks are not allowed to pay any return for the use of the depositors’ funds that take the form of loans, awarding such gifts should not take the form of a custom or a permanent feature of a bank’s operations.
Current Account deposits with Islamic banks can also be based on the principle of Qard, in which case the bank gets authority to use current accounts funds as non-interest loans to invest in its own operations. Current accounts with Islamic banks in case of Qard are similar to current accounts with conventional banks as regards the obligation of the bank to return the credit balance upon demand. The relationship between the depositor and the bank is that of lender and borrower whereby the client is simply the lender and the bank is the borrower. It is of bank’s responsibility to return the full amount of such deposits even in the case of loss in its overall business. If the bank indicates at the time of account opening that it will invest the funds deposited under current accounts at its own discretion in any Shari’ah-compliant business, it can benefit from these accounts without requiring passing on any part of their profit to the depositors, as they are not subject to risk. The bank will be liable for any possible loss and the depositors are guaranteed full repayment of the deposits, net of the service charge, if any. Instead, such accounts may be eligible for gifts for use of the clients’ funds on a non-regular basis, which cannot be seen as dividends.
Investment accounts in account are deposits that are taken on Partnership Basis. They cover all those accounts where the client agrees to place deposits for a fixed period of time or term, and are governed by the Mudarabah contract with the bank. No withdrawal is normally allowed in case of a fixed term deposit until the end of the period. However, more and more banks agree with the client on an early withdrawal notice, or they are simply allowing early withdrawals without notice. Fixed term deposits can be distinguished on the basis of maturity as well as on the basis of purpose, as it is possible to give special instructions to the bank to invest a particular deposit in a specified project or trade. This is the case in restricted investment deposits, where the depositor authorises the bank to invest the fund in specific projects or sectors for a specific period, determining the level of risk to be taken. There also unrestricted investment deposits where the depositor gives the Islamic bank unconditional permission to invest the fund without any restriction as to sector, project or period, etc., provided all transactions are in compliance with Islamic principles and fall within the bank’s investment criteria.
Term deposits follow Mudarabah rules in a first stage; the bank, as Mudarib, uses its discretion in managing the affairs of the Mudarabah and takes other necessary actions for the benefit of the Mudarabah. The deposits are allocated by the bank to a number of investment pools where it puts the invested amount in Shari’ah-compliant businesses. The investment should through the entire process of a business activity which involves risk taking at each stage. The Islamic bank bears all expenses related to general management and distributes the net proceeds between the pools and then among the depositors represented by the pool. How much profit each depositor earns depends on the final outcome of the bank's own investment; in fact, the bank proceeds to a constructive liquidation after the term or at the end of the accounting period, so that the joint relationship starts afresh for the next accounting period. The rate of return on a deposit in an Islamic bank is directly linked to the quality of the bank’s investment decisions. Therefore, instead of promising depositors a predetermined fixed rate of return on their investment, the bank tells them only the ratio in which it will share the profits with them. Profits are calculated and accrued every month and paid on maturity of the deposit or as agreed between a depositor and the bank. If a bank contributes part of its capital in a pool at the time of setting up an investment pool, the partnership will fall under the rules of Musharakah. The bank will be an investor just like other depositors. All participants in an investment pool will be partners among themselves, they will all have the right to participate in the appreciation of the business as a whole and the bank will serve as the fund manager responsible for investing the funds of the investment pool.
Similarly, the current account, as operated by conventional banks, is essentially a safekeeping arrangement between the depositors and the bank, which allows the depositors to withdraw their money at any time and permits the bank to use the depositors' money. However, deposits in these banks have their principal guaranteed, and they may agree to pay a return on the deposits that is either fixed or floating, but not linked with the outcome of their economic activities. The mobilised funds are freely used by the banks and are totally liable for their repayment even if the banks incur a loss.
In the case of Islamic banks, current account deposits can be categorised as loans. In fact, the bank guarantees the full return of these deposits on demand to the depositors, who in turn, authorize the bank to utilize their funds for any purpose permitted by the Shari’ah at the bank's own risk. Hence, if there is any profit resulting from the employment of these funds, it accrues to the bank and if there is any loss, it is also borne by the bank. Loans accounts are not eligible for a share in profits, as they are not subject to risk and there shall be no return or mark-up payable on them. Therefore, Islamic banks that have ruled current accounts may be eligible for payment of gifts, but not profits.
Current Account deposits with Islamic banks follow the principle of Amanah, where they cannot be guaranteed or Wadiah where their principle amount is treated as loan and therefore guaranteed, in that case the Islamic bank has the permission the deposits in their own operations. The depositors have no right to any return or profit on such deposits. However, gifts to such depositors can be given entirely at the discretion of the Islamic banks. And as the banks are not allowed to pay any return for the use of the depositors’ funds that take the form of loans, awarding such gifts should not take the form of a custom or a permanent feature of a bank’s operations.
Current Account deposits with Islamic banks can also be based on the principle of Qard, in which case the bank gets authority to use current accounts funds as non-interest loans to invest in its own operations. Current accounts with Islamic banks in case of Qard are similar to current accounts with conventional banks as regards the obligation of the bank to return the credit balance upon demand. The relationship between the depositor and the bank is that of lender and borrower whereby the client is simply the lender and the bank is the borrower. It is of bank’s responsibility to return the full amount of such deposits even in the case of loss in its overall business. If the bank indicates at the time of account opening that it will invest the funds deposited under current accounts at its own discretion in any Shari’ah-compliant business, it can benefit from these accounts without requiring passing on any part of their profit to the depositors, as they are not subject to risk. The bank will be liable for any possible loss and the depositors are guaranteed full repayment of the deposits, net of the service charge, if any. Instead, such accounts may be eligible for gifts for use of the clients’ funds on a non-regular basis, which cannot be seen as dividends.
Investment accounts in account are deposits that are taken on Partnership Basis. They cover all those accounts where the client agrees to place deposits for a fixed period of time or term, and are governed by the Mudarabah contract with the bank. No withdrawal is normally allowed in case of a fixed term deposit until the end of the period. However, more and more banks agree with the client on an early withdrawal notice, or they are simply allowing early withdrawals without notice. Fixed term deposits can be distinguished on the basis of maturity as well as on the basis of purpose, as it is possible to give special instructions to the bank to invest a particular deposit in a specified project or trade. This is the case in restricted investment deposits, where the depositor authorises the bank to invest the fund in specific projects or sectors for a specific period, determining the level of risk to be taken. There also unrestricted investment deposits where the depositor gives the Islamic bank unconditional permission to invest the fund without any restriction as to sector, project or period, etc., provided all transactions are in compliance with Islamic principles and fall within the bank’s investment criteria.
Term deposits follow Mudarabah rules in a first stage; the bank, as Mudarib, uses its discretion in managing the affairs of the Mudarabah and takes other necessary actions for the benefit of the Mudarabah. The deposits are allocated by the bank to a number of investment pools where it puts the invested amount in Shari’ah-compliant businesses. The investment should through the entire process of a business activity which involves risk taking at each stage. The Islamic bank bears all expenses related to general management and distributes the net proceeds between the pools and then among the depositors represented by the pool. How much profit each depositor earns depends on the final outcome of the bank's own investment; in fact, the bank proceeds to a constructive liquidation after the term or at the end of the accounting period, so that the joint relationship starts afresh for the next accounting period. The rate of return on a deposit in an Islamic bank is directly linked to the quality of the bank’s investment decisions. Therefore, instead of promising depositors a predetermined fixed rate of return on their investment, the bank tells them only the ratio in which it will share the profits with them. Profits are calculated and accrued every month and paid on maturity of the deposit or as agreed between a depositor and the bank. If a bank contributes part of its capital in a pool at the time of setting up an investment pool, the partnership will fall under the rules of Musharakah. The bank will be an investor just like other depositors. All participants in an investment pool will be partners among themselves, they will all have the right to participate in the appreciation of the business as a whole and the bank will serve as the fund manager responsible for investing the funds of the investment pool.
Interest-bearing deposits
Transactions in the Islamic banking system cannot take place on the basis of interest; instead they can take place on the basis of Qard Hasan or profit-sharing. Accordingly Islamic banks can accept interest-free demand deposits, time deposits with different maturities as well as savings deposits. Islamic deposits are generally based on profit-and-loss-sharing and their characteristics may differ from a country to another. The funds flowing into the time deposit accounts and demand deposits accounts form the principal source of Islamic banks’ financing activities on the assets side. Islamic banks can also have investment deposit accounts invested in specific projects with a return based on the outcome of the project and the ratio of profit-sharing agreed between the bank and the depositors.
Current deposits in the Islamic banking system are similar to those in the conventional banking system; they are fully repayable at all times on demand and banks do not usually pay any return on these deposits. In Islamic banking, current account deposits, also called Qard Hasan deposits, are treated as a loan from a customer to the Islamic bank; the bank should guarantee full payment of the principal amount on demand. Demand deposits are considered as Amanah which the bank is expected to hold in trust. Yet, resources of such deposits can be used in operations where there is a possibility of both profit and loss with the specific permission of the depositors.
Saving deposits also exist in the Islamic banking system and are different from conventional saving deposits as they do not include any fixed return based on interest. Holders of savings deposits within Islamic banks may have a return which is not fixed in the contract and which may fluctuate along with the profits of the bank and also share in the losses in there are any. They may be redeemable or non-redeemable and can also be subject to certain restrictions with respect to the amounts and timing of withdrawals from such accounts. However, holders of savings deposits may be given some benefits, though not in the form of a contractually fixed pre-determined return, even though the bank guarantees the full nominal value of these deposits; this is a kind of incentives to attract savings deposits. It could be in form of non-fixed prizes and bonuses in cash or kind; exemption or discount in the payment of commission and fees; and priority in the use of banking facilities.
Time deposits are replaced in the Islamic banking system by deposits which don’t earn a pre-determined return for a fixed period and don’t carry a guarantee of their nominal value. These deposits have different maturity periods and when the Islamic bank makes profits, holders of time deposits will be entitled to receive a certain proportion of these profits. But, the depositor will have also to share in losses that the bank may incur. Islamic banks in some countries may accept investment deposits on both short-term log-term or on unlimited-period. In the latter case, the period of deposit is not specified, and the deposits are automatically renewed unless the customer gives a notice of termination of deposit within an accepted time interval. It is generally agreed that investment deposits of a longer maturity could be given an advantage in form of higher weightages over deposits of shorter maturity in the profit-sharing arrangements.
Current deposits in the Islamic banking system are similar to those in the conventional banking system; they are fully repayable at all times on demand and banks do not usually pay any return on these deposits. In Islamic banking, current account deposits, also called Qard Hasan deposits, are treated as a loan from a customer to the Islamic bank; the bank should guarantee full payment of the principal amount on demand. Demand deposits are considered as Amanah which the bank is expected to hold in trust. Yet, resources of such deposits can be used in operations where there is a possibility of both profit and loss with the specific permission of the depositors.
Saving deposits also exist in the Islamic banking system and are different from conventional saving deposits as they do not include any fixed return based on interest. Holders of savings deposits within Islamic banks may have a return which is not fixed in the contract and which may fluctuate along with the profits of the bank and also share in the losses in there are any. They may be redeemable or non-redeemable and can also be subject to certain restrictions with respect to the amounts and timing of withdrawals from such accounts. However, holders of savings deposits may be given some benefits, though not in the form of a contractually fixed pre-determined return, even though the bank guarantees the full nominal value of these deposits; this is a kind of incentives to attract savings deposits. It could be in form of non-fixed prizes and bonuses in cash or kind; exemption or discount in the payment of commission and fees; and priority in the use of banking facilities.
Time deposits are replaced in the Islamic banking system by deposits which don’t earn a pre-determined return for a fixed period and don’t carry a guarantee of their nominal value. These deposits have different maturity periods and when the Islamic bank makes profits, holders of time deposits will be entitled to receive a certain proportion of these profits. But, the depositor will have also to share in losses that the bank may incur. Islamic banks in some countries may accept investment deposits on both short-term log-term or on unlimited-period. In the latter case, the period of deposit is not specified, and the deposits are automatically renewed unless the customer gives a notice of termination of deposit within an accepted time interval. It is generally agreed that investment deposits of a longer maturity could be given an advantage in form of higher weightages over deposits of shorter maturity in the profit-sharing arrangements.
Deposit-management based on Mudarabah
Mudarabah is one of the main arrangement Islamic Banks use to raise funds. under Mudarabah, the depositors provide the capital for the bank to invest in profitable business ventures which are legal and Shari’ah compliant. The depositor acts like the Rab-ul-maal and the bank as the Mudarib. As fund manager, the bank manages the affairs of the Mudarabah; it can, for example, appoint an agent for selling or buying assets or lease the assets of the Mudarabah, and also takes the necessary actions for the benefit of the Mudarabah, such as the creation reserves to anticipate any unforeseen event. The Mudarabah arrangement is used by Islamic banks in many types of deposits such as saving deposits, investment deposits, risk-prone deposits as well as other specific deposits. Islamic banks may also issue or purchase a variety of Mudarabah Sukuk and certificates
Depositis in savings accounts that are accepted by Islamic banks on the basis of mudarabah are considered investments of depositors for a share in the profit. They are generally placed in a joint investment pool with other deposits mobilised by the Islamic banks. The ratio of profit distribution is agreed upon at the outset between the bank and the depositor. The profit sharing weightages are assigned based on the various tenures and the amount invested under this arrangement. The bank is entitled to a part of the profit, whereas profit distribution amongst the depositors and the shareholders will be made according to these pre-assigned weightage usually at the beginning of each month to their investments.
Term investment deposits are also allocated to a number of Mudarabah investment pools where the Islamic bank invests the pooled amount in businesses which are in compliance with Shari’ah principles. All direct expenses are charged to the respective pools, expenses related to general management are borne by the bank itself, and the net proceeds are distributed between the bank and the pools and then among the depositors represented by the pool. Depositors in the Mudarabah pool are informed in advance of the ratio used for sharing the net earnings of the investment pool with the bank. The profit distribution among the depositors and the bank is done through a constructive liquidation after the accounting period to refresh the joint relationship for the next period. Profits are calculated and accrued every month and paid on maturity of the deposit or as agreed between a depositor and the bank. If the bank also provides funds, it would be entitled to get a profit on its own capital in the proportion which such capital has, to the total capital of the Mudarabah.
In the case where a bank also provides funds from its equity at the time of setting up of an investment pool, suppose the depositors provide $20,000 and the bank provides $20,000 to form an investment pool of $40,000 for a joint business venture; the arrangement would be a combination of Musharakah and Mudarabah and the bank would be entitled to a proportionate profit on its own investment in relation to the total Mudarabah investment pool. If it is agreed to share the profit in the ratio of 40:60 between the bank as mudarib and the depositors, and if the profit earned by the investment pool is $2,000, the bank will receive $800 (40%) as its profit on its own investment of $20,000 representing its share in the investment pool. In addition to such a share in the profit, the bank would also be entitled to share the remaining profit as fund manager for the investment pool on the pre-agreed ratio. The remaining profit of $1,200 will then be distributed between the bank, as mudarib and the depositors at the pre-agreed ratio of 40:60. It means that, out of the profit of $1,200, the bank will receive more $480 and the $720 will be distributed among the other depositors of the investment pool.
Depositis in savings accounts that are accepted by Islamic banks on the basis of mudarabah are considered investments of depositors for a share in the profit. They are generally placed in a joint investment pool with other deposits mobilised by the Islamic banks. The ratio of profit distribution is agreed upon at the outset between the bank and the depositor. The profit sharing weightages are assigned based on the various tenures and the amount invested under this arrangement. The bank is entitled to a part of the profit, whereas profit distribution amongst the depositors and the shareholders will be made according to these pre-assigned weightage usually at the beginning of each month to their investments.
Term investment deposits are also allocated to a number of Mudarabah investment pools where the Islamic bank invests the pooled amount in businesses which are in compliance with Shari’ah principles. All direct expenses are charged to the respective pools, expenses related to general management are borne by the bank itself, and the net proceeds are distributed between the bank and the pools and then among the depositors represented by the pool. Depositors in the Mudarabah pool are informed in advance of the ratio used for sharing the net earnings of the investment pool with the bank. The profit distribution among the depositors and the bank is done through a constructive liquidation after the accounting period to refresh the joint relationship for the next period. Profits are calculated and accrued every month and paid on maturity of the deposit or as agreed between a depositor and the bank. If the bank also provides funds, it would be entitled to get a profit on its own capital in the proportion which such capital has, to the total capital of the Mudarabah.
In the case where a bank also provides funds from its equity at the time of setting up of an investment pool, suppose the depositors provide $20,000 and the bank provides $20,000 to form an investment pool of $40,000 for a joint business venture; the arrangement would be a combination of Musharakah and Mudarabah and the bank would be entitled to a proportionate profit on its own investment in relation to the total Mudarabah investment pool. If it is agreed to share the profit in the ratio of 40:60 between the bank as mudarib and the depositors, and if the profit earned by the investment pool is $2,000, the bank will receive $800 (40%) as its profit on its own investment of $20,000 representing its share in the investment pool. In addition to such a share in the profit, the bank would also be entitled to share the remaining profit as fund manager for the investment pool on the pre-agreed ratio. The remaining profit of $1,200 will then be distributed between the bank, as mudarib and the depositors at the pre-agreed ratio of 40:60. It means that, out of the profit of $1,200, the bank will receive more $480 and the $720 will be distributed among the other depositors of the investment pool.
Protection of risk-averse depositors
In Islamic deposits, the extent of risk-exposure and the period of the deposit determine the return and the nature of the relationship between the bank and the depositors. If the bank records losses as a result of bad investments, depositors may lose some of their deposits. The contractual agreement between depositors and Islamic banks does not pre-determine any rates of return, it only sets the ratio according to which profits and losses are distributed between the parties to the deposit contract.
Risk-averse depositors must establish a capital adequacy requirement with the bank, to protect depositors and to give correct incentives to shareholders to promote prudent behaviour. Whereas, the funds of those who agree to take a risk, but are not in a position to incur a loss may be used for investments offering low-risk on the basis of Murabaha and Ijarah. As trustees, the banks can manage individual portfolios where the investors may have flexibility in choosing the best way and place to invest according to their priorities and risk-bearing levels.
In fact, Islamic banks should take into account the risk-exposure limit of its clients. Widows and the retired people, for example, are normally not in a position to bear the risk of loss, while some other groups, having excess money may be willing to take such risk. Therefore, the deposits of the risk-averse clients can be accepted either in current accounts, as loans that will be guaranteed with no share in the return from the financing operations of the bank, or by introducing special deposit products for them. They can also be made places in general or specific pools governed under the system of Mudarabah using the weightages system or on Wakalah basis.
Deposits accepted by Islamic banks can also be insured against possible losses, if the Takaful contribution does not involve the element of interest. However, According to the rules of partnership adopted by Islamic banks with the depositors, profit and even the repayment of the principal amount of deposits cannot be guaranteed. For that reason, Islamic banks have evolved procedures for deposit and investment protection that include risk management practices. These regulations also tend to limit excessive risk-taking.
Risk-averse depositors must establish a capital adequacy requirement with the bank, to protect depositors and to give correct incentives to shareholders to promote prudent behaviour. Whereas, the funds of those who agree to take a risk, but are not in a position to incur a loss may be used for investments offering low-risk on the basis of Murabaha and Ijarah. As trustees, the banks can manage individual portfolios where the investors may have flexibility in choosing the best way and place to invest according to their priorities and risk-bearing levels.
In fact, Islamic banks should take into account the risk-exposure limit of its clients. Widows and the retired people, for example, are normally not in a position to bear the risk of loss, while some other groups, having excess money may be willing to take such risk. Therefore, the deposits of the risk-averse clients can be accepted either in current accounts, as loans that will be guaranteed with no share in the return from the financing operations of the bank, or by introducing special deposit products for them. They can also be made places in general or specific pools governed under the system of Mudarabah using the weightages system or on Wakalah basis.
Deposits accepted by Islamic banks can also be insured against possible losses, if the Takaful contribution does not involve the element of interest. However, According to the rules of partnership adopted by Islamic banks with the depositors, profit and even the repayment of the principal amount of deposits cannot be guaranteed. For that reason, Islamic banks have evolved procedures for deposit and investment protection that include risk management practices. These regulations also tend to limit excessive risk-taking.
