RESOURCE & DEPOSIT

MOBILIZATION BY ISLAMIC BANKS

THE LIABILITY SIDE

Muhammad Saarim Ghazi

AssociateMuhammad Fellow IIBISaarim - London Ghazi

AGENDA

Features of contracts used in deposit management Shariah position of various deposits Profit mechanics Special considerations & recommendations for Islamic Bank Determining balances for profit entitlement Summary: Profit/Loss Allocation mechanism

Islamic banks may raise funds generally based on any of the following five arrangements.

Amanah or Wadiah (Trust) Qard-e-Hasan Mudaraba (P/L Sharing)

Musharaka (P/L Sharing)

Wakalatul Istismar (Funds Mobilized on an Investment Agency)

AMANAH OR WADIAH (TRUST)

Characteristics

Amanah refers to deposit held in trust. Amanah can not be used by the holder If the bank have any explicit or implicit permission then these are covered in Wadiah Amanah entails absence of liability for loss except in breach of duty The depositors will not be entitled to any profits

The depositors can withdraw his deposits at any time without giving notice

QARD-E-HASAN
Characteristics

The relationship between depositor & the bank is that of lender & borrower Qard-e-Hasan can be used by the holder Qard-e-Hasan does not entail absence of liability for loss; bank guarantees refund of entire amount even in case of loss(OIC Fiqh Academy Jeddah) The depositors will not be entitled to any profit The depositors can withdraw his deposits at any time without giving notice

Mudaraba (P/L Sharing)

It is a partnership agreement in which one party invests while the other manage the business Depositors are Rabb-ul-Maal & the Bank is Mudarib Profits are shared between depositors & bank according to a pre-agreed ratio Losses are borne by Investors (Rabb-ul-Maal) on a pro-rata basis while bank goes un-rewarded for all its efforts

Mudarabah + Musharaka (P/L Sharing)

It is a partnership agreement in which a joint pool of funds is formed, in which all partners contribute capital as well as efforts.

Bank & depositors are partners.

Profits are shared between partners on pre-agreed ratio. Losses are shared according to ratio of investment If bank invests its own money than bank will be investor just like other depositors. All participants in the investment pool will be partners among themselves & bank will also serve as the fund manager (Mudarib). Relationship within the pool would be governed by the rules of Musharaka & overall relationship between bank & the depositors remain as Mudarib and Rabb-al-Maal.

Example; Profit distribution in above case

Depositors Investment Bank Investment Agreed Profit Ratio Profit Bank Share

$2000 $1000 50:50 $300 $200(1/3rd on its own + $100($200*50%))

Depositors Share

$100

Wakalatul Istismar
(Funds Mobilized on an Investment Agency)

The model is used mostly for fund management by investment banks or by commercial banks Investors appoint bank as Wakeel (agent) to act on their behalf The bank as a Wakeel would charge a fee from investors for providing service

Bank will get a certain commission, irrespective of the profit or loss to the portfolio
So, all profits or losses, after deduction of fundmanagement commission, will be distributed among investor(s)

Deposit Mobilization

Current Account Deposits

Amanah or Wadiah Malaysian Practice Qard-e-Hasan Pakistani Practice

Saving (Deposit) Account

Mudarabah Musharakah

Investment (Deposit) Account

Musharakah Mudarabah
Investment deposit; Specific Purpose (Restricted Mudarabah) Investment deposit; General Purpose (Unrestricted Mudarabah)

Deposit Mobilization

Contd

Cash Management Account

Investment deposit; Specific Purpose (Restricted Mudarabah) Investment deposit; General Purpose (Unrestricted Mudarabah)

Mudarabah Certificates

Mudarabah

e.g. Meezan

Wakalatul Istismar

Wakalah

PROFIT MECHANICS

The whole profit from the assets given in the pool is distributed among the funds providers on the basis of weighted funds The profit sharing weightages are assigned based on the period & maturity of funds deposited with the bank The basic rule is that the longer the period of maturity, the higher the weightages The rationale behind this is that a longer-term depositor is adding greater value & taking a longer exposure

Example: The Bank of Khyber - 2006

Riba Free Certificates RFCs RFCs 1 year-Monthly RFCs 1 year-Quarterly RFCs 1 year-Six Monthly RFCs 1 year-Maturity

Weightages 1.090 1.158 1.168 1.178 1.192

RFCs 5 year-Monthly RFCs 5 year-Quarterly RFCs 5 year-Yearly RFCs 5 year-Maturities

1.910 1.920 1.940 1.984

The serious issue in this regard is assigning different weightages, keeping in view the size of investment account
The Bank of Khyber Interest free PLS Saving Account Less than 1 million 1 million upto 5 million 5 million upto 10 million 10 million &above 1.000 1.030 1.060 1.090

Assigning different weightages to larger deposits as a normal practice should not be allowed keeping in view the principle of justice

Another aspect that Islamic banks have to bear in mind is that no deposit should be excluded from the profit entitlement
Example: A deposit with less than a 1 million average monthly balance will not be entitled to any profit As a policy concept, above practice has to be avoided for the dispensation of justice that is the reason dtre of Islamic finance

SPECIAL CONSIDERATIONS RECOMMENDED FOR ISLAMIC BANK

Banks should take into account the risk-exposure limit of its clients. Widows & Retired Citizens, are normally not in a position to bear the risk of loss. Weightages given to various categories of savings/term deposits have to be indicated in advance. Banks should not be allowed to indicate Expected Rates of Return as it opens a back-door to interest.

DETERMINING BALANCES FOR PROFIT

ENTITLEMENT

The Islamic banks usually use daily credit balances or daily product to calculate the profits. This concept is applied to savings & term deposits.
More applicable for saving-type of accounts where depositors are permitted to make withdrawals. The calculation on daily product is just that the calculation on the minimum balance or average balance

Example: Daily Product Basis

Date June 1 2 . . 28 29 30 Profit Calculation 28*$10,000 = 2*$1,000 = Total Use = $282000/30=

Balance $10,000 $10,000 . . $10,000 $1,000 (Withdrawal of $9,000) $1,000

$280,000 $2,000 $282,000 $9400

SUMMARY: PROFIT/LOSS ALLOCATION MECHANISM

Deposits in current accounts are usually not eligible for payment of any profit. All savings and term deposits, irrespective of size, should be eligible for a share in the profit of the investment pool, except where it may be uneconomic to do so. The depositor, as sleeping partner, cannot receive a share of the profit that is more than the proportional share of the term-deposit to the total deposits in investment pool. Profit is calculated on the basis of daily credit balances rather than being paid on the maximum or the minimum balance during the agreed period, usually a month; Weightages have to be assigned to deposits based on tenure for which deposits are kept; Depositors wishing to withdraw their term-deposits in emergency without notice may be required to forfeit their profit. an

Thank You