ISLAMIC BANKING AND FINANCE

Mahyuddin Khalid

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SOURCE OF FUNDS – SAVING/INVESTMENTS AND THE UNDERLYING SHARIAH CONCEPTS

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MUAMALAH CONTRACT

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CATEGORIES OF CONTRACT

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CONTENT

SOURCES OF FUNDS SHAREHOLDER FUND DEPOSITORS FUND

CURRENT ACCOUNT SAVING ACCOUNT GENERAL INVESTMENT ACCOUNT SPECIFIC INVESTMENTS ACCOUNT

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SOURCE OF FUNDS

Source of Funds in Islamic bank is formulated based on the Shariah concepts of: Wadi'ah Mudharabah

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AL-WADIAH

Definition of Wadi'ah: A trust arrangement and involves the depositing (movable) or

monetary deposits with another person, for safe-keeping. The depository acts as a trustee or guarantor, and

guarantees repayment of the deposits on demand. Wadi'ah does not provide the depositors with the right to

receive a share of the profits. Pillars of Al – Wadi'ah:

Al-Muwaddi’ (Depositor, Owner of the property) Al-Wadi’ (Depositee, Custodian of the property) Al-Wadiah (Property for safe keeping) Sighah (Offer (Ijab) and Acceptance (Qabul))

Islamic banks mobilizes its customer’ deposits in current accounts on the contract of al-wadiah yad dhamanah (guaranteed custody)

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CONDITION OF AL-WADIAH

Essentials Conditions

Al-Muwaddi’ (Depositor, Owner of the property)

• Capable• Sound mind• Intelligent• BUT not necessarily attained age of

puberty • Individual or institution

Al-Wadi’ (Depositee, Custodian of the property)

• Same with above• Custodian is not allowed to promise any

rewards or return

Al-Wadiah (Property for safe keeping)

• Manageable by custodian• Storable

Sighah (Offer (Ijab) and Acceptance (Qabul))

• In definite and decisive language• Acceptance must be consistent with offer• Offer and acceptance made at same time• Both parties have the right to terminate

contract at any time

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MUDHARABAH

Definition of Mudharabah: A joint-venture profit sharing contract whereby one party is the

provider of capital while the other is the entrepreneur. Characteristics of Mudharabah:

The profit will be shared between parties whom involved in the contract according to the terms of their agreement.

The losses will be borne by the capital provider who is the financier of the project.

The entrepreneur suffers of their fruitless effort. Pillars of Mudharabah:

Sahibul Mal (Owner of capital, fund provider) Mudharib (Entrepreneur) Ra’sul Mal (Capital) Al-Amar or Mashruk (Business ventures or project) Ribh (Predetermined share of profit) Sighah (Offer and acceptance)

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CATEGORIES OF MUDHARABAH

Mudharabah al-Mutlaqah

• Unrestricted mandate• Under unrestricted

investment fund, entrepreneur (bank) has got the authority by the capital provider (depositor) to invest the funds in any manner which they think appropriate.

• Entrepreneur (bank) is free to invest on how, where and for what purposes the funds should be invested. They (depositor) will be no restriction to entrepreneur.

Mudharabah al-Muqayyadah

• Restricted mandate• The entrepreneur is

restricted in his activity in carrying out the mudharabah project in term of business, method, time period or place.

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SHAREHOLDERS FUND / EQUITY

Shareholder fund and equity in Islamic bank is formulated based on the Shariah concepts of Musharakah (Profit and Loss Sharing contract).

Through shares : Ordinary Shares quoted or unquoted Special share (Minister of Finance)

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DEPOSITOR FUND

Deposit Management in

Theory of Islamic Banking

Pure profit – Sharing Model

Profit Sharing – Model

Two Window Model

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PURE PROFIT–SHARING MODEL

Pure Profit–sharing Model was the first deposit model developed in Islamic banks.

This model enjoys much support amongst most of Islamic economists.

It assigns a significance role to profit sharing (mudharabah) on the both side of balance sheet, the asset and liability side.

Also know as the Two-Tier Mudharabah Model.

Concept based on two level of Mudharabah : The first tier The second tier

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TWO-TIER MUDARABAH MODEL

The 1st

Tier

• Between bank and depositor• Put their money in the bank’s investment account and share profits

with it.• Depositors are considered to be provider of the capital (rabb al

mal).• The bank functions as a working partner or manager of funds

(mudarib or amil).

The 2nd Tier

• Between the bank and the entrepreneurs.• Seek finance from the bank on the condition that profits accruing

from their business shall be shared between them and the bank in a mutually agreed proportion.

• But, the loss shall be borne only by the financier.• Bank functions as the provider of capital.• The entrepreneur is the manager of funds.

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TWO WINDOW MODEL

The liability side of the bank’s activities is divided into 2 window : The bank is required to pay the funds held in the current

account on demand, it is subjected to a 100% reserve requirement .

The Islamic precept – that funds of demand deposits are a trust (amanah) that is held by the bank on behalf of the depositors.

The banks neither have a right to use these funds to make profit nor it should be used for the purpose of money creation through fractional reserve system.

Funds held in the investment accounts shall not be subjected to any reserve requirement.

It is argued by the economists who have advocated this model that investment accounts of Islamic banks are not similar to time deposits of conventional banks, which are used for credit creation.

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PROFIT SHARING – COST PLUS MODEL A profit sharing (mudharabah) on the

liability side of the balance sheet and cost-plus technique of financing (murabahah) on the asset side.

Other Islamic/shariah permissible technique of finance such as mudharabah, musharakah, ijarah, etc. may also be used on the assets side.

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CUSTOMERS DEPOSITS IN CURRENT ACCOUNTS

Definition of Current Account: An account into which customer can deposit

money and effect payments by the drawing of cheques.

The bank accepts its customer’s deposit and undertake to honor any demand (invariably in the form of cheque) made by customer, provided there is available funds in the account.

The Current Account is formulated based on the Shariah concepts of:1. Al-Wadiah2. Al-Mudharabah

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MODES OF OPERATION OF WADIAH CURRENT ACCOUNT

The bank accepts deposits from its customers looking for custody of their funds and absolute convenience in their use in the form of CA on the principle of al-wadiah yad dhamanah.

The bank requests permission from such customers to make use of their funds so long as these funds remain with the bank.

The customers may withdraw a part or the whole of their balances at any time they so desire, and the bank guarantees the refund of such balances.

All the profits generated by the bank from the use of such funds belong to the bank.

The bank provides its customers with cheque books and other usual services connected with the CA.

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MODES OF OPERATION OF MUDHARABAH CURRENT ACCOUNT

Contract made between Depositor (provider of capital) AND Bank (entrepreneur)

The amount deposited for a stipulated period by the depositor will be used by the bank for investment purposes according to the al-mudharabah principle.

The bank becomes wholly responsible and liable in the management and investment the deposits in halal business ventures.

Profits gained will be divided and distributed accordingly, based on margins agreed upon earlier.

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CUSTOMERS DEPOSITS IN SAVING ACCOUNTS

Mobilizes customers’ deposits under the contract of al-wadiah yad dhamanah its modification on the payment of profit at the absolute discretion of the bank.

This is a trust arrangement and involves the depositing (movable) or monetary deposits with another person, for safe-keeping.

The depository acts as a trustee or guarantor, and guarantees repayment of the deposits on demand.

Wadi'ah does not provide the depositors with the right to receive a share of the profit.

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MODES OF OPERATION OF WADIAH SAVING ACCOUNT

The bank accepts deposits from its customers looking for safe custody of their funds and a degree of convenience in their use together with the possibility of some profits in the form SA on the principle of al-wadiah yad dhamanah.

The bank requests permission from such customers to make use of their funds so long as these funds remain with the bank .

The customers may withdraw a part of the whole of their balances at any time they so desire, and the bank guarantees the refund of such balances.

The bank provides its customers with saving passbook books and other usual services connected with the SA.

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DISCRETIONARY REWARDS OF WADIAH SAVING ACCOUNT

Under the principle of al-Wadiah, the bank is not obligated in any way to give returns on depositors.

However, the banks at its absolute discretion, may reward its customer a certain amount of return as deemed fit.

Calculation of profit is a follows: Cumulative daily

Balance for the monthNo. of days in the

month

x Rate x 1/12

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GENERAL INVESTMENT ACCOUNT BASED ON MUDHARABAH

The bank acts as ‘entrepreneur’ and the customers as the ‘ provider of capital’.

Both agree on show to distribute profits (if any) and in the event of loss, the customer bears all the loss.

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MODES OF OPERATION OF MUDHARABAH GENERAL INVESTMENT ACCOUNT

The bank accepts deposits from its customers for GIA on the principle of Mudharabah.

This investment is utilized as business capital by the bank. Customer will have no authority to interfere with the management of investment.

Bank will has the right to manage the investments as it deems fit by investing into businesses that are both Halal (permissible) and profitable.

The deposits will have to be for a specified period. In basic Shariah relationship, the bank acts in this case as the

‘entrepreneur’ and the customers as the ‘provider of capital’ and both will agree among others on how to distribute the profits, if any, generated by the bank from the investment.

In the event of loss in the investment, the customer bears all the loss.

Modes of investment of the funds and the ratios of profit decided by the bank for all customers.

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PROFIT ON MUDHARABAH GENERAL INVESTMENT ACCOUNT

Distribution of Profit: Bank in an agree predetermined ratio. This agreed distribution ratio must be

stated in the contract. Calculation of Profit:

When an investment certificate is presented on or after the maturity date of the investment deposit, profit due will be calculated.

The formula can be as follows: Profit Amount:

Tenor Rate 12 100

Capital x x

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PROFIT ON MUDHARABAH GENERAL INVESTMENT ACCOUNT

= Principal x Profit rate x (Days in Month divide by No. of Days in Year)

= 50,000  x 2.50% x (28/365) = RM95.89 for the month of March 2010

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SPECIAL INVESTMENT ACCOUNTS BASED ON MUDHARABAH

Mobilizes customers deposits from government or corporate customers under the contract of equity-financing.

The bank acts as the ‘entrepreneur’ and the customers as the ‘provider of capital’.

Modes of investment of the funds and the ratios of profit may usually be individually negotiated.

Mudharabah SIA operates under the same basic principles as Mudharabah GIA.

However, the Mudharabah SIA is more in tune with the requirements of the client may negotiate the tenure of the investment as well as the profit sharing ratio.

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DIFFERENCES BETWEEN MUDHARABAH AND CONVENTIONAL FIXED DEPOSIT

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