Mahyuddin Khalid emkay@salam.uitm.edu.

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ISLAMIC BANKING AND SOURCE OF FUNDS FINANCE

SAVING/INVESTMENTS AND THE UNDERLYING SHARIAH CONCEPTS

MUAMALAH CONTRACT
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CATEGORIES OF CONTRACT
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CONTENT
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SOURCES OF FUNDS SHAREHOLDER FUND DEPOSITORS FUND

CURRENT ACCOUNT SAVING

ACCOUNT GENERAL INVESTMENT ACCOUNT SPECIFIC INVESTMENTS ACCOUNT

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

Mudharabah

AL-WADIAH
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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)

CONDITION OF AL-WADIAH
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Essentials

Conditions

Al-Muwaddi Capable (Depositor, Owner of the Sound mind property) Intelligent BUT not necessarily attained age of puberty Individual or institution Al-Wadi (Depositee, Custodian of the property) Al-Wadiah (Property for safe keeping) Sighah (Offer (Ijab) and Acceptance (Qabul)) Same with above Custodian is not allowed to promise any rewards or return Manageable by custodian Storable 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

MUDHARABAH
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Definition of Mudharabah:

A joint-venture profit sharing contract whereby one party is the provider of capital while the other is the entrepreneur. 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.

Characteristics of Mudharabah:

Pillars of Mudharabah:

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

CATEGORIES OF MUDHARABAH
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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.

SHAREHOLDERS FUND / EQUITY

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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)

DEPOSITOR FUND
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Deposit Management in Theory of Islamic Banking

Pure profit Sharing Model

Profit Sharing Model

Two Window Model

PURE PROFITSHARING MODEL

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Pure Profitsharing 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

TWO-TIER MUDARABAH MODEL

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The 1st Tier

Between bank and depositor Put their money in the banks 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.

TWO WINDOW MODEL

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The liability side of the banks 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.

CUSTOMERS DEPOSITS IN CURRENT ACCOUNTS

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Definition of Current Account:

An

account into which customer can deposit money and effect payments by the drawing of cheques.

The bank accepts its customers 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. 2.

Al-Wadiah Al-Mudharabah

MODES OF OPERATION OF WADIAH CURRENT ACCOUNT

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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.

MODES OF OPERATION OF MUDHARABAH CURRENT ACCOUNT

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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 almudharabah 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.

CUSTOMERS DEPOSITS IN SAVING ACCOUNTS

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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.

MODES OF OPERATION OF WADIAH SAVING ACCOUNT

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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.

DISCRETIONARY REWARDS OF WADIAH SAVING ACCOUNT

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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 month No. of days in the
month x Rate x 1/12

GENERAL INVESTMENT ACCOUNT BASED ON MUDHARABAH

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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.

MODES OF OPERATION OF MUDHARABAH GENERAL INVESTMENT ACCOUNT

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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.

PROFIT ON MUDHARABAH GENERAL INVESTMENT ACCOUNT

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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 Capital x x
12 100

PROFIT ON MUDHARABAH GENERAL INVESTMENT ACCOUNT

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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

SPECIAL INVESTMENT ACCOUNTS BASED ON MUDHARABAH

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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.

DIFFERENCES BETWEEN MUDHARABAH AND CONVENTIONAL FIXED DEPOSIT

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END OF CHAPTER