Islamic Banking

Definition of Islamic Banking:
Islamic Banking is a financial Institution whose statutes, rules and procedures expressly state its commitment to the Islamic Shariah and to the banning of the receipt and payment of interest on any of its operations.

Bank Islam means such a company or an Islamic bank Branch (es) of a banking company licensed by respective authority, which follows the Islamic Shariah principles and modes of operations and avoids receiving and paying of interest at all levels.

Definition & Types of Riba (Interest):

Definition of Riba
The word’ Riba’ means excess, increase or addition, which correctly interpreted according to shariah terminology, implies any excess compensation without due consideration.

Types of Riba (Interest): There are two types of Riba:

a.  ‘Riba Nasiyah‘ is defined as excess which results from predetermined interest which a lender receives over and above the principal (Ras-ul-Maal).

b.  ‘Riba-AI-Fdl’ is defined as excess compensation without any consideration resulting from sale of goods. Riba-Al-Fadl actually mean that excess which is taken in exchange of specific homogenous commodities and encountered in their hand to hand purchase and sale.

Basic Principles of Islamic Banking

i. Prohibition of Riba (Interest):
Receipt and Payment of interest is totally prohibited in Islam.

ii. Money as” Potential” capital:
Money is not a commodity, but a medium of exchange, a store value and a unit of measurement. Money represents purchasing power and cannot be utilized to increase the purchasing power without any productive a finance advocates the creation of wealth through trade and commerce.

iii. Risk Sharing:
Because interest is prohibited, suppliers of funds become investors, rather than creditors.

iv. Prohibition of Speculative behavior:
Islamic finance discourages hoarding and prohibits transactions featuring extreme uncertainties(Gharar), and Gambling (Maysir).

v. Sanctity of Contract:
Islamic finance uphold contractual obligations and the disclosure of information as a sacred duty. This feature is intended to reduce the risk of asymmetric information and moral hazard

vi. Shari’ah approved Activities :
Only those business activities that do not violate the rules of the shariah qualifies for investment. For example, any investment in a business dealing with alcohol, gambling, tobacco is prohibited.

vii. Social Justice:
Any transaction leading to injustice and exploitation is prohibited

Application and practices of Islamic Banking theories and principles :
The theories and principles of Islamic Banking as stated above are applied in the General Banking, Investments,
Foreign Trade & Foreign Exchange Operations as under:
General Banking: Receiving of Deposits.
Principles of accepting Deposits and Deposit products.
AB Islamic Branches shall receive deposits under the following two principles:
i) Al-Wadeeah
ii) Al-Mudarabah

Al-Wadeeah:
Fund which is deposited with Banks by the depositors with clear permission to utilize/ invest the same is called Al-Wadeeah. Islamic banks receive deposits in Current Accounts on the basis of this Al-Wadeeah principle. Islamic banks obtain permission from the Al-Wadeeah depositors to utilize the funds at its own responsibility and the depositors would not share any profit or loss earned/incurred out of using of this funds by the bank. The banks have to pay back the deposits received on the principle of Al-Wadeeah on demand of the holders. The depositors have to pay govt. taxes and other charges, if any.

Mudaraba:
Mudaraba is a partnership of labor and capital, where one partner provides full capital and the other one the business. The capital provider is called Sahib-Al-Maal and the user of the capital is called Mudarib. Fund which is deposited with Banks by the depositors with clear permission to utilize/ invest the same is called Al-Wadeeah. Islamic banks receive deposits in Current Accounts on the basis of this Al-Wadeeah principle. Islamic banks obtain permission from the Al-Wadeeah depositors to utilize the funds at its own responsibility and the depositors would not share any profit or loss earned/incurred out of using of this funds by the bank. The banks have to pay back the deposits received on the principle of Al-Wadeeah on demand of the holders. The depositors have to pay govt. taxes and other charges, if any.

Mudaraba:
Mudaraba is a partnership of labor and capital, where one partner provides full capital and the other one the business. The capital provider is called Sahib-Al-Maal and the user of the capital is called Mudarib.

Mudara Deposit Products:
Mudaraba Short Notice Deposit ( MSND) Account
Mudaraba Savings Deposits ( MSD) Account
Mudaraba Term Deposit (MTD ) Account
Mucdaraba Probable Millionaire ( MPM) Scheme
Mudaraba Monthly Profit Deposit ( MMPD) Account
Mudaraba Quarterly Profit Deposit ( MOPD) Account
Mudaraba Pension Deposit ( MPD) Scheme
Mudaraba Halijl Deposit ( MHID) Scheme
Mudaraba Marriage Savings Deposit ( MMSD ) Account
Mudaraba Savings tlond ( MSD)
Mudaraba Cash Waqf Deposit (MCWD
Mudaraba Foreign Currency Deposit ( MFCD )

Compliance of Shariah Rules in Deposit Account:
Opening of an Account in a Bank is a contractual relationship. Therefore, before opening any Account, be it an Al-Wadeeah Current Account or any type of Mudaraba Deposit Account, the rules and procedures of the concerned account to be read out and clearly explained to the prospective account holder & his signature to be obtained at the appropriate place of the Account opening Forms. Special care to be taken to communicate the rules for distribution of profit to the Mudaraba depositors.

Investment (Uses and deployment of Funds)
For Islamic Banking the following Modes of Investments:

i) Mudaraba;
ii) Musharaka
iii) Bai-Murabaha (Murabaha to the purchase orderers)
iv) Bai-Muajjal;
v) Bai -Salam and parallel Salam;
vi) Bai- istisna and parallel İstisna;
vii) Ijara;
viii) Ijarah Muntahia Bittamleek(Hire Purchase)
ix) Hire Purchase Musharaka Mutanaqisa (HPMM);
x) Direct Investment;
xi) Investment Auctioning etc.
xii) Quard
xiii) Quard Hassan etc.

Importance of Bai-Muradaba System:

i. Definition of Bai-Murabaha :
Bai-Murabaha is a contract between a buyer and a seller under which the seller sells certain specific goods permissible under Islamic Shariah and law of the land to the buyer at a price determined by charging agreed profit, margin or mark-up over the cost price. In this case, the buyer either makes cash payment to receive the goods or is allowed to make payment by installments or on a fixed future date. The profit mark-up may be fixed in lump sum or in percentage over the cost price of the goods.

ii. Some important features of the Bai-Murabaha Mode of investment:
a) The client (buyer) request the bank to purchase particular goods and promises to purchase the same from the Bank at a price fixed by charging profit over the cost price.
b) Under the Bai-Muraba mode of investment there is no scepe to increase the price once it is fixed.
c) After buying the goods, the Bank has to bear all the risk until goods, are actually delivered to the client.
d) Import of goods under Bai-Muradaba Mode of Investment:
In the import business, the importer provides an irrevocable letter of authority to the Bank to import specific goods on behalf of him (the client)from the foreign seller and promises to buy the same from the Bank. In this case, the Bank is designated as a consignee in the Bill of Lading and later on the Bank hands over the same to the importer through endorsement i.e. the ownership of the goods is transferred to the importer i.e. the ownership of the goods is transferred to the importer. As per uniform customs and practices, the seller lodge his claim or places claim for dues to the Buyer’s Bank through the Bill of Exchange and the Buyer’s Bank discharge the claim on behalf of the Buyer. The above import system is fully approved / supported by the Islamic Shariah.

iii. Investment in import by Islamic Banks:
In the import business, Bai-Muradaba investment is accomplished through a single deal at the time of opening L/C, Bills and shipment for example
a) Bai-Murabaha Import Letter of Credit.
b) Bai-Murabaha Import Bills
c) Bai-Murabaha Post Import.

iv. Murabaha Post Import:
The importers apply for investment facility against imported goods after shipment for payment of the invoice values of the goods to the seller/suplier including customs duty , VAT and other expenses. In such a case, Islamic Banks allow a Bai-Muradaba investment facility under single deal concepts. It is so called as the Letter of Credit, Bils and the handiling of Post shipment are setted under one agreement while opening the letter of credit for importing the goods.

v. Accounting procedure for purchase price, profit and sale price :
a) Price Payable to the Supplier;
b) Other expenses related with Purchase:
i) Conveyance- TA/DA.
ii) Commission payable to the agents.
iii) The expenditure in connection with supplier’s payments.
iv) Transportation cost upto the Bank’s godown.
v) Transit Insurance and other expenses
vi) Godown rent and salary of officials etc. incurred before sale of goods.
Additional expenses:
1. Duty.
2. VAT
3. License fee.
4. Commission for C&F agent etc.
c) Cost price or total value =a + b.
d) Estimated profit/Mark-up profit (profit percentage on purchase/cost price)
e) Sale price =c+d.
f) The net Investment amount is determined after deduction of the down payment (if any) from figure at “e” above.

Import under the Bai-Muajjal mode of investment
The term Bai-Muajjal means “deferred payment sale” or “Sale on Credit.”Under this mode of investment a contract is made between the buyer and seller for buying and selling of goods approved by Islamic Shariah and law of the land on the stipulation to pay the agreed price at a specific future date or by fixed installments.

Some important features of the Bai-Muajjal mode of investment:
Most of the features of Bai-Murabaha and Bai-Muaijal are alike excepting the following:
i) Bai-Muajjal sale is executed completely on deferred payment system.

ii) The sale price is determined adding the profit with cost price. It is not necessary to disclose the cost price and the profit mark-up separately to the client. But in Bai-Murabaha, the cost price and the profit mark-up ratios are to be disclosed separately to the client.

iii)The accounting procedure for imported goods under both the Bai-Muajjal and Bai- Mudaraba mode are alike. But so far as contract is concerned they are different. Bai-Murabaha contract and Bai-Muajjal are executed for imports under Bai-Murabaha and Bai-Muajjal modes respectively.

The following principles should be followed by the banks of all categories in distributing investment income to the Mudaraba depositors:
a) Mudaraba depositors of the bank will share income derived from investment activites deploying the Mudaraba funds. Income under this category will mean and include profit, dividend, capital gain, rent, exchange gain and any other income derived from the deployment of fund.

b) Profit sharing ratio (PSR) between the Mudaraba deposits and the bank (Mudarib) should be declared before the starting of accounting year/at the time of Mudaraba contract and to be duly disclosed to the Mudaraba depositors.

c) The bank may reduce or raise the Profit Sharing Ratio before the starting of any accounting year / at thetime of Mudaraba contract but cannot be reduced after the declaration is done for any accounting year.

d) The gross income derived from investments during the accounting year will, at first, be allocated to Mudaraba deposits, as per ratio of participating fund in the outstanding investment. If the Mudaraba deposits is higher than total outstanding investment, then participating ratio of Mudaraba deposits to be considered as 100%. Profit on investment income to be distributed amongst the Mudaraba depositors as per pre-agreed ratio taking 100% as the participating fund in the total outstanding investment.

e) Management Fee and investment Loss Off Setting Reserve, if any, may be deducted from Mudarata share of investment income subject to prior declaration of the same before staring of the accounting year at the time of Mudaraba contract.

f) Mudaraba deposits shall get priority in the matters of investment over Bank’s Equity and other Cost – Free Fund i.e. Bank’s Equity & Cost Free Fund will be deployed only after full investment of Mudaraba deposits. Bank’s Equity shall mean and include paid up capital, statutory reserve, investment loss off setting reserve, general reserve and any other reserve or fund created by the bank. Cost Free fund means any type of Funds received by the bank free of cost and not for sharing any income of the bank.

g) Mudaraba fund accepted by the Islamic Bank’s shall be utilized in all sorts of investment activities (i.e. general investment, investment in shares & securities, placement with other banks and financial institutions etc.) approved by the bank’s Shariah Supervisory Board as well as Board of Directors of the bank.

i) Income from Exchange Gain derived from buying & selling of foreign currency should be shown separately and to be added in the distributable income for the purpose of the distribution of profit to depositors.

j) Islamic Banks and Islamic Branches of the Conventional Banks will be required to assign weightage to all types of Mudaraba deposits. The weightage will represent the importance attached to the holding of each deposit in determination of profit. In this context, the assumption held is that longer the tenure of a Mudaraba deposits, the higher the risk
The weightage and any subsequent change in weightage of Mudaraba deposits should be disclosed to Mudaraba depositors before the starting of any accounting year / Mudaraba contract.

k) Profit may be calculated on different types of Mudaraba deposit accounts as per their respective rules for time & manner of deposit and withdrawal restrictions.

l) Mudaraba deposits shall mean average balance of all types of Mudaraba deposit accounts books of the bank as on last day of each month during the accounting year to which the distribute income relates after deducting Statutory Liquidity Reserve to be maintained as per Bank Company Act,1991.