Shariah principles for receiving deposits & Investment (Banking law notes)

 

Shariah principles for receiving deposits & Investment

Shariah principles for receiving deposits

Islamic banks receive deposits under two principles:

• ·        Al-Wadeeah principle.
• ·        Mudaraba principle.

Al-Wadeeah:

The 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 AlWadeeah 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 these 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 government 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 manages the business. The capital provider is called Sahib-Al-Maal and the user of the capital is called Mudarib. As per Shariah principles, the Mudarib will conduct the business independently following Shariah principles. The Sahib-Al-Maal may provide advice if he deems fit but he can not impose any decision over the Mudarib. Profit, if any, is divisible between the Sahib-Al-Maal and the Mudarib at a predetermined ratio, while loss, if any, is borne by the Sahib-Al-Maal. Mudarib can not avail of any salary or remuneration against his labor as a manager or conductor of the enterprise/ business. The deposits, received by Islamic banks under this principle are called Mudaraba Deposits. Here, the depositors are called Sahib-Al-Maal and the bank is called Mudarib. The Mudaraba deposits include:

• ·        Mudaraba Savings Deposits (MSD)
• ·        Mudaraba Short Notice Deposits (MSND)
• ·        Mudaraba Term Deposits (MTD).

Different Islamic banks have developed various deposit schemes on the basis of this Mudaraba principle such as monthly deposit-based Hajj Scheme, Monthly/One-time deposit-based Term Deposit Scheme, Monthly Mudaraba Profit Deposit Scheme, Monthly Mudaraba Marriage Savings Scheme, Mudaraba Savings Bond, etc

Investment Principles & Investment Products

Islamic banks do not directly deal in money. They run businesses with money. The funds of Islamic banks are mainly invested in the following modes:

• 1)      Mudaraba;
• 2)      Musharaka;
• 3)      Bai-Murabaha (Murabaha to the purchase orders);
• 4)      Bai-Muajjal;
• 5)      Salam and parallel Salam;
• 6)      Istisna and parallel Istisna;
• 7)      Ijara;
• 8)      Ijarah Muntahia Bittamleek (Hire Purchase);
• 9)      Hire Purchase Musharaka Mutanaqisa (HPMM);
• 10)   Direct Investment;
• 11)   Investment Auctioning etc.
• 12)   Quard
• 13)   Quard Hassan etc.

1, Mudaraba:

Mudaraba is a shared venture between labor and capital. Here Bank provides with entire capital and the investment client conducts the business. The Bank, the provider of capital, is called Sahib-Al-Maal and the client is called Mudarib. The profit is to be distributed between the Bank and the investment client at a predetermined ratio while the bank has to bear the entire loss if any.

2. Musharaka:

Musharaka means partnership business. Every partner has to provide more or less equity funds in this partnership business. Both the Bank and the investment client reserve the right to share in the management of the business. But the Bank may opt to permit the investment client to operate the whole business. In practice, the investment client normally conducts the business. The profit is divided between the bank and the investment client at a predetermined ratio. Loss, if any, is to be borne by the bank and the investment client according to the capital ratio.

3. Bai-Murabaha:

Contractual buying and selling at a markup profit is called Murabaha. In this case, the client requests the Bank to purchase certain goods for him. The Bank purchases the goods as per specifications and requirements of the client. The client receives the goods on payment of the price which includes mark-up profit as per contract. Under this mode of investment, the purchase/ cost price and profit are to be disclosed separately.

4. Bai-Muajjal:

Meaning: "Bai-Muajjal" means a sale for which payment is made at a future fixed date or within a fixed period. In short, it is a sale on Credit.

 It is a contract between a buyer and a seller under which the seller sells certain specific goods (permissible under Shariah and Law of the Country), to the buyer at an agreed fixed price payable at a certain fixed future date in a lump sum or within a fixed period by fixed installments. The seller may also sell the goods purchased by him as per the order and specification of the buyer.

In Bank's perspective, Bai-Muajjal is treated as a contract between the Bank and the Client under which the bank sells to the Client certain specified goods, purchased as per order and specification of the Client at an agreed price payable within a fixed future date in a lump sum or by fixed installments.

5. Salam and Parallel Salam:

Salam means advance purchase. It is a mode of business under which the buyer pays the price of the goods in advance on the condition that the goods would be supplied/delivered at a particular future time. The seller supplies the goods within a fixed time.

 Parallel Salam:

 Parallel Salam is a Salam contract whereby the seller depends, for executing his obligation, on receiving what is due to him - in his capacity as purchaser from a sale in a previous Salam contract, without making the execution of the second Salam contract dependent on the execution of the first one.

 The following conditions are essential in the contracts of Murabaha, Bai-Muajjal and Salam. The respective contracts must include the following aspects regarding the goods:

• ·        Number/Quantity
• ·        Quality
• ·        Sample
• ·        Price and amount of profit
• ·        Date of supply/time limit
• ·        Place of supply
• ·        Who will bear the cost of supply?
• ·        Timeframe for payment in the case of Bai-Murabaha and Bai-Muajjal.

6. Istisna and parallel Istisna:

A contract executed between a buyer and a seller under which the seller pledges to manufacture and supply certain goods according to specifications of the buyer is called Istisna. An Istisna agreement is executed when a manufacturer or a factory owner accepts a proposal placed to him by a person or an Institution to produce/manufacture certain goods for the latter at a certain negotiated price.

 Here, the person giving the order is called Mustasni, the receiver of the order is called Sani and the goods manufactured as per order is called Maine.

 An order placed for manufacturing or producing those goods which under prevailing customs and practice are produced or manufactured will be treated as Istisna contract.

Conditions & characteristics of Istisna are enumerated below:

·        The concerned Agreement must contain the details, such as, the type, class, quantity and features of the goods to be produced, so that no misunderstanding is created later on.

·        The price has to be settled; payment time/schedule and modes thereof is to be predetermined.

·        When, where and on whose cost the goods to be supplied has to be clearly mentioned.

·        If agreed by both parties, payment may be made in advance to the seller in part or in full or may be deferred to be paid in due course/ agreed time.

·        Generally timeframe is not mandatory for supplying the goods under the Istisna agreement. It may be executed without determining the timeframe. But in the case of banks, timeframe for supplying goods must be determined to avoid any dispute in the future.

·        Condition for imposing stipulated compensation/penalty may be included in the Istisna agreement against the party who breaches the terms of the agreement causing the other party to suffer. But no compensation/penalty would be imposed on any party if it happens for any valid reason or unavoidable circumstances.

·        As per opinion of the contemporary jurists, the compensation in case of Istisna maybe treated as legal income.

 Parallel Istisna:

If it is not stipulated in the contract that the seller himself would produce/provide the goods or services, then the seller can enter into another contract with third party for getting the goods or services produced/ provided by the third party. Such a contract is called Parallel Istisna. This may be treated as a sub-contract. The main features of this contract are:-

·        The original Istisna contract remains valid even if the Parallel Istisna contract fails and the seller will be legally liable to produce/ provide the goods or services mentioned in the Istisna contract.

·        Istisna and Parallel Istisna contracts are treated as two separate contracts.

·        The seller under the Istisna contract will remain liable for failure of the sub-contract.

7. Ijara :

The mode under which any asset owned by the bank, by creation, acquirement / or building-up is rented out is called Ijara or leasing. In this mode, the leasee pays the Bank rents at a determined rate for using the assets/properties and returns the same to the Bank at the expiry of the agreement. The Bank retains absolute ownership of the assets/properties in such a case. However, at the end of the leased period, the asset may be sold to the client at an agreed price.

8. Ijarah Muntahia Bittamleak (Hire-Purchase):

Under this mode, the bank purchases vehicles, machinery and instruments, building, apartment,s etc. and allowed clients to use those on payment of fixed rents in installments with the ultimate objective to sell the asset to the client at the end of the rental period. The client acquires the ownership/ title of the assets/ properties subject to full payment/ adjustment of all the installments.

 9. Hire-purchase Musharaka Mutanaqasa (HPMM):

Hire-purchase Musharaka Mutanaqasa means purchasing and acquiring ownership by one party by sharing in equity and paying rents for the rest of the equity held by the Bank/or another party. Under this mode, the Bank and the client on a contract basis jointly purchase vehicles, machinery, building, apartments etc. The client uses the portion of the assets owned by the bank on a rental basis and acquires the ownership of the same assets by way of paying bank's portion of the equity on the assets in installments together with its rents as agreed upon.

The features of this mode are elaborated below:

A.     The client applies to the Bank expressing his/her wishes to purchase the assets/properties and the bank accords its approval after proper evaluation/ scrutiny.

B.     The client deposits his/her share of equity with the bank after obtaining approval and the bank pays total price of the assets/properties together with its equity.

C.     Before purchase of the assets/properties an agreement is executed stipulating the actual prices, monthly rents, price of the bank's portion of the assets/properties, payment schedule and installment amount, and the nature of the security etc.

D.     The bank shall rent out its own portion of the assets/properties to the client as per the terms & conditions of the agreement.

E.      The client (Hirer) pays off in installments the bank's portion of equity on the assets together with its fixed rent as per the terms and conditions of the agreement.

F.      With the payment of installments by the client, the ownership of the bank in the assets/properties gradually diminishes, while that of the client increases.

G.     The amount of the rent receivable by the bank, reduces gradually proportionate to the increase in the ownership of the client on the assets/properties.

H.     The client acquires full ownership of the goods/assets after payment of the entire dues of the bank.

I.       The client may acquire full ownership of the assets/properties before expiry of the deal by paying off the entire dues to the bank.

J.       The rent remains payable in proportion to Bank's ownership if the client fails to pay the due installment(s).

K.      The bank can take of the assets/properties under its control if the client fails to pay the installment(s) as per the terms and conditions of the agreement.

 10. Direct Investment:

Under this mode, the bank can under its full proprietorship conduct business by directly investing in the industries, trading, transports, etc. In these cases, the profit/loss fully goes to the bank.

11. Investment Auctioning:

Selling by auction of those assets/goods acquired by the bank through direct investment is called Investment auctioning. Generally, the bank establishes industrial units by direct investment, makes the same operationally profitable, and then sells out on the auction. This mode of investment is very helpful for the industrialization of the country.

12. Quard:

It is a mode to provide financial assistance/ loan with the stipulation to return the principal amount in the future without any increase thereon.

13. Quard Hassan:

This is a benevolent loan that obliges a borrower to repay the lender the principal amount borrowed on maturity. The borrower, however, has the discretion to reward the lender for his loan by paying any amount over and above the amount of the principal provided there will be no reference (explicit or implicit) in this regard.

If a bank provides its client any loan, it can receive actual expenditure relating to the loan as a service charge only once. It can not charge annually at a percentage rate.

If a loan is provided against the money deposited by a client in the bank, it has the right not to pay any profit against the amount of money given as a loan. But profit should be paid on the rest of the amount deposited as per the previous agreement.