While we are discussing the treatment of various types of customer deposits, it is appropriate to know if the Shariah principles allow an Islamic bank to offer any rewards or benefits to its depositors, in addition to the customary profit distribution. Yes, it may be possible for an Islamic bank to incentivize its Mudarabah deposit customers by way of prizes. In fact, we commonly observe Islamic banks offering reward schemes to depositors. In some cases, it is a draw for cash and in others it is for a car or other expensive gifts.
From where does an Islamic bank get the funds to give away large cash or luxurious gifts? Is the exercise at the cost of depositors’ share of profit from the common pool? If so, is the bank’s management authorized to divert depositors’ share of profit to such extravagance? We discussed last week that the common pool profit is determined on a periodic basis, and that it is audited and approved by the Islamic bank’s Shariah board before distribution among depositors and the bank takes place. Also, we know that the depositors do not bear the running expenses of the bank and as a result, the depositors’ gross profit is also their net profit.
It was also explained that all running expenses of the bank are deducted from the bank’s share of the common pool profit and all fee-related income and current account benefits are added to arrive at the bank’s net profit. If the Islamic bank’s senior management has laid out an effective marketing plan to promote its fee-related activities, its non-funded revenue can be strong, leading to an impressive overall yield for the bank’s shareholders. However, if the bank has been heavily reliant on income from the funded part, ie its share of the profit from the common pool, the bank’s dividend to shareholders could be unimpressive.
A well-managed Islamic bank firing on all cylinders will have a fuller picture where retail, wholesale/sovereign, capital market, asset management, trade finance, letters of credit and guarantees and allied activities contribute toward the overall profitability of the bank. Such complete functionality is a treat to watch since it brings cheers to depositors and shareholders alike.
Coming back to our discussion on how the Islamic bank meets the funding requirement to offer a reward scheme, Shariah scholars permit the bank to carry out such marketing campaigns provided the bank pays for all such expenses from its own account and does not charge it to the depositors’ share of the common pool profit in any manner whatsoever. As such, Islamic banks can offer any cash rewards or gifts to Mudarabah depositors subject to the same being categorized as the bank’s marketing and promotion expenses.
However, a segment which cannot be included in such a scheme is the current account holders since they have loaned the money to the Islamic bank against a guaranteed return. If any kind of reward or benefit is offered to them, this will be tantamount to interest in cash or kind. This is the reason that some Shariah scholars do not allow the Islamic bank to even offer a cheque book free of cost no matter how large the funds are that are lying in the current account. In fact, on the contrary, the current account is debited by the Islamic bank for providing routine services for the maintenance of the account.
What if a current account gets overdrawn? This could be due to any reason, such as honoring the cheque issued by a customer without having sufficient funds in the account. What if the bank honors the cheque on the customer’s promise to deposit cash the same day to cover the shortfall but the customer does not do so and the current account continues to remain overdrawn overnight or for days? In this situation, the Islamic bank shall pursue the client to square up the overdrawn position at the earliest and shall not impose any amount on any pretext, be it a fee or profit or charge, no matter how large the overdraft is and for how long the account remains overdrawn.
Another interesting question is how does an Islamic bank handle a situation if their Nostro account gets overdrawn and they have an interest claim from the correspondent bank? A Nostro account is defined as the Islamic bank’s settlement account with its correspondent bank in an overseas jurisdiction where the bills drawn under the bank’s import letters of credit and remittances in foreign currencies are paid.
First of all, it is the responsibility of the Islamic bank’s treasury department to keep track of all the financial commitments of the bank and accordingly provide adequate funds in the relevant Nostro account well in time to avoid getting the account overdrawn. Nevertheless, if the Nostro account gets overdrawn due to some reason, the Islamic bank will have the following options to deal with the claim:
• Pay the interest amount out of the earnings discarded by the bank’s Shariah board since it is related to transactions considered void due to not following the Shariah principles in their execution. Such tainted income is deducted from the bank’s bottom line to be given away for charity. As such, Shariah scholars allow paying the interest to the correspondent bank out of the tainted income as both are the same in nature.
• If the Islamic bank does not have any tainted income, it shall keep a certain amount of funds in excess of its needs in the Nostro account for a certain period of time so as to provide a benefit to the correspondent bank for not paying interest on the overdrawn Nostro account.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Sohail Zubairi is the projects advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected].
Next week: How an Islamic bank distributes a periodic profit to Mudarabah depositors based on their respective tenures.