For a quick recap, the funds in the Mudarabah common pool are mainly comprised of customer deposits received via saving accounts and term deposit accounts in addition to the shareholders’ funds which include the aggregate amount lying in current accounts.
Both the customers’ and shareholders’ funds should be deposited in the common pool on a non-discriminatory basis since they form a tacit Musharakah in the common pool.
Also, as explained earlier, the Shariah definition of profit is what exceeds the original capital. As such, when one-to-one Mudarabah takes place, the Rab Al Maal (capital provider) and the Mudarib (capital receiver) agree over the tenor and profit distribution ratio between them.
Upon completion of the Mudarabah tenor, it is the obligation on the Mudarib to not only return the original capital but also the share of the Rab Al Maal’s profit corroborated by the statement of the Mudarabah account. The Mudarib is able to retrieve the original Mudarabah capital along with the actual profit in cash by selling the Mudarabah assets in the market.
How does an Islamic bank distribute the common pool Mudarabah profit to depositors and itself on a periodic basis? Does it sell the entire Mudarabah assets in the market against cash on the profit distribution date and, pursuant to the distribution of the profit, re-invest the original capital of the common pool all over again in the new assets?
Such liquidation and reinvestment could be cumbersome and fairly risky since the Islamic bank may not find the right price for the common pool Mudarabah assets or it does not quite succeed in locating the new assets with the desired returns. So, what is the Shariah guidance to deal with such a situation?
There could be two Shariah ways of liquidating an investment comprising assets or a portfolio of various investments represented by a set of different assets. These are either the actual liquidation or the constructive liquidation. While the former is commonly known, the latter needs explanation.
Constructive liquidation takes place where, in a going concern, it is not possible to sell the assets since it will mean the end of the business operation. In such a situation, all non-cash assets are professionally assessed to arrive at a notional value as if such an amount would have been received had all the assets been sold on that day.
An example could be the audited financials of a trading entity where the external auditors certify its snapshot position in monetary terms after having completed their examination of all assets and liabilities on the closing date of the entity’s financial year.
The auditors have a number of specialized skills to gauge the present market value of all the assets besides the extent of liabilities to arrive at the net worth of an entity on a given date.
Similarly, an Islamic bank, which is very much a going concern, does not follow the actual liquidation process but opts for constructive liquidation where all its common pool investments are valued on a periodic basis, ie based on the dates it is required to close the accounts and determine the common pool profit for carrying out the required profit distribution.
Since the assessment of the share of the profit for the bank and depositors passes through several stages of examination, verification and approval (including the Shariah board clearance), it is possible that depositors receive the profit in their account by up to a fortnight from the closing date.
How does an Islamic bank come to the conclusion that it has actually had a profitable distribution period? This is done by the Islamic bank by ensuring that the value of all common pool investments on a constructive liquidation basis has not fallen below the opening balance for that period.
There could be genuine losses on some investments which are debited to the common pool during the concerned period, and at the same time various other investments must have been profitable, but the net result of all losses and profits must be positive for the bank to carry out the profit distribution for a certain period.
While it is easy to ascertain and allocate the profit attributable to a customer whose funds remain invested in the common pool from the beginning until the end of a certain period, what should the treatment criteria be for a customer whose funds were introduced to the common pool in the middle of the period, or if a customer’s deposit matured during the period and the original amount was redeemed, or if a customer sought premature encashment, ie before the completion of the relevant profit period? How all such situations are addressed shall be the subject of next week’s deliberation.
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: Continuation of the discussion on an Islamic bank’s distribution of a periodic profit.