The deposits received by an Islamic bank in the investment savings and investment deposit accounts constitute the Mudarabah capital and are entitled to receive an agreed portion of the profit made by the Islamic bank on an ongoing basis. These funds are put into a common pool that the bank draws on for its day-to-day deployment with customers needing funds.
The common pool is usually comprised of the funds from the following sources:
1. Shareholders’ equity: For a new Islamic bank starting its operation, this will be the residual amount of the paid-up capital by the shareholders pursuant to the usage of funds for the pre-operative expenses including salaries and wages, rent, utilities, setting up of head office and branches, etc.
As for an up and running bank, this amount may include, in addition to the original equity, any increase in the capital, retained earnings, unpaid dividend, reserves, minority interest and Tier 1 Sukuk issued by the bank.
2. Customers’ deposits: These are term deposits with varying maturities starting from one or three months until one year or even longer. In addition, there are savings account deposits in the common pool.
It has been a general phenomenon that customers’ deposits in a common pool constitute about 90-95% of the amount and the rest is shareholders’ equity.
This is to be noted that although for savings account and term depositors, the underlying contract for placement of their funds is the Mudarabah, there is a tacit Musharakah in the common pool between the depositors and the shareholders since both have invested equity and are exposed to the equity risks and gains, ie if the Islamic bank makes a profit on an ongoing basis, both will benefit, whereas in the case of an adverse situation, both will suffer.
One important aspect is the agreement for the distribution of profit between the depositors and the shareholders acting as the Mudarib at the time of the placement of a deposit by a customer.
This ratio could be anything from 50:50 or 60:40 or even 80:20 in favor of the Islamic bank provided that it is accepted by both parties at the start of the deposit period and is mentioned in the Mudarabah contract.
Normally, Islamic banks will also mention this ratio in the tariff chart displayed at their branches or on their websites, in addition to the deposit contract. However, whatever the means of communication, this is the Shariah requirement that both parties in the Mudarabah contract must agree with the ratio of distribution of profit the bank will make as the Mudarib by utilizing the common pool funds. Once agreed, this ratio cannot be changed by the Islamic bank unilaterally.
An Islamic bank enjoys the Mudarabah profit on two tiers. First, upon the distribution of profit by the Islamic bank as the Mudarib, ie between the bank and depositors based on the agreed ratio of sharing the profit. Secondly, the bank also gets a profit on the shareholders’ funds (see the aforementioned (a)) deposited into the common pool.
The Islamic bank has the sole discretion of utilizing the common pool funds since Shariah principles give this right to the Mudarib. The depositors, being Rab Al Maal, do not have the right to interfere in the day-to-day running of the Islamic bank’s business.
Although Shariah permits that the Rab Al Maal may restrict the Mudarib from investing the Mudarabah capital in a particular business chosen by the Rab Al Maal, the Islamic banks do not accept the condition of restricted Mudarabah since it is nearly impossible for the bank to segregate the deposits from various customers for investing in different segments of their choice. As such, the Islamic banks accept customer deposits purely based on the unrestricted Mudarabah basis.
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: We continue to discuss the explanation of the full cycle of a customer’s deposit in an Islamic bank.