We are still on the subject of differences between Islamic and conventional banks.
After appreciating how an Islamic bank arrives at the common pool profit, distributable among the depositors and the bank, we shall now discuss what ancillary earning streams are available to an Islamic bank on an exclusive basis.
Once the shareholders obtain the Islamic banking license from the country’s apex bank after completing all required formalities, it becomes legally entitled for them to not only start receiving the deposit amounts from the public, but also to offer various other services against a certain fee. Such ancillary income is solely meant for the Islamic bank and is not shared with depositors. Let us have a look at these services.
The main revenue-generating services offered by an Islamic bank are connected to trading and advisory. On the trading side, the Islamic bank earns fee income by establishing the import letters of credit, negotiating export letters of credit, issuing various types of guarantees handling import and export collection documents, effecting remittances, processing wage payments, providing safekeeping lockers and various other services relevant to the jurisdiction where the Islamic bank is operating.
On the advisory side, the Islamic bank earns a fee by providing its expert advice to governments or government-related entities and private sector corporate clients on fundraising through Islamic capital market tools such as IPOs, right issues and Sukuk (Islamic bonds), or for restructuring of a client’s balance sheet and any other matter needing Islamic financing solutions.
In all of the aforementioned fee-generating services offered by an Islamic bank, none of them use depositors’ money but simply the expertise possessed by the skilled bank staff. As such, the entire fee income generated by the Islamic bank from offering these services remains with the Islamic bank and is not shared with depositors. The only income shared with depositors at the agreed-upon ratio is the one earned by the bank by deploying the common pool funds.
Also, there are funds lying in customers’ current accounts whose entire benefit goes to the Islamic bank. The current accountholders are the only depositors in the Islamic bank who are guaranteed a safe return of their money and hence are not paid any profit on their funds, no matter how large the amounts may be. These funds are considered senior debt on the Islamic bank and come under the ownership of the Islamic bank – similar to shareholders’ funds – and are invested in the common pool entirely for and on its behalf.
We had earlier discussed the Shariah principle of keeping the guarantee and profit separate in the sense that the current account funds are guaranteed, hence do not carry any profit whereas the Mudarabah-based term and saving deposits are not guaranteed since they are entitled to profit distribution with the Islamic bank.
The revenues earned by the Islamic bank are from two streams, through the deployment of shareholders’ funds in the common pool and by offering all types of ancillary fee-related services to the customers where the common pool funds are not utilized. All running expenses of an Islamic bank are borne by the bank alone and are not charged to the depositors. This is for the reason that the Islamic bank’s shareholders are the owners of the bank’s assets and the employer of staff, and hence responsible to bear entire expenses connected to them.
Another important aspect to remember is that the profit earned by deploying common pool funds is distributed between the bank and depositors at the gross level, ie without deducting any running expenses of the bank. As such, it will be in order to state that the depositors’ gross profit is also their net profit at the common pool level whereas the dividend to shareholders is paid after deducting all running expenses of the bank from their share of the common pool profit and adding all fee-based income.
There are different types of depositors in a common pool. Some are there for short-term purposes and the others place funds for a longer term. On one hand, there are savings account depositors whose balance fluctuates from time to time and on the other, there are customers who have unwavering placement of up to one year, or beyond. And then there are depositors in the middle, say for three to nine months.
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: Will it be justified to treat all of them in the same manner while carrying out the distribution of the depositors’ share from the common pool profit?