SOURCES OF FUNDS
Islamic banks rely on the following sources of funds:
Capital & Equity;
Transaction deposits that are risk free and yield no return; and
Investment deposits that carry the risks of capital loss for the promise of variable returns.
Capital & Equity
Capital is the amount injected into the Islamic bank during the setting-up stages i.e. the paid-up capital of the Islamic bank.
Equity is usually the retained earning of the Islamic bank that accumulated during its operational period.
Current accounts are based on the principle of Wadiah, whereby the depositors are guaranteed repayment of their funds. At the same time, the depositor does not receive remuneration for depositing funds in a current account, because the guaranteed funds will not be used for PLS ventures. Rather, the funds accumulating in these accounts can only be used to balance the liquidity needs of the bank and for short-term transactions on the bank’s responsibility.
Savings accounts also operate under the Wadiah principle. Savings accounts differ from current deposits in that they earn the depositors income: depending upon financial results, the Islamic bank may decide to pay a premium, hiba, at its discretion, to the holders of savings accounts.
An investment account operates under the Mudaraba al-mutlaqa principle, in which the Mudarib (active partner) must have absolute freedom in the management of the investment of the subscribed capital. The conditions of this account differ from those of the savings accounts by virtue of:
1. a higher fixed minimum amount,
2. a longer duration of deposits, and
3. most importantly, the depositor may lose some of or all his funds in the event of the bank making losses.
Special investment accounts
Special investment accounts also operate under the Mudaraba principle, and usually are directed towards larger investors and institutions. The difference between these accounts and the investment account is that the special investment account is related to a specified project, and the investor has the choice to invest directly in a preferred project carried out by the bank.
UTILISATION OF FUNDS
To generate revenue, Islamic banks utilized the funds by giving out financing facilities. The financing facilities are done based on the Islamic concepts accepted by the Islamic bank Shariah Council / Committee.
The concepts usually applied by the Islamic bank are as follows.
- Murabaha (cost plus / mark up)
This is the most commonly used mode of financing device. In a Murabaha transactions, the bank finances the purchase of a good or assets by buying it on behalf of its client and adding a mark-up before reselling it to the client on a cost-plus basis profit contract.
Bai’ muajjal (deferred payment)
Islamic banks have also been resorting to purchase and resale of properties on a deferred payment basis. It is considered lawful in Fiqh (jurisprudence) to charge a higher price for a good if payments are to be made at a later date. According to Fiqh this does not amount to charging interest, since it is not a lending transaction but a trading one.
Bai’ salam (prepaid purchase)
This method is really the opposite of the Murabaha. There the bank gives the commodity first, and receives the money later. Here the bank pays the money first and receives the commodity later, and is normally used to finance agricultural products.
This is a contract to acquire goods on behalf of a third party where the price is paid to the manufacturer in advance and the goods produced and delivered at a later date.
Ijarah and Ijara Wa Iqtina (leasing)
Under this mode, the banks buy the equipment or machinery and lease it out to their clients who may opt to buy the items eventually, in which case the monthly payments will consist of two components, i.e. rental for the use of the equipment and installment towards the purchase price.
Qard Hasan (benevolent loans)
This is the zero return type of loan that the Holy Quran urges Muslims to make available to those who need them. The borrower is obliged to repay only the principal amount of the loan, but is permitted to add a margin at his own discretion.
Contributed by : Mohd Kamil Hadsrim Ibrahim
In general, the Balance Sheet of an Islamic Bank looks no different from a Conventional Bank. Conventionally, all deposits are managed internally and the Treasury team will use the funds as efficient as possible into the various instruments in the market. In this sense, all the deposits are used to fund mixed assets into a single pool, and its returns are a consolidation of all the returns derived from the assets.
Under the Islamic Banking regime, there is greater emphasis on matching the deposits against assets. While the management of the deposits into a single pool is not disallowed by Islamic Banking, it is the payment of returns that is most important under Sharia compliance where the fairness and justice to the customer is deemed to happen.
As such, to ensure that the returns to customer’s deposits (or investment) is fair, the level of transparency in the management of the deposits needs to be increased. Therefore, it is easier to be transparent when calculations are done based on “Funds”. In general, the funds are usually separated between “Mudharabah funds” and “Non-Mudharabah funds”.
There is specific guidelines on the treatment of Mudharabah funds (ROR Framework and Mudharabah Guidelines) as the Mudharabah arrangement is an investment contract between Bank and Customer. And since the contract has the risk element of potential capital losses arising from investments, it is important for the Bank to be transparent on the use of funds to the customers. More importantly, the IFSA recognised this that all Mudharabah-based deposit must be classified as an Investment, with its appropriate disclosures and risk warnings. It is prudent for the Bank to clearly separate the Mudharabah funds and match it against specific Assets where its “actual” performance can then justify the returns paid to depositors (investors).
With the introduction of the IFSA and the need to match Deposits into specific assets (as opposed to existing methods of investing into a “General” pool), Banks ideally must identify specific performing assets to enable clear calculation of returns back to the investors i.e. customers. Therefore, the amounf in the Pool of Deposit MUST BE equal to Pool f Assets where the Pool of Revenue is derived to pay a return to the Pool of Depositors.
Moving forward, under the IFSA and the issuance of the ROR Framework and new Investment Account guidelines, the sources and uses of funds become more important due to the elevated need of transparency and disclosure, as well as financial prudence of matching Assets against Liabilities.