What is Islamic Banking
A contract in which the owner of property allows use of the property for a specified period of time in lieu of specific periodic payments. In Islamic finance it refers to an arrangement in which the Islamic bank purchases and leases an asset to the client against an agreed periodic rental amount for a specified term, under certain terms and conditions
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Literally it means a sale on mutually agreed profit. Technically, it is a contract of sale in which the seller declares his cost and the profit. This contract has been adopted by Islamic banks as a mode of financing. As a financial product, it can involve a request by the client to the bank to purchase a certain item in order to sell it to the client at cost plus the pre-agreed markup
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Partnership between two or more parties who provide capital towards the financing of a project. Profits are shared as per the pre-agreed ratio whilst losses are shared in proportion to capital contribution towards the project. Each partner has the right, but is not required, to participate in the management of the project. The management of the project can be left to the most capable partner/s or outsourced to a third party. Musharaka can take the form of Permanent Musharaka or Diminishing Musharaka
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The Bank offers Qard Accounts (i.e. transactional Accounts) which allow clients to deposit and withdraw their funds on demand. Since these funds are not exposed to any business risk, they are guaranteed but are not entitled to any profit. The bank may choose to invest such funds at its own risk and retain the profit
The Bank offers various Mudaraba investment accounts which allows clients to deposit funds for investment purposes. Any profit earned by the Bank on the investment deposits is shared with the depositors on a 60:40 split. Any capital loss will be borne by the depositors in line with the dictates of the Mudaraba contract
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How is profit calculated and distributed to depositors?
The investment deposits are pooled together in the Mudaraba Pool. The Mudaraba Pool is commingled, in the General Pool, with the shareholders’ funds that are available for investment, thereby forming a partnership between the shareholders’ funds and the Mudaraba Pool.
The bank calculates the profit to be distributed to depositors, based on the profit available for distribution for the month. The Profit available for distribution is determined by adding the income earned from the bank's financing activities and, investment in equity deals less any valid provisions for doubtful debts for the month.
The Net Profit for distribution against the Mudaraba Pool is derived after firstly deducting the Bank's share as a partner (Shareholder's funds) in proportion to its capital contribution towards to the General Pool, and secondly after deducting the Bank's share as a Mudarib (Investor of the Capital).
This is explained further: The Bank participates in profit sharing on two levels. Firstly, the Bank is entitled to a share of the profits as a partner due to it having also contributed to the General Pool in the form of Shareholders' funds. The percentage the Bank is entitled to at this stage is calculated by working out the percentage of Shareholders' funds as a percentage of the total funds in the General Pool.
For example, let us assume that the Bank earned a profit of R100 000 on the financing transactions during a particular month. If the current Capital Structure of the Bank is as follows
Depositors’ Funds (Mudaraba Pool) - R90 000 000
Shareholders’ Funds Available for Investment - R10 000 000
Total Capital Employed (General Pool) - R100 000 000
The available profit will be distributed as follows:
a) Calculation of % of Banks contribution to General Pool:
10 000 000 / 100 000 000 * 100 = 10%
b) The Bank is therefore entitled to 10% of the profits as a partner:
10 % of 100 000 = R10 000
c) The remaining profit attributable to the Mudaraba Pool is calculated as follows,
100 000 – 10 000 = R90 000
Then, the remaining income of the Mudaraba Pool (as per point d below) is shared between the Bank as an Investor of the Capital (Mudarib) and the Mudaraba Pool as investor (Rab ul Mal) on the basis of a pre-determined profit-sharing ratio.
This profit-sharing ratio is currently fixed as follows:
The Bank's share is 40%
Depositors share 60%
d) This R90 000 is distributed as follows 40% to the Bank (Mudarib) = R 36 000 60% to the Depositors = R54 000
e) Total profit due to the Bank = R36 000 + R10 000 = R 46 000
f) The R54 000 due to Mudaraba Pool is shared amongst depositors using the points system as mentioned above, the 60% of profit accruing to depositors is distributed on the basis of the points system.
The points system takes into account the amount of the investment and its duration or type of account in the Mudaraba Pool. The reason for this is that the deposits of the investors as a whole participate in the production of income in accordance with their respective amounts and duration - this is the most equitable method of delivering the respective entitlements (to investors) and is in accordance with resolution 13/5 issued by the Islamic Fiqh Academy of Jeddah.
The profit ratios defined on Al Baraka Bank's deposit products are in fact weighting ratios to allow deposits of a longer term or those of a specific type of account to have a greater share in the available profit. Therefore, based on this principle, if Ahmed has deposited R1000 in a 35 Day Participation Account which has a weighting of 65% and Ebrahim has also deposited R1000 but in a Haj account which has a weighting of 80% then even though the amounts are the same, Ebrahim could expect to receive more profits because of the higher weighting on the type of account his deposit lies in. The weightings on the deposit products have been structured to allow for longer term deposit accounts to have a higher weighting. Similarly, due to the type of certain accounts, they are given a greater weighting e.g., Haj has a higher weighting of 80% compared to some other accounts.
1. Are Islamic banking and finance products available to Muslims only?
No. Islamic financial institutions serve all members of the public including those of other faiths
2. What is the fundamental difference between Islamic banking and conventional banking?
The fundamental difference between Islamic and conventional banking is that conventional banks take deposits and advance funds on interest. In contrast, Islamic banks take deposits and advance funds on a profit and loss sharing basis. In addition, Islamic banks as ethical banking institutions do not deal with entities that are engaged in activities that are detrimental to the moral fibre, & socio-economic wellbeing, of society
3. Why is interest prohibited in Islam?
Interest is prohibited in Islam fundamentally because money is not considered a commodity with an intrinsic economic value of its own; rather it is considered to be a unit of account, medium of exchange and a store of value. Charging interest on money is deemed unjust as the lender is guaranteed the capital plus interest without taking exposure to any commercial risk. However, the borrower is required to pay back the money (capital + interest) irrespective of the outcome of the investment
4. How does an Islamic bank make money if it does not charge interest?
Islamic banks take investment deposits as an agent and invest same on behalf of the depositors on a profit and loss sharing basis. Islamic banks advance funds to individuals and the real sector of the economy using “cost plus sale” and equity modes of finance. The bank shares the income it earns from advances with depositors on a pre-agreed profit-sharing ratio. The profit earned by both the bank and depositors is a function of the performance of the underlying investment assets
5. How do investments in Islamic banks work?
Islamic banks accept investment deposits on a Mudaraba (Venture Capital) basis and invest same on behalf of the depositors. Profits are shared with depositors as per a pre-agreed profit-sharing ratio