GE20803 DEPOSIT & FINANCING

OPERATION OF ISLAMIC BANKING

DEPOSIT MOBILIZATION BY ISLAMIC BANKS

Updated version 21st October 2015

BY DR. HANUDIN AMIN

LABUAN FACULTY OF INTERNATIONAL FINANCE
UNIVERSITI MALAYSIA SABAH
 BRIEF INFORMATION ON DEPOSIT
MOBILIZATION BY ISLAMIC BANKS

Unlike Islamic banks,

deposits in
conventional
Factors like framework is
philosophical, moral explained by
Like conventional In Islamic banks, legal and economic liquidity preference
banks, customer deposits are used to play a role in Major source of theory explains why
deposits are both finance the purchase differentiating the funds for Islamic people need money
sources of funds and of assets such as management of banks besides for transactions,
liability products in houses, vehicles, deposits in Islamic shareholders’ funds precautions and
Islamic banking land and building banking from that of investments -
conventional making demand
banking deposits, savings
deposits and
investment deposits
are of utmost
importance
 TWO MAIN FUNCTIONS OF ISLAMIC
DEPOSITS
Transaction function
• Wadiah dhamanah current
and savings account
• Current or demand deposits do not
pay any return both in
conventional and Islamic banking
• But conventional savings pay
interest while Islamic savings do not
• Transaction function of Islamic
deposits is conducted via the
contract of wadiah dhmanah – has
no profit motive
• Benefits – ease of cash withdrawals
on call & protection of deposits
• Current account is used to make
payments to third parties while
savings account is intended for safe-
keeping and convenience purposes
Investment function
• Al-mudarabah investment account
• Al-ghornm bil ghonm – no profit can
be gained without taking risk (no
reward without risk)
• The incentive to place money in
mudarabah deposits should
revolve around profits
• Subject to systematic risk
• Subject to operational risks
• Mudarib can abuse his responsibility
(thus moral hazard is a serious factor
to account for in decision making
when people plan to place their
savings in the mudarabah deposits
 MICRO LEVEL OF MUSLIM BEHAVIOR
ON SAVINGS
Hoarding:
1. In Islam, savings will 1. Idle cash 20,000
always means surplus 2. Zakat 0.025 x 20,000 = 500
income to be placed for
investment purposes – 3. Cash balances = 19,500
thus keeping money in
circulation. All savings
Savings:
must be invested again in
the economy. Otherwise, 1. Cash invested 20,000
it is hoarding (ihtikar) 2. Profit 10% 2,000
2. Hoarding money is
3. Wealth 20,000
prohibited in the religion
+2,000=22,000
of Islam. Why it is so?
4. Zakat 22,000 x 0.025 = 550
3. Does hoarding money
better? 5. Wealth after zakat = 21,450
WHY DEPOSIT NEEDED IN ISLAMIC
BANKING?

DEPOSITS
DEPOSITS ARE PROMOTE
THE MAIN CREDIT
SOURCE OF CREATION
FUNDS (e.g. Islamic
mortgage)

DEPOSITS
DIRECT LINK TO
ALLOW TO CATER
ECONOMIC
THE FINANCIAL
GROWTH AND
NEEDS OF
PROSPERITY
SURPLUS UNITS
 Transaction motive Current account

What are purposes

of different types of Precautionary motive Savings account deposits?

Investment motive Islamic fixed

deposit
 Does penalty impose by an
Islamic bank when a current
account holder has an
insufficient fund for payment
to a third party, but the check
has been issued?
 LECTURETTE #1

TRUE/FALSE QUESTIONS:
1. Both Islamic and conventional savings deposits
are considered as a major source of funds for
both banking systems, therefore, the savings
deposits are similar -FALSE

2. Liquidity preference theory explains muslim

behavior to hold money in an Islamic bank -
FALSE
TYPES OF DEPOSITS

Demand Savings
deposits accounts

Negotiable
Investment
deposits instruments
of deposits
 DEMAND DEPOSITS

• Definition – a bank account that entitles the account holder to

receive his or her funds on demand using checks
• Common features of demand deposits facilities offered by Islamic
banks:
1. Customers – who have the capacity to enter into a contract (i.e. 18 years old)
2. For businesses, clubs, societies and associations, certificates of registration
and documents such as MAA and minutes of meetings relating to the
opening of the account must be presented (i.e. as evidence of the
establishment)
3. Banks are of their discretion to determine the minimum amount required
during the opening the account
4. A cheque book will be supplied by the bank to the account holder
5. Withdrawals can be made with the issuance of cheques or other written
instructions given by the account holder
6. The cheques issued by the account holder will be honoured by the bank but
is subjected to the availability of funds of the account holder
7. Islamic banks may impose a service charge for servicing and maintaining the
account
8. Account holder can terminate the account provided a notice is given in
advance
 DEMAND DEPOSITS
• Wadiah current accounts – guarantee the paying back of money but
not any return:
• The bank’s responsibility is in the form of guarantee and therefore Shariah Principle used:
it is compulsory for the bank to return the fund as and when
requested by the customer Wadiah yad dhamanah – the bank
• If the bank earns high profit the depositor, but to compulsory, to pools and utilizes the fund
receive hibah
• At a loss, the bank will not give any hibah to customers

• Qard hassan current account– a benevolent loan:

Shariah Principle used: • The bank is free to utilize these funds at its own risk
• The depositor in its role as the lender is not entitled to any return
Qard hassan– deposits are treated as as this would constitute to riba
qardh or a benevolent loan by the • The bank owes the depositor only the principal amount borrowed
depositors • Less popular – commercial consideration that any profits gained
by the bank cannot be given (i.e. hiba) to depositors

• Mudarabah current account– profit sharing basis:

• The depositor brings capital, the bank brings a personal effort Shariah Principle used:
• At a profit, it is distributed according to PSR ratio
• At a loss, the depositor borne the loss
Mudarabah– the depositors
• The depositor has no control over the management of the project contribute capital (deposited funds)
and the bank is a mudarib
• Customers entitle to earn dividends based on the profit made by
the bank from the investment
WADIAH CURRENT ACCOUNT
DEPOSIT FUNDS
~safe-keeping
~CUSTOMER GIVES PERMISSIONS TO THE BANK TO UTLISE ANY SUM OF MONEY DEPOSITED
~ Wadiah yad dhamanah (an Islamic bank is
a custodian)
~ The principal amount is guaranteed by the
bank

1
5
CHEQUE BOOK
4 100% 3

Hibah at the bank’s 2

discretion PROFIT
QARD HASSAN CURRENT ACCOUNT
Depositors give a benevolent loan to the Islamic bank. The Bank is free to utilize the funds at its own risk. The depositor serves as a
lender and is not entitled to any return as this would constitute riba

Banks find it difficult to market such product

as there is no return for account holder

1
4
CHEQUE BOOK
At a bank’s
3
100% risk

PROFIT 2
 MUDARABAH CURRENT ACCOUNT
INVESTS FUNDS FOR TRANSACTIONS USING CHEQUE AND
INVESTMENTS. PSR= 30 % CUSTOMERS
70 % AN ISLAMIC BANK

1
5
CHEQUE BOOK

100% 30% 70%

PROFIT
3
LOSS
 IN THE MARKETPLACE

• Maybank Islamic Berhad offers an Islamic

checking account based on al-wadiah yad
dhamanah and mudarabah
• Current account-i à a current account
based on the Shariah concept of Wadiah
Thank you to Yad Dhamanah (safe custody), with
promote us checking facility. Flexibility of making
unlimited withdrawal s at home branch and
outstation withdrawals of RM10,000.
Protected by MIDC
• Premier mudarabah account-i à A Shariah-
compliant current account that pays
indicative dividends, plus premium banking
and takaful benefits. A combination of safe
custody (al-wadiah yad dhamanah) and
profit sharing (mudarabah). Provides a
cheque book
Islamic banks offer products for
savings, checking (demand) and
fixed deposits, structured to
comply with Shariah principles
 SAVINGS DEPOSITS

• Definition – a bank account that offers to account holders who

seek safe custody of their funds and wish to save money as well
as to earn an income from that savings
• Common features of savings deposits facilities offered by Islamic
banks:
1. Customers – individual account, minor account, joint account, club
and associations
2. A passbook will be supplied by the bank to the account holder
3. Withdrawals can be made either over the counter or ATM
4. Islamic banks may impose a service charge for withdrawal,
replacement of ATM card etc
5. Account holder can terminate the account in writing and must sign
necessary documents
6. Hibah is given at a bank’s discretion (i.e. not compulsory)
7. The savings account facility has no profit sharing characteristics
except for contracts under the concept of al-mudarabah
8. As for minors below the age of 15 years, the savings account must
be under the name of their guardian (i.e. trust account)
 SAVINGS DEPOSITS

Wadiah Yad al-Damanah (Safekeeping with Guarantee):

• Banks guarantee the deposits
• Banks can use the deposits
• Banks replace or compensate whatever gets lost
• Banks are expected to give the deposits whenever they are requested by the owners
• According to many scholars, this category is most suitably termed as qard – loan. Some do
not even consider this type in Islamic law.
Wadiah Yad al-Amanah (Act of Trust):
• By definition, keeping with trust.
• No compensation in case of loss or damage
• No reward for keeping
• No right at all to use the property
• This type of wadiah is also called Amanah

• The Apostle of Allah (P.B.U.H) said: “he who accepts a trust property (as a trustee) has no
liability”
WADIAH SAVINGS ACCOUNT
DEPOSIT FUNDS
~safe-keeping
~convenience
~ Wadiah yad dhamanah (an Islamic
bank is a custodian)
~ The principal amount is guaranteed by
the bank

1
4
Hibah at the bank’s
discretion 100% 3 2

PROFIT
 IN THE MARKETPLACE

• Bank Muamalat offers an Islamic

savings account account based on al-
wadiah yad dhamanah principles
• BSAà Al-wadiah yad Dhamanah. Basic That’s great! We are
features à minimum initial deposit is progressing over
RM 20.00, withdrawal can be made the years
using ATM, MEPS throughout the
country
• WSA à Al-wadiah yad Dhamanah.
Minimum deposit RM 100.00.
Withdrawals can made as similar as
BSA
 NORMAL CALCULATION OF HIBAH

• Daily Average Balance x (number of days/365) x hiba rate = Profit

(RM, hiba):

• For example, hiba rate from 16 Jun until 15 July is 2.0%, daily average
balance is RM 5,000, the deposit is kept for one month (Jun 2012, 30
days) so the hiba will be; and

• RM 5,000 x (30/365) x 0.02 = RM8.22

• In essence, the amount of RM8.22 will directly be credited into the

current account-i holder after the rate and the calculation for the profit
has been made. The computation of the hibah rate is anchored in the
performance of the bank, size of the deposit, period of the saving and
the policy of the bank, which may differ from one bank to another
 CALCULATION OF HIBAH WHEN
TIER MATTERS
• Given the following information on En. Dollah’s Wadiah savings at 31.12.2015
• Mutli- hibah rates (effective 16/12/2015-15/01/2016 and 16/01/2016 – 15/02/2016)

• Examples
Tier Range Rate (% p.a)
Tier 1 Up to RM 1,000 1.05 %
Tier 2 RM 1,001 to RM 5,000 1.85 %
Tier 3 RM 5,001 and above 2.54 %

• Hence compute WSA with a balance of RM7,000 for whole of January (31 days), 2016
based on the above hibah rates:

31/365 x 1.05% x 1,000 = RM 0.89

31/365 x 1.85% x 4,000 = RM 6.28
31/365 x 2.54% x 2,000 = RM 4.31
Total Hibah = RM 11.48
 LECTURETTE #2

• Given the following information on En. Matlan’s Wadiah savings at 31.12.2015

• Multi- hibah rates (effective 16/12/2015-15/01/2016 and 16/01/2016 – 15/02/2016)

Tier Range Rate (% p.a)

Tier 1 Up to RM 1,000 1.15 %
Tier 2 RM 1,001 to RM 5,000 1.95 %
Tier 3 RM 5,001 and above 2.34 %

Hence compute WSA with a balance of RM10,000 for whole of January, 2016 based on the
above hibah rates
 INVESTMENT DEPOSIT

• Definition – a bank account that allows customers to keep money for

investment motives, be it short-term or be it long-term
• Common features – the following are among the common features
of the investment deposit:
1. Minimum amount of deposit (e.g. 5,000)
2. Types of customers who can operate an investment account (i.e.
individuals, joint individuals, firms and corporations & societies,
associations and clubs)
3. Withdrawal and renewal process
4. Distribution of profits (i.e. Profits are distributed between the owner of the
capital and the entrepreneur based on PSR such as 70:30 – Islamic banks:
Customers)
 Mudarabah

Al-Mutlaqah Al-
Moqayyadah
 MUDARABAH ACCOUNT

INVESTS FUNDS
PSR= 70 % CUSTOMERS
30 % AN ISLAMIC BANK
1

100% 70% 30%

PROFIT
3
LOSS
 ELABORATION

Key elaboration:
• Suppose you deposit RM20,000 with a bank and the PSR is 30:70, 30%
is to the bank, 70% is to you
• The bank takes the money to invest in a project. It does not

guarantee that the investment will be profitable

• Now suppose there is a net profit of RM1,000. The profit is shared as

follows – 30% x 1,000 = RM300 for the bank, 70% x 1,000 = RM700 for
you. Your account would then show a balance of RM20,700
(RM20,000 + 700)
• In the even of a loss, say, RM500, you as depositor will be the only

one to bear the loss. The loss is 100% for you (100% x –RM500=-
RM500) while the bank is 0%, Your account would then show a
balance of RM19,500 (RM20,000 – RM500=RM19,500)
 CALCULATING DIVIDEND FOR
MUDARABAH ACCOUNT
If Aly places RM10,000 in MGIA on 20/1 until 20/4, with declared rates as below:
rates
16/1 - 15/2 3.30 %
16/2 - 15/3 3.25 %
16/3 - 15/4 3.20 %
16/4 - 15/5 3.12 %
Dividend computation RHB Bank

Based on daily accrual basis on the prevailing declared rates.

(20/1-15/2 = 27 days) 27/365 x 3.30 % x 10,000 = 24.41

(16/2-15/3 = 28 days) 28/365 x 3.25% x 10,000 = 24.93
(16/3-15/4 = 31 days) 31/365 x 3.20% x 10,000 = 27.18
(16/4-20/4 = 05 days) 05/365 x 3.12% x 10,000 = 04.27
Total dividend RM 80.79
 IN THE MARKETPLACE

BIMB introduces a first in Islamic

banking, that is, al-awfar
investment account-i. NOT CIMB
ISLAMIC. Minimum initial deposit is
that of RM1,000 – 1 month tenure.
FIRST OF ALL,
RM500 – 1- 60 months tenure:
BIMB, surely… PSR=70 Bank: 30 Customer
we are the best

Are you sure?

 NEGOTIABLE INSTRUMENTS OF
DEPOSITS

• Definition – refers to a sum of money deposited with the

bank and repayable to the bearer on a specified future date
• Common features of the instrument:
1. Two Shariah principles used, BBA and Mudarabah
2. A certificate of investment will be supplied by the bank to the
account holder
3. Equivalent to the conventional certificate of deposits (CDs)
4. A bank-issued short-term security that documents a deposit and
specifies the profit rate and maturity date
5. As bearer instruments
6. May be issued based on BBA or Mudarabah as above
 NEGOTIABLE INSTRUMENTS OF
DEPOSITS
Negotiable Islamic
Debt Certificate
(NIDC)
The Islamic bank sells the bank’s
asset to the depositor at an agreed
price on CASH BASIS. The Islamic
bank, in turn, buys the similar asset
from the depositor at PRINCIPAL
VALUE + PROFIT and done at an
agreed FUTURE DATE
Islamic Negotiable
Instruments of
Deposit (INID)
The depositor places money with
the Islamic bank and REPAYABLE to
the depositor (THE BEARER) on a
specified future date at the
NOMINAL VALUE + DIVIDEND
 NEGOTIABLE ISLAMIC DEBT
CERTIFICATE
1-SELL ASSET, RM50K
MOP: CASH - ‘ISLAMIC DEPOSIT’
1
2

2-BUY BACK ASSET, RM50K +

PR%
MOP: DEFERRED OVER A
PERIOD OF SAY 4 YEARS

• The bank sells its’ asset to a customer for immediate cash, whom
simultaneously sells back the asset to the bank for a credit price.
The deferred marked up credit price, is re-paid by the bank to the
customer within a period from overnight up to 365 days
• The bank issues a Certificate of Debt (Shahadah al-Dayn) as
evidence of the bank's debt to the customer
• NIDC is done on an inah transaction & may be subsequently
traded as a debt to a third party
 NORMAL CALCULATION OF NIDC

Bank sells an asset to its customer

• Selling Price (SP) RM1,000,000

• Profit margin ( r ) 7.5% p.a

• Tenor (months) ( t ) 6
or, days to maturity 182.5
Bank purchases from the customer SP x [ 1+ (r* t / 365 ) ]

1,000,000 x [ 1 + (0.075 x 182.5 / 365) ] = 1,037,500

Customer’s profit 37,500

ISLAMIC NEGOTIABLE INSTRUMENTS
OF DEPOSITS
1- CONTRIBUTES 100% CAPITAL

1
2

2-REPAYABLE TO THE BEARER

ON A SPECIFIED FUTURE DATE,
NOMINAL VALUE + DIVIDEND

• The maturity is from 90 days up to 60 months

• Similar to a MIA
• Can be sold or traded in the IMM
• Profit or declared dividend rate depends on the PSR
• Return is equivalent to the time value of the depositor’s money
 NORMAL CALCULATION OF INID

• Profit Sharing ratio in favor of customer (PSR) 80 : 20

• Deposit placement (D) RM1,000,000

• Declared dividend rate ( r ) 7.5% p.a

• Tenor (months) ( t ) 6
or days to maturity 182.5

Proceeds D x [ 1+ (r* t /365 ) ]

1,000,000 x [1 + (0.075 x 182.5 / 365) ] = 1,037,500

Customer’s profit 37,500
 IN THE MARKETPLACE

• Bank Muamalat offers a Negotiable Islamic

Debt Certificate (NIDC)
• Done on BBA principle
• The bank sells the NIDC to the customer at
an agreed price on cash basis We are again!
• The bank buys back the NIDC at
principal+profit at an agreed future date
• Tenors of issuance vary from 1 mth – 5

years
• Minimal nominal amount issued is

RM10,000,000 in multiples of RM 1,000,000

• Fixed return over the entire tenor of the
investment
THANKS TO ALLAH AZZA WA
JALLA FOR EVERYTHING