DEPOSIT PRODUCTS Mobilization of funds from depositors/savers to borrowers/investors is an important task of a financial intermediary in the economy. Financial intermediaries attempt to achieve this goal by creating and selling a variety of financial products to channel funds between the savers and entrepreneurs such that investment opportunities emerge and increase. Higher savings are necessary for higher investment. Firms usually reinvest their own savings; and the savings of households are passed to firms, either directly through the purchase of stocks and bonds or indirectly through financial intermediaries In the longer-term, higher saving rates results in higher economic growth While needs related to returns, liquidity, maturity, safety, stability and the like are important for the Muslim saver, he / she has a unique concern - Shari a compliance. Hence, even if there is possibility of a trade-off between the other concerns, Islamic deposit products allow no trade-off in the matter of Shari a compliance. Islamic banks are engaged in mobilizing savings from savers by offering Shari a compliant products that also vary with respect to other dimensions of return, risk, liquidity, maturity, safety, stability and the like. The underlying concept for each product is simple and can be compared to an existing conventional financial instrument. On the deposit end, Islamic banks normally operate three broad categories of accounts: current, savings, and investment (general and special) accounts. 1
CURRENT ACCOUNT (WADI A/QARD) DEPOSIT As in the case of conventional banks, the current account is essentially a safekeeping arrangement between the depositors and the bank, which allows the depositors to withdraw their money at any time and permits the bank to use the depositors' money for liquidity purposes. This account gives no return to the depositors and more often than not, the banks make no service charges in this regard. As in the case of conventional banks, Islamic banks provide a broad range of related services that ensure easy access to withdrawals whenever and wherever needed, such as, checking facility, automated-teller-machine cards, charge cards, traveler s checks, telephone banking, branch service, standing instructions, statement request facility, balance enquiry facility, remittances and the like. This product is based on various alternative Shari a models such as: 1. Wadi a-wad-dhamana or guaranteed deposits o Wadi a refers to the action of leaving an item with a person who is not the owner for the purpose of safe-keeping for a temporary period of time. o Under this mechanism, the deposits are held as amana or in trust and utilized by the bank at its own risk. o The depositor does not share in the risk or return in any form. Any profit or loss resulting from the investment of these funds accrues entirely to the bank. o Another feature of such deposits is the absence of any condition with regard to deposits and withdrawals. The term wadi a account or trust account is used for such deposits. 2
2. Qard or benevolent loan by the depositor o In this case, the bank operates "qard hasan current account". o As in above, the bank is free to utilize these funds at its own risk. o The depositor in its role as the lender is not entitled to any return as the latter would constitute riba. o In fact, any kind of benefit passed on to the depositor that is a part of the agreement, is deemed to be riba. o The qard hasan model is less popular than the wadi a model among bankers because banks would like to provide additional benefits to their depositors for marketing purposes. o Under qard hasan framework, benefits to a lender (the depositor in this case) are rightly looked at as being against the spirit of this model. SAVINGS (WADI A/MUDHARABA) DEPOSIT This deposit account serves the need for the safekeeping of one s surplus funds while providing a modest return. Here, the bank has the discretion to periodically pay the depositors a positive return, depending on its own profitability. Such payments are considered lawful in Islam since they are not a condition for lending, nor are they predetermined. The savings account holders are allowed to withdraw their money as they please. The objective of a modest return is provided by using alternative models. 1. Wadi a Model o This model is similar to the one of current deposit. This model is quite popular in South East Asian countries. 3
o The principal amount of deposit is guaranteed. The bank guarantees the withdrawal of funds from this account anytime the customer may wish to do so. o Savings deposit however, differs from current account deposit in that the bank now provides a return to the depositor, purely at its discretion as a gift. Such gift is not part of the contract. o Generally, the gift or reward on deposit is granted if the customer meets the minimum deposit required under this account. Such reward is variable in nature since it is profitbased and is discretionary on the part of the bank. 2. Mudharaba Model o The bank now requires the depositors to authorize the bank (or appoint the bank as mudharib) for the purpose of investing the funds. Depositors however, have the right of withdrawal. o Profits are calculated on the basis of the minimum balance maintained for a time period (say, a month). The minimum balance maintained is deemed as the investment for that time period. o A minimum balance is required to be maintained in order to qualify for a share in profits. 3. Al Qard Al Hasan Model o This model is primarily used by Iranian banks. o As in the case of current accounts, this model essentially views deposits as loans from savers to the banks. o The functioning of such product is similar to wadi a-based products highlighted above. 4
o Although no dividends are payable to qard hasan depositors, banks provide a range of benefits including non-contractual gifts to their customers. INVESTMENT (MUDHARABA) DEPOSITS This is the core deposit product of an Islamic bank. The product is based on the concept of mudharaba and as such, is also known as profit-and-loss sharing (PLS) deposit or participatory deposit. It can be seen as the Islamic counterpart of the conventional fixed deposit product that cannot be withdrawn prior to a maturity date. At times, such deposits allow withdrawal, but only at the cost of foregoing the profit share. The profit-sharing ratio varies from bank to bank and from time to time, depending on supply and demand conditions. The rate of return could be positive or negative, but in practice, the returns are usually positive and quite comparable to the rates that conventional banks offer on their term deposits. Islamic banks always bear in mind that since investment accounts are based on the Mudharaba principle, there is always a chance that the rate of return could be negative. In that case, they should remove the loss incurred from the deposit account. Such a scenario would disrupt the system by decreasing the bank s credibility. To prevent that imbalance in the system, Islamic banks set aside part of their profit in a stabilization fund to compensate for losses so that depositors have a stable return!! There are several types of investment deposits: 5
1. General Investment Deposits o This is a popular deposit product of Islamic banks under which an investment pool is established. The pool includes investment deposits of different maturities. o The funds are not tied to any specific investment project but are utilized in different and continuous financing operations of the bank. o Profits are calculated and distributed at the end of the accounting period, which is either three months, six months or one year. 2. Special Investment Deposit o This deposit account is similar in all respects to general investment deposit except that the depositor should meet the required minimum to invest in this product, and the holders of the special investment accounts (usually government and large corporations) have the option to choose specific projects that they wish to invest their funds in. As a result, the funds in special investment accounts normally end up in large popular investment projects and institutions known for their solid credibility and high rates of return. o The modes of investment of the funds and the ratio of profit distribution may usually be individually negotiated. 3. Limited and Unlimited Period Investment Deposits o As the name suggests, investment deposits under the limited contract are accepted for a specified period, which is mutually determined by the depositor and the bank. The contract terminates at the end of the specified period but profits are calculated and distributed at the end of the accounting period. 6
o In case of the unlimited, the period is not specified. Deposits are automatically renewable unless a notice of three months is given to terminate the contract. No withdrawals or further deposits are permitted in this kind of contract, but customers are allowed to open more than one account. The profits are calculated and distributed at the end of the accounting period. IMPLEMENTATION ISSUES IN DEPOSIT PRODUCTS Gifts in Wadi a and Qard When deposit products are modeled after wadi a or qard, the customer does not participate in any way in risk. The nominal value of deposits is not allowed to decline if the bank incurs losses instead of profits. As we have discussed above, banks invariably provide gifts or bonus in cash and in kind and various other benefits to the depositor. These constitute reward for the depositor. However, is such a reward Islamically admissible given that the depositor is not exposed to any risk? The answer to this question is somewhat tricky. On the one hand, the excess or expected return is not contractual in nature. The bank is under no obligation to provide a return and the return is purely in the nature of gift. Gifts, by definition, do not constitute riba. At the same time, even while the returns in the form of gifts are not part of the agreement, these may be recurring in nature. When the bank provides such gifts at a certain rate on deposits without fail, the customer would now have a clear expectation of returns. He/she would expect returns without bearing any risk. This comes dangerously close to devouring riba. For example, HSBC announced that with an HSBC Interest Free Checking account and a combined balance of $15,000 or more, one can enjoy (i) a free HSBC's MasterMoney debit card, (ii) no monthly maintenance fee, (iii) no ATM fees, (iv) free internet banking, (v) internet bill pay service, (vi) no issuance fee for money 7
orders, official checks and travelers cheques, (vii) 50% discount on small safe deposit box annual fee, plus other benefits associated with the use of the MasterMoneyTM Card. With this HSBC Interest-Free account, the depositor receives a host of benefits that are contractual in nature and come with deposits or qard. Can these be justified simply as withdrawal mechanisms that provide for the right of the lender to seek partial or full redemption of his loan or that of the depositor to seek withdrawal of his/ her deposits any time? Guaranteed Return in Mudharaba Investment deposits are modeled after the classical contract of mudharaba. As such, the depositor as the rabb-ul-mal is exposed to the possibility of both profits and losses and the possibility of guaranteeing the nominal value of deposits or guaranteeing a minimum rate of return does not exist. However, local law may mandate such a guarantee. Because of this practical requirement, the question of guarantee has been repeatedly subjected to scrutiny and as a result, one may observe a wide range of views in this matter. o One view asserts that such a guarantee could be provided by the state as a third party. o Another view calls for a radical departure from the classical mudharaba in the light of wide spread fraud in dealings. o Still another view calls for a special parental treatment of small depositors. There is yet to be a consensus on such concessions for a deposit modeled after mudharaba. 8
Bahrain Banking System (2008) Banking Sector: Assets US$259 billion (May 2008) No. of institutions 125 (June 2008) Retail banks 24 Locally incorporated 9 Branches of foreign banks 15 Wholesale banks 64 Representative Offices 35 Islamic Banks (included in above): No. of banks 26 Assets US$18.9 billion (May 2008) 9