“Investment mechanism of Islami Bank Bangladesh Limited”
Introduction
Definition of Islami banking:
An Islamic bank is a financial institution which operates with the objective to implement and materialize the economic and financial principles of Islam in the arena of banking.
“An Islamic Bank is a financial institution whose status, rules and procedures expressly state its commitment to the principle of Islamic Shariah and to the banning of the receipt of interest on any of its operations”-OIC.
Objective of Islamic banking
Islamic banks operate on Islamic principles of profit and loss sharing ,strictly avoiding interest, which is the root of all exploitation and is responsible for large-scale inflation and unemployment
The objectives of Islamic banking are not only to earn profit, but to do good and welfare to the people. Islam upholds the concept that money, income and property belong to Allah and this wealth is to be used for the good of the society.
An Islamic bank is committed to do away with disparity and establish justice in the economy, trade, commerce and industry; build socio-economic infrastructure and create employment opportunities.
Special Features of Islamic banking:
ü All activities are conducted on interest-free system according to Islamic Shariah Principles.
ü Investment is made through different modes as per Islamic Shariah.
ü Investment Income of the Bank is shared with the Mudaraba depositor according to an agreed upon ratio ensuring a reasonably fair rate of return on their deposits.
ü To introduce a welfare-oriented banking system and also to establish equity and justice in the field of all economic operations.
ü Extend socio-economic and financial services to individuals of all economic backgrounds with strong commitment in rural uplift.
ü Plays a vital role in human resources development and employment-generation particularly among the unemployed youths.
ü Portfolio of investment and investment policy have been specially tailored to achieve balanced growth and equitable development through diversified investment operation particularly in the priority sectors and in the less developed areas of the national economy.
Comparison between Conventional & Islamic banking:
Conventionalbanking is essentially based on the debtor-creditor relationship between the depositors and the bank on the one hand, and between the borrowers and the bank on the other. Interest is considered to be the price of credit, reflecting the opportunity cost of money.
Islam, on the other hand, considers a loan to be given or taken, free of charge, to meet any contingency. Thus in Islamic Banking, the creditor should not take advantage of the borrower. When money is lent out on the basis of interest, more often it happens that it leads to some kind of injustice.The first Islamic principle underlying such kinds of transactions is that “deal not unjustly, and ye shall not be dealt with unjustly”. Hence, commercial banking in an Islamic framework is not based on the debtor-creditor relationship.
The second principle regarding financial transactions in Islam is that there should not be any reward without taking a risk. This principle is applicable to both labor and capital. As no payment is allowed for labor, unless it is applied to work, there is no reward for capital unless it is exposed to business risk.
Thus, financial intermediation in an Islamic framework has been developed on the basis of the above two principles. Consequently financial relationships in Islam have been participatory in nature. Several theorists suggest that commercial banking in an interest-free system should be organized on the principle of profit and loss sharing.
The institution of interest is thus replaced by a principle of participation in profit and loss.That means a fixed rate of interest is replaced by a variable rate of return based on real economic activities. The distinct characteristics which provide Islamic banking with its main points of departure from the traditional interest-based commercial banking system are: (a) the Islamic banking system is essentially a profit and loss sharing system and not merely an interest (Riba) banking system; and (b) investment (loans and advances in the Conventional sense) under this system of banking must serve simultaneously both the benefit to the investor and the benefit of the local community as well. The financial relationship as pointed out above is referred to in Islamic jurisprudence as Mudaraba.
The distinguishing features of the conventional banking and Islamic banking are shown in terms of a box diagram as shown on the next page:
| Conventional Banks | Islamic Banks |
| 1. The functions and operating modes of conventional banks are based omanmade principles. | 1. The functions and operating modes of Islamic banks are based on the principles of Islamic Shariah. |
| 2. The investor is assured of a predetermined rate of interest. | 2. In contrast, it promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur). |
| 3. It aims at maximizing profit without any restriction. | 3. It also aims at maximizing profit but subject to Shariah restrictions. |
| 4. It does not deal with Zakat. | 4. In the modern Islamic banking system, it has become one of the service-oriented functions of the Islamic banks to collect and distribute Zakat. |
| 5. Leading money and getting it back with interest is the fundamental function of the conventional banks. | 5. Participation in partnership business is the fundamental function of the Islamic banks. |
| 6. Its scope of activities is narrower when compared with an Islamic bank. | 6. Its scope of activities is wider when compared with a conventional bank. It is, in effect, a multi-purpose institution. |
| 7. It can charge additional money (compound rate of interest) in case of defaulters. | 7. The Islamic banks have no provision to charge any extra money from the defaulters. |
| 8. In it very often, bank’s own interest becomes prominent. It makes no effort to ensure growth with equity. | 8. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity. |
| 9. For interest-based commercial banks, borrowing from the money market is relatively easier. | 9. For the Islamic banks, it is comparatively difficult to borrow money from the money market. |
Riba:
‘Riba’ Arabic word means Excess. Excess in case of spot transaction of one or same kind of goods. General reason – quality. Or, Excess in case of deferred transaction of same goods. Reason is time –basis.
The Basic Features Of Riba
The word used by the Quran concerning ‘interest’ is Riba. The literal meanings of Riba are money increase, increase of anything or increment of anything from its original amount (Maududi 1979, p.84). However, all increases are not considered as Riba in Islam. Money may increase in business activities as well. This increase is not at all considered as Riba. The increase, instead of being prohibited (Haram), is approved (Halal) in Islam. Islam prohibits only those increases that are charged on theloan with a prefixed rate.
Muslim scholars equate interest with Riba. In the Shariah, Riba technically refers to the premium that must be paid by the borrower to the lender along with the principal amount as a condition for the loan or for an extension in its maturity. In other words, Riba is the predetermined return on the use of money. In the past there has been dispute about whether Riba refers to interest or usury, but there is now consensus among Muslim scholars that the term covers all forms of interest and not only “excessive” interest.
The most important characteristic of Riba is that it is the positive and definite result of money when changed. In other words, when money begets money, without being exchanged for goods or services, it is called Riba.
Its Basic Characteristics are:
It must be related to loan.
A prefixed amount of money to be paid when due.
A time is fixed for the repayment; and
All these elements for repayment are taken as conditions for loan.
Basic difference between Riba & Profit:
There are persons who try to equate Riba with profit. In effect, they are fundamentally different from each other as can be seen from the following:
| Riba | Profit |
| 1. When money is “charged”, its imposed positive and define result is Riba | 1. When money is used in trading (for e.g.) its uncertain result is profit. |
| 2. By definition, Riba is the premium paid by the borrower to the lender along with principal amount as a condition for the loan. | 2. By definition, profit is the difference between the value of production and the cost of production. |
| 3. Riba is prefixed, and hence there is no uncertainty on the part of either the givers or the takers of loans. | 3. Profit is post-determined, and hence its amount is not known until the activity is done. |
| 4. Riba con not be negative, it can at best be very low or zero. | 4. Profit can be positive, zero or even negative. |
| 5. From Islamic Shariah point of view, it is Haram. | 5. From Islamic Shariah point of view, it is Halal. |
Investment of Islami Bank Bangladesh Limited (IBBL)
Introduction:
On the basis of IBBL investment is a set of strict rules that forbid making or receiving interest payments. To get around this prohibition, trade financing is obtained by buying inventory that will be resold at a pre-determined price on a future date, which is called Murabaha. Financing for capital projects is called Musharaka, which is funding by two or more parties who may be active managers in a partnership. Losses are shared on the basis of the capital contribution. Profits may be shared in any way the partners decide.
The special feature of the investment policy of the Bank is to invest on the basis of profit-loss sharing system in accordance with the tenets and principles of Islamic Shariah. Earning profit is not the only motive and objective of the Bank’s investment policy rather emphasis is given in attaining social good and in creating employment opportunities.
Pursuant to the Investment Policy adopted by the Bank, a ‘7-year Perspective Investment Plan’ has been drawn-up and put into implementation. The plan aims at diversification of the investment port-folio by size, sector, geographical area, economic purpose and securities to bring in phases all sectors of the economy and all types of economic groups of the society within the fold of Bank’s investment operations.
Accordingly, the plan envisages composition of the investment port-folio with 2.5% for agriculture and rural investment, 18% for industrial term investment, 13% for industrial working capital, 10% for housing and real-estate, 4% for transport and communication, 0.5% for electricity, gas, water and sanitation services, 2% for storage, 43% for import, export and local trade and trade related activities 1% for poultry and dairy,2% for Rural Development Scheme, 2.5% for other Special Scheme, 0.5% for Micro Industry and 1% for other productive purposes by the end of the plan period.
Further, in order to diversify investment portfolio, the Bank engaged itself in investment operations through special schemes introduced during the years. The Bank is planning to introduce yet other new investment schemes in addition to welfare-oriented Investment Schemes, Rural Development Scheme, Transport Investment Scheme, Car Investment Scheme, Small Business Investment Scheme, Doctors Investment Scheme, Household Durables Investment Scheme, Housing Investment Scheme and Agricultural Implements Investment Scheme etc.
Objectives and Principles of IBBL:
The objectives and principles of investment operations of the Islami Bank are:
To invest fund strictly in accordance with the principles of Islamic Shariah.
To diversify its investment portfolio by size of investment, by sectors (public & private), by economic purpose, by securities and by geographical area including industrial, commercial & agricultural.
To ensure mutual benefit both for the Bank and the investment-client by professional appraisal of investment proposals, judicious sanction of investment, close and constant supervision and monitoring thereof.
To make investment keeping the socio-economic requirement of the country in view.
To increase the number of potential investors by making participatory and productive investment.
To finance various development schemes for poverty alleviation, income and employment generation with a view to accelerating sustainable socio-economic growth and upliftment of the society.
To invest in the form of goods and commodities rather than give out cash money to the investment clients.
Investment Mechanism of IBBL:
Allah has permitted Bai (Buying and selling i.e. trading) & prohibited Riba. Islamic Banks in all its transactions follow the verdict of Al-Qur’an and Sunnah and prohibit Riba in all its operations. The Banks conduct investment portfolio under three mechanism, The mechanisms are:
(1) Bai Mechanism
(2) Share Mechanism
(3) Ijara Mechanism
Graphical distribution of Investment mechanism
(a) Bai-Mechanism
v Bai Murabaha:
Meaning of Murabaha
The terms “Bai-Murabaha” have been derived from Arabic words Bai and Ribhun. The word ‘Bai’ means purchase and sale and the word ‘Ribhun’ means an agreed upon profit. “Bai-Murabaha” means sale for an agreed upon profit. Bai-Murabaha may be defined as a contract between a buyer and a seller under which the seller sells certain specific goods permissible under Islamic Shariah and the Law of the land to the buyer at a cost plus an agreed upon profit payable today or on some date in the future in lump-sum or by installments. The profit may be either a fixed sum or based on a percentage of the price of the goods.
Types of Murabaha
In respect of dealing parties Bai–Murabaha may be of two types :
Ordinary Bai-Murabaha, and
Bai-Mudabaha order on and Promise.
Ordinary Bai-Murabaha is a direct transaction between a buyer and a seller. Here, the seller is an ordinary trader who purchases goods from the market in the hope of selling these goods to another party for a profit. In this case, the seller undertakes the entire risk of his capital investment in the goods purchased. Whether or not he earns a profit depends on his ability to find a buyer for the merchandise he has acquired.
Bai-Murabaha order on and Promise involvesthree parties – the buyer, the seller and the bank. Under this arrangement, the bank acts as an intermediary trader between the buyer and the seller. In other words, upon receipt of an order and agreement to purchase a certain product from the buyer, the bank will purchase the product from the seller to fulfill the order.
However, it should be noted here that the Islamic Bank acts as a financier in this transaction. This is the case, not in the sense that the bank finances the purchase of goods by the consumers; rather it is a financier by deferring payment to the seller of the product. Thus, there is a chance that this transaction could resemble nothing more than a loan for which interest (Riba) is earned, which is contrary to Islamic beliefs.
There are some important features of Bai-Murabaha as given below.
Important Features of Murabaha
1. A client can make an offer to purchase particular goods from the bank for a specified agreed upon price, including the cost of the goods plus a profit.
2. It is permissible to take cash/collateral security to guarantee the implementation of the promise or to indemnify any losses that may result.
3. Documentation of the debt resulting from Bai-Murabaha by a Guarantor, or a mortgage, or both like any other debt is permissible. Mortgage/Guarantee/Cash Security may be obtained prior to the signing of the Agreement or at the time of signing the Agreement.
4. The bank must deliver the goods to the client at the date, time, and place specified in the contract.
5. It is permissible for the bank to contract with a third party to buy and receive the goods on its behalf. This agreement must be a separate contract.
These features make Bai-Murabaha distinctive from all other modes of Islamic Investment. There are certain steps to accomplish a deal of Bai-Murabaha as shown below.
Rules of Bai-Murabaha
ü It is permissible for the client to offer to purchase a particular commodity, deciding its specifications and committing itself to buy it on Murabaha for the cost plus the agreed upon profit.
ü It is permissible that the mutual agreement shall contain various conditions agreed upon by the two parties, especially with respect to the place of delivery, the payment of a cash security to guarantee the implementation of the operation and the method of payment.
ü It is permissible to stipulate the binding nature of the promise to purchase. Thus, the agreement can only be satisfied by either fulfilling the promise to purchase or by indemnifying the bank for any losses incurred if the promise to purchase is not fulfilled.
ü It is a condition that the bank purchases the requested commodity (first purchase contract) before selling it on Murabaha to the buyer. The contract in the first purchase must be settled, in principle, between the source seller and the bank.
ü It is permissible for the bank to authorize a second party including the buyer to receive the commodity on its behalf. This authorization must be in a separate contract, particularly if the buyer is going to receive the goods on behalf of the bank. This is necessary to avoid any conflicts with the ensuing Murabaha sale.
ü Once the bank takes ownership of the goods, it is responsible for any damages or defects. Thus, if the goods are damaged, the bank is liable and must repair the damage prior to delivering the goods to the purchaser.
It is a condition that the Bai-Murabaha contract be drawn at the last phase. That is after the promise to purchase and the purchase of the commodity in the name of the bank and receipt of the commodity directly by the bank or through an agent.
v Bai-Muajjal (Deferred Sale):
Meaning of Bai-Muajjal
The terms “Bai” and “Muajjal” are derived from the Arabic words ‘Bai’ and ‘Ajal’. The word ‘Bai’ means purchase and sale and the word ‘Ajal’ means a fixed time or a fixed period. “Bai-Muajjal” is a sale for which payment is made at a future fixed date or within a fixed period. In short, it is a sale on credit.
The Bai-Muajjal may be defined as a contract between a buyer and a seller under which the seller sells certain specific goods, permissible under Shariah and law of the country, to the buyer at an agreed fixed price payable at a certain fixed future date in lump sum or in fixed installments.
There are some important features of Bai-Muajjal as given below:
Important Features of Bai-Muajjal
It is permissible and in most cases, the client will approach the bank with an offer to purchase a specific good through a Bai-Muajjal agreement.
It is permissible to make the promise binding upon the client to purchase the goods from the bank. In other words, the client is required to either satisfy the promise or to indemnify the bank for damages caused by breaking the promise without excuse.
Stock and availability of goods is a basic condition for signing a Bai-Muajjal Agreement. Therefore, the bank must purchase the goods in accordance with the specifications of the client, prior to signing the Bai-Muajjal Agreement with the client.
All goods purchased on behalf of a Bai-Muajjal agreement are the responsibility of the bank until they are delivered to the client.
The bank must deliver the goods to the client at the time and place specified in the contract.
The bank may sell the goods at a higher price than the purchase price to earn profit.
The price is fixed at the time of the agreement and cannot be altered.
The bank is not required to disclose the profit made on the transaction.
Some Observations
This type of financing by the bank is considered to be more risky than the other Islamic modes of investment previously discussed. Therefore, the application/proposal for Bai-Muajjal investment must be reviewed very carefully to ensure the client can ultimately make payment. The following steps may be taken to ensure the Bai-Muajjal Investment is a good proposition for the bank:
1. The bank may meet with the prospective client regarding his investment needs and business experience prior to an application /proposal is submitted.
2. The bank may review the client’s past performance and other financing arrangements he may have had with the bank in the past.
3. The bank may review its current investment policy regarding this type of financing arrangement to ensure the proposal meets bank guidelines.
It should be remembered that if the Bai-Muajjal investment is not secured by first class collateral securities, it becomes more risky than investments under other modes of Islamic banking.
v Bai-Salam:
Meaning of Bai-Salam
Bai-Salam is a term used to define a sale in which the buyer makes advance payment, but the delivery is delayed until some time in the future. Usually the seller is an individual or business and the buyer is the bank.
The Bai-Salam sales serve the interests of both parties.
ü The seller receives advance payment in exchange for the obligation to deliver the commodity at some later date. He benefits from the Salam sale by locking in a price for his commodity, thereby allowing him to cover his financial needs whether they are personal expenses, family expenses or business expenses.
ü The purchaser benefits because he receives delivery of the commodity when it is needed to fulfill some other agreement, without incurring storage costs. Second, a Bai-Salam sale is usually less expensive than a cash sale. Finally a Bai-Salam agreement allows the purchase to lock in a price, thus protecting him from price fluctuation.
Steps of Bai-Salam
1. Cash sale or Sale on Credit – The bank pays the agreed upon price at the time of the contracts inception. The seller agrees to the delivery of the commodity some specified date in the future.
2. Delivery and Receipt of the Commodity on the Specific due Date: There are several options for delivery available to the bank-
· The bank may receive the commodity and resell it to another party for cash or credit.
· The bank may authorize the seller to find another buyer for the commodity.
· The bank may direct the seller to deliver the commodity directly to a third party with whom the bank has entered into another agreement.
3. The Sale Contract: The bank agrees to sell the commodity for cash or a deferred price, which is higher than the Salam purchase price. The buyer agrees to purchase and to pay the price according to the agreement.
There are some rules for Bai-Salam as given below.
Rules of Bai-Salam
Ø It is a condition that the commodity known by both parties to the agreement. Misunderstandings about the commodity may lead to disputes, which could void the contract.
Ø It is a condition that the quality of the commodity be monitored closely, as very little variation from specifications in the contract are allowable. If the commodity cannot be monitored for quality standards, a Salam transaction is impermissible.
Ø It is a condition that the commodity be deliverable on the due date. If there is uncertainty about the ability to deliver the commodity at the due date, a Salam transaction is impermissible.
Ø It is a condition that the commodity is a liability debt. The seller is obliged to deliver the commodity when it is due, according to the specifications stipulated in the contract, whether or not his firm produces the commodity or obtained from other firms.
Ø Salam sales are impermissible on existing commodities because damage and deterioration cannot be assured before delivery on the due date.
Application of Bai-Salam
Salam sales are frequently used to finance the agricultural industry. Banks advance cash to farmers today for delivery of the crop during the harvest season. Thus banks provide farmers with the capital necessary to finance the cost of producing a crop.
Salam sale are also used to finance commercial and industrial activities. Once again the bank advances cash to businesses necessary to finance the cost of production, operations and expenses in exchange for future delivery of the end product. In the meantime, the bank is able to market the product to other customers at lucrative prices.
In addition, the Salam sale is used by banks to finance craftsmen and small producers, by supplying them with the capital necessary to finance the inputs to production in exchange for the future delivery of products at some future date.
v Istisna Sale
Meaning of Istisna’a Sale
The Istisna’a sale is a contract in which the price is paid in advance at the time of the contract and the object of sale is manufactured and delivered later. The majority of the jurists consider Istisna’a as one of the divisions of Salam, Therefore, it is subsumed under the definition of Salam. But the Hanafie school of Jurisprudence classifies Istisna’a as an independent and distinct contract. The jurists of the Hanafie School have given various definitions to Istisna’a some of which are: “That it is a contract with a manufacturer to make something” and “It is a contract on a commodity on liability with the provision of work”. The Purchaser is called ‘Mustasnia’ contractor and the seller is called ‘Sania’ maker or manufacturer and the thing is called ‘Masnooa’, manufactured, built, made (ABIIB). Islamic banks can utilize Istisna’a in two ways.
1. It is permissible for the bank to buy a commodity on Istisna’a contract then sell it after receipt for cash or deferred payment.
2. It is also permissible for the bank to enter into a Istisna’a contract in the capacity of seller to those who demand a purchase of a particular commodity and then draw a parallel Istisna’a contract in the capacity of a buyer with another party to manufacture the commodity agreed upon in the first contract.
Each transaction is deemed a separate contract with payment being made in cash either immediately or on a deferred basis. Any disagreements that may arise are settled under each contract separately according to the provisions therein. The steps of the Istisna’a sale and the parallel Istisna’a have been discussed below.
Steps of Istisna’a Sale
Ø The Buyer expresses his desire to buy a commodity and brings a request to purchase the commodity to the bank. The method of payment, whether cash or deferred is set forth in the agreement. The bank agrees to deliver the commodity to the buyer at some agreed upon time in the future.
Ø The Parallel Istisna’a Contract: In order that the bank is able to deliver said commodity in the Istisna’a agreement, the bank enters into a parallel Istisna’a agreement with a third party to either manufacture or otherwise deliver-said commodity. Obviously, the bank stipulates a price that is lower than that agreed to in the original agreement and requires delivery on or before the date stipulated in the original contract.
Ø Delivery and Receipt of the Commodity: The seller in the parallel Istisna’a agreement, delivers the commodity to the bank on the agreed upon date. The bank, in turn, delivers the product to the buyer of the original Istisna’a contract, in accordance with the original agreement. In this way, all parties fulfill their obligations to the contract.
Rules of Istisna’a Sale
o It is a condition in the Istisna’a contract to clearly define dimensions and specifications of the product being purchased. This is important to ensure that there is no room for dispute over what is required.
o The Istisna’a contract is only used for objects that can be manufactured. It can not be used to purchase corn, wheat, barley, fruit or any natural product.
o The object sold in a Istisna’a contract is a fixed liability debt and it is permissible for the object to be a custom manufactured product, made in accordance with certain specifications.
o The maker should supply the materials. If they are supplied by the buyer, the contract is Ijara and not Istisna’a.
o Once the contract is drawn the ownership of the asset is confirmed to the buyer and the purchase price is confirmed to the manufacturer.
o It is not a condition in the Istisna’a contract to advance the price. Usually part of the price is paid in advance and the remainder is withheld until the time of delivery.
o It is a condition that the time of delivery be specified in the agreement to avoid confusion that may lead to a dispute over the transaction.
o It is a condition that the place of delivery be stated in the contract if the commodity requires special handling and delivering arrangements.
o The buyer may stipulate in the Istisna’a contract that the commodity shall be manufactured or produced by a specific manufacturer, or manufactured with specific materials. This is not permitted in a case of Salam Sale.
Application of Istisna’a Sale
The Istisna’a contract allows Islamic banks to finance the public needs and the vital interests of the society to develop the Islamic economy in accordance with Islamic teachings. For example Istisna’a contracts are used to finance high technology industries such as the aviation, locomotive and ship building industries. In addition, this type of business transaction is also used in the production of large machinery and equipment manufactured in factories and workshops. Finally, the Istisna’a contract is also applied in the construction industry such as apartment buildings, hospitals, schools, and universities to whatever that makes the network for modern life. One final note, the Istisna’a contract is best used in those transactions in which the product being purchased can easily be measured in terms of the specified criteria of the contract.
(b) Sharing Mechanism
v Mudaraba
Definition of Mudaraba
The term Mudaraba refers to a contract between two parties in which one party supplies capital to the other party for the purpose of engaging in a business activity with the understanding that any profits will be shared in a mutually agreed upon. Losses, on the other hand, are the sole responsibility of the provider of the capital. Mudaraba is also known as Qirad and Muqaradah.
Mudaraba is a contract of those who have capital with those who have expertise, where the first party provides capital and the other party provides the expertise with the purpose of earning Halal (lawful) profit which will be shared in a mutually agreed upon proportion. This type of business venture serves the interest of the capital owner and the Mudarib (agent).
The capital owner may not have the ability or the experience to run a profitable business. On the other hand, the agent (the Mudarib) may not have adequate capital to invest in a business or project. Therefore, by entering into a contract of Mudaraba each party compliments one another, allowing a business venture to be financed. The following are the steps of the Mudaraba contrac.
Steps of Mudaraba
The bank provides the capital as a capital owner. The Mudarib provides the effort and expertise for the investment of capital in exchange for a share in profit that is agreed upon by both parties.
ü The Results of Mudaraba: The two parties calculate the earnings and divide the profits at the end of Mudaraba. This can be done periodically in accordance with the terms of the agreement, subject to the legal rules that apply.
ü Payment of Mudaraba Capital: The bank recovers the Mudaraba capital it contributed before dividing the profits between the two parties because the profit is considered collateral for the capital.
ü Distribution of wealth resulting from Mudaraba: In the event a loss occurs, the capital owner (the bank) is responsible for the entire loss. In the event of profits, they are divided between the two parties in accordance with the agreement between them, subject to the capital being recovered first.
Rules of Mudaraba
There are some legal rules that govern the business relationship Mudaraba which are as follows in the next page:
Ø It is a condition in Mudaraba that the capital be specific in nature. In other words, the amount of capital must be known at the inception of the contract. The purpose of this rule is to ensure that there is no uncertainty about the amount of capital and, thus, no uncertainty about the division of profits.
Ø It is a condition that capital must be in the form of currency in circulation. However, merchandise can be contributed, so long as both parties to the business arrangement agree upon its value.
Ø It is a condition that the capital cannot be subject to indebtedness.
Ø It is permissible for a Mudarib to mix his private capital with the capital of the Mudaraba, thus becoming a partner. In addition, it is also permissible for the Mudarib to dispose of capital on behalf of the Mudaraba.
Ø It is a condition that the capital of the Mudaraba is delivered to the Mudarib. Some of the jurists permit the capital owner to withhold capital and release it gradually according to the needs of the Mudarib since the Mudaraba adjudges unrestricted disposal.
Ø It is permissible for the capital owner to deliver capital to two Mudharibs in a single contract. It is permissible for the capital owner to vary the in profit sharing agreement between the two Mudharib based upon differences in the services provided.
Ø It is permissible for the Mudarib to hire an assistant to perform difficult work that he is unable to perform on his own.
Ø The disposal of capital by the Mudarib is restricted to reasons that are conducive to the Mudaraba. The Mudarib must not lend or donate any of the Mudaraba capital. Further, he is not allowed to enter into indebtedness nor enter into another partnership agreement with the Mudaraba capital. However, these activities are permissible if the capital owner consents and authorizes the agent to use his discretion.
Concluding Remark
It is an investment-based form of financing. The provider of capital in Mudaraba has no role in the management of the capital. However, he has to bear the risk of capital loss as well as the opportunity cost of capital for the entire period of the contract. The rate of return is quite uncertain and the cost of capital is also uncertain. Hence, there is a perfect correlation between cost of capital and rare of return on capital.
v Musharaka (Partnership)
Meaning of Musharaka
The word Musharaka is derived from the Arabic word Sharikah meaning partnership. Islamic jurists point out that the legality and permissibility of Musharaka is based on the injunctions of the Qura’n, Sunnah, and Ijma (consensus) of the scholars. It may be noted that Islamic banks are inclined to use various forms of Shariakt-al-Inan because of its built-in flexibility. At an Islamic bank, a typical Musharaka transaction may be conducted in the following manner.
One, two or more entrepreneurs approach an Islamic bank to request the financing required for a project. The bank, along with other partners, provides the necessary capital for the project. All partners, including the bank, have the right to participate in the project. They can also waive this right. The profits are to be distributed according to an agreed ratio, which need not be the same as the capital proportion. However, losses are shared in exactly the same proportion in which the different partners have provided the finance for the project.
Types of Musharaka
Musharaka may take two forms:
Ø Permanent Musharaka and
Ø Diminishing Musharaka.
These are discussed below:
In this case, the bank participates in the equity of a company and receives an annual share of the profits on a pre-rate basis. The period of termination of the contract is not specified. This financing technique is also referred to as continued Musharaka.
The contributions of the partners under this mode may be equal or unequal percentages of capital for the purpose of establishing a new income-generating project or to participate in an existing one. In this arrangement, each participant owns a permanent share in the capital structure and receives his share of the profits accordingly. This type of a partnership is intended to continue until the company is dissolved. However, one can exit the partnership by selling his share of the capital to another investor.
Permanent Musharaka is used by Islamic Banks in many income generating projects. They can provide financing to their customers, in exchange for ownership and profit sharing in the proportion agreed upon by both parties. In addition, the bank may leave the responsibility of management to the customer-partner and retain the right of supervision.
Rules for Permanent Musharaka
ü It is a condition that the capital provided by each partner is specific, existent and easily accessible. It is inappropriate to establish a company with borrowed money, for the purpose of profit.
ü It is permissible for partners to have unequal ownership in the project. The percent of ownership is set forth in the agreement.
ü It is a condition that the capital of the company is money and valuables. Some of the jurists permit contributing merchandise as invested capital. However, the merchandise must be evaluated, and the value agreed upon by all parties. Once the value has been established, it is counted as capital and stipulated in the contract as such.
ü It is a condition that each partners’ share of the profits be known to avoid uncertainty. Also, it is required that the ownership interest be in percentage terms and not a fixed sum, because this would violate the requirements of a partnership.
ü In principle, profit must be divided among partners in ratios proportionate to their shares in capital but some of the jurists permit variation in profit shares, so long as it is agreed to by all of the partners. This may be the case when one of the partners is more dexterous and more diligent and does not agree to parity, so variation in the sharing of profits becomes necessary.
ü In principle, a partnership is a permissible and non-binding contract. Thus, if a partner wishes, he could rescind the agreement provided that this occurs with the knowledge of the other partner or partners. Rescinding the agreement without the knowledge of the other partners’ prejudices the rescinding partner’s interest. On the other hand, some of the jurists take the view that the partnership contract is binding up to the liquidation of capital or the accomplishment of the job accepted at the contract.
Diminishing Musharaka
Diminishing or Digressive Musharaka is a special form of Musharaka, which ultimately culminates in the ownership of the asset or the project by the client. It operates in the following manner.
The Bank participates as a financial partner, in full or in part, in a project with a given income forecast. An agreement is signed by the partner and the bank, which stipulates each party’s share of the profits. However, the agreement also provides payment of a portion of the net income of the project as repayment of
The principal financed by the bank. The partner is entitled to keep the rest. In this way, the bank’s share of the equity is progressively reduced and the partner eventually becomes the full owner.
When the bank enters into a Diminishing Musharaka its intention is not to stay in the partnership until the company is dissolved. In this type of partnership, the bank agrees to accept payment on an installment basis or in one lump sum, an amount necessary to buy the bank’s partnership interest.In this way, as the bank receives payments over and above its share in partnership profits, it’s partnership interest reduces until it is completely bought out of the partnership.
Steps of Diminishing Musharaka
1. Participation in Capital: The bank – tenders part of the capital required for the project in its capacity as a participant and agrees with the customer/partner on a specific method of gradually selling its share in capital back to the partner.
2. Results of the Projects: The intent of the project is capital growth. The project may be profitable or lose money.
3. The distribution of the Wealth accrued from the Projects: In the event of loss each partner bears his share in the loss in his exact proportionate share of capital. In the event that the project is successful, profits are distributed between the two partners (the bank and the customer) in accordance with the agreement.
4. The bank sells its Share of Capital: The bank expresses its readiness, in accordance with the agreement, to sell a specific percentage of its share of capital.
Application of Diminishing Musharaka
The decreasing Musharaka is suitable for the financing of industrial businesses that have regular income. It can be considered to be the appropriate mode to finance collective investment. In this arrangement, the bank earns periodic profits throughout the year and it encourages the partner to participate in the joint investment. In addition it fosters individual ownership by allowing the partner to gradually buy the bank’s ownership interest. In terms of society as a whole it corrects the course of the economy by developing a mode of positive partnership instead of the negative relationship of indebtedness. In addition, it assists in the equitable distribution of societies wealth.
(c) Lease Mechanism
v Ijarah
Meaning of Ijarah
Fuqaha (jurists) have defined Ijaraha as ownership of a benefit for consideration. This is also known as lease or Hire contract. Al-Ijarah is an Arabic term. This has been derived from the Arabic term “Ujr” or “Ujrat” which means ‘consideration’ or ‘return’ or ‘wages’.
According to Islamic Shariah (jurisprudence), Ijarah is a contract between two parties – the lessor and the lessee, where the lessees (Hirer or Mustajir) have the right to enjoy/reap a specific benefit against a specified consideration/rent/wages from the lessor – the owner (Muajjir).
Elements of Ijarah
According the majority of Fuqaha, there are three general elements of Ijarah:
1. The wording: This includes offer and acceptance.
2. Contracting parties: This includes a lessor, the owner of the property, and a lessee, the party that benefits from the use of the property.
3. Subject matter of the contract: This includes the rent and the benefit.
Rules for Ijarah
It is condition that the subject (benefit/service) of the contract and the asset (object) should be known comprehensively.
It is a condition that the assets to be leased must not be a fungible one (perishable or consumable) which can not be used more that once, or in other words the asset(s) must be a non-fungible one which can be utilized more than once, or the use/benefit/service of which can be separated from the assets itself.
It is a condition that the subject (benefit/service) or the contract must actually and legally be attainable/derivable. It is not permissible to lease something, the handing-over of the possession of which is impossible. If the asset is a jointly owned property, any partner, according to be majority of the jurists, may let his portion of the asset(s) to co-owner(s) or the person(s) other than the co-owners. However, it is also permissible for a partner to lease his share to the other partner(s),
It is a condition that the lessee shall ensure that he will make use of the asset(s) as per provisions of the Agreement or as per customs/norms/practice, if there is no expressed provision.
The lease contract is permissible only when the assets and the benefit/service derived from it are within the category of ‘Halal’ or at least ‘Mobah’ as per Islamic Shariah.
The lessor is under obligation to enable the lessee to the benefit from the assets by putting the possession of the asset(s) at his disposal in useable condition at the commencement of the lease period.
In a lease contract, the period of lease and the rental to be paid in terms of time, place or distance should be clearly stated.
3.4 – Qard-E-Hasana (Benevolent Loans)
Qard Hasan is a contract in which one of the parties (the lender) places into the ownership of the other party (the borrower) a definite parcel of his property, in exchange nothing more than the eventual return of something in the same value of the property loaned.
Ausaf Ahmad (1998,) mentioned that since interest on all kinds of loans is prohibited in Islam, a loan that is to be given in accordance with the Islamic principle has to be, by definition, a benevolent loan (Qard Hasan) i.e. a loan without interest. It has to be granted on the grounds of compassion, i.e. to remove the financial distress caused by the absence of sufficient money in the face of dire need. Since banks are profit driven organizations, it would seem that there is not much opportunity for the application of this technique. However provisions to provide Qard Hasan besides engaging in income generating activities.
Islamic banks also play a socially useful role. Hence they make provisions to provide Qard Hasan besides engaging in income generating activities. There may be slight variations among different Islamic banks in the use of this technique. The Faisal Islamic Bank of Egypt provides interest-free benevolent loans to the holders of investment and current accounts, in accordance with the conditions set forth by its board of directors.
The bank also grants benevolent loans to other individuals under conditions decreed by its Board. On the other hand, the Jordan Islamic Bank Law authorizes it to give “benevolent loans (Qard Hasan) for productive purposes in various fields to enable the beneficiaries to start independent lives or to raise their incomes and standard of living. Iranian banks are required to set aside a portion of their resources out of which interest free loans (Qard Hasan) can be given to small producers, entrepreneurs and farmers who are not able to secure financing for investment or working capital from other alternative sources, and needy customers. It should also be noted that Iranian banks are permitted to charge a minimum service fee to cover the cost of administering these funds.
v Hire-Purchase Under Shirkatul Melk (HPSM)
Hire-Purchase under Shirkatul Melk has been developed through practice. Actually, it is a synthesis of three contracts: (a) Shirkat; (b) Ijarah, and (c) Sale. These may be defined as follows:
(a) Definition of Shirkatul Melk: ‘Shirkat’ means partnership. Shirkatul Melk means share in ownership. When two or more persons supply equity, purchase an asset and own the same jointly and share the benefit as per agreement and loss in proportion to their respective equity, the contact is called Shirkatul Melk. In the case of Hire Purchase under Shirkatul Melk, Islamic banks purchase assets to be leased out, jointly with client under equity participation, own the same and share benefit jointly till the full ownership is transferred to the client.
(b) Definition of Ijara: The term ‘Ijara’ has been defined as a contract between two parties, the lessor and the lessee, where the lessee enjoys or reaps a specific service or benefit against a specified consideration or rent from the asset owned by the lessor. It is a lease agreement under which a certain asset is leased out by the lessor or to a lessee against specific rent or rental for a fixed period.
(c) Definition of Sale contract: This is a contract between a buyer and a seller under which the onwnership of certain goods or asset is transferred by the seller to the buyer against agreed upon price paid by the buyer. In the case of Hire Purchase under Shirkatul Melk, the lessor bank sells or transfers its title to the asset under a sale contract on payment of sale price.
Thus in Hire Purchase under Shirkatul Melk mode, both the bank and the client supply equity in equal or unequal proportion for purchase of an asset like land, building, machinery, transports, etc., purchase the asset with that money, own the same jointly, share benefit as per agreement and bear the loss in proportion to their respective equity.
Stages of Hire Purchase under Shirkatul Melk (HPSM):
Hire Purchase under Shirkatul Melk Agreement has got three stages:
1. Purchase of asset under joint ownership of the lessor and the lessee.
2. Hire, and
3. Sale and transfer of ownership by the lessor to the other partner – lessee.
Important Features HPSM:
1. In case of Hire Purchase under Shirkatul Melk transaction the asset/property involved is jointly purchased by the lessor (bank) and the lessee (client) with specified equity participation under a Shirkatul Melk contract in which the amount of equity and share in ownership of the asset of each partner (lessor bank and lessee client) are clearly mentioned. Under this agreement the lessor and the lessee become co-owners of the asset under transaction in proportion to their respective equity.
2. The share of the purchased asset owned by the lessor (bank) is put at the disposal possession of the lessee (clients) keeping the ownership with him for a fixed period under a hire agreement in which the amount of rent per unit of time and the benefit for which rent to be paid along with all other agreed upon stipulations are clearly stated. Under this agreement the lessee (client) becomes the owner of the benefit of the asset not of the asset itself, in accordance with the specific provisions of the contract that entitles the lessor (bank) the rentals.
3. As the ownership of leased portion of asset lies with the lessor (bank) and rent is paid by the lessee against the specific benefit, the rent is not considered as price or part of price of the asset.
Hire Purchase under Shirkatul Melk Mode is a combination of three contacts. All rules governing the lease contract should be applicable in this mode also. Moreover, the rules for Musharakah and sale contracts will also apply to this. In addition, the following should also be followed:
Growth of Investment Modes of Islami Bank Bangladesh Limited (IBBL):
| YEAR | AMOUNT IN MILLION TAKA |
| 2005 | 521.385 |
| 2006 | 570.161 |
| 2007 | 636.265 |
| 2008 | 771.13 |
| 2009 | 856.52 |
| 2010 | 1078.96 |
Graphical Position of Investment Mode
Sector-wise Investment of IBBL:
Sector wise investment as on 31.12.2010 is as under:
Graphical Position of Investment Sector
Investments:
(Figure in million taka)
Mode Wise Investment of IBBL:
Mode-wise investment of the Bank as on 31.12.2010 is as under:
(Figure in million taka)
| Mode | Investment | % Total Investment |
| Bai Muajjal | 5,588,875 | 0.571872221 |
| Bai Murabaha | 2,820,687 | 0.288622046 |
| HPSM | 513,731,999 | 52.56676151 |
| QTDR | 25,230,690 | 2.581687859 |
| Bai Salam | 2,100,000 | 0.214878963 |
| MPI | 287,727,505 | 29.44123229 |
| Murabaha TR | 140,094,611 | 14.33494511 |
| Total | 977,294,366 | 100 |
| Sector | Investment | % Total Investment |
| Industry | 312,812,380 | 31.45830038 |
| Commercial | 289,522,032 | 29.11608246 |
| Real Estate | 329,463,271 | 33.13281445 |
| Transport | 31,121,820 | 3.129798002 |
| H.D.S | 620,417 | 0.062392877 |
| Others | 30,831,601 | 3.100611829 |
| Total |