General Banking Operation of Shahjalal Islami Bank Limited.(Chapter-3)

3.1 Concepts of Islami Bank:

Islami 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 and payment of interest on any of its operation. For millions of Muslims, banks were institution to be avoided. Islam is a religion, which keeps Believers from the tellers’ window. Their Islamic beliefs prevent them from dealings that involve usury or interest (Riba). Yet Muslim needs banking services as much as anyone and for many purposes: to finance new business ventures, to buy a house, to facilitate capital Investment to undertake trading activities and to offer safe place for saving. Muslims are not averse to legitimate profit as Islam encourages people to use money in Islamic ally legitimate ventures not just to keep their funds idle.

However in this fast moving world more than 1400 years after the Prophet (S.A.W) can Muslims find room for the principles of their religion? The answer comes with the fact that a global network of Islamic banks investment house and other financial institution have started to take shape based on the principals of Islamic finance laid down in the Quran and the Prophet’s traditions some 14 centuries ago. Islamic banking based on the Quranic prohibition of changing interest has moved from a theoretical concept to embrace more than 100 banks operating in 40 countries with multibillion-dollar deposits worldwide. Islamic banking is widely regarded as the fastest growing sector in the Middle Eastern financial services market. Exploding onto the financial scene barely thirty years ago an estimated $US100 billion worth of funds are now managed according to Shariah.

The best-known feature of Islamic Banking is the prohibition on interest. The Holy Quran forbids the charging of ‘Riba’ on money lent. It is important to understand certain principles of Islam that underpin Islamic finance. Muslim scholars accepted the word ‘Riba’ to mean any fixed or guaranteed interest payment on cash advances or on deposits.

The rules regarding Islamic finance are quite simple and can be summed up as follows:

a) The predetermined payment over and above the actual amount of principal is prohibited.

b) The lender must share in the profits or losses arising out of the enterprise for which the money was lent.

c) Making money from is not Islamically acceptable

d) Ggharar (Uncertainty, Risk or Speculation) is also prohibited.

e) Investment should only support practices or products that are not forbidden.

3.2 Objectives of Islamic Banking

The objective of Islamic Banking is not only to earn profit but also 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. The main objectives of Islamic Banking are as follows:

To conduct interest free banking.
To establish participatory Banking instead of Banking on debtor-creditor relationship.
To invest through different modes permitted under Islamic Shariah.
To accept deposits on profit-loss sharing basis.
To establish welfare oriented Banking System.
To extend operation to the poor, helpless and low income group for their economic enlistment.
To contribute in achieving the ultimate goal of Islamic economic system.
To facilitate the Islamic banking system in the country.
To create new entrepreneurs and to arrange required finance them.

3.3 Evolution of Islamic Banking

Islamic Banking comes into reality through a long theoretical exercise of several renowned Islamic scholars and economists. The first attempt to establish an Islamic financial institution took place in Pakistan in 1950. In the modern world, the pioneering role in establishing the first Islamic Bank in 1963 named ‘Mit- Ghamar’ Saving Bank in Egypt at rural area of Nile Delta. As on today, there are many Islamic financial institutions operating through out the world covering both Muslim and non-Muslim countries of various socio-economic environment.

The first Islamic bank in Malaysia was established in 1983. In 1993, commercial banks, merchant banks and finance companies were allowed to offer Islamic banking products and services under the Islamic Banking Scheme (IBS). These institutions however, are required to separate the funds and activities of Islamic banking transactions from that of the conventional banking business to ensure that there would not be any co-mingling of funds.

In Malaysia, the National Syariah Advisory Council additionally set up at Bank Negara Malaysia (BNM) advises BNM on the Shariah aspects of the operations of these institutions, as well as on their products and services.

3.4Legitimate Business Contracts for Islamic Banks

The modes of mobilization in Islamic banks have derived from the overall permissible contracts in Islam. In what follows we fast describe the concept of Aqd or contract form business perspective and then discuss the legitimate forms contracts that can be used in Islamic banks for both deposit collection and their profitable employment.

A business contract can be defined as the exchange of a thing of value by another thing of value with mutual consent. There are four element of an Aqd or contract:

Contrat(Aqd).
Subject Matter (Mabe’e).
Price (Thaman).
Prossession of delivery (Qabdh)

3.5Common practices of Islamic banks in mobilization of funds

The common practices of Islamic banks in the sources of funds may be described as follows:

3.5.1Current Accounts

All Islamic banks operate current account on behalf of their client individuals and business firms. These accounts are operated for the safe custody of deposits and for the convenience of customers. There is little different between conventional banks as far the operation of current accounts is concerned. There are two dominant views about current account. One is to treat demand deposit as amnah (trust). A trust deposit is defined by the Jordan Islamic Banks as “cash deposits received by the bank where the bank is authorized to use the deposits at its own risk and responsibility in respect to profit or loss and which are not subject to any conditions for withdrawals or depositing”.

3.5.2 Saving Account

All Islamic banks operate saving accounts. It must be pointed out that any return on capital is Islamically justified only if the capital is employed in such a way that it is expected to a business risk. Savings accounts at Islamic Banks Generally operate as follows:

Savings accounts are opened with the condition that deposits provide the bank with an authorization to invest.
Depositors have the right to deposit and withdraw funds.
The profits in savings accounts are calculated on the minimum balance maintained during the month. Depositors participate in the profits of savings accounts with effect from the beginning of the month following the month in which the deposits are made. Profits are not calculated with effect from the beginning of the month in which a withdrawal is made from the account.
A minimum balance has to be maintained in order to qualify for a share in profit.

3.5.3 Investment Deposit

Investment deposits are Islamic banks counterparts of term deposits or time deposits in the conventional system. They are also called profit and Loss-Sharing (PLS) Accounts or Participatory Account. However they can be distinguished from traditional fixed term deposits in the following manner:

Fixed term deposits in the conventional system operate on the basis of interest while investment accounts in Islamic banks operate on the basis of profit sharing Instead of promising depositors a predetermined fixed rate of return on their investment the bank tells them only the ratio in which it will share the profits with them.
While fixed term deposit are usually distinguished from each other on the basis of their maturities investment deposits can be distinguished on the basis of maturity as well as on the basis of purposes as it is possible to give special instructions to the bank to invest a particular deposit in a specified project or trade.

The main distinguishing characteristics of investment deposits can be described as follows:

Deposit holders do not receive any interest. Instead they participate in the share of the profits or losses.
Usually these accounts are opened for a specific period e.g. three months, six month, one year or more.
The return on investment is determined according to actual profit s from investment operations of the bank and shared in an agreed proportion by depositors according to the amount of their deposits and the period for which the bank holds them.
Generally speaking depositors do not have the right to withdraw from these accounts as is customary in time deposits in conventional banks.

3.6 Islamic Financial Vehicles

Islamic banks around the world have devised many creative financial products based on the risk sharing and profit sharing principles of Islamic banking. For day to day banking activities a number of financial instruments have been developed that satisfy the Islamic doctrine and provide acceptable financial returns for investors.

3.6.1 Al-Mudaraba (Profit sharing)

This implies a contract between two parties whereby one party the rabb al mal (beneficiary; owner or the sleeping partner), entrusts money to the other party called the mudarib (managing trustee or the labor partner). Important features of Mudaraba are as follows:

The division of profits between the two parties must necessarily be on a proportional basis and cannot be a lump sum or guaranteed return.
The investor is not liable for losses beyond the capital he has contributed.
The mudarib does not share in the losses except for the loss of his time and efforts.

3.6.2 Murabaha

This is the sale of a commodity at a price, which includes a stated profit, which includes a stated profit known to both the vendor and the purchaser. This can be called a cost plus profit contract. The buyer in deferred payments usually pays the price back. Under Murabaha the Islamic bank purchases in its own name, goods that an importer or a buyer wants and then sells them to him at an agreed mark-up. This technique is usually used for financing trade, but because the bank takes title to the goods, and is therefore engaged in buying and selling its profit derives from a real service that entails a certain risk and is thus seen as legitimate.

3.6.3 Musharaka (Profit and loss sharing)

This is a partnership normally of limited duration formed to carry out a specific project. It is therefore similar to a western- style joint venture, and is regarded by some as the purest from of Islamic financial instrument, since it conforms to the underlying partnership principles of sharing in and benefiting from risk. In this case the bank enters into a partnership with a client in whom both share the equity capital and perhaps even the management of a project or deal and both share in the profits or losses according to their equity shareholding.

3.6.4 Ijarah (Lease financing)

Another popular instrument is leasing which is designed for financing an asset or equipment. It is a manfaah (benefit) or the right to use the asset or equipment. The lessor leases out an asset or equipment to the client at an agreed rental fee for a pre-determined period pursuant to the contract.

3.6.5 Ijara Wa Iktina (Hire Purchase)

Equivalent to the leasing and installment loan, hire- purchase, practices that put millions of drivers on the road each year. These techniques as applied by Islamic banks include the requirement that the leased items be used productively and permitted by Islamic law.

3.6.6 Muqarada

This technique allows a bank to flat what are effectively Islamic bonds to finance a specific project. Investors who buy muqaradah bonds take a share of the profits of the project being financed, but also share the risk of unexpectedly low profits or even losses.

3.6.7 Bai-Salam

A buyer pays in advance for a specified quality of a commodity, deliverable on a specific date at an agreed price. This financing technique, similar to a futures or forward- purchase contract is particularly applicable to seasonal purchase but it can also be used to buy other goods in cases where the seller needs working capital before he can deliver.

3.6.8 Istisna (Purchase order)

This is a sale and purchase agreement whereby the seller undertakes to manufacture or construct according to the specification given in the agreement. It is similar to bai salam the main distinction being the nature of the asset and method of payment. Istisna generally covers those things which are customarily made to order and advance payment of money is not necessary as required in bai salam. The method of payment in istisna is flexible.

3.6.9 Bai-Muajjal

The terms ‘Bai’ and ‘Muajjal’ have been derived from Arabic words ‘Bai’ and ‘Ajl’. The word ‘Bai’ means purchase and sale. The word ‘Ajl’ means fixed time or a fixed period. ‘Bai-Muajjal’ means sale for which payment is made at a future fixed date or within a fixed period. In short, it is a sale on credit. ‘Bai-Muajjal’ may be defined as a contract between a buyer and seller under which the seller sells specific goods to the buyerat an agreed fixed price payable at a certain fixed future date in lump sum or within a fixed period by fixed installment’s.

3.6.10 Hire Purchase under Shirkatul Melk

Shirkat means partnership. Shirkatul Melk means share in ownership when two or more persons supply equity to purchase an asset own the same jointly and share the benefit as per agreement and bear the loss in proportion to their equity, the contract is called Shirkatul Melk contract.

3.6.11 Quard-Al-Hasan

It is a virtuous loan. Through this mode, Bank provides loan to its customer for a certain period, which bears no profit/loss/compensation.

3.6.12 Direct Investment

Islamic Bank without the help/assistance of any client may directly invest its fund/capital in share, securities, business and industry. Profit and loss in this business is exclusively, the internal matter of the Bank.

The concepts of equity and morality are at the root of Islamic banking .In Islam moral and equitable values from an integral part of the rules of law governing contractual and financial relations to such an extent that the relationship, which exists between equity law and relation, is an organic rather than supplementary relationship. The importance of Islamic banking has increased dramatically over the past 10 years. The main differences between Western and Islamic style banking is the concentration on people and their businesses rather than on accounts it is a much more grass roots banking according to one expert.