Investment Deposits at Islamic Banks

Mudarabah or profit and loss sharing account is a common feature of Islamic banking. The customer provides the capital and the bank acts as the Mudarib to manage the funds. The bank may invest these funds in one or more Shari’ah compliant projects and share the profits with the customer based on an agreed upon ratio. If the ventures result in losses, the customer has to share in the loss while the bank loses the fruits of its services.

Mudarabah accounts requiring fixed term deposits usually do not allow withdrawals until the end of the term. There are also accounts that have no withdrawal penalty but their profit share is usually less than the fixed deposits. The Islamic bank is obligated to invest the depositors’ investment in Shari’ah compliant ventures. The bank can charge the venture any expenditures and net proceeds should be distributed according to the contract. The investors must be aware of the distribution ratios of the contract to avoid any ambiguity.

Mudarabah could be unrestricted or restricted. In restricted Mudarabah, the banks may offer a general investment fund where bank can select any project it deems profitable, whereas, for restricted Mudarabah, the bank can provide a list of industries or projects from which the investor can choose based on his risk preference. The bank acting as the fund manager, may take a number of actions, such as appointing agents, leasing assets, maintain cash reserves, etc. to manage the fund.

A Mudarabah account can be explained by the following example:
The Islamic bank finances a project for $100,000. It pools money from one hundred different investors with each share being $1,000. The agreed profit ratio is set at 50:50 which means that the bank (Mudarib) will keep one half of the profit for its services and the other half will be distributed among the share holders according to their investment. There can be no other guarantees or compensation for the bank or the investors. If the venture makes $20,000 in profit, the first $10,000 will be kept by the bank for its services as per the contract. The rest of the profit will be distributed among 100 share holders which will get $100 for each share in the venture. If the venture lost $10,000, the bank will not get anything and each share will lose $100.

Risk-averse investors include widows, retired people, or any others who cannot afford to take loss of capital. Mudarabah is a profit and loss sharing account which may be risky for risk-averse investors. These investors should deposit their funds in current accounts where the capital is guaranteed and no return is expected. If the depositors require earning potential then they could purchase units in Murabaha (cost with profit mark-up) and Ijarah (leasing) funds and they would earn profit from trading and leasing transactions of these funds.

Another opportunity for risk-averse investors is to invest in Sukuk. These are quasi-fixed income securities which are available in the capital markets and sold by brokerage houses and Islamic banks. They are similar to bonds but do not pay interest to make them Shari’ah compliant. They are tied to cash flows or returns generated from a physical asset. The funds collected from Sukuk can be invested in a project on the basis of Murabaha, Mudarabah, Musharakah, Ijarah, Istisna’a, or any other Shari’ah compliant contract.

In order to mobilize deposits from small investors, who are usually risk-averse, Islamic banks have floated the idea of Shari’ah complaint Islamic deposit insurance schemes (takaful of deposits). The scholars have allowed for such instruments as long as takaful does not deal with interest. Shari’ah requires that there cannot be any guarantee of the capital or profit in any investment type account. To accommodate this requirement yet allow for certain level of protection, Islamic banks have developed capital advocacy and risk management schemes. Deposit insurance schemes for small risk-averse investors could provide certain level of capital protection and open the investment field for these investors to Mudarabah projects.