Chapter 9

Tracing the Sources and Uses of Funds in Islamic Banks

In This Chapter

arrow Figuring out where the money comes from

arrow Sorting out debt instruments for Islamic banks

arrow Setting up options for customer deposits

arrow Putting a bank’s funds into action

In Chapter 7, I provide an overview of the primary functions of a commercial bank, which acts as a financial intermediary between the lucky people who have excess money and the rest of the population, which needs money. The bank stands between depositors and borrowers, handing money back and forth (and finding ways to make some profit so it can continue to exist).

In this chapter, I narrow the discussion by focusing on how Islamic banks manage their funds: where the money comes from and how the banks use funds to generate profit and fulfill their social responsibilities. Although the focus here is on Islamic banks, I do compare Islamic banking practices to those of conventional banks when necessary to point out similarities and differences between the two banking systems.

Discovering the Sources of Bank Funds

Every organization — even a nonprofit charity group — requires funds to run its operations. (You can’t pay the electric bill with paper clips or good intentions.) And like many other types of organizations, commercial banks have multiple sources of funds, including the following:

check.png Paid-up capital

check.png Reserves

check.png Debt instruments or debt securities

check.png Money market loans

check.png Customer deposits

For both conventional and Islamic commercial banks, available funds are categorized as either the banks’ own money or borrowed money.

Capitalizing on bank capital: Money in hand

Before a bank can even open its doors, it needs to acquire funds that allow it to operate. And when the bank operations are in full swing, it likely retains some of its profits for the sake of ensuring its future health. Here are the sources of a bank’s own funds (whether it’s a conventional or Islamic bank); they’re the same sources found at any other type of corporation:

check.png Paid-up capital: Also called owners’ equity, paid-up capital is the amount of capital the bank has actually received by issuing stocks. I’m not talking about the authorized capital of the bank, which is the maximum amount it can receive by issuing all the stocks allowable per its governing documents. Paid-up capital reflects real dollars in hand — not the bank’s future capital potential.

As I note in Chapter 8, the central banking authorities in some countries (including the United States) set minimum limits for the paid-up capital for each bank to try to promote stability in the industry. In Malaysia, for example, the minimum requirement for paid-up capital for a domestic banking group is 2 billion Ringgits.

check.png Reserves: These funds, also called retained earnings, come from earned and undistributed shareholder dividends. Generally, a bank doesn’t distribute every penny of its profits in a given period to its shareholders; it reserves some of these funds for future use. Doing so boosts the bank’s liquidity and stability, which is why shareholders go along with it. After all, shareholders expect the bank’s board of directors to make sound business decisions so the bank earns more profits in the future and shareholders continue to benefit over a long period of time.

Focusing on borrowed funds

The dividing line between conventional and Islamic banks occurs in relation to borrowed funds. Both types of banks receive borrowed money in the form of money raised by issuing bonds, loans from other banks, customer deposits, and loans from central banks (which are the lenders of last resort for the banks they regulate). But an Islamic bank’s borrowed funds must come from products and contracts that align with sharia principles (see Chapter 1 for details on sharia).

In the next three sections, I detail the three categories of sources of borrowed funds for Islamic banks: debt instruments, interbank borrowing, and customer deposits. (For information about how Islamic banks handle loans from central banks, check out Chapter 8.)

Working with Debt Instruments

Debt instruments provide individuals and organizations (including banks) with a way to borrow money in exchange for a promise to repay funds according to a specific contract. A debt instrument can be written on paper or issued as an electronic promise.

Conventional banks handle many types of debt instruments, including bonds, certificates of deposit (CDs), bills, and guaranteed investment contracts (GICs), which are contracts that guarantee the return of principal along with interest within a set period of time. Similarly, Islamic banks use Islamic debt instruments to facilitate borrowing without running afoul of sharia principles.

remember.epsTo be clear, an Islamic debt instrument isn’t a single, stand-alone tool. Rather, it’s an overall category of instruments associated with a variety of sharia principles and Islamic contracts, such as the following:

check.png Partnership (mudaraba)

check.png Joint venture (musharaka)

check.png Cost plus profit (murabaha)

check.png Forward sale (salam)

check.png Lease (ijara)

check.png Agent representation (wakala)

check.png Sale by order (istisna)

See Chapter 6 for the lowdown on Islamic contracts and Chapter 10 for a better understanding of how those contracts are employed by Islamic banks to create a variety of commercial products.

In conventional financing, debt is always associated with interest. So how can Islamic banks, which are prohibited from undertaking interest-based transactions, issue debt instruments?

remember.epsKeep in mind that a debt in the conventional finance system is a financial obligation that arises when an entity borrows money from a lender. In Islamic finance, the relationship between the two parties is completely different. The debt obligation arises from a trade relationship between two parties, and the profit potential from the trade relationship has nothing to do with interest payments.

Like conventional banks, Islamic banks use Islamic debt instruments to fund their short-term and long-term liquidity requirements. Here are two such debt instruments that an Islamic bank can use to raise funds:

check.png Corporate sukuk: Sukuk are the Islamic version of bonds; head to Chapter 13 for detailed coverage.

check.png Term financing certificates: These debt products are slightly different from sukuk because the holder of a term financing certificate may redeem the principal amount at any point during the term of the contract rather than only at the end.

Even though debt instruments are available in the Islamic capital markets, Islamic banks don’t have nearly as much access to them as conventional banks do. For this reason, Islamic banks may struggle with liquidity more than conventional banks. The development of interest-free debt instruments is a work in progress. Islamic debt instruments are developed and widely used in Malaysia.

realworldexample.epsOne example of a term financing certificate that is used by Islamic banks in Malaysia is the negotiable Islamic debt certificate (NIDC). It’s considered to be the sharia-compliant equivalent of a conventional negotiable instrument of deposit (NID): a document that guarantees that a set amount of money will be repaid at a specific date (or on demand). This instrument is based on the Islamic contract of deferred payment sales (bay bithaman ajil). A certificate is issued by the Islamic bank to the customer as evidence of the debt owed by the bank to the customer.

Borrowing Funds from Other Banks

Like conventional banks, Islamic banks use interbank lending markets to fund their liquidity requirements. Here’s how these markets work: Banks with excess liquidity lend to the interbank lending market, and banks in need of liquidity borrow from the market. When a bank borrows money from the market, the term of the debt instrument is one week or less.

In conventional banking, the transaction takes place using interbank interest rates that are set by specific markets, including the following:

check.png Federal Funds Rate in the United States

check.png London Interbank Offered Rate (LIBOR) in the United Kingdom

check.png Euro Interbank Offered Rate (Euribor) in the European Union

check.png Emirates Interbank Offered Rate (EIBOR) in United Arab Emirates

Of course, such interest-based transactions are forbidden in Islamic finance, so Islamic banks must find their own interbank markets. Like conventional banks, Islamic banks use interbank borrowing as a short-term tool to manage liquidity. But they do so in a sharia-compliant way.

remember.epsCurrently, the products of Islamic interbank money markets are based on the sharia concepts of mudaraba (partnership), murabaha (commodity deposit), musharaka (joint venture), and wakala (agent representation):

check.png Profit and loss sharing contract (mudaraba): Under this contract, the Islamic bank with deficit liquidity obtains the necessary short-term funds from another Islamic bank on a profit and loss sharing (PLS) basis. Both banks negotiate the PLS ratio. (As I explain in Chapter 10, in a mudaraba contract, both parties share any profits. However, in case of loss, only one party sustains a financial loss; the other party’s loss occurs due to any time and effort it put into the transaction.) Current mudaraba products allow for this contract to be as short as an overnight transaction and as long as one year. Funds returned by the borrowing bank to the lending bank at the end of the contract reflect the total capital plus the profit ratio that belongs to the lending bank.

check.png Cost-plus-profit liquidity contract (commodity murabaha deposit): This vehicle is a quite complicated murabaha (cost plus profit) instrument used in Islamic capital markets to raise funds for the liquidity requirements of banks. It’s a kind of Islamic deposit contract backed by a liquidity commodity, such as metal or stocks, and the contract is generally valid for as little as two weeks and as long as one year.

check.png Joint venture basis Islamic interbank borrowing (musharaka): This kind of partnership agreement involves a silent partner and a working partner. The lending bank participates in the funding pool as an investor and silent partner. The borrowing bank is the working partner of the joint venture. At the end of the contract, both banks share the profit and loss according to the predetermined contract.

check.png Representation (wakala): In a wakala contract, one bank works as the agent for another bank. The Islamic bank deposits funds in another bank to invest them in a sharia-compliant manner in the effort to manage the Islamic bank’s liquidity.

realworldexample.epsIslamic interbank borrowing isn’t yet widely used or fully developed, but I expect it to grow in coming years. Following are just two examples of how Islamic interbank money markets are functioning in the real world:

check.png Malaysia has a sophisticated Islamic Interbank Money Market (IIBMM), which was established in 1994 by the Malaysia Central Bank (Bank Negara Malaysia) to facilitate short-term investment sources within the country based on sharia.

check.png Thomson Reuters initiated the first ever Islamic Interbank Benchmark Rate (IIBM) in November 2011 to facilitate short-term borrowing among Islamic banks. Prior to the IIBM, the Islamic banking industry was using the interest-based conventional benchmark rate to calculate its short-term financing costs. The IIBR is calculated by Thomson Reuters with guidance from the Islamic Benchmark Committee (comprised of Islamic financing professionals representing individual banks, the Islamic Development Bank, regulatory associations, and more) and is approved by a sharia committee. The IIBR is officially published at 11:00 Mecca, Saudi Arabia, time. (Mecca, or Makkah, is the holy city of Muslims.)

Attracting Deposits

Customers make bank deposits for various reasons, including safeguarding their money and earning income. And customer deposits are major funding sources for both conventional and Islamic banks. A bank uses customer deposits to provide loan and investment products to other customers (and to make a profit from doing so).

The basic difference between deposits made in Islamic banks and conventional banks is that Islamic banks act as fund managers between a depositor and borrower, while conventional banks act simply as intermediaries between the two parties. Here’s the distinction:

check.png A fund manager actively manages the customers’ funds, investing them and seeking returns so the customers and the bank can share profits.

check.png Intermediaries link money borrowers and lenders. They take the money from the customer and guarantee the customer a fixed return. They then lend the money to those who need it. In between, they make a profit by charging higher interest rates from the borrowers and paying lower interest rates to the lenders.

Current (checking) accounts, savings accounts, and investment accounts are all instruments Islamic banks offer in order to attract deposits. The following sections cover them in more detail.

Checking into current accounts

In conventional banks, current accounts are called demand accounts. In the United States, they’re called checking accounts. As I explain in Chapter 7, this type of account differs from others because it gives depositors freedom to withdraw or transfer their money any time without any limitation on the withdrawal amount.

Islamic banks have current accounts similar to those found at conventional banks; customers can write checks and use debit cards to withdraw their money just as customers at conventional banks do. However, the Islamic current accounts differ conceptually. An Islamic bank current account pays no interest and doesn’t charge for overdrafts or for the involvement of credit cards. The nominal value of deposit is guaranteed in an Islamic bank current account.

The current account offerings differ from bank to bank. Theoretically, the following three basic Islamic contracts apply to current accounts in Islamic banks, which you can read about in the following sections:

check.png Deposit (wadia)

check.png Trust deposit (amana)

check.png Loans (qard hasan)

Deposit (wadia) and trust deposit (amana)

In these types of contracts, someone gives his property to a trustee for safety reasons and doesn’t expect to receive any return for the use. In the wadia contract, the trustee is allowed to use the asset while the asset is in its possession — with the condition that the property should be returned when demanded. In the amana contract, the trustee cannot use the asset; it must simply safeguard the asset.

If the trustee charges any fee for the asset’s safekeeping under a wadia contract, the trustee is liable for any damage incurred to the asset. With an amana contract, the trustee is held liable if it’s found to be negligent with the asset’s safekeeping.

Here’s how the wadia or amana contract plays out for an Islamic bank and its customers: The bank is the trustee, and the customer’s money is the property or asset. Under an amana contract, the bank simply holds the customer’s money and safeguards it; the customer pays a fee for this service. Under a wadia contract, the bank may use the customer’s money (by investing it, for example) but must return the money to the customer whenever the customer needs it.

Profit-free loan (qard hasan)

I explain in Chapter 7 that Islamic banks rarely deal with loans because loans usually imply the accrual of interest. However, qard hasan is a type of loan accepted by Islamic banks because it demands no profit. Basically, qard hasan works when the lender extends a loan without demanding any interest charges or any other compensation from the borrower. (However, as a sign of appreciation, the borrower may give the lender extra money along with the principal when the loan is paid off.) Islamic banks give qard hasan loans to the community in the interest of social responsibility.

Current accounts with Islamic window banks

You may wonder what assurance exists for an Islamic customer who deposits money in an Islamic window of a conventional bank. Does that money get mixed in with conventional funds? Is it tainted in this way? Rest assured that sharia boards for Islamic windows of conventional banks require that the conventional banks maintain a separate account for this type of Islamic product so that the deposits are used only for sharia-compliant financing activities. For example, Lloyds TSB Islamic windows assure that money deposited in Islamic business accounts is used only for sharia-compliant financing; see Chapter 1 for an explanation of the types of activities prohibited by sharia.

remember.epsYou may wonder why I’m discussing loans in a section about customer deposit accounts. Here’s the connection: Islamic banks may accept customer deposits under a qard hasan contract, which means that the depositor is giving the bank a loan and expects no returns from it. In other words, the bank and the customer treat the customer’s deposit as a loan to the bank, and the customer expects no profit in return for letting the bank use her money.

realworldexample.epsMany Islamic banks, such as Bank Islam Brunei Darussalam, Barwa Bank of Qatar, and Mashreq al Islami, use qard hasan contracts in this way. The Islamic Bank of Britain explains its qard hasan current accounts to its customers this way on its website ( “A Qard is a loan, free of profit. We use this arrangement for our Current Accounts. In essence, it means that your Current Account is a loan to the bank, which is used by the bank for investment and other purposes. Obviously it has to be paid back to you, in full, on demand.”

Surveying savings accounts

As I note in Chapter 7, Islamic banks offer savings accounts similar to those at conventional banks. They are usually based on the partnership contracts of mudaraba or musharaka. The capital is usually not guaranteed in this type of account, but Islamic banks take measures to invest in relatively risk-free projects. And savings account holders at Islamic banks are entitled to returns based on a profit and loss sharing basis. The account can be based on either a mudaraba (profit and loss sharing) or musharaka (joint venture) contract.

realworldexample.epsHere’s an example of an Islamic savings account (based on a mudaraba contract) in operation: The Dubai Islamic Bank offers the Al Islami Savings Account, which gives the depositor profit on a quarterly basis and allows for the daily withdrawal of up to AED 7,000. (AED stands for the Dubai currency, Arab Emirates Dirham.) If the deposit amount falls below a minimum level, the customer isn’t entitled to PLS, and the bank charges the customer a service fee.

Some Islamic bank savings accounts differ from the mudaraba and musharaka accounts; they’re instead based on the deposit (wadia) or trust deposit (amana) contracts. (Refer to the earlier section “Deposit [wadia] and trust deposit [amana]” for more on these items.) In these cases, the bank typically guarantees the nominal value of the deposits, and the depositors don’t receive a return for their money. However, the bank, at its own discretion, may offer a customer a gift (hiba) based on the profitability of the deposited amount. For example, the Standard Chartered Saadiq offers savings accounts based on the wadia contract and states that it may (at its discretion) offer a gift representing a portion of the bank’s profit from the deposit’s investment.

Eyeing investment accounts

Islamic banks also offer investment accounts based on the profit and loss sharing basis; these accounts may be called participating accounts, PLS accounts, or equity investments. Fixed-term deposits (such as certificates of deposit) with conventional banks may be compared to Islamic investment accounts, but they differ in concept because fixed-term deposit accounts are linked to interest payments (as opposed to profit and loss sharing).

Islamic investment accounts are usually offered with a pre-agreed maturity period. Some accounts allow customers to arrange to withdraw money before the maturity date as long as they give the bank a certain amount of advance notice.

You probably realize that the letters PLS mean that a mudaraba (profit and loss sharing) contract can be the basis for an Islamic investment account. In addition, a second type of account, based on a representation (wakala) contract, can come into play.

Mudaraba: PLS investment contracts

In Chapter 10, I explain mudaraba contracts in detail. For now, just be aware that this contract exists between a fund manager (mudarib) and investors (rab al mal) to share the profit and loss of a transaction. Basically, the manager and investors are partners, and they have the freedom to determine (in advance of the investment) a PLS ratio that is fair to each.

Keep in mind: Although the term PLS ratio implies that both parties absorb any cash loss related to the transaction (and benefit from any profit), the reality is that if a loss occurs, the investor is usually the only party on the hook. That’s because the manager loses any time and energy it has devoted to the venture. (Luckily, Islamic banks work very hard to avoid losses so they don’t also lose their investors!)

Here are two examples of investment accounts based on the mudaraba contract:

check.png Unrestricted investment account (UIA): In this type of investment account, the bank — in its role as fund manager (mudarib) — has complete freedom to put the money into investment activities in any sector, industry, or project. The profit and loss shared with the customer is based on the overall investment activities of this type of investment account.

In practice, UIA accounts are more common than RIA accounts (see the following Bullet1). Here’s how the Lebanese Islamic Bank (on its website, describes the UIA product: “As an Unrestricted Investment Account Holder, your funds will be placed in [the] general bank’s pool of Sharia’a compliant banking activities. In return, you will be entitled to a percentage share of the investments’ income, distributed at the end of each period.”

check.png Restricted investment account (RIA): The RIA lets the investor (the bank customer) choose which specific activities to invest in, such as projects or business segments. The investment is placed only in the investment activities selected by the investor. The investor then shares the profit and loss of the specific activities he chose to invest in. Suppose he selects a retail industry investment; he receives returns only from that specific sector. Any profit or loss arising from other investment sectors doesn’t affect his investment.

For example, say Mr. A wants to make a sharia-compliant investment. When he visits his Islamic bank, he realizes that he has to choose to make the investment in real estate, book publishing, housing scheme construction, and so on. He selects the housing scheme as his investment choice. The bank invests his funds in the housing scheme projects with agreed-upon mudaraba (profit and loss sharing) terms. Mr. A shares the profit and loss of the investment with the housing projects only. His investment isn’t affected by changes in real estate or the book publishing sector.

Many other types of mudaraba-based accounts exist; you get the full rundown in Chapter 10. (Go ahead and peek if you must. I’ll wait.)

Wakala: Representation

The Arabic word wakala means representing someone, and wakil refers to the agent who acts on behalf of that someone. The wakala contract can facilitate many trading transactions. The relationship between the two parties involved is similar to the relationship that exists with a mudaraba contract — but not exactly the same. In a mudaraba contract, the fund manager is given the freedom to use the funds according to his experience and knowledge. In the wakala contract, the agent doesn’t have such freedom; he acts only according to the instruction given by the fund owner. Hence, the agent acts as the investor’s representative.

Realizing How an Islamic Bank Uses Funds

When a bank gets funds from sources such as stockholders, depositors, and investors, what does it do with that money? For example, when you deposit $10,000 of your money into a U.S. bank CD for a 9-month term with a 1.00 percent rate of return, how does the bank manage to earn the return it will owe you at your CD maturity date (plus some profit for its efforts)? I guarantee the bank doesn’t shut the money in a locker for 9 months. If it does, it won’t be in business very long.

A conventional bank takes on its role as a financial intermediary and pushes your cash back out the door in ways that earn the bank some money. For example, the bank may spend your dough to acquire cash assets or fixed assets, to give out loans, to purchase interest-earning securities and investments, and so on.

An Islamic bank has the same goal: to earn some profit by using your money wisely. After all, its stockholders and investors expect some return for their investment, just as they do in conventional banks. To accomplish that goal, the bank places its funds into various products.

In the following sections, I show you how an Islamic bank’s funds are applied to various categories of activities, starting with the simplest options. I save specifics about a bank’s many financial products for Chapter 10. (These products are a major use of any Islamic bank’s funds, so the discussion in Chapter 10 expands nicely on this section.) Here are the categories:

check.png Cash

check.png Fixed assets

check.png Financial instruments

check.png Community service

Keeping some cash

To meet the needs of its day-to-day operations, a bank needs to keep some cash on hand: in vaults, in safes, and in cashiers’ drawers. Additionally, in most countries a bank must maintain a certain level of cash reserves with the central bank (as I discuss in Chapter 8). The cash held in its own facility obviously doesn’t earn the bank any profit, so it must perform a balancing act to avoid the opportunity costs associated with holding onto too much . . . and the liquidity risks associated with having too little.

Purchasing fixed assets

All businesses require fixed assets in order to run their operations, and Islamic banks are no exception. Therefore, a bank uses some of its funds to purchase land and buildings, vehicles, furniture, office equipment, electronic equipment such as ATMs, information systems, and so on.

Funding financial instruments

Sharia-compliant financial instruments are the only income-generating funding sources in Islamic banks. I devote Chapter 10 to a discussion of the full range of such instruments available in Islamic banks, which includes products based on a variety of Islamic contracts that allow customers to invest money in equities, assets, and trade agreements. Here, I offer just a quick overview.

remember.epsIslamic banks don’t lend money in order to make profit. Instead, they use funds for equity investments, investment financing, consumer financing, and so on. These products are developed based on Islamic contracts (see Chapter 6).

Authors and industry experts categorize Islamic financial instruments in many ways (according to contract type, liquidity, risk, and so on). Here and in Chapter 10, I categorize the products according to the following modes of financing: equity financing, asset-based financing, and trade-based financing.

Equity financing

The phrase equity financing refers to the fact that with certain financial instruments, an Islamic bank participates in an economic activity with an investment and shares the profit and loss based on the contract. Equity financing products are the most preferred and widely used financial instruments in Islamic banks. Two major product lines fall under this type of financing:

check.png Mudaraba (sharing profit and loss with venture capital): The most often used and well-known Islamic financial products are based on mudaraba contracts. In a mudaraba equity financing contract, an investor engages with an entrepreneur who has expertise in a particular field. The result is a partnership contract in which both parties share the profit and loss. The PLS ratio is decided in advance by both parties based on what each of them brings to the table.

check.png Musharaka (supporting joint ventures): Also widely used, musharaka contracts allow both the bank and the customer to contribute to a project in the form of technical assistance, capital, working capital, or expertise. Both parties share the profit and loss according to the contract terms.

Asset-based financing

These non-equity financing instruments facilitate the exchange of goods and services. Because they’re backed up by assets, they’re generally low-risk financial products. Following is a quick introduction; I go into much more detail in Chapter 10:

check.png Murabaha (managing trade financing): In this contract, the seller offers an asset to the buyer at cost plus a profit markup. The date of payment (decided on by both seller and buyer) can be either the spot date (the day on which the contract is entered) or a later date.

controversy_religion.epscheck.png Tawarruq (profiting through reverse mudaraba): This product is quite controversial among sharia scholars because the intention of the contract is for the buyer to purchase something that he won’t actually use or own. In this contract, money is borrowed by engaging in two separate transactions (or legal contracts):

1. A buyer purchases an asset from a seller for installments or for a deferred lump sum payment.

2. The buyer sells the asset to a third party for cash — at a price that may actually be lower than the buyer’s purchase price (from Step 1, which is cost plus profit). The benefit to the buyer is that he gets the cash he needs.

3. The buyer settles with the initial seller (from Step 1) by making installment payments or a lump sum payment on a deferred basis. (He gets to keep the cash for a while.)

Some scholars accept tawarruq because it’s based on two different legal contracts (murabaha and sale). Others argue that the basic intention is to get cash — not to use the asset — so tawarruq is prohibited.

check.png Ijara (leasing or renting): The ijara contract allows one party to use an asset owned by another party in exchange for some consideration (usually money). Generally, ijara comes into play when leasing tangible assets. (In Chapter 10, I compare conventional and Islamic leases and the conditions of the respective lease contracts.)

check.png Istisna (financing construction projects): This product, which is sometimes called partnership manufacturing, is mostly used to finance the construction of an asset or to finance a manufacturing project. The istisna contract is effective when a manufacturer agrees to produce an asset for the buyer at a future date. Both parties agree in advance on the product specifications.

Trade-based financing

Trade-based financing products in Islamic banks provide short-term solutions for individuals or corporations so these entities can purchase homes, vehicles, consumer durable goods, and so on. Basically, two major contracts develop these types of financing products:

check.png Bay al-muajil (deferred payment sale): According to this contract, a good can be sold for a deferred payment (either installment payments or a lump sum payment), but the price of the good must be agreed upon by both the buyer and seller, and no extra charges are allowed.

check.png Salam (purchase with deferred delivery): This contract allows the buyer to make full payment for a good that is promised by the seller for delivery at a later date. Strict conditions apply to this contract (which I explain in Chapter 10). This contract is helpful for farmers so they don’t need to get bank loans to start farming.

In addition, Islamic banks provide service-fee-based instruments (ujra): services for fixed fees agreed upon by both parties. Under this contract, the bank offers consumer financing services such as fund placement, asset management, and professional advisory services.

Serving the community

remember.epsIslamic banking is an ethical banking system that operates not only to make income for the owners but also to help the general public. Each bank takes part in socially responsible activities by setting aside a certain amount of money from its total funding sources to serve the community in which it operates. In addition, Islamic banks collect zakat (obligatory alms, which I explain in Chapter 2) from customers and give that money to the relevant authority, which uses it to help people in need. (In Chapter 14, I explain Islamic banks’ zakat accounts in more detail.)

Further, when an Islamic bank invests in equities (such as company stocks), it may earn profits from a small percentage of transactions that aren’t sharia-compliant. As I explain in Chapter 12, an equity investment may still be considered sharia-compliant if up to 5 percent of the company’s business is not permissible per sharia. Whatever profits the bank earns from such prohibited equity transactions are given away as charity. In other words, if the bank invests in the stock of a company and 3 percent of the company’s business is not sharia-compliant, the bank must donate 3 percent of its profits from that investment to charity.

One example of a socially responsible banking activity is qard hasan, which I explain earlier in this chapter. Basically, qard hasan is a contract with which the bank offers a loan to someone in need without expecting any profit from the loan. Only the principal must be repaid.

Islamic banks also determine specific ways they can reach out to their communities to support services that benefit everyone, including education programming, healthcare services, and microfinance grants.

realworldexample.epsFollowing are a few examples of ways in which Islamic banks enact their objective to serve the greater public good:

check.png Al Rajhi Bank of Saudi Arabia reports these recent accomplishments:

• Set up a training and development program for men and women that would eventually lead them to employment in banking

• Supported diploma programs for women in conjunction with Women’s University with the goal of later aiding their efforts to set up small business ventures

• Pledged to purchase 600 medical machines for people in need

• Pledged to help 600 ill men and women travel to medical centers for treatment

check.png Recently incorporated Social Islami Bank Ltd. of Bangladesh offers a wide array of community service programs, including the following:

• A credit program intended to alleviate poverty

• Another credit program focused on empowering families (such as by helping young married couples secure durable assets)

• A special fund designated for social investment purposes

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