deposit mobiliziation.ppt

7/29/2019 deposit mobiliziation.ppt

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DEPOSITS MOBILAZATIONBy

HAMDAN HJ IDRIS,

BSc Econs, MBA ( Islamic banking & Finance)

CPTrainer (MIM), Academic Fellow

INCEIF


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DEPOSITS MOBILAZATION

By

HAMDAN HJ IDRIS,BSc Econs, MBA ( Islamic banking & Finance)

CPTrainer (MIM)

Academic Fellow

INCEIF


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Islamic deposits usually serve two main

functions, namely:

1.Transaction function : Wadiah Dhamanahcurrent and savings account

2.Investment function :Al-Mudarabah

Investment account


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By virtue of the transactional nature ofwadiahdhamanah deposits, depositors are only interested inderiving benefits from the facility offered by the

product. The benefits shall include the ease of cashwithdrawals on call as well as protection of deposits.The bank serves as a custodian or safe-keeper to thedeposits but is allowed use them to generate incomefrom say, murabahah or ijarah financing. But financing

activities do not guarantee fixed income to the bank asit (ie bank) may incur losses arising from bad debts.


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Wadiah dhamanahdeposits however areprotected even if the bank earns nothing fromfinancing. In return for the protection, all income

earned from financing activities shall solelybelong the bank and depositors do not hold anylegal claims on banks earning. The trade-offbetween capital protection and ex-postrate of

return is one important economic principle ofwadiah dhamanahdeposits.


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That is, depositors stand to receive returns butonly as gifts (hibah). In this way, the distributionalmodel ofwadiah dhamanah does not provide

any guaranteed sum or return to the depositors.If any, returns are given without any equivalentcountervalue, say risk-taking. Wadiahdhamanahcustomers exposure to capital risk is zero. Thus,

by virtue of the principle ofal-ghorm bil ghonm,they do not deserve to receive any income orprofits from the deposits.


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hibahs are determined ex-postmeaning it is setonly when the outcome is actualized. Butactualizing outcome, say making RM100 million

profits from murabahahfinancing does notmean that the bank must or obligated (wajib) todistribute the profits. In this way, the supplycurve ofwadiah dhamanahdeposits may be a

flat one since the incentive to save does notrevolve around the rate of returns but for safe-keeping and convenience purposes.


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Investment function

But the same does not apply to the al-mudarabah investment deposits. This is because

al-mudarabah deposits are meant forinvestments with explicit agreements aboutprofit distribution and the role of capital andknowledge. Here the economic principle of risk-

return shall apply well to the contracting partiesin the mudarabah transaction between the bankand the depositors.


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The Islamic economic principle on risk-returnrelationship is none other than that adoptedfrom the legal maxim al-ghorm bil ghonm

which means that no profit can be gainedwithout taking risk. Since Islamic investmentaccount as a product is based on the

mudarabah contract (i.e. trustee partnership),incentive to place money in mudarabahdeposits must revolve around profits. It isbusiness and nothing more


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When the performance ofmudarabah depositsoutperform interest-bearing fixed deposits, morepeople are expected to place their money in theIslamic banks. But the risk associated with mudarabah

deposits is market related. Systematic risks are risks ofcapital loss due to say, economic recession and naturalcalamities that often destabilize markets and thereforeprices. They are not controllable by the contractingparties. Mudarabah deposits are not sparred from

systematic risks. Depositors can see their savingsdepleting. There is no capital protection in mudarabahdeposits. Instead, systematic risks are endogeneous inmudarabah.


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In fact, the Islamic principle of risk-return actuallypointed to the fact that risk ie ghormpredominantly refers to systematic risks.

However, mudarabah investments are alsoexposed to operational risks as human error andnegligence may jeopardize the mudarabahventure. The mudarib (ie the agent-manager) canabuse his responsibility. Thus, moral hazard is a

serious factor to account for in decision makingwhen people plan to place their savings in themudarabah deposits.


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Bearing in mind that mudarabah deposits are

exposed to both systematic and operational

risks, the decision to place savings in

mudarabah deposits can be a challenging one.


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How Deposit Insurance Works

Deposit insurance is provided to you

automatically, so you don't need to sign up for

it and you don't have to pay us to enjoy the

protection.

Deposit Insurance


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Who We Are and What We Do?

A Government agency established under the

Akta Perbadanan Insurans Deposit Malaysia

2005 to protect you against the loss of your

deposits in the unlikely event of a bank failure,

and promote financial system stability.

Contd


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It is established by the Government to

enhance the consumer protection framework

and promote financial system stability. It is not

related to or managed by general or life

insurance companies. Generally, it is a

Government sponsored scheme, although in

certain countries it is sponsored by the banks.

Contd


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The deposit insurance system in Malaysia was

launched in September 2005 and is managed

by Perbadanan Insurans Deposit Malaysia

(PIDM). PIDM is a Government agency

established under the Akta Perbadanan

Insurans Deposit Malaysia 2005.

Contd


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Benefits to depositors

Deposit insurance protection is automatic

PIDM protects depositors holding deposits

with banks

There is no charge to depositors for deposit

insurance protection

Should a bank fail, PIDM will promptlyreimburse depositors on their deposits

Contd


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Benefits to the financial system

PIDM promotes public confidence in the Malaysian financial system byprotecting depositors against the loss of their deposits

PIDM reinforces and complements the existing regulatory andsupervisory framework by providing incentives for sound risk management

in the financial system

PIDM minimises costs to the financial system by finding least cost

solutions to resolve troubled banks

PIDM contributes to the stability of the financial system by dealing withbank failures expeditiously and reimbursing depositors promptly

Contd


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With the introduction of a deposit insurancesystem in Malaysia, depositors receiveprotection for their deposits under the law.

Depositors will know how and whenreimbursement of their deposits will be madein the event of a bank failure.

Deposit insurance is recognised internationally as animportant component of a countrys financial safety net andhas been implemented in some 100 countries around theworld.

Contd


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Role and FunctionsPIDM's main functions are to:

Assess and collect premiums or fees from banks

Manage the Deposit Insurance Funds

Undertake resolution of non-viable banks

Reimburse depositors should a bank become insolvent

Comply with Shariah principles in respect of Islamic deposits

and funds

Conduct ongoing public awareness and education initiatives

Contd


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Corporate values

To support the mission and vision, PIDM adopts

five core values to shape its working culture.

Excellence and professionalism

Integrity and trustworthiness

Communication and teamwork

Respect and fairness

Financial stewardship

Contd


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Management of Deposit Insurance Fund

Since the deposit insurance system provides coverage for both

conventional and Islamic deposits, PIDM maintains and

administers two separate funds Conventional Deposit Insurance Fund

all premiums and/or other monies received by PIDM and

assets received or vested in PIDM, as well as all expenditures

incurred, in respect of conventional deposits; and

Contd


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Islamic Deposit Insurance Fund all premiums and/or other monies received by PIDM and assets received or vested

in PIDM, as well as all expenditures incurred, in respect of Islamic deposits.

PIDM will manage and invest the Funds prudently to generate a reasonable return

for PIDM while ensuring that the Funds are readily available to cover operating

costs and make payments to depositors in the event of a bank failure. The Islamic

Deposit Insurance Fund is being managed in accordance with appropriate

guidelines in line with Shariah principles.

For this reason, PIDM currently only invests its funds in safe and liquid instrumentssuch as Ringgit denominated securities issued or guaranteed by the Government

or Bank Negara Malay

Contd


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Since mudarabah deposits and incomes are notguaranteed, the bank that acts as the mudarib must beable to convince depositors that placing their money asmudarabah deposits is a good investment. It should beable to show depositors their good track records andcapacity to perform well in the mudarabah ventures.

Since mudarabah deposits are risky, depositors expectmore returns for each investment made. In fact anysuccessful mudarabah deposits should outperforminterest income derived from fixed deposits.

Contd


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Finally, the Islamic principle of deposits in

essence defies the law that guarantees the

right of creditors to interest payments. This is

because the law of depreciation must hold for

all creatures and creations of Allah. It is

common knowledge that all things in this

world will undergo wear and tear. They losevalue over time. This is a law in nature


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In Islam, Allah is the only Being that cannot

depreciate as He is the Creator and therefore

all creation of God must depreciate.

The Holy Quran says, Everything thereon is

vanishing, there remaining only the Face of

Your Lord, the Possessor of Majesty and

Generosity (55:26-27).


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In conventional economics, people will supplydeposits only when they decided to saveinstead of spending their income on current

goods and services. The decision to save, thatis postponing current consumption is muchinfluenced by the amount of money needed tocompensate them from postponing currentspending. This saving behaviour is explainedby the concept of time-value of money (TVM).

THE SAVING BEHAVIOUR OF CUSTOMERS


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Time preference indicates the extent of a familys overfuture consumption. The rationalization of interest as aprice of credit began when people believe that presentconsumption is superior to future consumption.Peopleprefer the present because the future is uncertain.They also think that present wants are more keenly feltthan future wants. Also, people think that the presentgoods possess a technical superiority over future

goods. That is, the passage of time allows the use ofmore roundabout methods of production that aremore productive

Contd


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In this way, the concept of time value of

money examined people preferences about

spending their income today or in the future.

If people prefer current consumption to future

consumption, then they are said to adopt a

positive-time preference (PTP) outlook. They

believe that current consumption brings moresatisfaction than future ones

Contd


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Therefore, people who are asked to postponecurrent consumption (i.e. creditors) must becompensated for the benefits the pleasure

foregone today. They do so because it is firmlybelieved that the future is uncertain and risky,thus one may not know how much utility heor she can enjoy out of future spending asopposed to current spending. In a nutsell, thePTP concept says that 1 dollar today is worthmore than 1 dollar tomorrow.

Contd


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However, some people do not believe that

future spending is inferior to current

spending. Instead they are truly convinced

that they can derive more satisfaction or

utility if money is spent not now but in the

future. By believing so, the decision to save is

based on the negative time preference (NTP)model.

Contd


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For example, when people are not surewhether they can secure permanent orlifetime job, spending all their money today is

not a good idea at all. Without a job in thefuture, money becomes a scarce commodityand thus spending them during difficult timeyields higher utility. The NTP concept believesthat 1 dollar today is worth less than 1 dollartomorrow which is opposite to the positivetime preference (PTP) model.

Contd


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Finally, there are also some people who feelindifferent about spending their money todayor tomorrow. They believe that money spent

today always yield the same level of utility asmoney spent tomorrow. This is the neutraltime preference model. People with neutraltime preference do not care less about whento spend.

Contd


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Conventional economics actually believed that

people prefer current consumption to future

consumption. This is the dominant view in

global financial markets today. This is only

because they believe the future as uncertain

and people have no idea what the future has

to offer them !!!

Contd


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The belief that current spending generates more

satisfaction than future spending (ie PTP) paves

the way for the rationalization of interest-rates as

the reward for saving. In other words, peoplewho save will forego the satisfaction derived from

current consumption. The same level of

satisfaction cannot be realized when they spendthe same money, say one year from now.

Contd


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The saving behaviour in conventional economics istherefore dependent on the reward or compensationfor waiting ie postponing current consumption. Byvirtue of positive time preference (PTP), creditorsdemand interest while debtors pay interest. But thesame cannot apply to saving behaviour in Islam.Although Islam has to some extent recognizes theconcept of positive time preference, it does not

implicate or bring about the payments and receipts ofinterest as evident in conventional economics.

Contd


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THEFACTTHAT ISLAMFORBIDSINTERESTAS RIBAIT

DOESNOTMEANITISAGAINSTTHECONCEPTOF

POSITIVE-TIMEPREFERENCE (PTF). INDEED, ISLAM

HASGIVEDUERECOGNITIONTO PTF ASEVIDENTIN

THESAYINGSOF PROPHET MUHAMMAD (PBUH). THE

PROPHET (PBUH) SAID, VIRTUOUSARETHEYWHO

PAYBACKTHEIRDEBTSWELL.

Contd


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INTHEABOVEHADITH, DEBTORSAREENJOINEDTOPAYMORETHANTHEPRINCIPLELOAN (QARD) RECEIVED. ONEMAYASKWHYTHISISSO? ONEREASONISGRATITUDE.

THEDEBTORISTHANKFULFORTHELOANHEGETSANDBENEFITEDFROM. HEKNEWTHECREDITORHASFORGONEHISCURRENTCONSUMPTIONFORTHESAKEOFHELPINGHIMWITHTHEMONEY. HEALSORECOGNIZESTHATTHE

CREDITORHASRELINQUISHEDTHEOPPORTUNITYTOEARNRETURNSFROMLOANGIVENAWAY. THESERETURNSAREUNKNOWNASTHEYARESUBJECTTOBUSINESSRISK.

Contd


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INTHISMANNER, ONEDOLLARTODAYISSEENMORE

VALUABLETHANONEINTHEFUTURE. ASATOKENOF

APPRECIATION, THEDEBTORPAYSMORE. UNLIKERIBA,

THEINCREMENTALAMOUNTISNOTSTATEDUPFRONT

ANDDOESNOTCONSTITUTEALEGALCLAIMOFTHE

LENDINGPARTY.

Contd


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In Islam, therefore recognizing PTP does notimply awarding a contractual increase on theprinciple loan. Any increase from an Islamic

loan (qard) can only be stated at maturity andnot upfront as normally practiced in interest-bearing loan contract. The increment which isvoluntary is set by the debtor. It is given awayout ofgoodwill. In contrast, the incrementfrom riba loans is contractual and set by thecreditor.

Contd


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In Islamic economics, spending behaviour of

household is expected to influence their saving

behaviour as well. For example, consumers who

practice moderation (zuhud), will secure moresurplus income ie. savings compared with those

who are extravagant (tadrif). The moderation

behaviour is approved by Islam and applicableonly on the consumption of luxuries (kamaliyat).

Contd


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Under a zuhudlifestyle, Muslims live a simple lifealthough they can afford luxuries. While Islamdoes not prohibit Muslims to consume luxury

goods, Muslims are free to choose their lifestyles.They can live a simple life or lead a luxurious oneas long as they do not fall into debt or amasswealth from illegal sources. They too must spend

on basic necessities (daruriyat) and make spendwell for their families.

Contd


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Savings in Islam does not mean keepingmoney as idle balances. All savings must beinjected back into circulation. It must be

invested. If money is kept as idle balances,people who need money for working capitalor to purchase plant and machinery will notbe able to do so. Without money to spendbusiness will cease to exist and the economywill fall into a recession with implications ongrowth and employment

Contd


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Savings can be put into many financial

products. People can save by buying stocks

and bonds or unit trusts. They can also save by

buying insurance policy. But usually most

people save in bank deposits.

Contd


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The objective of savings is best described in

the Quranic story of Prophet Yusof(may God

be pleased with him) where the importance of

savings is highlighted in its true color. Surah

Yusof (12:3-49) tells the story of a Pharaoh in

Egypt who had a strange dream about seven

fat cows. He also saw in his dream sevengreen ears of wheat and seven withered or

ears of wheat.

Contd


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He asked his advisors to interpret the dream,

but no one is good enough to do so. Prophet

Yusuf who is well known for his honesty and

special ability to interpret dreams was brought

to see the Pharoah.

Contd


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In his interpretation about the dream, Prophet Yusufenlightened the Pharoah about the future problems ofEgypt. He also suggested the remedies. He said that Egyptwill enjoy seven years of prosperity with abundant

harvests. In modern times, this may be taken to mean higheconomic growth. Prophet Yusof advised the people ofEgypt to cultivate their crops diligently and use areasonable amount for food and sustenance while storingthe remaining surplus. This is because when prosperitycomes to an end, Egypt will suffer from serious drought for

seven long years when no crops would grow. But with thereserves in store, the people of Egypt could survive theseven bad years.

Contd


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Prophet Yusuf cautioned the Pharoah not toconsume all the reserves but to leave the bestportions for seeds to cultivate later when rains

filled the Nile. In other words, people must setaside money for savings and investment. Topostpone current consumption to make way forproduction of future goods was one of the main

messages that Prophet Yusuf wanted the Pharaohto do for his people.

Contd


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The incentive to save can also be examined at

the micro level of Muslim behaviour. In Islam,

savings will always means surplus income to

be placed for investment purposes, thus

keeping money in circulation. All savings must

be invested again in the economy. Otherwise

it is tantamount to hoarding (ihtikar)

Contd


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The basic idea of savings is to avoid hoarding

money as the latter is prohibited in Islam.

When people hoard money, there is less

currency around to use. It will frustrate

business transaction and put production to a

halt since there is no money available to pay

suppliers and workers. Hoarding money willput money out of circulation and therefore

reduces sale and purchases.

Contd


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When people hoard money for fear of losingthem, they must know that the idle money issubject to Zakat. For example, Ali places his$20,000surplus in his safe-deposit buried underhis house. At the end of the year, he must pay 2.5per cent zakat ie $500 from the idle balances.Zakat in this manner is a penalty for the hoardingbehaviour where he will find his money to fall in

value to $19,500. If the money is keep idle foryears, it will soon depreciate in nominal valueand Ali losses his money to his own ignorance.

Contd


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For this reason, Muslims must save and invest

their surpluses so that the value of the savings

increases over time despite the payment of

zakat. Zakat on idle balances is penalty on

hoarding behaviour and eventually leads to

the depreciation of wealth if kept unchecked.

In this way, zakat both purifies wealth as wellas penalizes those who choose to hoard

wealth.

Contd


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To prevent this unnecessary depreciation, zakatwill force people to spend their cash balanceseither for nafaqah, sadeqah or investment ie.savings in bank deposits, unit trust funds orinvestments in projects based on the partnershipprinciples. Doing so will allow money to circulatein the economy, which then help reduce shortfallin business spending and capital formation For

example, when money is put in circulation viainvestment, zakat income and individual wealthwill both increase

Contd


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Case (1) Hoarding

Idle cash (i.e. wealth/mal) at year end = $20,000

Zakat = 0.025 x $20,000 = $500

Cash balances (wealth) after Zakat = $19,500

Case(2) Savings

Cash invested = $20,000

Profit = 10% = $2,000

Wealth/mal = $22,000

Zakat = 0.025 x $22,000 = $550

Wealth after zakat = $21,450.

Contd


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From the above illustrations, it is clear that in

Islam wealth is not an end by itself. Wealth is

a means to attain happiness (saada) and

success (falah). To do so, Islam enjoins man to

spend it well (infaq) and not to indulge in

hoarding. By spending, it can mean many

things such as:

Contd


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Consumption of basic necessities (daruriyat)

Consumption of comfortables (hajiyat)

Consumption of luxuries (kamaliyat) Savings in bank deposits, mutual funds, stocks,

properties etc.

Sadeqah as amal jariah (continous gooddeeds)

Zakat obligation

Contd


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To attract people to save in Islamic bank

deposits, the banking firms are expected to

invest deposits into projects with high yield

potentials. If Islamic deposits can outperform

investments in unit trusts and other equities

products, it should be able motivate more

people to save. This will increase capitalformation much needed for economic growth

and development.

Contd


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Savings in Islam does not mean keeping

money as idle balances. All savings must be

injected back into circulation. It must be

invested. The role of zakat and the underlying

motivations for savings in Islamic economics

are also discussed in this topic,

Summary


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Differences between conventional and Islamic deposits

There are distinctive differences for deposits receivedunder conventional banking and Islamic bankingsystem. The main criteria is the avoidance of interestor usury by Islamic banks throughout its activities.

Although usually the deposit operations and facilitiesare very similar, the differences lie in severalunderlying principles, such as follows:-

COMPARATIVE ANALYSIS BETWEEN ISLAMIC AND

CONVENTIONAL DEPOSITS


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Deposit contract

The deposits received under conventional banks

are based on borrowing contract, i.e. banksborrow the money (deposit) from depositors fora stipulated period of time, payable uponmaturity with the promised interest.

Meanwhile, under Islamic banks, deposits are

received under either one of these two contracts


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a Wadiah contract Wadiah, literally means safeguarding of

assets, where banks received the depositors

money for safekeeping until withdrawalrequest is made.

Although under this contract the banks areallowed to use the deposits for investment

activities, they not obliged to give return todepositors. Yet they are allowed to give it on avoluntary basis or known as hibah.


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Mudharabah contract

Mudharabah deposits, are deposits made purportedly forinvestments with the bank based on an agreed profit-

sharing percentage. The bank acting as investmentmanager, invests the money into permitted investmentsand Islamic financing activities, realise profits and share theoutcomes with depositors based on the ratio agreed.Therefore, for depositors the actual return on deposits isknown only upon maturity (or upon periodical payment ofprofit, e.g. monthly). The return varies according to theactual outcome of investments, though some of them arerelatively predictable.


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Return on deposits Under conventional banking, the return or interest on deposits is

fixed and guaranteed regardless of the actual outcome oninvestments.

Under Islamic banking, the return or profit to depositors is subjectto the actual investment outcomes. The profit on investments isshared based on the agreed profit-sharing ratio, say 70:30 fordepositors and banks respectively.

Therefore, under Islamic banking, depositors and banks are equalpartners who would definitely share any windfalls or losses, ifany, derived from the investments.


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Risk-sharing

Under Islamic banking, the parties to

Mudharabah contracts are entitled to equal risksharing. Therefore, the risk is higher fordepositors under Islamic banking as compared toconventional banking, and yet providing

opportunity for higher rewards should theinvestments yields higher profit.


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In summary, the deposits under conventionalbanking has matured and evolved quitesignificantly especially in terms of its operationsand facilities in pace with the technology and

Internet developments.

Compared to other investment avenues; e.g. unittrusts, capital market, commodity market;deposits are still attractive due to its liquidity,low-risk and payment facilities.


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Deposits are defined as funds placed in a financial institution

by economic surplus units such as households, corporations,

investors and government. These funds can either be from

cash, claims to money, like checks placed in depositors

accounts, bank loans or money from investments (Van Dahm,1975). Financial institutions such as commercial banks,

merchant banks, finance companies and discount houses are

granted licenses by Bank Negara Malaysia, the central bank, to

accept deposits from their customers.


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These institutions are called deposit-taking

institutions. Other financial institutions that

do not comply with the definition in the Act

are non-deposit taking institutions and hence,

are prohibited from taking deposits from the

public. Examples of non- deposit taking

financial institutions are factoring or leasingcompanies.


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deposits represent customers savings or their

financial assets (Deposit creation). By

depositing money in a bank, the customers

expect the bank to safeguard their savings, to

utilize them into productive investments for a

satisfactory rate of return or to enable them

to facilitate their payment transactions.


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At minimum, a customer expects that he gets

back a dollar that he puts in a bank and the

bank has a contractual obligation to honor the

claim on demand or upon withdrawal.


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To a bank, either operating conventional

banking or Islamic banking, deposits is its

main source of funding for which it uses to

produce income. Some literature has cited

that deposits contribute 75 percent of a

banks total fund (Rose, 1997).


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Banks use customers deposits mainly to giveout loans/financing to deficit economic unitsor borrowers. Besides financing, banks also

mobilize deposits by purchasing tradingsecurities, investments and maintain some ascash in hand to meet withdrawals on demand.The larger the amount of deposits a bank

receives from its customers, the better is itscapacity to give out financing and the higher isthe profit income.


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Because of this positive relationship between

deposits, loan and interest income, banks are

competing intensively and aggressively among

other deposit-taking institutions to obtain

higher deposits by offering attractive deposit

rates or rates plus other appealing packages

depositors. Islamic banks are equallyaggressive in attracting additional deposits.


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To the economy, bank deposit is the main source of money

supply that can be mobilized to generate economic growth

and wealth creation. By giving out loans to borrowers and

investors, banks create credits (Abdul Gafoor, 1996). Banks

ability to create credit enable them to supply money toborrowers, suppliers and investors to conduct economic

activities, such as opening up plants, funding their working

capital requirements, financing their business expansion or

increasing their investments.


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Such economic activities create job

opportunities, increasing productivity and

income, which subsequently lead to wealth

creation in the economy. For interest-bearingdeposits, interest rate is very important. When

market interest rates rise, so would deposit

rates and this would attract higher deposits toflow into the economic system.


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In the philosophy of Islamic finance, money is

required to be mobilized in productive

investments. There should not be idle money.

Whoever holds idle cash or demand depositsexceeding the nisab over a year, must pay

zakat.


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Deposits are equally important to Islamic

banks as a source of funds as in conventional

banks. But unlike its counterparts, Islamic

banks need to comply to Shariah principleswhich prohibit any payment of interest or a

fixed return on deposits


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To attract idle cash or deposits from the public

for sustaining their financing activities and

wealth creation, Islamic banks are offering

deposits whose returns are based on wadiah,

mudharabah or qard hasan.


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The mudharabah or profit-loss sharing basis of

Islamic banking is conceived as more

production oriented and growth promoting

than its interest-based counterparts. Further,the replacement of interest with profit-loss

sharing principle is also said to increase

investment opportunities in the economy(Islamic Bank Bangladesh Limited, 2006).


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Three main concepts of deposits will be

discussed here. These are deposits as a source

of funds, as liabilities of banks and the returns

from deposit mobilization.

CONCEPT AND THEORIES ON DEPOSITS


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A bank has three sources of funds namely (i) bank

capital, (ii) banks reserves or retained earnings and

(iii) deposits. Among the three sources, depositsform the main component of a banks source of

funds.

Source of Funds


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The basic concept is that deposits are the

foundation upon which banks thrive and grow.

They provide the most raw materials for bank

financing /loans and other investments (Rose,2002: 387)


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Despite increasing diversification towards fee-

based income from projects and financial

advisory services, banks are relying greatly on

interest-bearing deposits and assets togenerate interest income and profits ( Rose,

1997 ). Hence, banks compete aggressively to

source more deposits from its customers,which can be government, suppliers,

corporations, investors or households.


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Deposit is also as an integral source of funds

for Islamic banking. However, unlike

conventional bank, an Islamic bank cannot use

its deposits to make profits. This is becauseunder Syariah principles, one cannot trade on

non-commodity items and money is treated as

a non-commodity item.


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Traditionally, a bank borrows or utilizes a

large proportion (approximately 80%) of its

customers deposits to give loans to

borrowers. A banks deposits, then, are the

amounts that it owes to its customers (Money

and Banking). Hence, deposits are the

principal liability of banks.


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The significance of this conduct is that in the

event that the bank is liquidated, the

depositors have the first claim on the

proceeds of sale of the banks assets (Rose,

2002: 119).


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A specified amount of the deposits is allocated

to meet the statutory reserve requirement

ratio (SRR) imposed by a central bank. By

definition, SRR is the percentage of depositsthat commercial banks must maintain as

required reserves (Madura, 2003, BNM

Statistical Bulletin, 2006) in a central bank.


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This item is recorded as Statutory deposits

with Central Banks in the asset side of the

Balance Sheet of a commercial bank). For

many countries, SRR ratio is sometimes usedas monetary tool to control money supply in

the economic system.


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The ratio varies between countries. ForMalaysia, SRR is currently set at 2%,. BesidesSRR, a commercial bank may utilize the

remaining amount of deposits to purchaseinterest-bearing short-term money marketinstruments (which are termed as tradingsecurities) and for investments (stocks, shares

and medium to long-term securities).


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Similar to conventional banking, deposit of an

Islamic bank is a liability. The concept of

deposit as borrowing in Islamic banking

started during the leadership of Ar-Zubair al-Awwan. (Sudin Haron, 2005). Ar-Zubair

treated the money entrusted to his father for

safe keeping as borrowing.


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Under this concept, he was able to use themoney for economic purposes. The depositbecame safer since as a borrower, Ar-Zubair

argued that he is responsible to pay back themoney to the owner. The change in theconcept of deposit from trust (wadiah) toborrowing consequently enabled the people

to use the money to operate business basedon the principles ofqirador mudarabah aswell as to share the profits from the business.


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Similar to conventional bank, not 100 percent

of the deposit amount is lent out to

borrowers. An Islamic bank is still subjected to

SRR ratio .The remaining amount is utilized topurchase liquid assets and investment and

Islamic trading securities.


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The third concept related to deposit is return. -

depositors are rewarded with a pre-determined

rate of return by the conventional bank. The rate

of return depends on the type of deposits, thedeposit amount, the length of the maturity

periodsand the banks cost of funds. In

conventional banking, market interest rate is very

instrumental in determining the deposit rate.


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The concept of return for depositors in Islamic banking is different from

conventional banking. Based on Syariah principles, ribaor interest is

prohibited and a predetermined fixed rate or a guaranteed return on

investment is strictly not acceptable. Al-Quran states that:

That which you give as interest to increase the peoples wealth

increases not with Allah but that which you give in charity, seeking the

goodwill of Allah, multiplies manifold

(Surah

al-Rum, verse 39)


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The underlying trust in prohibiting a fixed or

guaranteed return on deposit is that there is

an existence of an element of uncertainties in

any project or investment ventures financedby the bank from mobilization of its

customers deposits.


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The profit and loss sharing (P-L) basis is a basis

of return where the bank shares business risks

with the borrower in return for shares in the

profits of the business venture. It is based onmudharabah dan musyarakahprinciples.

Profit and loss sharing concept is a unique

feature of Islamic banking and is increasinglygetting popular among investors especially in

times of economic uncertainties.


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Deposit accounts and Principles Applied inReturn Computation

Account Type

Principles Applied

Current Account qard hasan or wadiah

Saving Account wadiah,mudharabah or qard hasan

Investment Account pre-determined share of profits

Islamic Negotiable Certificate of Deposit mudharabah or qard hasan


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The fixing in advance of a positive return isstrictly prohibited by Syariah (Cert : 47). Therationale for this prohibition of a pre-determined

rate of return is explicitly expressed by Imam Razias quoted in Muhamad Umar Chapra, (2005: 52):when asked what was wrong in charging interestwhen the borrower was going to employ the

funds borrowed in his business and thereby earna profit, his answer is as follows:


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While the earning of profit is uncertain, the

payment of interest is pre-determined and

certain. The profit may or may not be realized.

Hence, there can be no doubt that thepayment of something definite in return for

something uncertain inflicts a harm

(Razi, op.cit:87).


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Islam only recognizes return on capital

(deposits) after all costs have been accounted

for, and it may be positive or negative since it

depends to a great extent on factors beyondthe control of entrepreneur. Hence, Islam

prohibits a pre-determined positive rate of

return in the form of interest but seeks returnin a profit and loss sharing basis (Muhamad

Umar Chapra: 57).


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Below are two commonly used principles

governing deposits of an Islamic bank.

(a) Wadiah Wadiah is quite similar to savings account in conventional

banking where a depositor places or deposits his money in an

Islamic bank. In doing so, the customer trust his banker to

manage his savings in the most professional manner, that is

the bank should keep proper records of its clients accountsand investing his savings in profitable, halalventures.


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The bank has to secure the agreement of its

depositor to utilize the deposit and be

responsible for its risks management and

possible outcomes. Hence, the bank acts acustodian to the customers deposits and

undertakes the commitment (or guarantees)

to return the customer his savings on demand.


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. However, the bank is not bound to pay its depositor with a

fixed return but in line with the Syariah concept of profit

sharing, the Islamic bank may reward or hibah part of the

benefits to the depositor for the use of his money. The reward

may be in the form ofcash or in kinds. In Malaysia, it is acommon practice of an Islamic bank to declare a percentage

of the banks profit as hibah to Al Wadiah depositor. This

practice allows an Islamic bank to contribute efforts in

creating and distributing wealth to people or the ummah atlarge.


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Mudharabah

Mudharabah is a principle most commonly

used in Islamic finance and banking. Theprinciple suggests that a person that has

capital will give his capital to another person

that he trusts to run a business venture. Hewill not interfere with the business but rathergive the partner the independence to run it


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In return, the partner will return back the

amount of capital that he borrowed plus a

share of the profit at the end of the business

period. In essence, both parties have a rightto the business profits because one party

provides the capital and the other, his

expertise.


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In the context of deposit, the depositor

provides capital to an Islamic bank to run

banking operations. For the deposit

mobilization, the depositor is entitled to ashare of the profits agreed by the depositor

and the bank. The share can be a third or a

half of the profits depending on prioragreement between the depositor and the

bank.


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This agreement is set at the beginning of thecontract. However, the bank does notguarantee the depositor that the business

must be profitable although the bank willconduct the investment on best efforts basisto ensure it is profitable. Nevertheless, in theevent of a business failure, the depositor will

bear the losses.


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The Islamic economic principle on risk-return

relationship is none other than that adopted

from the legal maxim al-ghorm bil ghonm

which means that no profit can be gainedwithout taking risk. Since Islamic investment

account as a product is based on the

mudarabah contract (i.e. trustee partnership),incentive to place money in mudarabah

deposits must revolve around profits

THE ECONOMIC THEORIES RELATED TO DEPOSIT


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The reduction of interest rates will now makemany investment opportunities more viable. Thisis because, decision to invest usually deals withcomparing cost of borrowings (i) and the projectsexpected rate of return (r) also known as theinternal rate of return (IRR). For example, when r= 7 per cent while i = 9 per cent, cost of

borrowing is higher than the projects expectedreturn, firm will not borrow and the project willnot be undertaken as it will only lead to loss.

THE ECONOMIC THEORIES RELATED TO DEPOSIT

Contd


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But when the central bank increases the moneysupply by making more excess reserves availableto make loans, interest rates will decrease. If itfalls from 9 per cent to 5 per cent, then manyprojects at r = 7 per cent are now viable since r >i.

Case 1: i > r Investment decision : Do not

invest Case 2: i < r Investment decision: Invest

Contd

Contd


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total deposit created by the banking system froman initial deposit from the formula given below:

TD = D / R (1) Where:

TD: Total deposits created

D: Initial deposit R: Statutory reserve requirement

Contd

Contd


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Suppose statutory reserve requirement is set

at 5 per cent and initial deposit of $100

million. Total deposits created by the banking

system amounts to $2 billion.

$2000 million = $100 million / 0.05

Con td

Contd


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MD = TD / D (2)

Where:

MD : Deposit multiplier

TD: Total deposits created

D: Initial deposit

Con td

Contd


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Given TD = $2000m and D = $100m, Deposit

(money) multiplier in the above example is 20.

That is:

$2000m / $100m = 20 ( DM)

Con td

Contd


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The deposits multiplier says that total deposits

will increase by the multiple of 20 from a

given initial deposit. If initial deposit is $500m,

then the banking system can create up to$10,000 million total deposits or10 b deposits

!

Con td

The process of deposit creation


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The process of deposit creation makes a lot of assumptions.

The simple model of deposits creation assumes the

following:

Transactions conducted through the checking system only.

That is, bank loans are given in checkable. Borrowers pay theirpurchases using checks as well.

Excess reserves are used to make loans only. That is, no

investments in securities. Banks also do not keep idle balances

i.e. excess reserves = 0

The process of deposit creation

Contd


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All deposits are demand deposits or checkable

deposits,

There are no leakages i.e. customers do not

keep idle cash in their pockets for

transactional purposes.

Con td

Contd


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In this sense, banking companies posses

power to create money as they create

deposits. The central bank can do so by

printing money, that is coins and currency alsoknown as the monetary base or high-powered

money.

Con td

Contd


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The central bank control money creation in

the banking system by manipulating monetary

policy instruments such as reserve

requirement to affect the amount of excessreserves available to the banks.

Con td

Contd


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Reserves means cash not utilized in the bank.

Under a fractional banking system, once a

bank receives deposits, say $100m, the asset

side will record a new total reserves (TE)amounting to $100m. Total reserves can be

broken down into two, namely the required

reserves (RR) and excess reserves (ER). Thus TE = RR + ER (3)

Con td

Contd


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Required reserves (RR) do not generate

interest income. The same applies to excess

reserves (ER). Usually the bank as a profit

maximizing firm will make sure that the excessreserves are converted into loans/financing so

as to earn interest/profit.

Con td

Contd


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The central bank can influence the deposit

multiplier and hence money supply by

manipulating monetary policy instruments

which in turn will affect the amount of excessreserves (ER) available in banks. For example,

if the central bank is expansionary. It will

reduce the reserve requirement (RR), to say 3per cent, thus increasing the excess reserves

(ER) in banks

Con td

Deposit creation in Islamic banking


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The process of deposit creation in Islamic bankingwill be similar with conventional banking when itruns on a fractional banking system and adoptfiat money as a legal tender. Under a fractionalbanking system, the bank will put aside a fractionof deposits as reserves (i.e cash balances) anduses the remaining balance (ER) to in its financingactivities such as al-bai bithman jil, murabahah,and ijarah thumma al-bay.

Deposit creation in Islamic banking

Contd


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The conventional system uses the contract ofdebts to mobilize deposits that gives them theright to use the deposits to make loans. The sameapplies for Islamic banks as they apply thecontract ofwadiah dhamanah and al-mudarabahto mobilize deposits. Both contracts allow thebank to use deposits to finance its investmentactivities. In this way, the contracts of Islamicdeposits make way for Islamic banks to adoptcurrent fractional banking system.

Con td

Contd


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The process of money creation in Islamic bankingsystem will make assumptions similar to theconventional system. One difference is thatIslamic banks do not make loans to customers butcontracted their purchases under the contract ofdeferred sale that eventually amounts to creditfinancing. The other difference is that Islamicbanks only use al-bai-bithaman ajil(BBA)contract in its deferred sale products.

Con td

Contd


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An understanding about the Islamic economic

principles of deposits is a significant element

in the business of Islamic banking since the

demand and supply of Islamic deposits (i.e.the market for Islamic deposits) are expected

to observe the rules and regulation ordained

by Allah swt.

Con td

Contd


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By doing so, the market for Islamic deposits is

expected to be free from any form of unfair

and inequitable transactions. It will generate a

deposit market where justice prevails fromwhich people will gain benefits (manfaat) and

utility from the services rendered.

Con td

Contd


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what motivate people to

supply deposits?

Con td

Contd


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Economic principles are guidelines that peopleuse in their economic decision making. InIslam, these principles are derived from the

Quran and Sunnah. They are in essence a bodyof knowledge. Economics primarily deals withthe problem of choice arising from scarcity. Tomake the correct choice man is expected to do

so with knowledge.

Con td

Contd


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Making a choice without knowledge can mean

choosing by way of conjecture and guesswork.

It can lead to misallocation of resources and

adversely affect economic growth anddevelopment. Rational choice alone is

inadequate since reason has its shortcomings.

Con td

Contd


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Making a choice using reason is good but

using reason alone as the source of knowledge

can lead to bad choices. This is because, man

who use reason alone can never be free fromtemptations and evil desires and in many

cases will make them irrational instead.

Con td

Contd


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The same applies in shopping behaviour. With

huge discounts on offer, people buy things

they dont need !

Con td

Contd


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To guide mankind into make the correct choice, the Islamic

economics says that choice must be made on the basis of

knowledge revealed by Allah swt. This knowledge is

therefore divine in nature. It teaches man about right and

wrong, about reward and punishment and about therelationship between man and Allah as well as among man.

This knowledge is given in the Quran and the Hadith. Reason

and experience are also useful but both must submit to the

supremacy of revelation (wahy).

Con td

Contd


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Islamic economic principles are predominantlybased on revelation. But some are based on

common sense and reason (aql). Choosing what

goods to produce requires knowledge from Allah

as this will define the permissible (halal) itemsfrom the prohibited (haram) items. But how

much one should produce and using what

technique of production do not require theQuran to give answers. This can be readily

handled by reason and factual evidence

Con td

Contd


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In the economic life, there are a number ofIslamic principles relevant for Islamic bankingapplications. These are given as follows:

The contract (aqd) on which the depositproducts are engineered must be valid (sahih).

The income generated from the investment ofdeposits must contain some degree ofa) risk-

taking (ghorm) b) work and effort (kasb) and c)responsibility (daman)

Con td

Contd


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In the economic life, there are a number ofIslamic principles relevant for Islamic bankingapplications. These are given as follows:

The contract (aqd) on which the depositproducts are engineered must be valid (sahih).

The income generated from the investment ofdeposits must contain some degree of a) risk-

taking (ghorm) b) work and effort (kasb) and c)responsibility (daman)

Con td


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legal maxims are divine principles that one can use in making

a ruling about the behaviour of the believer (mukallaf). These

principles are constructed by Muslim jurists and are based on

explicit Quranic verses as well as the Hadith. One example is

that profit must be accompanied with responsibility(al-

kharaj bil-daman). Another is about risk-return relation - no

reward without risk (al-ghorm bil ghonm). Since the marketfor deposits consists of the banking firm and depositors, it is

important that the decision to supply deposits by depositors

and the decision to mobilize deposits by banksare made on

the basis of the legal maxims.


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When Allah swt prohibits riba, it implies thatprofits arising from loans are unlawful(haram). This is because profits from loans are

both fixed and collateralized. So it only favourthe lending party who will receive profitswithout taking any risk. By doing so, itintroduce injustice into the business since

borrowers must pay up even though they arenot capable of doing so, say due to loss of jobor declining earning capacity.


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In the conventional deposit market,particularly in the supply of deposit - a bankactually borrow from the depositors at a fixed

interest rate. In other words, depositors gavethe bank a loan (qard) with a fixed interestpayment. This payment is an interest expenseand constitutes a cost to the bank. It also riba

as deposits are created out of a loan (qard)contract between the bank and thedepositors.


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In theory, the higher the interest rates the

higher is the supply of deposits. People are

motivated to postpone current consumption

when the compensation for doing so isattractive. This positive relationship between

supply of deposits and interest rates actually

reveal the behaviour of the economic man


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Islamic deposits usually serve two main

functions, namely:

Transaction function : Wadiah Dhamanah

current and savings account

Investment function :Al-Mudarabah

Investment account

Contd


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By virtue of the transactional nature ofwadiah dhamanah deposits, depositors areonly interested in deriving benefits from the

facility offered by the product. The benefitsshall include the ease of cash withdrawals oncall as well as protection of deposits. The bankserves as a custodian or safe-keeper to the

deposits but is allowed use them to generateincome from say, murabahah or ijarahfinancing

Contd


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That is, depositors stand to receive returns butonly as gifts (hibah). In this way, the distributionalmodel ofwadiah dhamanah does not provide anyguaranteed sum or return to the depositors. Ifany, returns are given without any equivalentcounter value, say risk-taking. Wadiahdhamanahcustomers exposure to capital risk is zero. Thus,by virtue of the principle ofal-ghorm bil ghonm,they do not deserve to receive any income orprofits from the deposits.

Contd


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In economics, hibahs are determined ex-postmeaning it is set only when the outcome isactualized. But actualizing outcome, say makingRM100 million profits from murabahah financingdoes not mean that the bank must or obligated(wajib) to distribute the profits. In this way, thesupply curve ofwadiah dhamanah deposits maybe a flat one since the incentive to save does notrevolve around the rate of returns but for safe-keeping and convenience purposes.

Contd


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Since mudarabah deposits and incomes are not guaranteed,the bank that acts as the mudarib must be able to convince

depositors that placing their money as mudarabah deposits is

a good investment. It should be able to show depositors their

good track records and capacity to perform well in themudarabah ventures. Since mudarabah deposits are risky,

depositors expect more returns for each investment made. In

fact any successful mudarabah deposits should outperform

interest income derived from fixed deposits.

Contd


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In this way, the concept of time value ofmoney examined people preferences about

spending their income today or in the future.

If people prefer current consumption to futureconsumption, then they are said to adopt a

positive-time preference (PTP) outlook. They

believe that current consumption brings moresatisfaction than future ones.

Contd


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Therefore, people who are asked to postponecurrent consumption (i.e. creditors) must becompensated for the benefits the pleasureforegone today.. They do so because it is firmly

believed that the future is uncertain and risky,thus one may not know how much utility he orshe can enjoy out of future spending as opposedto current spending. In a nutsell, the PTP conceptsays that 1 dollar today is worth more than 1dollar tomorrow.

Contd


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However, some people do not believe thatfuture spending is inferior to currentspending. Instead they are truly convinced

that they can derive more satisfaction orutility if money is spent not now but in thefuture. By believing so, the decision to save isbased on the negative time preference (NTP)

model. The NTP concept believes that 1 dollar today is worth less than 1 dollar

tomorrow which is opposite to the positive time preference (PTP) model.

Contd


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Finally, there are also some people who feelindifferent about spending their money todayor tomorrow. They believe that money spent

today always yield the same level of utility asmoney spent tomorrow. This is the neutraltime preference model. People with neutraltime preference do not care less about when

to spend.

Contd


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Conventional economics actually believed thatpeople prefer current consumption to future

consumption. This is the dominant view in

global financial markets today. This is onlybecause they believe the future as uncertain

and people have no idea what the future has

to offer them

Contd


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Changes in tastes and preferences or theprice-level may alter and reduce the level ofutility of happiness derived from future

consumption. On the contrary, when peoplebuy goods today, they can instantly enjoy theutility derived from spending. In this way, onedollar today is worth more than one dollar

tomorrow.

Contd


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The belief that current spending generates moresatisfaction than future spending (ie PTP) paves

the way for the rationalization of interest-rates as

the reward for saving. In other words, peoplewho save will forego the satisfaction derived from

current consumption. The same level of

satisfaction cannot be realized when they spend

the same money, say one year from now.

Contd


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The saving behaviour in conventional economics is thereforedependent on the reward or compensation for waiting ie

postponing current consumption. By virtue of positive time

preference (PTP), creditors demand interest while debtors pay

interest. But the same cannot apply to saving behaviour inIslam. Although Islam has to some extent recognizes the

concept of positive time preference, it does not implicate or

bring about the payments and receipts of interest as evident

in conventional economics.

Contd


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THEFACTTHAT ISLAMFORBIDSINTERESTAS RIBAITDOESNOTMEANITISAGAINSTTHECONCEPTOF

POSITIVE-TIMEPREFERENCE (PTF). INDEED, ISLAM

HASGIVEDUERECOGNITIONTO PTF ASEVIDENTINTHESAYINGSOF PROPHET MUHAMMAD (PBUH). THE

PROPHET (PBUH) SAID, VIRTUOUSARETHEYWHO

PAYBACKTHEIRDEBTSWELL.

Contd


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INTHEABOVEHADITH, DEBTORSAREENJOINEDTOPAYMORETHANTHEPRINCIPLELOAN (QARD) RECEIVED. ONEMAYASKWHYTHISISSO? ONEREASONISGRATITUDE.THEDEBTORISTHANKFULFORTHELOANHEGETSANDBENEFITEDFROM. HEKNEWTHECREDITORHASFORGONEHISCURRENTCONSUMPTIONFORTHESAKEOFHELPINGHIMWITHTHEMONEY. HEALSORECOGNIZESTHATTHECREDITORHASRELINQUISHEDTHEOPPORTUNITYTOEARNRETURNSFROMLOANGIVENAWAY. THESERETURNSAREUNKNOWNASTHEYARESUBJECTTOBUSINESSRISK.

Contd


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INTHISMANNER, ONEDOLLARTODAYISSEENMOREVALUABLETHANONEINTHEFUTURE. ASATOKENOF

APPRECIATION, THEDEBTORPAYSMORE. UNLIKERIBA,

THEINCREMENTALAMOUNTISNOTSTATEDUPFRONTANDDOESNOTCONSTITUTEALEGALCLAIMOFTHE

LENDINGPARTY.

Contd


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IN ISLAM, THEREFORERECOGNIZING PTP DOESNOTIMPLYAWARDINGACONTRACTUALINCREASEONTHEPRINCIPLELOAN. ANYINCREASEFROMAN ISLAMICLOAN (QARD) CANONLYBESTATEDATMATURITYANDNOTUPFRONTASNORMALLYPRACTICEDININTEREST-BEARINGLOANCONTRACT. THEINCREMENTWHICHISVOLUNTARYISSETBYTHEDEBTOR. ITISGIVENAWAY

OUTOFGOODWILL. INCONTRAST, THEINCREMENTFROMRIBALOANSISCONTRACTUALANDSETBYTHECREDITOR.

Contd


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In Islamic economics, spending behaviour ofhousehold is expected to influence their saving

behaviour as well. For example, consumers who

practice moderation (zuhud), will secure moresurplus income ie. savings compared with those

who are extravagant (tadrif). The moderation

behaviour is approved by Islam and applicable

only on the consumption of luxuries (kamaliyat).

Contd


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Under a zuhudlifestyle, Muslims live a simple lifealthough they can afford luxuries. While Islamdoes not prohibit Muslims to consume luxurygoods, Muslims are free to choose their lifestyles.

They can live a simple life or lead a luxurious oneas long as they do not fall into debt or amasswealth from illegal sources. They too must spendon basic necessities (daruriyat) and make spendwell for their families.

Contd


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Savings in Islam does not mean keepingmoney as idle balances. All savings must beinjected back into circulation. It must beinvested. If money is kept as idle balances,people who need money for working capitalor to purchase plant and machinery will notbe able to do so. Without money to spend

business will cease to exist and the economywill fall into a recession with implications ongrowth and employment.

Contd


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The objective of savings is best described in theQuranic story of Prophet Yusof(may Allah bepleased with him) where the importance ofsavings is highlighted in its true color. Surah Yusof

(12:3-49) tells the story of a Pharaoh in Egyptwho had a strange dream about seven fat cows.He also saw in his dream seven green ears ofwheat and seven withered or dying ears ofwheat.

Contd


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He asked his advisors to interpret the dream,but no one is good enough to do so. Prophet

Yusuf who is well known for his honesty and

special ability to interpret dreams was broughtto see the Pharoah.

Contd


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In his interpretation about the dream, ProphetYusuf enlightened the Pharoah about the futureproblems of Egypt. He also suggested theremedies. He said that Egypt will enjoy seven

years of prosperity with abundant harvests. Inmodern times, this may be taken to mean higheconomic growth. Prophet Yusof advised thepeople of Egypt to cultivate their crops diligentlyand use a reasonable amount for food andsustenance while storing the remaining surplus.

Contd


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This is because when prosperity comes to anend, Egypt will suffer from serious drought for

seven long years when no crops would grow.

But with the reserves in store, the people ofEgypt could survive the seven bad years.

Contd


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Prophet Yusuf cautioned the Pharoah not toconsume all the reserves but to leave the bestportions for seeds to cultivate later when rainsfilled the Nile. In other words, people must set

aside money for savings and investment. Topostpone current consumption to make way forproduction of future goods was one of the mainmessages that Prophet Yusuf wanted the Pharaohto do for his people.

Contd


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The incentive to save can also be examined atthe micro level of Muslim behaviour. In Islam,

savings will always means surplus income to

be placed for investment purposes, thuskeeping money in circulation. All savings must

be invested again in the economy. Otherwise

it is tantamount to hoarding (ihtikar)

Contd


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The basic idea of savings is to avoid hoardingmoney as the latter is prohibited in Islam.

When people hoard money, there is less

currency around to use. It will frustratebusiness transaction and put production to a

halt since there is no money available to pay

suppliers and workers. Hoarding money willput money out of circulation and therefore

reduces sale and purchases.

Contd


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For this reason, Muslims must save and investtheir surpluses so that the value of the savings

increases over time despite the payment of

zakat. Zakat on idle balances is penalty onhoarding behaviour and eventually leads to

the depreciation of wealth if kept unchecked.

In this way, zakat both purifies wealth

Contd


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For example, when money is put in circulation via investment, zakat income and individualwealth will both increase. This is illustrated in the following examples:

Case (1) Hoarding

Idle cash (i.e. wealth/mal) at year end = $20,000

Zakat = 0.025 x $20,000 = $500

Cash balances (wealth) after Zakat = $19,500

Case(2) Savings

Cash invested = $20,000

Profit = 10% = $2,000

Wealth/mal = $22,000 Zakat = 0.025 x $22,000 = $550

Wealth after zakat = $21,450.

Contd


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From the above illustrations, it is clear that inIslam wealth is not an end by itself. Wealth is

a means to attain happiness (saada) and

success (falah). To do so, Islam enjoins man tospend it well (infaq) and not to indulge in

hoarding. By spending, it can mean many

things such as:

Contd


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Consumption ofbasic necessities (daruriyat)

Consumption ofcomfortables (hajiyat)

Consumption ofluxuries (kamaliyat)

Savings in bank deposits, mutual funds, stocks,properties etc.

Sadeqah as amal jariah (continous good deeds)

Zakat obligation

Contd


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To attract people to save in Islamic bankdeposits, the banking firms are expected to

invest deposits into projects with high yield

potentials. If Islamic deposits can outperforminvestments in unit trusts and other equities

products, it should be able motivate more

people to save. This will increase capitalformation much needed for economic growth

and development.

Contd


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Deposit mobilisation is one of the crucial functions of aconventional financial institutions or banks to satisfy one of

the requirements of a banking business, i.e. sourcing of

funds or borrowing money from customers.

Continuous and adequate deposit mobilisation would ensure

the bank shall be able to sustain its business of lending and

investing, thus incurring profit for future growth.

Contd


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Nevertheless, different types of deposits havedifferent and distinct characteristics and

features which in consequence impose

different risks and costs to the banks.Therefore, in many cases, deposit mobilisation

strategy relies heavily to the banks asset and

liability management policy.

Contd


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In a relationship between bank anddepositors, the rights and duties for both

parties vary according to the nature of deposit

mobilisation. The ability of the bank to fulfilltheir duties is an important measure of the

banks acceptance by the public, or by far as a

comparison yardstick with other banks.

Contd


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Banks mobilise deposits as their primarysource of funds. Having optimal deposits level,

banks shall be able to lend the funds to

generate interest on lending. In addition tolending, the deposits fund can be placed in

certain investments avenues which suits the

banks or the deposits objectives.

Contd


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Deposit mobilisation is a continuous functionfor a bank to ensure the sum total of deposits

at any time adequate to maintain the current

level of lending and investments especially tocompensate the withdrawals made by

depositors.

Contd


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Usually, the deposits level is kept slightly orcertain percentages above the lending and

investments level to ensure the bank has

adequate cash reserves to meet expectedwithdrawals and also recurring withdrawals.

The cash reserves are called Liquidity

Reserves.

Contd


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How a Bank Mobilises Deposits?


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Bank receives deposits from individuals,organisations and businesses, initially by

opening an account with the bank itself.

Based on the types of deposits, minimuminitial deposits are set together with the rules

and regulations governing the accounts.


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Depositors maintain deposits with specificbanks due to many factors, but in particular

trust and confidence with the banks are the

major factors. Once these are established, thebanks continuously attract depositors and

deposits by providing convenience banking,

quality services, excellent brand associationand higher interest/profit payout.


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However, there are instances wheredepositors put their money into the banksmainly for security purposes, i.e. the banks toprotect their money from loss and theft andalso warrant the deposits from investmentloss. As such in Malaysia the governmentprovides guarantee upon deposits placed with

commercial banks.


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The banks must have adequate deposits tomeet the lending volume required by thepublic and at the same time maintain extracash for withdrawals by depositors.

The withdrawals made from the reserves areoddly-offset against new deposits which thebanks should continuously mobilise. The

inability to get sufficient deposits could resultin negative fund situation.


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The level of deposits growth also indicates thebanks performance in relation to customers

satisfaction on interest/profit payout and

services rendered.


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Deposits are made mainly in cash, the mostliquid asset for banks. Once withdrawal

requests are made by depositors, banks must

immediately provide cash for that particularpurpose. As compared to other liquidity

components such as short term investments

which take time to be converted into cash, it is

rather wise for a bank to simply get more

deposits beyond the withdrawal amount.


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However, the percentage of the cash reservesmust be kept at optimum level. Idle cash does

not create profit, but in fact, brings additional

costs in terms of storage and insurance.Therefore, by maintaining cash reserves at

optimal level enables bank to generate

maximum profits from lending and investment

activities.


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The costs for cash reserves are mainly on thestorage and insurance. The storage of cashreserves involves the requirement foradequate vault rooms, cash in-transit securityand cash handling at branches. The insurancecosts are to cover the amount of cashavailable anytime at branches or in-transit

from loss, fire and theft. It generally coversthe maximum cash amount allowed atbranches or in-transit.

THE RISK AND REWARDS


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Deposits placed with conventional banks areconsidered low-risk and low-return

investments. Perhaps, the risks to depositors

are almost zero considering that the return isguaranteed and the banks shall absorb any

unexpected loss derived from investments or

lending activities.

Internet banking


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Internet technology and high security featuresallow banks to introduce internet banking

services to their customers especially for tech-

savvy youngsters and middle-agedprofessionals. Internet banking provides

mobility convenient and time freedom for

accountholders to perform related

transactions anytime anywhere.

Contd


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Among the transactions that can beperformed are fund transfer, balance enquiry,

other enquiries, bills payment, loan and credit

card payment, ad-hoc statement printing andcheque book request. Through internet

banking, depositors can communicate with

their bankers using emails from anywhere.

Contd


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Mobile banking

Mobile banking uses the mobile phones as

medium to perform limited transactions andenquiries onto depositors accounts. Among

the transactions that can be performed are

fund transfer, balance enquiry, other enquiriesand loan payment.


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Corporate desktop

Corporate desktop is provided for subscribed corporate customers only.

Desktop computer(s) and dedicated computer line are provided within

customers office to assigned officers to allow them to perform related

transactions with the bank.

Among the transactions that can be performed are fund transfer, balance

enquiry, other enquiries, FD placement request, bills payment, loan

payment and cheque book request.


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The following are the costs related todeposits;

Deposits maintenance cost

Deposits maintenance cost in general refers to the cost of manpower and

facilities provided by banks to facilitate all transactions performed on

deposits accounts, including the direct promotional activities and deposit

retention programmes. These costs are classified under banks overheadcosts. The cost includes security and insurance coverage on hard-cash.


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Interest payout/Profit payout

Savings and fixed deposits accounts are

interest-bearing accounts. Therefore, for everydollar received under these accounts banksmust pay the interest rate upon maturity orperiodical basis based on the promised

interest rate.


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Relationships between deposits,investments and financing

Deposits have indirect relationships to the lending activities

and the investments made by the banks. Normally, the

various deposits types are combined into a pool and treatedas a single fund. Under this concept, any deposits regardless

of amount and period, provides a low-entry point into fixed

duration and high denomination investments and loans.

SHARIAH PRINCIPLES GOVERNING

DEPOSIT FACILITIES


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Al-Wadiah The Bank accepts deposits for Savings Account

under the Islamic principle of Al-Wadiah.

Definition

It is a contract between two parties i.e. the

owner of goods and the custodian of the

goods to ensure the safe custody of the goodsfrom being stolen, lost, destroyed etc.

Contd


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Types of Goods The goods can be referred to anything that is

of value such as:

Fixed assets

Money

Jewels

Certificates

Contd


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There are two (2) types of Al-Wadiah: a) Al-Wadiah Yad Amanah (Trust)

b) Al-Wadiah Yad Dhamanah (Guarantee)

Contd


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Discretionary Reward Under the principle of Al-Wadiah,

The custodian i.e. the Islamic bank is not allowed to mention or to promise

any rewards or return.

The customers/depositors, on the other hand, are also not allowed to

demand any rewards or return on their savings.

Any promised rewards given under the contract of Al-Wadiah is

considered as riba which is strictly prohibited.

Rewards do not only referring to monetary items. It includes also other

forms of incentives such as coin boxes, clothes etc.

Rewards cannot be promised earlier but as and when the Islamic bank

wants to reward his customers, the bank can always do it on its own

discretion.


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Concept of Returns/Profit

Islamic bank is not obliged to

deposit mobiliziation.ppt

Documents

Transcript of deposit mobiliziation.ppt