Investment & Fixed Deposit Account

Three (3) common Shariah principles used in structuring deposit products are: :-

1. Mudharabah;

2. Murabahah; and

3. Wakalah.

Let's examine the Mudharabah Deposits first..!

1. MUDHARABAH DEPOSITS

Under Mudharabah Deposits, there are three (3) types of deposit contracts; namely

(i) Mudharabah General Investment Account (MGIA):

(ii) Mudharabah Special Investment Account (MSIA);

(iii) Mudharabah Specific Investment Account (MCIA).

Mudharabah Deposits accounted to almost 50-60% of the deposits volume for most Islamic banks in Malaysia. Before we discuss in details on the various types of Mudharabah deposits, let's understand the Shariah requirements for Mudharabah deposits, which can graphically explained in Chart 1 below:

Chart 1

In summary, Mudharabah Deposit can be described as follows:-

1- Profits (if any) arising from the business venture will be shared between the two parties in accordance with predetermined profit-sharing ratios;

2 - Should the entrepreneur suffer losses in his business ventures, the loss will be borne entirely by the depositor/investor (unless there is evidence of gross negligence on the part of the entrepreneur i.e. the bank);

3 - In this venture, there must not be any provisions for “loss sharing”;

4 - It should be noted that since actual profit is calculated on monthly basis, potential income (or return) from investment of the deposits differs from month-to-month depending on the overall deposit taking strategy of the Bank.What it means here, if the deposit is placed under 12-month deposit tenor, there may be 12 different profit rates applicable to it when the bank calculates profits normally payable on maturity.

What are the differences between Mudharabah and conventional FD? This can be summarized as follows:-

Chart 2

Now, what are the differences between the three (3) types of Mudharabah Deposits?

(i) Mudharabah General Investment Account (MGIA)

MGIA is the most popular among the three (3) types of Mudharabah Deposits. It is common for depositors to compare the MGIA deposit rates with the conventional FD rates as generally, Islamic banks (most of them) in Malaysia (especially the Islamic subsidiary) tend to declare profit rates similar or as close to the conventional FD rates.

In practise, when a Customer intends to open MGIA deposit account, the counter staff will provide the followings:

a) An application form (normally for first time applicant);

b) Bank will show the past few months profit rates that it had declared as an "indicative" of the future profit rates that the bank may be paying. Since actual profits will be declared at month-end (actually on 16th of each month), the bank (this is the tasks of the counter staff as front liners) cannot guarantee on the potential profit rates that it will be declaring.

c) Bank will advise the Customer the applicable or standard profit sharing ratio (PSR) and the deposit tenor available for placement. Irrespective whether the Customer is a Muslim or a non-Muslim, the counter staff MUST explain why only PSR will be printed in the MGIA certificate. For transparency purposes, the Customer must be made aware that:-

(i) MGIA is not a fixed profit rate investment; and

(ii) any losses (if incurred by the bank) shall be borne entirely by the Customer (of course in practise, there are various steps to be undertaken by the bank before deduction of any losses from the depositors' principal placement can be done. We shall discuss this in later sessions)

Note: The above terms are printed in the application form but generally, new Customer does not read thorougly the application form so it is good governance to inform Customer of the two (2) important differences between conventional FD and MGIA. Once the Customer is made aware of these terms, the Customer should then be able to decide on the amount and the placement tenor.

d) One very important document that the Customer must sign is a "Profit Equalisation Reserve" (PER) consent/waiver letter. By signing this letter, the Customer gave consent to the Bank to transfer certain percentage of the profits to PER and also agree whatever amount deducted by the Bank is to be treated as donation (tabarru'). We shall discuss in details on PER in later sessions.

An example of PER letter to be signed by Customer is as per Chart 3 below

Chart 3

The Customer must endorsed their agreement on the consent/waiver of PER otherwise the Bank should not open the account. An example of acknowledgement/or acceptance is as per Chart 4 below:

Chart 4

If the Islamic Bank has not obtain the PER waiver/consent letter, Shariahlly, the bank has to declare whatever gross profit amount due after deducting the eligible expenses approved by BNM. The situation will become more difficult when the bank has yet to request such waiver/consent from existing depositors. To ensure Shariah compliant (to validate the use of PER account), the Bank should make stern decision to withdraw or separate the deposits account, if such consent/waiver letters are not obtained from Depositors.

e) Unlike savings deposit where depositors can withdraw their money anytime without notice, any premature upliftment of MGIA before maturity, the bank reserves the right not to declare the full income potentials of the deposit placed. For example, when a 12-month deposit is uplifted prematurely on the 7th month, the Bank will still pay ACTUAL profits but payment shall be made using this formula:-

i) Only completed month will be considered - For example, placement date is 1st Feb (refer Chart 5 below) and it was prematurely uplifted on 7th Sept. Completed months will be 7 i.e. up to 1st Sept and the additional 6 days, will not be counted

ii) Subject to the lowest standard tenor to the completed month - For example, assume deposit tenors available are 1, 3, [ 6 ], 9, 12, 15, 18 and 24 months. Customer placed deposit for 12-month and decided to uplift prematurely on 7 Sept. The nearest lower standard tenor for 7 completed months is the "6-month standard tenor" and for the past 7 months, the actual profit rates declared is say, (abcdefgh%). So, the bank will pay that profit rates (abcdefgh%) instead of paying the actual profit rates meant for 12-month deposit tenor. Let's further examine using this simple and straight forward example in Chart 5.

Chart 5

Using Formula [ Principal x Profit rate x (Days in Month divide by No. of Days in Year or 50,000) x 2.50% x 28/365 = RM95.89 ] for the month of March '10 and so on, up to the 7th month on Sep '10. Practically, the calculation is a bit more complex because in Malaysia, the profit rates are declared from 16th to the 15th of the following month. So, technically the Bank should apply profit rates declared from 1st to 15th and another from 16th to 31st of the month. We shall not discuss or argue on this issue but sufficient to say that the main reason for declaring profit rates within the period earlier mentioned is because most banks prepare their profit distribution table manually (using excel table) thus, to ensure sufficient time for collection and calculation of data, profit rates are only declare on 16th day of each month.

It is interesting to note that if conventional FD is uplifted before maturity, the depositor will either get half the contracted FD rate or based on savings rate. Thus, technically there is no penalty for upliftment before maturity for Islamic investment deposits.

(ii). Mudharabah Special Investment Account (MSIA)

MSIA is normally used by Treasury Department when taking large deposit amount from Corporate Depositors or from another Bank for placement under Islamic Interbank Money Market (IIMM). Under MSIA, the depositor can negotiate the profit sharing ratio but minimum placement amount is at least RM50k.

We shall discuss further on MSIA when we talk about IIMM in our next couple of sessions.

(iii). Mudharabah Specific Investment Account (MCIA)

MCIA can be graphically explained in Chart 6 below:

Chart 6

Under MCIA, the depositor is entitled to negotiate the profit sharing ratio (PSR) and also decide on the type of projects/risks that depositor intends to participate e.g. on telecommunication industry only. Profits earned from the specific project will be placed in a “special pool” where Bank share the profits/(or loss) solely with that particular “specific” depositor.

Specific depositor is not allowed to uplift their MCIA prematurely i.e. cannot terminate the contract before completion of project. If the contract is breached, the bank may at its discretion, choose not to pay whatever profits earned to-date but can claim whatever losses incurred to-date by reducing the original principal placement amount. Depending on the internal policy of the Bank, it can however, request Depositor to get a replacement depositor (to cover similar amount) but subject to the new depositor agreeing with the existing terms of the original specific contract.

2. MURABAHAH DEPOSITS (Fixed Deposit Account)

Literally Murabahah means cost-plus or mark-up sales. Murabahah contract can be used for "cash creation" for the purpose of investment or financing.

In structuring deposit product using Murabahah, Islamic Banks can use

(a) Bai Al-Enah contract which involves purchase and sale of Assets between two (2) parties; or

(b) Commodity Murabahah contract (or Tawwaruq) which involves purchase and sale of commodity such as palm oil, metal and the like, but the transaction usually involves three (3) or four (4) parties.

Again, the Writer wish to stress that we should not argue about the validity of Bai Al-Enah or Tawarruq transaction. Let's the Shariah scholars argue about these principles. What the Writer

will do is to comment on how the Bai Al-Enah or Commodity Murabahah transactions are conducted i.e. its practical implementation.

Now let's further examine the two earlier contracts mentioned.

a) Bai Al-Enah

Under Bai Al-Enah, the underlying assets are normally the bank's own Assets such as floor space/lot (identified by plots) or other assets such as company car and the like other than gold and silver. Some Shariah Committee insists that the Asset to be used for transaction purposes cannot be used but place as a display item. For example, if the bank wishes to use a new car value at RM100k, the car will be placed on display at certain location accessable to all Customers, if they wish to see it. Due to depreciation, the said car will be placed on display for only about a year and then disposed-off by tender.

Let's for our example, we are using floor space/plot as the Bank's Asset to validate the Bai Al-Enah contract.

The Bank will sell these plots (after assigning certain value on the plots) and then buy back on deferred payment basis. Graphically, the floors are divided as per Chart 7

Chart 7

For good governance, to use the office space/plots as the underlying assets for Bai Al-Enah transaction, proper Board of Directors' resolution and Shariah Committee's approval must be obtained. On why the Plots are divided into different sizes, it is basically to cater for the different transaction volume. In addition, once the plot is being used for a particular transaction, the same plot cannot be used again unless the Bai Al-Enah transaction has been concluded.

b) Commodity Murabahah (Tawwaruq)

Under Tawarruq, the underlying asset is commodity such as palm oil or metal. Some banks use stocks such as halal tin products that are easily identify and touch. Basically, it is a sales of certain specified commodities, through an exchange, on a cost plus profit basis.

It should be noted that Commodity Murabahah Deposit is a product that gives the investor a pre-determined rate of return (different but akin to conventional FD pricing) via buying and selling of commodities as the underlying transactions. Like Bai Al-Enah, Commodity Murabahah can also be transacted as a deposit taking or a financing instruments.

The transaction flows for Commodity Murabahah where the Bank accepts money from a depositor is as per Chart 8 below:

Chart 8

For the Bank to accept deposit under Commodity Murabahah, it must undertake the purchase and sale transaction of the commodity. Parties involve in Commodity Murabahah transactions, are:-

i) Depositor (Party A or Investor) who has surplus funds;

ii) The Bank (wakeel or agent) which requires the funds;

iii) Broker 1 (party which transacts or sell the underlying commodity);

iv) Broker 2 (the other party which also transact or buy the underlying commodity from the Bank).

The transaction flows can be read together with Chart 8 above:-

#1 - Bank receives fund from Depositor (Party A) as a Wakeel (under the principle of wakalah).

Note

In practise, the Bank staff who is assigned to transact the deal on behalf of the bank must call the customer, record the customer's name (deal only with authorized staff of the Customer), note the time and payment mode, to be followed by written confirmation by both parties;

#2 - Bank as wakeel uses the fund provided by Depositor to buy the commodity from Broker 1 (through Agent or direct) on behalf of the Depositor (Party A) on SPOT basis;

#3 - Due to the size and volume of the Commodity, Broker 1 shall retain the commodity in its possession (storage yard) as a safe keeper (fully covered by Takaful or insurance etc) but the "beneficial ownership" of the commodity is transferred to the Depositor (Party A). Official letter

of confirmation/or Purchase confirmation receipt shall also be sent to Party Depositor (Party A) for purchase of the commodity.

Note

In practise, the Bank (preferably the Shariah Officer of the Bank) will visit and verify the storage place, the transaction documents, confirm the quantity etc so as to ensure the transaction is valid and ensure existence of the commodity. Surprise audit/check may need to be done from time to time.

#4 - Being the beneficiary owner, Depositor (Party A) has absolute right to deal with the commodity. Since the Depositor (Party A) does not to keep the commodity, the Depositor (Party A) sells the commodity to the Bank at agreed sale price comprising original cost plus mark-up on deferred payment basis to the Bank. The beneficial ownership of the commodity is then transferred to the Bank;

#5 - As the new beneficiary owner, the bank has the option to keep or sell the commodity. Since it wanted cash, it then sell the back to Broker 2 (through Agent or direct) at a discount equivalent to the original cost price on SPOT basis;

#6 - Broker 2 will pay the Bank at the SPOT price;

#7 - On maturity date of the deferred payment contract between the Bank and the Depositor, the Bank will pay Depositor (Party A) at the agreed sale price i.e. the original amount plus the profit.

The above transaction flows must be supported by proper accounting entries to ensure the transaction is Shariah compliant.

It should be noted that some Shariah Committee insist that the commodity to be sold to different party i.e. must have two (2) brokers instead of one (1). However based on various practises on Commodity Murabahah, the Writer opines there are still a number of issues that need to be resolved at industry level to ensure the Commodity Murabahah is really transacted in accordance with Shariah requirements. In situation where two (2) Brokers are used, the Brokers are supposed to be a different entity but in practise, they are from same group although on paper they are not connected. Both Broker 1 and Broker 2 are required to maintain a non-checking account in the Bank. Broker 1's non-checking account will be credited by the Bank (when the Bank purchase the Commodity) and when concluding the transaction, Broker 2 will pay to the Bank (as agent of Party A when it sold the commodity to Broker 2).

The Writer wish to highlight the following issues raised by certain practitioners. Where does Broker 2 gets the money to pay the Bank when it buys the Commodity from the Bank..?

Again in practise, both Broker 1 and 2 will square their positions by Broker 1 instructing the Bank to transfer whatever money credited into its non-checking account to non-checking account

of Broker 2, so payment for the commodity purchase from the Bank by Broker 2 can be affected. Is this arrangement acceptable by Shariah? How about using only one (1) Broker i.e. the commodity is sold to the bank and when the transaction is completed, pay for the purchase of commodity using same money earlier credited to its account by the Bank to purchase the commodity. This is more straight forward.

Another issue, why do we need to use Commodity Murabahah when the real intention ("niat atau tujuan sebenar") is "creation of cash". Why the long-winded process as though "Allah" is not aware of one's intention. Under this argument, using Bai Al-Enah contract is more straight forward (Allah knows our intention) without using "back-door process such as commodity murabahah" to validate cash creation transaction although most Shariah scholars argue on its validity.

We hope the Shariah scholars can clarify the above issues.

3. Wakalah Deposits

Another deposit product which is normally transacted by the Treasury Department is Wakalah Deposit (some spell it as wakala). Wakalah is a contract whereby the bank in its capacity as Agent, raises funds from its customers to invest these funds in a Sharia'h compliant good and/or financial assets. The Wakil (bank) has a responsibility to ensure investing in assets will yield certain return greater than as specified by the Principal. The rate of return that the bank normally offers to Wakalah customers is the "expected/anticipated profit rates" and not "guaranteed rates" as these are based on the underlying earning assets performance. The Bank as an agent, receives agency fee for undertaking the job of investing on the Principal's behalf.

Saving & Current Account Deposits (Wadiah, Mudharabah & Al-Qardh)

Shariah principles applicable to savings account are Al-Wadiah, Mudharabah and Al-Qard. However, Al-Qard is commonly offered by Islamic banks in the Middle East. Let's us examine the principle/concept and brief operation aspects of each type of deposits.

1. Al-Wadiah Deposits (Savings & Current Account)

Al-Wadiah is a contract (akad) between the Owners of good and the Custodian of the goods. The role of the Custodian (in banking perspective, the bank) is to protect the goods from damaged, destroyed, stolen etc. Basically, the contract is entered between both parties to ensure safe custody. 

In Malaysia, SAVINGS ACCOUNT offered by Islamic banks is under the contract of Al-Wadiah Yad Dhamanah (Guaranteed Custody). The core of this arrangement is that the bank has authority to use the depositors' money and guarantee to return the same when the depositors

need it. Most Islamic banks (particularly in Malaysia) requires the depositors to give their consent for the bank to use the depositors' money but for some Islamic banks, they kept it silent i.e. no consent is required.

As trustee under this Guaranteed Custody contract, the bank is not allowed to mention or promise any rewards in the form of profits or gifts (“hibah”) on the deposits it received. Similarly, the depositors too cannot demand any reward or return from the Bank on their savings placement. 

It seems, BNM National Shariah Council (NSC) had made decision disallowing payment of profit or "hibah" for Al-Wadiah deposits. However, in practise, Islamic banks in Malaysia (except the International Islamic banks or IIB) are giving "hibah" in monetary form (as gesture of appreciation by the bank to the Depositors) and somehow, the Shariah Committee (SC) of the individual Islamic bank does not prevent but kept silent about this "hibah" issue.  Perhaps, the SCs allow payment of "hibah" due to "maslahah" (public interest) in order for Islamic banks to compete as alternative to the conventional savings deposit account where paying "interest" is standard for all types of savings deposit accounts. 

The Writer opines that as long as the Islamic banks maintain this view, we may not be able to clearly differentiate between the Islamic from the conventional savings deposit. We have to make a stand when it comes to Shariah compliant issue. Anyhow this is just the personal view of the Writer. Perhaps, Shariah scholars can share their views to clarify this issue.

What are the differences between Islamic from conventional savings account. In summary, the differences are as follows:-

Chart 1

It is interesting to note that although payment of "hibah" is somehow practise in Malaysia, NSC decision that NO free gifts or inducement items (e.g. free umbrella, coin box etc) should be given to new depositors is being strictly adhered by Islamic banks. So, unlike conventional banks where new savings depositors are given free gift such as an "umbrella with the bank's logo", new Al-Wadiah savings depositor normally do not enjoy such gift.

There is a Shariah opinion allowing Islamic banks to give gifts to loyal depositors whom have maintain their accounts with the bank for example, more than 6 months. If such gifts are given, it should be given without any differentiation or category such as special gift to those whom maintain deposit amount of more than RM10,000 and the like. It should be given to all depositors whom meet the same criteria irrespective the balances in their accounts.

As for CURRENT ACCOUNT, it is also offered under the principle of Al-Wadiah Yad Dhamanah. Unlike savings account holders whom are given passbooks, Current Account depositors are given cheque books where it can be issued to pay 3rd parties or withdraw cash for own use.

Technology has changed the operations of banks in Malaysia where previously banking counters/banking halls are the busiest place in  a bank, nowadays withdrawal of cash, transfer of funds, bills payment etc can be done through the Automatic Teller Machine (ATM) or deposit cash via the Cash Deposit Machine (CDM). Banking transactions can also be done on-line through Internet banking services and now fund transfer can also be done via mobile phone. To-date there is no Shariah issue relating to services using technology but it would be interesting to observe what Islamic banks will do when one day, conventional bank grant loans such as

overdraft without requiring the customer to sign any agreement or go to the bank, suffice with just an application via the Internet.

2. Al Mudharabah Savings.

Another popular savings account offered by Islamic Bank is Al-Mudharabah savings accounts. Under this concept, the depositors shall entrust the bank to utilize the deposits for its financing and investment activities without any interference from the depositors. 

Note : Mudharabah principle shall be discussed in details in next session.

Profit earned from the bank's  investment will be shared between the Bank and depositors in accordance with the agreed profit sharing ratio (PSR). It is interesting to note that under Mudharabah savings, the profit-sharing-ratio (PSR) is only valid for one (1) day. At end of the day, whatever PSR during the day is terminated but it will be automatically renewed the next day. To operate in this manner, the Bank need to seek consent from the Depositors on this automatic profit sharing renewal arrangement on condition the PSR remained unchanged.

If the Bank decides to change the PSR, it still need to advise the depositors in writing by giving sufficient time such as 14 days to object the change in the PSR. Without any objection, the bank can change the PSR without any written acknowledgment or consent from the depositors. If the depositor objected to the change in the PSR, the bank reserves right to request the depositor to withdraw the money.

This type of arrangement must be clearly explained to depositors to ensure transparency. So when a new depositor intends to open a Mudharabah savings account, the depositor MUST BE VERBALLY advise by the counter staff of this arrangement before opening the account instead of just asking the depositors to read the fine line (most depositors do not read the standard terms) in the application form.

Since this savings account uses Al-Mudharabah principle, the depositors are exposed to risk i.e. losses (if any) is to be borne by the depositors. Likewise, this possibility must also be highlighted to the depositors. To match risks with rewards, profit rates payable to Mudharabah savings account holders are normally higher than conventional savings deposits rates.

Looking at the above conditions, what is so attractive about Al-Mudharabah savings deposits? Compare to Al-Wadiah Savings where granting of "hibah" is an issue, there are no profit payment issue under Mudharabah Savings products. In addition, depositors under Mudharabah savings account enjoy MULTI-TIER profit sharing ratios normally structured as per Chart 2 below:-

Chart 2

If you review Chart 2, higher PSR is given to depositors with high deposit amount. Thus, generally the profit rates for Mudharabah savings are higher than conventional savings "interest" rates.

One important aspect of Mudharabah savings deposits is that all depositors MUST SIGN A WAIVER FORM FOR THE CREATION OF PROFIT EQUALISATION RESERVES (PER) account by the Bank. PER is a reserve account (allowed by BNM and an important item in the Islamic accounting ) where the bank places undeclared profit amount i.e. this amount is deducted from the gross profit before distribution and placed in a reserve account i.e. PER, to support   the Al-Mudharabah profit rates in conventional bank interest hike situation, to avoid Islamic banks from exposing to what is known as  "deposit displacement risk" due to outward movement of deposits from the Islamic banks to conventional banks due to sudden hike in conventional deposit rates. Under such situation, in order to remain competitive, Islamic banks may need to match the conventional savings rate.

We have to admit that there are three (3) types of depositors in our banking system as follows:

(a) those who seek high return and can switch from Islamic to Conventional or vise verse (basically non-Muslims); 

(b) those who only want to deal with Islamic bank; and

(c) Muslims who are still indifferent on the type of banking system (still does not understand the implication of "riba" to a Muslim) as long as they can get high return on their investment. This type of Muslims behave like (a) above. They are among the group who accuses Islamic banking financing products as expensive and prefers to take "riba" product to enjoy lower pricing. As mentioned in this blog banner, the Writer will provide examples in later session to prove that conventional bank loans are more expensive than Islamic financing products.

3. Al-Qard (Benevolent loan)

Al-Qard deposits is very popular savings product in the Middle East. Qard literally means a debt or loan "without interest, profit or hibah (gift)". There should be no promise of return or reward either by the borrower or the lender. In this perspective, the Bank is the borrower by providing safe keeping services to the Depositors. The bank can also charge certain fees for its service, for example, fees for ATM, internet banking services etc which are normally offered free of charge in Malaysia.

Islamic banks in Malaysia may not be able to promote this type of deposit product since depositors in Malaysia are already been exposed to receiving return for the "money" kept by the Bank but a number of countries in the Middle East, they are able to promote this product since Customers requires save keeping.

The Bank reserves the rights to use the Al-Qard deposits as it like, this include providing lease or debt financing to other customers.