The Features of a Conventional Bank

The conventional banking, which is interest based, performs the following major activities: 1. Deposit creation 2. Financing (Refer to section IV) 3. Agency services 4. Issuing LGs 5. Advisory services 6. Other related services We now would like to make a comparison of these activities with Islamic concept of banking:

Deposits (The liability side)
Deposit - qard (loan) not amanah (Trust)

The common misconception regarding "deposit" is that
it is a form of amanah (security/trust). However, according to SHARIAh definition, deposit has more resemblance to qard (loan) than amanah. This conclusion is based on the fact that in Islam an item is termed as amanah, if it bears all the features of amanah. Deposits cannot be termed amanah, as they do not have two of its special features, i.e.

• Amanah cannot be used by the bank for its business or benefit.
• The bank cannot be liable in case of any damage or loss to the amanah resulting from circumstances beyond its control.
  

Whereas in banks, deposits are primarily placed to earn profit, which is only possible when the bank uses these deposits to invest in other business. Hence deposits do not fulfill the first condition of amanah, which says that it should not be used by the caretaker for his own business or benefit.

Secondly, the bank is held 100% responsible for these deposits in all circumstances even in case of loss or damage to the bank. This feature releases deposits from the ruling of amanah where the assets will not be returned in case of any damage to the asset resulting from circumstances beyond caretaker's control. According to this justification, all three kinds of deposit namely current accounts, fixed deposits and saving accounts are not amanah. They are all governed by qard.

One school of thought says that only fixed deposit and saving accounts fall under the laws of qard but current account is governed by amanah. However, this is also not correct because the bank is as much liable to current account holders as its PLS account holders and is called the "guarantor" in fiqh terminology. Due to this feature, current account is also governed by qard.

The depositors are not interested in terminology but the end-result of holding an account. Therefore if a bank does not offer security to the assets, the depositors under normal circumstance will never keep their assets at such a bank. Similarly if the depositors are told that the status of their account will that be of amanah and in case of any loss to the assets, without any negligence of the bank, will not be returned to them, not a single person would put his asset in the bank. Therefore the bank provides the security to the assets, which the depositors themselves want.

We therefore conclude that the main intention of the depositors is not to put the assets in banks as amanah; rather as qard by having collateral security by appointing the bank as guarantor.

Example of Syedna Zubair bin Awwam (RA)
Hazrat Zubair bin Awwam (RA) was famous for his honesty and trustworthiness. Prominent people used to leave with him their properties in trust. Based on their needs they would also withdraw all or part of their properties. It has been reported in Al Bukhari and Tabaqaat-e-Ibn-e-Saad in respect of Hazrat Zubair bin Awwam (RA) that he would decline to accept such property as amanah (trust) but rather accepted them as qard (loan).

The reason for this action on his part was his fear that the property may be lost and it may be suspected that he was neglectful in its safekeeping. As such, he decided to consider it a loan so that the depositor felt more comfortable and his reputation remained intact. Another reason for it was that it could become possible for him to employ these funds for trading and earn profit out of them. The loan amount calculated at 2.2 million at the time of his death by his son Syedna Abdullah bin Zubair was specified as qard not amanah. He also used the term loan while instructing his son before his death "Son, dispose off my property to settle the loans".

Conclusion
From the above discussion, we come to the conclusion that all three forms of bank deposits are governed by the law of qard as a consequence of which the account holder may withdraw only the assets deposited. Any increase on it will be interest. It has already been discussed in the chapter of commercial interest that if the purpose of the lender is business or security and not providing financial assistance, then to get an excess amount is also interest, which is prohibited in Islam just like usury.

It is also clear that there is a consensus of Muslim scholars on the point that the transactions in Fixed Deposit and Savings Account is prohibited because the bank pays excess to their account holders over their actual capital, which is interest. The Islamic Fiqh Academy Jeddah in their 2nd session has further endorsed such transactions as interest based transaction. Therefore it is illegal for a Muslim to keep their deposits in such accounts. As far as the current account is concerned, the bank does not pay any excess (interest) over the actual capital, therefore holding such an account is allowed.

To sum up, profit given on fixed deposit and savings accounts is interest and therefore prohibited. However if the banking system is based on Islamic principles, Musharakah can play a very important role. Therefore we will now discuss how the banks can operate on Musharakah basis. As we already know a bank has two sides, one where it receives deposits from customers which is called the liability side and the other where it advances finance to investors and businessmen which is called the asset side. Both sides can operate on Musharakah basis. As far as deposits are concerned, Musharakah is the only instrument in which money can be received from customers meaning that every depositor will become a partner in bank's business through their deposited money. However, for the asset or finance side, there are other instruments apart from Musharakah but since those instruments are not covered in our subject, we will stick to the operation of Musharakah. We will begin by the role of Musharakah in the deposits and its relevant laws and will then discuss the procedure of Musharakah in the finance side.

Role of the Bank as Agent
A bank under Islamic SHARIAh can act as an agent (on Al-Wakalah basis) of the customer and can carry out the transaction on his behalf. Moreover it can charge agency fee for the services.

The agency fee can be charged in the following cases

• Payment / receiving of cash on behalf of the customer
• Inward bill of collection
• Outward bill of collection
• LC opening and acceptance
• Collection of export bills / bills of exchange. In this case the undertaking or guarantee commission and take-up commission can be Islamized. Bank will charge an agency fee for accepting the bills, which is bought at face value.
• Underwriting & IPO services
  

Role of the Bank as Guarantor
The bank or financial institute gives a guarantee on behalf of its customer but according to SHARIAh, guarantee fee cannot be charged. Normally conventional banks charge fee for following guarantees:

• Letter of guarantee
• Shipping guarantee

Advisory Services
Most of the advisory services provided by the financial institutes can be carried out easily in compliance with SHARIAh as long as the nature of business is halal:

• Financial advisory services
• Privatization advisory services
• Equity placement
• Merger & acquisition advise
• Venture capital
• Trading (Capital market operations)
• Cash & portfolio management advice
• Brokerage services (Purchase & buying of share of companies involved in halal business, a fee could be charged for it).

Other allowed Islamic financial services & products

• Remittance
• Zakat deduction
• Sale & purchase of foreign currency
• Sale & purchase of travelers checks (local foreign currency)
• ATM services
• Electronic online transfer
• Telegraphic transfer (of cash)
• Demand draft
• Pay order
• Lockers & custodial services
• Syndicate funds arrangements services (non-interest or markup based) for some fee
• Opening of bank account (current & non-interest or no-markup)
• Clearing facility
• Sales & purchase of shares/stock (of companies involved in halal activities)
• Collection of dividends
• Electronic banking window
• Telephone banking

Musharakah in Bank Deposits
An important value of an Islamic society is mutual dealing. It also refers to deposits in banks. The operation of fixed deposits and savings account in Islamic banks will be different from conventional banks because the Islamic banks will be based on Musharakah (combination of Shirkah & Mudarabah) in which like conventional banks, people will invest in two ways:

• Participation in setting up the bank like any other company by joint investment and the participants will be called the "shareholders". They will have a partnership (Shirkah) effected by a mutual contract since they have used their capital and deed on the bank; and
• Participation by opening their account in fixed deposit and savings account and participants will be called the "account holders". These will not be the actual owner or shareholders of the bank - rather partners in profit only, meaning that they will have a contract of Mudarabah

The status of the bank or the shareholders will be that of a Mudarib and the account holders will be Rubb-ul-mal. The contract known as Musharakah will be a combination of Shirkah and Mudarabah. This is the reason why the profit ratio of depositors is less than the actual shareholders and the depositors will not have any voting power or the right of management because they are not involved in the deed but has only supplied the capital. This kind of dual relationship is not uncommon in Islamic Fiqh. Therefore if the Mudarib (Bank or the shareholders) wants to merge his assets with the assets of depositor, it is allowed in which case he will be regarded as owner of half the assets and Mudarib of the other half. This has already been discussed at length in chapter 13 on Musharakah.

In the previous chapter, following facts have been established:

• The actual status of deposits is debt and not amanah.
• The excess paid on loan is interest, not profit. 3. If a bank is operating on Islamic principles, the bank and the depositor will have a partnership through a contract of Shirkah or Mudarabah in which case the depositor's capital will not be regarded as loan.
• The shareholders will act as Rubb-ul-mal as well as Mudarib.
• The depositors will only act as Rubb-ul-mal.
• Fixed deposit and saving account will be converted into Mudarabah account where the distribution of profit for each partner will be determined in proportion to the actual profit accrued to the business and not according to a fixed ratio or in proportion to the capital invested by him. Fixing lump sum amount is not allowed or any rate of profit tied up with any investment.
• The entire set up of the bank is on Musharakah basis where the relationship of the bank and shareholders is through partnership agreement (Shirkah) because they are participating in labor as well as investment and the relationship between the bank and depositors is only that of Mudarabah because they have only invested without participating in labor. Therefore this combination of Shirkah and Mudarabah is called Musharakah in modern terminology.

Distribution of Profit Under Musharakah Agreement
The distribution of profit will be done according to the rules of Musharakah. Before we begin the summary of the distribution of profit, it is found appropriate to mention here that the conventional banks do not pay interest to current account holders. Therefore there is no need to convert the operation of current account into any Islamic mode of financing. However the distribution of profit to the rest of the partners and account holders will be made on the following rules governing Musharakah:

It is not a condition for the final distribution of profit that all assets are liquid - rather the profit and loss is calculated on the basis of evaluation of assets. In case of loss, each partner shall suffer the loss exactly according to the ratio of his investment and in case of profit; the profit will be distributed according to the agreed ratio between the partners. It should be taken into account that both parties are free to determine any ratio of profit of the bank as the manager (Mudarib), therefore it can be agreed mutually that Rubb-ul-mal will have a higher profit margin and Mudarib lower. However as a shareholding partner, the share of profit of the Mudarib cannot be less than the ratio of his investment since he is the sole provider of labor. Same rule will apply on the operation of Islamic Banks on the basis of Musharakah. The actual shareholders apart from being the manager are also shareholding partners; their ratio of profit cannot be less than their ratio of investment. However their ratio of profit as Mudarib can be determined at whatever rate they please.

The above may be explained in the following illustration: Suppose the total investment of the bank is Rs.15 million in which the depositors have invested Rs.10 million on Mudarabah basis and the shareholders as Mudarib have invested Rs.5 million. This means that one third share of the total capital belongs to the shareholders and two third to the depositors. The role of Mudarib in the 2/3rd capital raised by depositors is played by the shareholders, therefore their ratio of profit as manager (Mudarib) can be agreed between themselves through mutual consent but their ratio of profit, as shareholders cannot be less than 1/3rd. If their share is agreed at less than 1/3rd, it would mean that the depositors' share has exceeded 2/3rd although it has been established that they will not be managing the bank and their share of profit will not exceed their ratio of investment.

If it has been agreed in the above example that the shareholders as managing partners will get 1/3rd of the profit and the rest 2/3rd will be distributed equally between depositors and shareholders as per the Mudarabah contract between them, then if for eg. the profit amount is Rs.15 lacs then the shareholders will get its 1/3rd i.e. Rs.5 lacs (1 Lac = 100,000) as the investor (Rubb-ul-mal) and half of the 2/3rd profit i.e. Rs.5 lacs as the manager (Mudarib) whereas the other half of the 2/3rd profit will go to the depositor as Rubb-ul-mal. The following table will clarify the shares of shareholders and depositors:

To sum up, the above procedure can be adopted to run the bank on the principles of Musharakah.

Running Musharakah Account on the Basis of Daily Products
Many financial institutions finance the working capital of an enterprise by opening a running account for them from where the clients draw different amounts at different intervals, but at the same time, they keep returning their surplus amounts. Thus the process of debit and credit goes on up to the date of maturity, and the interest is calculated on the basis of daily products.

Can such an arrangement be possible under the Musharakah or Mudarabah modes of financing? Obviously, being a new phenomenon, no express answer to this question can be found in the classical works of Islamic Fiqh. However, keeping in view the basic principles of Musharakah the following procedure may be suggested for this purpose:

• A certain percentage of the actual profit must be allocated for the management.
• The remaining percentage of the profit must be allocated for the investors.
• The loss, if any, should be borne by the investors only in exact proportion of their respective investments.
• The average balance of the contributions made to the Musharakah account calculated on the basis of daily products shall be treated as the share capital of the financier.
• The profit accruing at the end of the term shall be calculated on daily product basis, and shall be distributed accordingly.

If such an arrangement is agreed upon between the parties, it does not seem to violate any basic principle of the Musharakah. However, this suggestion needs further consideration and research by the experts of Islamic jurisprudence. Practically, it means that the parties have agreed to the principle that the profit accrued to the Musharakah portfolio at the end of the term will be divided based on the average capital utilized per day, which will lead to the average of the profit earned by each rupee per day. The amount of this average profit per rupee per day will be multiplied by the number of the days each investor has put his money into the business, which will determine his profit entitlement on daily product basis.

Some contemporary scholars do not allow this method of calculating profits on the ground that it is just a conjectural method, which does not reflect the actual profits really earned by a partner of the Musharakah. Because the business may have earned huge profits during a period when a particular investor had no money invested in the business at all, or had a very insignificant amount invested, still, he will be treated at par with other investors who had huge amounts invested in the business during that period. Conversely, the business may have suffered a great loss during a period when a particular investor had huge amounts invested in it. Still, he will pass on some of his loss to other investors who had no investment in that period or their size of investment was insignificant.

This argument can be refuted on the ground that it is not necessary in a Musharakah that a partner should earn profit on his own money only. Once a Musharakah pool comes into existence, all the participants, regardless of whether their money is or is not utilized in a particular transaction earn the profits accruing to the joint pool. This is particularly true of the Hanafi School, which does not deem it necessary for a valid Musharakah that the monetary contributions of the partners are mixed up together. It means that if 'A' has entered into a Musharakah contract with 'B', but has not yet disbursed his money into the joint pool, he will be still entitled to a share in the profit of the transactions effected by 'B' for the Musharakah through his own money. Although his entitlement to a share in the profit will be subject to the disbursement of money undertaken by him, yet the fact remains that the profit of this particular transaction did not accrue to his money, because the money disbursed by him at a later stage may be used for another transaction. Suppose 'A' and 'B' entered into a Musharakah to conduct a business of Rs. 100,000/- They agreed that each one of them shall contribute Rs. 50,000/- and the profits will be distributed by them equally. 'A' did not yet invest his Rs. 50,000/- into the joint pool. 'B' found a profitable deal and purchased two air conditioners for the Musharakah for Rs. 50,000/- contributed by himself and sold them for Rs. 60,000/-, thus earning a profit of Rs. 10,000/-. 'A' contributed his share of Rs. 50,000/- after this deal. The partners purchased two refrigerators through this contribution which could not be sold at a greater price than Rs. 48000/- meaning thereby that this deal resulted in a loss of Rs. 2000/- Although the transaction effected by 'A's money brought loss of Rs. 2000/- while the profitable deal of air conditioners was financed entirely by 'B's money in which 'A' had no contribution, yet 'A' will be entitled to a share in the profit of the first deal. The loss of Rs. 2000/- in the second deal will be set off from the profit of the first deal reducing the aggregate profit to Rs. 8000/-. This profit of Rs. 8000/- will be shared by both partners equally. It means that 'A' will get Rs. 4000/-, even though the transaction effected by his money has suffered a loss.

The reason is that once the parties enter into a Musharakah contract, all the subsequent transactions effected for Musharakah belong to the joint pool, regardless of whose individual money is utilized in them. Each partner is a party to each transaction by virtue of his entering into the contract of Musharakah.

A possible objection to the above explanation may be that in the above example, 'A' had undertaken to pay Rs. 50,000/- and it was known before hand that he would contribute a specified amount to the Musharakah. But in the proposed running account of Musharakah where the partners are coming in and going out every day, nobody has undertaken to contribute any specific amount. Therefore, the capital contributed by each partner is unknown at the time of entering into Musharakah, which should render the Musharakah invalid.

The answer to the above objection is that the classical scholars of Islamic Fiqh have different views about whether it is necessary for a valid Musharakah that the capital is pre-known to the partners. The Hanafi scholars are unanimous on the point that it is not a pre-condition. Al-Kasani, the famous Hanafi jurist, writes:

" According to our Hanafi School, it is not a condition for the validity of Musharakah that the amount of capital is known, while it is a condition according to Imam Shafi'i. Our argument is that Jahalah (uncertainty) in itself does not render a contract invalid, unless it leads to disputes. And the uncertainty in the capital at the time of Musharakah does not lead to disputes, because it is generally known when the commodities are purchased for the Musharakah, therefore it does not lead to uncertainty in the profit at the time of distribution." (Badai-us-sanai v.6 p.63)

It is, therefore, clear from the above that even if the amount of the capital is not known at the time of Musharakah, the contract is valid. The only condition is that it should not lead to the uncertainty in the profit at the time of distribution. Distribution of profit on daily product basis fulfills this condition.

It is true that the concept of a running Musharakah where the partners at times draw some amounts and at other times inject new money and the profits are calculated on daily products basis is not found in the classical books of Islamic Fiqh. But merely this fact cannot render a new arrangement invalid in SHARIAh, so far as it does not violate any basic principle of Musharakah. In the proposed system, all the partners are treated at par. The profit of each partner is calculated on the basis of the period for which his money remained in the joint pool. There is no doubt in the fact that the aggregate profits accrued to the pool is generated by the joint utilization of different amounts contributed by the participants at different times. Therefore, if all of them agree with mutual consent to distribute the profits on daily products basis, there is no injunction of Shari'ah which makes it impermissible; rather, it is covered under the general guidelines given by the Holy Prophet in his famous hadith, as follows:

"Muslims are bound by their mutual agreements unless they hold a permissible thing as prohibited or a prohibited thing as permissible."

If distribution on daily products basis is not accepted, it will mean that no partner can draw any amount nor can he inject new amounts to the joint pool. Similarly, nobody will be able to subscribe to the joint pool except at the particular dates of the commencement of a new term. This arrangement is totally impracticable on the deposit side of the banks and financial institutions where the accounts are debited and credited by the depositors many times a day. The rejection of the concept of the daily products will compel them to wait for months before they deposit their surplus money in a profitable account. This will hinder the utilization of savings for development of industry and trade, and will keep the wheel of financial activities jammed for long periods. There is no other solution for this problem except to apply the method of daily products for the calculation of profits, and since there is no specific injunction of Shari'ah against it, there is no reason why this method should not be adopted.