ISLAMIC FINANCE LESSON TWO
Prohibition of interest rates in light of ahadith
Interest (riba) is disallowed and admonished:
Prophet Muhammad has cursed the receiver of interest (riba), the payer of interest (riba), the
witness, and the recorder of riba
Evil of interest (riba) has seventy degrees, it is as severe as committing adultery with your
mother.
Impermissibility of riba prevents actual economic activity- If one were allowed the option to
earn a profit by simply lending, why would that person want to bear the risk of investing in
actual economic activities? This, in turn, affects the economic welfare of the society.
N.B. The element of riba is present in conventional banking, hence the need for Islamic banking.
Main differences between Islamic Banking and Conventional Banking
Deposit side
Islamic banks accept deposits based on a non-interest-based loan (Qard). Savings and term
deposits are accepted based on Mudarabah, which are invested in Sharia-compliant
business/activity or profit and loss sharing.
Asset side
Islamic banks provide financing facilities to customers through Sharia-compliant
models/products that include Murabahah, salam, Istisna, and Diminishing Murahaba.
Basis of Deposit in Banking
Qard-loan
In transactions in which a thing of value (often money) is given by a lender to a borrower for
their use, the loan is repaid by the borrower on demand by the lender. It is permissible in Sharia
to give a loan, however, it is not allowed any additional gain/benefit, and it is tantamount to
interest (riba), which is haram.
In Islamic banks, current accounts are generally opened on a loan (qard) basis as the purpose of
such accounts is not to earn profit but to keep the funds secure and guaranteed. As customers do
not assume any risk on such funds, they are not entitled to earn any profit on them. In line with
Sharia requirements pertaining to loan (qard), the bank ensures that customers receive the
deposited amounts on demand.
Mudarabah
Partnership in which one partner invests funds while the other manages the work, the profit
earned is distributed between them as per the pre-agreed sharing ratio. The investing partner and
managing/working partner known as Rabb-ul-Maal and Mudarib, respectively.
In savings and term deposits an Islamic Bank works in the capacity of a Working Partner (
Mudarib ) whereas the depositor are investing partners (Raab –al-Maal). After receiving the
deposits on Mudarahab basis, the Islamic banks invest them across various Sharia complaint
avenues e.g rental, commercial partnerships, trading, investment e.t.c to earn profit.
Rules of Mudarabah
1. The partners must agree on the profit-sharing ratio at the time of entering Mudarabah.
2. The Investing Partner (Raab-Ul-Maal) and Working partner Mudarib cannot pre-agree
on a fixed amount.
3. The profit amount cannot be linked to the investment amount, e.g, it is impermissible to
assume that the profit received will be 10% of Kshs.100,000 (capital invested).
4. In case of a loss, the investing partner (Raab-Ul Maal) will bear it completely, while the
working partner (mudarib) will not earn a profit for the services rendered. ( However, if
the loss incurred is due to negligence of the working partner Mudarib, it will be borne by
the working partner Mudarib
Mudarabah with Bank deposits
In Mudarabah with an Islamic bank, normally, one works and investing in Mudarabah, all
the depositors of say term deposits are collectively investing partners, Baab-Ul-Maal. And
the Islamic Bank is the working partner (Madarib). Records keeping of all the investors
(considering) they can invest and withdraw frequently), and a subsequent profit and loss
distribution separately with each depositor, is a strenuous activity. To make it easier and
practical, a mechanism has been designed with the guidance of Sharia scholars.
Procedure of Mudarabah in Islamic banking
The duration is set as one month with renewal at the end of the month. At least three working
days prior to the start of every month, profit sharing between the depositor and as well as
weightages between the deposit pool are decided and announced. The profit-sharing ratio and
weightages are published on the banks' websites and noticeboards of the branches.
A national pool of funds is formed through deposits, and weightages are used to differentiate
between the depositors based on differences in amount and tenure. Every end month, the
profit from banking operations is divided between the pool and the bank as per the pre-
agreed profit sharing ratio. After this, the profit earned by the pool is distributed to the bank
amongst depositors on a weighted average monthly balance basis. An expected rate of profit
can be quoted on deposits received under Mudarabah, i.e, remunerative deposits, but this
profit cannot be guaranteed. The profit is distributed as per the pre-agreed profit-sharing ratio
and weightages. At the end of the Mudarabah term, if the bank makes a profit, each party is
entitled to a share as per the pre-agreed profit-sharing ratio and weightages
