MODES OF DEPLOYMENT OF FUND

BY ISLAMIC BANKS

PRESENTED BY:
VIVEKANANDA ROY (ID NO: 435)
FIRST EXECUTIVE OFFICER (FEO)
BOARD DIVISION, HEAD OFFICE
SBAC BANK LTD.

(GROUP: J; TOPIC COVERED: 1-3)

DEFINITION OF ISLAMIC BANKING
 An Islamic bank is a financial institution which operates with the objective to
implement and materialize the economic and financial principles of Islam in the arena
of banking.

 Bangladesh Bank Guidelines for Islamic Banking states “Islamic Bank” means
such a company or an Islamic Bank Branch(es) of a banking company licensed by
Bangladesh Bank, which follows the Islamic Shariah in all its principles and modes
of operations and avoids receiving and paying of interest at all levels.

 According to Organisation of Islamic Cooperation (OIC) “An Islamic Bank is a

financial institution whose status, rules and procedures expressly state its
commitment to the principle of Islamic Shariah and to the banning of the receipt of
interest on any of its operations”
PHILOSOPHY OF ISLAMIC BANKING
 Riba (Interest) Nasia and Riba Fadl are prohibited.
 Riba Nasia means interest on Loan, and Riba Fadl is the exchange of the
homogenous commodity but of unequal quality and quantity.
 Gharar (uncertainty/ambiguity) is prohibited.

 Maiser (Gambling) prohibited.

 Safqatayn Fi Safqah or Bay’atayn Fi Bay’ah (Combination of Two

Contracts)is prohibited.
 Non-permissible Goods/Services is prohibited.

 Injustice/Zulmis is prohibited.
 Conducting Shariah permissible businesses and services only.
SUPERIORITY OF ISLAMIC BANKING
Risk Sharing: No predetermined rate of return. Sharing the end result of the
business. Loss arising out of Mudaraba business is entirely borne by the Shahib-Al-
Maal.
 
Emphasis on Productivity, not on Credit Worthiness:

(i) Dominant consideration not on collateral.

(ii) Emphasis on soundness of the project.
 

Moral Dimension: Islamic value oriented system. Full compliance of Shariah. No

finance for wine/ tobacco/ casino/ pork production or trading.
 
Equity:

Justice to all parties.

Riba is unjust.
 

Allocation of Efficiency:
(i) Productivity of the project.
(ii) Finance goes to high productive project even if creditworthiness is lower.
 
 Stability of the Banking system: Mudaraba & Musharaka ensures stability.

 Growth: Promoting & emphasizing entrepreneurship development.

 Allocation of Efficiency:
(i) Productivity of the project.
(ii) Finance goes to high productive project even if creditworthiness is
lower.
 
 Stability of the Banking system: Mudaraba & Musharaka ensures stability.
 
COMPARISON BETWEEN
CONVENTIONAL & ISLAMIC BANKING
 The functions and operating modes of conventional banks are based on
manmade principles. On the other hand, The functions and operating modes of
Islamic banks are based on the principles of Islamic Shariah.

 The investor is assured of a predetermined rate of interest in conventional

banks. In contrast, Islamic banks promote risk sharing between provider of
capital (investor) and the user of funds (entrepreneur).

 Leading money and getting it back with interest is the fundamental function
of the conventional banks. Where as, participation in partnership business is
the fundamental function of the Islamic banks.

 Conventional Bank can charge additional money (compound rate of interest)

in case of defaulters. On the other hand, the Islamic banks have no provision to
charge any extra money from the defaulters.
 Conventional banks give greater emphasis on credit-worthiness of the
clients. Islamic banks, on the other hand, give greater emphasis on the
viability of the projects.

 The status of a conventional bank, in relation to its clients, is that of

creditor and debtors. The status of Islamic bank in relation to its clients is that
of partners, investors and trader.

 conventional bank does not deal with Zakat. In the modern Islamic banking
system, it has become one of the service-oriented functions of the Islamic
banks to collect and distribute Zakat.

 In conventional bank, bank’s own interest becomes prominent very often. It

makes no effort to ensure growth with equity. On contrary, Islamic bank gives
due importance to the public interest. Its ultimate aim is to ensure growth
with equity.
MODES OF DEPLOYMENT OF FUND
According to Fahmy & Sarkar "The systematic and detailed Shariah rules that
govern the contractual relationship of an investment activity that can be applied
for attracting money capital"

Exchange-based Contract (Bai)

Murabaha
Contractual buying & selling at a mark-up profit is called Murabaha. In
this case, the client requests the bank to purchase certain goods for him.
The Bank purchases the goods as per specification & requirement of the
client. The client receives the goods on payment of the price which
includes mark-up profit as per contract. Under this mode of investment,
the purchase/cost price & profit are to be disclosed separately.
It is a contract for purchase and resale and allows the customer to make
purchases without having to take out a loan and pay interest. The
customer pays the sale price for the goods over installments.
Example of Murabaha
Say a manufacturer wants to buy $100,000 worth of wood but doesn’t have
enough funds. The manufacturer approaches the bank and signs an agreement to
purchase the wood from the bank at cost ($100,000) plus profit (may be 20
percent of the contract amount, or $20,000).
The manufacturer is liable to pay the bank $120,000 after the bank delivers the
goods. Both parties know the profit and the cost of the product at the onset;
there’s no financial uncertainty in the transaction.

Salient Features of Murabaha

 Murabaha is a part of Muamalat

 Most of the Islamic Financing Contract is done in ‘Murabaha’ form globally.

 It is also exchange-based contract

 It may be known as trade-based transaction in Islamic Banking

 It is a Bai mode includes buying and selling
 It is based on concept of sale at cost plus profit
 It is used for financing, inter-bank placements and borrowings

It is the sale of commodities or goods (normally for a deferred price) which includes
an agreed profit added to cost.
 In case of Murabaha, cost and added profit must be disclosed separately

 If a person sells a commodity for a lump sum without disclosing the cost or the
profit, it would not be considered as Murabaha.
 It would be permitted if it is not exclusively prohibited.

Murabaha: Key Rules

 The subject matter should not be a prohibited goods/services/item;

 The subject matter of the sale must be existed at the time of contract;

 The subject matter should have value;

 Seller should have ownership on the subject matter at the time of contract;

 Seller should have physical or constructive possession on the subject

matter;
 Proper description of the subject matter, price and other transparent terms of
contract.
Salam
Salam means advance purchase. It is a mode of business under which the buyer
pays the price of the goods in advance on the condition that the goods would be
supplied / delivered at a particular future time. The seller supplies the goods
within the fixed time.
Bai-Salam is a sale whereby the seller undertakes to supply some specific
Commodity (ies)/ Product(s) to the buyer at a future time in exchange of an
advanced price fully paid on the spot. Here the price is paid in advance, but the
delivery of the goods is deferred.

Parallel Salam
In an arrangement of parallel salam, the bank enters into two different contracts.
In one of them, the bank is the buyer and in the second one the bank is the
seller. Each one of these contracts must be independent of the other. They
cannot be tied up in a manner that the rights and obligations of one contract are
dependent on the rights and obligations of the parallel contract. Each contract
should have its own force and its performance should not be contingent on the
other.
Example of Salam
Bank enters into a contract with “Ali” to purchase 500 Bags of Rice from him
with full prepayment now and the commodity to be delivered on June-30th, it is
‘Salam contract’
Bank then enters into another contract to sell that commodity to a Third-Party,
called “Company” on credit, which is called Parallel Salam.
After taking its delivery on the agreed date, Bank delivers it to “Company”. After
taking delivery from Bank, the “Company” signs a promissory note against
payment, on an agreed specified time.
 
Pillars of Bai' al-Salam
 Rabb-as-salam/ Musallim (The Buyer)

 Muslam Ilaihi (The Seller)

Ra’s al-Mal (The Price)

Al-Musallim Fih (The Product)

Sighah [Ijab (Offer) and Qabul (Acceptance)]
Istisna
The term Istisna is derived from the Arabic ward `Sana’ that means manufacturing. The word
Istisna means request to construct. Technically, Istisna refers to an agreement to sell to or buy
from a customer a nonexistent asset which is to be manufactured or built according to the ultimate
purchaser’s specifications and is to be delivered on a specified future date at a pre-determined
selling price. Here, the person giving the order is called Mustasni, the receiver of the order is
called Sani and the goods manufactured as per order is called Masnu.

Parallel Istisna
If it is not stipulated in the contract that the seller himself would produce/provide the goods or
services, then the seller can enter into another contract with third party for getting the goods or
services produced/ provided by the third party. Such a contract is called Parallel Istisna. This may
be treated as a sub-contract.

The subject matter of Istisna

The contract is valid only for those objects that have to be manufactured or constructed.
The subject of Istisna (the thing to be manufactured or constructed) must be known and specified

to the extent of removing any ignorance or lack of knowledge of its kind, type, quality and
quantity.

 
InIstisna the manufacturer arranges both the raw material and the labour.
An Istisna contract may be drawn for real estate developments.

Invalid subject matter:

It is invalid for natural things or products like animals, corn, fruit, etc.
It is not permissible that the subject matter of an Istisna contract be an existing
asset.

Example of Istisna & Parallel Istisna

Say for fictional customer Acme, Inc., approaches an Islamic Bank to
manufacture a housing scheme with specifications for $1 million. Then the bank
enters an agreement with ‘A’ Construction Company to build the houses with the
same specifications for $800,000.
When the construction project is complete, ‘A’ Construction Company hands
over the project to the bank, which verifies the specifications and delivers the
product to Acme, Inc., on the payment basis agreed to in that part of the istisna.
The bank goes for a parallel contract in this scenario because it can’t produce the
assets and doesn’t want to hold the produced assets after their completion. In a
parallel contract, the bank has both a buyer for its products and a manufacturer.
Tawarruq
Tawarruq means “to buy on credit and sell at spot value.” It is a financial
instrument in which a buyer purchases a commodity from a seller on a deferred
payment basis, and the buyer sells the same commodity to a third party on a spot
payment basis (meaning that payment is made on the spot). The buyer basically
borrows the cash needed to make the initial purchase.
It is an arrangement whereby a person, in need of liquidity, purchases a
commodity from a seller on credit at a higher price. The person who acquires
commodity in this way is called ‘Mutawarriq’. Below is the illustration:

.
Bai-al-Sarf
Bai-al-Sarf is a contract of exchange of money for money. This contract is tightly
regulated under Shariah because it can be easily manipulated for the purpose of
producing an interest-bearing loan, which is prohibited in Islam.
In respect of Bank, Bai-al-Sarf is a contract/agreement between the Bank and the
Client under which the Bank purchase the foreign currency against the foreign
documentary bill in advance from the Client at specified/agreed exchange rate.
“Bai-al-Sarf (FDB)” is practiced for providing post shipment finance facility against
Foreign Currency export Bills and “Bai-al-Sarf (FCD)” is done for providing advance
finance facility against Foreign Currency Cheque /Draft.

Features of Bai-al-Sarf
 This is a post-shipment finance mechanism under Bai mode.

 Bai-al-Sarf means ‘sale of price for price’ and each price is consideration of the
other. It also means sale of monetary value for monetary value i.e. currency
exchange.

 This is also known as purchase/sale of Foreign Currency to earn Exchange income

under the Bai-al-Sarf agreement.
 Usually exchange of one currency into another currency is dealt under Bai-al-
Sarf mode.

 The related foreign currency will be received by the bank as the client sold out
the same to the bank at agreed upon exchange rate.

Since no law in this regard is prevalent in Bangladesh to govern such Bai-al-Sarf

agreement, the relationship between the Client and the Bank shall be treated as
seller and buyer.

Incase of any dispute arising out of Bai-al-Sarf agreement or regarding the terms
and conditions of the agreement, the Banks decision shall be final and binding
upon the parties.

 In the event of the Client's failure to repatriate the export proceeds by any
consequence even for which the client is not responsible, the Client shall be liable
to pay back the amount paid to him in connection with the said documents with
Compensation/Fine/Penalty to the Bank.
EQUITY-BASED CONTRACT (SHARIKA)
Mudarabah
Mudarabah is a partnership of labor and capital, where one partner provides full
capital and the other one manages the business. The capital provider is called
Sahib-Al-Maal and the user of the capital is called Mudarib. As per shariah
principles, the Mudarib will conduct the business independently following
shariah principles. The Sahib-Al-Maal may provide advices, if he deems fit but
he can’t impose any decision over the Mudarib. Profit, if any, is divisible
between the Sahib-Al-Maal and the Mudarib at a predetermined ratio, while
loss, if any, is borne by the Sahib-Al-Maal.
Mudarib can not avail of any salary or remuneration against his labor as a
manager or conductor of the enterprise/business. The deposits, received by
Islamic banks under this principle are called Mudaraba Deposits. Here, the
depositors are called Sahib-Al-Maal and the bank is called Mudarib.
Example of Mudarabah Contract
Consider an example of a two-tier mudarabah contract in action. Two contracts must be executed:
One between the depositor as investor (rab-al-mal/ Sahib-Al-Maal) and the bank as a fund manager
(mudarib): The depositor signs a contract with the bank for a two-year shariah-compliant project.
The investor and the bank agree to share the profit in a 60:40 ratio (60 percent of profit goes to the
investor and 40 percent to the bank). The investment made by the depositor for this specific project
is $1 million.
One between the Islamic bank serving in the capacity of investor (rab-al-mal/ Sahib-Al-Maal) and
the project client as the working partner (mudarib): This contract indicates that the two parties will
share the profit on a basis of 70:30 (with the Islamic bank getting 70 percent and the client getting
30 percent). Assume that the client isn’t making any capital contribution but is instead investing
time, effort, and expertise in the project.
The project earns $1.5 million by the final contract date. The fund manager or entrepreneur gets 30
percent of the profit, or $150,000, based on the second contract. The bank recovers the capital of $1
million plus a $350,000 profit.
The $1 million principal is returned to the initial investor, along with 60 percent of the bank’s profit
from the second contract. ($350,000 x 60 percent equals $210,000.) The bank holds onto the
remaining 40 percent of $350,000, or $140,000. So the bank earns $140,000 for serving as
intermediary between the depositor and the entrepreneur.
Musharakah
Musharakah means partnership business. Every partner has to provide more
or less equity funds in this partnership business. Both the Bank and the
investment client reserve the right to share in the management of the
business. But the Bank may operate to permit the investment client to operate
the whole business. In practice, the investment client normally conducts the
business. The profit is divided between the bank and the investment client at
a predetermined ratio. Loss, if any, is to be borne by the bank and the
investment client according to capital ratio.
 
Important Features
 The investment client will normally run and manage the business.

 The bank shall take part in the policy and decision making as well as
overseeing (supervision and monitoring)the operation of the business of the
client. The bank may appoint suitable personnel(s) to run the business andto
maintain books of accounts of the business properly, and
 In case of loss it will be shared on the basis of capital ratio.

 
Diminishing Musharakah
Diminishing Musharakah is a form of partnership, which ends with the complete
ownership of a partner who purchases the share of another partner in that project by
a redeeming mechanism agreed between both of them. Diminishing Musharakah is
used mostly when one party who wants to own an asset or a commercial business
which does not have adequate funds to pay the full price; and takes the assistance of
financing from another party.
Types of Diminishing Musharakah

Diminishing
Musharakah

Shirkat-ul-Aqd Shirkat-ul-Milk
(Joint Venture) (Joint Ownership)
Example of Diminishing Musharakah
A’ wants to purchase a taxi to use it for offering transport services to passengers and to
earn income through fares recovered from them, but he is short of funds. So he goes to
an Islamic Bank that agrees to participate in the purchase of the taxi, therefore, both of
them purchase a taxi jointly in which 80% of the price is paid by the Bank and 20% is
paid by ‘A’, where the client promises to the financier that he will purchase an unit
after each three months. So the share of financier is further divided in eight equal
units, each unit representing 10% ownership accordingly. After the taxi is purchased, it
is employed to provide transport to the passengers whereby the net income of Tk.
1000/- is earned on daily basis. Since bank has 80% share in the taxi it is agreed that
80% of the fare will be given to the bank and the rest of 20% will be retained by ‘A’
who has a 20% share in the taxi. It means that Tk. 800/- is earned by the bank and Tk.
200/- by ‘A’ on daily basis. At the same time the share of Bank is further divided into
eight units. After three months ‘A’ purchases one unit from the share of the Bank.
Consequently the share of Bank is reduced to 70% and share of ‘A’ is increased to
30% meaning thereby that as from that date ‘A’ will be entitled to Tk. 300/- from the
daily income of the taxi and Bank will earn Tk. 700/-. This process will go on until the
expiry of two years. After the end of two years whole taxi will be owned by ‘A’ and
the Bank will take back it’s original investment along with income.
LEASE-BASED CONTRACT (IJARAH)

Ijarah
The mode under which any asset owned by the bank, by creation,
acquirement/or building-up is rented out is called Ijara or leasing. In this mode,
the leasee pays the Bank rents at a determined rate for using the
assets/properties and returns the same to the Bank at the expiry of the
agreement. The Bank retains absolute ownership of the assets/properties in such
a case. However, at the end of the leased period, the asset may be sold to the
client at an agreed price.
 
Ijarah Muntahia Bittamleek
Under this mode, the bank purchases vehicles, machineries and instruments,
building, apartment etc. and allow clients to use those on payment of fixed rents
in installments with the ultimate objective to sell the asset to the client at the
end of the rental period. The client acquires the ownership/ title of the assets/
properties subject to full payment/ adjustment of all the installments.
AGENCY-BASED CONTRACT (WAKALA)
 Wakalah refers to a contract where a party, as principal (muwakkil) authorizes
another party as his agent (wakil) to perform a particular task on matters that
may be delegated, with or without imposition of a fee.The inherent nature of
wakalah is the delegation of powers to, or authorization of, the agent by the
principal which gives rise to the agent having fiduciary duties (amanah) towards
the principal within what he has been authorized to do.
A wakalah contract shall be binding in any of the following situations: (a) the
wakalah contract involves rights of third party; (b) the wakalah contract involves
a fee (wakalah bi al-ujrah) to be paid to the agent; (c) the agent has commenced
the work that he has been authorized to do and discontinuance of the work
would cause the principal or the agent to suffer damages; or (d) the principal and
the agent have agreed not to terminate the wakalah contract within a specified
time.
OTHER MODES OF FINANCING
Hawala
Hawala (also spelled hawalah) is the transfer of debt from one party (the
transferor or in Arabic al-muheel) to another party (the payer or in Arabic al-
muhal alaihi). Hawala could also refer to the transfer of right where a creditor is
replaced with another creditor. The former form of hawala (debt transfer or in
Arabic hawalat-ul dayn) differs from the latter (right transfer or in Arabic hawalat-
ul haqq) in that in the former a debtor is replaced with another debtor, while the
latter involves the replacement of a creditor with another creditor. The contract of
hawala is not a contract of sale (ba’i), as it is used to facilitate payments and debt
recovery.

Trust (Amana/Wadiah)
The term wadiah literally means to keep, lodge, store or deposit. It means
something that is placed under the safe keeping & trust of a person who is not
owner of the item. The school of Hanafi defines it as ‘authorizing someone to
keep his wealth explicitly or implicitly’.
Wadiah amanah means keeping in trust. There is no compensation in case of loss/
damage. For instances banks if they lose the $ that is kept in the account by the
customer, they don’t have to pay compensation to them. There is no reward for
keeping the item in trust. There is also no right by the bank to use the property.
They cannot use the property or money that was given by the customer to the
bank for safekeeping.

Suretyship (Kifala)
Kafalah is an Arabic word for responsibility, amenability or suretyship. It often
refers to an act of someone adding himself to another person, and making himself
liable to perform the responsibility, together with the person.
According to Accounting and Auditing Organization for Islamic Financial
Institutions (AAOIFI) Shariah Standard No. 5, kafalah are guarantees that are
intended to secure obligations and protect amount of debts, either from being
uncollectible or from being in default.
Ibn Al-Qudamah defines kafalah as a conjoining of the guarantor’s liability to the
liability of the guaranteed. Thus, the debt would be established on both of them.
Direct Investment
Under this mode, the bank can under its full proprietorship conduct business by
directly investing in the industries, trading, transports etc. In these cases, the
profit/loss fully goes to the bank.

Investment Auctioning
Selling by auction of those assets/goods acquired by the bank through direct
investment is called Investment auctioning. Generally, the bank establishes
industrial units by direct investment, makes the same operationally profitable and
then sells out on auction. This mode of investment is very helpful for
industrialization of the country.

Quard
It is a mode to provide financial assistance/ loan with the stipulation to return the
principal amount in the future without any increase thereon.
Quard Hassan
This is a benevolent loan that obliges a borrower to repay the lender the principal
amount borrowed on maturity. The borrower, however, has the discretion to
reward the lender for his loan by paying any amount over and above the amount
of the principal provided there will be no reference (explicit or implicit) in this
regard.
If a bank provides its client any loan, it can receive actual expenditure relating to
the loan as service charge only once. It can not charge annually at a percentage
rate.

Sukuk
The latest development of the Islamic economic product is sukuk which is a
instrument of capital market. Sukuk is the Arabic name for financial certificates,
but commonly referred to as Shariah compliant bonds. Sukuk, in its simplest
definition are similar to a bond in conventional finance but must comply with the
Islamic religious law, Shariah.
Sukuk are defined by AAOIFI (Accounting and Auditing Organization for Islamic
Financial Institutions) as-securities of equal denomination representing individual
ownership interests in a portfolio of eligible existing or future assets.
PROSPECTS OF ISLAMIC BANKING IN BANGLADESH
Like other Muslim countries Islamic Banking has been growing fast in
Bangladesh. So it has tremendous prospects in future. Islamic bank’s prospects are
enumerated below:
 Presently, in Bangladesh almost half of the banks are being operated with a
belief in Shariah. The growth shows that the entire banking sector may come under
the umbrella of Shariah Banking in near future.
 Allah has forbidden Interest. Allah has permitted trading and forbidden “Riba”
(usury) (Surat Al Baqarah,Verse 275). A Muslim can not deals in Interest if he
believes in Qur‘an. In Bangladesh 90% people are Muslim. So there is a good
prospect of Islamic Banking in Bangladesh.
 Islamic Banks do business on the basis of profit and loss, which other banks can
not do. The Musharaka and Mudaraba are the unique modes of Investment of
Islamic Banks which are operated on the basis of profit and loss.
 As the Islamic Banks use their funds in asset-backed investment operations, it
can help to reduce the inflation in the economy.
Islamic Bank allows Quard Hasana investment without profit in emergency cases
and to the less fortunate people, which helps to eradicate poverty of the society.
CONCLUSION
The Islamic banking sector of Bangladesh, due to popular support and market
demand continued to grow at a rapid pace which is reflected by the increasing
branch network of Islamic Banking Institutions. Islamic Banking Industry in
Bangladesh has been highly contributing to spur economic growth and generate
employment in the country to fulfill the vision of the government to reach the
country at Middle Income Level. Thereby, this banking industry with more than
20% market share have been playing a very dominant role in mobilizing deposits
and financing in the real sector industries, services and other key sectors of the
economy and collecting about a one third portion of total foreign remittances in
Bangladesh. At present more than 40% of existing commercial Banks are
directly involved with running their shariah based banking. As the growth of
Islamic banks in Bangladesh is increasing fast, there is a possibility to lead the
Islamic banking sector in the globe by the Islamic banking of Bangladesh in near
future. So the Government of Bangladesh should pay more attention to develop
the Islamic Banking sector of Bangladesh.