Profit on Mudaraba deposit in Islamic banking

Although the functions of a modern bank are expanded manifold with the dynamic progress of state-of-the-art technology, the core functions still remain as collecting and providing of fund. Conventionally these are conducted by a bank as borrower and lender of money. The vehicles of these two major functions are liability or deposit products, and asset or investment (loan) products. Let us now look at the liability product or the deposit product, and then gradually concentrate on a specific type of deposit. This is the deposit collected on Mudaraba (profit sharing) principle, obviously under Islamic banking operations. Final concentration would be on the mechanism to provide profit on such Mudaraba deposit. In principle it is 'interest' element of conventional banking system which necessitated the architecture of Islamic banking as a separate discipline. So Islamic banking, among other criteria, is to be saved and save others from interest. Collection of Mudaraba deposits by Islamic banks is designed to provide the depositors with profit, the permissible return instead of interest, the prohibited return in the eye of Shariah or Islamic jurisprudence. Mudaraba means an arrangement in which a party participates in a venture as provider of fund and another as manager of fund. In Mudaraba accounts, the party providing the fund i.e. the depositor is termed as Rabb-ul-Mal or Saheb-al-Mal (owner of the fund) and the bank as the Mudarib (manager of the fund). As Mudarib, the bank arranges proper deployment of the fund. Hand in hand with the expectation to share profit, Mudaraba in one hand implies that the depositor as Rabb-ul-Mal is to bear the commercial risk associated with the deployment of fund. On the other hand, it also implies that Islamic banks as Mudarib is under fiduciary obligation (of trust) to safeguard the interest of the depositors. Trading off between the two is the excellence of Mudaraba principle. Under mudaraba system, the distributable income i.e. investment income net off declared provisions, resulting from deployment investment of the Mudaraba fund is distributed between the bank and the depositor. The distribution of that income is made according to respective agreed sharing ratios (with different types of Mudaraba depositors) or a standard declared profit sharing ratio (PSR) with respective agreed Weightages. Loss, if any, not resulting from the negligence of the bank or any of its representatives, is to be borne by the depositor. Mudaraba deposit is one of the major sources of fund for Islamic banks and as usual, only the Mudaraba depositors are entitled to share return derived from deployment of an Islamic bank's collected fund. Among the provisions or stipulations to calculate profit on such deposits, variations are observed to a great extent among the Islamic banking operators. Such variety includes calculation of profit on deposit on 'daily balance' or 'minimum monthly balance'. Sometimes withdrawal restrictions are set allowing no profit for violations thereof. Stipulation of notice to withdraw any amount, an amount exceeding a specific limit or drawing at more than the stipulated frequency for any specific period of time etc are also observed among the different operators. Question may arise regarding choosing the Mudaraba deposit for discussion and again with special emphasis on the rate of profit on such deposit. This has become of pivotal importance because the rate of profit on Mudaraba deposit works as the pulse of Islamic banking. Such profit rate is the visible indicator of Islamic banking in the sense that operation of asset products of Islamic banking cannot, in most of the cases, transparently demonstrate the distinction between Islamic banking and the conventional one. Reasons are there, which make it difficult for an Islamic bank to transparently demonstrate its distinction. Interest, in conventional banking is expressed in terms of a fixed rate. Some Islamic banking investment products are also based on fixed return (although variable return based products are also available). Such a fixed rate-based asset product of Islamic banking triggers confusion among the stakeholders and as such the question of alikeness of 'profit and interest' is raised by different quarters. But unlike a fixed return based product, Mudaraba or profit sharing method, by virtue of yielding variable return, finds its way to transparently show the difference and the inherent beauty of Islamic banking. This very feature of variable return is transparently opposed to the predetermined fixed rate base of interest in conventional banking. There is no fixed return based deposit product till date in Islamic banking industry of the country. And as far as a product is a Mudaraba based one, return thereon (rate of profit on deposits, in this case) must not be fixed or predetermined. The rate must be variable, obviously a dependent variable. Usually it needs to vary in the same direction of corresponding income from deployment of the concerned fund. This is because of positive correlation between the two, profit on Mudaraba deposit and the investment income. Expressing from another point of view, profit on deposit is the Bank's cost of deposit. The higher profit on deposit would similarly mean higher cost of deposit and vice versa. So to find the cost of deposit under Mudaraba contract, it needs a second tier calculation after arriving at the first tier result. That is, bank's total income or revenue derived from investment (i.e. deployment of the concerned deposit) has to be worked out first, to finally arrive at the emerged rate of profit for the fund provider (and the bank's share as well). Thus in Islamic banking, the cost of Mudaraba deposit, represented by the profit paid on such deposit should be very transparently demonstrated as a function of investment income. The function, therefore, gets the shape of the equation DC = f(IR) where, DC = Cost of Mudaraba Deposit, f = Function of (dependent on), IR = Revenue from Investment. The sole characteristic of cost of Mudaraba deposit being the function of investment income can be treated as an 'Acid-test' for judging authenticity of Islamic banking. Therefore, it is the excellence of performance of the bank which can produce better profit for the Mudaraba depositors and it is never unrelated predetermined rate, be it in the name of provisional profit or whatever name by which one likes to call it. The writer is Head of Islamic Banking of Bank Asia Limited. He can be reached at email: afzal@bankasia.com.bd Opinions expressed in the article are exclusively of the writer's own and not necessarily of the organisation he is serving