Provisional profit rate in Islamic banking

Md Gias Uddin Ahammed Conventional banks offer different fixed interest rates on different types of interest-bearing deposits. Islamic banks, on the other hand, provide depositors with provisional profit rate on different types of profits bearing Mudaraba deposit. Provisional profit rate is nothing but an approximate rate estimated by the management of the bank-bearing in mind previous year's final rate of profit, bank's intention which definitely depends on money market scenario to increase profit-sharing ratio (PSR) to depositors, regulatory decision as well as projected performance of the bank in investment portfolio. Bank can change provisional profit rate at any time. Question may arise as to why an Islamic bank has to offer provisional profit rate having pre-fixed profit sharing ratio in a Mudaraba agreement. The simple answer is that as Mudaraba principle does not permit any pre-fixed rate or lump sum amount on any Mudaraba deposit, an Islamic bank has to declare and subsequently pay some profit on a conditional basis to deal with inevitable circumstances of modern banking. Islamic banks, like conventional ones, collect two types of deposits. Nonprofit-bearing deposit is collected under Al-Wadeeah principle and profit bearing-deposit is collected under Mudaraba principle. Under the principle of Mudaraba in which the bank plays the role of entrepreneur fund manager (Mudarib) and the depositor as fund provider (SahibRabb ul Maal), profit accrued from investment and financing of Mudaraba fund is shared between the Mudaraba depositors and the bank as per some agreed upon ratio. Losses, if any, will be borne by the depositors unless the loss is due to the negligence by the bank in managing the depositors' money. For this reason, Islamic banks cannot offer different fixed interest rates for different types of profit-bearing deposits. They, instead, declare PSR to Mudaraba deposits (let us say, a minimum 65 per cent of investment income earned through deployment of Mudaraba Fund) as well as different weightages for continuous Mudaraba deposits of different tenure (period), before the start of accounting year at the time of Mudaraba contract, i.e. account opening. But the general people are rarely concerned about PSR and weightages. They are concerned about final rate of return. So they always ask bank officials about previous year's final rate of profit or probable final rate of profit for the present year. The bank provides information to depositors who are interested to know probable profit rate with provisional profit rate. Some Mudaraba contracts such as Mudaraba Term Deposit Account (MTDA), Mudaraba Hajj Saving Account (MHSA) etc., are for some specific period of time, and MSA and MSND are for an unlimited period of time. But any party to the contract may decide to terminate the contract at any time. In this case, profit is paid on condition that any difference between the profits paid and the final profit arrived will be adjusted after declaration of final profit rate. In case of closure of any account, bank agrees to give up its share if the final rate is less than provisional rate. It is assumed that an Islamic bank, being an entity, will continue its activities in the future, including its investment operations. But the relationship between the bank (Mudarib) and the depositors (Rabb ul Maal) may not continue until the liquidation of investments, when their actual results become known. It may, therefore, be appropriate to measure investments during the life of such investments at their cash-equivalent values in order to achieve equity in determining the right of the depositors who wish to withdraw their funds before the actual liquidation of investments. Again, the periodicity concept allows an entity (Islamic bank) to break its life into reporting periods to prepare financial report, reflecting its financial position, as of a given date, and the result of its operation during the specific period so that rights and obligations of an Islamic bank and those of the interested parties could be focused. In Bangladesh, the length of a financial period for making audited and final report is one year. So the calculation of final rate of profits as per agreed upon PSR and respective weightage, requires at least, one year. Profit, related to any transaction in between a period (profit paid on MTR-3, 6, 9 months) has no option other than remaining provisional. Moreover, a bank needs a provisional profit rate to estimate its expenditure on deposits and take necessary action accordingly. Although Rabb ul Maal is bound to bear genuine losses in a Mudaraba business, it does not necessarily mean that he should not expect any profit. Rather he, expecting business success, may request Mudarib (bank) to pay some monthly profit on condition that bank can adjust the amount paid out as profit with the final profit or his capital (if loss). As such, some products such as Mudaraba Monthly Profit Deposit Scheme (MMPDS) are designed. However, there are some rhetoric, arguments and criticism about provisional profit rate. Some critics suggest it as a guaranteed rate; some accuse Islamic banks of declaring provisional rate as the final rate of profit. Increasing or decreasing provisional rate, on the basis of liquidity position of the bank, is also questioned. It is simply illogical and unfair to deem provisional rate as a guaranteed rate as long as some condition applies or exists. For, profit already paid out, is finally adjusted with final rate of profit. It means Mudaraba Acs are not closed before declaration of a final rate of profit always, if actual profits are earned. Islamic banks are not supposed to and required to declare provisional rate as the final rate of profit since provisional profit out is paid on condition that any difference between the profit paid-out and the final profit calculated, will be adjusted. Nothing is wrong with a bank if it is able to arrive at, by paying minimum 65 per cent (estimating correctly) or more than 65 per cent (sacrificing its share) distributable profit as per Mudaraba contract, a final profit rate identical to the rate it paid as the provisional profit. Unnecessarily varying final rate from that of provisional rate is not required to authenticate it. It may be mentioned here that Islamic banking is a part of 'Muamalaat' (daily-life activities). All actions of 'Muamalaat' are 'mubaah' (permissible) unless there is specific proof in the holy Quran andor Sunnah to make it 'haraam', 'makrooh', 'mustahab' or 'fard' whereas all actions of 'Ibadah' (ritual acts of worship) are 'haraam' unless there is specific proof in the holy Quran andor Sunnah to legalise it. Liquidity is negatively correlated to profitability. So liquidity management becomes one of the crucial tasks for any bank especially for Islamic banks, having no Islamic money market. Again, an Islamic bank has to maintain certain percent of cash reserve ratio (CRR) and statutory liquidity requirements (SLR). To help address any liquidity problem, the bank may increase provisional profit rate and subsequently give up its profit share in order to attract new depositors for the time being or retain existing depositors who (let us, non-Muslim) prefer Islamic banking not for its being Sha'ria-based but for its better rate of return. As noted earlier, provisional profit is not applicable for the depositors who keep their fund for the full financial period. One system should not be accused of being misused or abused. Instead, those who misuse or abuse it should share the blame for it. As Prophet Muhammad (PBUH) has said, "The deeds are only upon the intentions and every person has only what he has intended for." [The writer is a Senior Officer, Sonali Bank Limited, Marketing and Development Division, (Islamic Banking Department), Head Office, Dhaka. The views expressed in this write-up are his own and not necessarily of the organisation he is working for. He may be reached at e -mail: gias49@ovi.com]