CIFP Part 2

Shariah issues in Islamic finance

Shariah issues in deposit (banking)

Dr. Ahcene Lahsasna

INCEIF, Kuala Lumpur
hasan@inceif.org

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 Issues in Deposit (banking)

• Wadiah (saving account)

• Qard Hasan

• Mudarabah (investment account)

• Fixed Deposit (Tawarruq deposit, or commodity murabaha

deposit)
 Issues in Wadiah
• The jurists collectively maintain that the custodian is not liable for
compensation or damages in the event of loss or damage to the
deposit unless the damages happened as a result of negligence.

• The views of the scholars regarding this issue can be noted in the
following different possibilities:

• 1. Utilising the Deposit

• All the jurists unanimously agree that the custodian is not allowed
to use the deposit without the prior consent from the depositor.

• The custodian is also obliged to guarantee the deposit if he

utilises it for any purpose, be it for trading or other activities.

• This rule is applicable in both situations whether the consent of

the depositor has been obtained or not.
 Cont.
• The scholars differ in their rulings regarding profit gained from
the trading activities.
– Malik, al-Layth and Abu Yusuf maintained that if the custodian returns
the deposit in full, he is entitled for the profit, though he is both an
usurper and a custodian.
– Abu Hanifah, Zufar and Muhammad maintained that the custodian has
to pay back the principal and give away the profit as charity.
– A group says that both the principal and the profit belong to the owner
of the deposit, that is, depositor.
– Since wadiah is supposed to be a safekeeping contract and not an
investment tool, the custodian must be able to gurantee the capital to
the depositor at any point in time when the depositor needs the
deposit.
– Unless the custodian can guarantee the capital, he is not allowed to
utilise the deposit for any trading activities.
– In the current banking system, the bank will usually have enough
liquidity to return the capital to the depositor at any point in time.
– The depositor shall give the consent to the institution to utilise the
fund and the institution can give a portion of the earned profit to the
depositor as gift (hibah) which is given at the sole discretion of the
bank .
 Cont.
• 2. Travelling with the Deposit
• The jurists differ regarding the custodian’s right to travel with the
deposit and the resulting rulings if he does as follows:

• A. Abu Hanifah held the view that a custodian has the right to
travel with the deposit, provided that the depositor did not
explicitly forbid him from doing so.
• he ruled that the wadiah contract is unrestricted by any
geographic area unless such a restriction is explicitly stipulated in
the contract.
• Therefore, if the custodian travels with the deposit and it results in
any loss or damages, he is not liable for compensation.

• B. Malikis stipulated that a custodian has no right to travel with a

deposit, unless the deposit was given to him during a journey.
• They ruled that under normal circumstances, the custodian must
keep the deposit in the same place where it was handled.
 Cont.
• The custodian is allowed to re-deposit it with a trustworthy person
in the same area if he embarks on a journey.
• On such occasions, the custodian is not liable if the deposit is lost
or damaged.

• C. Shafi‘is and Hanbalis also stipulated that a custodian is not

allowed to travel with a deposit.
• In case the custodian needs to travel, he has to return the deposit
either to the depositor, his legal agent or legal authorities.
• They argued that the custodian holds the deposit as a voluntary
uncompensated act, therefore he is not bound to keep it.
• However, if the custodian is to travel with the deposit, then he will
be liable for compensation in case of loss or damage.

• Travelling with the deposit is prohibited in the view of the majority

of jurists.
 Cont.
• In modern day transactions, the actual cash deposited by the
customer in the bank is always subjected to being used or
transported from one place to another or from one institution to
another.

• Such a move is allowed as long as the bank has taken all the
necessary steps to ensure the safety of the deposit and it can be
handed over to the depositor upon request.
 Cont.
• 3. Entrusting Deposits to a Third Party
• The custodian does not have the right to entrust the deposit to a
third party without any valid reason.

• Abu Hanifah and Malik, there is no objection to placing the

deposit with immediate families of the custodian as this will
facilitate the safekeeping.

• if the deposit is lost or damaged, the custodian is not liable for any
compensation.

• In contemporary practice, if the deposit is given to an individual

for safekeeping, they will usually prefer to keep it in a safe place
such as a financial institution.
 Cont.
• In this case, there shall be no restriction on the individual to keep
the asset or deposit it with the institution as long as the safety of
the deposit is assured.

• Similarly if the asset is kept by a financial institution (bank) in the

wadiah account, the bank shall have the freedom to allow other
institutions or agencies to keep the money as long as the bank can
guarantee the return of the deposit on the request of the
depositor.
 Cont.
• 4. Mixing Deposits with Other Properties
• The custodian is obliged to ensure that the deposit is separated
from his own asset to avoid any disputes.

• The jurists are in agreement that in a situation where the custodian

can easily identify and separate the mixed property from his own,
there is no liability due on him as he shall be able to return the
deposit to the depositor upon request.

• Abu Hanifah maintained that such an act is considered as

negligence on the part of the custodian. Therefore, the custodian is
responsible to return the deposit or the equivalent value.

• In present day transactions, at institutional level, the issue of

identification does not arise particularly in dealing with cash
deposit. The depositors account is separated from others and the
question of mixing does not arise.
 Cont.
• 5. Violating Depositor Conditions
• This is a situation where a depositor makes it a condition that the
custodian holds the deposit in a specific place or in a specific
manner, but the custodian breaches this condition.

• In such a situation, most jurists agreed that the custodian is liable

in case of loss, or damage if he had placed the deposit in a place
which is less secured than the place requested by the depositor.
 Mudarabah as an investment account
• Mudharabah is a principle most commonly used in
Islamic finance and banking.

• The principle suggests that a person that has capital will

give his capital to another person that he trusts to run a
business venture.

• He will not interfere with the business but rather give the
partner the independence to run it.

• In return, the partner will return back the amount of

capital that he borrowed plus a share of the profit at the
end of the business period. 12
 Cont.
• In the context of deposit, the depositor provides capital
to an Islamic bank to run banking operations.

• For the deposit mobilization, the depositor is entitled to a

share of the profits agreed by the depositor and the
bank.

• The share can be a third or a half of the profits depending

on prior agreement between the depositor and the bank.

• This agreement is set at the beginning of the contract.

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 Cont.
• The bank does not guarantee the depositor that the
business must be profitable although the bank will
conduct the investment on best efforts basis to ensure it
is profitable.

• in the event of a business failure, the depositor will bear

the losses.

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 Promising Fixed Returns in Mudarabah/Wadiah Contracts
• This is related to Islamic deposit accounts based on either
mudarabah or wadiah account.

• Conventionally, all deposit accounts other than the current account

have a fixed return which is promised upfront by the bank.

• This fixed return is interest payable to depositors or account

holders.

• Islamic depositors are equally interested in receiving some return

from their deposits.

• The issue arises whether IFIs can promise any kind of fixed return
to their depositors in both mudarabah and wadiah contracts. 15
 Mudarabah
– For mudarabah any promised return to this account is not acceptable.
– This is the basic feature of mudarabah contract which imposes on the capital
provider to take the risk of the loss of capital.

– Neither the capital nor the profit can be guaranteed.

– In all mudarabah-based accounts, any stipulation of any fixed return will

render the contract null and void.

– The IFIs may publish the historical rate of return or may publish an estimated
rate of return for respective maturity period of mudarabah-based account.

– This quoted estimated profit is not a liability on the IFIs.

– Any promotional gift can be advertised to the public for them to open a
mudarabah account as this is not deemed as interest because the bank is
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not a borrower under mudarabah contract.
 Wadiah
– The same prohibition of promising fixed returns applies to wadiah-based a
account.

– Wadiah involving money has been deemed as qard by the Muslim scholars.

– The depositor under wadiah contract is deemed as the lender and the
custodian which is the bank is deemed as the borrower.

– Under this description, the borrower/custodian that is the bank, is not in the
position to stipulate or promise any fixed returns to wadiah account
depositors.

– This is a clear-cut prohibition for wadiah contract.

– Unlike mudarabah contract, any promotional gifts to open a wadiah-based

account is not allowed to be advertised.

– Any advertisement leading to giving away some gift, either in terms of cash
or kind is not permissible for this account.
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 How these accounts operate to reward the depositors?
• Depositors under mudarabah-based accounts will share the profit
with the bank on agreed profit sharing ratio.

• As for wadiah-based accounts, the IFIs have absolute discretion to

reward the depositors either in cash or in kind.

• this cannot be published or advertised to avoid the prohibition of

riba in wadiah-based contract.

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 Profit Equalisation Reserve: PER
• The relevant issue is whether the ‘extra’ profit paid under Profit
Equalisation Reserve (PER) will be tantamount to a fixed return or
not.

• This profit is paid from PER to smoothen the payment of profit at

the rate which is competitive to the rate in the market particularly
the rate of interest paid for conventional accounts.

• This cannot be deemed as interest as the extra profit is taken from

the reserve account and not paid by the bank.

• What is prohibited from the Shariah perspective is any promised

fixed return which is paid by the bank using their shareholders
fund.

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 Cont.
• The PER is an account which is created to maintain a good and
competitive rate of return to Islamic depositors.

• any conditions or modes of profit allocation in any investment

contract which include any clause or condition that may result in
the probable violation of the principle of sharing profit will not be
acceptable.

• Any condition, term or mode of profit allocation with such an

effect would render a partnership contract void.

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 Indicative Rate in Islamic Banking
• The indicative rate uses profit rate declared by every Islamic
banking institution.

• In mudharabah contract, the actual profits distributed will only be

known after the contract has matured based on an pre-agreed
profit-sharing ratio.

• In the context of Islamic banking in Malaysia, generally, most of

the investment portfolios are in the form of fixed return such as
financing based of bai` bithaman ajil concept.

• Hence, the bank could determine from the very beginning the
expected returns for a certain period.

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 Cont.
• Therefore, for an investor invests his money for certain period of
time, the profit distribution (according to an agreed profit sharing
ratio) should appropriately be made according to the bank’s
expected profit.

• A proposal was made that the profit rate to be given to investors

may be determined at the time when the contract is executed if
the expected profit rate is known based on the asset portfolios
held.

• The issue raised here is whether it is permissible in Shariah to

indicate profit rate in mudharabah contract.

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 Cont.
• Resolution
• The Council in its 9th meeting held on 25th February 1999/8th
Zulkaedah 1419 resolved that the application of indicative profit
in Islamic banking mudharabah contract is permissible based on
the following conditions:

– (i) The Islamic banking indicative profit rate is only regarded as an

reference of the expected return that will be received; and
– (ii) If the actual profit rate received by Islamic banking at the time the
contract

• matured is different from the indicative profit rate agreed at the

inception of the contract, the profit rate paid to investor must be
based on the actual profit rate.

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 Qard Hasan contract as an account
• Qard Hasan is used to replaced the wadiah contract due to its
flexibility.

• In addition to that most of the issues in wadia contract are not

present in Qard hasan contract.

• However the issue of Qard Hasan is related to the hibah extended

by the bank. Whether it is permissible or not?

• Hibah for Loan Contract (Qardh)

• Qard contract is one of the contracts used to manage liquidity in
Islamic finance.
• The contract obliges a borrower to return the loan amount to the
lender without contracting to pay any additional return.
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 Cont.
• However, in normal practice a borrower sometimes give hibah at
his own discretion when paying off the debts.
• The issue is whether the practice of giving hibah complies with
Shariah.

• Resolution
• The Council in its 55th meeting held on 29th December 2005/ 27th
Zulkaedah 1426 resolved that the practice of giving unconditional
hibah in a loan contract is permissible.
• Nevertheless, the Council advised that such practice should be
implemented wisely so as to avoid it becoming a norm (`urf) which
can make it a condition attached to the loan contract

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 Rights of Investment Account Holders (IAH)
• IFSB stipulated a very clear principle that govern
Mudarabah account.

• This is known under the right of investment account holders

(IAH). Under the corporate governance standards.

– Principle 2.1: IIFS shall acknowledge IAHs’ right to monitor the

performance of their investments and the associated risks, and
put into place adequate means to ensure that these rights are
observed and exercised.

• IIFS should acknowledge IAH’s right to access all relevant

information in relation to their investment.
 Cont.
• The IAHs’ right to monitor the performance of their investment
should not be misconstrued as a right to intervene in the
management of the investments by the IIFS.

• The Guiding Principles require that IIFS shall have an internal

guideline that sets out:

• the eligibility of the IIFS employees who are responsible for

managing investment accounts operated by the IIFS;

• the adequate protection of the IAH investments.

• the disclosure of relevant and material information to the IAH; and

 Cont.
• a proper and disclosed basis for profit allocation and investment
policies to be based on the risk expectations of the IAH.

• IIFS shall inform the IAH from the outset when opening their
investment accounts that in accordance with the principle of
Mudarabah:

• the IIFS shall be liable for losses arising from their negligence,
misconduct or breach of their investment mandate; and

• The nature of the relationship with IAH has implications on profit

sharing basis and risk exposures.
 The investment in mudarabah account
• IFSB stipulated the following principle:
– Principle 2.2: IIFS shall adopt a sound investment strategy which
is appropriately aligned to the risk and return expectations of IAH
(bearing in mind the distinction between restricted and
unrestricted IAH), and be transparent in smoothing any returns.

• IIFS is to implement an investment strategy which is aligned to the

risk and return expectations of the IAH as mutually agreed in the
investment account contracts between the IAH and the IIFS.

• They should take into account the consideration of any restrictions

that may be imposed by the IAH.
 Islamic FD (Murabahah)

IFD is Special offer provided by some IFI for short term

tenures of 3 months.

Customer will be awarded with higher rate of return.

For the 3 months tenure plus a rollover of another 3

months.
 Islamic Fixed Deposit-i (Murabahah concept)

Features Description

Shariah Concept Murabahah (Cost plus sale)

Eligibility Individual (18 yrs & above) & Non-Individual

Initial Deposit 1 mth – RM5,000

2 mths up to 60 mths – RM1,000

Profit Rate Fixed Rate determined upon placement

 FD (ISLAMIC)
Commodity Murabahah Modus Operandi & Process Flow

1 CUSTOMER

3
Commodity Deferred

Bank acting as Commodity

2 agent Spot Price + Customer then
profit $ sells the
commodity to the
Bank on deferred
Spot payment.
Customer Commodity
Price $
appoints the
Bank as his Bank as principal
agent to buy
commodity from 4
Commodity
Commodity Trader 1
Trader 1 on The Bank sells the
Spot
cash basis. Commodity commodity to
Price $
Commodity Trader
2 for cash.

Commodity
Trader 2
 Cont.
The Murabahah purchase & sale transactions of an identified
commodity will be performed by IFI with the commodity brokers.
Steps Action
1 Customer approaches the Bank to place his money under a
term deposit account for a specific tenure.
2 Customer appoints the Bank as his agent to buy a
commodity from Commodity Trader 1 on cash basis.
3 Upon payment of the commodity price (which is equivalent
to the deposit amount) to the Bank, the Bank undertakes to
purchase the commodity from the customer under
Murabahah contract on deferred payment basis.
3 The customer then sells the commodity to the Bank at an
agreed sale price on deferred payment basis.
4 The sale price comprises of :-
a) The deposit amount.
b) The Profit (return) on the deposits
4 The Bank sells the commodity to Commodity Trader 2.
5 Upon maturity of the customer’s deposit, the Bank will pay
the customer the deposit amount and the profit.
 Product Features
Features Description

Islamic Scheme
3. Individual /Joint Account
Type of Account
4. SMEs

Features Description
 Individuals / Joint Account
Eligibility  SMEs
 Islamic

Tenure 3 months tenure with a rollover of another 3 months

RM50,000 for Individual and RM100,000 for SME in a

Minimum Placement
single certificate.

Maximum Placement No limit for individuals and RM1.0Million for SME.

 Administrative Costs in Mudharabah Deposit Account
• Mudharabah deposit account is an Islamic financial product
offered in the market.

• There is a proposal from Islamic banking institution to charge

administrative cost on depositors (sahibul mal) of mudharabah
deposit account.

• The issue is whether the bank as mudharib can charge

administrative cost on depositors from the Shariah perspective.
 Cont.
• Resolution
• The Council in its 16th meeting held on 11th November 2000/12
Sya`aban 1421 resolved that bank cannot impose administrative
cost on depositors (sahibul mal) in mudharabah deposit account.

• If the bank requires additional amount to cover the administrative

cost, it should be taken into account when deciding on the profit
sharing ratio as agreed by both parties.
 Deposit Product based on Tawarruq
• Islamic financial institution made a proposal to offer deposit
product and financing based on the concept of tawarruq or
commodity murabahah.

• In brief, the mechanism of deposit murabahah commodity involves

the following transactions:
– (i) The customer (depositor) appoints bank as an agent to purchase metal
commodity from metal trader A seller on cash basis in an established metal
commodity market;

– (ii) The bank will thereafter purchase the metal commodity from the
customer on a deferred sale at a cost price plus profit margin;

– (iii) Next, the bank will sell back the metal commodity to metal trader B in
the metal commodity market.
 Cont.
• As an agent to purchase the metal commodity on behalf of the
customer, the bank receives cash from the customer for the price
of commodity which is deemed as deposit in the bank’s account.
As a result of the transactions.

• above, the bank assumes liability (the cost price of the commodity
plus profit margin) to be paid to the customer on maturity.

• The price of commodity purchased by metal trader A and the

commodity’s price when sold to the metal trade B are same.

• Resolution
• The Council in its 51st meeting held on 28th July 2005 / 21st Jamadil Akhir 1426
resolved that deposit product and financing based on the concept of tawarruq
is known as commodity murabahah is permissible
 Negotiable Instruments of Deposits
• There are two types of negotiable instruments of deposits based
on Islamic principles.

• These are
• (1) Negotiable Islamic Debt Certificate (NIDC) based on the
concept of Bai’ Bithaman Ajil and

• (2) Islamic Negotiable Instruments of Deposits (INID) based on Al-

Muharabah.

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 Cont.
• Bai’ Bithaman Ajil (BBA) – Negotiable Islamic Debt Certificate
(NIDC)
– BBA refers to the sale of goods on a deferred payment basis.
– The Islamic bank sells the identified asset to a customer and
subsequently buys the asset from the customer at an agreed
price (the sale price), which includes the customer’s mark-up
(profit).
– Or it refers to a sum of money deposited with the Banking
Institutions and repayable to the bearer on a specified future
date at the nominal value of the NIDC’

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 Cont.
• Al-Mudharabah – ‘Islamic Negotiable Instruments of Deposits
(INID).
• Al-Mudharabah refers to an agreement between two (2) parties
that is:
• the provider of the funds (customer) – which provides 100%
capital for the financing, and
• the entrepreneur (Islamic bank) – who manage the project using
his entrepreneur skills
• or it refers to a sum of money deposited with the Bank and
repayable to the bearer on a specified future date at the nominal
value of NIDC plus declared profit.
• Profits arising from the project are distributed according to pre-
determined profit sharing ratio (PSR)
• Any losses accruing are borne solely by the provider of the funds.
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 Floating Islamic Negotiable Instrument of Deposit (INID)
• Bank Negara Malaysia has introduced floating INID with the
following mechanisms:
– (i) A customer deposits money into a bank;
– (ii) The bank accepts customer’s deposit and issues INID to the customer as
an evidence of receiving deposit;
– (iii) INID is tradable in the secondary market;
– (iv) On maturity, the customer or holder of INID returns it to the bank and
receives the principal value of INID and declared divided; and
– (v) The declared dividend is the dividend derived from the investment of
the deposit.

• The term “floating” refers to the characteristic of product that

changes in value based on the dividend declared by the bank from
time to time.
• The question is whether the investment mechanism mentioned
above is in line with mudharabah principle.
 Cont.
• Resolution
• The Council in its 3rd meeting held on 28th October 1997/ 26
Jamadil Akhir 1418, resolved that Floating Islamic Negotiable
Instrument of Deposit (INID) using mudharabah concept is
permissible and can tradable in the secondary market

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Thank you

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