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Knowledge Centre

About Islamic banking

Nowadays about 700 Islamic financial institutions in more than 90 countries operate worldwide. Islamic financing sphere is the most rapidly increasing in global financial system: it grows annually by 15-20%.

Main principles of Islamic banking are based on Islamic canons. For this reason a specific body operates in Islamic banks – Sharia Supervisory Board, which consists of scholars, experts in Islamic law and finances, and ensures compliance with Islamic financing and does not allows financing of forbidden fields.

It is strictly forbidden to finance any activity connected with:

- pig breeding;

- production of alcohol, tobacco, drugs;

- gambling;

- usurious lending;

- arms;

- forbidden entertainments industry.

Main principles of Islamic financial system:

1)      Money cannot be arisen from money.

2)      Money are not a commodity, they are only a measure of value.

3)      Relations between parties shall be built on the basis of partnership with sharing risks and profit.

4)      Investors’ revenue shall be connected to investments in commerce and production, i.e. in real sector of economy. Transactions performed shall be secured by real assets.

Main forbiddances of Islamic financing system:

1)      Riba – interest rate, i.e. it is forbidden to lend or receive money at interest.

Instead of interest rate the Bank receives profit (margin) and commission fee from borrowed funds granted to the customers. And depositors receive share in the profit of Islamic bank, but not interest;

2)      Gharar – speculations, uncertainty in relation of subject and terms of agreement. transactions shall be clear, transparent, and permanent until performance of the transaction;

3)      Maisir – profit, arisen from coincidence (i.e. gambling, bargain, betting);

4)      Haram – prohibition to finance certain fields of economy according to Islamic standards.

Basic products of Islamic banking:

Islamic banks as well as conventional ones provide services on maintenance of current and deposit accounts for their customers. Potential customers of Islamic bank may be divided in two categories:

а) those, who want to save their capital and do not expect any reward on deposit;

б) those, who intend to invest for possible increase of their capital in future.

Qard (current deposit)

Current accounts do not gain any profit, because they are accepted from depositors as Qard (debt) to the bank and they might be withdrawn at the first request of the customers without prior notification. They do not carry any risk of loss, because they are kept as Amana – a property transferred for keeping. Whereas the Bank has a right to charge minimal commission fee for its services to cover administrative expenses.

Example 1: A Customer has opened Current account based on Qard and put an amount of 50.000 tenge. After a while Customer  decides to withdraw whole amount and the Bank is obliged to give him out exact amount of 50.000 tenge.

Profitability of saving and investment accounts is changeable, it depends on the results of the Bank’s activity and profit from allowed commercial operations. Though this profit is not necessarily guaranteed and is subject to a certain risk, they are professionally managed to provide higher profitability than of many other conventional banking deposits.

Mudaraba (investment account)

Mudaraba is a form of investment deposit, where the Depositor (Rabbul Mal) transfers its capital to the Bank which acts as a Manager (Mudarib) and invests the capital in investment projects with different risk levels. Profit is divided between the Bank and the Depositor according to prior agreement. As in other types of Islamic deposits, reward may not be directly or indirectly guaranteed, since the result of investment activity is not predictable and all profit is shared on actual basis. The Depositor’s capital also may not be guaranteed, because only Depositor bears all financial losses, unless the Bank’s negligence or the fact of breach of Mudaraba agreement terms by the Bank is proved.

In other words, it is capital transferred by the customer to the bank for a certain period without guarantee of their return in nominal terms, under the condition of payment of profit on it depending on the results of using transferred capital.

This type of deposit will be of interest for those, who have some savings and are ready to take risk. Peculiarity of the investment deposit is in availability of limit on minimum deposit amount and duration.

Example 2: The Customer opens an investment deposit based on Mudaraba, put an amount of 5.000.000 tenge with account of agreement to divide profit by 70% to the Customer and 30% to the Bank. Upon expiration of the agreement, summing up the results of its investment activity the Bank decides that total profit under this project amounted to 2.400.000 tenge. According to agreement on profit share, the Customer receives 1.680.000 tenge (2.400.000-70%) and the Bank receives 720.000 tenge (2.400.000-30%). Thus the Customer receives in total 6.680.000 tenge excluding minimum commission fees, administrative and other expenses associated with this investment project. The Bank in its turn receives 720.000 tenge and service fee.

Leasing (Ijara)

The word “ijara” means “renting”. According to Islamic law the term “Ijara” has the following meanings:

1)      hiring an expert for agreed payment to receive certain services. The employer is called “mustadjir”, employee is “adjir”, the salary is “udjra”;

2)      transfer of the property to another person in return for rental payment. At that lessor is called “mudjir”, and the lessee is “mustadjir”, the rental paid to the lessor is called “udjra”.

Example 3: To provide transportation services Customer decided to get a HOWO truck costing 10.000.000 tenge into leasing and applied to Islamic Bank. Parties came to agreement that the Bank purchases a vehicle from the Vendor and rents it to the Customer for 3 years. The Bank sets the size of the rental profit as agreed with the Customer, for example 2.000.000 tenge. Therefore in accordance with the agreement the Customer monthly pays 333.333 tenge during 36 months. Upon repayment of all payments for 36 months and in the absence of any obligations of the Customer to the Bank, the Bank transfers ownership of the vehicle to the Customer at the residual (nominal) cost.

Partnership (Musharaka)

Musharaka means “participation” or “sharing”. This term means joint venture where the partners share profit or loss. Thus Islamic bank is an Investor, and the Customer is a Performer.

An obligatory condition of Musharaka is that investments come from all partners and all partners may participate in enterprise management, nonetheless it is allowed to assign one of them as a Manager or Executive. Also the partners share losses proportionally and not exceeding their investment share, and profit is divided proportionally as agreed by the parties. Responsibility of the partners is limited in the joint activity agreement by approved and agreed business-plan, and the parties are not responsible for the obligations of their partners arisen from the parties’ activity not provided by the agreement. In order to perform a business-plan, partners join their funds in a certain business-project, after which all assets become joint property proportionally to their investment share. Depending on type of activity and agreement terms, profit is divided based on the results of the business-project and is distributed upon receipt during the period of agreement or at the end of the agreement period. Partners may vest capital in monetary form or in the form of assets market price of which determines the share of the participant in the partnership.

Example 4: The Customer decided to begin an agribusiness and to build a farm in Almaty region. Therefor he applied to the Islamic bank in order to finance the project under the terms of partnership. The Parties coordinated the business-plan and came to agreement that each party will vest 100 million tenge with a 60% share of profit to the Investor and 40% share to the Executive. It is a 3 year term project. The Customer is assigned as Executive. By the end of the third year the Executive gained actual profit in amount of 460 million tenge for the last three years. According to profit share agreement each the Bank and the Customer will regain 100 million tenge of their vested capital, and the rest 260 million is divided in proportion of 60/40, i.e. the Bank will gain 156 million tenge, and the Customer receives 104 million tenge.

Installment sale of commodities with extra charge (Murabaha)

The term “Murabaha” originates from Arabic word “ribkh” which means extra charge or margin.

Practically, Murabaha is sale of commodity at cost price with fixed margin, which may not be changed in future under no circumstances. It is important in Murabaha to inform the Customer and get his approval of the commodity’s cost price and the size of margin. Any asset not prohibited by Islamic principles (commodity, property) may be the subject of transaction.

Although at first sight Murabaha is almost no different from conventional financing, there are following peculiarities in Murabaha:

a)    the Customer doesn’t deal with the Bank’s funds, only with purchased asset;

b)   in case of overdue payment, the Islamic bank may not charge additional amount as the value of money in time as in conventional banks. In such cases a fine may be imposed on the Customer, and this fine may not be considered as profit, the bank shall sent this amount to charity;

c)    the Bank shares all the risks related to purchase of the commodity and its delivery to the Customer;

d)   financing only Sharia compliant production;

e)    в случае дефолта Клиента, цена в Мурабаха не может быть увеличена, кроме возможности выставления штрафа, как и в пункте (б.)  in case of default of the Customer, price of Murabaha may not be increased, except for charging a fine as stipulated in clause b).

Example 5: The Customer needs to purchase equipment at the cost of 5.000.000 tenge for business expansion. Due to the fact that the Vendor is not going to sell the equipment by instalment, the Customer applies to the Islamic bank for financing under Murabaha agreement. Upon coordinating financing term and margin size, the parties agreed that the Customer is ready to purchase this equipment by instalment for a period of 15 months with 2.000.000 tenge margin. Confirming the seriousness of his intensions, the Customer signs an obligation to purchase the equipment from the Bank and makes a deposit in amount of 200.000 tenge. After that the Bank purchases required equipment from the vendor with discount for 4.700.000 tenge and delivers it to the Customer. Meanwhile the Customer signs an agreement on instalment purchase of the equipment with annual payment in amount of 453.333 tenge (5.000.000+2.000.000-200.000=6.800.000/15). It should be noted that registering the title of the equipment to the Customer, the Bank puts it in pledge, and if the Customer performs his liabilities timely and in full, all encumbrances are removed.

Knowledge Centre

About Islamic banking

Nowadays about 700 Islamic financial institutions in more than 90 countries operate worldwide. Islamic financing sphere is the most rapidly increasing in global financial system: it grows annually by 15-20%.

Main principles of Islamic banking are based on Islamic canons. For this reason a specific body operates in Islamic banks – Sharia Supervisory Board, which consists of scholars, experts in Islamic law and finances, and ensures compliance with Islamic financing and does not allows financing of forbidden fields.

It is strictly forbidden to finance any activity connected with:

- pig breeding;

- production of alcohol, tobacco, drugs;

- gambling;

- usurious lending;

- arms;

- forbidden entertainments industry.

Main principles of Islamic financial system:

1)      Money cannot be arisen from money.

2)      Money are not a commodity, they are only a measure of value.

3)      Relations between parties shall be built on the basis of partnership with sharing risks and profit.

4)      Investors’ revenue shall be connected to investments in commerce and production, i.e. in real sector of economy. Transactions performed shall be secured by real assets.

Main forbiddances of Islamic financing system:

1)      Riba – interest rate, i.e. it is forbidden to lend or receive money at interest.

Instead of interest rate the Bank receives profit (margin) and commission fee from borrowed funds granted to the customers. And depositors receive share in the profit of Islamic bank, but not interest;

2)      Gharar – speculations, uncertainty in relation of subject and terms of agreement. transactions shall be clear, transparent, and permanent until performance of the transaction;

3)      Maisir – profit, arisen from coincidence (i.e. gambling, bargain, betting);

4)      Haram – prohibition to finance certain fields of economy according to Islamic standards.

Basic products of Islamic banking:

Islamic banks as well as conventional ones provide services on maintenance of current and deposit accounts for their customers. Potential customers of Islamic bank may be divided in two categories:

а) those, who want to save their capital and do not expect any reward on deposit;

б) those, who intend to invest for possible increase of their capital in future.

Qard (current deposit)

Current accounts do not gain any profit, because they are accepted from depositors as Qard (debt) to the bank and they might be withdrawn at the first request of the customers without prior notification. They do not carry any risk of loss, because they are kept as Amana – a property transferred for keeping. Whereas the Bank has a right to charge minimal commission fee for its services to cover administrative expenses.

Example 1: A Customer has opened Current account based on Qard and put an amount of 50.000 tenge. After a while Customer  decides to withdraw whole amount and the Bank is obliged to give him out exact amount of 50.000 tenge.

Profitability of saving and investment accounts is changeable, it depends on the results of the Bank’s activity and profit from allowed commercial operations. Though this profit is not necessarily guaranteed and is subject to a certain risk, they are professionally managed to provide higher profitability than of many other conventional banking deposits.

Mudaraba (investment account)

Mudaraba is a form of investment deposit, where the Depositor (Rabbul Mal) transfers its capital to the Bank which acts as a Manager (Mudarib) and invests the capital in investment projects with different risk levels. Profit is divided between the Bank and the Depositor according to prior agreement. As in other types of Islamic deposits, reward may not be directly or indirectly guaranteed, since the result of investment activity is not predictable and all profit is shared on actual basis. The Depositor’s capital also may not be guaranteed, because only Depositor bears all financial losses, unless the Bank’s negligence or the fact of breach of Mudaraba agreement terms by the Bank is proved.

In other words, it is capital transferred by the customer to the bank for a certain period without guarantee of their return in nominal terms, under the condition of payment of profit on it depending on the results of using transferred capital.

This type of deposit will be of interest for those, who have some savings and are ready to take risk. Peculiarity of the investment deposit is in availability of limit on minimum deposit amount and duration.

Example 2: The Customer opens an investment deposit based on Mudaraba, put an amount of 5.000.000 tenge with account of agreement to divide profit by 70% to the Customer and 30% to the Bank. Upon expiration of the agreement, summing up the results of its investment activity the Bank decides that total profit under this project amounted to 2.400.000 tenge. According to agreement on profit share, the Customer receives 1.680.000 tenge (2.400.000-70%) and the Bank receives 720.000 tenge (2.400.000-30%). Thus the Customer receives in total 6.680.000 tenge excluding minimum commission fees, administrative and other expenses associated with this investment project. The Bank in its turn receives 720.000 tenge and service fee.

Leasing (Ijara)

The word “ijara” means “renting”. According to Islamic law the term “Ijara” has the following meanings:

1)      hiring an expert for agreed payment to receive certain services. The employer is called “mustadjir”, employee is “adjir”, the salary is “udjra”;

2)      transfer of the property to another person in return for rental payment. At that lessor is called “mudjir”, and the lessee is “mustadjir”, the rental paid to the lessor is called “udjra”.

Example 3: To provide transportation services Customer decided to get a HOWO truck costing 10.000.000 tenge into leasing and applied to Islamic Bank. Parties came to agreement that the Bank purchases a vehicle from the Vendor and rents it to the Customer for 3 years. The Bank sets the size of the rental profit as agreed with the Customer, for example 2.000.000 tenge. Therefore in accordance with the agreement the Customer monthly pays 333.333 tenge during 36 months. Upon repayment of all payments for 36 months and in the absence of any obligations of the Customer to the Bank, the Bank transfers ownership of the vehicle to the Customer at the residual (nominal) cost.

Partnership (Musharaka)

Musharaka means “participation” or “sharing”. This term means joint venture where the partners share profit or loss. Thus Islamic bank is an Investor, and the Customer is a Performer.

An obligatory condition of Musharaka is that investments come from all partners and all partners may participate in enterprise management, nonetheless it is allowed to assign one of them as a Manager or Executive. Also the partners share losses proportionally and not exceeding their investment share, and profit is divided proportionally as agreed by the parties. Responsibility of the partners is limited in the joint activity agreement by approved and agreed business-plan, and the parties are not responsible for the obligations of their partners arisen from the parties’ activity not provided by the agreement. In order to perform a business-plan, partners join their funds in a certain business-project, after which all assets become joint property proportionally to their investment share. Depending on type of activity and agreement terms, profit is divided based on the results of the business-project and is distributed upon receipt during the period of agreement or at the end of the agreement period. Partners may vest capital in monetary form or in the form of assets market price of which determines the share of the participant in the partnership.

Example 4: The Customer decided to begin an agribusiness and to build a farm in Almaty region. Therefor he applied to the Islamic bank in order to finance the project under the terms of partnership. The Parties coordinated the business-plan and came to agreement that each party will vest 100 million tenge with a 60% share of profit to the Investor and 40% share to the Executive. It is a 3 year term project. The Customer is assigned as Executive. By the end of the third year the Executive gained actual profit in amount of 460 million tenge for the last three years. According to profit share agreement each the Bank and the Customer will regain 100 million tenge of their vested capital, and the rest 260 million is divided in proportion of 60/40, i.e. the Bank will gain 156 million tenge, and the Customer receives 104 million tenge.

Installment sale of commodities with extra charge (Murabaha)

The term “Murabaha” originates from Arabic word “ribkh” which means extra charge or margin.

Practically, Murabaha is sale of commodity at cost price with fixed margin, which may not be changed in future under no circumstances. It is important in Murabaha to inform the Customer and get his approval of the commodity’s cost price and the size of margin. Any asset not prohibited by Islamic principles (commodity, property) may be the subject of transaction.

Although at first sight Murabaha is almost no different from conventional financing, there are following peculiarities in Murabaha:

a)    the Customer doesn’t deal with the Bank’s funds, only with purchased asset;

b)   in case of overdue payment, the Islamic bank may not charge additional amount as the value of money in time as in conventional banks. In such cases a fine may be imposed on the Customer, and this fine may not be considered as profit, the bank shall sent this amount to charity;

c)    the Bank shares all the risks related to purchase of the commodity and its delivery to the Customer;

d)   financing only Sharia compliant production;

e)    в случае дефолта Клиента, цена в Мурабаха не может быть увеличена, кроме возможности выставления штрафа, как и в пункте (б.)  in case of default of the Customer, price of Murabaha may not be increased, except for charging a fine as stipulated in clause b).

Example 5: The Customer needs to purchase equipment at the cost of 5.000.000 tenge for business expansion. Due to the fact that the Vendor is not going to sell the equipment by instalment, the Customer applies to the Islamic bank for financing under Murabaha agreement. Upon coordinating financing term and margin size, the parties agreed that the Customer is ready to purchase this equipment by instalment for a period of 15 months with 2.000.000 tenge margin. Confirming the seriousness of his intensions, the Customer signs an obligation to purchase the equipment from the Bank and makes a deposit in amount of 200.000 tenge. After that the Bank purchases required equipment from the vendor with discount for 4.700.000 tenge and delivers it to the Customer. Meanwhile the Customer signs an agreement on instalment purchase of the equipment with annual payment in amount of 453.333 tenge (5.000.000+2.000.000-200.000=6.800.000/15). It should be noted that registering the title of the equipment to the Customer, the Bank puts it in pledge, and if the Customer performs his liabilities timely and in full, all encumbrances are removed.