About Islamic banking
Nowadays about 700 Islamic financial institutions in more than 90 countries operate
worldwide. Islamic Financing sphere remains the fastest growing in the global financial system,
growing by 15-20% annually.
Main principles of Islamic banking are based on Islamic canons. For this reason, Islamic banks
have a special body-Sharia Supervisory Board, consisting of scholars, experts in Islamic law and
finances, which monitors compliance with the principles of Islamic Finance and does not allow
the financing of prohibited industries.
Islamic Financing System Principles
Main principles of Islamic financial system:
1) Money cannot be arisen from money;
2) Money is not a commodity, it is only a measure of value;
3) Relations between the parties to the transaction should be built on the basis of partnership with
sharing of risks and income;
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.
Islamic Financing System Prohibitions
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 forbiddances of Islamic financing system:
1) Riba – loan interest, i.e. it is forbidden to accept money at interest. Instead of loan
interest the Bank receives profit (margin) and commission fee from the loan funds provided to
customers. And depositors receive share in the profit of Islamic bank, but not interest;
2) Gharar – speculations, uncertainty about the subject matter and terms of agreement.
Transactions must be clear, transparent, and unchangeable until the transaction is completed;
3) Maisir – profit, arising through casual concurrence of circumstances (i.e. gambling,
bargain, betting);
4) Haram – prohibition to finance certain fields of economy according to Islamic standards.
Islamic Banking Products
Basic products of Islamic banking:
Islamic banks as well like traditional ones provide current and Deposit account management services.
Potential customers of Islamic bank can be roughly divided in two categories:
a) Those, who want to save their capital and do not expect any reward on deposit;
b) 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 bear 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 costs and expenses.
Example: the Client opened a Current Deposit on the basis of Qard and put the amount of 50,000
tenge. After some time, the Client decided to withdraw the entire amount and the Bank is obliged to
give him exactly 50,000 tenge.
Profitability on savings and investment accounts is changeable, it depends on the results of the
Bank’s activity and profit from allowed commercial operations. Although this profit is not
necessarily guaranteed and is subject to a certain risk, they are managed professionally to provide
higher profitability than many traditional Bank deposits.
Mudaraba (investment deposit)
Mudaraba is a form of investment deposit, where the Depositor (Rabbul Mal) transfers his capital to
the Bank who 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 pre-agreed
proportion. As in all other types of Islamic deposits, remuneration cannot be guaranteed either
directly or indirectly, due to the fact that the result of investment activity is not known and any
profit received is distributed in fact.
The Depositor’s capital also may not be guaranteed, because only Depositor bears all financial
losses, unless proved: negligence of the Bank and/or there is a violation of the terms of the
Mudaraba agreement by the Bank.
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: The Customer opened an investment deposit based on Mudaraba, put an amount of 5.000.000
tenge taking into account the agreement of profit sharing: 70/30, to the Client and the Bank
respectively. Upon expiration of the agreement, summing up the results of its investment activity
the Bank came to the conclusion that total profit under this project amounted to 2.400.000 tenge.
Taking into account the profit sharing agreement, the Customer receives 1.680.000 tenge
(2.400.000-70%) and the Bank receives 720.000 tenge (2.400.000-30%).
In total, the Client receives 6.680.000 tenge excluding minimum commission fees, administrative and
other expenses associated with this investment project. The Bank also receives 720,000 tenge from
the investment project, as well as a service fee.
Wakala (agency deposit)
Wakala is an agency agreement where the Client (Muwakkil) instructs the Bank (Wakil) to invest its
funds, which makes every effort to make a profit by investing in any Sharia-compliant business
project, as agreed by the parties.
Muwakkil provides his funds in money, which will is in trust governance and disposal have Wakil.
Cases in Wakala must be conducted exclusively by Wakil within the framework of the obligations
specified in the investment Agency Deposit agreement.
The profit from the investment project should be directed away from the Wakil to Muwakkil in the
amount specified in the expected profit. In case of excess of the total profit, Wakil is entitled to
receive a Wakil award in the amount of the balance after the payment of the estimated profit. At the
same time Wakil, in any case, in advance at the beginning of the agreement, receives the agreed
amount of Commission fee as an Agency fee.
The financial losses within the framework of Wakala are fully borne by Muwakkil, unless Wakil's
guilt of fraud, negligence or wilful default is proved. Muwakkil's obligations are limited to its
investments, unless otherwise specified in the Wakala agreement.
Example: Client A opened an investment agency deposit based on Wakala, placed 5,000,000 tenge for a
period of 12 months with an expected return on the deposit of 10% or 500,000 tenge. At the same
time, the Client paid in advance the agency commission to the Bank in the amount of 300,000 tenge.
Upon the expiration of the agreement, analyzing the results of its investments, the Bank came to the
conclusion that the profit on the project amounted to 1.200.000 tenge, which exceeds the expected
return. Considering the peculiarities of the Wakala agreement, in case of exceeding the expected
return, the Prize is provided for: the Bank sends 500,000 tenge (expected return) to the Client.
Thus, the Client receives 5.500.000 (5.000.000+500.000) tenge. The Bank also receives an income of
1.000.000 tenge, consisting of 300.000 Agency fee and 700.000 Wakala premium.
Ijara (Leasing)
The word “ijara” from Arabic 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”, expert 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: 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 Client pays 333.333 tenge per month for 36 months.
After payment of payments for the period and in the absence of any obligations of the Client to the
Bank, the Bank transfers ownership of the vehicle to the Client at the residual (nominal) value.
Musharaka (Partnership)
Musharaka from Arabic 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.
The mandatory terms of the Musharaka partnership agreement are 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, in the joint venture agreement, 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: The Customer decided to begin an agribusiness and built 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 client was appointed as the executive of the project.
By the end of the third year the Executive gained actual total profit in amount of 460 million tenge
for the last three years. In accordance with the agreement on profit sharing, the Bank and the
Client will regain 100 million tenge of their vested capital, and the balance of 260 million tenge
is divided in the proportion of 60/40 of which 156 million tenge is sent to the Bank, and 104
million tenge – to the Client.
Murabaha (Installment sale of commodities with markup)
The term “Murabaha” originates from Arabic word “ribkh” which means markup or margin.
Practically, Murabaha is sale of commodity at cost price with fixed margin, which may not be changed
in the future under no circumstances. An important point in Murabaha is to inform and subsequent
agreement of the Client with the cost of goods and the size of the margin on the goods. 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 monthly payment by the Customer, 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) 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: 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 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.