PRODUCTS, ACTIVITIES OFFERED BY ISLAMIC BANKS (HOW

ISLAMIC BANKS OPARATES).

Since Islamic banking do not clash with normal banking activities, Islamic
banks have adopted the current banking tools and procedures. Where any clash
arises, the Islamic banks have devised their own tools and procedures to
accomplish their banking activities. Such tools and procedures that have been
devised so far are enumerated here:

A. DEPOSITS
B. INVESTMENTS ACTIVITIES

A: DEPOSITS

This refers to an act of placing money or valuable item like gold or papers in a
bank or other financial institution.1

Islamic banks receive two types of deposits:

I. Deposits not committed for investment which take the form of current
accounts or saving account(savings account)
II. Deposits committed for investment.(investment accounts)

Current account is operating on the same way as it is operating in conventional

banking system

I. Saving accounts
In this account customers can deposit their savings. Though these depositors
allow the bank to use their money, they get a guarantee of getting their full
amount bank from the bank.in this case bank guarantees their savings but is not
obliged to pay any rewards to the saver.however,most of the banks are still
paying either a cash reward from their profit at the end of their financial year or
are giving some privileges to the holders of these accounts,e.g. providing
financial support for small projects, sale of consumer durables or producers

1
Encarta dictionaries
 goods by installment, distributing gifts etc. These rewards are discretionary and
not obligatory and are paid only in case the bank is earning substantial profits. 2
II. Investment accounts
Investment accounts can be of two types,
a. Accounts with authorization
Here account holders authorize the bank to invest the money in any of its
projects. After the expiry of a specified period, the account holder will get the
profit.
b. Account without authorization
In investment accounts without authorization, the account holder may choose
any particular project for investment of his deposited money. He may or may
not specify the period of deposit. The bank will give share to the account
holder from the profit particular project which has been chosen by him
according to agreed percentage. If the investment accounts are opened for a
fixed period, the customer is not allowed to withdraw his money before the
lapse of specified period. If he does so, the customer either is not entitled to the
share of in profit at all or may be entitled to receive some discounted profit
depending upon the duration of the deposit with the bank.
These deposit schemes of Islamic banks have been able to attract a substantial
number of depositors.3

B.INVESTMENT ACTIVITIES
As the bank cannot earn interest by lending the money, therefore the Islamic
banks have to undertake investment to earn profit not only for the bank itself
but also for the depositors in the investment account. Below are the investment
procedures on the Islamic principles:

A. MUSHARAKAH(EQUITY PARTIPATION,JOINT VENTURE):

A joint venture based on musharakainvolves a partnership in which
both the bank and its customer-client contribute to entrepreneurship and
capital.4
The banks and their clients agree to join in a temporary participation (not quite
different from joint venture) for effecting a certain operation within an agreed
period of time. Both parties contribute to the capital of the operation (meanly
2
Op.cit,p 18
3
Op.cit,p14
4
Mohammed Obaidullah(2005),Islamic financial services,Islamic economics research centre king Abdulaziz
university Jeddah,SaudiArabia,march.p 45
 assets and managerial expertise working capital etc.) in varying degrees and
agree to divide the net profit in proportions agreed upon in advance. There is
no set formula for profit sharing and each case is dealt with on its own merits.5

Types of Musharaka partnerships6

There are many types of Musharaka ranging from traditional types of
partnerships to modern corporations. Musharaka could either be:

 Permanent musharaka: An Islamic bank participates in the equity of a

project and receives a share of the profit on a prorata basis. The time length of
the contract is specified, making it suitable for financing projects where funds
are committed over a long period.

 Diminishing musharaka: This allows equity participation and sharing of

profits on a prorata basis, and provides a method through which the bank keeps
on reducing its equity in the project, ultimately transferring ownership of the
asset to the customer. The contract provides for payment over and above the
bank's share in the profit for the equity held by the bank. Simultaneously the
entrepreneur purchases some of the banks equity, progressively reducing it
until the bank has no equity and thus ceases to be a partner.

B. MUDARABAH OR QIRADH(Agencies):
It is a partnership in profit whereby one party provides capital (rab al-maal-the
bank) and the other party provides the know how/labor (Mudharib).7
In this procedure of investment, bankcontributes all the financing (and
customer contributes only his managerial efforts or labor) and gets again an
agreed proportion of the profit actually realized.in both mudarabah and
musharakah, both sides stand to incur any profit depending on the actual
performance of the operation. In the mudarabah contract however,
themudarabah (the partner offering his efforts) will lose nothing but his labor
(as the principle capital is not his) in case of financial loss resulting from
normal business conditions. The bank that has financed the capital bears all the
finance risks. This financial risk justifies the bank to claim his share in the
profit. The client is however held responsible for loss of capital, should this be
the result of his negligence or willful act.to guard against this,the bank may
require a security from the customer.

C. MURABAH(mark-up sale):
This is a procedure where a partner approaches the bank that certain items(be a
commodity or otherwise) be bought for him and he agrees to pay the bank later
5
Op,cit,p 18
6
Introduction to Islamic banking www.gulfafricanbank.com,may15 2012,12:44
7
Introduction to Islamic banking,www.gulfafricanbank.may15 2012,01:50
 on, upon the fulfillment of the actual buying, an agreed percentage of profit.in
order to avoid any riba element one of the banks provides that the agreement of
the bank and the actual execution of buying do not contribute any legal
obligation(according to shariah) on the partner to buy. Hence the risk is still
that of the bank’s. Until the partner fulfills his original promise of “rebuying”
the commodity, the risk remains with the bank which justifies the profit.8

D. BAI SALAM (post-delivery sale):

The bank buys certain goods on post-delivery and pays the cost immediately or
sells certain goods on post-delivery and receives its cost immediately.in this
sale, cost of goods is fixed and paid in advance but the delivery of the sold
items is postponed or delayed up to a certain period. Similarly, the place of
delivery, its expenses and quantities of the sold goods should also be fixed and
defined as they are conditions for such a sale.9

E. IJARAH(LEASE,RENT):

Is the same as leasing thus leasing practiced in interest – free banks are similar
to its conventional practice. During the life of the asset, the risk of ownership
remains with the bank, while the lessee is liable for misuse of the asset.

 Ijarahthumma al bai' (hire purchase)10

Parties enter into contracts that come into effect serially, to form a complete
lease/ buyback transaction. The first contract is an Ijarah that outlines the terms
for leasing or renting over a fixed period, and the second contract is a Bai that
triggers a sale or purchase once the term of the Ijarah is complete. For example,
in a car financing facility, a customer enters into the first contract and leases
the car from the owner (bank) at an agreed amount over a specific period.
When the lease period expires, the second contract comes into effect, which
enables the customer to purchase the car at an agreed to price.

The bank generates a profit by determining in advance the cost of the item, its
residual value at the end of the term and the time value or profit margin for the
money being invested in purchasing the product to be leased for the intended
term. The combining of these three figures becomes the basis for the contract
between the Bank and the client for the initial lease contract.

8
Op,cit,p 18
9
Op,cit,p 18
10
Islamic banking,www.en.wikipedia.org,may 15 2012,05:00
 This type of transaction is similar to the contractumtrinius, a legal maneuver
used by European bankers and merchants during the middle Ages to sidestep
the Church's prohibition on interest bearing loans. In a contractum, two parties
would enter into three concurrent and interrelated legal contracts, the net effect
being the paying of a fee for the use of money for the term of the loan. The use
of concurrent interrelated contracts is also prohibited under Shariah Law.

 Ijarah-wal-iqtina11

A contract under which an Islamic bank provides equipment, building, or

other assets to the client against an agreed rental together with a unilateral
undertaking by the bank or the client that at the end of the lease period, the
ownership in the asset would be transferred to the lessee. The undertaking or
the promise does not become an integral part of the lease contract to make it
conditional. The rentals as well as the purchase price are fixed in such manner
that the bank gets back its principal sum along with profit over the period of
lease.

F. ISTISNA’A

Istisna’a is a contract whereby a party undertakes to produce a

specific thing which is possible to be made according to certain
agreed-upon specifications at a determined price and for a fixed date
of delivery. This undertaking of production includes any process of
manufacturing, construction, assembling or packing.12

The Arabic word “Istisna’a” means “asking someone to manufacture”. It may

be further defined and elaborated as a sale contract between the seller and the
buyer for the sale of an asset described in the sale contract and transacted
before it comes into existence. To fulfill its obligation, the seller can either
manufacture/construct it by itself or can get it manufactured/constructed by
someone else to deliver it to the buyer on the date described in the sale
contract. The buyer can pay the sale price in lump sum at the time of signing
the contract or later in different stages as the manufacturing/construction
process proceeds.13
11
Islamic banking,www.en.wikipedia.org,may 15 2012,08:09.
12
Istisna’a www.isdb.org may 15 2012,02:22
13
Major real estate products,www.sib.ae/en, may 15 2012,01:09.
 The bank can utilize Istisna'a in two ways:

 It is permissible for the bank to buy a commodity under Istisna'a contract

and sell it on receipt of cash installment or deferred payment basis.
 It is also permissible for the bank to enter into Istisna'a Contract in the
capacity of seller to those who demand a purchase of a particular commodity
and then draw a parallel Istisna'a Contract in the capacity of a buyer with
another party to make (manufacture) the commodity agreed upon in the first
contract. 14

14
Istisna’a www.barakaonline.com, May 15, 2012,11:23