Islamic Banking and Finance: Fundamentals and Contemporary Issues

Sayyid Tahir

Two more points are also noteworthy:

1. In general, initial instalments paid by the borrowers are counted
   toward recovery of interest, and treated as bank income.


2. Banks can also meet their operating expenses out of funds in the
   deposits.
   Prudential regulations are prescribed by the central bank in order to
   ensure solvency of the banks. The Shari[ah, however, gives rise to issues of a
   different sort for Islamic banking. These are discussed below under three
   headings: management of accounts, admissible operating costs for
   partnership-based deposits and reporting matters.

5.1 Management of Funds in Various Categories of Deposits

Islamic banks at present follow the aforementioned aggregative approach
used by interest-based banks (Figure 1) for the management of funds.^10 This
practice needs review, especially for investment deposits. Some of the reasons
are noted hereunder.

Ahkam of the Shari[ah are given at the micro level. The Islamic position
on ownership implies that if someone does business with his money, then the
goods purchased, proceeds from their sale and the profits (= sale proceeds
minus costs) also belong to him. Others would require his express willing
consent (An-Nisaa’ 4: 29) before they can exercise any claim on these profits.
This principle carries over to two-person mudarabah as follows.

As noted in section III.2, mudarabah is a limited purpose arrangement for
a specified period. The provider of capital shares its ownership with the
mudarib. This enables the mudarib to exercise his discretion on the funds—of
course, according to the stipulated purpose of the mudarabah. And, there is no
need for fresh approval of the ultimate owner of funds for every action taken
by the mudarib. This joint ownership means that profits, if any, belong to
both the parties.^11 Accordingly, the mudarabah is consummated with division
of the profits between the partners as per the agreed formula, of course,
along with the owner of capital getting back his funds.

Ahkam for mudarabah or musharakah between bank and its depositors are
logical extension of the above principle. Consider first the simple case of
there being only one line of mudarabah deposits Mudarabah 1 offered by an
Islamic bank. The working of this mudarabah is shown under Mudarabah 1 in
Figure 2.