The Islamic Financial System 117
referred to as the “two - tier mudarabah” model, while the second model is
known as the “two - windows” model. As mentioned earlier, a mudarabah is
a principal/agent contract, where the owner of the capital (investor/deposi-
tor) forms a partnership with the owner of a specialized skill (professional
manager or bank) to invest capital and to share the profi ts and losses of the
investment. The third model is the wikala - based model, as discussed below.
Two - tier mudarabah This model is so called because the contract is utilized
on each side of the bank’s balance sheet and integrates the assets and liabili-
ties. It envisages depositors entering into a contract with a bank to share
the profi ts accruing to the bank’s business. The basic concept is that both the
mobilization and utilization of funds are conducted on the basis of profi t
sharing among the investor (depositor), the bank and the entrepreneur or
the users of the funds. The fi rst tier of the contract is between the investor
(analogous to a depositor) and the bank, where investors act as suppliers of
funds to be invested by the bank, which acts as the mudarib on their behalf.
The investors share in the profi ts and losses earned by the bank’s business
related to their investments. Funds are placed with the bank in an investment
account.
The liabilities and equity side of the bank’s balance sheet thus shows
the deposits accepted on a mudarabah basis. These investment deposits are
not liabilities (the capital is not guaranteed and they incur losses if the bank
does so) but a form of limited - term, non - voting equity. In this model, banks
can also accept demand deposits that yield no returns and are repayable on
demand at par; these are treated as liabilities. This model, though requiring
that current deposits be paid at the demand of the depositors, has no specifi c
reserve requirement.
The second tier represents the mudarabah contract between the bank,
as supplier of funds, and the entrepreneurs, who are seeking funds and agree
to share profi ts with the bank according to a certain percentage stipulated
in the contract. The bank’s earnings from all its activities are pooled and are
then shared with its depositors and shareholders according to the terms of
their contract. Thus the profi t earned by the depositors is then a percentage
of the total banking profi ts. A distinguishing feature of the two - tier model is
that, by design, the assets and liabilities sides of a bank’s balance sheet are
fully integrated, which minimizes the need for active asset/liability manage-
ment, which, in turn, provides stability against economic shocks. The model
does not feature any specifi c reserve requirements on either the investments
or the demand deposits.
Two - windows model This model also features demand and investment
accounts but takes a different view from the two - tier model on reserve
requirements. The two - windows model divides the liabilities side of the
bank’s balance sheet into two windows; one for demand deposits (transac-
tions balances) and the other for investment balances. The choice of the
window is left to the depositors. This model requires a 100-percent reserve