154 AN INTRODUCTION TO ISLAMIC FINANCE
to a predetermined ratio (typically 80:20 but may vary considerably from
bank to bank).
A bank may also offer special investment accounts customized for the
investors, who may be ordinary householders, high - net - worth individuals or
institutional clients. These accounts also operate on the principle of muda-
rabah, but the modes of investment of the funds and distribution of the prof-
its are customized to suit the needs of the clients. In general, these accounts
are linked to special investment opportunities identifi ed by the bank. These
opportunities have a specifi c size and maturity and result from the bank’s
participation in a pool of investment, private equity, joint venture or a fund.
To some extent these accounts resemble specialized funds to fi nance different
asset classes. The maturity and the distribution of profi ts for special invest-
ment accounts are negotiated separately for each account, with the yield
directly related to the success of the particular investment project. Special
investment accounts have considerable potential for designing and develop-
ing funds with specifi c risk–return profi les to offer customers and clients
opportunities to manage portfolios and to perform risk management. In
addition to deposits, an Islamic bank offers basic banking services such as
fund transfers, letters of credit, foreign exchange transactions, and invest-
ment management and advice, for a fee, to retail and institutional clients.
The last item on the liabilities side is, typically, equity capital and
reserves accumulated over the time. It should be noted that given the pro-
hibition of debt, Islamic banks do not carry any debt capital, which could
be a signifi cant source of capital for the conventional banks. Rather, they
are capitalized through equity. It has been argued that since the mode of
intermediation is based on the profi t/loss - sharing agreement which is a
“pass - through” system, Islamic banks do not need to keep signifi cant equity
capital. This notion may be theoretically correct but as we will see later
Islamic banks are still required to maintain a certain minimum level of capi-
tal. They can also set aside a portion of the profi ts each year as reserves to
be used during times of economic slowdown.
Table 8.2 shows the major liabilities of a typical Islamic bank broken
into sub - categories used for reporting purposes.
Assets
While the liabilities side of the bank has limited modes of raising funds, the
assets side can carry a more diversifi ed portfolio of heterogeneous asset classes,
representing a wider spectrum of risk and maturity profi le. For short - term
maturity, limited - risk investments, there is a choice of investing in short -
term trade fi nancing. Such assets originate from trade - related activities, such
as murabahah, bay’ al - muajjil, or bay’ salam, and are arranged by the bank,
which uses its skills, market knowledge and customer base to fi nance the
trading activity. In addition, the bank can provide short - term funds to its
clients to meet their working capital needs. The short - term maturity of these
instruments and the fact that they are backed by real assets minimize their