The origin and basis of Islamic Banking is Shariah, i.e. Islamic laws and sometimes referred to as Islamic Jurisprudence.While Islamic banking and financial facilities and services carry Shariah implications for Muslims, these facilities and services are completely available to the Non-Muslims at their own free choice.
Sources Of Funds
(i) Shareholders’ Equity (Al-Musharakah/Joint-Venture Profit-Sharing)
The bank can raise its initial equity (or paid-up capital) in a straightforward way through the Islamic equity-financing contract of al-Musharakah among its initial shareholders. The bank can further expand its equity by listing its entire ordinary shares on the Board of the Kuala Lumpur Stock Exchange (KLSE).
(ii) Customers’ Deposits in Current Accounts (Al-Wadiah Yad Dhamanah/Guaranteed Custody)
The bank can mobilise its customers’ deposits in Current Accounts on the contract of al-Wadiah Yad Dhamanah. This is neither equity financing nor strictly debt-financing. It is based on the combination of two other categories of Islamic Commercial Contracts, namely al-Wadiah (Custody) and al-Dhamanah (Guarantee).
(iii) Customers’ Deposits in Savings Accounts (Al-Wadiah Yad Dhamanah/Guaranteed Custody)
The customers’ deposits in Savings Account are taken by the bank on the same contract with modification on the payment of profit at the absolute discretion of the bank.
(iv) Customers’ Deposits In General Investment Accounts (Al-Mudharabah/Trustee Profit Sharing)The bank mobilises its deposits in General Investment Accounts from its customers on the equity-financing contract of al-Mudharabah.
(v) Customers’ Deposits in Special Investment Accounts (Al-Mudharabah/Trustee Profit-sharing)
In addition to the above facilities for accepting deposits from the ordinary customers, the bank may also selectively accept deposits from the government or corporate customers in the form of Special Investment Accounts. These accounts are also operated on the principle of alMudharabah; but the modes of investment of the funds and the ratios of distribution of profit may usually be individually negotiated.
(i) Project Financing (Al-Mudharabah/Trustee Profit-Sharing)
The bank may undertake to finance acceptable project under the principle of al-Mudharabah. In this instance, the bank is the “provider of capital” and will provide 100 percent financing for the relevant project.
(ii) Project Financing (Al- Musharakah/Joint-Venture Profit-Sharing)
The bank may undertake to finance acceptable project under the principle of al-Musharakah. In this instance, the bank together with the initiator or initiators of the relevant project will provide the whole financing for the project in agreed proportions.
(iii) Financing The Acquisition Of Assets (AI-Bai Bithaman Ajil/Deferred Instalment Sale)
The bank may finance the customers who wish to acquire a given asset but to defer the payment for the asset for a specific period or to pay by instalments under the principle of al-Bai Bithaman Ajil.
(iv) Financing The Use Of Services Of Assets (Al-Ijarah/Leasing)
The bank may finance its customers to acquire the right to use the services of a given asset under the principle of al-Ijarah.
(v) Syndication Services (AI-Ujr/Fee)
This facility may be organised on a syndication basis for a fee if the financial requirements are beyond the capability of a single bank, or if it is desirable to spread the risk. Similar syndication services also apply to trade finance facilities.
(vi) Securitisation and Debt Trading: (Bai al-Dayn/Debt-Trading)
Facilities (iii) al-Bai Bithaman Ajil and (iv) al-Ijarah are debt-financing modes. They give rise to debt or al-Dayn. The Islamic debt market will be enormously enhanced through the securitisation of such debt and the creation of institutional framework for trading in such debt instruments.
The bank provides specific facilities and financings mostly on short-term basis for the purpose of facilitating trade or working capital requirements for its customers. These facilities may be granted in connection with the purchase, import and sale, export of goods and machineries, and the acquisition and holding of stock and inventories, spares and replacements, raw materials and semi-finished goods.
(i) Letter Of Credit (AI-Wakalah/Agency)
The bank establishes the Letter of Credit and pays the proceeds to negotiating bank utilising the customer’s deposit; and subsequently releases the documents to the customers. The bank charges the customer fees and commission for its services under the principle of al-Ujr (Fee).
(ii) Letter of Credit (AI-Musharakah/Joint-Venture Profit-Sharing)
The bank establishes the Letter of Credit and pays the proceeds to negotiating bank utilising the customer’s deposit as well as its own shares of financing, and subsequently releases the documents to the customers. The bank and the customer share in the profit from the venture as provided for in the agreement.
(iii) Letter Of Credit (Al-Murabahah/Deferred Lump-Sum Sale or Cost Plus)
The bank establishes the Letter of Credit and pays the proceeds to the negotiating bank utilising its own funds. The bank sells the goods to the customer at a sale price comprising its cost and a profit margin under the principle of al-Murabahah for settlement on a deferred term.
(iv) Letter of Guarantee (Al-Kafalah/Guarantee)
The bank may provide the facility of a Letter of Guarantee to its customers for certain purposes under the principle of Al-Kafalah. The Letter of Guarantee may be provided in respect of the performance of a task, the settlement of a loan, etc.
(v) Financing Working Capital (Al-Murabahah/Deferred Lump-Sum Sale or Cost Plus)
The customer may approach the bank to provide financing for his working capital requirements to purchase stocks and inventories, spares and replacements, or semi-finished goods and raw materials.
(vi) Securitisation and Islamic Accepted Bill (Bai Al-Dayn/ Debt- Trading)
The previous working capital financing under al-Murabahah which gives rise to debt or al-Dayn may indeed be securitised. In that instance, the bank draws a Bill of Exchange on and to be accepted by the customer. This Bill of Exchange will be drawn for the full amount of the bank’s selling price on the maturity date of the financing.
Subject to certain guidelines, Bank Negara Malaysia has allowed this Bill of Exchange, referred to as Islamic Accepted Bill (IAB), to be traded ip the secondary market.
(vii) Securitisation and Islamic Export Credit Refinancing: Scheme (Bai Al-Dayn/Debt Trading)
The customer’s Bill of Exchange for exports may be purchased by the bank, and subsequently traded in the secondary market.
If the exports meet the list of goods and other guidelines of Bank Negara Malaysia under its export-promoting “Export Credit Refinancing Scheme”, the bank may resell this Bill of Exchange to Bank Negara Malaysia under the special terms of this scheme.
Major Differences in Equity-financing and Debt-financing In Islamic Finance And Conventional Finance
In equity financing, there are practically no major differences. The contract of al-Musharakah (Joint-Venture Profit-Sharing) is, in essence, similar to the conventional concept of joint-stock company. Therefore – except for some minor details – to finance projects through equity participation, to float a company on the stock exchange, to organise a venture capital company, or to form an equity unit trust, would be generally the same under the Islamic equity-financing as under the conventional equity-financing.
The contract of Al-Mudharabah (Trustee Profit-Sharing) – whereby one party (the owner of capital) provides fund for the other party (the entrepreneur) to invest or trade and generate profit and both share in the profit in pre-agreed proportions – while not widely practised is actually not totally unknown in the conventional financial system. A clear example is the occurrence of this type of contract sometimes in portfolio management business.
However, major differences between the Islamic financial system and the conventional financial system prevail in debt financing. Debt financing in the conventional financial system is almost totally based on interest-based lending, while this contract is forbidden (that is, Haram) in the Islamic financial system. Conversely, the Islamic debt-financing instruments of Deferred Contracts of Exchange are not generally known in the conventional financial system.
Nonetheless, there are some similarities even in debt financing. The contract of al-Ijarah (leasing) is practised in the conventional system. Likewise, the contract of Bai’ Al-Murabahah (Deferred Lump-Sum Sale) is practised in credit sale-and-purchase, both in the domestic and international trade.