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DEPOSITS MOBILAZATIONBy
HAMDAN HJ IDRIS,
BSc Econs, MBA ( Islamic banking & Finance)
CPTrainer (MIM), Academic Fellow
INCEIF
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DEPOSITS MOBILAZATION
By
HAMDAN HJ IDRIS,BSc Econs, MBA ( Islamic banking & Finance)
CPTrainer (MIM)
Academic Fellow
INCEIF
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Islamic deposits usually serve two main
functions, namely:
1.Transaction function : Wadiah Dhamanahcurrent and savings account
2.Investment function :Al-Mudarabah
Investment account
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By virtue of the transactional nature ofwadiahdhamanah deposits, depositors are only interested inderiving benefits from the facility offered by the
product. The benefits shall include the ease of cashwithdrawals on call as well as protection of deposits.The bank serves as a custodian or safe-keeper to thedeposits but is allowed use them to generate incomefrom say, murabahah or ijarah financing. But financing
activities do not guarantee fixed income to the bank asit (ie bank) may incur losses arising from bad debts.
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Wadiah dhamanahdeposits however areprotected even if the bank earns nothing fromfinancing. In return for the protection, all income
earned from financing activities shall solelybelong the bank and depositors do not hold anylegal claims on banks earning. The trade-offbetween capital protection and ex-postrate of
return is one important economic principle ofwadiah dhamanahdeposits.
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That is, depositors stand to receive returns butonly as gifts (hibah). In this way, the distributionalmodel ofwadiah dhamanah does not provide
any guaranteed sum or return to the depositors.If any, returns are given without any equivalentcountervalue, say risk-taking. Wadiahdhamanahcustomers exposure to capital risk is zero. Thus,
by virtue of the principle ofal-ghorm bil ghonm,they do not deserve to receive any income orprofits from the deposits.
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hibahs are determined ex-postmeaning it is setonly when the outcome is actualized. Butactualizing outcome, say making RM100 million
profits from murabahahfinancing does notmean that the bank must or obligated (wajib) todistribute the profits. In this way, the supplycurve ofwadiah dhamanahdeposits may be a
flat one since the incentive to save does notrevolve around the rate of returns but for safe-keeping and convenience purposes.
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Investment function
But the same does not apply to the al-mudarabah investment deposits. This is because
al-mudarabah deposits are meant forinvestments with explicit agreements aboutprofit distribution and the role of capital andknowledge. Here the economic principle of risk-
return shall apply well to the contracting partiesin the mudarabah transaction between the bankand the depositors.
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The Islamic economic principle on risk-returnrelationship is none other than that adoptedfrom the legal maxim al-ghorm bil ghonm
which means that no profit can be gainedwithout taking risk. Since Islamic investmentaccount as a product is based on the
mudarabah contract (i.e. trustee partnership),incentive to place money in mudarabahdeposits must revolve around profits. It isbusiness and nothing more
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When the performance ofmudarabah depositsoutperform interest-bearing fixed deposits, morepeople are expected to place their money in theIslamic banks. But the risk associated with mudarabah
deposits is market related. Systematic risks are risks ofcapital loss due to say, economic recession and naturalcalamities that often destabilize markets and thereforeprices. They are not controllable by the contractingparties. Mudarabah deposits are not sparred from
systematic risks. Depositors can see their savingsdepleting. There is no capital protection in mudarabahdeposits. Instead, systematic risks are endogeneous inmudarabah.
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In fact, the Islamic principle of risk-return actuallypointed to the fact that risk ie ghormpredominantly refers to systematic risks.
However, mudarabah investments are alsoexposed to operational risks as human error andnegligence may jeopardize the mudarabahventure. The mudarib (ie the agent-manager) canabuse his responsibility. Thus, moral hazard is a
serious factor to account for in decision makingwhen people plan to place their savings in themudarabah deposits.
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Bearing in mind that mudarabah deposits are
exposed to both systematic and operational
risks, the decision to place savings in
mudarabah deposits can be a challenging one.
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How Deposit Insurance Works
Deposit insurance is provided to you
automatically, so you don't need to sign up for
it and you don't have to pay us to enjoy the
protection.
Deposit Insurance
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Who We Are and What We Do?
A Government agency established under the
Akta Perbadanan Insurans Deposit Malaysia
2005 to protect you against the loss of your
deposits in the unlikely event of a bank failure,
and promote financial system stability.
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It is established by the Government to
enhance the consumer protection framework
and promote financial system stability. It is not
related to or managed by general or life
insurance companies. Generally, it is a
Government sponsored scheme, although in
certain countries it is sponsored by the banks.
Contd
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The deposit insurance system in Malaysia was
launched in September 2005 and is managed
by Perbadanan Insurans Deposit Malaysia
(PIDM). PIDM is a Government agency
established under the Akta Perbadanan
Insurans Deposit Malaysia 2005.
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Benefits to depositors
Deposit insurance protection is automatic
PIDM protects depositors holding deposits
with banks
There is no charge to depositors for deposit
insurance protection
Should a bank fail, PIDM will promptlyreimburse depositors on their deposits
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Benefits to the financial system
PIDM promotes public confidence in the Malaysian financial system byprotecting depositors against the loss of their deposits
PIDM reinforces and complements the existing regulatory andsupervisory framework by providing incentives for sound risk management
in the financial system
PIDM minimises costs to the financial system by finding least cost
solutions to resolve troubled banks
PIDM contributes to the stability of the financial system by dealing withbank failures expeditiously and reimbursing depositors promptly
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With the introduction of a deposit insurancesystem in Malaysia, depositors receiveprotection for their deposits under the law.
Depositors will know how and whenreimbursement of their deposits will be madein the event of a bank failure.
Deposit insurance is recognised internationally as animportant component of a countrys financial safety net andhas been implemented in some 100 countries around theworld.
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Role and FunctionsPIDM's main functions are to:
Assess and collect premiums or fees from banks
Manage the Deposit Insurance Funds
Undertake resolution of non-viable banks
Reimburse depositors should a bank become insolvent
Comply with Shariah principles in respect of Islamic deposits
and funds
Conduct ongoing public awareness and education initiatives
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Corporate values
To support the mission and vision, PIDM adopts
five core values to shape its working culture.
Excellence and professionalism
Integrity and trustworthiness
Communication and teamwork
Respect and fairness
Financial stewardship
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Management of Deposit Insurance Fund
Since the deposit insurance system provides coverage for both
conventional and Islamic deposits, PIDM maintains and
administers two separate funds Conventional Deposit Insurance Fund
all premiums and/or other monies received by PIDM and
assets received or vested in PIDM, as well as all expenditures
incurred, in respect of conventional deposits; and
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Islamic Deposit Insurance Fund all premiums and/or other monies received by PIDM and assets received or vested
in PIDM, as well as all expenditures incurred, in respect of Islamic deposits.
PIDM will manage and invest the Funds prudently to generate a reasonable return
for PIDM while ensuring that the Funds are readily available to cover operating
costs and make payments to depositors in the event of a bank failure. The Islamic
Deposit Insurance Fund is being managed in accordance with appropriate
guidelines in line with Shariah principles.
For this reason, PIDM currently only invests its funds in safe and liquid instrumentssuch as Ringgit denominated securities issued or guaranteed by the Government
or Bank Negara Malay
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Since mudarabah deposits and incomes are notguaranteed, the bank that acts as the mudarib must beable to convince depositors that placing their money asmudarabah deposits is a good investment. It should beable to show depositors their good track records andcapacity to perform well in the mudarabah ventures.
Since mudarabah deposits are risky, depositors expectmore returns for each investment made. In fact anysuccessful mudarabah deposits should outperforminterest income derived from fixed deposits.
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Finally, the Islamic principle of deposits in
essence defies the law that guarantees the
right of creditors to interest payments. This is
because the law of depreciation must hold for
all creatures and creations of Allah. It is
common knowledge that all things in this
world will undergo wear and tear. They losevalue over time. This is a law in nature
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In Islam, Allah is the only Being that cannot
depreciate as He is the Creator and therefore
all creation of God must depreciate.
The Holy Quran says, Everything thereon is
vanishing, there remaining only the Face of
Your Lord, the Possessor of Majesty and
Generosity (55:26-27).
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In conventional economics, people will supplydeposits only when they decided to saveinstead of spending their income on current
goods and services. The decision to save, thatis postponing current consumption is muchinfluenced by the amount of money needed tocompensate them from postponing currentspending. This saving behaviour is explainedby the concept of time-value of money (TVM).
THE SAVING BEHAVIOUR OF CUSTOMERS
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Time preference indicates the extent of a familys overfuture consumption. The rationalization of interest as aprice of credit began when people believe that presentconsumption is superior to future consumption.Peopleprefer the present because the future is uncertain.They also think that present wants are more keenly feltthan future wants. Also, people think that the presentgoods possess a technical superiority over future
goods. That is, the passage of time allows the use ofmore roundabout methods of production that aremore productive
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In this way, the concept of time value of
money examined people preferences about
spending their income today or in the future.
If people prefer current consumption to future
consumption, then they are said to adopt a
positive-time preference (PTP) outlook. They
believe that current consumption brings moresatisfaction than future ones
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Therefore, people who are asked to postponecurrent consumption (i.e. creditors) must becompensated for the benefits the pleasure
foregone today. They do so because it is firmlybelieved that the future is uncertain and risky,thus one may not know how much utility heor she can enjoy out of future spending asopposed to current spending. In a nutsell, thePTP concept says that 1 dollar today is worthmore than 1 dollar tomorrow.
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However, some people do not believe that
future spending is inferior to current
spending. Instead they are truly convinced
that they can derive more satisfaction or
utility if money is spent not now but in the
future. By believing so, the decision to save is
based on the negative time preference (NTP)model.
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For example, when people are not surewhether they can secure permanent orlifetime job, spending all their money today is
not a good idea at all. Without a job in thefuture, money becomes a scarce commodityand thus spending them during difficult timeyields higher utility. The NTP concept believesthat 1 dollar today is worth less than 1 dollartomorrow which is opposite to the positivetime preference (PTP) model.
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Finally, there are also some people who feelindifferent about spending their money todayor tomorrow. They believe that money spent
today always yield the same level of utility asmoney spent tomorrow. This is the neutraltime preference model. People with neutraltime preference do not care less about whento spend.
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Conventional economics actually believed that
people prefer current consumption to future
consumption. This is the dominant view in
global financial markets today. This is only
because they believe the future as uncertain
and people have no idea what the future has
to offer them !!!
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The belief that current spending generates more
satisfaction than future spending (ie PTP) paves
the way for the rationalization of interest-rates as
the reward for saving. In other words, peoplewho save will forego the satisfaction derived from
current consumption. The same level of
satisfaction cannot be realized when they spendthe same money, say one year from now.
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The saving behaviour in conventional economics istherefore dependent on the reward or compensationfor waiting ie postponing current consumption. Byvirtue of positive time preference (PTP), creditorsdemand interest while debtors pay interest. But thesame cannot apply to saving behaviour in Islam.Although Islam has to some extent recognizes theconcept of positive time preference, it does not
implicate or bring about the payments and receipts ofinterest as evident in conventional economics.
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THEFACTTHAT ISLAMFORBIDSINTERESTAS RIBAIT
DOESNOTMEANITISAGAINSTTHECONCEPTOF
POSITIVE-TIMEPREFERENCE (PTF). INDEED, ISLAM
HASGIVEDUERECOGNITIONTO PTF ASEVIDENTIN
THESAYINGSOF PROPHET MUHAMMAD (PBUH). THE
PROPHET (PBUH) SAID, VIRTUOUSARETHEYWHO
PAYBACKTHEIRDEBTSWELL.
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INTHEABOVEHADITH, DEBTORSAREENJOINEDTOPAYMORETHANTHEPRINCIPLELOAN (QARD) RECEIVED. ONEMAYASKWHYTHISISSO? ONEREASONISGRATITUDE.
THEDEBTORISTHANKFULFORTHELOANHEGETSANDBENEFITEDFROM. HEKNEWTHECREDITORHASFORGONEHISCURRENTCONSUMPTIONFORTHESAKEOFHELPINGHIMWITHTHEMONEY. HEALSORECOGNIZESTHATTHE
CREDITORHASRELINQUISHEDTHEOPPORTUNITYTOEARNRETURNSFROMLOANGIVENAWAY. THESERETURNSAREUNKNOWNASTHEYARESUBJECTTOBUSINESSRISK.
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INTHISMANNER, ONEDOLLARTODAYISSEENMORE
VALUABLETHANONEINTHEFUTURE. ASATOKENOF
APPRECIATION, THEDEBTORPAYSMORE. UNLIKERIBA,
THEINCREMENTALAMOUNTISNOTSTATEDUPFRONT
ANDDOESNOTCONSTITUTEALEGALCLAIMOFTHE
LENDINGPARTY.
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In Islam, therefore recognizing PTP does notimply awarding a contractual increase on theprinciple loan. Any increase from an Islamic
loan (qard) can only be stated at maturity andnot upfront as normally practiced in interest-bearing loan contract. The increment which isvoluntary is set by the debtor. It is given awayout ofgoodwill. In contrast, the incrementfrom riba loans is contractual and set by thecreditor.
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In Islamic economics, spending behaviour of
household is expected to influence their saving
behaviour as well. For example, consumers who
practice moderation (zuhud), will secure moresurplus income ie. savings compared with those
who are extravagant (tadrif). The moderation
behaviour is approved by Islam and applicableonly on the consumption of luxuries (kamaliyat).
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Under a zuhudlifestyle, Muslims live a simple lifealthough they can afford luxuries. While Islamdoes not prohibit Muslims to consume luxury
goods, Muslims are free to choose their lifestyles.They can live a simple life or lead a luxurious oneas long as they do not fall into debt or amasswealth from illegal sources. They too must spend
on basic necessities (daruriyat) and make spendwell for their families.
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Savings in Islam does not mean keepingmoney as idle balances. All savings must beinjected back into circulation. It must be
invested. If money is kept as idle balances,people who need money for working capitalor to purchase plant and machinery will notbe able to do so. Without money to spendbusiness will cease to exist and the economywill fall into a recession with implications ongrowth and employment
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Savings can be put into many financial
products. People can save by buying stocks
and bonds or unit trusts. They can also save by
buying insurance policy. But usually most
people save in bank deposits.
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The objective of savings is best described in
the Quranic story of Prophet Yusof(may God
be pleased with him) where the importance of
savings is highlighted in its true color. Surah
Yusof (12:3-49) tells the story of a Pharaoh in
Egypt who had a strange dream about seven
fat cows. He also saw in his dream sevengreen ears of wheat and seven withered or
ears of wheat.
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He asked his advisors to interpret the dream,
but no one is good enough to do so. Prophet
Yusuf who is well known for his honesty and
special ability to interpret dreams was brought
to see the Pharoah.
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In his interpretation about the dream, Prophet Yusufenlightened the Pharoah about the future problems ofEgypt. He also suggested the remedies. He said that Egyptwill enjoy seven years of prosperity with abundant
harvests. In modern times, this may be taken to mean higheconomic growth. Prophet Yusof advised the people ofEgypt to cultivate their crops diligently and use areasonable amount for food and sustenance while storingthe remaining surplus. This is because when prosperitycomes to an end, Egypt will suffer from serious drought for
seven long years when no crops would grow. But with thereserves in store, the people of Egypt could survive theseven bad years.
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Prophet Yusuf cautioned the Pharoah not toconsume all the reserves but to leave the bestportions for seeds to cultivate later when rains
filled the Nile. In other words, people must setaside money for savings and investment. Topostpone current consumption to make way forproduction of future goods was one of the main
messages that Prophet Yusuf wanted the Pharaohto do for his people.
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The incentive to save can also be examined at
the micro level of Muslim behaviour. In Islam,
savings will always means surplus income to
be placed for investment purposes, thus
keeping money in circulation. All savings must
be invested again in the economy. Otherwise
it is tantamount to hoarding (ihtikar)
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The basic idea of savings is to avoid hoarding
money as the latter is prohibited in Islam.
When people hoard money, there is less
currency around to use. It will frustrate
business transaction and put production to a
halt since there is no money available to pay
suppliers and workers. Hoarding money willput money out of circulation and therefore
reduces sale and purchases.
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When people hoard money for fear of losingthem, they must know that the idle money issubject to Zakat. For example, Ali places his$20,000surplus in his safe-deposit buried underhis house. At the end of the year, he must pay 2.5per cent zakat ie $500 from the idle balances.Zakat in this manner is a penalty for the hoardingbehaviour where he will find his money to fall in
value to $19,500. If the money is keep idle foryears, it will soon depreciate in nominal valueand Ali losses his money to his own ignorance.
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For this reason, Muslims must save and invest
their surpluses so that the value of the savings
increases over time despite the payment of
zakat. Zakat on idle balances is penalty on
hoarding behaviour and eventually leads to
the depreciation of wealth if kept unchecked.
In this way, zakat both purifies wealth as wellas penalizes those who choose to hoard
wealth.
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To prevent this unnecessary depreciation, zakatwill force people to spend their cash balanceseither for nafaqah, sadeqah or investment ie.savings in bank deposits, unit trust funds orinvestments in projects based on the partnershipprinciples. Doing so will allow money to circulatein the economy, which then help reduce shortfallin business spending and capital formation For
example, when money is put in circulation viainvestment, zakat income and individual wealthwill both increase
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Case (1) Hoarding
Idle cash (i.e. wealth/mal) at year end = $20,000
Zakat = 0.025 x $20,000 = $500
Cash balances (wealth) after Zakat = $19,500
Case(2) Savings
Cash invested = $20,000
Profit = 10% = $2,000
Wealth/mal = $22,000
Zakat = 0.025 x $22,000 = $550
Wealth after zakat = $21,450.
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From the above illustrations, it is clear that in
Islam wealth is not an end by itself. Wealth is
a means to attain happiness (saada) and
success (falah). To do so, Islam enjoins man to
spend it well (infaq) and not to indulge in
hoarding. By spending, it can mean many
things such as:
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Consumption of basic necessities (daruriyat)
Consumption of comfortables (hajiyat)
Consumption of luxuries (kamaliyat) Savings in bank deposits, mutual funds, stocks,
properties etc.
Sadeqah as amal jariah (continous gooddeeds)
Zakat obligation
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To attract people to save in Islamic bank
deposits, the banking firms are expected to
invest deposits into projects with high yield
potentials. If Islamic deposits can outperform
investments in unit trusts and other equities
products, it should be able motivate more
people to save. This will increase capitalformation much needed for economic growth
and development.
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Savings in Islam does not mean keeping
money as idle balances. All savings must be
injected back into circulation. It must be
invested. The role of zakat and the underlying
motivations for savings in Islamic economics
are also discussed in this topic,
Summary
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Differences between conventional and Islamic deposits
There are distinctive differences for deposits receivedunder conventional banking and Islamic bankingsystem. The main criteria is the avoidance of interestor usury by Islamic banks throughout its activities.
Although usually the deposit operations and facilitiesare very similar, the differences lie in severalunderlying principles, such as follows:-
COMPARATIVE ANALYSIS BETWEEN ISLAMIC AND
CONVENTIONAL DEPOSITS
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Deposit contract
The deposits received under conventional banks
are based on borrowing contract, i.e. banksborrow the money (deposit) from depositors fora stipulated period of time, payable uponmaturity with the promised interest.
Meanwhile, under Islamic banks, deposits are
received under either one of these two contracts
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a Wadiah contract Wadiah, literally means safeguarding of
assets, where banks received the depositors
money for safekeeping until withdrawalrequest is made.
Although under this contract the banks areallowed to use the deposits for investment
activities, they not obliged to give return todepositors. Yet they are allowed to give it on avoluntary basis or known as hibah.
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Mudharabah contract
Mudharabah deposits, are deposits made purportedly forinvestments with the bank based on an agreed profit-
sharing percentage. The bank acting as investmentmanager, invests the money into permitted investmentsand Islamic financing activities, realise profits and share theoutcomes with depositors based on the ratio agreed.Therefore, for depositors the actual return on deposits isknown only upon maturity (or upon periodical payment ofprofit, e.g. monthly). The return varies according to theactual outcome of investments, though some of them arerelatively predictable.
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Return on deposits Under conventional banking, the return or interest on deposits is
fixed and guaranteed regardless of the actual outcome oninvestments.
Under Islamic banking, the return or profit to depositors is subjectto the actual investment outcomes. The profit on investments isshared based on the agreed profit-sharing ratio, say 70:30 fordepositors and banks respectively.
Therefore, under Islamic banking, depositors and banks are equalpartners who would definitely share any windfalls or losses, ifany, derived from the investments.
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Risk-sharing
Under Islamic banking, the parties to
Mudharabah contracts are entitled to equal risksharing. Therefore, the risk is higher fordepositors under Islamic banking as compared toconventional banking, and yet providing
opportunity for higher rewards should theinvestments yields higher profit.
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In summary, the deposits under conventionalbanking has matured and evolved quitesignificantly especially in terms of its operationsand facilities in pace with the technology and
Internet developments.
Compared to other investment avenues; e.g. unittrusts, capital market, commodity market;deposits are still attractive due to its liquidity,low-risk and payment facilities.
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Deposits are defined as funds placed in a financial institution
by economic surplus units such as households, corporations,
investors and government. These funds can either be from
cash, claims to money, like checks placed in depositors
accounts, bank loans or money from investments (Van Dahm,1975). Financial institutions such as commercial banks,
merchant banks, finance companies and discount houses are
granted licenses by Bank Negara Malaysia, the central bank, to
accept deposits from their customers.
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These institutions are called deposit-taking
institutions. Other financial institutions that
do not comply with the definition in the Act
are non-deposit taking institutions and hence,
are prohibited from taking deposits from the
public. Examples of non- deposit taking
financial institutions are factoring or leasingcompanies.
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deposits represent customers savings or their
financial assets (Deposit creation). By
depositing money in a bank, the customers
expect the bank to safeguard their savings, to
utilize them into productive investments for a
satisfactory rate of return or to enable them
to facilitate their payment transactions.
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At minimum, a customer expects that he gets
back a dollar that he puts in a bank and the
bank has a contractual obligation to honor the
claim on demand or upon withdrawal.
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To a bank, either operating conventional
banking or Islamic banking, deposits is its
main source of funding for which it uses to
produce income. Some literature has cited
that deposits contribute 75 percent of a
banks total fund (Rose, 1997).
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Banks use customers deposits mainly to giveout loans/financing to deficit economic unitsor borrowers. Besides financing, banks also
mobilize deposits by purchasing tradingsecurities, investments and maintain some ascash in hand to meet withdrawals on demand.The larger the amount of deposits a bank
receives from its customers, the better is itscapacity to give out financing and the higher isthe profit income.
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Because of this positive relationship between
deposits, loan and interest income, banks are
competing intensively and aggressively among
other deposit-taking institutions to obtain
higher deposits by offering attractive deposit
rates or rates plus other appealing packages
depositors. Islamic banks are equallyaggressive in attracting additional deposits.
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To the economy, bank deposit is the main source of money
supply that can be mobilized to generate economic growth
and wealth creation. By giving out loans to borrowers and
investors, banks create credits (Abdul Gafoor, 1996). Banks
ability to create credit enable them to supply money toborrowers, suppliers and investors to conduct economic
activities, such as opening up plants, funding their working
capital requirements, financing their business expansion or
increasing their investments.
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Such economic activities create job
opportunities, increasing productivity and
income, which subsequently lead to wealth
creation in the economy. For interest-bearingdeposits, interest rate is very important. When
market interest rates rise, so would deposit
rates and this would attract higher deposits toflow into the economic system.
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In the philosophy of Islamic finance, money is
required to be mobilized in productive
investments. There should not be idle money.
Whoever holds idle cash or demand depositsexceeding the nisab over a year, must pay
zakat.
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Deposits are equally important to Islamic
banks as a source of funds as in conventional
banks. But unlike its counterparts, Islamic
banks need to comply to Shariah principleswhich prohibit any payment of interest or a
fixed return on deposits
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To attract idle cash or deposits from the public
for sustaining their financing activities and
wealth creation, Islamic banks are offering
deposits whose returns are based on wadiah,
mudharabah or qard hasan.
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The mudharabah or profit-loss sharing basis of
Islamic banking is conceived as more
production oriented and growth promoting
than its interest-based counterparts. Further,the replacement of interest with profit-loss
sharing principle is also said to increase
investment opportunities in the economy(Islamic Bank Bangladesh Limited, 2006).
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Three main concepts of deposits will be
discussed here. These are deposits as a source
of funds, as liabilities of banks and the returns
from deposit mobilization.
CONCEPT AND THEORIES ON DEPOSITS
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A bank has three sources of funds namely (i) bank
capital, (ii) banks reserves or retained earnings and
(iii) deposits. Among the three sources, depositsform the main component of a banks source of
funds.
Source of Funds
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The basic concept is that deposits are the
foundation upon which banks thrive and grow.
They provide the most raw materials for bank
financing /loans and other investments (Rose,2002: 387)
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Despite increasing diversification towards fee-
based income from projects and financial
advisory services, banks are relying greatly on
interest-bearing deposits and assets togenerate interest income and profits ( Rose,
1997 ). Hence, banks compete aggressively to
source more deposits from its customers,which can be government, suppliers,
corporations, investors or households.
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Deposit is also as an integral source of funds
for Islamic banking. However, unlike
conventional bank, an Islamic bank cannot use
its deposits to make profits. This is becauseunder Syariah principles, one cannot trade on
non-commodity items and money is treated as
a non-commodity item.
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Traditionally, a bank borrows or utilizes a
large proportion (approximately 80%) of its
customers deposits to give loans to
borrowers. A banks deposits, then, are the
amounts that it owes to its customers (Money
and Banking). Hence, deposits are the
principal liability of banks.
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The significance of this conduct is that in the
event that the bank is liquidated, the
depositors have the first claim on the
proceeds of sale of the banks assets (Rose,
2002: 119).
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A specified amount of the deposits is allocated
to meet the statutory reserve requirement
ratio (SRR) imposed by a central bank. By
definition, SRR is the percentage of depositsthat commercial banks must maintain as
required reserves (Madura, 2003, BNM
Statistical Bulletin, 2006) in a central bank.
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This item is recorded as Statutory deposits
with Central Banks in the asset side of the
Balance Sheet of a commercial bank). For
many countries, SRR ratio is sometimes usedas monetary tool to control money supply in
the economic system.
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The ratio varies between countries. ForMalaysia, SRR is currently set at 2%,. BesidesSRR, a commercial bank may utilize the
remaining amount of deposits to purchaseinterest-bearing short-term money marketinstruments (which are termed as tradingsecurities) and for investments (stocks, shares
and medium to long-term securities).
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Similar to conventional banking, deposit of an
Islamic bank is a liability. The concept of
deposit as borrowing in Islamic banking
started during the leadership of Ar-Zubair al-Awwan. (Sudin Haron, 2005). Ar-Zubair
treated the money entrusted to his father for
safe keeping as borrowing.
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Under this concept, he was able to use themoney for economic purposes. The depositbecame safer since as a borrower, Ar-Zubair
argued that he is responsible to pay back themoney to the owner. The change in theconcept of deposit from trust (wadiah) toborrowing consequently enabled the people
to use the money to operate business basedon the principles ofqirador mudarabah aswell as to share the profits from the business.
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Similar to conventional bank, not 100 percent
of the deposit amount is lent out to
borrowers. An Islamic bank is still subjected to
SRR ratio .The remaining amount is utilized topurchase liquid assets and investment and
Islamic trading securities.
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The third concept related to deposit is return. -
depositors are rewarded with a pre-determined
rate of return by the conventional bank. The rate
of return depends on the type of deposits, thedeposit amount, the length of the maturity
periodsand the banks cost of funds. In
conventional banking, market interest rate is very
instrumental in determining the deposit rate.
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The concept of return for depositors in Islamic banking is different from
conventional banking. Based on Syariah principles, ribaor interest is
prohibited and a predetermined fixed rate or a guaranteed return on
investment is strictly not acceptable. Al-Quran states that:
That which you give as interest to increase the peoples wealth
increases not with Allah but that which you give in charity, seeking the
goodwill of Allah, multiplies manifold
(Surah
al-Rum, verse 39)
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The underlying trust in prohibiting a fixed or
guaranteed return on deposit is that there is
an existence of an element of uncertainties in
any project or investment ventures financedby the bank from mobilization of its
customers deposits.
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The profit and loss sharing (P-L) basis is a basis
of return where the bank shares business risks
with the borrower in return for shares in the
profits of the business venture. It is based onmudharabah dan musyarakahprinciples.
Profit and loss sharing concept is a unique
feature of Islamic banking and is increasinglygetting popular among investors especially in
times of economic uncertainties.
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Deposit accounts and Principles Applied inReturn Computation
Account Type
Principles Applied
Current Account qard hasan or wadiah
Saving Account wadiah,mudharabah or qard hasan
Investment Account pre-determined share of profits
Islamic Negotiable Certificate of Deposit mudharabah or qard hasan
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The fixing in advance of a positive return isstrictly prohibited by Syariah (Cert : 47). Therationale for this prohibition of a pre-determined
rate of return is explicitly expressed by Imam Razias quoted in Muhamad Umar Chapra, (2005: 52):when asked what was wrong in charging interestwhen the borrower was going to employ the
funds borrowed in his business and thereby earna profit, his answer is as follows:
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While the earning of profit is uncertain, the
payment of interest is pre-determined and
certain. The profit may or may not be realized.
Hence, there can be no doubt that thepayment of something definite in return for
something uncertain inflicts a harm
(Razi, op.cit:87).
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Islam only recognizes return on capital
(deposits) after all costs have been accounted
for, and it may be positive or negative since it
depends to a great extent on factors beyondthe control of entrepreneur. Hence, Islam
prohibits a pre-determined positive rate of
return in the form of interest but seeks returnin a profit and loss sharing basis (Muhamad
Umar Chapra: 57).
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Below are two commonly used principles
governing deposits of an Islamic bank.
(a) Wadiah Wadiah is quite similar to savings account in conventional
banking where a depositor places or deposits his money in an
Islamic bank. In doing so, the customer trust his banker to
manage his savings in the most professional manner, that is
the bank should keep proper records of its clients accountsand investing his savings in profitable, halalventures.
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The bank has to secure the agreement of its
depositor to utilize the deposit and be
responsible for its risks management and
possible outcomes. Hence, the bank acts acustodian to the customers deposits and
undertakes the commitment (or guarantees)
to return the customer his savings on demand.
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. However, the bank is not bound to pay its depositor with a
fixed return but in line with the Syariah concept of profit
sharing, the Islamic bank may reward or hibah part of the
benefits to the depositor for the use of his money. The reward
may be in the form ofcash or in kinds. In Malaysia, it is acommon practice of an Islamic bank to declare a percentage
of the banks profit as hibah to Al Wadiah depositor. This
practice allows an Islamic bank to contribute efforts in
creating and distributing wealth to people or the ummah atlarge.
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Mudharabah
Mudharabah is a principle most commonly
used in Islamic finance and banking. Theprinciple suggests that a person that has
capital will give his capital to another person
that he trusts to run a business venture. Hewill not interfere with the business but rathergive the partner the independence to run it
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In return, the partner will return back the
amount of capital that he borrowed plus a
share of the profit at the end of the business
period. In essence, both parties have a rightto the business profits because one party
provides the capital and the other, his
expertise.
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In the context of deposit, the depositor
provides capital to an Islamic bank to run
banking operations. For the deposit
mobilization, the depositor is entitled to ashare of the profits agreed by the depositor
and the bank. The share can be a third or a
half of the profits depending on prioragreement between the depositor and the
bank.
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This agreement is set at the beginning of thecontract. However, the bank does notguarantee the depositor that the business
must be profitable although the bank willconduct the investment on best efforts basisto ensure it is profitable. Nevertheless, in theevent of a business failure, the depositor will
bear the losses.
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The Islamic economic principle on risk-return
relationship is none other than that adopted
from the legal maxim al-ghorm bil ghonm
which means that no profit can be gainedwithout taking risk. Since Islamic investment
account as a product is based on the
mudarabah contract (i.e. trustee partnership),incentive to place money in mudarabah
deposits must revolve around profits
THE ECONOMIC THEORIES RELATED TO DEPOSIT
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The reduction of interest rates will now makemany investment opportunities more viable. Thisis because, decision to invest usually deals withcomparing cost of borrowings (i) and the projectsexpected rate of return (r) also known as theinternal rate of return (IRR). For example, when r= 7 per cent while i = 9 per cent, cost of
borrowing is higher than the projects expectedreturn, firm will not borrow and the project willnot be undertaken as it will only lead to loss.
THE ECONOMIC THEORIES RELATED TO DEPOSIT
Contd
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But when the central bank increases the moneysupply by making more excess reserves availableto make loans, interest rates will decrease. If itfalls from 9 per cent to 5 per cent, then manyprojects at r = 7 per cent are now viable since r >i.
Case 1: i > r Investment decision : Do not
invest Case 2: i < r Investment decision: Invest
Contd
Contd
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total deposit created by the banking system froman initial deposit from the formula given below:
TD = D / R (1) Where:
TD: Total deposits created
D: Initial deposit R: Statutory reserve requirement
Contd
Contd
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Suppose statutory reserve requirement is set
at 5 per cent and initial deposit of $100
million. Total deposits created by the banking
system amounts to $2 billion.
$2000 million = $100 million / 0.05
Con td
Contd
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MD = TD / D (2)
Where:
MD : Deposit multiplier
TD: Total deposits created
D: Initial deposit
Con td
Contd
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Given TD = $2000m and D = $100m, Deposit
(money) multiplier in the above example is 20.
That is:
$2000m / $100m = 20 ( DM)
Con td
Contd
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The deposits multiplier says that total deposits
will increase by the multiple of 20 from a
given initial deposit. If initial deposit is $500m,
then the banking system can create up to$10,000 million total deposits or10 b deposits
!
Con td
The process of deposit creation
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The process of deposit creation makes a lot of assumptions.
The simple model of deposits creation assumes the
following:
Transactions conducted through the checking system only.
That is, bank loans are given in checkable. Borrowers pay theirpurchases using checks as well.
Excess reserves are used to make loans only. That is, no
investments in securities. Banks also do not keep idle balances
i.e. excess reserves = 0
The process of deposit creation
Contd
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117
All deposits are demand deposits or checkable
deposits,
There are no leakages i.e. customers do not
keep idle cash in their pockets for
transactional purposes.
Con td
Contd
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In this sense, banking companies posses
power to create money as they create
deposits. The central bank can do so by
printing money, that is coins and currency alsoknown as the monetary base or high-powered
money.
Con td
Contd
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The central bank control money creation in
the banking system by manipulating monetary
policy instruments such as reserve
requirement to affect the amount of excessreserves available to the banks.
Con td
Contd
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Reserves means cash not utilized in the bank.
Under a fractional banking system, once a
bank receives deposits, say $100m, the asset
side will record a new total reserves (TE)amounting to $100m. Total reserves can be
broken down into two, namely the required
reserves (RR) and excess reserves (ER). Thus TE = RR + ER (3)
Con td
Contd
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Required reserves (RR) do not generate
interest income. The same applies to excess
reserves (ER). Usually the bank as a profit
maximizing firm will make sure that the excessreserves are converted into loans/financing so
as to earn interest/profit.
Con td
Contd
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The central bank can influence the deposit
multiplier and hence money supply by
manipulating monetary policy instruments
which in turn will affect the amount of excessreserves (ER) available in banks. For example,
if the central bank is expansionary. It will
reduce the reserve requirement (RR), to say 3per cent, thus increasing the excess reserves
(ER) in banks
Con td
Deposit creation in Islamic banking
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123
The process of deposit creation in Islamic bankingwill be similar with conventional banking when itruns on a fractional banking system and adoptfiat money as a legal tender. Under a fractionalbanking system, the bank will put aside a fractionof deposits as reserves (i.e cash balances) anduses the remaining balance (ER) to in its financingactivities such as al-bai bithman jil, murabahah,and ijarah thumma al-bay.
Deposit creation in Islamic banking
Contd
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The conventional system uses the contract ofdebts to mobilize deposits that gives them theright to use the deposits to make loans. The sameapplies for Islamic banks as they apply thecontract ofwadiah dhamanah and al-mudarabahto mobilize deposits. Both contracts allow thebank to use deposits to finance its investmentactivities. In this way, the contracts of Islamicdeposits make way for Islamic banks to adoptcurrent fractional banking system.
Con td
Contd
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The process of money creation in Islamic bankingsystem will make assumptions similar to theconventional system. One difference is thatIslamic banks do not make loans to customers butcontracted their purchases under the contract ofdeferred sale that eventually amounts to creditfinancing. The other difference is that Islamicbanks only use al-bai-bithaman ajil(BBA)contract in its deferred sale products.
Con td
Contd
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An understanding about the Islamic economic
principles of deposits is a significant element
in the business of Islamic banking since the
demand and supply of Islamic deposits (i.e.the market for Islamic deposits) are expected
to observe the rules and regulation ordained
by Allah swt.
Con td
Contd
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By doing so, the market for Islamic deposits is
expected to be free from any form of unfair
and inequitable transactions. It will generate a
deposit market where justice prevails fromwhich people will gain benefits (manfaat) and
utility from the services rendered.
Con td
Contd
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what motivate people to
supply deposits?
Con td
Contd
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Economic principles are guidelines that peopleuse in their economic decision making. InIslam, these principles are derived from the
Quran and Sunnah. They are in essence a bodyof knowledge. Economics primarily deals withthe problem of choice arising from scarcity. Tomake the correct choice man is expected to do
so with knowledge.
Con td
Contd
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Making a choice without knowledge can mean
choosing by way of conjecture and guesswork.
It can lead to misallocation of resources and
adversely affect economic growth anddevelopment. Rational choice alone is
inadequate since reason has its shortcomings.
Con td
Contd
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Making a choice using reason is good but
using reason alone as the source of knowledge
can lead to bad choices. This is because, man
who use reason alone can never be free fromtemptations and evil desires and in many
cases will make them irrational instead.
Con td
Contd
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The same applies in shopping behaviour. With
huge discounts on offer, people buy things
they dont need !
Con td
Contd
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To guide mankind into make the correct choice, the Islamic
economics says that choice must be made on the basis of
knowledge revealed by Allah swt. This knowledge is
therefore divine in nature. It teaches man about right and
wrong, about reward and punishment and about therelationship between man and Allah as well as among man.
This knowledge is given in the Quran and the Hadith. Reason
and experience are also useful but both must submit to the
supremacy of revelation (wahy).
Con td
Contd
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Islamic economic principles are predominantlybased on revelation. But some are based on
common sense and reason (aql). Choosing what
goods to produce requires knowledge from Allah
as this will define the permissible (halal) itemsfrom the prohibited (haram) items. But how
much one should produce and using what
technique of production do not require theQuran to give answers. This can be readily
handled by reason and factual evidence
Con td
Contd
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In the economic life, there are a number ofIslamic principles relevant for Islamic bankingapplications. These are given as follows:
The contract (aqd) on which the depositproducts are engineered must be valid (sahih).
The income generated from the investment ofdeposits must contain some degree ofa) risk-
taking (ghorm) b) work and effort (kasb) and c)responsibility (daman)
Con td
Contd
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In the economic life, there are a number ofIslamic principles relevant for Islamic bankingapplications. These are given as follows:
The contract (aqd) on which the depositproducts are engineered must be valid (sahih).
The income generated from the investment ofdeposits must contain some degree of a) risk-
taking (ghorm) b) work and effort (kasb) and c)responsibility (daman)
Con td
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legal maxims are divine principles that one can use in making
a ruling about the behaviour of the believer (mukallaf). These
principles are constructed by Muslim jurists and are based on
explicit Quranic verses as well as the Hadith. One example is
that profit must be accompanied with responsibility(al-
kharaj bil-daman). Another is about risk-return relation - no
reward without risk (al-ghorm bil ghonm). Since the marketfor deposits consists of the banking firm and depositors, it is
important that the decision to supply deposits by depositors
and the decision to mobilize deposits by banksare made on
the basis of the legal maxims.
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When Allah swt prohibits riba, it implies thatprofits arising from loans are unlawful(haram). This is because profits from loans are
both fixed and collateralized. So it only favourthe lending party who will receive profitswithout taking any risk. By doing so, itintroduce injustice into the business since
borrowers must pay up even though they arenot capable of doing so, say due to loss of jobor declining earning capacity.
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In the conventional deposit market,particularly in the supply of deposit - a bankactually borrow from the depositors at a fixed
interest rate. In other words, depositors gavethe bank a loan (qard) with a fixed interestpayment. This payment is an interest expenseand constitutes a cost to the bank. It also riba
as deposits are created out of a loan (qard)contract between the bank and thedepositors.
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In theory, the higher the interest rates the
higher is the supply of deposits. People are
motivated to postpone current consumption
when the compensation for doing so isattractive. This positive relationship between
supply of deposits and interest rates actually
reveal the behaviour of the economic man
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Islamic deposits usually serve two main
functions, namely:
Transaction function : Wadiah Dhamanah
current and savings account
Investment function :Al-Mudarabah
Investment account
Contd
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By virtue of the transactional nature ofwadiah dhamanah deposits, depositors areonly interested in deriving benefits from the
facility offered by the product. The benefitsshall include the ease of cash withdrawals oncall as well as protection of deposits. The bankserves as a custodian or safe-keeper to the
deposits but is allowed use them to generateincome from say, murabahah or ijarahfinancing
Contd
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That is, depositors stand to receive returns butonly as gifts (hibah). In this way, the distributionalmodel ofwadiah dhamanah does not provide anyguaranteed sum or return to the depositors. Ifany, returns are given without any equivalentcounter value, say risk-taking. Wadiahdhamanahcustomers exposure to capital risk is zero. Thus,by virtue of the principle ofal-ghorm bil ghonm,they do not deserve to receive any income orprofits from the deposits.
Contd
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In economics, hibahs are determined ex-postmeaning it is set only when the outcome isactualized. But actualizing outcome, say makingRM100 million profits from murabahah financingdoes not mean that the bank must or obligated(wajib) to distribute the profits. In this way, thesupply curve ofwadiah dhamanah deposits maybe a flat one since the incentive to save does notrevolve around the rate of returns but for safe-keeping and convenience purposes.
Contd
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Since mudarabah deposits and incomes are not guaranteed,the bank that acts as the mudarib must be able to convince
depositors that placing their money as mudarabah deposits is
a good investment. It should be able to show depositors their
good track records and capacity to perform well in themudarabah ventures. Since mudarabah deposits are risky,
depositors expect more returns for each investment made. In
fact any successful mudarabah deposits should outperform
interest income derived from fixed deposits.
Contd
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In this way, the concept of time value ofmoney examined people preferences about
spending their income today or in the future.
If people prefer current consumption to futureconsumption, then they are said to adopt a
positive-time preference (PTP) outlook. They
believe that current consumption brings moresatisfaction than future ones.
Contd
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Therefore, people who are asked to postponecurrent consumption (i.e. creditors) must becompensated for the benefits the pleasureforegone today.. They do so because it is firmly
believed that the future is uncertain and risky,thus one may not know how much utility he orshe can enjoy out of future spending as opposedto current spending. In a nutsell, the PTP conceptsays that 1 dollar today is worth more than 1dollar tomorrow.
Contd
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However, some people do not believe thatfuture spending is inferior to currentspending. Instead they are truly convinced
that they can derive more satisfaction orutility if money is spent not now but in thefuture. By believing so, the decision to save isbased on the negative time preference (NTP)
model. The NTP concept believes that 1 dollar today is worth less than 1 dollar
tomorrow which is opposite to the positive time preference (PTP) model.
Contd
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Finally, there are also some people who feelindifferent about spending their money todayor tomorrow. They believe that money spent
today always yield the same level of utility asmoney spent tomorrow. This is the neutraltime preference model. People with neutraltime preference do not care less about when
to spend.
Contd
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Conventional economics actually believed thatpeople prefer current consumption to future
consumption. This is the dominant view in
global financial markets today. This is onlybecause they believe the future as uncertain
and people have no idea what the future has
to offer them
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Changes in tastes and preferences or theprice-level may alter and reduce the level ofutility of happiness derived from future
consumption. On the contrary, when peoplebuy goods today, they can instantly enjoy theutility derived from spending. In this way, onedollar today is worth more than one dollar
tomorrow.
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The belief that current spending generates moresatisfaction than future spending (ie PTP) paves
the way for the rationalization of interest-rates as
the reward for saving. In other words, peoplewho save will forego the satisfaction derived from
current consumption. The same level of
satisfaction cannot be realized when they spend
the same money, say one year from now.
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The saving behaviour in conventional economics is thereforedependent on the reward or compensation for waiting ie
postponing current consumption. By virtue of positive time
preference (PTP), creditors demand interest while debtors pay
interest. But the same cannot apply to saving behaviour inIslam. Although Islam has to some extent recognizes the
concept of positive time preference, it does not implicate or
bring about the payments and receipts of interest as evident
in conventional economics.
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THEFACTTHAT ISLAMFORBIDSINTERESTAS RIBAITDOESNOTMEANITISAGAINSTTHECONCEPTOF
POSITIVE-TIMEPREFERENCE (PTF). INDEED, ISLAM
HASGIVEDUERECOGNITIONTO PTF ASEVIDENTINTHESAYINGSOF PROPHET MUHAMMAD (PBUH). THE
PROPHET (PBUH) SAID, VIRTUOUSARETHEYWHO
PAYBACKTHEIRDEBTSWELL.
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INTHEABOVEHADITH, DEBTORSAREENJOINEDTOPAYMORETHANTHEPRINCIPLELOAN (QARD) RECEIVED. ONEMAYASKWHYTHISISSO? ONEREASONISGRATITUDE.THEDEBTORISTHANKFULFORTHELOANHEGETSANDBENEFITEDFROM. HEKNEWTHECREDITORHASFORGONEHISCURRENTCONSUMPTIONFORTHESAKEOFHELPINGHIMWITHTHEMONEY. HEALSORECOGNIZESTHATTHECREDITORHASRELINQUISHEDTHEOPPORTUNITYTOEARNRETURNSFROMLOANGIVENAWAY. THESERETURNSAREUNKNOWNASTHEYARESUBJECTTOBUSINESSRISK.
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INTHISMANNER, ONEDOLLARTODAYISSEENMOREVALUABLETHANONEINTHEFUTURE. ASATOKENOF
APPRECIATION, THEDEBTORPAYSMORE. UNLIKERIBA,
THEINCREMENTALAMOUNTISNOTSTATEDUPFRONTANDDOESNOTCONSTITUTEALEGALCLAIMOFTHE
LENDINGPARTY.
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IN ISLAM, THEREFORERECOGNIZING PTP DOESNOTIMPLYAWARDINGACONTRACTUALINCREASEONTHEPRINCIPLELOAN. ANYINCREASEFROMAN ISLAMICLOAN (QARD) CANONLYBESTATEDATMATURITYANDNOTUPFRONTASNORMALLYPRACTICEDININTEREST-BEARINGLOANCONTRACT. THEINCREMENTWHICHISVOLUNTARYISSETBYTHEDEBTOR. ITISGIVENAWAY
OUTOFGOODWILL. INCONTRAST, THEINCREMENTFROMRIBALOANSISCONTRACTUALANDSETBYTHECREDITOR.
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In Islamic economics, spending behaviour ofhousehold is expected to influence their saving
behaviour as well. For example, consumers who
practice moderation (zuhud), will secure moresurplus income ie. savings compared with those
who are extravagant (tadrif). The moderation
behaviour is approved by Islam and applicable
only on the consumption of luxuries (kamaliyat).
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Under a zuhudlifestyle, Muslims live a simple lifealthough they can afford luxuries. While Islamdoes not prohibit Muslims to consume luxurygoods, Muslims are free to choose their lifestyles.
They can live a simple life or lead a luxurious oneas long as they do not fall into debt or amasswealth from illegal sources. They too must spendon basic necessities (daruriyat) and make spendwell for their families.
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Savings in Islam does not mean keepingmoney as idle balances. All savings must beinjected back into circulation. It must beinvested. If money is kept as idle balances,people who need money for working capitalor to purchase plant and machinery will notbe able to do so. Without money to spend
business will cease to exist and the economywill fall into a recession with implications ongrowth and employment.
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The objective of savings is best described in theQuranic story of Prophet Yusof(may Allah bepleased with him) where the importance ofsavings is highlighted in its true color. Surah Yusof
(12:3-49) tells the story of a Pharaoh in Egyptwho had a strange dream about seven fat cows.He also saw in his dream seven green ears ofwheat and seven withered or dying ears ofwheat.
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He asked his advisors to interpret the dream,but no one is good enough to do so. Prophet
Yusuf who is well known for his honesty and
special ability to interpret dreams was broughtto see the Pharoah.
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In his interpretation about the dream, ProphetYusuf enlightened the Pharoah about the futureproblems of Egypt. He also suggested theremedies. He said that Egypt will enjoy seven
years of prosperity with abundant harvests. Inmodern times, this may be taken to mean higheconomic growth. Prophet Yusof advised thepeople of Egypt to cultivate their crops diligentlyand use a reasonable amount for food andsustenance while storing the remaining surplus.
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This is because when prosperity comes to anend, Egypt will suffer from serious drought for
seven long years when no crops would grow.
But with the reserves in store, the people ofEgypt could survive the seven bad years.
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Prophet Yusuf cautioned the Pharoah not toconsume all the reserves but to leave the bestportions for seeds to cultivate later when rainsfilled the Nile. In other words, people must set
aside money for savings and investment. Topostpone current consumption to make way forproduction of future goods was one of the mainmessages that Prophet Yusuf wanted the Pharaohto do for his people.
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The incentive to save can also be examined atthe micro level of Muslim behaviour. In Islam,
savings will always means surplus income to
be placed for investment purposes, thuskeeping money in circulation. All savings must
be invested again in the economy. Otherwise
it is tantamount to hoarding (ihtikar)
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The basic idea of savings is to avoid hoardingmoney as the latter is prohibited in Islam.
When people hoard money, there is less
currency around to use. It will frustratebusiness transaction and put production to a
halt since there is no money available to pay
suppliers and workers. Hoarding money willput money out of circulation and therefore
reduces sale and purchases.
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For this reason, Muslims must save and investtheir surpluses so that the value of the savings
increases over time despite the payment of
zakat. Zakat on idle balances is penalty onhoarding behaviour and eventually leads to
the depreciation of wealth if kept unchecked.
In this way, zakat both purifies wealth
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For example, when money is put in circulation via investment, zakat income and individualwealth will both increase. This is illustrated in the following examples:
Case (1) Hoarding
Idle cash (i.e. wealth/mal) at year end = $20,000
Zakat = 0.025 x $20,000 = $500
Cash balances (wealth) after Zakat = $19,500
Case(2) Savings
Cash invested = $20,000
Profit = 10% = $2,000
Wealth/mal = $22,000 Zakat = 0.025 x $22,000 = $550
Wealth after zakat = $21,450.
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From the above illustrations, it is clear that inIslam wealth is not an end by itself. Wealth is
a means to attain happiness (saada) and
success (falah). To do so, Islam enjoins man tospend it well (infaq) and not to indulge in
hoarding. By spending, it can mean many
things such as:
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Consumption ofbasic necessities (daruriyat)
Consumption ofcomfortables (hajiyat)
Consumption ofluxuries (kamaliyat)
Savings in bank deposits, mutual funds, stocks,properties etc.
Sadeqah as amal jariah (continous good deeds)
Zakat obligation
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To attract people to save in Islamic bankdeposits, the banking firms are expected to
invest deposits into projects with high yield
potentials. If Islamic deposits can outperforminvestments in unit trusts and other equities
products, it should be able motivate more
people to save. This will increase capitalformation much needed for economic growth
and development.
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Deposit mobilisation is one of the crucial functions of aconventional financial institutions or banks to satisfy one of
the requirements of a banking business, i.e. sourcing of
funds or borrowing money from customers.
Continuous and adequate deposit mobilisation would ensure
the bank shall be able to sustain its business of lending and
investing, thus incurring profit for future growth.
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Nevertheless, different types of deposits havedifferent and distinct characteristics and
features which in consequence impose
different risks and costs to the banks.Therefore, in many cases, deposit mobilisation
strategy relies heavily to the banks asset and
liability management policy.
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In a relationship between bank anddepositors, the rights and duties for both
parties vary according to the nature of deposit
mobilisation. The ability of the bank to fulfilltheir duties is an important measure of the
banks acceptance by the public, or by far as a
comparison yardstick with other banks.
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Banks mobilise deposits as their primarysource of funds. Having optimal deposits level,
banks shall be able to lend the funds to
generate interest on lending. In addition tolending, the deposits fund can be placed in
certain investments avenues which suits the
banks or the deposits objectives.
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Deposit mobilisation is a continuous functionfor a bank to ensure the sum total of deposits
at any time adequate to maintain the current
level of lending and investments especially tocompensate the withdrawals made by
depositors.
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Usually, the deposits level is kept slightly orcertain percentages above the lending and
investments level to ensure the bank has
adequate cash reserves to meet expectedwithdrawals and also recurring withdrawals.
The cash reserves are called Liquidity
Reserves.
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How a Bank Mobilises Deposits?
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Bank receives deposits from individuals,organisations and businesses, initially by
opening an account with the bank itself.
Based on the types of deposits, minimuminitial deposits are set together with the rules
and regulations governing the accounts.
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Depositors maintain deposits with specificbanks due to many factors, but in particular
trust and confidence with the banks are the
major factors. Once these are established, thebanks continuously attract depositors and
deposits by providing convenience banking,
quality services, excellent brand associationand higher interest/profit payout.
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However, there are instances wheredepositors put their money into the banksmainly for security purposes, i.e. the banks toprotect their money from loss and theft andalso warrant the deposits from investmentloss. As such in Malaysia the governmentprovides guarantee upon deposits placed with
commercial banks.
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The banks must have adequate deposits tomeet the lending volume required by thepublic and at the same time maintain extracash for withdrawals by depositors.
The withdrawals made from the reserves areoddly-offset against new deposits which thebanks should continuously mobilise. The
inability to get sufficient deposits could resultin negative fund situation.
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The level of deposits growth also indicates thebanks performance in relation to customers
satisfaction on interest/profit payout and
services rendered.
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Deposits are made mainly in cash, the mostliquid asset for banks. Once withdrawal
requests are made by depositors, banks must
immediately provide cash for that particularpurpose. As compared to other liquidity
components such as short term investments
which take time to be converted into cash, it is
rather wise for a bank to simply get more
deposits beyond the withdrawal amount.
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However, the percentage of the cash reservesmust be kept at optimum level. Idle cash does
not create profit, but in fact, brings additional
costs in terms of storage and insurance.Therefore, by maintaining cash reserves at
optimal level enables bank to generate
maximum profits from lending and investment
activities.
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The costs for cash reserves are mainly on thestorage and insurance. The storage of cashreserves involves the requirement foradequate vault rooms, cash in-transit securityand cash handling at branches. The insurancecosts are to cover the amount of cashavailable anytime at branches or in-transit
from loss, fire and theft. It generally coversthe maximum cash amount allowed atbranches or in-transit.
THE RISK AND REWARDS
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Deposits placed with conventional banks areconsidered low-risk and low-return
investments. Perhaps, the risks to depositors
are almost zero considering that the return isguaranteed and the banks shall absorb any
unexpected loss derived from investments or
lending activities.
Internet banking
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Internet technology and high security featuresallow banks to introduce internet banking
services to their customers especially for tech-
savvy youngsters and middle-agedprofessionals. Internet banking provides
mobility convenient and time freedom for
accountholders to perform related
transactions anytime anywhere.
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Among the transactions that can beperformed are fund transfer, balance enquiry,
other enquiries, bills payment, loan and credit
card payment, ad-hoc statement printing andcheque book request. Through internet
banking, depositors can communicate with
their bankers using emails from anywhere.
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Mobile banking
Mobile banking uses the mobile phones as
medium to perform limited transactions andenquiries onto depositors accounts. Among
the transactions that can be performed are
fund transfer, balance enquiry, other enquiriesand loan payment.
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Corporate desktop
Corporate desktop is provided for subscribed corporate customers only.
Desktop computer(s) and dedicated computer line are provided within
customers office to assigned officers to allow them to perform related
transactions with the bank.
Among the transactions that can be performed are fund transfer, balance
enquiry, other enquiries, FD placement request, bills payment, loan
payment and cheque book request.
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The following are the costs related todeposits;
Deposits maintenance cost
Deposits maintenance cost in general refers to the cost of manpower and
facilities provided by banks to facilitate all transactions performed on
deposits accounts, including the direct promotional activities and deposit
retention programmes. These costs are classified under banks overheadcosts. The cost includes security and insurance coverage on hard-cash.
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Interest payout/Profit payout
Savings and fixed deposits accounts are
interest-bearing accounts. Therefore, for everydollar received under these accounts banksmust pay the interest rate upon maturity orperiodical basis based on the promised
interest rate.
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Relationships between deposits,investments and financing
Deposits have indirect relationships to the lending activities
and the investments made by the banks. Normally, the
various deposits types are combined into a pool and treatedas a single fund. Under this concept, any deposits regardless
of amount and period, provides a low-entry point into fixed
duration and high denomination investments and loans.
SHARIAH PRINCIPLES GOVERNING
DEPOSIT FACILITIES
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Al-Wadiah The Bank accepts deposits for Savings Account
under the Islamic principle of Al-Wadiah.
Definition
It is a contract between two parties i.e. the
owner of goods and the custodian of the
goods to ensure the safe custody of the goodsfrom being stolen, lost, destroyed etc.
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Types of Goods The goods can be referred to anything that is
of value such as:
Fixed assets
Money
Jewels
Certificates
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There are two (2) types of Al-Wadiah: a) Al-Wadiah Yad Amanah (Trust)
b) Al-Wadiah Yad Dhamanah (Guarantee)
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Discretionary Reward Under the principle of Al-Wadiah,
The custodian i.e. the Islamic bank is not allowed to mention or to promise
any rewards or return.
The customers/depositors, on the other hand, are also not allowed to
demand any rewards or return on their savings.
Any promised rewards given under the contract of Al-Wadiah is
considered as riba which is strictly prohibited.
Rewards do not only referring to monetary items. It includes also other
forms of incentives such as coin boxes, clothes etc.
Rewards cannot be promised earlier but as and when the Islamic bank
wants to reward his customers, the bank can always do it on its own
discretion.
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Concept of Returns/Profit
Islamic bank is not obliged to