Thursday, May 24, 2012

Islamic banking : An overview

The first modern experiment with Islamic banking was undertaken in Egypt without proj

jecting an Islamic image for fear of being seen as a manifestation of Islamic ftndamentalism

that was anathema to thepolitical regime. The Pioneering effort, led by Ahmad Elnaggar, took

the form of a savings bank based on profit-sharing in the Egyptiantown of Mit Ghamr in 1963.

This experiment lasted until 1967.

Islamic banking is a banking system that is consistent with the Sharia'a (Islamic law)

and, as such, an important part of the system is the prohibition on collecting riba (intere

est or usury). The Sharia'a also prohibits trading in financial risk because this is seen as

a form of gambling, something forbidden in Islam. Another prohibition under the Sharia'a

is that Musiims cannot invest in businesses that are considered haram (forbidden or sin-

ful) such as those that sell alcohol, pork engage in gambling or produce un-Islamic


The central religious Precept driving the Islamic finance industry is the idea that riba is

haram. At first glance, this appears to rule out most aspects of modern finance. But although

the Qur 'an bans the creation of money, by money, it does allow money to be used for trading

tangible assets and businesses — which can then generate a profit.
Mudaraba Model

Under the Mudaraba model, any surplus is shared between the policyholders and the Takaful

operator. The sharing of such profit (surplus) may be in a ratio of 50:50, 60:40, 70:30 or

whatever is mutually agreed between the contracting parties. Generally, these risk sharing

arrangements allow the Takaful operator to share in the underwriting profits from operations

as well as any favourable performance returns on invested premiums.

Wakala Model

Under the Wakala model, the cooperative risk sharing occurs among participants with a

Takaful operator who earns a fee for services (as would a lawyer (Wakeel) or agent) and does

not participate or share in any underwriting profits, because these belong to the participants.

Under the Wakala model the operator may also charge a fund munagement fee and a

performance incentive fee.

A mixed model of Wakala and Mudaraba is the dominant model in the Middle East market and

it is widely practised by Takaful operators worldwide. Under this model the Wakala structure

is adopted for underwriting activities while the Mudaraba contract is adopted for investment

activities. Consequently the Takaful operator has two funds, one for the shareholders and the

other for participunts (policyholders). With regard to underwriting activities, the shareholders

act as the Wakeel (agent) on behalf of participants when managing their funds, whereby the

Takaful operator (shareholders) receives contributions, pays claims, and arranges Re Takaful

 and all other necessary actions related to Takafiulbusiness.

In exchange for performing these tasks, the operator charges each participant a fee known

as the Wakala fee, which is usually a percentage of the contribution paid by each participant.

On the investment side, the operator invests the surplus contributions in different Islamic

instruments based on the Mudaraba contract, whereby the operator acts as Mudarib on behalf

of participants the Rab ul Mall and capital provider(s). In order to satisfy the Sharia'a

requirements, the profit-sharing ratio is fixed and agreed upon between the two parties at the

inception of the contract.

Dubai Islamic Bank P.J.S.C. 16

Notes to the consolidated financial statements

for the year ended 31 December 2011 (continued)


The following terms are used in the consolidated financial statements with the meaning specified:


An agreement whereby the Bank sells to a customer a commodity or asset, which the Bank has purchased

and acquired based on a promise received from the customer to buy the item purchased according to

specific terms and conditions. The selling price comprises the cost of the commodity and an agreed profit


Salam finance

An agreement whereby the Bank purchases specified commodity and pays full price of a commodity in

advance, whereas the customer delivers the goods with certain specifications and certain quantity on the

agreed future date(s). i.e. purchase of commodity for deferred delivery by the customer in exchange for

upfront payment of the full purchase price by the purchaser (the Bank).


An agreement between the Bank and a customer whereby the Bank would sell to the customer a

developed property according to agreed upon specifications. The Bank would develop the property either

on its own or through a subcontractor and then hand it over to the customer against an agreed price.


An agreement whereby the Bank (lessor) leases an asset or usufruct to the customer (lessee) according to

the customer‘s request and based on his promise to lease the asset or the usufruct for a specific period and

against certain rent installments. Ijarah could end by transferring the ownership of the asset to the lessee.


An agreement between the Bank and a customer contribute to a certain investment enterprise, whether

existing or new, or the ownership of a certain property either permanently or according to a diminishing

arrangement ending up with the acquisition by the customer of the full ownership. The profit is shared as

per the agreement set between both parties while the loss is shared in proportion to their shares of capital

in the enterprise.


An agreement between the Bank and a third party whereby one party would provide a certain amount of

funds, which the other party (Mudarib) would then invest in a specific enterprise or activity against a

specific share in the profit. The Mudarib would bear the loss in case of default, negligence or violation of

any of the terms and conditions of the Mudaraba.


An agreement whereby the Bank provides a certain sum of money to an agent, who invests in a Sharia

compliant manner and according to specific conditions in return for a certain fee (a lump sum of money or

a percentage of the amount invested). The agent is obliged to return the invested amount in case of

default, negligence or violation of any of the terms and conditions of the Wakala.


These comprise asset backed, Sharia’a compliant trust certificates. 

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