Question

Islamic accounting undergraduate student…

Investors deposit OMR 1000,000 with Islamic Bank under a Mudaraba contract for a period of 12 months and a profit allocation set out in the agreement as 80% to the investors and 20% to Islamic Bank. The investors receive Mudaraba Certificates (investment deposit certificates) in exchange for their deposits.

Subsequently, Islamic Bank invests the OMR 1000,000 in Islamic Enterprises, MirrerCold Enterprise Private Limited to build a new factory. MirrerCold Enterprise Private Limited contributes its expertise in managing the project, but no capital. MirrerCold Enterprises is responsible for the day-to-day management of the project and will deduct its management fee from the profits of the development. MirrerCold Enterprises' Mudarib share is based on a percentage of the profit and agreed to be 30% and 70% belongs to Bank. At the end of the Mudaraba, when the factory is completed, it is sold at a pre-agreed amount of OMR 1200,000. Islamic Bank recovers its OMR 1000,000 capital and the OMR 200,000 profit is returned.

1. Explain how the deposit products of an Islamic Bank differs from conventional deposits.
2. Explain what is two-tier Mudharaba.                                                                              
3. Analyze with relevant calculation how the profit is shared between the Islamic Bank and MirrerCold Enterprise Private Limited and the Bank and the Depositors in each stage of the two tier Mudharaba as explained in the case above.                                            

Answer 1

1. In the conventional deposits, interest is generally paid either on fixed basis or floating basis. Under, Islaming Bank, Interest is forbidden as per the religious practice and hence, depositor does not receive any interest. Further, under Islamic Bank, Bank guarantees the return of capital. The Islamic principles prohibit charging and receiving of interest. Unlike the conventional banking system, which makes profit from charging interest on lending, Islamic banks make profits through investments.

2. It is a earning sharing agreement between 2 parties- an investor and the entrepreneur. In Islamic banking, the investor funds the entrepreneur for business ventures and the returns will be based on profit, on the ratio that has been agreed upon at inception.

Mudharabah works in two ways- where a bank plays the role of an entrepreneur and the customer becomes a capital provider. Where customer plays the role of entrepreneur, the bank becomes a capital provider.

In both cases losses suffered will be borne by the capital provider.

3. The profit sharing agreement between Bank and MirrerCold Enterprise Private Limited is 30:70. Hence, out of profit of OMR 200,000, 70% i.e. 70% * 200,000 = OMR 140,000 belongs to the Bank as capital provider share.

Now, Bank will share 80% of OMR 140,000 with the deposit based on 80:20 ratio. Hence, depositor shall receive OMR 112,000 and Bank shall retain OMR 28,000 as its share.