Theory and Practice of Banking

Theory and Practice of Banking-Islamic and conventional

What is the banking system in Bangladesh?

Now, banks in Bangladesh are primarily of two types: Scheduled Banks: The banks that remain in the list of banks maintained under the Bangladesh Bank Order, 1972.

Non-Scheduled Banks: The banks which are established for special and definite objective and operate under any act but are not Scheduled Banks.

What is the concept of banking?

Banking is defined as the business activity of accepting and safeguarding money owned by other individuals and entities, and then lending out this money in order to conduct economic activities such as making profit or simply covering operating expenses. ... Above all, central banks are responsible for currency stability.

What is the role of banks in the financial system?

Banks perform various roles in the economy. First, they ameliorate the information problems between investors and borrowers by monitoring the latter and ensuring a proper use of the depositors' funds. ... Third, banks contribute to the growth of the economy. Fourth, they perform an important role in corporate governance.

 

Financial system of Bangladesh

The financial system of Bangladesh is comprised of three broad fragmented sectors:

1.     Formal Sector,

2.     Semi-Formal Sector,

3.     Informal Sector.

The sectors have been categorized in accordance with their degree of regulation.

The formal sector includes all regulated institutions like Banks, Non-Bank Financial Institutions (FIs), Insurance Companies, Capital Market Intermediaries like Brokerage Houses, Merchant Banks etc.; Micro Finance Institutions (MFIs).

The semi formal sector includes those institutions which are regulated otherwise but do not fall under the jurisdiction of Central Bank, Insurance Authority, Securities and Exchange Commission or any other enacted financial regulator. This sector is mainly represented by Specialized Financial Institutions like House Building Finance Corporation (HBFC), Palli Karma Sahayak Foundation (PKSF), Samabay Bank, Grameen Bank etc., Non Governmental Organizations (NGOs and discrete government programs.

The informal sector includes private intermediaries which are completely unregulated.

 

 

 

SOURCE: Bangladesh Bank Website ( https://www.bb.org.bd)
DEFINITION OF UNIT BANKING

Unit Banking implies a banking practice wherein the banking operations are carried out by only one office, which is situated in a specified location. It is managed by its own governing body or the Board members. It has an independent existence, as it is not under the control of any other individual, bank, or body corporate.

A unit bank has no branches at all and for the purpose of providing facilities related to remittance and collection of funds, a unit bank takes recourse of the correspondent banking system. A correspondent bank refers to a financial institution, which enters into an agreement with another bank to render services to the customers as a representative of the latter.

The unit bank serves a limited area, and so it possesses an expert knowledge of the problems and basic needs of the localities and aims at resolving them.

 

DEFINITION OF BRANCH BANKING

Branch Banking implies a banking system wherein a banking organization, through its wide network of branches provides banking services to its customers throughout the country and even in abroad.

It has a central office called as the head office and other offices which are set up at different locations to serve the customers are called as branches. The branches are controlled and coordinated by the head office, with the help of their regional or zonal offices.

 

CHAIN BANKING

Chain banking is a situation in which three or more banks that are independently chartered are controlled by a small group of people. The mechanisms used to establish this type of arrangement normally involve securing enough stock between the individuals to have a controlling interest in each of the bank corporations involved. The arrangement can also be managed with the establishment of interlocking directorates or boards of directors that effectively create a network between the banks without the need for some type of central holding company.

The concept of chain banking is different from group banking, in that the entities involved in the chain bank arrangement remain autonomous and are not owned by a single holding company. By contrast, the group banking model requires a holding company to own all the banks involved, effectively creating an umbrella under which all the banks operate. Chain banking is also different from branch banking, a situation where all local branches of a bank are owned by a single banking institution.

In years past, chain banking afforded several benefits for investors. The strategy made it possible to earn steady returns from several banks that operated in the same community, without any fears of a great deal of competition from other banks in the area. The network approach made it possible for investors to use their cumulative influence to keep bank services and their attendant fees similar from one enterprise to another, thus ensuring that returns remained consistent. The chain banking process also made it possible for investors to create a network where each bank in the chain served a different part of the market within the area. For example, one bank may focus on business accounts while another specialize in personal accounts, and the third bank in the chain provided services related to the purchase and sale of securities.

Over time, the chain banking approach has become less popular in a number of nations. This is due to changes in banking laws in many places that helped to redefine the process of interstate banking as well as international banking. This redefinition has made it possible for some banks that were once somewhat restricted in what they could offer customers to be able to offer a wider range of services. With more liberalized banking laws in many jurisdictions, the benefits afforded by the chain banking model can now be realized using other approaches, sometimes with a greater degree of efficiency and without the need for establishing this type of investor network.

 

DIFFERENCE BETWEEN UNIT BANKING AND BRANCH BANKING

Banking refers to a business activity in which the entity accepting deposits from the customers, safeguards it and lends it to those who need it, and earns a profit. Different countries of the world adopt different types of the banking system . Basically there are two types of banking system prevalent in most of the countries, which are unit banking and branch banking. A unit banking is a banking system in which one bank, generally a small independent bank that renders banking services to its local community.

BASIS FOR COMPARISON	UNIT BANKING	BRANCH BANKING
Meaning	Unit banking is that system of banking in which there is a single small banking company, that provides financial services to the local community.	Branch banking is a banking method wherein a bank operates in more than one place to provide banking services to customers, through its branches.
Local economy	Affected by the ups and downs of the local economy.	It is not affected by the ups and downs of the local economy.
Independence of operations	More	Comparatively less
Supervision Cost	Low	Comparatively high
Financial Resources	Limited financial resources	Large pool of financial resources
Competition	No or little within the bank	Exist between the bank branches
Rate of interest	Not fixed, as the bank has its own policies and norms.	Fixed by the head office, and directed by the central bank.
Decision making	Quick	Time Consuming

 

 

 

WHAT IS CHAIN BANKING?

Chain Banking is a form of banking when a small group of individuals control three or more banks which are independently chartered.  Individuals secure enough stocks to get the controlling interest in the banking corporations involved. The management can also be established via a board of directors that can effectively create a network and undertake supervision of banking activities. Chain banking systems took shape in USA around 1925 when 33 chains were co-existing having ownership of 933 banks. The purpose was to maximize profit and goodwill in the market. The banks which entered into chains within a community had little scope of competition from other banks operating in the same area. The investors ensured that each bank in the chain catered to the interests of different segments in the market so that there was no overlapping of interests and the returns were not compromised. There is generally no holding company to control the interests of banks. Thus, the underlying principles of chain banking are:

A small group of persons own and control a number of independent banks

Each bank carries its operations independently without any external interference by any holding company.

Every member of the chain retains its independent identity.

Key Features and relevance of Chain Banking

Chain banking at the time of its growth and emergence offered amazing services to the customers due to targeted approach, to the investors in form of consistent returns and complete control.  The investors made sure that there was an optimum utilization of resources which will maximize the profits and potential. It provided for quick decision-making due to centralized and unified control which trickled down to customers in form of efficient service. However, the system lost significance with the introduction of more liberal banking laws as the banks which were part of chains opened more to offer more services to their customers. On the other hand, chain banking introduced non-flexible controls and risk of speculations. There were cases of maladministration and frauds

 

RETAIL BANKING

What is Retail Banking?

Definition: Retail banking, also known as Consumer banking, refers to the offering of banking services to retail customers instead of institutional customers, such as companies, corporations and/or financial institutions.

According to Cambridge Dictionaries Online, a retail bank is:

“A bank that provides  services to the public and to small businesses rather than to large companies or organizations.”

What Does Retail Banking Mean?

What is the definition of retail banking? Retail banking includes a wide range of banking services that belong to similar categories, such as savings accounts, checking accounts, consumer lending, credit cards, debit cards, mortgages, e-banking services, phone-banking services, insurance, investment and fund management.

Consumers use local branches that have the capacity to deliver all these services to retail customers. In fact, retail-banking keeps the money circulating as the Fed allows only 10% of deposits on hand. So, the retail banks have to circulate the remaining 90% either in the form of loans or in the form of investment products.

 

What is retail banking? Definition and meaning

Retail banking refers to the provision of financial services by a bank to individual customers (private individuals), rather than corporations, local and central governments and other banks.

The term ‘retail,’ in this context, means that the ‘consumer’ acquires or buys a product for personal use. In this case, the consumer is the bank customer and the products are banking services.

https://marketbusinessnews.com/financial-glossary/retail-banking/

Retail Banking

Definition: Retail Banking is a form of commercial banking wherein service is provided to the retail (individual) customers for non-entrepreneurial purposes. In banking, the term ‘retail’ signifies, that the consumer avails banking products for personal use, wherein the consumer is the customer of the bank and the products are the services that a bank offers to its customers. It is also known as consumer banking.

In short, retail banking is when commercial banks deal with individual customers, irrespective of the side of the balance sheet. This means that fixed, current/savings accounts on the liabilities side and mortgages and loans on the asset side. There are a large number of rural, semi-urban, and urban branches of a bank that provide retail banking.

The facility is specially designed to take care of the personal financial needs of the retail customers, who are nothing but a part of the general public for everyday spending. Hence, we can say that retail banking is the primary face of the banking which general public deals with. It is a means of managing money, such as the customers can have access to credit as well as deposit their funds securely.

It is that part of the bank which is visible to all. The products and services are provided through physical brick-and-mortar branches and through ATMs which can be found everywhere. Moreover, the delivery model of retail banking is not confined to the traditional branches and ATMs, rather it expands to the internet and mobile too.

Characteristics of Retail Banking

The three main characteristics of retail banking are:

Multiple Products: In retail banking, commercial banks offer products like deposits, credit/debit cards, insurance, investments, and securities to the customers.

Multiple Channels of Distribution: With the emergence of technology, a range of channels of distribution has come into being like 24/7 customer care, kiosk, bank branch, internet/mobile banking, etc.

Multiple Customer Groups: Retail banking has a huge customer base that includes various groups of customers, including consumers, small businesses, and corporates. Hence, a large number of transactions take place on a daily basis.

Now, you must be wondering, what a retail bank gets? So bank gest fees for providing these services. The fees earned by banks at the time of extending these services to the general public include:

1.     Retail loan processing fees

2.     Credit card and debit card fees

3.     Transaction banking fees

4.     Fees from distribution of their party products

Types of Retail Banking

Retail banking is targeted at individual customers, by focusing on the mass market segment. That is to say, it offers generalized products and services, which target a wider population. It is classified into two types: types-of-retail-banking

Mass Retail Banking: It can be understood as that type of retail banking in which standardized banking products and services are offered to a large customer base. At this stage the aim of the bank is to develop a large customer base, to ensure a stable source of funding. When it comes to volume the number of transactions is large in retail banking but the amount per transaction is small in mass retail baking.

Class Retail Banking: This is another type of retail banking, in which customized products and services are offered to a niche customer segment, which encompasses high net worth individuals, as they are the primary source of business to banks.

Key Dimensions of Retail Banking

1.     Customer Focus

2.     Prudent Risk Management

3.     Convenience of Customer

4.     Widespread distribution network

5.     Variety of Products

6.     Strong Processes

The services can be offered through offline and online modes, i.e. when a customer chooses offline mode, he/she has to visit the nearby branch or kiosk center for availing the facility, whereas in online mode, the customer can avail different facilities any time and anywhere using the internet or mobile banking.

 

Retail Banking Products

There are end number of retail banking products which are offered by banks. These are divided into three main categories:

Retail Deposit Product

1.     Savings Account

2.     Current Account

3.     Term Deposit

4.     Fixed Deposit

5.     Recurring Deposit

6.     Foreign Currency Accounts (FCNR)

7.     Zero Balance account for salaried class people

8.     Basic Saving Bank Deposit account (erstwhile No frill accounts for the general public)

9.     Senior Citizen Deposit accounts

10.                        Home Loan for buying land and constructing a house for residential purposes or for buying a ready-built house or for repairing or renovating an existing house.

11.                        Auto Loan for buying new or used two or four-wheelers.

12.                        Education Loan for furthering education

13.                        Personal Loan for varied purposes like a holiday, medical treatment, and so forth

14.                        Consumer Loan for buying electronic goods for domestic use like air conditioner, refrigerator, television, etc.

15.                        Crop Loan for buying improved seeds, machinery, and fertilizers for farming.

16.                        Credit Card

17.                        Other Products

 

18.                        Safe deposit lockers

19.                        Depository services

20.                        Remittance services like NEFT, RTGS, IMPS, etc

21.                        Investment advisory services

22.                        Debit Card

23.                        Issue of draft

24.                        Collection of Cheques

25.                        Collection of Taxes from customers on the central government’s behalf.

26.                        Purchase and sale of securities in the stock market on the customer’s behalf.

27.                        Internet banking and mobile banking

28.                        Purchase and sale of foreign currencies to/from customers when they return from or go back to a foreign country.

Advantages of Retail Banking

The deposits from retail customers are stable and form core deposits. Such deposits are interest insensitive with less bargaining for additional interest. Also, they constitute low-cost funds for the banks.

An effective customer relationship management helps in developing a vast and strong customer base.

Retail banking also assists in increasing subsidiary businesses of the banks like insurance, etc.

It amounts to better yield and profitability.

It contributes to the economic development and economic revival of the country, through increased production.

Helps in improving  the lifestyle of consumers by providing loans at affordable rate of interest.

Involves minimum marketing efforts.

Due to its large customer base, they have a diversified portfolio, which reduces the bank’s dependence on a single borrower.

Disadvantages of Retail Banking

Monitoring and follow-up of a large number of  loan accounts induce banks to spend heavily on manpower.

Banks invest heavily in technology for better services however, they are not utilized to that extent.

Nowadays, most customers are interested in other financial products such as mutual funds.

Long-term loans may turn into Non-Performing Asset (NPA) if they are not monitored and followed up properly.

https://businessjargons.com/retail-banking.html

 

WHOLESALE BANKING

Definition: The Wholesale Banking refers to the provisions of banking services offered to the industrial and business entities which are rich in resources and have sound income statements. These institutes are generally the mortgage brokers, corporate houses, multinationals, government agencies, real estate investors, other banks and financial institutions.

The wholesale banking comprises of the services such as Finance Wholesaling, Mergers and acquisitions, Underwriting, Market Making, Consultancy and Fund Management. The need for the wholesale banking arises because of the inadequacy of retail banking in meeting the industry requirements and a large number of financial transactions of a huge cost.

The Industrial or business entities can avail several advantages from the wholesale banking such as single point of contact for all the corporate dealings whether national or international, expert recommendations, specialized products customized as per the corporate requirements, etc.

https://businessjargons.com/?s=wholesale+Banking

 

AGENT BANKING

What is meant by agent banking?

Agent Banking means providing limited scale banking and financial services to the underserved population through engaged agents under a valid agency agreement, rather than a teller/ cashier. It is the owner of an outlet who conducts banking transactions on behalf of a bank.

What are the benefits of Agent Banking?

Quick: no travelling to the bank, no queues, fast transaction processing.

Affordable: transaction fees are lower than branch fees.

Convenient: Agents open longer hours than bank Branches and are close to where customers live, work and shop.

 

 

 

 

Real-Time Gross Settlement (RTGS)

Definition: RTGS, is a short form for Real-Time Gross Settlement. It is a facility provided by the banks, that allows instant and complete settlement of funds from one bank to another and from one place to another, on an individual order basis. This means that the transactions are settled at the same time when they take place and so there is no waiting period.

Payments made through RTGS are final in nature which cannot be revoked. Moreover, the prescheduling of a transaction is allowed.

RTGS is mainly used for the high-value interbank transfer of money, in order to mitigate the risk of settlement and fraud.

Details Required for RTGS

The person (sender) who initiates the transfer must have the following details:

Indian Financial System Code (IFSC) of the beneficiary’s bank.

Name of beneficiary

Account number of the beneficiary

Amount to be remitted

Name of the beneficiary’s bank and branch

Account number of the sender/originator

Along with this, the bank branches of both the parties need to be RTGS-enabled, only then the transaction will be processed.

Minimum and Maximum Limit

This system is primarily developed to facilitate the transfer of large value funds between parties. Hence the least amount which is transferred through this system is Rs. 2 lakhs, while no maximum ceiling is there in RTGS.

 

Banks provide this service for a specified fee, wherein inward transactions are free, but a certain amount is charged on the outward transaction, depending upon the amount remitted.

 

How to do RTGS?

To transfer funds using RTGS, the first thing you require is the activation of internet banking facility. For this purpose, you need to visit your bank branch and complete the formalities for its activation. Nowadays, one can activate this facility online also using the concerned bank’s website.

Log in to the web portal, using the UserID and password.

Once you enter the user ID and password, you will land at your account and profile where you have to select the profile.

Thereafter click on Add and manage beneficiary.

Then, you need to enter your profile password and click the submit button.

You will see various options for adding a beneficiary, choose the relevant option as per your need.

Upon clicking the appropriate option, you will be asked to fill the details of the beneficiary.

Check the details and click on approve now button.

Next click on the approve beneficiary radio button, where you will have two options – Approve through ATM, or Approve through OTP

If you choose to approve through OTP, you will receive a high-security password at your registered mobile number, linked to the account. Now simply enter the password and click on approve button.

Once the beneficiary is added the following steps are required to follow:

Go to the payment/transfer tab and click inter-bank transfer.

Select the Transaction Type, i.e RTGS and go to fund transfer section

A list of beneficiaries will be displayed, select the beneficiary/payee

Enter the amount to be transferred

Select the checkbox stating that you agree with the terms of service and accept.

Review the details and confirm.

In this way, the amount will be transferred successfully to the beneficiary’s account.

 

Advantages of RTGS

RTGS is one of the safest as well as the fastest mode of interbank transfer

This facility is available on all business days, whose timings may vary from bank to bank.

It is an immediate fund transfer mechanism.

It is a paperless transfer of funds.

The beneficiary is not required to visit the bank, to deposit the money.

The funds can be transferred using the internet banking service.

Limitations of RTGS

RTGS does not provide the facility to track the transaction to its customers, as only the positive confirmation feature is implemented by the central bank in which the remitting bank gets a message of fund transfer to the beneficiary bank, from the central bank.

In general, the beneficiary branches may receive funds in real-time, i.e. as and when the funds are sent by the remitting bank. The beneficiary bank has to credit the fund in the account of the beneficiary, within half an hour of the funds’ transfer message.

However, if the funds are not transferred to the beneficiary’s account due to the reasons like account frozen, or non-existence of account, then the funds are returned to the originating bank. Moreover, if there is a delay in refunding the failed amount, the initiating party is entitled to receive compensation at the current repo rate + 2%

https://businessjargons.com/real-time-gross-settlement-rtgs.html

https://businessjargons.com/e-banking.html

https://businessjargons.com/?s=virtual+banking

SUB-BRANCH BANKING

A sub-branch is basically a small business center similar to a bank branch. In the language of Bangladesh Bank, a sub-branch refers to a low-cost business hub operated under the control of a full-fledged branch of the bank to provide limited range of banking services in the light of the policy guidelines prescribed from time to time. Each sub-branch is operated under the control of a branch near the concerned bank. The minimum distance from the controlling branch to the sub-branch should be more or less one kilometer. In case of setting up a sub-branch outside the district town, its distance from the branch is determined keeping in view the regular communication from the controlling branch, easy and safe transportation of cash and overall security. The distance from the branch to the existing agent outlet of the bank has to be maintained at 3 and 5 km inside and outside the metropolitan area respectively. The floor space of the sub-branch will be not more than 1000 square feet and a minimum of two and a maximum of 10 officers will be appointed for smooth running of banking activities. They will provide almost all the services that are provided in the main branch.

Cost is also low due to low manpower and equipment. As a result, banks are becoming more and more interested in setting up sub-branches. Sub-branch cash deposits such as security of bank vaults should be ensured and full insurance of cash should be ensured. In addition, vaults can be set up in sub-branches if required. The central bank has said it will ensure adequate security to open these business centers. The sub-branch should have an IT structure with adequate security to ensure uninterrupted banking services. Sub-branch works under one branch for low cost financial services. All kinds of services are being provided from these sub-branches except foreign trade activities.

According to the latest data from the central bank, there were 393 sub-branches of banks in the country in December 2019, which increased to 1,147 in December 2020. In June of this year, the number increased to 1,672 out of these, the highest 500 sub-branches are in the private sector IFIC Bank. Next in line is NRBC Bank. This new generation bank has 393 branches. Other notable banks include 194 branches of IBBL, 88 branches of First Security and 79 branches of SIBL.

Almost all the facilities of banking are available in the sub-branch. The sub-branch is considered as an outlet for low cost banking services. As such, the cost of setting up a sub-branch will not be more than the various expenditure limits for setting up a conventional branch and the fees, charges, commissions, etc. will be less than the fees, charges, commissions for banking services provided by a conventional branch. The aims and objectives of the sub-branch are to expand banking business in Bangladesh and provide financial services to the disadvantaged people and ensure more financial services through low cost banking service outlets.

Bangladesh Bank has taken various initiatives to bring banking services to all in the country and one of them is the sub-branch through which all kinds of banking services are being provided in the villages. If everyone’s banking services are ensured, the country will move forward and everyone will benefit from it. It has been said that the initiative taken by the government to ensure banking services in rural areas of the country should be considered as a very timely step. At present, there are a total of 63 state-owned, private and foreign banks operating in Bangladesh.

At a point of time, the business of the bank was available included branch banking, agriculture branch, SME branch, booth (collection booth, fast truck, service house and electronic booth) and business development center. In December 2018, Bangladesh Bank issued a policy on setting up banking booths in the light of how low cost banking services can be made accessible to the people. It is said that the size of the banking booth will be within one thousand square feet. After that the banks strengthened the establishment of booths. It may be mentioned that last December 2019, Bangladesh Bank issued a circular to transform the banking booth into a sub-branch to remove the confusion of the people.

 

The country’s economic development, progress and financial performance largely depend on the banking sector. Just as blood flows through arteries in the human body to different parts of the body, so it does money flow and development in different sectors of the economy through banking channels. Consumer deposits, investments, imports, exports and remittances strengthen the country’s economic base. The well-organized role of the banking sector in economic and financial recovery during and after COVID-19 pandemic is undeniable and undeniable. Banks have played an important role in the implementation of economic and financial activities related to the COVID-19 of the government and the central bank. Sub-branches like mobile and agent banking have played an important role in banking services during the COVID-19 pandemic period. With the introduction of sub-branch and agent banking services, the overflow of customers in the branches has reduced a lot. Customers are also able to avail banking services with ease. Undoubtedly, new horizons have been opened for financial inclusion through sub-branch.

Bangladesh is moving forward and is now recognized for its booming economy worldwide. Bangladesh’s progress in social indicators is now an example for many countries. The country has been steadily advancing since independence. According to the World Bank, Bangladesh will become a middle income country by 2026 and will surpass the Western countries in terms of growth. In this case, the role of the banking sector is the most vital and the sub-branch has added new horizons to banking services for financial inclusion.

 The writer is a banker. He can be contacted at zrbbbp@gmail.com

 

Main features of sub-branch banking

According to the sub-branch banking policy, at least two officers will be appointed at a sub-branch, having not more than 1,000 square feet.

Fees, charges and commission of banking services will be less here if compared to branches.

Transactions at the sub-branch will be carried out on a real time basis and customers will get instant SMS and printed slip against their transactions.

The sub-branch, however, will not be allowed to carry out any sort of foreign transaction, according to the policy.

To set up a sub-branch, the banks must submit application to the central bank along with decision of its board of directors.

The central bank, however, preserves the rights to close any such sub-branch without giving prior notice.

According to the policy, the sub-branch will now also be treated as business development centers’ of the banks.

Such branch will be regulated under the central bank’s rules and regulations for providing limited scale services and will be operated within a limited expenditure under the supervision of a nearby full-fledged branch of a bank.

https://businesspostbd.com/opinion/sub-branches-adding-new-horizons-to-banking-services-42592

VIRTUAL BANKING

Definition: The Virtual Banking is the provision of accessing the banking and related services online without actually going to the bank branch/office in person. Simply, availing the banking services through an extensive use of information technology without any requirement for the physical walk-in premises is called as virtual banking.

Any financial institution that offers the traditional banking services online is termed as a virtual bank. Virtual banking enables a customer to pay bills online, check account details, secure loans, withdraw and deposit money anytime as per the convenience.

Some common forms of virtual banking are, ATMs, use of magnetic ink character recognition code (MICR), Electronic clearing service scheme, electronic fund transfer scheme, RTGS, computerized settlement of clearing transactions, centralized fund management schemes, etc.

One of the advantages of virtual banking service is that the transactions can be checked in real time, i.e. as and when the transactions are made and the customer is not required to wait for the day or a month to end to check the transaction details. The cost incurred in handling the transactions is lower than the traditional form of banking, and also, it charges low fee comparatively because of less overhead expenses.

Also, the response time has increased manifold with the invent of online banking. The customer can access his account any time round the clock and indulge in the banking activities as per his convenience.

 

WHAT IS A UNIVERSAL BANK?

A universal bank is a bank that combines the three main services of banking under one roof. The three services are wholesale banking, retail banking, and investment banking. In other words, it is a retail bank, a wholesale bank, and also an investment bank. As well as being able to offer an all-encompassing service, universal banks can reap the synergies that exist when they operate in the three services simultaneously.

A universal bank, logically, offers universal banking. Universal banking is a type of financial service that combines the aspects of investment, retail, and wholesale banking.

A typical universal bank also offers other financial services such as insurance.

The Financial Times’ glossary of terms, ft.com/lexicon, has the following definition of universal bank:

“A universal bank is a financial service conglomerate combining retail, wholesale and investment banking services under one roof and reaping synergies between them.”

“The notion is that they would benefit from economies of scale in information technology and access to capital to serve companies and retail customers around the world.”

https://marketbusinessnews.com/financial-glossary/universal-bank/

 

WHAT IS THE CONCEPT OF ISLAMIC BANKING?

Islamic banking, also referred to as Islamic finance or shariah-compliant finance, refers to finance or banking activities that adhere to shariah (Islamic law). ... Islamic banks make a profit through equity participation, which requires a borrower to give the bank a share in their profits rather than paying interest.

What Is Islamic Banking?

Islamic banking, also referred to as Islamic finance or shariah-compliant finance, refers to financial activities that adhere to shariah (Islamic law). Two fundamental principles of Islamic banking are the sharing of profit and loss, and the prohibition of the collection and payment of interest by lenders and investors. (Investopedia)

Accordingly  OIC  Islami  Bank  is  a  financial  institution  whose  statutes,  rules  and  procedures  expressly  states  its commitment to the principles of  Islamic Shariah and to the banning of the receipt and payment of riba (usury) on any of its operations.

According  to  International  Association  of  Islamic  Banks,  ―The  Islamic  bank  basically  implements  a  new  banking concept,  in  that  it  adheres  strictly  to  the  ruling  of  the  Islamic  Shariah  in  the  fields  of  finance  and  other  dealings. Moreover, the bank  which functioning in this   way, must reflect Islamic principles in real life. The bank should work towards the establishment of an Islamic society; hence, one of its primary goals is the deepening of the religious spirit among the people.

Islamic banking has been defined in a number of ways. The definition of Islamic bank, as approved by the General Secretariat of the OIC, is stated in the following manner. "An Islamic bank is a financial institution whose status, rules and procedures expressly state its commitment to the principle of Islamic Shariah and to the banning of the receipt and payment of interest on any of its operations"(Ali & Sarkar 1995, pp.20-25). Shawki Ismail Shehta viewing the concept from the perspective of an Islamic economy and the prospective role to be played by an Islamic bank therein opines: "It is, therefore, natural and, indeed, imperative for an Islamic bank to incorporate in its functions and practices commercial investment and social activities, as an institution designed to promote the civilized mission of an Islamic economy" (Ibid). Ziauddin Ahmed says, "Islamic banking is essentially a normative concept and could be defined as conduct of banking in consonance with the ethos of the value system of Islam" (Ibid).

It appears from the above definitions that Islamic banking is a system of financial intermediation that avoids receipt and payment of interest in its transactions and conducts its operations in a way that it helps achieve the objectives of an Islamic economy. Alternatively, this is a banking system whose operation is based on Islamic principles of transactions of which profit and loss sharing (PLS) is a major feature, ensuring justice and equity in the economy. That is why Islamic banks are often known as PLS-banks.

 

Objectives of Islamic Banking

The primary objective of establishing Islamic banks all over the world is to promote, foster and develop the application of Islamic principles in the business sector. More specifically, the objectives of Islamic banking when viewed in the context of its role in the economy are listed as following:

1.      To offer contemporary financial services in conformity with Islamic Shariah;

2.      To contribute towards economic development and prosperity within the principles of Islamic justice;

3.      Optimum allocation of scarce financial resources; and

4.      To help ensure equitable distribution of income.

These objectives are discussed below.

Offer Financial Services: Interest-based banking, which is considered a   practice of Riba in financial transactions, is unanimously identified as anti-Islamic. That means all transactions made under conventional banking are unlawful according to Islamic Shariah. Thus, the emergence of Islamic banking is clearly intended to provide for Shariah approved financial transactions.

Islamic Banking for Development: Islamic banking is claimed to be more development- oriented than its conventional counterpart. The concept of profit sharing is a built-in development promoter since it establishes a direct relationship between the bank's return on investment and the successful operation of the business by the entrepreneurs.

Optimum Allocation of Resources: Another important objective of Islamic banking is the optimum allocation of scarce resources. The foundation of the Islamic banking system is that it promotes the investment of financial resources into those projects that are considered to be the most profitable and beneficial to the economy.

 

 Islamic Banking for Equitable Distribution of Resources: Perhaps the must important objective of Islamic banking is to ensure equitable distribution of income and resources among the participating parties: the bank, the depositors and the entrepreneurs.

 

Distinguishing features of Islamic Banking

An Islamic bank has several distinctive features as compared to its conventional counterpart. Chapra (1985, PP.154-57) has outlined six essential differences as below:

Abolition of interest (Riba): Since Riba is prohibited in the Quran and interest in all its forms is akin to Riba, as confirmed by Fuqaha and Muslim economists with rare exceptions, the first distinguishing feature of an Islamic bank must be that it is interest-free.       

 Adherence to public interest: Activity of commercial banks being primarily based on the use of public funds, public interest rather than individual or group interest will be served by Islamic commercial banks.  The Islamic banks should use all deposits, which come from the public for serving public interest and realizing the relevant socio-economic goals of Islam. They should play a goal-oriented rather than merely a profit-maximizing role and should adjust themselves to the different needs of the Islamic economy.

Multi-purpose bank: Another substantial distinguishing feature is that Islamic banks will be universal or multi-purpose banks and not purely commercial banks. These banks are conceived to be a crossbreed of commercial and investment banks, investment trusts and investment -management institutions, and would offer a variety of services to their customers. A substantial part of their financing would be for specific projects or ventures. Their equity-oriented investments would not permit them to borrow short-term funds and lend to long-term investments. This should make them less crisis-prone compared to their capitalist counterparts, since they would have to make a greater effort to match the maturity of their liabilities with the maturity of their assets.

More careful evaluation of investment demand:  Another very important feature of an Islamic bank is its very careful attitude towards evaluation of applications for equity oriented financing. It is customary that conventional banks evaluate applications, consider collateral and avoid risk as much as possible. Their main concern does not go beyond ensuring the security of their principal and interest receipts. Since the Islamic bank has a built in mechanism of risk sharing, it would need to be more careful in how it evaluates financing requests. It adds a healthy dimension in the whole lending business and eliminates a whole range of undesirable lending practices.

Work as catalyst of development: Profit-loss sharing being a distinctive characteristic of an Islamic bank fosters closer relations between banks and entrepreneurs. It helps develop financial expertise in non-financial firms and also enables the bank to assume the role of technical consultant and financial adviser, which acts as catalyst in the process of industrialization and development.

Conventional and Islamic banking

Conventional banking is essentially based on the debtor-creditor relationship between the depositors and the bank on the one hand, and between the borrowers and the bank on the other. Interest is considered to be the price of credit, reflecting the opportunity cost of money.

 Islam, on the other hand, considers a loan to be given or taken, free of charge, to meet any contingency.  Thus in Islamic Banking, the creditor should not take advantage of the borrower. When money is lent out on the basis of interest, more often it happens that it leads to some kind of injustice. The first Islamic principle underlying such kinds of transactions is that "deal not unjustly, and ye shall not be dealt with unjustly" [2:279]. Hence, commercial banking in an Islamic framework is not based on the debtor-creditor relationship.

The second principle regarding financial transactions in Islam is that there should not be any reward without taking a risk. This principle is applicable to both labor and capital. As no payment is allowed for labor, unless it is applied to work, there is no reward for capital unless it is exposed to business risk (Ausaf Ahmed 1995, P.17).

Thus, financial intermediation in an Islamic framework has been developed on the basis of the above two principles. Consequently financial relationships in Islam have been participatory in nature. Several theorists suggest that commercial banking in an interest-free system should be organized on the principle of profit and loss sharing. The institution of interest is thus replaced by a principle of participation in profit and loss. That means a fixed rate of interest is replaced by a variable rate of return based on real economic activities (Mangla & Uppal 1990. pp.179-215, 185). The distinct characteristics which provide Islamic banking with its main points of departure from the traditional interest-based commercial banking system are: (a) the Islamic banking system is essentially a profit and loss sharing system and not merely an interest (Riba) banking system; and (b) investment (loans and advances in the Conventional sense) under this system of banking must serve simultaneously both the benefit to the investor and the benefit of the local community as well.  The financial relationship as pointed out above is referred to in Islamic jurisprudence as Mudaraba.

 

For the interest of the readers, the distinguishing features of the conventional banking and Islamic banking are shown in terms of a box diagram as shown below:

Banks	Islamic Banks
1. The functions and operating modes of conventional banks are based on manmade principles.	1. The functions and operating modes of Islamic banks are based on the principles of Islamic Shariah.
2. The investor is assured of a predetermined rate of interest.	2. In contrast, it promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur).
3. It aims at maximizing profit without any restriction.	3. It also aims at maximizing profit but subject to Shariah restrictions.
4. It does not deal with Zakat.	4. In the modern Islamic banking system, it has become one of the service-oriented functions of the Islamic banks to collect and distribute Zakat.
5. Leading money and getting it back with interest is the fundamental function of the conventional banks.	5. Participation in partnership business is the fundamental function of the Islamic banks.
6. Its scope of activities is narrower when compared with an Islamic bank.	6. Its scope of activities is wider when compared with a conventional bank. It is, in effect, a multi-purpose institution.
7. It can charge additional money (compound rate of interest) in case of defaulters.	7. The Islamic banks have no provision to charge any extra money from the defaulters.
8. In it very often, bank's own interest becomes prominent. It makes no effort to ensure growth with equity.	8. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity.
9. For interest-based commercial banks, borrowing from the money market is relatively easier.	9. For the Islamic banks, it is comparatively difficult to borrow money from the money market.
10. Since income from the advances is fixed, it gives little importance to developing expertise in project appraisal and evaluations.	10. Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations.
11. The conventional banks give greater emphasis on credit-worthiness of the clients.	11. The Islamic banks, on the other hand, give greater emphasis on the viability of the projects.
12. The status of a conventional bank, in relation to its clients, is that of creditor and debtors.	12. The status of Islamic bank in relation to its clients is that of partners, investors and trader.
13. A conventional bank has to guarantee all its deposits.	13. Strictly speaking, and Islamic bank cannot do that.

 

Evolution of The Concept Of Islamic Banking

Though the directives of banking and trading were laid down in Quran and Sunnah, the idea of Islamic banking took as many as thirty years for its conceptual consolidation and only by the early seventies did it take the shape of the present comprehensive model. The system is based on the Islamic legal concepts of  shirkah (partnership) and mudaraba (profit sharing). Many Muslim economists contributed to the development of thinking on Islamic banking, the notables among them are Nejatullah Siddiqi, Baquir al Sadar, Abdullah al Araby, Sami Hassan Hamoud and Ahmed al Naggar. Siddiqi primarily  conceived  an  Islamic  bank  as  a  financial  intermediary  mobilizing  savings  from  the  public  on  the  basis  of mudarabah and  advancing  capital  to  entrepreneurs  on  the  same  basis.  Profit   accruing  to entrepreneurs  on  the  capital advanced by the bank are shared by the bank according to a mutually agreed upon percentage. The bank also provides a number  of  familiar  services  on  a  fee  or  a  commission  basis. The  bank's  own  capital  also  goes  into  the  business of offering banking services and advancing capital on a profit sharing basis. After accounting for administrative costs, the net  revenue  on  these  business  activities  constitutes  the  bank's  profits,  which  are  distributed  to  the  owners  of  capital, both to the individuals that deposited their savings on the basis of  mudarabah and the bank for its capital investment.

 

MAIN REASONS TO ESTABLISH ISLAMIC BANKING SYSTEM

 

There are mainly two reasons to establish Islami Banking system:

i)             Shariah

ii)            Socio -economic

a) To check inflation,

b) To do justice to the depositors,

c) To increase the investment,

d) To handover capital to the experts,

e) To protect the hoarders,

f)  To decrease the income discrimination,

g) To full utilization of foreign currency or foreign capital,

h) To ensure proper supply & distribution of goods/wealth,

i)  To increase the financial development of poors,

j)  To relief the poors from oppression,

k) To extend the hands to the productive sector,

l)  To stable the price hike.

 

MAIN OBJECTIVES OF ISLAMIC ECONOMY

 

The objectives of Islamic economy are as under:

 

i) To establish Adl (justice), to attain Hasanah (good) and Falah (welfare) in this life and

the life hereafter.

ii) To establish Ihsan (gracious conduct or kindness) in economic affairs.

iii) To establish Maroof (proper or good acts, institutions) in economic life.

iv) To eliminate Munker (evil, wrong or injurious practices from economic life)

v) To free the humanity from un-wanted burdens and shackles and to make life easier for them.

vi) To achieve maximum economic growth.

vii) To maximize employment to ensure proper distribution of wealth in the society.

viii) To achieve universal education.

ix) To encourage cooperation in the society.

x) To favoring the weaker sections of the society to establish them in life.

ISLAMIC BANKING AROUND THE GLOBE

https://www.islamibankbd.com/abtIBBL/cis_islamic_banking_around_the_world.php

https://www.researchgate.net/publication/337631730_ISLAMIC_BANKING_ON_ITS_WAY_TO_GLOBALIZATION

ISSUES AND PROBLEMS OF ISLAMIC BANKING

https://www.islamibankbd.com/abtIBBL/cis_issues_and_problems_of_islamic_banking.php

 

ISLAMIC BANKING: PROBLEMS AND PROSPECTS

Islamic Banking

Definition:

An Islamic Banking is a financial institution that operates with the objective to implement and materialise the economic and financial principles of Islam in the banking arena.

The Organisation of Islamic conference (OIC) defined an Islamic Bank as  a financial institution whose statutes, rules and procedures expressly state its commitment to the principles of Islamic Shariah and to the banning of the receipt and payment of interest on any of its operations.

According to Islami Banking Act 1983 of Malaysia, an Islamic Bank is a company which carries on Islamic Banking business....... Islamic Banking business means banking business whose aims and operations do not involve any element which is not approved by the religion Islam.

Objectives:

The objective of Islamic Banking is not only to earn profit, but to do good and bring welfare to the people, Islam upholds the concept that money, income and property belong to Allah and this wealth is to be used for the good of the society.

Islamic Banks operate on Islamic principles of profit and loss sharing and other approved modes of Investment. It strictly avoids interest which is the root of all exploitation and is responsible for large scale inflation and unemployment.

 

An Islamic Bank is committed to do away with disparity and establish justice in the economy, trade, commerce and industry; build socio-economic infrastructure and create employment opportunities. 

 

HISTORY AND PRESENT STATUS OF ISLAMIC BANKING AROUND THE WORLD

The History of Islamic Banking :

The History of Islamic Banking could be divided in to two parts. First When it still remained an Idea, Second-When it become a reality-by private initiative in some counties and by law in others.

Islamic Banking as an Idea :

The scholar of the recent past in early fifties started writing for Islamic Banking in place of Interest Free Banking. In the next two decades Islamic Banking attracted more attention.

Early seventies saw the institutional involvement. Conference of the Finance Ministers of the Islamic Countries was held. The involvement of institutions and Government led to the application of theory to practice and resulted in the establishment of the Islamic Banks. In this process the Islamic Development Bank (IDB) was established in 1975.

The coming into being of Islamic Banks:

The first private Islamic Bank, the Dubai Islamic Bank  was also set up in 1975 by a group of Muslim businessmen from several countries.  Two more private banks were founded in 1977 under the name of Faisal Islamic Bank in Egypt and Sudan. In the same year the Kuwaiti Government set up the Kuwait Finance House.

In the ten years since the establishment of the first private commercial bank in Dubai, more than 50 Islamic Banks have come into being. Though nearly all of them are in Muslim countries, there are some in Western Europe as well : in Denmak, Luxembourg, Switzerland and the UK.

In most countries the establishment of Islamic banking had been by private initiative and were confined to that bank. In Iran and Pakistan, however, it was by government initiative and covered all banks in the country. The Governments in both these counties took steps in 1981 to introduce Islamic Banking.

 

At present there are Islamic Banks in the following countries:-

 

01.      Afghanistan

02.       Algeria

03.       Albania

04.       Argentina

05.       Australia

06.       Bahamas

07.       Bahrain

08.       Bangladesh

09.       Brunei

10.     Cayman Islands

11.     Cyprus

12.     Denmark

13.     Djibouti

14.     Egypt

15.     Germany

16.     Guinea

17.Gambia

18.India

19.Indonesia

20.Iran

21.Iraq

22.Jordan

23.Kazakhstan

24.Kibris Turkish Republic

25.Kuwait

26.Lebanon

27.Liechtenstein

28.Luxembourg

29.Malaysia

30.Mauritania

31.Morocco

32.Niger

33.Pakistan

34.Palestine

35.Philippines

36.Qatar

 

37.Russia

38.Saudia Arabia

39.Senegal

40.South Africa

41.Sudan

42.Switzerland

43.Thailand

44.Tunsia

45.Turkey

46.U.A.E.

47.U. K.

48.S. S. A.

49.Yemen.

 

Problems being faced by Islamic Banking in the world in general

Most of the Islamic Banks operate on Bai- Murabaha, Bai Muazzal, Bai- Salam, Istisna, Hire Purchase/ Leasing mode of Investment i.e. Islamic Banks always prefer to run on markup/ guaranteed profit basis having Shariah coverage. For this reason some times the conventional Economists and General people failed to understand the real difference between Islamic Banking and conventional Banking.

Mudaraba and Musharaka modes of Investment are ideal but Islamic Banks are not going in these two modes, the reasons for the above are as follows:

i)         There is no systemic analysis and research and no real efforts to introduce above mentioned two modes but the practitioners blame the following factors:-

 a) There is lack of committed entrepreneur

b)  There is lack of committed professional who can create new  instruments.

c)  There is lack of committed sponsors who can pressurize the professionals

d)  There is shortage of skilled professionals.

 

2. The problem of forward contact/booking of foreign currency.

The  value of US Dollars ($), Pound Sterling, Euro and others are not fixed in Bangladesh, they are fluctuating from time to time Most of our imports and exports are made in USD and USD being a strong currency always moves upward and the exporters are in better position than the importer in our country. In Bangladesh Forward Booking is required to check the exchange fluctuation for import of heavy/project Machineries where it take long time say one year or six months to produce the same.

But due to the restrictions of Shariah we can not cover the risk of Exchange fluctuation by forward contract as Forward Booking is not permitted by Shariah. As per Shariah, currency, transaction is to be made under certain terms and conditions laid down for sarf by Shariah, such as spot possession of both the currencies by both the parties which is not available in forward Booking. It is also prohibited to deal in the forward money market even if the purpose is hedging to avoid loss of profit on a particular transaction effected in a currency whose value is expected to be declined.  This problem requires a solution by Shariah experts.

3. Inland Bill Purchase/Foreign Bill Purchase :

This is another problem of Islamic Bank where the exporters immediately after export of the goods approach to the bank for fund before maturity of the bills to meet their daily needs. Here the Bank has to deploy billions of Taka each year but how and on what mode of investment ? The Bank can not take anything by providing fund to the exporter except collection fee for collection of the Bill, which is very poor.

4. Unfamiliarity with the Islamic Banking System

The first problem, is that despite the growth of Islamic banks over the last 30 years, many people in the Muslim and non-Muslim world do not understand what Islamic banking actually is. The basic principle is clear, that it is contrary to Islamic law to make money out of money and that wealth should accumulate from trade and ownership of real assets. However, there does not appear to be a single definition of what is or not an Islamic-banking product; or there is not a single definition of Islamic banking. A major issue here is that it is the Shariah Councils or Boards at individual Islamic banks that actually define what is and what is not Islamic banking, and what is and what is not the acceptable way to do business, which in turn can complicate assessment of risk for both the bank and its customer. More generally, the uncertainty over what is, or is not, an Islamic product has so far prevented standardization. This is difficult for regulators as they like to know exactly what it is they are authorising. It is also an added burden on the banks that have to educate customers in new markets.

5. Portfolio Management :

The behavior of economic agents in any country is determined partly by past experience and present constraints. The Islamic banks are still growing in experience in many countries. Regarding constraints, Islamic banks in different countries do not freely choose arrangements, which best suit, their need. As a result, their activities are not demand-oriented and do not react flexibly to structural shifts in the economic setting as well as to changes in preferences It is known to the bank management that a certain portion of the short-term fund is normally not withdrawn at maturity; these funds are used for medium or long-term financing. However, a precondition for this maturity transformation is that the bank be able to obtain liquidity from external sources in case or unexpected withdrawals. Islamic banks, without having an interest-free Islamic money and capital market, have no adequate instruments to meet this pre-condition for effective maturity transformation. On the other hand, Islamic banks can enhance term transformation if there is an interest-free bond market or a secondary market for Islamic financial papers. Adequate financial mechanism still has to be developed, without which financial intermediation, especially the risk and maturity transformation, is not performed properly.

6. The Regulatory environment 

The relationship between Islamic banks and monetary authorities is a delicate one. The central bank exercises authority over Islamic banks under laws and regulations engineered to control and supervise both traditional banks. Whatever the goals and functions are, Islamic banks came into existence in an environment where the laws, institutions training and attitude are set to serve an economy based on the principles of interest. The operations of Islamic banks are on a profit and loss share basis (PLS), which actually do not come fully under the jurisdiction of the existing civil laws. If there are disputes to be handled, civil courts are not sufficiently acquainted with the rationale of the operations of Islamic Banking. Regarding the protection of depositors, Islamic Banks are required to let the authorities know the difference between money paid into current accounts and money paid into investment accounts. Islamic banks operate two broad types of deposits:

a)    Deposits, which cover transaction balance. These have a 100 percent reserve requirement and completely safe, thus satisfying the needs of risk averters, and

b)    The PLS or equity account, in which depositors are treated exactly as if they  were shareholders in the bank. There is no guaranteed rate of return or nominal  value of the share.

In non-Muslim counties (i.e., the countries with less than 50% Muslim population) the central banks are very stringent in granting licenses for Islamic banks to operate. In order to be established in those countries Islamic banks must also meet the additional requirements of other government and non-government authorities. (So, apart from legal constraints there are economic measures that result operations of Islamic banks in the non-Muslim world difficult). In Muslim countries also they face economic restrictions. Besides funding, acceptable investment outlets is a major challenge for Islamic financial institutions.

 

7. Absence of Liquidity Instruments

Many Islamic banks lack liquidity instruments such as treasury bills and other marketable securities, which could be utilised either to cover liquidity shortages or to manage excess liquidity. This problem is aggravated since many Islamic banks work under operational procedures different from those of the central banks; the resulting non-compatibility prevents the central banks from controlling or giving support to Islamic banks if a liquidity gap should occur. So the issue of liquidity management must come under active discussion and scrutiny by the authorities involved is Islamic banking.

8. Use of Advanced Technology and Media

Many Islamic banks do not have the diversity of products essential to satisfy the growing need of their clients. The importance of using proper advanced technology in upgrading the acceptability of a product and diversifying its application cannot be over emphasized. Given the potentiality of advanced technology, Islamic banks must have to come to terms with rapid changes in technology, and redesign the management and decision-making structures and, above, all introduce modern technology in its operations. Many Islamic banks also lack the necessary expertise and institutional capacity for Research and Development (R & D) that is not only necessary for the realization of their full potential, but also for its very survival in this age of fierce competition, sophisticated markets and an informed public. Islamic banking cannot but stagnate and wither without dynamic and ongoing programmes. In addition, Islamic banks have so far not used the media appropriately.

Even the Muslims are not very much aware that the Islamic banking is being practiced in the world. Islamic banks have not ever used an effective media to publicise their activities. The authorities concerned in Islamic banks should address these issues on a priority basis.       

9. Need for Professional Bankers

The need for professional bankers or managers for Islamic banks cannot be over emphasized. Some banks are currently run by direct involvement of the owner himself, or by managers who have not had much exposure to Islamic banking activities, nor are conversant with conventional banking methods. Consequently, many Islamic banks are not able to face challenges and stiff competition. There is a need to institute professionalism in banking practice to enhance management capacity by competent bankers committed to their profession. Because, the professionals working in Islamic banking system have to face bigger challenge, as they must have a better understanding of industry, technology and the management of the business venture they entrust to their clients. They also have to understand the moral and religious implications of their investments with the business ventures. There is also a need for banking professionals to be properly trained in Islamic banking and finance. Most banks professionals have been trained in conventional economics. They lack the requisite vision and conviction about the efficiency of the Islamic banking.      

10. Blending of Approach of Islamic Scholars with the Approach of the Conventional Bankers

Bankers, due to the nature of their jobs have to be pragmatic or application-oriented. There is and will be tendency in the bankers practicing in Islamic banks to mould or modify the Islamic principles to suit the requirement for transactions at hand. Additionally, being immersed in the travails of day to day banking, they find little time or inclination to do any research, which can make any substantial contribution to the Islamic banking. Islamic Scholars active in researching Islamic Banking and finance, on the other hand, typically have a normative approach, i.e. they are more concerned with what ought to be. A very few of them are knowledgeable about banking or the needs of the customers.

(II) PROBLEM SPECIFIC TO ISLAMIC BANKING IN BANGLADESH

1. Absence of Islamic Money Market

In the absence of Islamic money market in Bangladesh, the Islamic banks cannot invest their surplus fund i.e., temporary excess liquidity to earn any income rather than keeping it idle. Because all the Government Treasury Bills, approved securities and Bangladesh Bank Bills in Bangladesh are interest bearing. Naturally, the Islamic banks cannot invest the permissible part of their Security Liquidity Reserve and liquid surplus in those securities. As a result, they deposit their whole reserve in cash with Bangladesh Bank. Similarly, the liquid surplus also remains uninvested. On the contrary, the conventional banks of the country do not suffer from this sort of limitations. As such, the profitability of the Islamic banks in Bangladesh is adversely affected.           

2. Absence of Suitable Long-term Assets

The absence of suitable long term assets available to Islamic banks is mirrored by lack of short term tradable financial instruments. At present there is no equivalent of an inter-bank market in Bangladesh where banks could place, say, over night funds, or where they could borrow to satisfy temporary liquidity needs. Trading of financial instruments is also difficult to arrange when rates of return are not know until maturity. Furthermore, it is not clear whether Islamic banks in Bangladesh can utilise more exotic instruments, such as derivatives, that are becoming increasingly popular with conventional banks. Obviously, these factors place Islamic banking in Bangladesh at a distinct disadvantage compared to its conventional banking counterpart.

3. Shortage of Supportive and Link Institutions

Any system, however well integrated it may be, cannot thrive exclusively on its built-in elements. It has to depend on a number of link institutions and so is the case with Islamic banking. For identifying suitable projects, Islamic banking can profitably draw the services of economists, lawyers, insurance companies, management consultants, auditors and so on. They also need research and training forums in order to prompting entrepreneurship amongst their clients. Such support services properly oriented towards Islamic banking are yet to be developed in Bangladesh.

4. Organizing Relationship with Foreign Banks

Another important issue facing Islamic banks in Bangladesh is how to organise their relationships with foreign banks, and more generally, how to conduct international operations. This is, of course, an issue closely related to the creation of financial instruments, which would be simultaneously consistent with Islamic principles and acceptable to interest-based banks, including foreign banks.

5. Long-term Financing

Islamic Banks stick very closely to the pricing policies of the government. They can not benefit from hidden costs and inputs, which elevate the level of prices by certain entrepreneurs without any justification. On the other hand, Islamic banks as financial institutions are even more directly affected by the failure of the projects they finance. This is because the built in security for getting back their funds, together with their profits, is in the success of the project. Islamically, it is not lawful to obtain security from the partner against dishonesty or negligence, both of which are very difficult if not impossible to prove.              

Prospects

In my understanding the prospect of Islamic Banking is very bright.  Muslim people everywhere want Islamic Banking.  In Bangladesh, to give an example,  4/5 conventional Banks have opened separate Islamic branches recently.  Five hundred applications are pending with Islamic Bank Bangladesh Ltd. for opening of new braches.  IBBL has already 132 branches in the country.

The position may not be same in all countries.  But if Islamic Banking succeeds in any country, the position will same in every Muslim country in my judgment.  This means, that first Islamic Bank in any country should be well managed and successful so that people have faith in this system.  Established Islamic Banks should co-operate by lending competent officials in setting up new Islamic Banks.

The problems mentioned in the preceding pages are not insurmountable.  Most of them can be solved with more research and dedicated efforts.  IDB, OIC Fiqh Academy, Internatinal Islamic Banking organizations and individual Islamic banks should put more resources in research in Islamic Banking, Finance and Economic issues. Cooperation of Central Banks and the Governments. will be needed in some areas.  I have no doubt in mind that Islamic banking will expand more and more in the entire world.

http://www.shahfoundationbd.org/hannan/article10.html

 

FUNCTION OF COMMERCIAL BANKS

Top 5 Function of Commercial Banks

Function # 1. Mobilisation of Savings:

Function # 2. Supply of Finance:

Function # 3. Creation of 'Money':

Function # 4. Development and Growth of the Economy:

Function # 5. Subsidiary Functions:

 

14 FUNCTION OF COMMERCIAL BANKS

1. Accepting Deposits:

Banks attract the idle savings of people in the form of deposits.

These deposits may be of any of the following types:

2. Demand deposits, also known as current accounts:

These are repayable on demand without any notice. Usually no interest is paid on them, because the bank cannot utilize short-term deposits, and must, therefore, keep almost cent per cent reserve against them. On the other hand, a little commission is charged for the services rendered. Occasionally, however, a small interest is paid to people who keep large balances.

3. Fixed Deposits or Time Deposits:

These deposits can be withdrawn only after the expiry of the period for which these deposits have been made. Higher interest is paid on them—the rate rising with the length of the period and the amount of deposit. The usual rate in India today varies between 6 per cent and 110 per cent, depending upon the time-period for which deposits are made.

4. Savings Bank Deposits:

These deposits stand midway between current and fixed accounts. These deposits are not as freely withdraw-able as current accounts. One or two withdrawals up to a limit of one-fourth of the deposit but not more than Rs. 1,000 are generally allowed in a week. The rate of interest is less than that on the Fixed Deposits.

5. Giving Loans:

But receiving of deposits is not the whole story about a bank’s functions. If that were so, how could a bank pay interest? Hence, after collecting money by way of deposits, a bank invests it or lends it out. Money is lent to businessmen and traders usually for short periods only. This is so because the bank must keep itself ready to meet the demands of the depositors, who have deposited money for short periods.

6. By allowing an Overdraft:

Customers of standing are given the right to overdraw their accounts. In other words, they can get more than they have deposited, but they have to pay interest on the extra amount which has to repaid within a short period. The amount of permissible over-draft varies with the financial position of the borrower.

7. By Creating a Deposit:

Cash credit is another way of lending by the banks. When a person wants a loan from a bank, he has to satisfy the .manager about his ability to repay, the soundness of the venture and his honesty of purpose. In addition, the bank may require a tangible security, or it may be satisfied with the borrower’s personal security.

Usually such security is accepted as can be easily disposed of in the market, e.g., government securities or shares of approved concerns. Then details about time and rate of interest are settled and the loan is advanced. A borrower rarely wants to draw the whole amount of his loan in cash. Usually he opens a current account with that amount the bank, if he already has not got an account with this bank.

Now it is exactly as if that sum had been deposited by him. This is how a deposit is ‘created’ by a bank. That is why it is said “every loans creates a deposit.” A cheque book is given to the borrower with the right to draw cheques up to the full amount of the loan, but interest is charged on the whole sum even though only a part is withdrawn. After the period, for which the money has been borrowed, is over, the borrower returns the amount with interest to the bank. Banks make most of their profits thus by giving loans.

8. Discounting Bills:

The discounting of bills by a bank is another way of lending money. The banks purchase these bills through bill-brokers and discount; companies of discount them directly for the merchants. These bills provide a very liquid asset (i.e., an asset which can be easily turned into cash). The banks immediately any cash for the bill after deducting the, discount (interest), and wait for the bill to mature when they get back its full value.

The investment in bills is considered quite safe, because a bill beats the security of two businessmen, the drawer as well as the drawer, so that if one proves dishonest or fails, the bank can claim the money from the other. This is regarded as the best investment by the banks. It is liquid, lucrative and safe. That is why it is said that a good bank manager knows the difference between a bill and a mortgage.

9. Remitting Funds:

Banks remit funds-for their customers through bank draft to any place where they have branches or agencies. This is the cheapest way of sending money. It is also quite safe. Funds can also be remitted to foreign countries.

10. Miscellaneous Functions:

Besides these main functions, the banks perform several others as given below:

11. Safe Custody:

Ornaments and valuable documents can be kept in safe deposit with a bank, in its strong room fitted with lockers, on payment of a small sum per year. Thus the risk of theft is avoided.

12. Agency Functions:

The bank works as an agent of their constituents. They receive payments on their behalf. They collect rents, dividends on shares, etc. They pay insurance premia and make other payments as instructed by their depositors. They accept bills of exchange on behalf of their customers. They pass bills of lading or railway receipts to the purchasers of goods when they pay for them. This amount is passed on to the suppliers of goods.

13. References:

They provide references about the financial position of their customers when required. They supply this information confidentially. This is done when their customers want to establish business connections with some new firms within or outside the country.

14. Letters of Credit:

In order to help the travelers, the banks issue letters of credit travelers’ cheques. A man going on a tour takes with him a letter of credit from his bank. It is mentioned there that he can be paid sums up to a certain limit. He shows this letter to banks in other places which make the payment to him and debit the bank which has issued the letter of credit.

https://www.economicsdiscussion.net/banks/top-14-functions-of-commercial-banks-discussed/1877

 

ROLE OF BANKS IN ECONOMIC GROWTH:

Commercial banks have been playing an important role in the economic development of Bangladesh. They provide investible funds to both the public sector, and specially the private sector. Further, banks have played a significant role in respect of the four major drivers of economic growth in Bangladesh as discussed above.

The banking sector, however, is faced with various challenges, which include among others, weak management, poor governance, lack of strong leadership, and non-compliance with ethical standards leading to various types of banking scams such as money laundering and Non-Performing Loans (NPLs).

 

Bangladesh is an import-dependent country. It needs to import raw materials, accessories and machineries to foster development of the industrial sector, including the RMG sector. Banks have been facilitating payment, finance and risk management services to the sector.

https://thefinancialexpress.com.bd/views/views/economic-growth-in-bangladesh-and-the-role-of-banking-sector-1547220114#

 

Role of Commercial Banks in economic development of country

Commercial Banks have always played an important position in the country’s economy. They play a decisive role in the development of the industry and trade. They are acting not only as the custodian of the wealth of the country but also as resources of the country, which are necessary for the economic development of a nation.

We shall now discuss the contributions made by the banks for the economic development of the nation.

1. Capital Formation

Banks play an important role in capital formation, which is essential for the economic development of a country. They mobilize the small savings of the people scattered over a wide area through their network of branches all over the country and make it available for productive purposes.

Now-a-days, banks offer very attractive schemes to attract the people to save their money with them and bring the savings mobilized to the organized money market. If the banks do not perform this function, savings either remains idle or used in creating assets, which are low in scale of plan priorities.

2. Creation of Credit

Banks create credit for the purpose of providing more funds for development projects. Credit creation leads to increased production, employment, sales and prices and thereby they cause faster economic development.

3. Channelizing the Funds to Productive Investment

Banks invest the savings mobilized by them for productive purposes. Capital formation is not the only function of commercial banks. Pooled savings should be distributed to various sectors of the economy with a view to increase the productivity of the nation. Then only it can be said to have performed an important role in the economic development of the nation.

Commercial Banks aid the economic development of the nation through the capital formed by them. In India, loan lending operation of commercial banks subject to the control of the RBI. So our banks cannot lend loan, as they like.

4. Fuller Utilization of Resources

Savings pooled by banks are utilized to a greater extent for development purposes of various regions in the country. It ensures fuller utilization of resources.

5. Encouraging Right Type of Industries

The banks help in the development of the right type of industries by extending loan to right type of persons. In this way, they help not only for industrialization of the country but also for the economic development of the country. They grant loans and advances to manufacturers whose products are in great demand. The manufacturers in turn increase their products by introducing new methods of production and assist in raising the national income of the country.

6. Bank Rate Policy

Economists are of the view that by changing the bank rates, changes can be made in the money supply of a country. In our country, the Bank  regulates the rate of interest to be paid by banks for the deposits accepted by them and also the rate of interest to be charged by them on the loans granted by them.

 

7. Bank Monetize Debt

Commercial banks transform the loan to be repaid after a certain period into cash, which can be immediately used for business activities. Manufacturers and wholesale traders cannot increase their sales without selling goods on credit basis. But credit sales may lead to locking up of capital. As a result, production may also be reduced. As banks are lending money by discounting bills of exchange, business concerns are able to carryout the economic activities without any interruption.

8. Finance to Government

Government is acting as the promoter of industries in underdeveloped countries for which finance is needed for it. Banks provide long-term credit to Government by investing their funds in Government securities and short-term finance by purchasing Treasury Bills.

9. Bankers as Employers

After the nationalization of big banks, banking industry has grown to a great extent. Bank’s branches are opened in almost all the villages, which leads to the creation of new employment opportunities. Banks are also improving people for occupying various posts in their office.

10. Banks are Entrepreneurs

In recent days, banks have assumed the role of developing entrepreneurship particularly in developing countries like India. Developing of entrepreneurship is a complex process. It includes the formation of project ideas, identification of specific projects suitable to local conditions, inducing new entrepreneurs to take up these well-formulated projects and provision of counseling services like technical and managerial guidance.

Banks provide 100% credit for worthwhile projects, which is also technically feasible and economically viable. Thus commercial banks help for the development of entrepreneurship in the country.

https://accountlearning.com/role-of-commercial-banks-in-economic-development-of-country/

 

 

VARIOUS TYPES OF DEPOSITS ACCOUNTS

 

i)             Savings Deposit Account

ii)            Current Deposit Account

iii)           Short Term Deposit Account

iv)           Resident Foreign Currency Deposit

v)            Foreign Currency Deposit

vi)           Convertible Taka Account

vii)         Non-Convertible Taka Account

viii)        Exporter's FC Deposit(FBPAR)

ix)           Current Deposit Account-Bank

x)            Short Term Deposit Account-Bank

 

Social Islami Bank Limited mobilizes deposits through different types of accounts.

1)    Al-Wadeah Accounts

2)    Mudaraba Accounts

 

Al-Wadeah Accounts

The Law and regulation of  Bangladesh, usual customs and procedures common to banks in Bangladesh including Islamic Banking Principles shall apply to govern and conduct the account opened with the Bank.

1)    Any adult having sound mind can open this account in his/her name singly or jointly with others. Any proprietorship/partnership firm, limited company (private/public), educational institution, club, association, socio-economic organization can also open this account.

2)    Account opening balance is TK. 2,000 only, which is treated as minimum balance of the account.

3)    02 copies passport size photographs of account holder/holders duly attested by introducer.

4)    1 copy photograph of nominee duly attested by the account holder.

5)    Identification proof like National ID Card/Passport/Driving License; Tarde Licensee for Business Organizations; relevant document for Company and Partnership Firms.

6)    Introducer signature and Account Number.

 

Mudaraba Savings Deposit

The Law and regulation of Bangladesh, usual customs and procedures common to banks in Bangladesh including Islamic Banking Principles shall apply to govern and conduct the account opened with the Bank.

1)            Any adult having sound mind can open this account in his/her name singly or jointly with others. Any proprietorship/partnership firm, limited company (private/public), educational institution, club, association, socio-economic organization can also open this account.

2)            Account opening balance is TK. 500 only, which is treated as minimum balance of the account.

3)            02 copies passport size photographs of account holder/holders duly attested by introducer

4)            1 copy photograph of nominee duly attested by the account holder

5)            Identification proof like National ID Card/Passport/Driving License

WHAT IS CHEQUE:

A cheque is a very common form of negotiable instrument. If you have a savings bank account or current account in a bank, you can issue a cheque in your own name or in favour of others, thereby directing the bank to pay the specified amount to the person named in the cheque. A cheque is a document which guarantees the payment of a specific amount of money on demand to a certain person or to the bearer of the instrument.

A cheque is a negotiable instrument used to make payment in the day to day business transaction minimizing the risk and possibility of loss. It is used by individuals, businesses, corporate and others to transact for making and receiving payment.

Definition of Cheque:

As per negotiable instrument act 1881, A “cheque” is a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand.

There are three parties in Cheque Transaction – Drawer, Drawee and Payee.

Drawer (Maker of Cheque) – The person who issues the cheque or hold the account with a bank.

Drawee – The Person who is directed to make the payment against cheque. In case of cheque, it is a bank.

Payee – A person whose name is mentioned in the cheque or to whom the drawee makes payment. If the drawer has drawn the cheque in favour of self then drawer is the payee.

Types of Cheque

There are many different types of cheque’s available within financial institutions which serves different purposes. Some of them are:

 

 1. Open/ Bearer Cheque

This type of cheques is risky. When the word “Bearer” on the cheque is not crossed or canceled, the cheque is called a bearer cheque. Open / Bearer Cheques are payable to a person specified in the instrument or any person who posses it and present for payment over the counter. In case of a cheque is lost, a person who finds it can collect payment from the bank.

2. Order Cheque

When the word “Bearer” written on a cheque is crossed or canceled it becomes an order cheque. An order Cheque is payable to a specified as the payee or to anyone else to whom it is endorsed (transferred).

3. Crossed Cheque/Account Payee Cheque

The person who issues or write the cheque specify its as account payee by simply making two parallel lines on the top left or middle or right-hand corner of the cheque. This type of cheque cannot be encashed over the counter. Considered as safest type of cheque, it can only be credited to payee’s account whose name is mentioned in the Cheque. The payment of the account payee cheque taken place on the person, firm or company on which name the cheque issue.

4. Stale Cheque

If a cheque is presented for payment after 06 (Six) months from the date of the cheque, it is called stale cheque. This type of cheque cannot be honored by the bank. After expiry of that period, no payment will be made by banks against that cheque.

5. Post-Dated Cheque

If a cheque bears a date which is yet to come (future date) then it is known as a post-dated cheque. A post dated cheque cannot be honored earlier than the date on the cheque. A cheque is honored only on or after the date (up to six months validity) written on a cheque. For example, if a cheque presented on 15th Feb 2011 bears a date of 26th Feb 2011, it is a post-dated cheque. The bank will make payment only on or after 26th Feb 2011.

 

6. Anti-Dated Cheque

If a cheque bears a date earlier than the date on which it is presented to the bank, it is called as “anti-dated cheque”. Such a cheque is valid up to six months from the date of the cheque. For Example, a cheque issued on 10th Feb 2011 may bear a date 10th Dec 2010.

7. Mutilated Cheque

When cheque gets torn into two or more pieces and presented in a Bank for payment. Such cheques are called mutilated cheque. Bank requires confirmation by the drawer before honoring such cheques.

https://learningbdschool.wordpress.com/category/banking/

https://blog.ipleaders.in/need-know-paying-banker-collecting-banker/

 

RIGHTS AND DUTIES OF A COLLECTING BANKER.

1. The banker should present the cheque to the paying banker for encashment within a reasonable time. What is reasonable time depends upon the facts of each case. As per the prevailing practice, the collecting banker should present the cheques received for collection from customers at least by the following or next day after he receives it. Any undue delay in collection would render the banker liable to the customer for any loss the latter may suffer on account of the delay.

 

2. If the cheque presented in clearing is realized, then the proceeds of the realized cheque should be credited to the account of the customer without any delay.

 

3. In case the cheque sent for collection is dishonoured by the drawee bank, the collecting bank should return the cheque to the customer within a reasonable time so as to enable the customer to recover the amount of the cheque from parties liable thereto. If he fails to send the notice of dishonour of the cheque to the customer within a reasonable time and the customer suffers a loss as a consequence of the omission to send the notice, the collecting banker becomes liable to compensate the customer.

THE FOLLOWING ARE THE RIGHTS AND DUTIES OF A COLLECTING BANKER.

1)    Cheque crossed generally be paid only to banker

2)    A cheque crossed specially should be paid only to through banker

3)    Second special crossing in favour of the banker

4)    A banker cannot ignore the crossing

 

WHO IS A COLLECTING BANKER

Meaning of Collecting Banker:

According to Sir. John Paget, one of the main functions of a banker is “Collecting

cheques crossed or uncrossed for its customer”

In the ordinary course of any business, people used to buy and sell products, services, raw materials, semi-finished goods and even events. For settlement of the purchases, everybody used to issue cheques, for, cash payment is not passible in all situations. Another reason is that it is not safe to deal in cash always. Sometimes, the seller offers credit to the buyer. In modern business world even buyers and sellers in very remote areas are transacting with each other because of the colossal development in the field of communication. So, everyone cannot pay cash, one to one, and the use of cheques, bill of exchanges and other modes of electronic payments are made necessary.

So, when cheques and bills of exchange become the more preferred mode of trade payments and others, the necessity of a mediator, with knowledge and expertise, to collect that money for the true owner of the cheque is also felt much. He is the Collecting Banker.

A Collecting Banker undertakes to collect cheques, drafts, bills, pay orders, traveller’s cheque, Letter of credit, dividend warrants, debenture interest etc, on behalf of the customer.

For collecting these documents, the collecting banker used to charge some commission. The Rate of this collection commission for local cheques, outstation cheques etc, are fixed on the guidelines of central  Bank of Bangladesh India, then and there.

DOCUMENTS THAT A BANKER COLLECTS:

a) Cheques

- Local Cheques [Inter-Bank (means among various banks), Intra-Bank (means with in a bank]

- Outstation Cheques (Inter-Bank, Intra-Bank)

b) Drafts (Inter-Bank, Intra-Bank)

c) Bills of Exchange

- Documents against payment

- Documents against acceptance

- Foreign bills

d) Pay orders / Gift cheques

e) Traveller’s cheque

f) Letter of credits

g) Dividend warrants

h) Interest certificates (for debentures, bonds etc)

PROCEDURE OF COLLECTING A CHEQUE:

a) The customers are depositing, various instruments to be collected from other banks, to his banker (i.e the bank in which he is holding account)

b) The collecting banker segregates all the cheques / instruments to be collected into (a) Local instruments, that also into instruments to be collected from other branches of his own bank and instruments that are to be collected from other local banks, (b) outstation instruments, that also into, instruments to be collected from branches of his own bank, situated in other towns cities and villages and instruments to be collected from other outstation banks.

c) Local cheques of the same bank are collected through messenger service (i.e a person will be sent to other branches of its own bank in the local city and the money will be collected as per the bank procedure) (or) even through clearing service (i.e all local banks will meet in a common place called “Clearing House”, exchange instruments, related to them, and pay them duly).

Thus, the cheques of all local banks are collected through clearing service.

d) The outstation cheques, whether inter-bank or intra-bank are booked by the banker and sent to the respective branches in case of intra-bank cheques (i.e within one bank). In case of other bank cheques, the collecting banker used to send the cheques, not to the Drawee bank, but to another renowned bank of same locality and the cheques will be collected through clearing houses in the respective centres.

e) When collected, the proceeds will be sent to the respective bank branches, by the paying banker, on advice.

f) On receipt of the proceeds, the collecting banker, credits the proceeds to the respective accounts of customers, after deducting his commission, charges etc.

This is the circle of collection of cheques. A collecting Banker’s responsibility is not merely collecting these documents but should credit the realized amount to the account of the true owner of the instrument. So collecting banker acts in two various capacities – he is a bailee, when the banker is in possession of customer’s cheque and is a trustee, when he collects the amount for benefit of the customer.

Capacity of collecting banker:

In all situations, the collecting banker acts as either “agent for collection” or “Holder for value”

Agent for collection:

A collecting banker acts merely as an agent of his customer, when

a) Banker receives the cheque for collection

b) Sends to the paying Banker for realization of the cheque

c) Receives the proceeds (i.e) realized amount

d) Credits to the customer’s account after charging the collection expenses, his commission etc.

In this case, the banker acts just an agent of the principal i.e his customer. Here, the collecting banker is performing two functions.

i. If the cheque is realized the banker will credit the amount realised to the

customer account.

ii. If the cheque is dishonoured, the banker has to inform

If the cheque is dishonoured, the banker has to inform the matter to the customer and return the cheque to him properly.

 

Holder for value

When a collecting banker, advances some amount to his customer, before realisation of his cheque, the banker becomes owner of the cheque now and he istermed as “Holderfor value” (i.e person holding the cheque, for the value paid to the (or) true owner of the cheque, before realisation of the instruments)

As holder for value:

The collecting banker is said to acting as holder for value,

i. When the collecting banker advances money to the customer before the realisation of the cheques given for collection.

ii. When the collecting banker settles the loan amount due from the customer with the cheque amount given for collection, even before its realisation.

iii. Where a collecting banker reduces an overdraft with the amount for collection before its realisation.

iv. Where a part of the cheque amount is given by the collecting banker to the customer even before the realisation of the cheque.

v. By allowing the customer to draw the full amount of the cheque before its realisation

 

 

 

STATUTORY PROTECTION TO THE COLLECTING BANKER:

 

Statutory protection or Legal Protection is given to a Collecting Banker in sec. 131 of the Negotiable Instruments Act, 1881.

Sec. 131says,

1)    A banker who has in good faith

2)    received payment for a customer of a cheque

3)    crossed generally or specially to himself

4)    shall not, in case of title to the cheque proves defective

5)    incur any liability to the true owner of the cheque by reason only of having received such payment

 

This statement in sec. 131 shall be elaborated as conditions to get statutory protection for a Collecting Banker.

 

CONDITIONS ON WHICH A COLLECTING BANKER CAN GET PROTECTION

UNDER SEC. 131 OF THE NI ACT, 1881

If the following conditions are fulfilled, a collecting banker can get protection under sec. 131 of Negotiable Instruments Act.

a) Collecting for a Customer:-

A banker must collect a cheque or any other form of Negotiable Instrument only for a customer. Here, customer is predicted as one who has opened a savings bank or current account with the banker. Then also to come under the purview of the term “Customer” under section 131,

those savings or current account should have proper introduction, as required by law.

 

 

 

DUTIES AND OBLIGATIONS OF PAYING BANKER

Duties and Obligations of Paying Banker and Collecting Banker under NI Act, 1881

Paying Banker

>A Banker on whom a cheque is drawn should pay the cheque when it is presented for payment. ,

>This cheque paying function is a distinguished one of a banker.

>This obligation has been imposed on him by sec.31of the NI. Act, 1881.

>A banker is bound to honour his customer’s cheque, to the extent of the funds available and the existence of no legal bar to payment.

>Again, for making payment the cheque must be in order and it must be duly presented for payment at the branch where the account is kept.

>The paying banker should use reasonable care and diligence in paying a cheque, so as to, abstain from any action likely to damage his customer’s credit.

>lf the paying banker wrongfully dishonors a cheque, he will be asked to pay heavy damages.

>At the same time, if he makes payment in a hurry, even when there is no sufficient balance, the banker will not be allowed to debit the customer’s account. If he does so, it will amount to sanctioning of draft without prior arrangement, and, later on, the customer can claim it as precedent and compel the banker to pay cheques in the absence of sufficient balance. His position is very precarious and is in between the devil and the deep sea.

Precautions before honouring a cheque

In order to safeguard his position, the paying banker has to observe the following precautions before honoring a cheque:

 

Presentation of the cheque 

(a) Type of the cheque: Before honoring a cheque , he must find out the type to which It belongs. Cheques may generally be of two types- open or crossed.If it is an open one, the payment may be made at the counter. If it is crossed, the payment must be made only to fellow banker. If it is especially crossed, the payment must be specifically made to that banker, in whose favour it has been crossed.

If there are ‘ A/C Payee’ and ‘Not Negotiable’ crossings the paying banker need not worry, as they are the directions only to the collecting banker. If the paying banker pays a cheque contrary to the crossing, he is liable to the drawer and to the true owner and this payment cannot be regarded as a payment in due course. Therefore, he must pay special attention to the type of a cheque.

(b) Branch: The Paying banker should see whether the cheque is drawn on the branch where the account is kept. If it is drawn on another branch, without any prior arrangement, the banker can safely return the cheque.

(c)Account: Even in the same branch, a customer might have opened two or more accounts. For each account, a separate cheque book would have been issued. Hence, the paying banker should see that the cheque of one account is not used for withdrawing money from another account.

(d) Banking hours: The paying banker should also note whether the cheque is presented during the banking hours on a business day. Payment outside the banking hours does not amount to payment in due course. The hours, of banking business are statutorily laid down.

(e) MutilatIon: If the cheque is torn into pieces or canceled or mutilated, then, the paying banker should not honour it. He should return the cheque for the drawer’s confirmation. In a case cheque is torn accidentally, the drawer must confirm it by writing such words as ‘Accidentally torn by me’ and affixing his full signature. A cheque torn into two or more pieces is generally returned with a remark Mutilated’.

Il. Form of cheque

(a) Printed form: The cheque must be in proper form, It must satisfy all the requirements of law. The customers should draw cheques only on the printed leaves supplied by the bankers.

(b) Unconditional order: The cheque should not contain any condition. If it is a conditional one , the paying banker’s position will become critical and he may not honor it.

(c) Date: Before honoring a cheque, the bank must see whether there is a date on the instrument. If it is undated, it cannot be regarded as a valid instrument. If a cheque is ante- dated, it may be paid ¡f it has not become stale by that time. A cheque which is presented after six months, from the date of its issue is a stale one. If a cheque is post- dated, he should honour it only on its due date.

 (d) Amount: The next important precaution is that the banker should see whether the amount stated In the cheque, both in words and figures, agree with each other.

If the amount is stated only in figures, the banker should return it with a remark ‘Amount required to be stated in words’.

However if the amount stated only in words, the banker may honor it as per Sec.18 of the NI. Act. According to Sec, 18 of the NI. Act, if the amount undertaken or ordered to be paid is stated differently in figures and words, the amount stated in words shall be the amount undertaken or ordered to be paid.

But, usually the paying banker returns the cheque under such circumstances, since, there is an audit objection to the practice of honouring such cheques.

(e) Material alteration: A paying banker should be very cautious in finding out the alterations that may appear on a cheque. If there is any material alteration, the banker should return it with a memorandum ‘Alteration requires drawer’s confirmation.’

If the alteration is confirmed by the drawer by means of his full signature, then the banker can have no objection to honor it.

If the alteration is not apparent, and, if it is paid in due course, then, the banker will not be liable.

III. Sufficient Balance

There must be sufficient balance to meet the cheque. If the funds available are not sufficient to honor a cheque, the paying banker is justified in returning it. So, before honoring a cheque , he must check up the present state of his customers’ account.

Signature of the Drawer

The next important duty of a paying banker is to compare the signature of his customer found on the cheque with that of his specimen signature.

If he fails to do so and if he pays a cheque , which contains a forged signature of the drawer, then, the payment will not amount to payment in due course, Hence, he can not claim protection under Sec. 85 of the N.I.Act.

Endorsement.

Before honoring a cheque, the banker must verify the regularity of endorsement, if any, that appears on the instrument. It is more so in the case of an order cheque, which requires an endorsement before its delivery.

For instance, if there is per pro endorsement, the banker must find out the existence of authority. Failure to do so constitutes negligence on the part of the paying banker.

Legal Bar

The existence of legal bar like Garnishee Order limits the duty of the banker to pay a cheque. .

VII. Circumstances under which a cheque can be dishonored.

Countermanding: Countermanding is the instruction given by the customer of a bank requesting the bank not to honor a particular cheque issued by him. When such an order is received, the banker must refuse to pay the cheque.

Countermanding, in order to be really effective, must be in writing. The written mandate should contain all the details of the cheque, viz:, date, number of the cheque, name of the payee and the amount . The mandate must be signed by the customer.

(b) Upon the receipt of notice of the death of a customer: When a banker receives written information from an authoritative source, (preferably from the nearest relatives) regarding the death of a particular customer, he should not honor any cheque drawn by that deceased customer.

If the banker is unaware of the death of a customer, he may honor the cheque drawn by him. Death puts an automatic end to the contractual relationship between a banker and his customer. .

(c) Upon the receipt of notice of insolvency: Once a banker has knowledge of the insolvency of a customer , he must refuse to pay cheques drawn by him,

(d) Upon the receipt of notice of insanity: Where a banker receives notice of a customer’s insanity, he s justified in refusing payment of the cheque drawn by him. The banker should make a careful note, when the lunaçy order is received. It is advisable that the banker should act upon a definite proof of the customer’s insanity like a doctor’s certificate, a court order etc.

(e) Upon the receipt of notice of assignment: The bank balance of a customer constitutes an asset and it can be assigned to any person by giving a letter of assignment to the banker. Once an assignment has been made, the assignor has no legal rights over the bank balance and therefore, if any cheque is drawn by him, the banker should refuse to honour it.

(f) When a breach of trust Is intended: In the case of a trust account, mere knowledge of the customer’s intention to use the trust funds for his personal use, is a sufficient reason to dishonour his cheque.

(g) Defective title: If a person who brings a cheque for payment has no title or his title is defective, the banker should refuse to honour the cheque presented by him. For instance, a person who brings a cheque, which has been countermanded or which has been forged, has no title to it.

Answers to a Dishonored Cheque: (Usual Answers)

(a) NS., NF., N.S.F.: These abbreviations denote the absence of sufficient money in the account of the customer. N.S means Not Sufficient, NF means No funds, N.S.F. means not Sufficient Funds.

(b) El. It means Endorsement Irregular.’

(c) E.N.C. It refers to Effects Not Cleared.’ This answer is used when cheques are drawn against cheques paid ¡n but not yet collected.

(d) D.D. It denotes Drawer Deceased.’

(e) W.F,D. It means ‘Words and figures differ.’

(f) Exceeds Arrangement’: It ¡s used when the cash credit or 0.D. is completely exhausted.

(g) DR. It ¡s an abbreviation of ‘Discharge Required.’ It is used when the instrument is not discharged with proper endorsement.

(h) N.P.F. It means ‘Not Provided For.” It is used when no arrangements are made to meet a cheque in the absence of any balance. :

(I) RD.: It means ‘Refer to Drawer’. Now R.D is most commonly used by bankers, It is a mild form of refusal. It is generally meant to convey to the holder the idea that the cheque has been dishonored and he Should find out the reason for it from the drawer.

Statutory Protection to a Paying Banker

Supposing,  a paying banker pays a cheque which bears a forged signature of the payee or endorsee, he is liable to the true owner of the cheque. But, it is quite unjustifiable to make the banker responsible for such errors. It is so because, he is not expected to know the signature of the payee or the endorsee.

Therefore, law relieves the paying banker from his liability to the true owner in such cases, This relief is known as ‘statutory protection.’

To claim protection under Sec.85 of the Nl. Act, 1881, the banker should have fulfilled the following conditions:

He should have paid an order cheque.

Such a cheque should have been endorsed by the payee or his order.

It should have been paid in due course.

Payment in due course

The cheque should have been paid in due course as per Sec. 10 of the N.l. Act. This concept of payment in due course has three essential feature :

(I) Apparent tenor of the instrument: To avail of the statutory protection, the payment should have been made according to the apparent tenor of the instrument. The apparent tenor refers to the intention of the parties as it is evident from the face of the instrument.

Example: If a drawer draws a cheque with a post —date, his intention is to make payment only after a certain date. If it is paid before the due date, this payment does not amount to payment in due course. So also, the payment of a countermanded cheque does not amount to payment in due course.

(ii) Payment in good faith and without negligence: Good faith forms the basis of all banking transactions. As regards negligence, the banker may sometimes be careless in his duties which constitutes an act of negligence. If negligence is proved, the banker will loss the statutory protection given under Sec. 85.

Example:

(a) Payment of a crossed cheque over the counter.

(b) Payment of a post-dated cheque before maturity.

(c) Failure to verify the regularity of an endorsement.

(iii) Payment to a person who is entitled to receive payment: The banker must see that the person, who presents the cheque, is in possession of the instrument and he is entitled to receive the amount of the cheque.

Protection to a bearer cheque: Now this protection has .been extended to bearer cheques also under sec. 85(2). If a bearer cheque is paid in due course, the banker is entitled to get protection.

Statutory Protection in the case of a Materially Altered Cheque: A paying banker cannot normally claim any statutory protection for a materially altered cheque. However; Sec. 89 of the Negotiable instrument Act. Gives protection in the case of a materially altered cheque provided,

(1) He is liable to pay,

(2)Such an alteration is not apparent and,

(3) The banker has made the payment in due course.

Recovery of Money Paid by Mistake: Under the following circumstances, money wrongly paid can be recovered:

(I) Money received mala fide is recoverable: When a person receives money by mistake in bad faith, knowing that he is not entitled to receive that money then the banker is entitled to recover the same.

(ii) Money paid under a mistake of fact is recoverable: For instance, a banker pays money to X, thinking that he is Y. This is a mistake of fact regarding the identity of the parties. Y is under a legal duty to pay the money back to the banker.

Collecting Banker

A collecting banker is one who undertakes to collect the amount of a cheque for his customer from the paying banker. In collecting a cheque, the banker can act in two capacities namely (1) as a holder for value, and (2) as an agent for collection. The banker would be regarded as a holder for value:

(a) If he allows his customers to withdraw money before cheques paid In for collection are actually collected and credited.

(b) If any open cheque’ is accepted and the value is paid before collection, and

(c) If there is a reduction in the overdraft account of the customer before the cheque is collected and credited in the respective account.

In all these cases, the banker acquires a personal interest.

A Banker as an agent: In practice, no banker credits a customer account even before a cheque is collected. He collects a cheque on behalf of a customer. So, he cannot acquire any of the rights of a holder for value, He has to act only as an agent of the customer.

Statutory Protection to the collecting Banker

According to sec. 131 of the N. I. Act, statutory protection is available to the collecting Banker in the following cases:

(I) Crossed cheques only: Statutory protection can be claimed by a collecting banker only for crossed cheques It is so because, in the case of an open cheque it is not absolutely necessary for a person to seek the service of a bank.

(ii) Collections on behalf of customers as an agent: The above protection can be claimed by a banker only for those cheques collected by him as agent of his customers.

(iii) In good faith and without negligence: In order to get the protection under this section, a collecting banker must act in good faith and without negligence.

The basis of negligence: When a collecting banker wants to claim protection under Sec. 131 he has the burden of proving that he has acted without negligence.

(I) Gross negligence: If a banker is completely careless in collecting a cheque, then, h will be held liable under the ground of ‘gross negligence.’ Examples:

(a) Collecting a cheque crossed A/C payee’ for other than the payee’s account:

Account payee crossing ¡s a direction to the collecting banker. If he collects a cheque crossed ‘A/C payee’ for any person other than the payee, then, this fact will be proved as an evidence of gross negligence.

(b) Failure to verify the correctness of endorsement: If a banker omits to verify the correctness of endorsements on cheques payable to order, he will be deprived of the statutory protection.

(c) Failure to verify the existence of authority in the case bf per pro signatures: If a collecting banker fails to verify the existence of authority in the case of per pro signatures, if any, will be paid as an evidence of gross negligence.

(ii) Negligence connected with the immediate collection: If, on the face of a cheque there is a warning that there is the misappropriation of money, the collecting banker should make some reasonable enquiry and only after getting some satisfactory explanations, he can proceed to collect cheques. Examples:

(a) collecting a cheque drawn against the principal’s A/c, to the private A/c of the agent without enquiry.

(b) Collecting a cheque payable to the firm to the private Nc of a partner without enquiry.

(c) Collecting a cheque payable to the company to the private account of a direction or any other officer without enquiry.

(d) Collecting a cheque payable to the employer to the private account of the employee would constitute negligence under sec.131 of the Nl. Act.

(e) Collecting a cheque payable to the trustee, to the private account of the person operating the trust account is another instance of negligence of a banker. .

(iii) Negligence under Remote Grounds: Normally we can not expect a banker to be liable under certain circumstances. But, the bankers have been held negligent under those situations which are branded as remote grounds.’ Examples: .

(a) Omission to obtain a letter of introduction from a new customer causes negligence. .

(b) Failure to enquire into the source of supply of large funds into an account which has been kept in a poor condition for a long time constitutes negligence.

Duties of a collecting banker

(I) Exercise reasonable care and diligence in his collection work: When a banker collects a cheque for his customer, he acts only as an agent of the customer. He should exercise reasonable care, diligence and skill in collection work.

(ii) Present the cheque for collection without any delay: The banker must present the cheque for payment without any delay. If there is the delay in presentment the customer may suffer losses due to the insolvency of the drawer or insufficiency of funds in the account of the drawer or insolvency of the banker himself. In all such cases, the banker should bear the loss.

(iii) Notice to customer in the case of dishonor of a cheque: The N.l. Act has prescribed a reasonable time for giving the notice of dishonor. If he fails to do so, and consequently, any loss arises to the customer, the banker has to bear the loss.

(iv) Present the bill for acceptance at an early date: As per sec.61of the Nl. Act, a bill of exchange must be accepted, If a banker undertakes to collect bills, it is his duty to present them for acceptance at an early date.

(v) Present the bill for payment: The banker should present the bills for payment ¡n proper time and at proper place. If he fails to do so and if any loss occurs to the customer, then, the banker will be liable. According to Sec.66 of N,I Act a bill must be presented for payment on maturity. .

(vi) protest and note a foreign bill for non-acceptance: In case of dishonor of a bill by non-acceptance or non-payment, it is the duty of the collecting banker to inform the customer immediately. Generally he returns the bill to the customer. In the absence of specific instructions, collecting bankers do not get the inland bills noted and protested for dishonor. If the bill in question happens to be a foreign bill, the banker should have it protested and noted by a notary public and then forwarded it to the customer.

 

BANKER CUSTOMER RELATIONSHIP

37,807 views - Published April 15, 2020 By Sumita Taterway Leave a Comment

 

The relationship between a banker and a customer comes into existence when the banker agrees to open an account in the name of the customer.  The relationship between a banker and a customer depends on the activities, products, or services provided by the bank to its customers or availed by the customer. Thus the relationship between a banker and customer is the transaction relationship. Bank’s business depends much on the strong bondage with the customer. Trust plays an important role in building a healthy relationship between a banker and a customer.

 

 

VARIOUS TYPES OF RELATIONSHIPS

Termination of the relationship between a banker and a customer:

Bankers’ Special Relationship:

MANDATE LETTERS:

POWER OF ATTORNEY:

Powers of Attorney on Bank Accounts:

1. General Power of Attorney:

2. Special Power of Attorney:

DEFINITION OF BANKING

The Banking Regulations Act 1949, Sec.5 (b) defines the term banking as “Banking means accepting, for lending or investment, of deposits of money from the public repayable on demand or otherwise and withdraw by cheque, draft, and order or otherwise.”

Sec.5(c) of the BR Act defines a “banking company” as a company that transacts the business of banking in India. Since a banker or a banking company undertakes banking-related activities we can derive the meaning of banker or a banking company from Sec 5(b) as a body corporate that:

(a) Accepts deposits from the public.

(d) Allows withdrawals of deposits on-demand or by any other means.

Accepting deposits from the ‘public’ means that a bank accepts deposits from anyone who offers money for the purpose. Unless a person has an account with the bank, it does not accept the deposit. For depositing or borrowing money there has to be an account relationship with the bank. A bank can refuse to open an account for undesirable persons. It is the bank’s right to open an account. Reserve Bank of India has stipulated certain norms

“Know Your Customer” (KYC) guidelines for opening accounts and banks have to strictly follow them. In addition to the activities mentioned in Sec.5 (b) of the B R Act, banks can also carry out activities mentioned in Sec. 6 of the Act.

 

DEFINITION OF CUSTOMER

The term Customer has not been defined by any act. In simple words, a customer is such a person to whom you extend your services in return for consideration. A customer is a person who maintains an account with the bank without taking into consideration the duration and frequency of operation of his account. To be a customer for any bank the individual should have an account with the bank. The individual should deal with the bank in its nature of regular banking business.

 

Those who do not maintain any account relationship with the bank but frequently visit a branch of a bank to availing banking facilities such as for purchasing a draft, en-cashing a cheque, etc. Technically they are not customers, as they do not maintain an account with the bank branch. The term ‘customer’ is used only concerning the branch, where the account is maintained. He cannot be treated as a ‘customer’ for other branches of the same bank. However with the implementation of’ ‘Core Banking Solution’ the customer is the customer of the bank and not of a particular branch as he can operate his account from any branch of the bank and from anywhere. In the event of arising any cause of action, the customer is required to approach the branch with which it had opened an account and not with any other branch.

 As per ‘Know Your Customer’ guidelines issued by Reserve Bank of India, customer has been defined as:

A person or entity that maintains an account and/or has a business relationship with the bank;

One on whose behalf the account is maintained (i.e. the beneficial owner);

Beneficiaries of transactions conducted by professional intermediaries, such as Stock Brokers, Chartered Accountants, Solicitors, etc. as permitted under the  law, and

Any person or entity connected with a financial transaction, which can pose significant reputation or other risks to the bank, say, a wire transfer or issue of a high-value demand draft as a single transaction.

BANKER CUSTOMER RELATIONSHIP

It means that to become a customer account relationship is a must. Account relationship is a contractual relationship. Banking is a trust-based relationship. There are numerous kinds of relationships between the bank and the customer. The relationship between a banker and a customer depends on the type of transaction. Thus the relationship is based on contract, and certain terms and conditions.

These relationships confer certain rights and obligations both on the part of the banker and on the customer. However, the personal relationship between the bank and its customers is long-lasting. Some banks even say that they have a generation-to-generation banking relationship with their customers.

 

CLASSIFICATION OF RELATIONSHIP

The relationship between banker and customer is of utmost importance. The relationship between a bank and its customers can be broadly categorized into General relationships and Special relationships.

 A. GENERAL RELATIONSHIP

  If we look at Sec 5(b) of the Banking Regulation Act, we would notice that the bank’s business is accepting deposits for lending. Thus, the relationship arising out of these two main activities is known as General Relationship.

1. DEBTOR AND CREDITOR

When a ‘customer’ opens an account with a bank, he fills in and signs the account opening form. By signing the form he agrees/contracts with the bank. When a customer deposits money in his account the bank becomes a debtor of the customer and the customer a creditor. The money so deposited by the customer becomes the bank’s property and the bank has a right to use the money as it likes. The bank is not bound to inform the depositor of the manner of utilization of funds deposited by him. Bank does not give any security to the depositor i.e. debtor. The bank has borrowed money and it is only when the depositor demands, the banker pays. Bank’s position is quite different from normal debtors.

While issuing Demand Draft, Mail / Telegraphic Transfer, the bank becomes a debtor as it owns money to the payee/ beneficiary.

2. CREDITOR AND DEBTOR

Lending money is the most important activity of a bank. The resources mobilized by banks are utilized for lending operations. Customer who borrows money from the bank own money to the bank. In the case of any loan/advances account, the banker is the creditor and the customer is the debtor. The relationship is the first case when a person deposits money with the bank reverses when he borrows money from the bank. Borrower executes documents and offers security to the bank before utilizing the credit facility.

B. SPECIAL RELATIONSHIP

In addition to these two activities banks also undertake other activities mentioned in Sec.6 of the Banking Regulation Act.  In addition to opening a deposit/loan account banks provide a variety of services, which makes the relationship more wide and complex. Depending upon the type of services rendered and the nature of the transaction, the banker acts as a bailee, trustee, principal, agent, lessor, custodian, etc.

1. TRUSTEE AND BENEFICIARY (BANK AS A TRUSTEE AND CUSTOMER AS A BENEFICIARY):

As per Sec. 3of Indian Trust Act 1882, a “trust” is an obligation annexed to the ownership of property, and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another, or of another and the owner. Thus, the trustee is the holder of property on behalf of a beneficiary.

In the case of a trust, a banker customer relationship is a special contract. When a person entrusts valuable items to another person with the intention that such items would be returned on demand to the keeper the relationship becomes of a trustee and trustier. Customers keep certain valuables or securities with the bank for safekeeping or deposits certain money for a specific purpose (Escrow accounts) the banker in such cases acts as a trustee. Banks charge fees for safekeeping valuables.

2. BAILEE AND BAILOR (BANK-BAILEE AND CUSTOMER- BAILOR):

Sec.148 of Indian Contract Act, 1872, defines “Bailment” “bailor” and “bailee”. A “bailment” is the delivery of goods by one person to another for some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering them. The person delivering the goods is called the “bailor”. The person to whom they are delivered is called, the “bailee”.

Banks secure their advances by obtaining tangible securities. In some cases, physical possession of securities goods (Pledge), valuables, bonds, etc., are taken. While taking physical possession of securities the bank becomes bailee and the customer bailor. Banks also keep articles, valuables, securities, etc., of their customers in Safe Custody and act as a Bailee. As a bailee, the bank is required to take care of the goods bailed.

3. LESSOR AND LESSEE (BANK- LESSOR AND CUSTOMER- LESSEE):

Sec.105 of ‘Transfer of Property Act 1882’ defines lease, Lessor, lessee, premium, and rent. As per the section “A lease of immovable property is a transfer of a right to enjoy such property, made for a certain time, express or implied, or in perpetuity, in consideration of a price paid or promised, or of money, a share of crops, service or any other thing of value, to be rendered periodically or on specified occasions to the transferor by the transferee, who accepts the transfer on such terms.”

Definition of Lessor, lessee, premium, and rent:

(1) The transferor is called the lessor,

(2) The transferee is called the lessee,

(3) The price is called the premium, and

(4) The money, share, service, or another thing to be so rendered is called the rent.

Providing safe deposit lockers is an ancillary service provided by banks to customers. While providing a Safe Deposit Vault/locker facility to their customers’ the bank agrees with the customer. The agreement is known as the “Memorandum of letting” and attracts stamp duty.

 

The relationship between the bank and the customer is that of the lessor and lessee. Banks lease (hire lockers to their customers) their immovable property to the customer and give them the right to enjoy such property during the specified period i.e. during the office/ banking hours and charge rentals. Bank has the right to break open the locker in case the locker holder defaults in payment of rent. Banks do not assume any liability or responsibility in case of any damage to the contents kept in the locker. Banks do not insure the contents kept in the lockers by customers.

4. AGENT AND PRINCIPAL (BANK- AGENT AND CUSTOMER- PRINCIPAL):

Sec. 182 of ‘The Indian Contract Act, 1872’ defines “an agent” as a person employed to do any act for another or to represent another in dealings with third persons. The person for whom such act is done or who is so represented is called “the Principal”.

Thus an agent is a person, who acts for and on behalf of the principal and under the latter’s express or implied authority, and the acts that were done within such authority are binding on his principal and, the principal is liable to the party for the acts of the agent.

Banks collect cheques, bills, and makes payment to various authorities’ viz., rent, telephone bills, insurance premium, etc., on behalf of customers. . Banks also abides by the standing instructions given by their customers. In all such cases bank acts as an agent of its customer, and charges for these services. As per the Indian contract, the Act agent is entitled to charges. No charges are levied in the collection of local cheques through the clearing house. Charges are levied only when the cheque is returned to the clearinghouse.

5. INDEMNITY HOLDER AND INDEMNIFIER (BANK-INDEMNITY HOLDER AND CUSTOMER-INDEMNIFIER):

The dictionary meaning of the word Indemnity means ‘security or protection against a loss or other financial burden’. As per Section 124 of the Indian Contract Act 1872, the definition of Indemnity is as follows. ‘A contract by which one party promises to save the other from loss caused to him by the contract of the promisor himself, or by the conduct of any other person, is called a “contract of indemnity”. The right of indemnity-holder is defined in Section 124 of the Indian Contract Act 1872. An indemnity is an obligation by a person to provide compensation for a particular loss suffered by another person. In the case of banking, the relationship happens in transactions of issue duplicate demand draft, TDR, deceased account payment, etc. In that case, the indemnifier will compensate any loss arising from the wrong or excess payment. In these cases, the bank is an Indemnity Holder (Promisee) and the customer is Indemnifier (Promisor).

6. HYPOTHECATOR AND HYPOTHECATEE (BANK- HYPOTHECATEE AND CUSTOMER- HYPOTHECATOR):

The relationship between customer and banker can be that of Hypothecator and Hypothecatee. This happens when the customer hypothecates certain movable or non-movable property or assets with the banker to get a loan. In this case, the customer became the Hypothecator, and the Banker became the Hypothecatee.

7. PLEDGER AND PLEDGEE (BANK- PLEDGEE OR PAWNEE AND CUSTOMER- PLEDGER OR PAWNOR):

The relationship between customer and banker can be that of Pledger and Pledgee. This happens when the customer pledges (promises) certain assets or security with the bank to get a loan. In this case, the customer becomes the Pledger or Pawnor, and the bank becomes the Pledgee or Pawnee. Under this agreement, the assets or security will remain with the bank until a customer repays the loan.

8. MORTGAGOR AND MORTGAGEE (BANK- MORTGAGEE AND CUSTOMER- MORTGAGOR):

As per section 58 of Transfer of Property Act 1882, the mortgage is the transfer of an interest in specific immovable property to secure the payment of money advanced or to be advanced by way of loan, an existing or future debt, or the performance of an engagement which may give rise to a pecuniary liability. The mortgagor only pats with the interest in the property and not the ownership. The transferor of interest in the property is called a mortgagor and the transferee is called a mortgagee. In this case, the customer became the Mortgagor, and the Banker became the Mortgagee.

9. AS A CUSTODIAN:

A custodian is a person who acts as a caretaker of something. Banks take legal responsibility for a customer’s securities. While opening a D-Mat account bank becomes a custodian.

10. AS A GUARANTOR:

Banks give guarantees on behalf of their customers and enter into their shoes. A guarantee is a contingent contract. As per sec 31, of Indian contract Act guarantee is a “contingent contract”. A contingent contract is a contract to do or not to do something, if some event, collateral to such contract, does or does not happen.

11. ADVISOR AND CLIENT (BANK- ADVISOR AND CUSTOMER- CLIENT):

When a customer invests in securities, the banker acts as an advisor. The advice can be given officially or unofficially. While giving advice the banker has to take maximum care and caution. Here, the banker is an Advisor, and the customer is a Client.

 

VARIOUS TYPES OF RELATIONSHIPS 

Type of Transaction	Bank	Customer
Deposit in bank	Debtor	Creditor
Loan from bank	Creditor	Debtor
Safe Deposit Vault (SDV Locker)	Lessor	Lessee
Safe Custody	Bailee	Bailor
Issue of Draft	Debtor	Creditor
Payee of a Draft	Trustee	Beneficiary
Collection of Cheque	Agent	Principal
Pledge	Pledgee (Pawnee)	Pledger (Pawnor)
Mortgage	Mortgagee	Mortgagor
Hypothecation	Hypothecatee	Hypothecator
Sale/purchase of security on behalf of customer	Agent	Principal
Money deposited, but no instructions for its disposal	Trustee	Beneficiary
Article/Goods left by mistake by customer	Trustee	Beneficiary

 

 

TERMINATION OF THE RELATIONSHIP BETWEEN A BANKER AND A CUSTOMER:

It would thus be observed that the banker customer relationship is a transaction relationship. The relationship between a bank and a customer ceases on:

(a) The death, insolvency, lunacy of the customer;

(b) The customer closing the account i.e. Voluntary termination;

(c) Liquidation of the company;

 

(d) The closing of the account by the bank after giving due notice;

(e) The completion of the contract or the specific transaction;

(f) Lends to the borrower; or

(g) Invests the money so collected by way of deposits.

 

BANKERS’ SPECIAL RELATIONSHIP:

Normally, the customer operates his bank account. There are many situations in one’s life where an individual possessing property, bank accounts, etc. may not be in a position to perform his duties due to reasons like being abroad, ill, old, etc. In such situations, if the transaction requires the presence of an individual who is not able to be present personally, then the only way out is to give the powers to act on behalf of the individual to another person. This is when a Power of Attorney deed is to be created. It is very common these days to give the powers to a trustworthy person to conduct the registrations, or sale or rent out, etc. if you are busy with your other schedules.

For a banking operation, the customer may authorize, for his convenience, an agent or nominee to operate on his account. Such authority is given either by way of a Mandate Letter or Power of Attorney. By mandate letter, the particular banker is informed that certain powers have been delegated whereas a power of attorney acts as a general notice and authority.

MANDATE LETTERS:

A letter of the mandate is addressed by a customer to the bank informing that powers to operate the account (ordinary deposit account) have been delegated by the customer (the mandator) to a particular person (the mandatory). Such letters of mandate do not attract stamp duty.

 

As far as possible, branches should require customers to execute powers of attorney when they desire to authorize their agent or nominee to operate on their account on a more or less permanent basis. The procedure of obtaining mandate letters instead of powers of attorney should, as far as possible, be limited to operations on ordinary credit accounts.

POWER OF ATTORNEY:

A Power of Attorney is a legal document by which one person gives the right to perform or powers of transacting in matters relating to a property, banking, legal and judicial proceedings, tax payments, etc. to another person due to certain reasons like being out of the country, or getting old, or not able to look after one’s duties in those matters, etc. Power of Attorney is an authority given by a written formal instrument whereby one person termed the donor or principal authorizes another person termed the done, attorney, or agent to act on his behalf.

POWERS OF ATTORNEY ON BANK ACCOUNTS:

A power of attorney may be special or general. A special power of attorney authorizes a person to act in a single transaction whereas authority to act in more than one transaction such as a bank account or generally, is a general power of attorney. The power of attorney is a stamped document. The power to operate an account will not include, by itself, a power to overdraw or borrow money. Authority or power to borrow by the attorney should definitely/explicitly be stated/embodied in the instrument. Drawing on an overdraft account is borrowing.

Types of Power of Attorney: Power of Attorney can be of mainly two types;

1. GENERAL POWER OF ATTORNEY:

A person can give another person a complete general right or power to act lawfully concerning his property or bank accounts or tax payments, or registration work or to sue a third party, etc. It is commonly termed as General Power of Attorney.

 

Either you can give a General Power of Attorney for all your properties, banking transactions, tax matters, registration, legal disputes, and court matters, etc. or you can give general power to anyone category like only for all property matters or only for all Banking processes, etc. This type of power is very wide and has a lot of risks if the attorney is not a trustworthy person.

2. SPECIAL POWER OF ATTORNEY:

The other type of power granted is the special power which means it is granted for only a specific task or work. A special power of attorney is to be made by a person when any particular task or act is to be done. Once the particular act is completed the special power of attorney comes to an end.

This is generally used when you want to rent out your property or appear for the registration of any property or appear in a court on behalf of the Principal or to appear before the Tax authorities etc.

 

What Are Ancillary Services?

The term "ancillary services" describes any services offered by the banks that are not payment services, lending or deposit facilities. They generally lie outside the scope of traditional mainstream banking, with the result that they have developed on an ad hoc basis.

Collection:

1.     Gas bills.

2.     Electricity bills.

3.     Telephone bills.

4.     Water/Sewerage bills.

5.     Municipal holding Tax.

6.     Passport fees, visa fees and Travel tax.

7.     Customs & Excise duties.

8.     Source tax and VAT.

9.     Jakat fund.

10.                        Hajj deposit.

11.                        Land development tax.

 

Payment:

1.     Pension of employees of Government and other Corporate Bodies.

2.     Bangladesh Bank employees pension.

3.     Army pension.

4.     British pension.

5.     Students' stipend/scholarship.

6.     Govt. & Non-Govt. Teachers' salary.

7.     Food procurement bill on behalf of the Govt.

 

Social Services:

1.     Old age allowances.

2.     Widows, divorcees and destitute women allowances.

3.     Freedom Fighters' allowances.

4.     Rehabilitation allowances for acid survival women.

5.     Maternal allowances for poor women.

6.     Disability allowances.

7.     Sale & Encashment/Purchase:

8.     Savings Certificates.

9.     ICB Unit Certificates.

10.                        Prize Bonds.

11.                        Wage Earner's Development Bonds.

12.                        US Dollar Premium & Investment Bond.

13.                        Lottery tickets of different Semi-Govt. and Autonomous Bodies.

14.                        Sanchaypatra.

15.                        Public Service Commission's application form.

16.                        Judicial Service Commission's application form.

17.                        Exchange of soiled / torn notes.

Misc. Services:

1.     Bank a/c information of tax payee client according to demand of NBR.

2.     Local Governance Support Project.

3.     Enlist of Non Government Insurance company.

 

REMITTANCE - INWARD REMITTANCE- OUTWARD REMITTANCE

 

What do you mean by remittance?

A remittance is a payment of money that is transferred to another party. ... However, the term is most often used nowadays to describe a sum of money sent by someone working abroad to his or her family back home. The term is derived from the word remit, which means to send back.

 

What is Remittance?

Regarding the word formation, the term is derived from the word “remit” meaning “to send back”. Thus, in simple words, remittance refers to the act of transferring or sending certain amount of money by one party to the other. Most often people consider the transfer of funds overseas as remittance but the transfer within the country also comes under the same. As the trend of foreign migration is escalating, mostly among the working age group more so from the developing nations, the word “remittance” today has become a common household term. As a non-residents national, people face the need to send across money back home to their families for different purpose of life.

What are the types of remittance?

Since we have learned what remittance is and its role in economic growth, infrastructural development of a nation, let’s find out the different types of remittance based on the process of transaction. Based on same, remittance is divided into two different categories:

1.     Inward Remittance

2.     Outward Remittance

Inward Remittance:

The term inward remittance indicates transfer of funds from one account to another either domestically or internationally. In order to understand inward remittance, an easy example has to be the fact that most of the families have children living abroad either for work or study purpose and when they send money back home, it is termed as inward remittance for the family at home country. Likewise, when parents send across money to their children, it becomes inward remittance for them.

 

Outward Remittance:

The transfer of funds out of the country or overseas is termed as outward remittance. For instance, if parents transfer funds from their account to their children’s foreign account in order to support them, that becomes outward remittance for the parents. Outward remittance is applicable for the countries that send money whereas inward remittance is applicable to those countries that receive the same.

https://imeremit.com.np/blog/what-is-remittance

https://www.bankasia-bd.com/other/exchange_house

 

 

1	Al Ansari Exchange LLC	Global Partner
2	BFC Bank Limited (EZRemit)
3	Choice Money Transfer dba Small World
4	HomeSend SCRL
5	Instant Cash FZE
6	Merchantrade Asia Sdn. Bhd.
7	MoneyGram Payment Systems Inc.
8	NEC Money Transfer Limited
9	PayPal Pte. Ltd. (Xoom)
10	Placid Express
11	Prabhu Money Transfer
12	Ria Financial Services
13	TransFast Remittance LLC
14	Terra Payment Service
15	UAE Exchange Centre LLC
16	Western Union Money Transfer
17	WorldRemit Limited
18	Aussie Forex & Finance Pty Ltd	Australia
19	Zenj Exchange Co.	Bahrain
20	East Bengal Exchange Co.	Canada
21	First Security Islami Exchange Italy SRL	Italy
22	National Exchange Company S.R.L.
23	Queenbee Capital Ltd.	Japan
24	Unidos Co. Ltd-Kyodai Remittance
25	Al Alami Exchange	Jordan
26	Al Muzaini Exchange Co. K.S.C.C	Kuwait
27	Al Mulla Int. Exchange Co. K.S.C.C
28	Aman Exchange Company WLL
29	Bahrain Exchange Company WLL
30	Joyalukkas Exchange
31	Kuwait Asian Int'l Exchange Co. WLL
32	Kuwait Bahrain Int'l Exchange Co, K.S.C
33	Lulu Exchange Company WLL
34	CBL Money Transfer Sdn Bhd	Malaysia
35	MaxMoney Sdn Bhd
36	NBL Money Transfer Sdn. Bhd.
37	NBL Money Transfer (Maldives) Pvt. Ltd.	Maldives
38	Al Jadeed Exchange LLC	Oman
39	Hamdan Exchange LLC
40	Lulu Exchange Company
41	Joyalukkas Exchange LLC
42	Oman Exchange LLC
43	Global Money Exchange Co.
44	Gulf Overseas Exchange Co. LLC
45	Unimoni Exchange LLC
46	Al Zaman Exchange WLL	Qatar
47	Eastern Exchange Company WLL
48	Al Rajhi Bank (Tahweel)	Saudi Arabia
49	Bank Al Bilad (Enjaz)
50	Bank Al Jazira (Fawri)
51	Saudi National Bank (QuickPay)
52	Travelex Holdings (S) Pte Ltd.	Singapore
53	InstaRem Pte Ltd.
54	NBL Money Transfer Pte Ltd
55	GmoneyTrans Co. Ltd	South Korea
56	Global Money Express Co, Ltd
57	HanPass Co, Ltd
58	Southeast Exchange Co. (South Africa) Pty. Ltd.	South Africa
59	Al Ahalia Money Exchange Bureau	UAE
60	Al Fardan Exchange LLC
61	Emirates India Int'l Exchange LPC
62	Index Exchange LLC
63	LuLu Int'l Exchange LLC
64	Orient Exchange Company LLC
65	Universal Exchange Center
66	Daytona Capital Management	UK
67	Remitix Limited (Mukuru)
68	Standard Express, USA	USA
69	Wall Street Finance LLC, USA

 

Source: https://www.dutchbanglabank.com/services_company/remittance-exchange.html

OVERSEAS PARTNERS OF EBL

Global Partners :

1.     Western Union Money Transfer Services

2.     Continental Exchange Solution (Ria Financial Services)

3.     MoneyGram International

4.     Xpress Money Services

5.     Trans-Fast Worldwide Remittance LLC

6.     UK based Money Transfer Companies :

7.     Aftab Currency Exchange

8.     Eastern Union Money Transfer

9.     Brac Saajan Exchange Limited

10.                        KMB International Money Transfer

11.                        Small World Financial Services Group

12.                        NEC Money Transfer( UK) Ltd

13.                        Worldwide West 2 East Services Ltd(Sha Global)

14.                        Xpress Money Service Ltd.

15.                        UAE based Money Transfer Companies :

16.                        Al Ahalia Money Exchange Bureau

17.                        Al Fardan Exchange LLC

18.                        UAE Exchange Centre LLC

19.                        Wall Street Exchange Centre LLC

20.                        Al Ansari Exchange LLC

21.                        Index Exchange LLC (Previous name Habib)

22.                        Lulu International Exchange LLC

23.                        Malik Exchange

24.                        Bahrain based Money Transfer Companies :

25.                        Travelex Bahrain WLL(Under process)

26.                        Oman based Money Transfer Companies :

27.                        Oman & UAE Exchange Center & Co.LLC

28.                        Asia Express Exchange

29.                        Travelex and Co LLC(Under Process)

30.                        Malaysia based Money Transfer Companies :

31.                        Max Money Sdh Bhd (Under process)

32.                        USA based Money Transfer Companies :

33.                        Wall Street Finance LLC

34.                        Italy based Banking Partners :

35.                        National Exchange Company S.R.L

36.                        K.S.A (Kingdom of Saudi Arabia) based Banking Partners :

37.                        National Commercial Bank (NCB,KSA)

38.                        Bank Al-Bilad

39.                        Own Remittance Houses of SEBL :

40.                        Southeast Exchange Company (South Africa) Pty. Ltd.

https://www.southeastbank.com.bd/?page=overseas_partners

https://www.bb.org.bd/en/index.php/investfacility/drawing

https://premierbankltd.com/pbl/remittance-service/

 

DIFFERENT MODES OF INVESTMENT UNDER CONVENTIONAL AND ISLAMIC FRAME WORK

At the beginning it is better to give a clear definition of "Islamic Modes of Finance". The word "Modes" literally means "methods", or in other words, it refers to systematic and detailed rules, stipulations and steps to be followed for accomplishing a specific thing. The thing that needs to be accomplished in this context is, however, the subject matter of each of the said modes, i.e. any of the different types of investment activities (trade, leasing, real estate, manufacturing, agriculture, agriculture production etc., or, using Shariah expressions Murabaha, Mudaraba, Musharaka, Ijarah, Istisna, etc.). The word "Finance" in one of its different meanings refers to the supply of money capital or credit, provided by either a person (household), or an organization (private or public - financial or non financial). The word "Islamic" is inserted in the above expression to restrict the type of rules that can govern different modes of finance to the Shariah rules. A complete definition for the term "Islamic Modes of Finance"' may be given as follows:

 

"The systematic and detailed Shariah rules that govern the contractual relationship of an investment activity that can be applied for attracting money capital" (Fahmy & Sarkar). 

1. BAI-MURABAHA

Meaning of Murabaha

The terms "Bai-Murabaha" have been derived from Arabic Words Bai and Ribhun. The word 'Bai' means purchase and sale and the word 'Ribhun' means an agreed upon profit. "Bai-Murabaha" means sale for an agreed upon profit. Bai-Murabaha may be defined as a contract between a buyer and a seller under which the seller sells certain specific goods permissible under Islamic Shariah and the Law of the land to the buyer at a cost plus an agreed upon profit payable today or on some date in the future in lump-sum or by installments. The profit may be either a fixed sum or based on a percentage of the price of the goods.  

Types of Murabaha

In respect of dealing parties Bai-Murabaha may be of two types :

-  Ordinary Bai-Murabaha, and

-   Bai-Murabaha order on and Promise.

Ordinary Bai-Murabaha is a direct transaction between a buyer and a seller.  Here, the seller is an ordinary trader who purchases goods from the market in the hope of selling these goods to another party for a profit.  In this case, the seller undertakes the entire risk of his capital investment in the goods purchased. Whether or not he earns a profit depends on his ability to find a buyer for the merchandise he has acquired. 

 

Bai-Murabaha order on and Promise involves three parties - the buyer, the seller and the bank. Under this arrangement, the bank acts as an intermediary trader between the buyer and the seller. In other words, upon receipt of an order and agreement to purchase a certain product from the buyer, the bank will purchase the product from the seller to fulfill the order.

 

However, it should be noted here that the Islamic Bank acts as a financier in this transaction.  This is the case, not in the sense that the bank finances the purchase of goods by the consumers; rather it is a financier by deferring payment to the seller of the product. Thus, there is a chance that this transaction could resemble nothing more than a loan for which interest (Riba) is earned, which is contrary to Islamic beliefs.

 

Therefore, to avoid this potential misuse of the Bai-Murabaha relationship, the bank should purchase the goods on behalf of the bank from the seller and sell the goods to the buyer, receiving payment on behalf of the bank as well. In this way, the profits generated by the transaction to each of the parties involved cannot be misconstrued as interest or (Riba) profits.

There are some important features of Bai-Murabaha as given below.

Important Features of Murabaha

1.     A client can make an offer to purchase particular goods from the bank for a specified agreed upon price, including the cost of the goods plus a profit.

2.     A client can make the promise to purchase from the bank, that is, he is either to satisfy the promise or to indemnify any losses incurred from the breaking the promise without excuse.

3.     It is permissible to take cash/collateral security to guarantee the implementation of the promise or to indemnify any losses that may result.

4.     Documentation of the debt resulting from Bai-Murabaha by a Guarantor, or a mortgage, or both like any other debt is permissible. Mortgage/Guarantee/Cash Security may be obtained prior to the signing of the Agreement or at the time of signing the Agreement.

5.     Stock and availability of goods is a basic condition for signing a Bai-Murabaha Agreement. Therefore, the bank must purchase the goods in accordance with the specifications of the client, thereby taking ownership of the goods before signing the Bai-Murabaha agreement with the client.

6.     Upon acquiring the goods, the bank assumes the risk of ownership. In other words, the bank is responsible for damages, defects, and /or spoilage to the merchandise until such time that it is actually delivered to the buyer.

7.     The bank must deliver the goods to the client at the date, time, and place specified in the contract.

8.     The bank sells the goods at a price above the cost to obtain a profit.  The sale price that is charged by the bank is agreed upon in the Bai-Murabaha.  The profit can be stated in terms of a flat dollar amount or on a percentage of the purchase price.  If a percentage is used, the percentage shall never be expressed in terms of time, in order to avoid confusion that the price is a form of interest (Riba), which is not allowed.

9.     The price agreed to in the agreement is binding on both parties.

10.                      It is permissible for the bank to contract with a third party to buy and receive the goods on its behalf. This agreement must be a separate contract.

These features make Bai-Murabaha distinctive from all other modes of Islamic Investment.

Steps of Bai-Murabaha

First Step: The client submits a proposal regarding his requirements of the bank. The client sends a proposal with the specifications of the commodity to be acquired from the bank. The proposal also indicates details regarding the date, time and place of delivery as well as price and form of payment information. The bank responds by sending a counter proposal either accepting the buyer's price or stipulating a different price. 

 

Second Step:     The client promises to buy the commodity from the bank on a Bai-Murabaha basis, for the stipulated price. The bank accepts the order and establishes the terms and conditions of the transaction. 

 

Third Step: The bank informs the client (ultimate buyer) of its approval of the agreement to purchase.  The bank may pay for the goods immediately or in accordance with the agreement.

 

The seller expresses its approval to the sale and sends the invoice(s).

 

Fourth Step: The two parties (the bank and the client) sign the Bai-Murabaha Sale contract according to the agreement to purchase.

 

Fifth Step: The Bank authorizes the client or its nominee to receive the commodity

 

The seller   sends the commodity to the place of delivery agreed upon. The client undertakes the receipt of the commodity in its capacity as legal representative and notifies the bank of the execution of the proxy.

The Bai-Murabaha has some legal rules. These rules are mentioned below:

Rules of Bai-Murabaha

1.     It is permissible for the client to offer to purchase a particular commodity, deciding its specifications and committing itself to buy it on Murabaha for the cost plus the agreed upon profit.

2.     It is permissible that the mutual agreement shall contain various conditions agreed upon by the two parties, especially with respect to the place of delivery, the payment of a cash security to guarantee the implementation of the operation and the method of payment.

3.     It is permissible to stipulate the binding nature of the promise to purchase.  Thus, the agreement can only be satisfied by either fulfilling the promise to purchase or by indemnifying the bank for any losses incurred if the promise to purchase is not fulfilled.

4.     It is a condition that the bank purchases the requested commodity (first purchase contract) before selling it on Murabaha to the buyer. The contract in the first purchase must be settled, in principle, between the source seller and the bank.

5.     It is permissible for the bank to authorize a second party including the buyer to receive the commodity on its behalf. This authorization must be in a separate contract, particularly if the buyer is going to receive the goods on behalf of the bank. This is necessary to avoid any conflicts with the ensuing Murabaha sale.  

6.     Once the bank takes ownership of the goods, it is responsible for any damages or defects. Thus, if the goods are damaged, the bank is liable and must repair the damage prior to delivering the goods to the purchaser.

7.     It is a condition that the Bai-Murabaha contract be drawn at the last phase. That is after the promise to purchase and the purchase of the commodity in the name of the bank and receipt of the commodity directly by the bank or through an agent.

8.     The legal rules of Bai-Murabaha must be observed in drawing the contract of the Murabaha sale connected with a promise to purchase.  Particularly concerning the issue of the transparency of the cost of the first purchase and the amount of profit because discrepancies lead to disputes, which may invalidate the contract.

9.     It is permissible to document the debt resulting from Bai-Murabaha by a guarantor or a mortgage, like any other sale on credit. Further, it is permissible that the mortgage accompanies the contract, because it is possible to take a mortgage on actual debt as well as promised debt before it is realized.  However, the mortgage shall only be in effect if the debt is actually incurred.

The areas of application of Bai-Murabaha are discussed below.

Application of Bai-Murabaha

Murabaha is the most frequently used form of finance in Islamic banking throughout the world. It is suitable for financing the different investment activities of customers with regard to the manufacturing of finished goods, procurement of raw materials, machinery, and other required plant and equipment purchases.  

2. MUSHARAKA (PARTNERSHIP)

Meaning of Musharaka

The word Musharaka is derived from the Arabic word Sharikah meaning partnership. Islamic jurists point out that the legality and permissibility of Musharaka is based on the injunctions of the Qura'n, Sunnah, and Ijma (consensus) of the scholars.  It may be noted that Islamic banks are inclined to use various forms of Shariakt-al-Inan because of its built-in flexibility. At an Islamic bank, a typical Musharaka transaction may be conducted in the following manner.

 

One, two or more entrepreneurs approach an Islamic bank to request the financing required for a project.  The bank, along with other partners, provides the necessary capital for the project. All partners, including the bank, have the right to participate in the project. They can also waive this right. The profits are to be distributed according to an agreed ratio, which need not be the same as the capital proportion. However, losses are shared in exactly the same proportion in which the different partners have provided the finance for the project (Hussain 1986, p.61). 

Types of Musharaka

Musharaka may take two forms:

i)                   Permanent Musharaka and

ii)       Diminishing Musharaka.

Permanent Musharaka

In this case, the bank participates in the equity of a company and receives an annual share of the profits on a pre-rate basis. The period of termination of the contract is not specified. This financing technique is also referred to as continued Musharaka.

 

The contributions of the partners under this mode may be equal or unequal percentages of capital for the purpose of establishing a new income-generating project or to participate in an existing one. In this arrangement, each participant owns a permanent share in the capital structure and receives his share of the profits accordingly. This type of a partnership is intended to continue until the company is dissolved.  However, one can exit the partnership by selling his share of the capital to another investor. 

 

Permanent Musharaka is used by Islamic Banks in many income generating projects.  They can provide financing to their customers, in exchange for ownership and profit sharing in the proportion agreed upon by both parties.  In addition, the bank may leave the responsibility of management to the customer-partner and retain the right of supervision and follow up.

 

The three steps to establishing Permanent Musharaka are discussed below.

 

One - Partnership in Capital: The bank tenders part of the capital required in its capacity as a partner and authorizes the customer/partner to manage the project. The Partner tenders part of the capital required for the project and is entrusted with what he holds from the bank funds.

 

Two - Results of the Projects: The intent of the project is growth. However, the project may be profitable or it may loss money.

 

Three - The Distribution of wealth accrued from the Project: In the event a loss is incurred, each partner bears part of the loss proportionate to his share in capital. In the event the venture is profitable, earnings are divided between the two parties (the bank and the partner) in accordance with the agreement.

The following is a discussion of those legal rules that apply to the Musharaka relationship:

Rules for Permanent Musharaka

1.   It is a condition that the capital provided by each partner is specific, existent and easily accessible.  It is inappropriate to establish a company with borrowed money, for the purpose of profit. 

2.   It is permissible for partners to have unequal ownership in the project. The percent of ownership is set forth in the agreement. 

3.   It is a condition that the capital of the company is money and valuables. Some of the jurists permit contributing merchandise as invested capital. However, the merchandise must be evaluated, and the value agreed upon by all parties.  Once the value has been established, it is counted as capital and stipulated in the contract as such. 

4.   It is impermissible to impose conditions forbidding one of the partners from work.  The company is built on honor and each partner implicitly permits and gives power of attorney to the other partner(s) to dispose of and work with capital as is deemed necessary to conduct business. However, it is permissible for one partner to have full responsibility for the operations of the company, provided he is granted this authority by the other partners. 

5.   A partner is a trustee of company funds in his possession and is held responsible for their proper use. It is permissible to take a mortgage or a guarantee against company assets, but it is impermissible to take security for profit or capital.

6.   It is a condition that each partners' share of the profits be known to avoid uncertainty.  Also, it is required that the ownership interest be in percentage terms and not a fixed sum, because this would violate the requirements of a partnership. 

7.   In principle, profit must be divided among partners in ratios proportionate to their shares in capital but some of the jurists permit variation in profit shares, so long as it is agreed to by all of the partners. This may be the case when one of the partners is more dexterous and more diligent and does not agree to parity, so variation in the sharing of profits becomes necessary.  

8.   In principle, a partnership is a permissible and non-binding contract.  Thus, if a partner wishes, he could rescind the agreement provided that this occurs with the knowledge of the other partner or partners.  Rescinding the agreement without the knowledge of the other partners' prejudices the rescinding partner's interest. On the other hand, some of the jurists take the view that the partnership contract is binding up to the liquidation of capital or the accomplishment of the job accepted at the contract.

 

Application of Permanent Musharaka

 

Permanent Musharaka is helpful in providing financing for large investments in modern economic activities.  Islamic banks can engage in Musharaka partnerships for new or established companies and activities.  Islamic banks may become active partners in determining the methods of production cost control, marketing, and other day-to-day operations of a company to ensure the objectives of the company are met.  On the other hand, they can also choose to either directly supervise or simply follow up on the overall activities of the firm. As part of the agreement, Islamic banks will share in both profits and losses with its partners or clients in operations of the business.   

 

Diminishing Musharaka

 

Diminishing or Digressive Musharaka is a special form of Musharaka, which ultimately culminates in the ownership of the asset or the project by the client. It operates in the following manner.

 

The Bank participates as a financial partner, in full or in part, in a project with a given income forecast. An agreement is signed by the partner and the bank, which stipulates each party's share of the profits.   However, the agreement also provides payment of a portion of the net income of the project as repayment of the principal financed by the bank. The partner is entitled to keep the rest. In this way, the bank's share of the equity is progressively reduced and the partner eventually becomes the full owner.

 

When the bank enters into a Diminishing Musharaka its intention is not to stay in the partnership until the company is dissolved. In this type of partnership, the bank agrees to accept payment on an installment basis or in one lump sum, an amount necessary to buy the bank's partnership interest. In this way, as the bank receives payments over and above it's share in partnership profits, it's partnership interest reduces until it is completely bought out of the partnership.

 

After the discharge, the bank withdraws it claims from the firm and it becomes the property of the partner.  The decreasing partnership arrangement is an Islamic bank innovation.  It differs from the permanent partnership only in continuity.  It appears that there are four steps of the diminishing partnership. Those are mentioned below.

 

Steps of Diminishing Musharaka

 

1.   Participation in Capital: The bank - tenders part of the capital required for the project in its capacity as a participant and agrees with the customer/partner on a specific method of gradually selling its share in capital back to the partner.

2.   The partner - tenders part of the capital required for the project and agrees to pay the agreed upon amount in return for the ultimate full ownership of the business.

3.   Results of the Projects: The intent of the project is capital growth. The project may be profitable or lose money.

4.   The distribution of the Wealth accrued from the Projects: In the event of loss each partner bears his share in the loss in his exact proportionate share of capital.  In the event that the project is successful, profits are distributed between the two partners (the bank and the customer) in accordance with the agreement.

5.   The bank sells its Share of Capital: The bank expresses its readiness, in accordance with the agreement, to sell a specific percentage of its share of capital.

6.   The partner pays the price of that percentage of capital to the bank and the ownership is transferred to the partner.

 

This process continues until the bank has been fully compensated for it's capital share of the business. In this way the bank has its principal returned plus the profit earned during the partnership and vice versa.

 

In the first Conference of the Islamic Banks in Dubai, the conferees studied the topic of partnership ending with ownership (decreasing partnership) and they decided that this type of business relationship may take one of the following forms.

 

The First Form:  In this form, the bank agrees with the customer on the share of capital and the conditions of partnership. The Conference decided that the bank should sell its shares to the customer after the completion of the partnership. Furthermore, they determined that the selling of the banks interest to the partner should be done under an independent contract. 

 

The Second Form:  In this form, the bank participates in financing all or part of the capital requirements in exchange for sharing in the prospective earnings. In addition, the bank gains the right to retain the remainder of the income for the purpose of applying it towards the capital provided by the bank. 

 

The Third Form:  In this form, the bank and partner's ownership is determined by stocks comprising the total value of the asset (real estate). Each partner, (the bank and the customer) gets its proportionate share of the earnings accrued from the real property. On an annual basis , the partner may purchase a  prescribed number of the bank's shares until such time that the partner becomes the sole owner of the real property.

There are some legal rules for diminishing Musharaka as given below.

 

 

Rules for Diminishing Musharaka

 

In addition to all the legal rules that apply to the permanent partnership which also apply to the decreasing partnership, the following rules also must be observed.

1.   It is a condition in the decreasing partnership that it shall not be a mere loan financing operation. In other words there must be shared ownership and all the parties must share in the profits or losses during the period of the partnership.

2.   It is a condition that the bank must completely own its share in the partnership and all rights of ownership with regard to management of the business. In the event that bank authorizes its partner to manage the business, the bank shall have the right of oversight supervision and follow up.

3.   It is impermissible to include in the contract of decreasing partnership a condition that adjudges the partner to return to the bank the total of its shares in capital in addition to profits accruing from that share, because of resemblance to Riba (usury).

4.   It is permissible for the bank to offer a promise to sell its shares in the company to the partner, if the partner pays the value of the shares. The sale must be concluded as a separate deal with no connection to the contract of the company. 

Application  of Diminishing Musharaka

 

The decreasing Musharaka is suitable for the financing of industrial businesses that have regular income. It can be considered to be the appropriate mode to finance collective investment. In this arrangement, the bank earns periodic profits throughout the year and it encourages the partner to participate in the joint investment. In addition it fosters individual ownership by allowing the partner to gradually buy the bank's ownership interest. In terms of society as a whole it corrects the course of the economy by developing a mode of positive partnership instead of the negative relationship of indebtedness. In addition, it assists in the equitable distribution of societies wealth.   

 

3. MUDARABA

 

Definition of Mudaraba

 

The term Mudaraba refers to a contract between two parties in which one party supplies capital to the other party for the purpose of engaging in a business activity with the understanding that any profits will be shared in a mutually agreed upon. Losses, on the other hand, are the sole responsibility of the provider of the capital. Mudaraba is also known a Qirad and Muqaradah (Shirazi 1990, p.31).

 

Mudaraba is a contract of those who have capital with those who have expertise, where the first party provides capital and the other party provides the expertise with the purpose of earning Halal (lawful) profit which will be shared in a mutually agreed upon proportion.  This type of business venture serves the interest of the capital owner and the Mudarib (agent).

 

The capital owner may not have the ability or the experience to run a profitable business. On the other hand, the agent (the Mudarib) may not have adequate capital to invest in a business or project.  Therefore, by entering into a contract of Mudaraba each party compliments one another, allowing a business venture to be financed. The following are the steps of the Mudaraba contrac (ABIIB, p.53).

 

Steps of Mudaraba

 

The bank provides the capital as a capital owner. The Mudarib provides the effort and expertise for the investment of capital in exchange for a share in profit that is agreed upon by both parties.  

 

1.   The Results of  Mudaraba: The two parties calculate the earnings and divide the profits at the end of Mudaraba. This can be done periodically in accordance with the terms of the agreement, subject to the legal rules that apply. 

2.   Payment of  Mudaraba Capital: The bank recovers the Mudaraba capital it contributed before dividing the profits between the two parties because the profit is considered collateral for the capital.   

3.   Distribution of wealth resulting from Mudaraba: In the event a loss occurs, the capital owner (the bank) is responsible for the entire loss.  In the event of profits, they are divided between the two parties in accordance with the agreement between them, subject to the capital being recovered first.   

 

Rules of Mudaraba

 

There are some legal rules that govern the business relationship Mudaraba which are as follows.

1.   It is a condition in Mudaraba that the capital be specific in nature. In other words, the amount of capital must be known at the inception of the contract. The purpose of this rule is to ensure that there is no uncertainty about the amount of capital and, thus, no uncertainty about the division of profits.   

2.   It is a condition that capital must be in the form of currency in circulation. However, merchandise can be contributed, so long as both parties to the business arrangement agree upon its value.   

3.   It is a condition that the capital cannot be subject to indebtedness.  

4.   It is permissible for a Mudarib to mix his private capital with the capital of the Mudaraba, thus becoming a partner. In addition, it is also permissible for the Mudarib to dispose of capital on behalf of the Mudaraba.   

5.   It is a condition that the capital of the Mudaraba is delivered to the Mudarib. Some of the jurists permit the capital owner to withhold capital and release it gradually according to the needs of the Mudarib since the Mudaraba adjudges unrestricted disposal.  

6.   It is permissible for the capital owner to deliver capital to two Mudharibs in a single contract.  It is permissible for the capital owner to vary the in profit sharing agreement between the two Mudharib based upon differences in the services provided  

7.   It is permissible to impose restrictions on the Mudarib as long as the restriction is beneficial and does not hinder the agent's ability to make a profit.   

8.   It is permissible for the Mudarib to hire an assistant to perform difficult work that he is unable to perform on his own.  

9.   The disposal of capital by the Mudarib is restricted to reasons that are conducive to the Mudaraba. The Mudarib must not lend or donate any of the Mudaraba capital. Further, he is not allowed to enter into indebtedness nor enter into another partnership agreement with the Mudaraba capital. However, these activities are permissible if the capital owner consents and authorizes the agent to use his discretion.  

10.                      The Mudarib is not required to contribute any capital to the Mudaraba contract except when he is found to be negligent in the way the funds are handled. It is permissible to take a surety or mortgage from the Mudarib to guarantee payment in the event of negligence violation of the contract conditions. However, it is impermissible to take a mortgage as a guarantee of capital or profit.  

11.                      It is a condition that profits be carefully and properly accounted for to avoid confusion by the parties to the contract. The contracting parties should stipulate how profits are to be shared on a percentage basis. It is impermissible to stipulate a fixed lump sum as profit.   

12.                      Profits in a Mudaraba relationship are distributed according to the agreement of the two contracting parties. It is a condition that the capital owner be solely responsible for any losses.   

13.                      The Mudarib shall collect his share of the profit only after obtaining the permission of the capital owner. In addition, the Mudarib can not collect his share of profit until after capital outlay is recouped.   In the event the profits are split prior to the closing of the Mudaraba, any losses incurred shall be reimbursed by the distributed profits.   

14.                      The Mudarib does not receive his share of the profits until the final settlement of the Mudaraba. Once the Mudaraba has been settled, neither party is liable to the other without a new agreement being made.  

15.                      The Mudaraba agreement may be terminated if one of the two parties decides to rescind the agreement. This is possible because the Mudaraba is an optional non-binding agreement. Some of the jurists hold the view that Mudaraba is binding and it cannot be rescinded if the Mudarib commences work.  

 

Concluding Remark

 

It is an investment-based form of financing. The provider of capital in Mudaraba has no role in the management of the capital. However, he has to bear the risk of capital loss as well as the opportunity cost of capital for the entire period of the contract. The rate of return is quite uncertain and the cost of capital is also uncertain. Hence, there is a perfect correlation between cost of capital and rare of return on capital.  

 

 

4. BAI-SALAM

 

Meaning of Bai-Salam

 

Bai-Salam is a term used to define a sale in which the buyer makes advance payment, but the delivery is delayed until some time in the future. Usually the seller is an individual or business and the buyer is the bank.

 

The Bai-Salam sales serve the interests of both parties (Ibid).

 

1.   The seller receives advance payment in exchange for the obligation to deliver the commodity at some later date. He benefits from the Salam sale by locking in a price for his commodity, thereby allowing him to cover his financial needs whether they are personal expenses, family expenses or business expenses.

2.   The purchaser benefits because he receives delivery of the commodity when it is needed to fulfill some other agreement, without incurring storage costs. Second, a Bai-Salam sale is usually less expensive than a cash sale. Finally a Bai-Salam agreement allows the purchase to lock in a price, thus protecting him from price fluctuation. 

 

Steps of Bai-Salam

 

1.   Cash sale or Sale on Credit - The bank pays the agreed upon price at the time of the contracts inception. The seller agrees to the delivery of the commodity some specified date in the future. 

2.   Delivery and Receipt of the Commodity on the Specific due Date: There are several options for delivery available to the bank

a)      The bank may receive the commodity and resell it to another party for cash or credit.

b)      The bank may authorize the seller to find another buyer for the commodity.

c)       The bank may direct the seller to deliver the commodity directly to a third party with whom the bank has entered into another agreement.

3.   The Sale Contract: The bank agrees to sell the commodity for cash or a deferred price, which is higher than the Salam purchase price.  The buyer agrees to purchase and to pay the price according to the agreement.

There are some rules for Bai-Salam as given below. 

 

Rules of Bai-Salam

 

1.   It is a condition that the commodity known by both parties to the agreement. Misunderstandings about the commodity may lead to disputes, which could void the contract.

2.   It is a condition that the quality of the commodity be monitored closely, as very little variation from specifications in the contract are allowable. If the commodity cannot be monitored for quality standards, a Salam transaction is impermissible.

3.   It is a condition that the commodity be deliverable on the due date. If there is uncertainty about the ability to deliver the commodity at the due date, a Salam transaction is impermissible.

4.   It is permissible to draw a Salam sale contract for a total to be delivered increments on different specified future dates.

5.   It is a condition that the commodity is a liability debt. The seller is obliged to deliver the commodity when it is due, according to the specifications stipulated in the contract, whether or not his firm produces the commodity or obtained from other firms. 

6.   Salam sales are impermissible on existing commodities because damage and deterioration cannot be assured before delivery on the due date. 

7.   Salam is impermissible on Land lots and real estates.

8.   Salam is permissible on a commodity of a specific locality if it is assured that it is almost always available in that locality and it rarely becomes unavailable.

9.   It is a condition that the purchase price in Salam is specified and advanced to the seller at the time of signing of contract. 

10.                      It is a condition in a Salam sale that the due date is known to avoid confusion, which may lead to a dispute.

11.                      It is a condition that the place of delivery be stated in the contract if the commodity requires special handling and delivery arrangements.

12.                      It is permissible to take a mortgage on Salam debt to guarantee that the seller satisfies his obligation by delivering the commodity on the due date.

13.                      It is impermissible for the buyer of a Salam commodity to sell the commodity before receiving it. It is known that the Salam commodity is a liability debt to the seller and not a commodity that exists. However, it is permissible for the buyer to draw a parallel Salam contract without connecting it to the first Salam contract.

 

Typical Bai-Salam transactions are discussed below:

 

Application of Bai-Salam

 

Salam sales are frequently used to finance the agricultural industry. Banks advance cash to farmers today for delivery of the crop during the harvest season. Thus banks provide farmers with the capital necessary to finance the cost of producing a crop.

 

Salam sale are also used to finance commercial and industrial activities. Once again the bank advances cash to businesses necessary to finance the cost of production, operations and expenses in exchange for future delivery of the end product. In the meantime, the bank is able to market the product to other customers at lucrative prices. 

 

In addition, the Salam sale is used by banks to finance craftsmen and small producers, by supplying them with the capital necessary to finance the inputs to production in exchange for the future delivery of products at some future date.

 

Thus as has been demonstrated, the Salam sale is useful in providing financing for a variety of clients, including farmers, industrialists, contractors and traders. The proceeds in a Salam sale may be used to cover the finance of operation costs and capital costs.

 

Concluding Remark

 

The Bai Salam agreement is a combination of debt and trading. The capital provider has no control over the management of capital provided. However the capital provider takes all of the risk as profits cannot be determined until the commodity is delivered and the final sale price is determined. In addition the capital provider incurs the opportunity cost associated with the capital outlay. Like the other three previously discussed modes of finance there is no certain rate of return. In addition the cost of capital is uncertain ex-ante. Also, there is no correlation in the relationship of cost of capital and rate of return on capital.  

 

 

5. ISTISNA'A  SALE

 

Definition of Istisna'a Sale

 

The Istisna'a sale is a contract in which the price is paid in advance at the time of the contract and the object of sale is manufactured and delivered later (IDB 1992, p.28). The majority of the jurists consider Istisna'a as one of the divisions of Salam, Therefore, it is subsumed under the definition of Salam. But the Hanafie school of Jurisprudence classifies Istisna'a as an independent and distinct contract. The jurists of the Hanafie school have given various definitions to Istisna'a some of which are: "That it is a contract with a manufacturer to make something" and "It is a contract on a commodity on liability with the provision of work".  The Purchaser is called 'Mustasnia' contractor and the seller is called 'Sania' maker or manufacturer and the thing is called 'Masnooa', manufactured, built, made (ABIIB). Islamic banks can utilize Istisna'a in two ways.

1.   It is permissible for the bank to buy a commodity on Istisna'a contract then sell it after receipt for cash or deferred payment.

2.   It is also permissible for the bank to enter into a Istisna'a contract in the capacity of seller to those who demand a purchase of a particular commodity and then draw a parallel Istisna'a contract in the capacity of a buyer with another party to manufacture the commodity agreed upon in the first contract.

Each transaction is deemed a separate contract with payment being made in cash either immediately or on a deferred basis. Any disagreements that may arise are settled under each contract separately according to the provisions therein. The steps of the Istisna'a sale and the parallel Istisna'a have been discussed below.

 

Steps of Istisna'a Sale

 

Istisna'a Sale Contract:  The Buyer expresses his desire to buy a commodity and brings a request to purchase the commodity to the bank. The method of payment, whether cash or deferred is set forth in the agreement. The bank agrees to deliver the commodity to the buyer at some agreed upon time in the future. 

 

The Parallel Istisna'a Contract: In order that the bank is able to deliver said commodity in the Istisna'a agreement, the bank enters into a parallel Istisna'a agreement with a third party to either manufacture or otherwise deliver-said commodity. Obviously, the bank stipulates a price that is lower than that agreed to in the original agreement and requires delivery on or before the date stipulated in the original contract.

 

The seller, in the parallel agreement, agrees to manufacture the specific commodity and to deliver it on the due date agreed upon.

 

Delivery and Receipt of the Commodity: The seller in the parallel Istisna'a agreement, delivers the commodity to the bank on the agreed upon date. The bank, in turn, delivers the product to the buyer of the original Istisna'a contract, in accordance with the original agreement. In this way, all parties fulfill their obligations to the contract.

 

Rules of Istisna'a Sale

 

1.   It is a condition in the Istisna'a contract to clearly define dimensions and specifications of the product being purchased. This is important to ensure that there is no room for dispute over what is required.

2.   The Istisna'a contract is only used for objects that can be manufactured. It can not be used to purchase corn, wheat, barley, fruit or any natural product.

3.   The object sold in a Istisna'a contract is a fixed liability debt and it is permissible for the object to be a custom manufactured product, made in accordance with certain specifications.

4.   The maker should supply the materials. If they are supplied by the buyer, the contract is Ijara and not Istisna'a.

5.   Once the contract is drawn the ownership of the asset is confirmed to the buyer and the purchase price is confirmed to the manufacturer.

6.   It is not a condition in the Istisna'a contract to advance the price. Usually part of the price is paid in advance and the remainder is withheld until the time of delivery.

7.   It is a condition that the time of delivery be specified in the agreement to avoid confusion that may lead to a dispute over the transaction.

8.   It is a condition that the place of delivery be stated in the contract if the commodity requires special handling and delivering arrangements.

9.   The buyer may stipulate in the Istisna'a contract that the commodity shall be manufactured or produced by a specific manufacturer, or manufactured with specific materials. This is not permitted in a case of Salam Sale.

 

Application of Istisna'a Sale

 

The Istisna'a contract allows Islamic banks to finance the public needs and the vital interests of the society to develop the Islamic economy in accordance with Islamic teachings. For example Istisna'a contracts are used to finance high technology industries such as the aviation, locomotive and ship building industries. In addition, this type of business transaction is also used in the production of large machinery and equipment manufactured in factories and workshops. Finally, the Istisna'a contract is also applied in the construction industry such as apartment buildings, hospitals, schools, and universities to whatever that makes the network for modern life. One final note, the Istisna'a contract is best used in those transactions in which the product being purchased can easily be measured in terms of the specified criteria of the contract. 

 

6. QARD HASAN  (BENEVOLENT LOANS)

 

Qard Hasan is a contract in which one of the parties (the lender) places into the ownership of the other party (the borrower) a definite parcel of his property, in exchange nothing more than the eventual return of something in the same value of the property loaned.

 

Ausaf Ahmad (1998, p.49) mentioned that since interest on all kinds of loans is prohibited in Islam, a loan that is to be given in accordance with the Islamic principle, has to be, by definition, a benevolent loan (Qard Hasan) i.e. a loan without interest. It has to be granted on the grounds of compassion, i.e. to remove the financial distress caused by the absence of sufficient money in the face of dire need. Since banks are profit driven organizations, it would seem that there is not much opportunity for the application of this technique. However, Islamic banks also play a socially useful role. Hence they make provisions to provide Qard Hasan besides engaging in income generating activities.

 

There may be slight variations among different Islamic banks in the use of this technique. The Faisal Islamic Bank of Egypt provides interest-free benevolent loans to the holders of investment and current accounts, in accordance with the conditions set forth by its board of directors. The bank also grants benevolent loans to other individuals under conditions decreed by its Board. On the other hand, the Jordan Islamic Bank Law authorizes it to give "benevolent loans (Qard Hasan) for productive purposes in various fields to enable the beneficiaries to start independent lives or to raise their incomes and standard of living (Ibid, pp.49-50). Iranian banks are required to set aside a portion of their resources out of which interest free loans (Qard Hasan) can be given to small producers, entrepreneurs and farmers who are not able to secure financing for investment or working capital from other alternative sources, and needy customers. It should also be noted that Iranian banks are permitted to charge a minimum service fee to cover the cost of administering these funds.

 

Finally, in Pakistan, Qard Hasan is part of the bank's normal financing activities. Qard Hasan loans are granted compassionate basis and no service charges are imposed on the borrower. While these loans are considered loans of compassion, they are expected to be repaid when it is possible for the borrower to do so. Furthermore in Pakistan, Qard Hasan operations are concentrated in the head office of each bank. Branch offices are not permitted to extend these loans.  

 

7. BAI-MUAJJAL (DEFERRED SALE)

 

Meaning of Bai-Muajjal

 

The terms "Bai" and "Muajjal" are derived from the Arabic words 'Bai' and 'Ajal'. The word 'Bai' means purchase and sale and the word 'Ajal' means a fixed time or a fixed period. "Bai-Muajjal" is a sale for which payment is made at a future fixed date or within a fixed period. In short, it is a sale on credit.

 

The Bai-Muajjal may be defined as a contract between a buyer and a seller under which the seller sells certain specific goods, permissible under Shariah and law of the country, to the buyer at an agreed fixed price payable at a certain fixed future date in lump sum or in fixed installments.

 

There are some important features of Bai-Muajjal as given below (ABIIB).

 

Important Features of Bai-Muajjal

 

1.   It is permissible and in most cases, the client will approach the bank with an offer to purchase a specific good through a Bai-Muajjal agreement.

2.   It is permissible to make the promise binding upon the client to purchase the goods from the bank. In other words, the client is required to either satisfy the promise or to indemnify the bank for damages caused by breaking the promise without excuse.

3.   It is permissible to take cash/collateral security to guarantee the implementation of the promise or to indemnify the bank for damages caused by non-payment.

4.   It is also permissible to document the debt resulting from Bai-Muajjal by a Guarantor, or a mortgage or both, like any other debt. Mortgage/Guarantee/Cash security may be obtained prior to the signing of the Agreement or at the time of signing the Agreement.

5.   Stock and availability of goods is a basic condition for signing a Bai-Muajjal Agreement. Therefore, the bank must purchase the goods in accordance with the specifications of the client, prior to signing the Bai-Muajjal Agreement with the client.

6.   All goods purchased on behalf of a Bai-Muajjal agreement are the responsibility of the bank until they are delivered to the client.

7.   The bank must deliver the goods to the client at the time and place specified in the contract.

8.   The bank may sell the goods at a higher price than the purchase price to earn profit.

9.   The price is fixed at the time of the agreement and cannot be altered.

10.                      The bank is not required to disclose the profit made on the transaction.  

 

Some Observations

 

This type of financing by the bank is considered to be more risky than the other Islamic modes of investment previously discussed.  Therefore, the application/proposal for Bai-Muajjal investment must be reviewed very carefully to ensure the client can ultimately make payment. . The following steps may be taken to ensure the Bai-Muajjal Investment is a good proposition for the bank:

1.   The bank may meet with the prospective client regarding his investment needs and business experience prior to an application /proposal is submitted.  

2.   The bank may review the client's past performance and other financing arrangements he may have had with the bank in the past. 

3.   The bank may review its current investment policy regarding this type of financing arrangement to ensure the proposal meets bank guidelines. 

It should be remembered that if the Bai-Muajjal investment is not secured by first class collateral securities, it becomes more risky than investments under other modes of Islamic banking.

 

The following points should receive attention before making any investment decision under Bai-Muajjal.

1.   Whether the goods that the client intends to purchase are marketable and have steady demand in the market.

2.   Whether the price of the goods is subject to frequent and violent changes.

3.   Whether the goods are perishable in short or in long-term duration.

4.   Whether the quality and other specifications of the goods as desired by the client can be ensured.

5.   Whether the goods are available in the market and the bank will be in a position to purchase the Goods in time and at the negotiated price.

6.   Whether the sale price of the goods is payable by the client at the specified future date in lump sum or in Installments as per the agreement.  

 

8. IJARAH

 

Definition of Ijarah

 

Fuqaha (jurists) have defined Ijaraha as ownership of a benefit for consideration. This is also known as lease or Hire contract. Al-Ijarah is an Arabic term. This has been derived from the Arabic term "Ujr" or "Ujrat" which means 'consideration' or 'return' or 'wages'.

 

According to Islamic Shariah (jurisprudence), Ijarah is a contract between two parties - the lessor and the lessee, where the lessees (Hirer or Mustajir) have the right to enjoy/reap a specific benefit against a specified consideration/rent/wages from the lessor - the owner (Muajjir). 

 

Elements of Ijarah

 

According the majority of Fuqaha, there are three general and six detailed elements of Ijarah:

1.   The wording: This includes offer and acceptance

2.   Contracting parties: This includes a lessor, the owner of the property, and a lessee, the party that benefits from the use of the property.

3.   Subject matter of the contract: This includes the rent and the benefit.

 

The lessor (Mujjir) - The individual or organization who leases out/rents out the property or service is called the lessor.

 

The lessee: (Mustajir) - The individual or organization who hires/takes the lease of the property or service against the consideration rent/wages/remuneration is called the lessee (Mustajir).

 

The Benefit (Maajur) - The benefit that is leased/rented out is called the benefit (Maajur).

The rent (Aj'r or Ujrat) - The consideration either in monetary terms or in quantity of goods fixed to be paid against the benefit of the goods or service is called the rent or Ujrat or Aj'r.      

 

Rules for Ijarah

 

It is condition that the subject (benefit/service) of the contract and the asset (object) should be known comprehensively.

1.   It is a condition that the assets to be leased must not be a fungible one (perishable or consumable) which can not be used more that once, or in other words the asset(s) must be a non-fungible one which can be utilized more than once, or the use/benefit/service of which can be separated from the assets itself.

2.   It is a condition that the subject (benefit/service) or the contract must actually and legally be attainable/derivable. It is not permissible to lease something, the handing-over of the possession of which is impossible. If the asset is a jointly owned property, any partner, according to be majority of the jurists, may let his portion of the asset(s) to co-owner(s) or the person(s) other than the co-owners. However, it is also permissible for a partner to lease his share to the other partner(s),

3.   It is a condition that the lessee shall ensure that he will make use of the asset(s) as per provisions of the Agreement or as per customs/norms/practice, if there is no expressed provision.

4.   The lease contract is permissible only when the assets and the benefit/service derived from it are within the category of 'Halal' or at least 'Mobah' as per Islamic Shariah.

5.   The lessor is under obligation to enable the lessee to the benefit from the assets by putting the possession of the asset(s) at his disposal in useable condition at the commencement of the lease period.

6.   In a lease contract, the period of lease and the rental to be paid in terms of time, place or distance should be clearly stated.

7.   Everything that is suitable to be considered a price, in a sale, can be suitable to be considered as rental in a lease contract.

8.   It is a condition that the rental falls due from the date of handing over the asset to lessee and not from the date of contract or use of the assets.

9.   It is permissible to advance, defer or install the rental in accordance with the Agreement.

10.                      It is permissible to review the lease period or the rental or the both, if the lessor and the lessee mutually agree to do so.

11.                      The leased asset is a trust in the hands of the lessee. He will maintain the asset(s) with due prudence and shall not be held responsible for the damage or destruction of the asset without transgression, default or negligence, otherwise he must be responsible for the same.

12.                      The lessor/owner bears all the costs of legally binding basic repairs and maintenance including the cost of the replacement of durable parts on which the permanence and suitability of the leased assets depends.

13.                      It is permissible to make the lessee bear the cost of ordinary routine maintenance, because this cost is normally known and can be considered as part of the rental.

14.                      It is permissible for the lessee to let the asset to a third party during the lease period whether for the same rental or more as long as the asset is not affected by the change of user and not barred/restricted by the Lease Agreement/customs to do so.

15.                      It is permissible to purchase an Asset bearing a lease contract. The lease contract may continue since the purchased agrees to its continuity up to the end of the lease term. All rights and liabilities emanating from the lease contract will transfer to the new owner. But if the sale-contract is drawn and the purchaser is oblivious of the lease contract, he has the right to rescind the purchase contract and the lease continues.

16.                      As soon as the lease period terminates the lessee is under obligation to return the Asset to the owner or if the lessor agrees he may enter into a fresh lease contract or purchase if from the lessor on payment of agreed upon price as per market rate.

17.                      The lease contract is binding and no one party shall unilaterally rescind except reasons that abrogate binding contracts such as damage or destruction.

18.                      If the leased asset is damaged or destructed by the act of Allah and if the lessor offers a substitute with the same specifications agreed upon in the lease contract, the contract does not terminate.

19.                      It is permissible to sell the leased Asset by the lessor to the lessee during the tenure of the lease period either part by part or in full at a time. As soon as any part or in full the Asset is sold during the tenure of the Lease Agreement, the lease contract for that part or for the full Asset as the case may be, be lapsed and the rental ceased to apply.

20.                      It is permissible for the lessee to promise or to give undertaking to purchase the leased asset during the tenure of the lease period, either part by part or in full or at the end of the lease period in full. It is also permissible for the lessor to give similar promise to sell the Asset.

21.                      The lease with promise to purchase and sale is different from the memorandum of sale. The rent paid by the lessee cannot, in any way, be considered as part of the price of the Asset, rather it is the price of the service of the Asset.

22.                      It is permissible to divide the cost price of the Asset and ownership of the lessor to the Asset into several parts and to sell each part of ownership on payment of proportionate price/equity of the lessor under a separate sale contract. 

 

9.   HIRE-PURCHASE UNDER SHIRKATUL MELK or IJARAH MUNTAHIB BIL TAMLEK

 

Hire-Purchase under Shirkatul Melk has been developed through practice. Actually, it is a synthesis of three contracts: (a) Shirkat; (b) Ijarah, and (c) Sale. These may be defined as follows:

 

Definition of Shirkatul Melk: 'Shrkat' means partnership. Shirkatul Melk means share in ownership. When two or more persons supply equity, purchase an asset and own the same jointly and share the benefit as per agreement and loss in proportion to their respective equity, the contact is called Shirkatul Melk. In the case of Hire Purchase under Shirkatul Melk, Islamic banks purchase assets to be leased out, jointly with client under equity participation, own the same and share benefit jointly till the full ownership is transferred to the client.

 

Definition of Ijara: The term 'Ijara' has been defined as a contract between two parties, the lessor and the lessee, where the lessee enjoys or reaps a specific service or benefit against a specified consideration or rent from the asset owned by the lessor. It is a lease agreement under which a certain asset is leased out by the lessor or to a lessee against specific rent or rental for a fixed period.

 

Definition of Sale contract: This is a contract between a buyer and a seller under which the onwnership of certain goods or asset is transferred by the seller to the buyer against agreed upon price paid by the buyer. In the case of Hire Purchase under Shirkatul Melk, the lessor bank sells or transfers its title to the asset under a sale contract on payment of sale price.

 

Thus in Hire Purchase under Shirkatul Melk mode, both the bank and the client supply equity in equal or unequal proportion for purchase of an asset like land, building, machinery, transports, etc., purchase the asset with that money, own the same jointly, share benefit as per agreement and bear the loss in proportion to their respective equity. The share/part or portion of the asset owned by the bank is leased out to the client partner for a fixed rent per unit of time for a fixed period. Lastly, the bank sells and transfers the ownership of its share/part/portion to the client against payment of price fixed for that part either gradually part by part or as a whole within the lease period or on expiry of the lease agreement. Hire-Purchase under Shirkatul Melk contract is to a great extent similar to the contract of Ijarah Montahia Bil Tamlek as termed by Accounting and Auditing Standards Board of the Account and Auditing Organization of Islamic Financial Institutions (AAOIFI). 

 

Stages of Hire Purchase under Shirkatul Melk

 

Hire Purchase under Shirkatul Melk Agreement has got three stages:

1.   Purchase of asset under joint ownership of the lessor and the lessee.

2.   Hire, and

3.   Sale and transfer of ownership by the lessor to the other partner - lessee.

 

Important Features

 

1.   In case of Hire Purchase under Shirkatul Melk transaction the asset/property involved is jointly purchased by the lessor (bank) and the lessee (client) with specified equity participation under a Shirkatul Melk contract in which the amount of equity and share in ownership of the asset of each partner (lessor bank and lessee client) are clearly mentioned. Under this agreement the lessor and the lessee become co-owners of the asset under transaction in proportion to their respective equity.

2.   In Hire Purchase under Shirkatul Melk Agreement the exact ownership of both the lessor (bank) and lessee (client) must be recognized.  However, if the partners wish and agree the asset purchased may be registered in the name of any one of them or in the name of any third party clearly mentioning the same in the Hire Purchase Shirkatul Melk Agreement.

3.   The share/part of the purchased asset owned by the lessor (bank) is put at the disposal possession of the lessee (clients) keeping the ownership with him for a fixed period under a hire agreement in which the amount of rent per unit of time and the benefit for which rent to be paid along with all other agreed upon stipulations are clearly stated. Under this agreement the lessee (client) becomes the owner of the benefit of the asset not of the asset itself, in accordance with the specific provisions of the contract that entitles the lessor (bank) the rentals.

4.   As the ownership of leased portion of asset lies with the lessor (bank) and rent is paid by the lessee against the specific benefit, the rent is not considered as price or part of price of the asset.

5.   In the Hire Purchase under Shirkatul Melk agreement the Lessor (bank) does not sell or the lessee (client) does not purchase the asset but the lessor (bank) promise to sell the asset to the lessee only if the lessee only if the lessee pays the cost price/equity price of the asset as fixed and as per stipulations on which the lessee also gives undertakings.

6.   The promise to transfer legal title by the lessor and undertakings given by the lessee to purchase the ownership of leased asset upon payment part by part as per stipulations are affected only when it is actually done by a separate sale contract.

7.   As soon as any part of lesssor's (bank's) ownership of asset is transferred to the lessee (client), that becomes the property of the lessee and hire contract for that share/part and entitlement for rent thereof lapses.  

8.   In Hire Purchase under Shirkatul Melk Agreement, the Shirkatul Melk contract is effected from the day the equit7y of both parties deposited and the asset is purchase and continues up to the day on which the full title of lessor is transferred to the lessee.

9.   The hire contract becomes effective from the day on which the lessor transfers the possession of the leased asset in good order and usable condition, so that the lessee may make use of the same as per provisions of the agreement.

10.                      Effectiveness of the sale contract depends on the actual sale and transfer of ownership of the asset by the lessor to the lessee. It is sold and transferred part by part it will become effective part by part and with the sale and transfer of ownership of every share/part, the hire contract for the share/part will lapse and rent will be reduced proportionately. At the end of the lease, the period when the full title of the asset will be sold and transferred to the lessee, the lessee will become the owner of both the benefit and asset, hire contract will fully end.

11.                      Hire Purchase under Shirkatul Melk are binding contracts, and the parties to it - the bank and the client - are committed to meet their obligations in accordance with the relevant agreement.

12.                      Under this agreement, the bank acts as a partner, as a lessor and at last as a seller; on the other hand the client acts as partner, as a lessee and lastly as purchaser.

13.                      Ownership risk is borne both by the lessor and lessee in proportion to their ownership equity.

14.                      Under this agreement the role of lessee is one of a trustee, the leased asset being a trust in his hands: he will manage, in favor of the interest of thee lessor at his own cost the exact subject of lessee, except in cases of emergencies and acts of Allah.

15.                      The lessee is responsible for keeping the leased asset (s) in good condition throughout the whole period of lease, and if the asset is damaged or defrayed due to transgressions default or negligence of the lessee, he shall be responsible to compensate for that.

16.                      The lessee cannot without obtaining prior written permission of the bank make changes in the exact item of lease, and or remove it from its place of installation, and transfer it to another location.

17.                      In a hire purchase under Shirkatul Melk agreement, any stipulation may be made, provided it is not against the nature and requirements of the contract itself, nor does it violate the Lessee laws of Islam, and is also acceptable to both parties.

18.                      Hire purchase under Shirkatul Melk facileties may be for medium-term and long-term period, which may be utilized for the expansion of production and services. as well as housing activities. The duration of hire purchase under Shirkatul Melk contract shall not exceed the useful life of the subject asset of the transaction. The bank should not normally enter into a Hire Purchase under Shirkatul Melk transaction for items with useful life of less than two years.

19.                      Hire Purchase under Shirkatul Melk transaction facilitates the client (lessee) to get benefit from the lease asset in exchange of rental and also to become full owner of the asset by purchasing it.

20.                       

Hire Purchase under Shirkatul Melk Mode is a combination of three contacts. All rules governing the lease contract should be applicable in this mode also.

 

Moreover, the rules for Musharakah and sale contracts will also apply to this. In addition, the following should also be followed:

 

1.   Under Hire Purchase Shirkatul Melk Agreement, both the lessor and the lessee must pay their respective equity as agreed upon to purchase the desired asset under joint ownership.

2.   Ownership of the asset of both the lessor and the lessee should be recognized as per law of the land.            

 

B. COMPARISON OF ISLAMIC AND CONVENTIONAL MODES OF FINANCING

 

 

 

Before we go on make a comparison between the modes of finance of Islamic banks and those of conventional banks, let us very briefly state the financial arrangements of the later.

 

 

 

MODES OF ADVANCE OF THE CONVENTIONAL BANKS

 

 

Conventional banks engage in the following types of financing arrangements:      

 

1.     Loans

 

The most obvious form of financing by a conventional bank is the loan arrangement. The bank advances (loans) a lump sum to an individual (the borrower) for a set length of time at either a fixed or viable rate of interest. The borrower repays the loan with equal installments over the prescribed term or in one lump sum at the end of the term.  There are no checks issued in this type of relationship. 

 

2.     Overdrafts

 

The extension of financing through overdrafts can only occur when there is an existing demand deposit account. An overdraft occurs when the amount of a check presented for payment to the bank exceeds the clients deposit balance. The banks may choose to pay on the item, thereby causing a negative balance in the client's account.  This negative balance is effectively an extension of financing and can be a prior arrangement with the bank. In addition, overdraft facilities may be extended against deposit certificates and/or government promissory notes.

 

3.     Cash credits

 

 

 

Cash credit is a popular mode of borrowing by traders, industrialists and agriculturalists. It is a separate account by itself and does not require having any other account with the bank. It resembles the use of overdrafts on a checking account. It is an arrangement whereby the borrower may withdraw funds as needed for day-to-day operations without the delay associated with making a loan. The borrower may not exceed a predetermined limit and must deposit cash back into the account as funds become available from daily operations. Interest is charged on the daily balance in the account. 

 

4.     Medium term loans

 

This type of loan is advanced to industries and agriculture for fixed capital requirements. These loans are also granted to traders for purchase of fixed assets, to transport operators for purchase of vehicles, and to self-employed persons for purchase of equipment. These loans are usually extended for a term of 3 to 7 years and in special cases up to 10 years and are generally repayable by instalments. Since it will take a year or two to derive the full benefits of expansion or renovation, instalments for repayment may commence after one or two years of the disbursement of the loan. Interest is charged on annual basis. 

 

5.     Hire-purchase advances

 

Under this arrangement, conventional banks grant advances to its clients engaged in hire-purchase business relating to transports, refrigerators, and televisions, for example. This type of financing is usually repaid with instalments including principal and interest. The bank generally requires immovable property as collateral against this type of financing.  

 

6.     Bills purchased/discounted

 

Export-Import businesses are performed through opening of  L/Cs with Bank. The client, while opening the L/C, comes to an agreement with the bank that the latter will repay the bill received on the farmer's behalf on a certain date onward in exchange for a specific rate of interest determined at the time of agreement. If the bill happens to reach well ahead of the date mentioned, the bank may purchase the bill, if requested, with a discount. In this case, the bank makes the return twice: first, by charging interest and then by discounting the bill. 

 

 

 

COMPARISON OF FINANCIAL MODES

 

For an effective comparison between the modes used by the two systems of banking, the following categorizations common to both may be adopted:

 

1.     modes related to project financing,

 

2.     modes related to financing trade and commerce, and

 

3.     special modes or system specific modes.

 

In line with the above categorization, medium and long-term loans under conventional banking, and Mudaraba and Musharaka of PLS-banking come under category (a). Under category (b), loans, cash credits, Hire Purchase and bills purchased/discounted of conventional banking and Murabaha, Bai-Salam and Bai-Muajjal of PLS-Banking may be listed.  Loans and cash credits of conventional banks may be categorized under (c) to satisfy the working capital needs of the borrower. For Islamic banks, there are no similar modes like its conventional counterpart to meet working capital needs. Though the "Qard Hasan" is customarily grouped under this category, it is not widely practiced by PLS-banks since this mode, by its very nature, does not earn a return.  Qard Hasan is benevolent loans, made on an interest free basis.

 

Keeping in mind the above categorizations, one may analyze the similarities or differences between the modes of conventional and those of the PLS-banking. As far as the first category is concerned, unlike PLS banks, conventional banks advance money in exchange for a predetermined fixed rate of interest. That is, under the conventional banking system, every advance made by a bank is a contract between the bank and the client with the following essential features: (i) a creditor-borrower relationship is established; (ii) the lending or borrowing is time bounded qualifying specific date(s) on which a certain percentage of interest on borrowed capital becomes due for payment along with the principal; and (iii) the income of the bank is known and prefixed and not in any way related to or variable with the income of the borrower generated from the borrowed money.

 

On the other hand, the financing arrangements under the PLS system of Islamic banks, have the following features: (a) it is a contract between two partners - the bank and the client-providing a partner-partner relationship; (b) the contract is time bounded in the sense that the client has to return the capital on/within specific date(s). However, the return of the bank is not fixed either from the standpoint of time or that of the rate; and (c) bank shares a prefixed ratio of profit expressed in percentage terms. This is not a prefixed rate of return calculated on capital advanced. Thus, income (profit) for a PLS-bank, unlike the practice of its conventional counterpart, fluctuates with the profits of the borrower.

 

In summary, in conventional banking, the bank is simply a financier and is not directly concerned about the success or failure of the project for which the loan was made, as long as it receives its payments. This is so because the bank's income (interest income) does not fluctuate with the fluctuations in the profit generated from the specific project. In other words, conventional banks advance financing in return for a guaranteed fixed return. On the other hand, a PLS-bank has a high interest in the performance of each project it finances because its income is directly related to the returns from each project it finances.  Thus, with regard to the first grouping of financing methods, the conventional bank is a risk-avatar, whereas the PLS-bank is a risk-taker.

 

With regard to the second class of financing methods, those that are generally used for financing trade and commerce, the only comparison worth mentioning is that in Conventional banking, fixed interest payments are made to the bank, whereas in the Islamic counterpart, the bank earns a profit margin. The Murabaha, Bai-Salam and Bai-Muajjal arrangements have often been accused of being 'Riba' practices.  However, the accusation is countered by the argument that the PLS-banks, unlike its conventional counterparts, are obliged to buy the goods and establish the bank's ownership, prior to selling the goods for a profit.

 

Finally, concerning the third class of investment types, these modes are very much system specific and hence no meaningful comparison is possible.

 

REFERENCES:

Ahmed, A. (1992). "Contemporary Experiences of Islamic Banks". Journal of Objective Studies, Insititute of Objective Studies, Delhi.

 

Al-Baraka Islamic Investment Bank (1995).

 

Attia, G. (1985). "Financial Instruments Used by Islamic Banks". Paper presented in the Islamic Banking and Finance Conference, London. See also Attia, G. (1984). "Understanding Islamic Bank's Proposals". Paper presented in the Islamic Banking and Finance Seminar, New York.

 

Brockington, Raymond, (1986). A Concise Dictionary of Accounting and Finance, Pitman  Publishing Ltd.

 

Fahmy, H. K. and Sarker, A. A.(1997). "Islamic Modes of Finance and Financial Instruments for Resource Mobilization: A Survey". In Ausaf Ahmed and T. Khan (Eds). Islamic Financial Instruments for Public Sector Resource Mobilization, IDB/IRTI, Jedda, KSA.

 

Institute of Islamic Banking and Insurance.

 

Islami Bank Bangladesh Ltd. (1986), Manual for Investment under Bai-Mudaraba Mode.

 

Islamic Development Bank (1992)., Principles of Islamic Financing (A Survey), Jeddah,.

 

Hassan, H.H.(1997). "Flexibility of Shariah Principles of Finance and Resource Mobilization Needs of Governments."

 

Hussain, Md. Sharif, Islamic Banking : Ekti Unnatator Bank Babosthya, (in Bangla), published by IBBL, 1996.

 

Iqbal, Z. and Mirakhor, A. (1987). "Islamic Banking". Al-Tawhid, Vol. 4, No. 3. Islamic Thought and Culture.

 

Khan, M. S., and Mirakhor, A. (1989). Islamic Banking: Experiences in the Islamic Republic of Iran and Pakistan. (IMF Working Paper No. wp/89/12). Washington DC: International Monetary Fund. (JEL Classification Nos. 3116; 3120; 314).

 

Mirakhor, A. and  Zaidi, I. (1988). Stabilisation and Growth in an Open Islamic Economy. (IMF working paper No. wp/88/22). Washington DC: International Monetary Fund. (JEL classification nos. 3110; 4312).

 

Shirazi, H. (ed.) (1990). tr. Islamic Banking,  Butterworths (London).

 

Source: https://www.islamibankbd.com/abtIBBL/cis_islamic_financial_modes_and_financial_instruments.php

 

 

 

SECURITY- CONCEPT & TYPES CHARACTERISTICS OF GOOD SECURITY PROPER VALUATION OF SECURITY

Banks take/borrow money/fund/deposit from the people without security.

Banks don’t usually invest/deploy money/fund/deposit to the people without security.

 

>> A security is an interest or a right in property given to the bank/FI/creditor/investor to convert it into cash in case the Investment customer/ debtor fails to meet the principal and profit/charge/ interest on Investment/ loan within the stipulated time. The bankers hold various kinds of securities as a cover of investment exposures/advances to their customers. The securities offered to the banks vary in qualities.

 

>> Security is obtained as a line of last defense to fall back upon. It is meant to be an insurance against emergency.

 

Types of Security:

 

Basically, there are two types of securities available to Banks to secure an Investment/ loan. They are-

1.     Primary security and

2.     Collateral security.

 

i) Primary Security:

 

It refers to the asset directly created out of Bank finance. For example, where a Bank finances the purchase of a home, the home is the primary security. In the same way, a car purchased with the help of a Bank Investment/loan, is the primary security for that loan. Further in the case of working capital Investment/loan, "stock and book debts" is considered as primary security and in case of trading, it is trading stock.  Bank creates a charge against this primary security, to secure its Investment/loan. This charge gives the Bank the legal authority to dispose of the asset, and apply the proceeds there from to the Investment/loan amount in default.

 

ii) Collateral Security:

It refers to certain additional security obtained by the Bank to secure the Investment/loan. For example, a Bank has financed the purchase of rice for trading. This stock of rice would be the primary security for the Investment/loan. In addition, the Bank may obtain collateral security in the form of residential flat owned by the proprietor, as additional security. This will guard Bank’s interests in the event of the primary security not having sufficient value to liquidate the Investment/loan.   Sometimes, on account of adverse market conditions, the value of the primary security gets eroded, exposing the Bank to a higher risk than it had originally dealt for.

 

 

Support (Guarantee): Additionally, Investment/ loan can also be secured with the help of personal security of other individual/company/ borrower himself. It happens through charging of guarantor’s Intangible assets (Goodwill), if above two securities fails to cover the exposures.

Margin: In case of non-funded business, i.e payment undertaking on behalf of the client [LC, BG etc.], the bank usually takes cash in full or part to mitigate the inherent risk; which is called margin.

Post Dated Cheque: Post dated cheque is also widely used as security for repayment of loan/investment.

 

 

Characteristics of good Security:

 

1.     The ownership of the security, whatever it is movable or immovable, must be undisputed.

2.     The possession also be undisputed.

3.     It should be controllable as per norms of different method of charging the security.

Problems in documentation

The customer is able to influence legal process.

Difficulty in evicting unlawful occupants.

4.     Easily encashable without/with minimum loss of value.

Liquidation of security takes longer period.

Security is highly specialized.

The borrower has influence over potential buyers.

5.     Identification must be confirmed.

6.     The property must be un-encumbered.

7.     It must be covered to the exposures.

Security is perishable.

Security becomes obsolete.

Product has been customized for customer (i.e. tailor made suit.)

 

8.     The property is emotionally related with the borrower.

 

 

Proper Valuation of Security (Physical and Financial)

 

(i) Physical:

a) Land, Building & Heavy Machineries

b) Goods/Inventory Pledge with Bank

c) Gold/Gold Ornaments Pledge with Bank

 

a) Land, Building & Heavy Machineries:

Ownership & Rigidity

Factors influencing valuation

Distressed Value is considered

Revaluation

Review

 

a) Land, Building & Heavy Machineries:

 

1) Ownership & Rigidity:

All Land, Building & Heavy Machineries items that are mortgaged/to be mortgaged must be backed by appropriate legal documentation of the owner of the property along with completion of documentation in favour of the bank before disbursement. Bankers should always be in a safer side or in rigidity with the market rate while valuing property or commodity. Valuation may be appreciated and depreciated depending on the changed circumstances.

 

2) Factors influencing valuation:

Valuation will be done based on the current market situation, economic condition, recent sales record of nearby/same nature of land and building, future prospect, nature of land and building, present construction status, connecting road, land development, disposability of the land etc.

 

3) Distressed Value is considered:

Value at which property is sold at lower price than that of open market due to difficulties of vendor. Banker must assess Distressed Value (DV) based on maximum of 80% of market value in case of urban/industrial area and 70% in case of rural/other areas.

 

4) Revaluation:

Revaluation may be  done after 3(three) years from the date of 1st valuation. However revaluation may be done within 3 (three) years in case of infrastructural development activities undertaken by government/private in the locality or up gradation/development/new construction in the land/building.

 

c)       Gold/Gold Ornaments Pledge with Bank:

Market value of gold or gold ornaments pledged with the bank.

 

04. Proper Valuation of Security (Physical and Financial)

 

(ii) Financial:

a) Financial Instrument issued by bank/NBFI under lien and Pledge

b) Government Bond/Savings Certificate under lien

c) Share

 

Financial Instrument issued by bank/NBFI under lien and Pledge:

 

1.     Value of Financial Securities will be considered as Face Value of the financial instrument or present encashment balance and principal deposit against other Scheme Deposit issued by own bank and other schedule bank/NBFI of the country or otherwise as per approval.

 

2.     In case of Instrument/Financial Obligation issued by other bank/NBFI authenticity of the Instrument/Financial Obligation, present balance, present en-cashable balance and marking LIEN on the Instrument/Financial Obligation must be done by the issuing authority of the instrument.

 

3.      Reconfirmation of authenticity of the instrument and marking LIEN and pledge by the issuing branch must be done from the office higher than the issuing office (preferably from Head Office) of that bank/NBFI

 

b)      Government Bond/Savings Certificate under lien:

 

100% of the value of government Bond/Savings Certificate

 

c) Share:

 

The average market value of last 06 months or current market price, whichever is lower of the shares traded in stock exchange.

 

(iii) Others:

 

1.     Value of 100% of the guarantee amount given by the Government/ Bangladesh Bank.

 

2.     Cross Company Guarantee within a group can be accepted only where the issuer has authority as per their Memorandum and Articles of Association to issue such guarantee supported by Board

3.     Resolution.

 

Guarantees taken from cross border correspondents should be within the rules prescribed

in “Guidelines for Foreign Exchange Transaction” of Bangladesh Bank or directives issued

by the competent authority time to time.

 

 

What is the difference between primary security and collateral security?

 

Primary security is the asset created out of the credit facility extended to the borrower and / or which are directly associated with the business / project of the borrower for which the credit facility has been extended. Collateral security is any other security offered for the said credit facility. For example, hypothecation of jewellery, mortgage of house, etc. Example: Land, Plant & Machinery or any other business property in the name of a proprietor or unit, if unencumbered, can be taken as primary security.

 

What is Sukuk ?

Sukuk is an Islamic financial certificate, similar to a treasury bond, and structured to generate returns in compliance with Islamic finance principles. The ministry of finance as well as the central bank has made the latest moves against the backdrop of an upturn in excess liquidity in the country's banking system.

 

POTENTIAL OF ISLAMIC SUKUK BOND IN BANGLADESH

Md Imran Shikdar, Dhaka, 08-07-2021

The word ‘Sukuk’ refers to a financial instrument governed by Islamic Shariah law

Islamic Sukuk Bonds are a new investment vehicle for different categories of investors in Bangladesh.

The word ‘Sukuk’ refers to a financial instrument governed by Islamic Shariah law.

It’s different from a conventional investment as it prohibits interest (i.e., ‘riba’ in Arabic) and provides income in terms of shared profit.

Many developed markets have been utilizing sukuk bonds for financing because of its unique features and Bangladesh has now also begun launching products under this alternate investment tool so it is important for investors and issuers to understand how Sukuk works.

In 2020, Bangladesh Bank launched its maiden sukuk bond which will offer a fixed 4.69% rental yield per annum for a tenor of five years.

The rental yield provides the shared profit aspect that is one of the features of Sukuk that differentiates it from a conventional investment vehicle.

In this case, the rental yield derives from a project named "Safe Water Supply for the Whole Country."

Let’s look at how this works.

 

This Sukuk bond has three distinct parties – investors, borrower, and a third party who will connect these investors and the borrower.

So, while in a conventional bond, the investors will communicate directly with the borrower, in a Sukuk bond, both the investors and the borrower will communicate through a third party.

This third party will be termed as an SPV (Special Purpose Vehicle). In this case, the SPV will be Bangladesh Bank.

Bangladesh Bank will play a middleman role – it will collect the investment proceeds from the investors through issuing them electronic Sukuk certificates and then it will transfer these investment proceeds to the Government to develop and operate the project.

Before making this transfer, Bangladesh Bank will buy the project infrastructure from the Government on behalf of the investors.

Also, in this Sukuk structure, the borrower is called an originator who originates the project.

The originator, in this case, is the government of Bangladesh.

To generate rental income from this project, Bangladesh Bank will now lease the project infrastructure back to the government through a lease agreement.

The government will thereafter use the project infrastructure under this lease agreement and will pay periodic rental yields to Bangladesh Bank.

Bangladesh Bank will then transfer these periodic rental yields to the investors.

This lease agreement will continue to be effective for 5 years.

After that, the government will buy back the project infrastructure from Bangladesh Bank through returning the investment proceeds and the lease agreement will terminate.

Bangladesh Bank will transfer back these investment proceeds to the investors and the associated Sukuk bond certificates will mature.

 

This bond will be backed by the full faith and credit of the government for the whole tenor, and so, this will be considered a ‘risk-free’ asset for the investors.

Although the overall sukuk bond structure looks a bit complicated, this type of structure appeals to both traditional commercial and Islamic shariah-compliant banks as it meets the banks’ Statutory Liquidity Ratio (SLR) requirements, and it fulfills the long-term risk-free investment needs of both traditional and Islamic (known as “takaful”) life insurance companies by providing a good asset liability match.

With over 50 commercial banks (including Islamic banks) and more than 30 life insurance and takaful companies in the country at present, sukuk offerings are likely to grow as they represent a good investment initiative to develop the Islamic bond market in the country.

 

 

 

ইসলামি বন্ড বা সুকুক কী?

 

বাংলাদেশে সরকারি বন্ড দুই ধরণের হয়--- ট্রেজারি বিল এবং ট্রেজারি বন্ড।

ট্রেজারি বিল হয় স্বল্প মেয়াদী, আর ট্রেজারি বন্ড হচ্ছে দীর্ঘমেয়াদী, যেমন দুই থেকে দশ বছর।

 

বাংলাদেশে ব্যক্তি পর্যায়ে সঞ্চয়ের মাধ্যম হিসেবে বিভিন্ন সরকারি বন্ড, সঞ্চয়পত্র এবং প্রাইজবন্ড প্রচলিত ও জনপ্রিয়।

 

বন্ডের মধ্যে ওয়েজ আর্নার ডেভেলপমেন্ট বন্ড, ইউএস ডলার ইনভেস্টমেন্ট বন্ড এবং ইউএস ডলার প্রিমিয়াম বন্ড চালু রয়েছে।

 

এখন সাধারণভাবে বলা যায় ইসলামি বন্ড বা সুকুকও এক ধরণের সরকারি বন্ড।

 

কিভাবে এলো ইসলামি বন্ড?

 

বাংলাদেশ ব্যাংকের এক গবেষণায় দেখা গেছে, ব্যক্তি বা প্রতিষ্ঠান পর্যায়ে দেশের মোট সঞ্চয় ও বিনিয়োগকারীদের ২৮ শতাংশ ইসলামি ধারায় বিনিয়োগ করতে চান।

 

এর মানে হচ্ছে, তারা প্রচলিত ব্যবস্থার মত সুদ গ্রহণ ব প্রদান করতে আগ্রহী নন। সে কারণেই সরকার এই ইসলামি বন্ড চালুর ব্যাপারে আগ্রহী হয়।

 

বাংলাদেশ ব্যাংকের মি. পাইন বলেছেন, সাধারণত ঘাটতি বাজেট পূরণের জন্য সরকার অভ্যন্তরীণ উৎস থেকে অর্থ ঋণ নেয়, সেটি মূলত নানা ধরণের বন্ড বিক্রির মাধ্যমে উত্তোলন করে।

 

এখন ইসলামী বন্ড চালু হলে সেটি হবে সরকারের অর্থ সংগ্রহের নতুন একটি উৎস, যা উন্নয়ন কর্মকাণ্ডে ব্যয় করা হবে।

 

বাংলাদেশের নাগরিক যেকোন প্রাপ্তবয়স্ক ব্যক্তি, আর্থিক প্রতিষ্ঠান যেমন রাষ্ট্রায়ত্ত ও বাণিজ্যিক ব্যাংক এবং ইসলামী ব্যাংকসমূহ সুকুক কিনতে পারবে।

 

সাধারণ বন্ডে ইসলামি ব্যাংকগুলো বিনিয়োগ করে না।

 

বাংলাদেশ ব্যাংক বলছে, সর্বনিম্ন ১০ হাজার টাকা বিনিয়োগ করতে পারবেন একজন বিনিয়োগকারী। কিন্তু বিনিয়োগের সর্বোচ্চ সীমা নির্ধারণ করা নেই।

 

সুকুক হবে পাঁচ বছর মেয়াদি, এবং ছয় মাস অন্তর মুনাফা পাবেন একজন বিনিয়োগকারী।

 

মুনাফার প্রাক্কলিত হার নির্ধারণ করা হয়েছে ৪.৬৯ শতাংশ।

 

মি. পাইন বলেছেন, "দেশে প্রচলিত ইসলামী ব্যাংকগুলোর স্কিম যেমন ইসলামিক ইনভেস্টমেন্ট বন্ড চালু রয়েছে, তার মুনাফার হার ৩.৬৯ শতাংশ। এর সঙ্গে এক শতাংশ যোগ করে সুকুকের প্রাথমিক হার নির্ধারণ করা হয়েছে।"

 

সাধারণ বন্ডের সঙ্গে ইসলামি বন্ডের পার্থক্য কী?

 

ঢাকা বিশ্ববিদ্যালয়ের ব্যাংকিং ও ইনস্যুরেন্স বিভাগের অধ্যাপক হাসিনা শেখ বলেছেন, সাধারণ বন্ডের সঙ্গে সুকুকের মূল পার্থক্য হচ্ছে এটি পুরোপুরি ইসলামি রীতি অনুযায়ী পরিচালিত হবে।

 

এর মানে হচ্ছে এতে প্রচলিত বন্ড বা সঞ্চয় স্কিমের মত সুদের ব্যবহার থাকবে না।

 

সুদের হার নির্দিষ্ট করা থাকে, কিন্তু মুনাফার হার আগে থেকে নির্ধারণের উপায় নেই।

 

সেটি বাৎসরিক ব্যবসায়িক কর্মকাণ্ডের আয়-ব্যয়ের ওপর নির্ধারিত হয়।

 

অধ্যাপক হাসিনা শেখ বলেছেন, "প্রচলিত বন্ড বা সঞ্চয়পত্রে সুদের হার নির্দিষ্ট থাকে, বিনিয়োগকারী যে অর্থ বিনিয়োগ করেন, তার ওপর একটি নির্দিষ্ট হারে অর্থ লাভ করেন।

 

কিন্তু সুকুকের ক্ষেত্রে বিনিয়োগকারী নির্দিষ্ট হারে কোন অর্থ পাবেন না। অর্থাৎ নির্দিষ্ট সময়ে ওই প্রতিষ্ঠানের আয় ও মুনাফা, যখন যেমন হবে, তার অংশীদারিত্ব লাভ করবেন।"

 

বাংলাদেশ ব্যাংকের মি. পাইন বলেছেন, ইসলামি বন্ড হবে ইজারা ভিত্তিক মানে নির্দিষ্ট প্রকল্প ভিত্তিক, কিন্তু সাধারণ বন্ডের ক্ষেত্রে তা হয় না।

 

তিনি উদাহরণ দিয়ে বলেন, "যেমন জনস্বাস্থ্য প্রকৌশল অধিদপ্তরের 'সারা দেশে নিরাপদ পানি সরবরাহ প্রকল্প' এর সম্পদের বিপরীতে ছাড়া হচ্ছে এই সুকুক।

 

যিনি এতে বিনিয়োগ করবেন, তিনি এই প্রকল্পের মালিকানার মানে ওই প্রকল্পের যাবতীয় সম্পত্তির অংশীদার হয়ে যাবেন নির্দিষ্ট সময়ের জন্য।"

 

বাংলাদেশ ব্যাংক চার হাজার কোটি টাকা করে দুই দফায় বিনিয়োগকারীদের কাছে সুকুকের সার্টিফিকেট বিক্রি করবে।

 

বিপরীতে তারা মুনাফা পাবে।

 

এর ফলে সুকুকে বিনিয়োগকারী ব্যক্তি বা প্রতিষ্ঠান কেবল কোন নির্দিষ্ট অংকের হারে সুদ পাবেন না।

 

বরং তিনি ওই প্রকল্পের প্রাক্কলিত আয় এবং মুনাফার অংশীদার হবেন।

 

 

ISLAMIC CAPITAL MARKETS (ICM)

Muslim countries including Bangladesh are developing the Islamic Capital Markets (ICM) parallel to the existing conventional capital markets. Islamic Banking has gained wider acceptance by the people of Bangladesh after playing crucial roles in the area of deposits and financing sectors in the economy of Bangladesh

What is Islamic capital market product?

Today, various capital market products are available such as Shariah-compliant securities, sukuk, Islamic unit trusts, Islamic Real Estate Investment Trusts etc.

What is the importance of Islamic capital market?

The Islamic capital market functions as a similar and equivalent market to the conventional capital market. This plays an important and balancing role in the Islamic banking system in expanding and deepening the Islamic financial markets in Islamic world as well as other parts of the world.

What is Bangladesh's capital market?

The present day capital market in Bangladesh has an instrumental segment of securities market that includes two stock exchanges (one at Dhaka and the other at Chittagong) and a non-instrumental segment of institutional investors such as commercial banks (45), investment bankers and companies, merchant bankers (26)

What are the instruments of Islamic capital market?

Common Shariah principles that are used in Islamic debt instruments include murabahah (trade with mark up or cost plus), ijarah (lease financing), bai` al-salam (advance purchase), istisna` (purchase order) and others.

 

How does Islamic capital market work?

Islamic equity financing represents a component of the overall capital market activity. Typically, equity-financing is structured through profit-sharing contracts or `uqud al- isytirak. The two common types of equity financing instruments are mudharabah (profit-sharing) and musharakah (profit and loss sharing).