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Q: what are the business practices regarding uses and sources of funds in
Islamic banking.

SOURCES OF FUNDS
Islamic banks rely on the following sources of funds:
1. Capital & Equity;
2. Transaction deposits that are risk free and yield no return; and
3. Investment deposits that carry the risks of capital loss for the promise of variable
returns.
Capital & Equity
Capital is the amount injected into the Islamic bank during the setting-up stages
i.e. the paid-up capital of the Islamic bank.
Equity is usually the retained earning of the Islamic bank that accumulated during
its operational period.
Transaction Deposits
Current accounts
Current accounts are based on the principle of Wadiah, whereby the depositors are
guaranteed repayment of their funds. At the same time, the depositor does not receive
remuneration for depositing funds in a current account, because the guaranteed funds
will not be used for PLS ventures. Rather, the funds accumulating in these accounts can
only be used to balance the liquidity needs of the bank and for short-term transactions
on the banks responsibility.
Savings accounts
Savings accounts also operate under the Wadiah principle. Savings accounts differ from
current deposits in that they earn the depositors income: depending upon financial
results, the Islamic bank may decide to pay a premium, hiba, at its discretion, to the
holders of savings accounts.
Investment Deposits
Investment accounts
An investment account operates under the Mudaraba al-mutlaqa principle, in which the
Mudarib (active partner) must have absolute freedom in the management of the
investment of the subscribed capital. The conditions of this account differ from those of
the savings accounts by virtue of:
1. a higher fixed minimum amount,
2. a longer duration of deposits, and
3. most importantly, the depositor may lose some of or all his funds in the event of the
bank making losses.
Special investment accounts
Special investment accounts also operate under the Mudaraba principle, and usually
are directed towards larger investors and institutions. The difference between these
accounts and the investment account is that the special investment account is related to
a specified project, and the investor has the choice to invest directly in a preferred
project carried out by the bank.
UTILISATION OF FUNDS
To generate revenue, Islamic banks utilized the funds by giving out financing facilities.
The financing facilities are done based on the Islamic concepts accepted by the Islamic
bank Shariah Council / Committee.
The concepts usually applied by the Islamic bank are as follows.
Musharakah
Musharakah means a relationship established under a contract by the mutual consent of the
parties for sharing of profits and losses in the joint business. It is an agreement under which the
Islamic bank provides funds, which are mixed with the funds of the business enterprise and
others. All providers of capital are entitled to participate in management, but not necessarily
required to do so. The profit is distributed among the partners in pre-agreed ratios, while the loss
is borne by each partner strictly in proportion to respective capital contributions.

Murabaha (cost plus / mark up)
This is the most commonly used mode of financing device. In a Murabaha transactions,
the bank finances the purchase of a good or assets by buying it on behalf of its client
and adding a mark-up before reselling it to the client on a cost-plus basis profit contract.
Bai muajjal (deferred payment)
Islamic banks have also been resorting to purchase and resale of properties on a
deferred payment basis. It is considered lawful in Fiqh (jurisprudence) to charge a
higher price for a good if payments are to be made at a later date. According to Fiqh this
does not amount to charging interest, since it is not a lending transaction but a trading
one.
Bai salam (prepaid purchase)
This method is really the opposite of the Murabaha. There the bank gives the
commodity first, and receives the money later. Here the bank pays the money first and
receives the commodity later, and is normally used to finance agricultural products.
Istisnaa (manufacturing)
This is a contract to acquire goods on behalf of a third party where the price is paid to
the manufacturer in advance and the goods produced and delivered at a later date.
Ijarah and Ijara Wa Iqtina (leasing)
Under this mode, the banks buy the equipment or machinery and lease it out to their
clients who may opt to buy the items eventually, in which case the monthly payments
will consist of two components, i.e. rental for the use of the equipment and installment
towards the purchase price.
Qard Hasan (benevolent loans)
This is the zero return type of loan that the Holy Quran urges Muslims to make available
to those who need them. The borrower is obliged to repay only the principal amount of
the loan, but is permitted to add a margin at his own discretion.

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