Islamic banks collect their profit-sharing deposits on the basis of Mudaraba principle. According to this principle, the depositors are supposed to get profit on the basis of predetermined income sharing ratio, unlike that of a conventional bank. In case of the latter, depositors get interest at a predetermined and fixed rate on deposit.
Most of the Islamic banking operators in the country do not follow the 'income-sharing' concept of Mudaraba while distributing profit to their depositors. They instead practise Weightage system of conventional banking. According to this practice, the profit-sharing depositors or the Mudaraba depositors are rather given profit on the basis of two-tier ratios. The first tier is a fixed ratio between the bank and the Mudaraba depositors as a whole. In the second tier, ratio means Weightages among different groups of depositors. Weightage is then applied on the first tier ratio.
This Weightage formula involves cross connectivity among several independent depositors. This cross-connection irrationally affects the amount of profit of different groups. The change in the proportion of deposit of any such group or change of Weightage of any of the groups affects the interest of other groups. Even entry of a new or exit of an old group/scheme automatically affects the interest of other groups. This happens without the knowledge, intimation or reference to any other group. Weightage mathematics protects the interest of the bank only.
Most harmful aspect of the Weightage system is that this module is accompanied by another weapon called 'provisional rate of profit'. In the name of this provisional rate of profit, an Islamic bank directly uses the conventional formula of independent and predetermined fixed cost of deposit. This is enough for opening the door of interest in an Islamic bank.
Through the application of provisional rate of profit, Islamic banking operators compromise the key concept of profit-sharing Mudaraba. They violate the rule of arriving at the total revenue or income of the bank first to work out the actual cost of deposit. Rather they prepare their income-statement by using this so-called provisional rate.
It is done in the same manner as a conventional bank applies the fixed interest on their deposit. Difference is that they name the fixed interest as provisional profit. In the aftermath, they match their accounts with the output of Weightage formula.
Only a few Islamic banks (IBBL is one of them) do however make a post-event attempt to offset the effect of this malpractice of provisional rate by paying an adjustment profit in the following year. They pay this as the addition of profit the depositors actually deserve over and above the provisional profit paid earlier on the maturity date. Weightage is thus practically applied in the following year.
In a nutshell, the common practice of our Islamic banking industry is to pay profit to the depositors at a fixed rate in the name of provisional profit. It is contrary to what they deserve according to Mudaraba. Weightage or other equations are post-event adjustment only.
An Arabic terminology does not necessarily mean Islamic. Again an Islamic terminology does not remain Islamic in practice, if its inherent and fundamental traits are violated. Similarly a banking business cannot be made Islamic merely by applying Arabic or Islamic business terms in its operations.
To comply with Mudaraba principle, profit to the depositors must be distributed according to the ratio (agreed upon directly between the individual client and the bank) of income or revenue. Mudaraba profit could never be according to the rate on deposit in any name (such as provisional). In Islamic banking, depositors' profit is an output derived from income; it must not be used as an input. It is the effect, not cause.
Thus, reform in Islamic banking practice is urgent and this should start from the profit distribution module. Firstly, because the prevailing profit distribution method ignores the basic concept of Mudaraba. Secondly, only the intention of the bank management is enough to bring about this reform. The stakeholders would not need much orientation, no intervention by the regulators would be required, and neither any amendment to the existing Islamic banking law nor promulgation of a new one would be necessary.
Afzalul Haq is the former head of Islamic banking of Bank Asia Ltd.
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