Islamic Banking And Impact Of Two Tier Mudarabah Finance Essay

The Term Bank is an Italian driven “ banca ” which is derived from German – means bench or counter, as Florentine bankers used to utilize the Benches as their desks with green desk fabrics on it for doing their activities of minutess. Bank can be defined as a fiscal establishment or organisations permitted by fiscal authorization within a authorities organic structure or authorities itself to set about sedimentations, wage involvements, lend money to the borrowers. The term “ Bank ” is besides defined as “ An organisation, normally a corporation, chartered by a province or federal authorities, which does most or all of the followers: receives demand sedimentations and clip sedimentations, honours instruments drawn on them, and pays involvement on them ; price reductions notes, makes loans, and invests insecurities ; collects cheques, bill of exchanges, and notes ; certifies depositor ‘s cheques ; and issues bill of exchanges and teller ‘s cheques ” . Soon the word “ bank ” is referred to a fiscal establishment which bears a Banking License which could be granted by governments who supervise the fiscal establishment and let rights to execute the banking service.

“ Bank is an establishment transecting the concern of accepting, for the intent of loaning or investing, of sedimentations of money from the public repayable on demand or otherwise, and withdraw able by checks, bill of exchange order or otherwise and includes any station office salvaging bank ” Negotiable Instruments Act ( 1881 )

Banks offer different services depend on their state they are based in and its type. But normally Bankss accepts sedimentations from the common public, lends money to persons or companies, issues checks, converts checks into hard currency, and pull offing valuables of its clients. Banks besides borrows money by leting sedimentations on current histories and issues the same as bills or bonds. Banking involves imparting money to its clients on current histories which is allowed to be returned in episodes for which Bankss charge involvements.


Development of Islamic Banking

Islamic banking is a system of fiscal activities where minutess are perform as per the Islamic Law which is besides called as “ Sharia Law ” which prohibits accepting or paying involvements ( Riba ) for loans on money lend and besides forbids investings into the concerns which perform the activities of supplying goods and services which is considered to be against rules of “ Sharia ” . During the period of Prophet Mohammed ( PBUH ) , the limited banking activity started with the followings used to lodge their money with the prophesier or with the first Khalif of Islam Abu Bakr Siddique.

In Islamic Golden Age where free markets were exists in the concern activities and where the term mercantile system and market economic system was introduced which is used to be referred as “ Muslim Capitalism ” . In this epoch of Caliphate and Islamic capitalist economy a assorted signifiers of techniques and fiscal constructs were used in Islamic Banking like the mufawada ( partnership ) , mudaraba ( limited partnerships ) , measures of exchange and the construct of capital ( al-mal ) and other constructs like waqfs ( trusts ) , lending, minutess entering ( legers ) etc. Later in the twelvemonth 1972 the first modern-day Islamic bank was introduced named as Nasser ‘s Social Bank and in this twelvemonth the indispensable tool the Islamic bank – Muslim accounting have came into being at the University of Cairo. increasingly this tendency was non limited to the arab universe and was spread through out the universe. Most of the Islamic states formed Bankss which operate on the footing of Sharia Law. The system of Islamic Banking is non merely limited to constructs and footings instead it has transformed the system and theoretical account into a full fledged system and concern.

Due to the current fiscal jobs of the universe economic systems and their reply through the old economic systems like capitalist economy, socialist and assorted economic sciences which is proved to be hard or impossible taking to many economical ailments, poorness and instabilities in societal and economical justnesss, unemployment and many other jobs, the universe has diverted their attending to work out this issue a renewed involvement has been shown in the manner the Islamic fiscal system works, as Islamic economic system obligates the service to adult male, joined custodies co-operation among people, religion in God, and equality in society, and these basicss and rules have been laid down by the Koran and the Prophet Muhammed ( PBUH ) .

Islamic Banking system must adhere to the Islamic rules related to concern and fiscal activities in which it is prohibited to put or affect in any activity which includes intoxicant, chancing etc. and besides net income and loss sharing is non equal.

Modern Islamic banking

In the late 40 ‘s the restructuring of banking system based on net income sharing and non the involvement exists with Anwar Qureshi ( 1946 ) , Nayeem Siddiqi ( 1948 ) and Mahmud Ahmed ( 1952 ) . These personalities stressed to hold all reformation in commercial banking with the theory of Mudarabha – the Net income and Loss distribution theoretical account.

Last few decennaries has witnessed in wider execution of interest- free banking. And Shariah based assets touched around $ 400 billion through out the Earth ( 2009 ) , Saudi Arabia, Iran and Malaysia have the biggest Islamic law based assets, with Persian Bankss accumulated for around 40 % of the overall assets of the top Islamic Bankss around the universe. The assets of Bank Melli Iran have reached $ 45.5 billion and Saudi Arabia based bank Al Rajhi Bank and Bank Mellat reached with $ 39.7 Billion.

Islamic banking involves in the same activities as commercial banking but as per the sharia law jurisprudence called as Fiqh al-Maumalat ( Transaction Rules ) , the nucleus regulation of Islamic banking is that of net income and loss distribution

The cardinal codification of Islamic banking is the distribution of net income and loss and the bar ofA ” riba ” A ( vigorish ) . Common footings used in Islamic banking includeA net income sharingA ( Mudharabah ) , safekeeping ( Wadiah ) , A articulation ventureA ( Musharakah ) , cost plus ( Murabahah ) , andA leasingA ( Ijar ) .

Minutess related to mortgage in Islamic system is done by non leting the purchaser to take the money to purchase the point alternatively the bank buys the point direct from the marketer and sell it back to the purchaser at a net income and giving proviso to the purchaser to unclutter the money to the bank in episodes. This system does non let expressed net income to the bank, and therefore there is no extra mulcts or punishments for paying late to the bank. The ownership of the point or belongings is straight registered in the name of the purchaser during the initial measure of the dealing itself. This procedure of dealing is called Murabaha. The lending for vehicles are done in such a manner that the vehicle is sold at a higher monetary value so the bing market monetary value to the debitor and the ownership retains with the bank until the loan is paid. Some Bankss besides apply Musharaka al-Mutanaqisa an approached which allows a balanced monetary value in the form of allowing. In this attack the bank and the borrower forms a partnership in which they provide the capital on a predefined per centum to purchase the land or belongings. The belongings is so rented out to the borrower and charges rent.

An imaginative attack functional by a few Bankss for place loans, calledA ” Musharaka ” al-Mutanaqisa, agree to, for a balanced rate in the signifier of allowing. The bank and borrower organize a joint venture entity, both supplying financess at a settled ratio to purchase the assets. The partnership unit so lease out the belongings to the borrower and charge rental.

“ The partnership between two parties, both of them provide capital towards the funding of a undertaking. Both parties portion net incomes on a pre-agreed ratio, but losingss are shared on the footing of equity engagement. Management of the undertaking is carried out either by either parties or any one of them ” .


“ Mudarabah ” is a peculiar type of partnership where one spouse gives financess to

Another for spend it in a concern undertaking. The financess comes from the first spouse

who is called “ rabb-ul-mal ” , whereas the disposal and labour is

an elect answerability of the other, who is called “ mudarib ” . Under this attack the venture capital support for a concern which gives the labour and the funding is done by the bank and the net income and loss are shared every bit. This engagement of both the parties by set uping the capital and labour reflects the Islamic attack of non leting merely one party to portion the net income and other bearing the loss in instance of failure and guaranting the balanced distribution of net incomes. Under this spouse ship one party provides money to other to put in a commercial endeavor. The first party who invest the money is called as “ rabb-ul-mal ” , and the disposal and labour is the lone answerability of the other spouse known as “ mudarib ” . It is nil but a net income sharing contract in which 100 % of the investing is done by one party and the other party provides with cognition and pull off the undertaking. Net incomes are shared as per the pre defined ratios.

Business of Mudarabah:

The one system of Mudarabah is that the rab-ul-mal may direct the mudarib to utilize his investing for a peculiar concern specified by the rub-ul-mal and this is called al-mudarabah al-muqayyadah. In instance the Rab-ul-mal foliages upon the Mudarib to use his capital for any concern as per the mudarib so it is called al Al-Mudarabah al- Mutlaqah.

Contract can be done by the rabul-mal in mudarabah with one mudarib or more by one dealing. For illustration the rubul-mal can give money to A and B, where both the A and B can move as mudarib for him and the capital invested will be used by both A and B and the portion will be distributed among A and B as per the pre agreed ratio. In this type of activity both the mudaribs act and work as spouses in the venture which is considered to be normal concern trade, and if they want to travel beyond the concern activity they should acquire the permission from the rabul-mal.

Net income & A ; Loss Sharing:

The net income sharing understanding should be done at the beginning of the contract and should be explicitly defined for a valid mudarabah. It is left on the common concent of the parties involved by the sharia law. There should non be any peculiar sum of money be set for any of the spouse and should be every bit shared among the mudaribs. For case if there is a capital of ? 100000/- it is out to put a status of sharing a specific sum of net income among mudarib or to be given to rabul-mal instead it can be decided that 40 % of the existent net income shall be shared by mudarib and remainder of 60 % with by rabul-mal or vice-verca.

However it is considered to be void in mudarabah to put an proportion of net income at the beginning of the venture, if the rabul-mal directs the mudarib to use the capital in a trade which is specified by the rabul-mal. As per the pre defined portion of the net income the mudarib is non entitled for any salary or fee or wage for the work and clip he spends in the venture. However Imam Ahmad allowed the mudarib to acquire the disbursals related to his nutrient from the mudarabah history, but the Hanafi religious order has restricted this for the mudarib to acquire the disbursals merely if he is out of his town on concern trip

If the concern goes into loss in certain minutess and addition net income in some so the net income acquired shall be used to countervail the loss incurred at first so the staying of the net income shall be shared among the parties as per the agreed ratio.

Termination of Mudarabah:

The expiration of contract in mudarabah can be done at any clip by any of the two parties ; the lone status is to function with a notice prior to the expiration to the party. And if at the clip of expiration all the assets of mudarabah is in hard currency and some net income exists so it should be shared among the parties as per the in agreement proportion. And in instance the assets are non in hard currency so the mudarib shall be entitled to sell or neutralize the assets in order to determine the existent net income to be distributed.

There are different positions among the Muslim bookmans about the contract of mudarabh expiration after a period specified. Hanafi and Hanbali portions with position of mudarbah can be restricted to a specific clip period of one twelvemonth or half twelvemonth which could be terminated after completion of this period without notice. On other had shafai and Maliki have the different sentiment and they say that mudarabah should non be restricted for a specific period.

However there is no proper reply to this with the Islamic fiqh, but the general rules are used where in there is no clip period is fixed and each party is free to end the contract after giving notice.

With no proper clip period set for expiration of mudarabah there creates a jobs in the present markets as most concern activities rely on clip period for fruitful consequences with connoting proper attempts and hardworking. If the rabul-mal terminates the contract in mudarabah at the beginning of the contract there could be any net income or earning for the mudarib. And if there is some understanding between at the starting of mudarabah that no party shall stepbacks during the contract period and which does non go against the rules of Shariah and adheres to the celebrated Hadith as “ All the conditions agreed upon by the Muslims are upheld, except a status which allows what is prohibited or prohibits what is lawful ” ( sunan Abu Dawood, 1981 ) , so it could convey some fruitful consequences.

Two-Tier Mudaraba

The construct of two-tier Mudarabah was ab initio used by Islamic Banking. The theoretical account is structured for the Islamic Bankss to prosecute in two mudaraba activities, the first 1 with the depositors and the other one is with the individual who gives fundss.

The first Mudaraba is between the bank and the client with excess capital ( depositors ) and the 2nd one is between the bank and the clients who require funding.

In the first grade Mubaraba contract among the depositors and the Bank, the sedimentations acts as rabul-mal and the Islamic Bank as the Mudarib. The depositors who act as rabul -mal invest their money into the bank without warrant of their principal and a return on the net income of their money used by Bankss on their behalf. And as per mudaraba and pre agreed proportion the losingss and net incomes have to be shared with the Islamic Bank.

In tier two Mudarabah between the Islamic Bankss which provides the finance and act as the Rabul-mal and the receiving system of finance from the bank acts as the Mudarib. In this grade the losingss incurred by any abuse by the mudarib has to be shared by the Bank and if any net incomes generated so both shall portion as per the pre agreed ratio.

Muslim economic experts developed this construct as trusty replacement to salvaging histories. The theoretical account of two-tier Mudaraba serves as the bank as the jobbers for the depositors and the clients who need finance and who is able to acquire a sufficient result forestalling the depositors money from hazard. As the Islamic Bankss posses the liability for any losingss incurred which is finally suffered by the depositors, and this ground made the usage of this type of mudabarah in limited in pattern. The other drawback with the two tier Mudaraba is that it is non merely the depositors principal is at hazard but besides suffer many swings in the net income they get from their sedimentations.

10.0 Consequences in Two-tier Mudarabah Model

In malice of the sound net income potency of mudarabah funding theory, and accomplishment to face the involvement based construction, the method might non build a infiltrate modify in modern-day Islamic finance. It did bloom as a sedimentation collect system by agencies of the Islamic fiscal establishments. For illustration, mudarabah companies multiplied speedy, peculiarly in Pakistan. However these companies might non detect concern investing chances adequate to take up mass of the sedimentations they expected. They were bound, in logic, to do financess in approximative purchasing and merchandising of portions at the stock markets. One of the chief realistic problems with mudarabah is the irregular nature of the hazards implicated. For the bank depositor the cardinal hazards were of bank failure and the uncertainness ( “ gharar ” ) refering the phase of gross to be shared. With efficient bank regulation the danger of bank disappointment was negligible on the other manus, and uncertainness still applies to up-and-down involvement returns, so this was unlikely to scare depositors, surely it was the little danger they take that acceptable their refund. The excess terrible trouble by agencies of mudarabah arises by bank finance of industry, when there be no security that the bank might acquire their fundss repaid. In add-on the danger of acquiring no net incomes was significant, peculiarly by agencies of the sort of little concern so as to distinguish a batch of Muslim fiscal system. There are moreover ethical hazard jobs, as concern perchance will potentially cover the net incomes they prepared to cut down the net incomes shared, peculiarly wherever full audits are non obligatory.

This is the most of import hinder evidences Islamic banking and finance to travel after the way of slightest confrontation moreover to obtain protection in the irresponsible exercising of Islamic delayed irresistible impulse trade. The signifier with the purpose of might hold face the conventional banking if carefully set up Lashkar-e-Taiba to be unsuccessful. Soon, Islamic Bankss have practically no place for mudarabah understanding in their Muslim goods or set of picks. In Malaya by the terminal of 2003, mudarabah histories for 0 per centum of entire banking goods. Soaring non-payment in mudarabah understanding comprise for all clip exists the trouble meant for Islamic Bankss. However, in my position bank must take up a accurate process to measure the mudarib every bit good as concern endeavor that it mean to pass. The normal technique of scope of mudarib or industry must be capable to acknowledge the mostly recognition worthy patronage and executable concerns.

11. Decision

The setup and organisation of net income distribution under fiscal aid, identified as mudarabah be indispensable toward beginning hitch within the Islamic trade and industry order. Mudarabah is the chiefly equal construction of setup which is support on “ shirkah ” or net income distribution. Interest occured on the investing, is in violation of sharia law do non typify monetary value of production. Designed for that because Islam extremely promotes net income distribution which mudarabah plays a really of import function of direct the extra financess to arrears portion in modern-day Islamic banking and finance.

The two-tier mudarabah signifiers characterize an supreme signifier of economic intermediation with the purpose of replacing the involvement based construction. Interest based system being unjust, do non assume any jeopardy of provided the investing despite the effects of the consequence of undertaking. The involvement behaviour mechanism accordingly directs the fiscal system in to an unqualified status travel up against to gain sharing that is engage in monetary value construct. Justice is greatest warrant by net income distribution understanding as loot are a intent of realize end product that direct to every one of the concerned parties. In to ease, Islamic bank as a sedimentations accept establishment be different from a conventional at this point of clip, where to ease enterprisers to divide the jeopardy. Regardless of the information it is regarded as a powerful feature of Islamic finance, signifier have been strike by chief obstruction that might detect Islamic Bankss extra wantonnesss to execute. Islamic banking pattern in mudarabah have non been good. On the other manus, the reimbursement of practising two-tier mudarabah signifier outweighs its defect. Muslim Bankss must non neglect to detect this issue and maintain off from irresponsible pattern of delayed understanding. Shirkah understanding has invariably been experienced by Muslims ; accordingly present Islamic Bankss a appropriate signifier to prosecute in fiscal make-peace map.