The process of depositing the money with the LARIBA bank; i.e. entrusting
the bank with it not as an Amana (trust or in safe deposit boxes) but
as an ivestment with the LARIBA bank appointed as a Mudarib (money manager).
This deposit is called Mudaraba deposits.
The Mudaraba contract is an agreement between the owner of the capital
and the money manager Mudarib (in this case the LARIBA bank).
The use of capital is done through the work of the Mudarib or its designated
business person.
The two entities agree on a distribution formula of the profits of
the venture in case the venture is profitable.
If there is no profit and no loss, then the owner of capital would
recover his/her capital in full.
If there is a loss, then the owner of capital incurs all the losses
without liability to the Mudarib.
The Mudarib loses the value of time and effort put towards investing
the capital.
To encourage businessmen to assume the risk, the Mudaraba agreement
may define a minimum wage for the Mudarib to encourage him/her to undertake
the responsibility.
Of course, the underlying assumption is that the Mudarib performs with
due diligence and according to the defined articles of the contract.
In summary, the participants of the Mudaraba deposit transaction are:
The Depositor: owner of capital
The Business person: owner of the idea or business experience; Aamil
(worker or employed).
The LARIBA bank as an intermediary (money manager) between both sides
above and as a representative of the depositor for dispensing the funds.
DEPOSITING THE FUND IN THE LARIBA BANK
Each deposit is (theoretically) characterized as a personal deposit
owned by the depositor.
The title of the deposit is not transferred to the bank.
That means that the LARIBA bank can not lend it without the permission
of the owner as in the case of RIBA banks.
On the other hand, in reality, the deposits are not kept segregated
from one another except by the variation of the projected duration of
the investment and the level of risk accepted by the owner of the deposit.
The LARIBA bank would pool these deposits in a number of pools by the
permission and consent of the depositors.
Each depositor would own a certain fraction of the pool which is proportional
to the deposit.
The LARIBA bank would then act as an investment banker representative
(wakeel) to dispense the funds from the pool for investment purposes.
In order to motivate the depositors to deposit their money with the
RIBA bank, these banks offer the following motivating factors:
1. Customer deposits are guaranteed by the bank (as long as the bank
is viable), and in the U.S.>A.
deposits are insured by a federal government insurance agency, the
Federal Deposit Insurance Corporation, FDIC up to $100,000.
2. The income earned by the depositor on his/her deposit is paid in
the form of fixed and determined interest rate.
3. The depositor is able to withdraw his/her money at the end of the
period or at any time.
The challenge faced by the pioneers of LARIBA banking in a RIBA banking
world is to try to come up with creative ways and means to be able to
compete with the RIBA banks without violating the Sharia (Islamic Jurisprudence).
1. Insuring the Deposits of the LARIBA Bank
The LARIBA bank is allowed by Sharia point of view to guarantee the
principal and promise to return the deposits of its depositors in its
totality.
In case the project financed is not profitable, the Sharia stipulates
that the worker Aamil (businessman) who is in charge of investing the
funds can not guarantee the principal.
So, as long as the bank was not participating in the active investing
of the funds, the bank can then guarantee the principal.
So, if the bank acts as an intermediary between the depositors (pool
owner) and the workers (businessmen) Aamil, the bank is actually a third
party which can volunteer its guarantee to the depositors on their deposits.
2. Income on Deposits (Interest in RIBA banks and Return on Investment
in LARIBA banks).
The LARIBA bank would pay a certain percentage of its profits to the
depositors (owners of the funds in the pool of capital).
Here comes the possibility of project failure or losses.
This possibility is minimized to a very low level through diversification
by sector (both demography and business activity) and through dispersion
to avoid concentration of investment risk with a particular entity.
It should be noted here that the return on deposits should not be less
than the interest paid by the RIBA banks.
Otherwise, the depositors will fly away from the LARIBA banks to the
RIBA bank.
In fact, based on the prior operating experience of the LARIBA bank
and the opportunity expected rate of return as guided by the competition
(RIBA banks), the LARIBA bank should give its customers and depositors
an idea about the expected return on their deposits without guarantees.
There are other risks in addition to the major risk discussed above
regarding the failure of the project.
These are:
the risk of slower than expected economic activity, and
the risk of not investing the deposits immediately after they have been
deposited.
That is why, it may be recommended to indicate to the depositors that
a time lag may occur between the time their deposits are made and the
time these deposits get invested.
This period can be as long as two months.
However, the LARIBA bank should commit to doing all that it can to
redeploy the deposits in the economy as soon as deposited.
3. Ability of the Time Depositors to Cash Their Deposits on Demand
The difficulty here is in the ability of the LARIBA bank to keep enough
liquidity to pay the premature demand of the term depositors while most
of the deposits are invested in medium and long term projects.
This issue is the most important issue regarding the credibility of
any bank.
In fact, if any bank fails to meet the demands of its depositors, the
damage done will be serious, irreversible and may mean the closure of
such bank.
In the RIBA banking system, they developed a lender of last resort;
i.e. the Central Bank.
But because the LARIBA system does not have a lender of last resort,
it is important for the LARIBA bank, at least for now, to employ a chief
financial officer who would develop a model that is capable of projecting
the cash flow of the LARIBA bank and in the same time project the different
maturities of the different investments authorized by the bank.
The following should be taken in consideration:
3.1. During the start-up of the bank (the first 10 years), the LARIBA
bank should finance projects with maturities ranging between 3 months
and 3 years in the first 2 years of operation, 3 months and 5 years
in the following 3 years and then 3 months and 7 years in the following
5 years.
This way, cash will always be available for unexpected withdrawals
and /or reinvestment.
3.2. The shareholders of the LARIBA bank, should stand ready to meet
any run on the bank deposits.
This in itself will make the shareholders, who are in the same time
the managing directors of the LARIBA bank, careful about reviewing the
assets/liabilities management and cash flow projections by the chief
financial officer.
3.3. The commercial entities and individuals who seek financing from
the LARIBA bank should be required to keep a balance on deposit as an
investment with the LARIBA bank, with the bank having the right to offset
it against the financing facility (loan in RIBA banks).
This investment deposit can be built up over time.
3.4. The LARIBA bank executive committee should keep liquidity reserves
to meet expected demands on deposits as well as additional reserves
for unexpected demands.
The level of such reserves can be obtained from operating experience
of the LARIBA bank.
But the most important factor here is the close and continual contacts
with every depositor, investor and entrepreneur.
If these contacts are developed to reach the level of a big family,
then projections about the demands of the members of the family can
be assessed in advance without any unpleasant surprises.
3.5 As the LARIBA banking system develops into numerous branches and
outlets, they can develop amongst themselves, a central banking authority
and a deposit protection authority to become the "lender of last
resort" ( actually supplier of liquidity in case a run on a member
LARIBA bank is experienced).
TYPES OF DEPOSITS IN THE LARIBA BANK
In order to organize the deposits/investments (Assets/Liability) management
of the LARIBA bank, it may prove useful, based on our experience, to
offer the investors the following three categories of deposits to meet
the competition offered by RIBA banks:
1. Demand Deposits-Amana
These are deposits kept with the LARIBA bank for safekeeping.
The money can be withdrawn on demand.
Because these deposits are looked upon from a jurisprudence, Sharia,
point of view as an Amana(trust), then the money cannot be invested.
A fee can be charged by the LARIBA bank for the service.
The level of the fee is left for the LARIBA bank management to decide
based upon specific condition.
The withdrawal can be conducted by proper authorization through check
writing and/or telephone(wire) authorization providing that proper written
agreements are signed.
In LARIBA banking, all relationships should be formalized in the form
of a written contract, Aqd, as prescribed and required by the Holy Qur'an.
2. Time Deposits
To compete with the certificate of deposits (CD's) service offered
by RIBA banks, the LARIBA bank can offer the prospective depositors
various portfolios, Mahfaza of investments with an expected maturity
and expected rate of return.
This way the LARIBA bank financial manager can better plan and organize
his/her total portfolio.
Premature demands for withdrawals can be met.
However, all administrative and legal costs involved in the adjustments
of the portfolio as well as the cost of raising of the matching liquidity
to meet the demand should be charged.
In case of RIBA banks, a penalty is charged.
In case of LARIBA banks actual costs should be applied.
A detailed outline of the costs should be made clear to the depositors
at the time of making such deposits.
3. Investments
To compete with the Money Market Account type of deposits offered by
the RIBA bank, the LARIBA bank can offer open ended deposits.
However, it is important to ask the investor to indicate in writing
their expectations for the need of such deposits; i.e. time horizon
of such an investment.
In addition, the investment agreement should stipulate that the investor
should give the LARIBA bank enough time to meet their demand on their
deposits.
This can be two weeks to two months depending on the assets of the
LARIBA bank, the maturity and operating experience of its operations
and most importantly the size of the investment.
4. Savings
These accounts can be looked upon in the same way as investment type
deposits.
However, in this case the objective of the savings account holder should
be clearly delineated.
For example, if it is opened to save for retirement, savings for future
monthly income, saving for purchase of a home, saving for children education,
saving for pilgrimage Haj, or saving for spending in the cause of God.
The definition of the objectives of the savings will give the chief
financial officer of the LARIBA bank an estimate of the cash flow projections
of the bank assets and liabilities.
This will minimize the potential negative impact of a severe run on
the LARIBA bank and will make it easier on the budgeting process regarding
the kinds and investment duration of the investments financed by the
LARIBA bank.
As the picture of the different types of deposits become better defined,
the chief financial officer of the LARIBA bank would be better equipped
to budget and manage the funds of the bank for the other side of the
bank activities and that is: investing of the bank deposits.
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