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Across the world, people can generally be categorized into two types based on their professional focus. The first group consists of entrepreneurs and business owners who possess the skills to manage and run their businesses, often using their own capital or sometimes borrowing funds.
The second group consists of individuals employed in institutions. While these people may have capital available for investment, they often lack the time or expertise to manage a business themselves.
For this second group, there is a significant opportunity to earn passive income by depositing their excess capital in financial institutions.
In recent years, Islamic financial institutions have become an attractive option for these individuals, offering Shariah-compliant savings and term deposit accounts that allow them to earn passive income in line with Islamic principles.
An Islamic savings account is a type of deposit offered by an Islamic financial institution based on the Mudarabah model. In a Mudarabah arrangement, one party provides the capital (Rab al-Mal),
while the other party provides the expertise and management (Mudarib). The profits generated from the investment are shared between the two parties according to a pre-agreed ratio (e.g., 70:30).
The terms and conditions of the Mudarabah agreement, including the profit-sharing ratio and other operational details, are outlined in the account agreement, ensuring compliance with Islamic principles.
Read more about: Your Basic Guide to Mudarbah
An Islamic savings account is based on the Mudarabah model, which includes specific terms and conditions that align with Shariah principles. These include the determination of the profit-sharing ratio, the mechanism for risk-bearing, and the overall process flow of the Mudarabah arrangement.
These key elements ensure that the Islamic savings account remains Shariah-compliant, adhering to Islamic ethical standards and prohibiting interest-based transactions.
In a conventional savings account, the bank receives deposits from clients on a
(Qard) basis and pays a fixed interest to the client, which constitutes Riba (usury).
There is a well-known principle in Islamic finance regarding the benefits derived from loans: "كل قرض جر نفعا فهو ربا" ("Every loan that generates a benefit is impermissible").
This means that any loan that results in a benefit, such as interest, is prohibited. In the conventional banking setup, all transactions are based on this model.
In contrast, an Islamic savings account operates on a partnership contract, most often based on the Mudarabah model, where one party provides the capital (Rab al-Mal) and the other party provides the expertise (Mudarib).
The profit and loss distribution is clearly predetermined in the contract, ensuring that both parties share the risk and reward according to the Mudaraba terms and conditions.
These fundamental differences make the Islamic savings account fundamentally distinct from the conventional savings account.
Read more about: Islamic View of Debt, Lending & Borrowing
For all types of deposits (e.g., Savings and Term Deposits), Islamic banks assign different weightages for the distribution of profit at the time of entering into a contract with the client.
These weightages are based on factors such as duration, amount/volume, and profit distribution frequency.
The weightages typically range from 0 to 1, with higher weightages approaching 1 and lower weightages closer to 0.
The profit is then distributed based on a pre-agreed ratio between the capital provider (Rab al-Mal) and the working partner (Mudarib), in accordance with the terms of the contract.
In Islamic Savings Accounts, Islamic banks avoid Riba by accepting deposits in a Shariah-compliant manner, typically on a Mudarabah basis, which is a partnership model rather than a loan.
Under Mudarabah, the bank acts as the Mudarib (manager), while the client is the Rab al-Mal (capital provider). The deposits are then invested in Shariah-compliant avenues that are free from any Riba (interest) and adhere to Islamic principles of ethical finance.
Islamic banks take several steps to ensure their investments are in line with Shariah principles:
Ensuring that all financial products are reviewed and approved for compliance with Islamic law.
Guaranteeing that the implementation of products and transactions adheres to Shariah guidelines throughout the process.
Conducting both internal and external audits to verify the Shariah compliance of the transactions.
Investing in firms that meet Shariah criteria, often through mutual funds or other investment vehicles that have been Shariah-compliant.
Gharar is an Arabic term that refers to a lack of information, which can lead to uncertainty in a transaction.
There are two types of uncertainty: excessive uncertainty (Gharar Kaseer) and minor uncertainty (Gharar Yaseer).
Gharar can arise in various aspects of a transaction, including the subject matter, price, and the terms of the transaction.
Excessive uncertainty can result in undue loss for one party and unfair gain for the other, which is contrary to the principles of fairness in Islamic finance.
In the context of Islamic Saving Accounts (ISAs), the presence of uncertainty can undermine the Shariah-compliance of the product.
If an Islamic bank fails to provide sufficient information to the client regarding the nature of the transaction, profit distribution ratio, risk-sharing mechanisms, and other critical terms and conditions,
it can lead to uncertainty and potentially violate the principles of transparency and fairness that underpin Islamic finance.
Read more about: What is Gharar & How to avoid it?
Here’s the refined version of your explanation:
Yes, there is a difference between individual and joint Islamic saving accounts. In an individual saving account, the profit is solely distributed to the account holder based on a pre-agreed profit-sharing ratio.
In a joint Islamic saving account, the profit distribution process is a bit more complex. The bank may also invest its own capital into a Mudarabah pool along with the depositors’ funds.
After the profit is accrued, it is first distributed between the bank and the Mudarabah pool based on their respective capital ratios.
Once the bank's share of the profit is deducted, the remaining profit within the Mudarabah pool is then distributed among the Mudarabah account holders according to their respective weightages or shares of the pool.
References:
(Malik et al., 2019; Usmani, 2015)
1-Malik, A., & Ullah, K. (2019). Introduction to takaful: Theory and practice. In Introduction to Takaful: Theory and Practice. doi: 10.1007/978-981-32-9016-7
2-Usmani, M. I. A. (2015). Maktaba Ma’ariful Quran (Quranic Studies Publishers). 342.
3- https://aaoifi.com/ss-47-rules-for-calculating-profit-in-financial-transactions/?lang=en
4- https://images.app.goo.gl/HXS42a2Byv8U3KK79
5- https://www.sbp.org.pk/IB/FAQ.asp
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
