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Did you know that about 1.9 billion people in the world have faiths related to finances that keep them from accruing interest?
With increased awareness about ethical investment globally, many people are turning towards finances sharing a base with their values; hence, heightened interest has grown for Islamic banking.
Fixed deposits are one of the most popular investment instruments for stability seekers who prefer steady income. However, other than the rate of return, there is a crucial difference in choosing between conventional and Islamic fixed deposits. In this blog, we will review the indicators that differentiate an Islamic fixed deposit from a conventional deposit.
Fixed deposits are considered among the most stable types of investments in today's financial world.
They yield predictable returns with minimal risk, coming in a wide array of choices based on the different investment goals.
But when investing in conformation with Islamic principles, there lies a thin line of difference that needs to be understood between conventional fixed deposits and Islamic fixed deposits.
Both types of Fixed Deposits are designed to provide investors with secure and profitable opportunities, but they are based on different principles and practices.
The main differences between conventional and Islamic Fixed Deposits have been discussed in this blog to enable investors to make prudent choices that fit their financial and ethical goals.
Read more about: All You Need to Know About Islamic Saving Accounts (ISA)
A fixed deposit is a financial instrument provided by banks and Non-Bank Financial Companies, whereby investors can deposit any amount of money for a fixed tenure, which normally carries higher interest rates when compared with regular savings accounts.
The immediate attraction of a Fixed Deposit depends on predictability and stability (money deposited once and until maturity earns a guaranteed rate of return, thereby soothing the minds of investors).
A Fixed Deposit is interest-based, whereby the bank offers a predetermined interest rate for cash deposited over a specific period, with guarantees of return. The risks lie altogether with the bank, and early withdrawals may be liable to attract penalties.
i) Standard Fixed Deposits
This is depositing a sum for a fixed tenure, enabling reinvestment after maturity on receipt of a fixed return.
ii) Tax-saving Fixed Deposits
Typically, it offers a five-year lock-in period. The rebate is generally available on the principal invested booked under specified regulations.
iii) Flexi Fixed Deposits
It is linked to the savings account, allowing the investor flexibility in times of emergency to withdraw money yet earn an interest return.
The return on a conventional Fixed Deposit is pre-calculated and fixed in nature, hence the investor will be able to calculate how much he will earn right at the start.
Conventional FD interest rates vary by location, market conditions, and financial institution; however, they are generally stable over the deposit term.
In this type, the interest earned is not paid out at regular intervals but compounded and paid out at the end of the deposit tenure along with the principal amount. This helps investors to obtain the compounding effect that prefers those who don't require interest payouts at regular intervals.
Interest on such deposits is paid out periodically, that may be monthly, quarterly or yearly depending upon the case. Such a deposit can be placed by people desiring recurring income, such as retirees or people who desire another stream of receipts.
A sort of amalgamation between fixed deposit and savings or current account. Partial withdrawal of the remaining balance is allowed while interest is accruing at the fixed deposit rate. Thus, this provides flexibility for those at times needing access to capital.
This is a dedicated fixed deposit account to senior citizens that draws up interest at and above the current market rate for all fixed deposits. It assures added income to retirees and aids them in growing their savings at favorable interest rates.
Banks sometimes give fixed deposits with special tenures, usually for promotional periods, earning higher interest rates than normal. These do come in handy when you look to maximize returns within a given time space.
Instead of depositing a lump sum amount, here a specified amount is deposited every month. It would be apt for those who would like to make a corpus gradually but cannot invest a large amount at one go.
It is for those who wish to save in some foreign currency. This will also safeguard the saver against the fluctuating rates of exchange and finds its application in the case of an NRI or a person receiving income in some foreign currency.
Each of these caters to different financial goals, which range from long-term wealth creation to periodic income and tax savings.
Fixed tenure: Investors decide for what tenure they want to invest. It starts from a few months and goes up to several years.
Interest Rates: Fixed deposits are normally attractive in terms of interest rates, usually predetermined by the market.
Liquidity: Though the Fixed Deposits are for long-term investment, investors can withdraw the cash prematurely with generally a negligible penalty, hence liquid. It is considered a very low-risk investment. It guarantees a full return, no matter what the market conditions are.
It works on the Shariah principles basis, wherein the operation is linked to a profit-sharing model rather than interest-riba.
The return is completely at the discretion of the performance of the bank, and investments are strictly made in ethical, Shariah-compliant ventures only.
There is profit sharing between the bank and depositor with an element of risk-sharing. Islamic Fixed Deposits follow ethical finance, where the investor seeks a return without interest.
The investor invests in the form of capital; there is an entrepreneur bank. The profits would be shared in a pre-agreed profit-sharing ratio.
Under this type of structure, the investor mainly nominates a bank to act as an agent to invest his funds on his behalf in Shariah-compliant investments.
Returns are not guaranteed by the bank; however, it provides an indicative profit rate based on its anticipated performance.
The returns on Islamic Fixed deposits are not fixed; rather, they are based on the performance of Shariah-compliant ventures in which funds put by depositors are invested.
Islamic fixed deposit was an investment structure developed to be compatible with the principles of Shariah. These were essentially of the following kinds:
Mudarabah Deposit: It is a deposit on the basis of profit and loss sharing, whereby the bank invests depositors' funds available with it in Shariah-compliant ventures. The profits achieved would be distributed between the depositor and the bank in the predetermined ratio, and any losses that may arise are borne exclusively by the depositors.
Wakalah Deposit: This is when the bank acts as an agent by venturing into investment on behalf of the depositor. In most cases, the bank receives a pre-determined fee for its role, and profits derived are normally returned to the depositor with no returns guaranteed by the bank.
Murabaha Deposit: In this structure, the deposit is utilized by the bank in buying some goods and then selling them at a markup price. The profit generated on such sales is shared with the depositor. Unlike conventional interest, based on trade transactions and pre-determined profit.
Istisna Deposit: This is used for financing the production or construction of assets. The bank finances a manufacturing or construction project with the use of depositor funds. Once the project is completed and sold, it generates a profit to be shared with depositors.
Ijarah Deposit: The deposited amount is used by the bank to purchase assets for leasing purpose. The rental income generated from those assets is distributed as returns amongst depositors. This structure is ideal to be used for steady and stable streams of income, as the returns are derived from lease payments.
Qard Hassan Deposit: This is considered a form of benevolent loan where depositors invest nothing with expectations of returns. The bank may give depositors a non-obligatory gift, called Hibah in appreciation, although it does not have to do so. The system will further strengthen ethical savings and promote social welfare.
Profit-Sharing Model: It operates on the basis of a contract for profit sharing where returns will be a function of the bank's investment activity and not a predetermined interest rate, for example, Mudharabah.
Shariah Compliant: It invests in Shariah-compliant, ethical ventures, and avoids certain industries like alcohol, gaming, and riba-based financings.
Risk Sharing: The depositor shares investment risks and rewards with the bank, aligning with Islamic finance principles.
Variable Returns: Returns depend on actual profitability, so earnings returns could be higher or lower than those of traditional fixed deposits.
Withdrawal Terms: Penalties for early withdrawal are compliant with Shariah principles and may allow partial profit distribution.
The Conventional and Islamic Fixed Deposits have similarities exist, but conventional and Islamic fixed deposits run on totally different orientations.
Conventional fixed deposit accounts furnish interest earnings on the money that they have, while Islamic fixed deposits orient themselves around Shariah law that bans any form of interest transaction. Let's examine some key parallels and differences between these two:
Conventional Fixed Deposits: Here, the deposited amount earns interest. A specified rate at the time of depositing it decides the interest.
Islamic Fixed Deposits: It do not accrue interest in view of the fact that this is considered Riba and, therefore, prohibited under Islam. Income is accrued through profit-sharing arrangements or acceptable investments in Shariah-compliant undertakings.
Conventional Fixed Deposits: It mean that the banks and financial institutions can invest those funds in other valid investments, as may be forbidden in Islam, like gambling and alcohol.
Islamic Fixed Deposits: Investment in Islamic Fixed Deposits is strictly done in Shariah-compliant businesses, totally excluding those banned sectors like alcohol, gaming, and enterprises that deal in interest-based financing. These Fixed Deposits ensure that all returns come from Halal sources.
Conventional Fixed Deposits: In this type of deposit, the rate of interest is fixed right at the beginning, and hence, the investors are assured of a fixed return.
Islamic Fixed Deposits: Returns in Islamic Fixed Deposits are not pre-determined because the mechanism in respect of profit sharing depends on the actual performance of the underlying investment. Although the loss of principal amount is mostly bailed out, returns differ depending upon the profitability of certain ventures.
To investors who seek a trade-off between ethical investment and profitability, Islamic Fixed Deposits present a very alluring avenue. Following are a few reasons why people will opt for Islamic Fixed Deposits over conventional ones:
Ethical Compliance: Islamic Fixed Deposits allow investors to participate in undertakings that result in profit without compromising their faith and religious teachings.
Transparency and Justice: Profit-sharing in Islamic Fixed Deposits gives full justice and creates a sense of equity, as banks share risks and returns.
Social responsibility: Islamic Fixed Deposits ensure that no investment leads to industries that are considered harmful or unethical under the regimen of Islamic law.
Read more about: Is Islamic Banking Truly Halal?
Islamic fixed deposits are designed to be Halal-permissible under Islamic jurisprudence. The prohibition of Riba is often regarded as the epicentre of Islamic finance, and indeed, Islamic fixed deposits do try to fulfil this requirement by rejecting interest-based returns for either profit-sharing or agency-based agreements.
The main characteristics that make Islamic Fixed Deposits Halal are as follows:
Profit-Sharing Contracts: Mudarabah and Wakalah are a partnership- and agency-based models rather than those of lending for interest earnings.
Ethical Investment: Funds will be invested only in sectors approved under Shariah. Hence, returns must come only from permissible sources.
Conclusion
Understanding the difference between conventional and Islamic fixed deposits is important for informed financial decisions that are in line with one's personal values.
Conventional fixed deposits are designed for such types of investors who seek predictable income due to their return policies, which are stable and accrue interest. Islamic fixed deposits adhere to the Shariah precepts of profit-sharing and returns on ethical investments.
These have gained immense popularity worldwide, whether for religious reasons or as part of a socially responsible investment strategy.
Both conventional and Islamic Fixed Deposits have their comparative advantages, and one chooses which to use in line with the financial goals and ethical considerations.
Since more and more investors have started emphasizing socially responsible investing, the growth and appeal of Islamic Fixed Deposits are equally gaining ground, striking a harmonious balance between financial stability and moral integrity.
Reference:
Amin, H. (2016). An Overview of Islamic Banking and Finance. Oxford University Press.
Usmani, M.T. (2002). An Introduction to Islamic Finance. Kluwer Law International.
Central Bank of Malaysia. (2023). "Islamic Fixed Deposits: Guidelines and Returns." Retrieved from BNM.gov.my.
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
