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KSA عربي
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The amounts kept by depositors in savings accounts at Islamic financial institutions are based on the Mudarabah contract. The depositor acts as Rab ul Maal and the Islamic financial institution acts as Mudarib. In a Mudarabah contract, the Rab ul Maal is exposed to the risk on both the principal amount and the expected profit.
Islamic financial institutions maintain different reserves to provide protection and safeguards for depositors against adverse situations.
Most depositors are risk-averse and prefer not to invest in avenues where the probability of risk is high. To maintain stability in returns and ensure protection of the principal amount, the PER and IRR reserves are managed by the Islamic financial institutions.
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- PER: stands for Profit Equalization Reserves, which are maintained to ensure sustainable and smooth returns to depositors.
- IRR: stands for Investment Risk Reserves, which are maintained to protect the principal amount of the depositors.
The primary role of both reserves is to protect depositors from adverse situations and to stabilize the financial position and returns for the depositors.
However, the specific roles of each reserve are different. PER is used to mitigate fluctuating returns and ensure more equalized and stable returns to depositors. In the context of investment account holders, this amount is deducted from the gross profit.
IRR, also known as solvency reserves or reserves for meeting losses of the depositor’s capital, is used to absorb losses before they impact the underlying capital of the depositors or investment account holders. The deductions for this reserve are made from the investment income.
It is permissible from a Shariah perspective to maintain such reserves for the protection of the depositors’ principal amount and to stabilize and strengthen the return mechanism for investment account holders.
These clauses are often included in the articles of association or mutually agreed upon by the partners.
Yes, these clauses are included in the Saving Account opening terms and conditions and are explicitly explained to the account holder.
However, the basis of both Investment and Saving accounts is the Mudarabah contract, under which the Mudarib cannot guarantee returns or protection of the capital under any circumstances.
In the event of unstable profit returns or losses affecting the principal amount, if sufficient reserves are available, the investment and saving account holders may be compensated from these reserves. Otherwise, the account holders bear the loss or receive a reduced portion of the profit.
PER is usually taken from the gross income while the IRR is taken from the investment income. The periodic contribution to these reserves should not be greater than the two percent of net income.
50 percent of the Reserve’s funds will be disclosed as a reserve while the remaining 50 percent will be disclosed as the liability in the bank balance sheet.
The reserved amount may be invested in the Shariah-Compliant avenues, such as Sukuk and similar instruments to Sukuk. Returns/profit earned from such investment will be credited in the reserved.
The bank may fully or partially utilize the reserve’s for the equalization of the return if the return is less than the expected return.
According to the saving account terms and conditions, the depositors allow the Islamic financial institution to deduct such reserves from the depositor’s gross income or net income.
In case no loss is incurred, the bank, at its own discretion and with approval from the Shariah Board, may allocate the accumulated funds to another pool.
The depositors do not have any right to claim these reserves because, with their consent, they agreed to the allocation and utilization of the reserves.
In the saving and investment account, the Islamic financial institution acts as a Mudarib, the active partner, and the saving account holders are the Rab-ul-Maal, acting as the sleeping partner.
Both parties agree, while entering into the contract, on the weightages and the profit ratio of the returns.
In case there is a lower return than the expected return, the Islamic financial institution, at its sole discretion, may voluntarily relinquish its ratio and allocate it for the depositors. So, in this context, the expected ratio of return may be fulfilled.
Read more about: Why Interest Is Haram in Islam?
References:
1- https://www.abl.com/islamic/per-and-irr-policy/
2- https://www.meezanbank.com/wp-content/themes/mbl/downloads/accountOpening.pdf
3- https://www.sbp.org.pk/ibd/2012/C3-Annex.pdf
4- Ansari, J. A. (2010). Book Review of: Meezan Bank’s Guide to Islamic Banking by Muhammad Imran Ashraf Usmani. Business Review, 5(1), 171-174.
Disclamer:
This post is for educational purposes only, and does not constitute investment advice or a solicitation to take any financial action. It should not be relied upon when making investment or financing decisions.
