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Islamic Deposits: Its benefit and drawbacks

One important aspect of Islamic Banking is the acquisition of Islamic funds, which is mainly obtained from 2 main sources, just like in conventional banks. The sources are the shareholders fund and that of the depositors.

Deposits are taken based on 2 main contracts: Wadiah or Amanah or Trust and Mudharabah or Profit Sharing. There is however, another contract that is applicable which is the Qardhul Hassan or in local context, benevolent fund.

There are 3 main categories of deposits of Islamic Banks, i.e..

1. Demand Deposits like savings and current account are normally placed under trust in Islamic Banks. These types of deposits can be withdrawn on demand and the withdrawal of which can be conducted by proper authorization through cheques, automated machines, over the counter provided proper written agreement or aqad is signed.

Demand Deposits are more commonly placed under the contract of Wadiah, or trust. The Islamic Banks guarantee the return of the principal sum. The principal is not used for investments by the bank unless authorization from the depositors is acquired. Since the deposit is placed under trust, Islamic Banks may not give any returns on their deposits but when they do, it is purely based on the concept of hibah or gift. Most Islamic Banks are now more innovative in their product offerings and a number of demand deposits are now structured under the contract of Mudharabah.

2. General Investment Deposits are investments with an expected maturity and expected rate of return. General investment deposits are usually placed under the Mudharabah contract where depositors and the Islamic Banks agree at the time of placement, a profit sharing ratio of the expected returns of the depositors' investments.

3. Specific Investment Deposits are more specific and the size of investment is normally bigger. The projects into which the Islamic Banks will undertake are usually identified. Investments can also be in money market instruments.

The rate of returns on deposits largely depends on the returns on the investments made by the Islamic Banks themselves. Unlike conventional banking whereby depositors will get a fixed return regardless of how the banks perform, depositors in Islamic Banking will earn higher returns when the returns on the investments made by the Islamic Banks are higher, because of the profit sharing ratio and vice versa.

The other advantage is the ability of the depositors to cash their deposits on demand even before the maturity of the contract. A very notable advantage is that the Islamic Banks will pay the returns on the depositors' investment for the actual period the investment is made with the bank as compared to conventional banks which normally pay half the agreed fixed rate.

One major drawback in Islamic Banking which depositors are still not accustomed to is the application of profit sharing ratios in all deposits under the contract of Mudharabah. Since returns on investment made by the bank can only be quantified after the said profit has been identified, Islamic Banks will not be able to translate the profit sharing ratio at the time the deposits are placed with the bank. Thus, Islamic banks will use the profit rates of the previous months as 'indicative rates'. A point to note is that this indicative rate will only act as a guide to gauge the kind of returns depositors will get for their investment which is by no means 'the' rate for the following months. The returns on the deposits for the following months will be higher or lower and will fluctuate depending on the actual returns of investments obtained by the Islamic Banks. Depositors are advised to look into the profit rate trend of Islamic Banks to ascertain how the banks are fairing in terms of returns.
 

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