Chapter 10: Deposits in LARIBA Banks
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.
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.
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.
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.