Article Review: A Study on Conventional Banking, Islamic Banking and its Treatment of Profit and Loss
By Asst. Prof. Sameena Begum
Justice is the unique law of Islamic banking, a basic requirement for all sort of Islamic financing. Profits or loss are being shared with the investor and receiver rather than putting the entire burden to the entrepreneur. When the investor shares the profit, he will also has to bear the loss in accordance with proportional share. The principle of fairness and justice is important between two parties in order to have a fair distribution of output. Because of profit sharing, Islamic banks gives a higher rate of returns as oppose to conventional banking that gives a fixed return to the depositors without looking at the performance of banks.
Islamic banks are offers the contract of Mudarabah. In Mudarabah partnership, Rabbul Mal and Mudarib are to agree on the proportion of profit sharing between them with mutual consent. The profit ratio has to be decided at the time of contract. They can agree on equal sharing or different proportions. If profit goes beyond a particular ceiling, one party can have the larger amount of profit only with mutual consent. In case the profit is below or at the stipulated ceiling, it will be distributed according to the ratio agreed during contract. The financer has to bear everything in case of loss. In this Mudarabah contract, the financers are the only that bears any loss. However, if Mudarib also has contributed to the capital, he can also bear the loss with mutual consent.
Apart from Mudarabah, there is also Musharakah partnership. Which means company business. It is a partnership between two or more partners who contributes to the capital in a business. Partners may not contribute in the management but they direct with the follow up in order to maintain the effective and efficient progress of the business. The partner who works actively is called active partner and the partner who does not is called as sleeping partner. The active partner participates in profit and at the same time receives monthly salary. However, a loss must be shared exactly according to the ratio each partners invested. This is legal according to Imam Abu Hanifa and Imam Ahmad. With this contract, the bank pools deposits from investors and invests in company business or partnership. The profit gained from that investment is treated as income, not interest.
The profit and loss mechanism of Islamic banks are known as Mudarabah plus Musharakah model. The bank will create an investment pool with categories based on different tenors of deposits. Each depositors of the bank will deposit its funds in specific category of the investment pool. All members will have a Musharakah relationship with each other. The bank will then invests in the pool as depositors. Now all partners of the pool collectively enter Mudarabah contract. The pool acts as Rabbul Mal and the bank will be Mudarib. The bank undertakes the business with funds from the pool and the earned profit shared between the parties in an agreed ratio.
Murabahah is the last type of contract. In this type of transaction, the bank will deal with commodities. The customer will select the type of goods and the bank will purchase it on behalf of the customer then later sell the goods to him after mentioning the profit margin. The customer then will pay the bank in instalments. This type of transaction is free from interest and is acceptable by Shariah principles.