Common structuresi Consumer finance
Islamic banks provide a comprehensive range of core consumer banking services similar to those offered by their conventional counterparts. In particular:
- Islamic banks accept deposits into current accounts for safe custody of their funds, as well as convenience and use. A bank may levy a charge for providing this service. These deposits are not subject to any conditions on drawing or depositing. The bank may use such deposits at its own risk and responsibility in respect of profit or loss.
- Savings accounts are operated similarly to current accounts. However, customers may be restricted as to the frequency with which they can withdraw their funds, or may be required to give notice to the bank and observe a notice period prior to the withdrawal. The bank, at its discretion, may reward its customers with a profit-share generated from their deposits at the end of its financial year.
- Islamic banks open investment accounts into which they accept deposits from customers seeking investment opportunities for their funds using the mudarabah contract. Deposits are held for a specified period. While the profits generated by the bank from the investment of the funds are shared between both the bank and the customer, according to a predetermined ratio, any losses must be borne by the customer, unless the loss was attributed to any fault by the bank.
- Islamic banks are unlikely to give an overdraft facility to their customers since they will not charge interest for such a service. Instead, the bank may give a qard hasan to customers in cases of hardship to enable them to meet certain obligations.
- To provide trade finance facilities, Islamic banks use either a conventional letter of credit or the murabahah contract. In practice, Islamic banks tend to open a letter of credit only for customers who have an equivalent credit balance with the bank and in return for a fee. An Islamic bank is likely to use the murabahah contract for trade financing where a customer does not have adequate credit with the bank. As mentioned, under a murabahah contract, the bank earns its return from the markup profit.
For the acquisition of completed properties an Islamic bank will generally provide funding by using the murabahah structure. However, for properties under construction, banks generally use the istisnah and forward ijarah structure.
For a murabahah financing the bank will acquire title to the asset from a third party and then transfer title to the customer (subject to a mortgage over land or a flat, etc.).
Under an ijarah financing, once the asset is completed the title will first pass to the customer and then (following entry into the ijarah financing) pass to the bank. Once the lease term is completed, the title should revert to the customer (assuming that the customer has complied with its obligations under the ijarah).iii Insurance
Participants jointly donate funds (on a tabarru' basis) to a pool for the purpose of providing mutual indemnity and protection to the participants exposed to defined risks under the takaful policy. The takaful contract is a combination of, on one hand, tabarru' (donation) and dhaman (indemnity) contracts between the individual insured and the pool of insured (policyholders) as represented by the takaful and, on the other hand, agency (wakalah) or profit-sharing (mudarabah) contracts between the insured and the takaful operator.iv Project finance
Many investors get together to become shareholders in large financial projects through the mechanism of the mudarabah. The Islamic bank's role in these funds is to act as the mudarib and to use these funds to finance a large project. This mudarabah fund can be utilised by the bank in conducting its business using any of the Islamic contracts, such as murabahah, ijarah, salam or istisnah.v Asset finance
Islamic banks finance acquisitions of assets by using the ijarah contract and the ijarah wa iqtina for longer-term assets. This technique is particularly popular for vessel financing by Islamic banks. The title to the asset will pass from the customer to the bank. The asset will be leased back to the customer for the term of the lease. At the end of the lease period, the title to the asset will revert to the customer.vi Investment funds
The Islamic structure used for a fund will depend on the underlying objectives of the fund. Fixed-income funds usually invest in murabahah (commonly commodity murabahah), sukuk and ijarah, with the investors investing their funds with mudarib using a mudarabah or wakalah contract (which governs the relationship between the investors and the mudarib). The ijarah fund structure is favoured as it can generate higher returns.
Legislation establishing a general corporate income tax regime is currently in force in the UAE. The regime is, however, only applicable to companies active in the hydrocarbon industry and branches of foreign banks operating in the wider UAE. Under the current legislation, there is no requirement for withholding or deducting for or on account of UAE taxation in respect of payments of accrued return or principal on investments.
The Constitution of the UAE specifically reserves to the federal government of the UAE the right to raise taxes (such as VAT) on a federal basis for the purposes of funding its budget. It is not clear how or if such taxes will affect Islamic finance agreements or institutions. This will only become clear once the relevant laws are passed.