Non-Interest Banking – Frequently Asked Questions
Non-Interest banking operates on defining principles such as: interest prohibition in debt and exchange contracts; the prohibition of uncertainty or speculative behavior in business transactions; the prohibition of any form of gambling. It also prohibits funding of unethical concerns such as, alcohol, tobacco, ammunition manufacturing and adult entertainment institutions; just to mention a few.
Non-Interest Banks engage in partnership contracts, trading contracts, leasing contracts, and other financial services that conform to Islamic commercial jurisprudence.
The major difference between NIB and conventional banking is in the definition of money. In conventional economics, money is often defined as a store of wealth, a means of exchange and a commodity, which can freely be rented, bought or sold for a gain in form of interest payments.
NIB principles consider money as only a medium of exchange between contracting parties as it has no intrinsic value and cannot be a means of storing wealth or be considered a commodity. Non-Interest banking deals in tangible assets which are bought, sold or leased.
Interest is when ‘money’ earns or receives ‘money’ without counter value. It is the additional amount a client pays a creditor over a loan borrowed. When money is earned or received on money of the same denomination, i.e. in a loan, certain forms of monetary exchange or a claim after sales transaction, earning represents the interest paid or received on these credit transactions.
The rules above do not apply when an individual sells an asset and makes a margin or a profit from such trading activities because such are not currencies.
Yes, a customer can earn returns on NIB deposits depending on the underlying contract applied for the deposits that are lodged in the bank. Popular opinion allows the use of interest-free loan for transactional accounts such as current and savings account.
The depositor is the lender while the bank is the borrower, thus the bank returns the exact amount to the depositor on demand. However, if the underlying contract is not a loan, returns can be earned using any of the partnership contracts which grant customers the opportunity to earn varied or fixed profits.
Non-Interest banking uses various modes of contracts such as partnership, lease and sales to meet customer’s financing needs.
For a customer dealing in trading, Sterling Alternative Finance may opt for the option of ‘purchase and resale at a markup’; while for other customers the option may be a lease arrangement where they wish to benefit from the use of assets such as real estate, machineries, equipment, generators, vehicles etc. without full payment for ownership.
A customer cannot get a predetermined profit on a deposit; rather, profits are shared according to a pre-agreed ratio between Sterling Alternative Finance and the customer. In restricted deposit accounts whereby a customer’s transaction is matched directly with a particular transaction, the bank may offer a predetermine profit rate from inception.
This is, however, dependent on the kind of contract used in financing the business transaction for example a sales transaction where cost is fixed and markup is fixed.
It is permissible to benchmark markup rates to those of conventional banks. This way, non-interest banks remain within competitive and profitable margins of the financial market. Practically, determination of markup would be a strategic decision for the Non-Interest bank with recognition of financial market conditions at any point in time.
Profit rates received by depositors are a function of profit sharing ratios between the customer and the bank duly agreed upon at the initiation of the investment contract. Profit determination is dependent on the performance of the particular instrument(s) or underlying contract(s) the bank invests the funds in. For example: 10 customers deposit a total of N1,000,000.00 and the bank buys goods worth same amount for a business woman using a cost plus markup contract on the agreement that she will buy the goods back from the bank at N1,200,000.00. The N200,000.00 margin can be equated to 20% profit on the N1,000,000.00. If the sharing formula between the bank and the depositors is 40:60, it means the bank will have N80,000.00 while the depositors will have N120,000.00 distributed to them in the proportion of their capital. This N120, 000.00 constitute 12% of the N1,000,000.00 the depositors kept with the bank for investment purpose. In order to ensure more or less consistent profits, regulatory bodies have recommended the use of profit equalization reserves and Investment risk reserves in order to provide depositors to with a more consistent profit to cover fluctuations in profits earned from various transactions.