Last article we talked about various deposit products and Al-Mudharabah General Investment Account (MGIA), the popular equivalent Shariah version of the conventional fixed deposit. Unlike conventional fixed deposits where interest rates are fixed on placement of deposits, profits for MGIA are declared on actual profit made on a monthly basis. In addition, they shall be distributed based on an agreed profit-sharing ratio between the customer and the bank, determined prior to the placement of deposits. An important question that arises from this is how the bank shares its profits with its customers.

We believe that since there has not been any article published pertaining to this topic, we will take this opportunity to educate our customers and especially potential users of Islamic banking services. Here, we will demonstrate and highlight two (2) common profit distribution methods adopted by Islamic banks in Malaysia. This subject is quite technical but we will try to explain in the simplest way.

The two (2) methods on profit distribution commonly used here in Malaysia are:-

Weightage Method (WM) – for this method, the bank will use various ratios known as the Weighted Average Ratio (WAR) for each deposit placement tenure (e.g. 3, 6, 9 months and so on) to represent the importance of one deposit tenure in comparison with another, e.g. a 12-month deposit is considered much more stable for the operation of an Islamic bank when compared to a 1-month deposit. If a customer places a deposit for a 1-month tenure, the bank needs to monitor the deposit movement closely as it does not have assurance that the 1-month deposit will not be withdrawn on maturity compared to a 12-month deposit tenure. Thus, to ensure fairness in terms of profit distribution, depositors who place funds under a longer deposit tenure should be paid higher profits compared to those who place under a shorter tenure. Due to this, higher WAR will be assigned to a longer deposit tenure. As an example, the profit distribution WAR (column iii) is as shown in Table 1 below:-

To understand Table 1, let’s pick an 18-month deposit tenure as an example.

Under column (v) and row total, total profit to be distributed between the customer and the bank is, say, RM5,800 and the agreed profit-sharing ratio (PSR) is 50% to the customer and 50% to the bank or 50:50 as normally written in the deposit placement receipt.

Although the monthly average balance (column ii) for 18 months is RM100,000, for profit distribution purposes, the balance is assumed as RM110,000 (RM100,000 x WAR of 1.10). Incidentally, the monthly average balance is calculated on a total daily balance over no. of days in the month.

To determine the gross profit in column (v), take the balance in column (iv), divide it by the total of column (iv) times profit of RM5,800 (in column v) and that will entitle all customers under the  18-month tenure to a gross profit of RM 708.89.

Gross profit percentages in column (vi) are calculated by dividing the profits of RM708.89 over the original deposit amount in column (ii) times 100 times 365 days in a year and divide by no. of days in the month, say 31 days. That will give us a percentage of 8.35.

Customers’ profit is calculated by taking the gross profit amount of RM708.89, then times that with the profit-sharing ratio of 50% to give a return of RM354.44 (4.17%). The similar formula mentioned earlier is used to calculate the effective return to the customer.

The Profit-Sharing Ratio Method is the simplest method of profit distribution. The bank will assign different profit-sharing ratios for the various deposit tenures. For example, for the same 18-month tenure, the profit-sharing ratio offered may be, say, 80:20 in favour of depositors.

As mentioned in our earlier article, there is no penalty imposed for premature withdrawal for MGIA. Based on the earlier example, if a 24-month deposit placement is prematurely withdrawn on the 20th month, profits due to the deposits shall be RM354.44 per month for a complete 20 months.

Asian Finance Bhd
4th May 2008