Seyyid Ebu Bekir: Understaning Participation Banking

With the increase in participation banking in Turkey, it is important to know how these participation banks work and how they are different from conventional banking.

We may look at the difference from both sides;assets and liablilities. On deposit side, the depositor in a conventional bank is lender and the bank is borrower. The customer deposits its money in the bank and the bank pays him the interest on the money lent to the bank. The bank is borrower and the customer is lender. On contrary, participation banks do not take loan from the customer and do not give interest. The contract between the bank and customer is mudaraba or partership ( that is why these banks are called participation banks). Under this contract, the bank is fund manager and the customer is fund provider. The customer gives the money to the bank for investment and the profit is distributed or shared between the bank and the customer as per the agreed ratio. This partnership ratio must be agreed at the time of contract. For example, the customer deposits 1,000 dollars in the bank with the profit sharing ratio of 40:60. Now, if the bank invests this 1,000 dollars and earns 1,00 dollar it shall be shared as per 40:60. The bank shall get 40 dollars and the customer shall get 60 dollars. If the profit is 2,00 dollars the bank shall get 80 dollars and the customer shall get 1,20 dollars. This means that the profit amount and profit rate is not fixed. There is no guarateed profit, instead only the actual profit shall be distribued to the depositor. And in case of loss, no profit shall be given to the customer.

However, the conventional banks guatantee the profit whehther there is profit or loss in the investment. This is the difference between a loan contract and a mudaraba ( partnership contract). In loan, the amout and interest is fixed and guaranteed. In mudaraba contract, the profit to the customer depends on the actual profit of the investment.

The difference on assets/ investment side shall be explained in a separate article.

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