What is Participation Banking? How Does It Work?
Participation banking is a type of banking activity where the participation banks collect funds with two different account types, i.e. current and participation accounts, and generate profits by purchasing or leasing in cash any goods, service or right requested by their customers in accordance with the principles of participation banking and selling or leasing them to their customers on installments or creating partnerships with the funds they collect.
The participation banks offer banking services such as hiring safe deposit boxes, remittance, negotiable instrument and bill collection and act as an intermediary for other transactions such as trading in FX, securities etc. in line with their own principles in addition to the fund collection and utilization services.
Due to their fundamental principle of interest-free banking, the participation banks share the revenues that they generate by collecting funds from their customers in line with the partnership principle with their customers at the pre-determined rates. The participation banks do not directly grant loans, but generate revenues over the collected funds by purchasing or leasing in cash any goods, rights and services requested by their customers and selling or leasing them to their customers in installments over a certain maturity.
Islamic Methods Used in Our Products
The participation account is a type of partnership. In this partnership, one of the parties provides capital while the other provides labor. The partnership created with the capital by one party and the labor by the other is called labor-capital partnership (community of interest - mudaraba).
In this partnership, the capital owner gives their capital to the operator to invest in through legal methods and the operator utilizes the collected funds and turn them into revenues. The business manager then shares the generated revenue with the capital owner at a pre-agreed rate. In participation banks, the individuals who deposit money to the participation accounts are capital owners while the participation banks are operators.
The bank acting as the operator runs the collected fund and shares the generated revenue with those individuals who deposit money to the participation accounts.
Credit Cards and İhtiyaç Card
The credit and İhtiyaç cards issued by the participation banks to divide payments into installments work on the principle that any goods or service is purchased by the participation bank in its name based on the permission given to the customers and then sold by the participation bank to the customer in installments over a maturity. Murabaha (usury) method is mostly used for those cards.
In this method, a permission is given to customer to purchase any goods to be purchased in installments on behalf of the participation bank and the customer gives an undertaking for not to purchase any goods and services violating the principle of interest-free banking and not to make payments for such goods and services while signing the card agreement.
The Private Pension System enables repayment of regular savings made during the active work life turned into long term investment in a lump sum together with the profit generated or as a regular salary during the retirement. This system works on the principle of permission to make investment.
In this system, savers are investors while the pension company is the investment agent. The individuals who want to save for a certain time, to invest those savings and to use them in lump sump or installments at a later age can start saving by depositing money to this system. The pension company invests the collected savings into non-interest paying investment instruments and charges a fund management fee and premium at a certain rate for the service it provides.
The participation pension companies invest the collected savings in non-interest paying investment instruments such as participation accounts opened before participation banks, securities suitable for participation index, gold and other precious metals, interest-free security mutual funds, sukuk (non-interest paying bonds) issued in Turkey and abroad, lease certificates etc.
Moreover, the government supports the private pension system in order to encourage savings and makes a direct money contribution of 25% of the savings made by the system participants provided that they remain within the system for a certain period of time. This contribution provided by the government is like a conditional gift offered by a third party. Since the saved money is invested in by the pension company based on the permission to make investment, it does not guarantee any revenue or principal amount guarantee.
The non-interest paying insurance system is known as the “takaful insurance”. Even though it has many types, the most common form also preferred in Turkey is the insurance system that works on donation-permission principle. The participating insured parties pay premiums on donation basis to an insurance pool against any loss in future and undertake each other’s losses.
This system is based on a permission relation between the insurance company and the insured. The insurance company acts as an agent in all necessary transactions and charges a service fee. It also invests the surplus amount in the insurance pool as mudarip (operator) and generates profits and earns premiums from those investments at a certain rate.
The money in the pool does not belong to the company. If any balance remains in the pool or the pool generates profits at the end of the year, the insurance company acting as the agent may repay the insured in line with the pre-agreed principles or donate the same to the charitable foundations.
Sukuk (Non-Interest Paying Bonds)
Sukuk is the name of the certificates issued with a share ownership and an equal value on any goods, interest or service or a certain/existing project or a private investment activity with a share ownership.
The types of sukuk among the investment certificates are as follows:
- Sukuk which allows being the owner of leased assets
- Sukuk which allows being the owner of the interests of assets
- Sukuk which allows being the owner of the service package
- Sukuk based on murabaha (usury), sukuk based on the agreement to exchange cash with standard goods (selem akdi)
- Sukuk based on the agreement between a contractor and a work owner to create a work against a consideration (istisna akdi), sukuk based on labor - capital / mudaraba (community of interest) partnership
- Sukuk based on capital / musharakah partnership
- Sukuk based on permission to make investment
- Sukuk based on muzara’a (agricultural partnership)
- Sukuk based on musakat (yard - garden partnership)
- Sukuk based on mugarase (partnership based on planting trees).
The most preferred type of sukuk is leasing sukuk, i.e. lease certificate. The lease certificate allows the source company to sell its assets for a certain period of time with a commitment to repurchase and lease them during the lease certificate issuance process.
The transaction steps are as follows:
- The source company sells / transfers their leasable assets to a special purpose vehicle (SPV).
- The company (SPV) purchasing the assets divides their values into equal parts and issues a certificate for each part bearing its value.
- This company then sells the related certificates to the investors.
- The collected sales price is paid to the source company.
- SPV leases these assets to the source company on behalf of the investors and pays the lease fees paid by the source company to the certificate owners based on their shares.
- The source company makes a promise to repurchase the related assets as the lessee at the end of a certain period.
- The sources company re-purchases the sold assets at the end of the relevant period (termination / redemption stage).
Mutual Funds are comprised of non-interest paying financial instruments such as sukuk (non-interest paying bonds), FX, gold and other precious metals approved by the advisory board for the investors who want to invest their savings into non-interest paying monetary and capital market instruments.
In this system, the company acting as the fund manager invests with the fund as the agent of the investors. The company charges a certain fee and premium for such service. The profit and loss of the fund belongs to the investors.