Ethica Institute of Islamic Finance™

Is it permissible for a bank to set aside a certain percentage of investors’ money for the creation of a reserve fund as a remedy against investment risks?

It is permissible to create a fund out of the investors’ money in order to mitigate risks arising out of investments. The terms and conditions of the investors’ contribution, including the percentage to be deducted, are mentioned in the Mudarabah contract.

The money so contributed by each investor is in the form of a gift, such that the investor will have no further claims on that money. The reserve fund is managed by the bank (working partner) and will be used either when the investors’ money is at risk or when the return on investment is so low that it adversely affects the bank’s reputation. It is the bank’s responsibility, as working partner of the reserve fund, to invest the fund’s resources in suitable and profitable ventures.

All yields from such investments are added to the reserve fund. The bank continues to operate the fund for as long as it remains in operation. In the event of the bank’s winding up, the fund is dissolved and all proceeds are donated to charity.

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