By: Basheer Oshodi Boshodi@financialfreedomng.com
- Agency contract is unique because it can be used for several financial structures. In an agency contract, the financial institution manages the depositor’s fund and collects a fee.
- Commercial banks, use this contract when dealing with corporate that are knowledgeable about market volatility and would be happy to absorb arising shocks.
- Used by non-interest financial institutions in risk asset deals.
The non-interest finance business proposition is hinged on duly established contracts where terms are clearly stated. Deposit takes the form of interest free loan contract (qardh), partnership contract (mudarabah) and agency contract (wakala) contract. Agency contract is unique because it can be used for several financial structures. Practically, it serves almost the same purpose as partnership contract which is used by fund managers and for termed deposit in non-interest banks. In an agency contract, the financial institution manages the depositor’s fund and collects a fee. The fee may be a percentage of the amount invested or a flat sum. The financial institution may also engage in a second contract that may allow bonus where the investment performs above a certain benchmark. If funds are invested in equities and market volatility leads to a fall of the performance of the portfolio, the financial institution would still get its fees. More so, where the investment performs well, fees will still be paid.
In commercial banks, this contract is mainly used when dealing with corporates that are knowledgeable about market volatility and would be happy to absorb such shocks that may come. Some high net-worth individuals may also be willing to invest using this model.
Assuming a non-interest financial institution wants to embark on agro-commodity trade that would require N2bn. The institution may mobilise this fund under a restricted-investment with minimum investment of N100m. If expected return is N500m in 180 days, it means the financial institution will take out its mutually agreed fee from the profit and share the profits to investors in proposition of the capital they invested. Thus, they get back there N2bn plus N500m less agency fee. If there is a loss and no profit was made, then the investors will have nothing to share but the financial institution will still get its fee, unlike a partnership contract where the profit is to be shared between the financial institution and client who owns the fund.
Wakala contract is also used by non-interest financial institutions in risk asset deals. The bank simply appoints the customer that wants a particular asset as the agent to go and identify the specific asset and get the necessary invoice. In such agency, the financial institution usually does not pay the customer nor give cash to the agent/customer. Instead, the bank will pay the supplier directly. If the financial institution gives money to the agent/customer, then, the extra payment made on money given is termed as interest which is not acceptable.
There are other cases where the financial institution wants to fund a third party and identifies an agent (wakeel) to act on its behalf. Where this agent is not the beneficiary of the end product but specifically act on behalf of the financial institution, such transaction would be compliant. Assuming there is an oil and gas transaction and the non-interest financial institution does not have expertise in such a deal. It may appoint an agent who understands the transactional dynamics to monitor the supplies, ensure the required quality and quantity is delivered in agreed time. Typically, non-interest institutions are expected to pay the supplier directly but may sometimes entrust such capital in the hands of the agent. In non-interest banking windows or commercial banks that offer non-interest banking departments, such a window may even appoint the energy unit as its agent. It is however best practice for such non-interest banking window to pay the suppliers directly.
For micro, small and medium enterprises (MSME), the non-interest institution may also appoint the cooperative as agent to help buy or lease assets to its members, thus acting on behalf of the financial institution. The agent in this case cannot disburse cash to members except in the case of interest-free loan (qardh).
Agency or wakala contract is one of the most dynamic contract in the non-interest finance model and such may even be considered by non-interest financial institutions to access the apex bank’s intervention funds. Multilateral banks also use the agency structure to disburse funds through local financial institutions to the local market or users of fund.