Regulatory Framework for IBIs-Zahid

8/8/2019 Regulatory Framework for IBIs-Zahid

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1 | Regulatory Framework for Islamic Banking

Sheikh Zayed Islamic CentreUniversity of Karachi

Regulatory Framework for Islamic Banking

March 19, 2007

Zahid ur Rehman Khokher *Assistant Director

Islamic Banking DepartmentState Bank of Pakistan

The views expressed in this presentation are those of thepresenter and do not necessarily represent State Bank of Pakistan.


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Major International Regulatory Organizations for Islamic Finance

Major Challenges

Agenda

Current Regulatory Approach and Industry Status

Draft Instructions and Guidelines for Shariah Compliance in IBIs

SBP Shariah Compliance Framework for Islamic Banking Institutions

Brief History and Background


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Major Challenges






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Regulatory Framework

It is the due process of regulation surrounding a singleor set of areas that entails all of the relevantlegislative documents (acts, rules, regulations andguidelines etc.).

The regulatory framework should be effective inachieving measurable targets, efficient in terms of

cost and equitable in its effects.


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SBP as a Regulator of Banking Sector

Regulation and supervision of the financial systemto ensure its soundness and stability as well as toprotect the interests of depositors:

1. Comprehensive Legal Framework

2 . Prudential Regulations

3. Effective Monetary and Exchange Rate Policy

4. Efficient Supervisory Techniques5. Proper Accounting & Disclosure System


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Background-Legal ChangesDifference of Approach Between Pakistan and Other courtiers

Deposit side & Lending Side Relationship

Introduction of Profit & Loss sharing Deposits

Changes in BCO- provision of bank finance through PLS, mark-up inprices, leasing and hire purchase

Major amendments were made in corporate and financial regulatory setup on June 26, 1980

Permitting issuance of a new corporate financing instrument -PTCs

Establishment of Modaraba Companies under 1980 Ordinance

SBP Islamic EFS- Amendment in SBP Act 1956

Three Pronged Strategy-IB Subsidiaries: a new clause in section 23(1)(aa)of BCO was added in 2002

New Draft Banking Ac t- New Chapter, SBP Shariah Board, Relationshipbetween client and IBI


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Reasons for Failure of Previous EffortsAbsence of Shariah compliance mechanism in financial institutions.Some examples

Non-availability of Shariah compliant government securities

Ineffective enforcement of contracts and inefficient system for earlyrecovery

Lack of continued R&DInadequate training to the staff of SBP and Commercial banks

Disoriented education system devoid of Islamic principles. (Currentinitiatives)

Lack of public awareness about Islamic banking

Weak Political resolve of successive governments for Islamization ofeconomy


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Major Challenges






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After Two Decades

1999 Shariah Appellate Bench hearing-views

Commission for Transformation of Financial System

Change in Approach

Introduce, promote and implement Islamic Banking inPakistan as a parallel banking system comparable and compatible to conventional banking

system in terms of functionality & profitability Shariah compliant Provide a level playing field to Islamic Banking in

Regulations, Instruments and Taxation


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10 | Regulatory Framework f or Islamic Banking

Current Regulatory Approach

Not a Legal Issue but a Change Management Issue

Model Agreements vs. Standard Agreements

Essentials of Islamic Modes (But not limited)

Shariah Advisor

In the long run let people vo te thr ou gh their wallets


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11 | Regulatory Framework f or Islamic Banking

Current Status Of Industry

Sept 2003 One full fledge bank and one conventional bankwith one stand alone Islamic banking branch

Currently five full fledge Islamic banks and thirteenconventional banks with Islamic Branches.

Islamic banking is available through more than 15 0 branches in 2 4 cities of all four provinces of Pakistan. Meezan Bank, with 62 branches in 19 cities. Al Baraka Islamic Bank with 11 branches in 5 cities. Dubai Islamic 10 branch and Bank Islami 10 branches 12 Conventional banks (MCB, HBL, Bank of Khyber,

Soneri, Bank Al-falah, Bank Al Habib, Habib MetropolitanBank, Standard Chartered Bank, Prime, Askari, ABNAMRO and UBL) with 57 IBBs.


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Current Status of Industry and Market Share(Rs. In Billi o n)

Description Dec-06 Dec-05 Dec-04 Dec-03

Total Assets 118 72 44 13

%age of Banking Industry 2.9% 2.1% 1.4% 0.5%Deposits 83 50 30 8

%age of Banking Industry 2.8% 1.9% 1.2% 0.4%

Financing. & Invest. 72 48 30 10

%age of Banking Industry 2.4% 1.8% 1.3% 0.5%

No. of Branches Licensed 150 70 48 17


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Major Challenges






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Shariah compliance Framework

Three Pronged StrategyShariah Board of SBP

Essentials of Islamic modes (7+1 modes)

Model Agreements on Islamic Modes

Shariah Advisor in every IBI

Internal Shariah Review

SBP Shariah Inspection

Accounting Standards for Islamic Modes

Draft Essentials and Guidelines on Shariah Compliance


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Three Pronged Strategy

Three options for doing Islamic Banking: DFIs?Conversion from Conventional to Islamic5 Full Fledged Banks+ 1 LicenseIssues in Islamic Banking Subsidiaries (Capital etc.)

Issues in Islamic Banking Branches

Whether exclusive branches or IB windowsShariah Compliance Mechanism-AdviserComplete Segregation of FundsCapital adequacy & SLRSeparate set of Financial Statements

Effective Liquidity & Risk management policiesShariah AuditRelationship with foreign correspondent banks in Nostro/Vostroaccounts


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Guidelines For Islamic Banking Branches

CAMELS rating of 1, 2 and 3 in the last ON-SITE inspection No Major adverse inspection findings Method of segregating the funds of IBB Prepare P r o ced u re man u als for the IBD and IBB operations

duly approved by Shariah Adviser/Committee and the Boardof Directors

Shariah C o mpliance Certificate from the Shariah Adviserregarding all Products

Islamic Banking F u nd - Minimum amount Rs. 50 million or 8%of risk-weighted assets, whichever is higher- approved by theBoD


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Guidelines For Islamic Banking Branches

Proper Systems and Controls be in place Comprehensive internal audit including internal Shariah Review on

the operations of the IBB(s) and IBD at least once in a year. Existing branch network may be utilized to sell the Islamic banking

deposit schemes

Funds be transferred on the same day to/from the IBB Authorized branches may charge a reasonable fee/commission and

shall not receive/pay interest on such services Proper training be provided to staff of authorized branches in

Islamic banking

Accounting Records and Disclosure Separate book of accounts in order to ensure segregation of funds Prepare daily trial balance for Islamic banking operations Separate annual as well as quarterly financial statements


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SBP Shariah Board

Members (2 Shariah Advisors, Account, Lawyer, Banker)

Formally established in December 2003

So far has held 15 meetings have been held

Approved Essentials of Islamic Modes of Financing

Approved 9 Model Agreements

Approved Fit & Proper Criteria for Shariah Advisors

Approved structure of Govt. Ijara Sukuk

Approved WAPDA Sukuk structure

Prepared Essentials for Diminishing Musharaka

Discussed Essentials and Guidelines for Shariah Compliance


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Essentials of Islamic modes ( 7+ 1 modes)

AAOIFI Shariah StandardsIssued as Guidelines, Minimum Conditions to follow

Prepared by Commission for Transformation of Financial System

Revised by SBP Shariah Board

Modes Include: Murabaha, Musawama, Ijara, Mudaraba, Musharaka,Salam, Istisna

Latest Addition is Diminishing Musharaka

Model Agreements on Islamic ModesIssued for above mentioned modes

Comparison with Standard Agreements

Flexibility


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2 0 | Regulatory Framework for Islamic Banking

Shariah Advisor in every IBI

Shariah Supervisory Board vs. Shariah Advisor

One SA can work in only one IBI

Fit and Proper for Shariah Advisors

Prior Approval of SBP before appointment

All products have to be approved from SA before launching

Checks transactions on test check basisRole in Internal Shariah Audit

Recent Revision in F&P Criteria

Internal Shariah ReviewPart of Internal Shariah Audit

Mostly being done on the basis of AAOIFI Shariah Standards

Outsourcing


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SBP Shariah Inspection

Unique in the Globe

Manual prepared by Consultants of International Repute

Training of SBP Inspectors

A Major breakthrough

Can refer the case to SBP Shariah Board


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Accounting Systems

International PracticeFinancial statements have been reviewed in light of AAOIFIstandards-Balance sheet of IBIs

ICAP Co mmittee o n Acc ou nting Standards f o r Islamic Financeand In v estment reviewing the Standards prepared by AAOIFI andIAS for adoption in Pakistan.

Islamic Financial Accounting Standard-I (IFAS-1) issued by SECPon 24th August 2005.

Implementation has to be started from 1-January-2006.

Implementation Issues

IFAS-2 on Ijarah approved


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The Future-Strengthening the Regulatory Regime

ComplianceInternal Shariah Audit

Charity Funds

Disclosure to Account Holders

Duties and Function of Shariah Advisor

Conflict Resolution

Shariah Advisor Report

Deposit Protecting Scheme

Profit Distribution with PLS Account Holders???

Regulatory Limits for Consumer Financing

Islamic Microfinance

Risk Management Framework


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Major Challenges






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Draft Instructions for Shariah Compliance in IBIs

A. Appointment of Shariah Advisor:Terms of Reference of the Shariah Advisor should beapproved by the Board/management, as the case may be.

Shariah Advisor should not be a director or shareholder of

the IBI concerned.The fatawa and rulings of the Shariah Advisor in allfinancial matters shall be binding on the IBI. He may,however, advise/issue guidelines on any matter referred tohim by BoD/management.


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B. Duties and Responsibilities of Shariah Advisor:

Ensure that all products and services and related policiesand agreements of IBIs are in compliance with Shariahrules and principles.

Shall also conduct/arrange Shariah training programs forthe IBIs staff.

shall prepare a report on the Banks annual financialstatement in respect of its Shariah compliance

Shall review operations of the IBI on a periodical basis incoordination with officials responsible for Shariahcompliance


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C. Report of Shariah Advisor :

Whether or not he has examined, on test check basis, eachclass of transaction, the relevant documentation andprocedures adopted by IBI.

Whether or not in his opinion, the IBI has complied with

Shariah rules and principlesWhether or not in his opinion, any earnings that have beenrealized from sources or by means prohibited by Shariahrules and principles have been credited to charity account.


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D. Conflict Resolution in Shariah Rulings:

Between Shariah Advisor of the IBI and the State BanksInspection staff or other SBP departments

IBIs may refer issues relating to Shariah compliance toState Bank for consideration of SBP Shariah Board

Shariah Advisor of any IBI, with the concurrence ofmanagement, may also refer issues relating to Shariahcompliance


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E. Permissible Modes of Financing and Investment:

16 ModesList of modes, however, does not preclude the possibility ofdeveloping new products by the IBIs with prior approval of theirShariah Advisor.

Any security obtained by IBIs for participatory modes of Islamicfinancing shall not be applied or utilized to cover losses exceptthose in case of negligence, fraud or misconduct by thecustomers.

F.Essentials of Islamic Modes of Financing:

As minimum requirements for Shariah complianceIBIs may include additional conditions and controls in theirprocedures for the sake of more effective Shariah Complianceand prudence.


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G. Use of Charity Fund:

Income of the IBI s from non-Shariah compliant sources

Penalties and late payment charges received from clients indefault or overdue cases

The IBIs shall maintain proper accounts and records regarding alltransactions relating to Charity Fund

Disclose in their annual audited financial statements aStatement of Sources and Uses of Charity Fund.

H. Introduction of New Products and Services:

I. Schedule of Service Charges:

IBBs shall have a separate set of Schedule of Charges for theirbusiness.

shall be signed by the banks Shariah Advisor as an endorsementof Shariah compliance.


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Draft Guidelines For Shariah Compliance In IBIs

I. Shariah Compliance:

A system of compliance having special emphasis onShariah aspects

Monitoring and reviewing for Shariah Compliance shouldcover all activities, products and locations of the IBI.

All necessary documents should be provided to Shariahcompliance officials in performance of their functions.

Irregularities, if any, related to Shariah Compliance shallbe rectified with the approval of Shariah Advisor.


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II. Internal Shariah Audit:

primary objective of the Internal Shariah Audit is to ensure thatthe management of the IBI is discharging its responsibilities incompliance with Shariah rules and principles

The internal Shariah auditors shall have direct and regularcommunications with all levels of management and Shariah

Advisor.No scope limitation and restriction of access to documents,reports etc. shall be placed on Internal Shariah auditors.

The report of Internal Shariah Audit shall contain observationsand assessment of systems and controls in place for Shariahcompliance.

The report of the Internal Shariah Audit shall be placed beforethe Audit Committee of the IBI for consideration and appropriateremedial action as may be deemed necessary.


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III. Investment in Shares:

A screening process for the selection of shares shall befollowed. In this process, companies with acceptableprimary business activities should be identified, whichshould be further evaluated according to several ratiofilters as advised by the Shariah Advisor of the IBI in order

to eliminate companies with unacceptable levels of non-Shariah compliant debts/non-Shariah compliantincome/liquid assets.

In the event a portion of non-Shariah compliant incomeexists in the investment companys accounts, then incomeof IBIs shall need to be purified and IBIs share of non-Shariah compliant income shall be donated to charity onpro-rata basis for the period of its holding of the share.


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IV. Policy for Profit Distribution with PLS depositors:

Identification and determination of pools of Assets and relatedincome and the basis of such determination

Method for allocation of profits/losses between the PLSdepositors and the IBI

Policy for charging provisions against non-performing assets incompliancePolicy on the priority for investment of own funds and those ofPLS depositors

Basis for allocating expenses to equity holders and variousclasses of depositors for determination and appropriation ofprofit.Profit Sharing Ratio and Weight-ages for distribution of profitamong various categories of deposits and periodicity forchanging the same .


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Major Challenges






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1. IFSB-Islamic Financial Services Board, Malaysia

based in Kuala Lumpur

inaugurated on 3rd November 2002

International-standard setting body of regulatory andsupervisory agencies for soundness and stability of the IFSI-banking, capital market and insurance.

introducing new or adapting existing international standards

110 members of the IFSB include 27 regulatory and supervisoryauthorities +IMF, World Bank, BIS, IsDB, ADB and 78 market

players from 21 countries.General Assembly, Council, Technical Committees and WorkingGroups


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IFSB Performance

Guiding Principles of Risk Management (December 2005)Capital Adequacy Standard (December 2005)

Guiding Principles on Corporate Governance (December 2006)

Issues in Regulation and Supervision of Takaful (August 2006)

Preparing standards onGuidance on key elements on supervisory review process

Disclosure to promote Transparency and market discipline

Special issues in capital adequacy, and

Governance of investment funds.Shariah Governance

Market Conduct


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2 . AAOIFI-Accounting and Auditing Standards forIslamic Financial Institutions

Based in Bahrain

Working since March 1991

Prepares accounting, auditing, governance, ethics and Shari'astandards for Islamic financial institutions.

So far, 56 standards on accounting, auditing, governance, ethical, andShari'a standards, including a statement on capital adequacy

Either mandatory or used as a guideline by the regulators in Bahrain,Sudan, Jordan, Malaysia, Qatar, Saudi Arabia, Dubai and Lebanon &Syria.

Conferences in regulatory and Shari'a issues

Accounting & Auditing Standards Board-bi annual meeting

Annual Publication of standards

Pakistans Case-ICAP Committee


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Main Standards of AAOIFI

Accounting, Auditing and Governance Standards ( Arabic &

English)

General Representation, Disclosure, Islamic Modes, SSB, SA,

Internal Shariah Review, Code of Ethics for employees andAuditors of IFIs etc.

Shariah Standards ( Arabic & English)

Islamic M o des, C u rrencies, Debit and Credit Cards, Defa u lt in

payment o f Deb, Sale o f C o mm o dities, Financial P aper etc.


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Major Challenges






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Major Challenges

Liquidity InstrumentsOnly Wapda SUKUK

Bait-ul-Mal Certificates?

Lender of Last Resort

Investment Avenue, Liquidity, Trading

Profit Sharing Mechanism

Islamic Agriculture Finance

Risk Management

Human Resources


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Thank You

Phone: 245 3744

Email: [email protected]

Regulatory Framework for IBIs-Zahid

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