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FINANCIAL REPORTING OF ISLAMIC FINANCIAL INSTITUTIONS IFI: ISSUES AND CHALLENGES FOR TRANSPARENCY, DISCLOSURE AND GOVERN

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FINANCIAL REPORTING OF ISLAMIC FINANCIAL INSTITUTIONS IFI: ISSUES AND CHALLENGES FOR TRANSPARENCY, DISCLOSURE AND GOVERN

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    1. FINANCIAL REPORTING OF ISLAMIC FINANCIAL INSTITUTIONS (IFI): ISSUES AND CHALLENGES FOR TRANSPARENCY, DISCLOSURE AND GOVERNANCE

    2. Purpose & Scope of Presentation To discuss the distinguishing nature of relationships and behavior of Islamic Financial Activities and Institutions influencing reporting process of IFI & information needs of investors and stakeholders Scope of presentation: Factors influencing the historical development of IFI Primordial Covenant of Islamic Finance Investor Expectations & Information Needs Impact of Supporting Institutions, Industry Standards On Information Infra Structure Reforms In Islamic Financial Industry The Way forward.

    3. FACTORS INFLUENCING THE DEVELOPMENT OF ISLAMIC FINANCIAL INSTITUTIONS

    4. Early Development – An Alternative Financial Intermediation Model 1960s : Addressed the religious and social welfare needs of the Muslims & formulating alternate financial intermediary and intermediation models Need for Large scale mobilization of Muslim (Islamic) Funds. Nasser Social Bank, Egypt and Pilgrimage Funds Board Malaysia are special purpose investment institutions addressing specific needs of Muslims From 1970s Islamic Development Bank & Dubai Islamic Bank were the first development finance and commercial financial institutions respectively that chart the new frontiers in Islamic Finance

    5. Critical Phases of Development of Islamic Finance

    6. Dual vis a vis Single Financial System Early developments are manifested in two systems, namely,

    7. Other Exogenous Considerations Driven by Private Initiative or Government Directed? Focus on Banking or Capital Market Orientation? Directed towards Domestic (Retail) or International (Institutional) Trends?

    8. Country Analysis of IFI: Government & Private Initiatives

    9. Country Analysis : Banking Operations & Capital Market

    10. Main Drivers of Growth of Islamic Financial industry

    11. Islamic Financial Systems & Institutions

    12. Development of Islamic Capital Markets: Islamic Stock Index Chronology of Events 1996 RHB Islamic Equity Index 1999 (February) Dow Jones Islamic Equity Index 1999 (April) Kuala Lumpur Shari'ah Index 1999 FTSE Global Islamic Index (dormant) 2006 FTSE SGX Islamic Index

    13. Other Factors – facilitative, stability and confidence generating elements for IFI Regulatory system Regulatory structure Licensing conditions Shari’ah compliance process Currency controls Foreign ownership policies Compliance with international Standards & Best Practices Harmonization & Comparability of International Reporting Standards Dispute resolution process Industry organizations International co-operation Ease of doing business

    14. Islamic banks have achieved comparative higher asset growth than conventional banks

    15. Islamic bonds/Sukuk are increasingly being issued

    16. Impacting the Need for Accounting Standards in Islamic Banking Developments of Islamic Banking demand financial reporting framework and information useful for investors and stakeholders. Existing financial reporting standards on conventional financial institutions are not adequate to address the information needs of Islamic financial Institutions. Nature of Islamic banking emphasizes importance of lawful and equitable banking business and financial activities - require accounting treatment of unique features of IFI activities

    17. Primordial Covenant in Islamic Finance: The Premise of Islamic Financial Activities

    18. Man as an Economic & Social Unit - Islamic Financial Activities Existence – Servant (‘Abd) & Vicegerent (Khilaafah) Purpose – Worship (‘ibaadah) Role – Administer trust (amaanah) Function – To make the right choice (‘ikhtiyaar) Guidance – Prescribed Path to Lawful & Goodness (Shariah : Quran & Sunnah) Wealth – God’s Absolute Ownership Relationships – Man & God (Seeking His Pleasure) as well as Man & fellow beings (mutual consent) Social Responsibility – Zakat, Charity & Waqf

    19. Nexus of Contractual Rights & Obligations in Islamic Financial Activities

    20. Impact of Nexus of Contractual Rights & Obligations on Financial Reporting of IFI Accounting in Islam deals with contractual rights & obligations based on the prescribed relationships Interest based financial institutions as an entity (shareholders interest) mobilize deposits for financing in the forms of loans and advances IFI as an entity mobilizes Investment Account Holders funds based equity profit sharing contracts for financing and investment in the forms of trade and equity profit sharing contracts. Hence a lacunae of ‘proprietor interest of profit sharing contracts’ in ‘entity based reporting’ needs to be addressed based on Shariah requirements

    21. Impact of Shari’ah Contractual Conditions of Transactions on Reporting Process

    22. View of Capital & Performance Measurement: Shariah Principles Capital derives its value from real assets in lawful economic activities. Loan capital by itself is non productive (interest being contracted return is prohibited) Equity capital - financial claims recognized based on profit & loss sharing contracts for an expected return derived from exchange transactions involving real assets. Trade credit and asset based financing such as sales receivables and lease investments are priced from transactions of real assets. Performance measurement of IFI should relate to real economic activities based on underlying contractual rights and obligations.

    23. Various features have been identified in classifying contracts as follows: Price Cost Price (Tawliya)/ Mark up price with disclosure (Murabaha) / Negotiated price (Musawamma)/Discounted Price (Wadhi’) Payment Cash Payment/ Deferred Payment (Muajjal) Delivery Immediate delivery/Deferred delivery (Salam) /Piecemeal Delivery (Istisna’a) These features also influence classification and reporting of types IFI Financing assets.

    24. Investor Expectations & Information Needs

    25. Reporting Impact IFI : IAH & Multi-contract Financing PLS features of restricted and unrestricted IAH are addressed in AAOIFI standards. Adoption of various contracts in IFI products and services advocate the need for segment reporting of contracts type for each product Sources and % of asset financing and its related returns & risk exposures to IAH to be distinguished in terms of IAH risk preference Distributable income to IAH using pooling or separate investment account method in terms of deductible expenses PER allocation time varying deposit period allocation

    26. Entity Perspective: Unique Risks of Islamic Financial Institutions Rate of return risk relates to market factors affecting rate of return on assets vis a vis rate of return for IAH Displaced commercial risk relates to market factors affecting rate of return on assets vis a vis rate of return for Shareholders Equity investment risk relates to risk characteristics of equity investments in the form of Mudaraba and Musharaka (including transformation of risks at various stages of investment life cycle) Operational risk fiduciary risk relates to Shariah non-compliance structure, process and policies. Impacting soundness, stability and going concern of IFI

    29. Meeting Investment Account Holders Expectation Scenario Analysis: Expected versus Actual Yield

    30. Meeting Investment Account Holders Expectation Scenario Analysis: Expected versus Actual Yield

    31. Impact Of Supporting Institutions, Industry Standards On Information Infra Structure Reforms In Islamic Financial Industry

    32. AAOIFI ACCOUNTING FRAMEWORK, REPORTING, AUDITING, GOVERNANCE & SHARIAH STANDARDS

    33. IFSB STANDARD, GUIDELINES & PRINCIPLES

    34. FINANCIAL REPORTING, AUDITING & GOVERNANCE INSTITUTIONS

    35. Multi-Disciplinary Perspectives on Role of Shariah Audit, Audit & Governance

    36. THE WAY FORWARD Integrated representation and communication between various institutions that promulgate financial reporting, auditing, governance and prudential standards and guidelines pertinent to the development of Islamic Financial Industry Enhance global collaborative efforts towards convergence in adopting Financial Reporting Standards of IFI as part of International Financial Reporting Standards. Mutual recognition of distinguishing reporting requirements will enable reporting of IFI and activities as distinct from conventional financial institution and activities. Harmonization of practices in the international reporting environment to reflect comparable and consistent practices of both conventional and Islamic financial institutions and activities.

    37. Thank You & Wassalam

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