Islamic financial services have two main market entry approach. One approach is being fully fledged financial institution and the other one is through conventional financial institutions. Conventional financial institution have four options such as setting up a subsidiary such as Citi Islamic Investment Bank, CIMB Islamic; setting up a branch such as HSBC Amanah, PBZ Islamic; Islamic window such as KCB Bank Kenya and Tanzania, NBC, Muslim Commercial Bank in Pakistan, NBK, ABSA Kenya among others and finally transaction based approach such as Morgan Stanley among others. These institutions offer a wide range of Islamic financial transactions using different shari’ah compliant contracts.
AAOIFI Standards.
In the light of diverse nature of Islamic financial transactions, AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) issued several Financial Accounting Standards (FAS) for variety of contracts used for Islamic financial transactions. This is necessitated by several reasons just to mention a few.
- The contractual relationship between providers of Islamic financial services and customers that deal with them differs from that of conventional financial providers. For instance, where as conventional banks borrow and lend money based on interest, Islamic financial service providers mobilizes and use the funds through investment accounts based on Mudharaba and invest through cost plus profit sale (Murabaha), leasing (Ijarah) arrangement respectively.
- Due to the above, providers of Islamic financial services should demonstrate to the common users of general purpose financial reports or financial statements that the entities they are associated with comply, in form and substance, with the principles and rules of the Shari’ah in their financial and other dealings.
Therefor, proper financial accounting and reporting of these transactions is one of aspect of Shari’ah compliance that if unchecked tends to be ignored. Every transaction such as loan, Murabaha, or Musharakah or Ijara or Tawarruq or Mudharaba among others needs to be properly recorded in the books of accounts of a particular financial institutions, presented and reported to the end users of such information from time to time.
Financial and non-financial information.
Financial information have different kinds of users such as internal users and external users. External users such as customers, creditors, investors, researchers, industry analysts among others have limited access of information and thus rely on information presented in the general purpose financial reports. For example, customer of Islamic branch or window ought to know the overall financial position of the branch or window as well as the Shari’ah compliance status of the transactions undertaken under the branch or window from time to time.
AAOIFI states that “it is essential that the common information needs of these categories of users be the focus of the financial reports.” However, it is impossible for financial reports to provide every possible information need of these categories of users. In recognition of this, AAOIFI through Financial Accounting Standard (FAS) 1 on “Presentation and Disclosure in Financial Statement s of Islamic banks and Financial Institution” and FAS 18 on “Islamic Financial Services Offered by Conventional Financial Institutions” provide guidance on what kind of information must be disclosed in their financial reports.
Islamic Branch and Windows of Kenya and Tanzania.
Kenya has three fully fledged Islamic banks and four Islamic windows and one Takaful company where as in Tanzania, there is one fully fledged Islamic bank, one Islamic branch and two Islamic windows. There is no Takaful operator in Tanzania.
To a certain extent, fully fledged Islamic financial institutions meets requirements of FAS 1. However, the status of conventional banks with Islamic branch and windows has very little to be desired in relation to the requirements of FAS 18.
Shari’ah and Reputation risks.
Contrary to some point of view that think Shari’ah compliance risk arises only from failure of the product structure, legal and process flows underpinning the product but it also arises from misrepresentation or lack of relevant disclosures of relevant information on the Islamic products and services in their financial reports. For example, a review of financial reports of KCB Bank Group PLC, ABSA Bank PLC, National Bank of Commerce, People Bank of Zanzibar for 2019 shows little and non-relevant information to end users as per FAS 18 requirements. This gap contradict essential requirement of transparency as a key element on the value proposition of Islamic finance.
Besides, words such as loans to describe Islamic financing products as well as interests income in the income statements combining Islamic banking and conventional banking poses significant reputation risk and erode credibility of the Islamic windows and Islamic branches to the professional and common users of financial reports of these institutions.
Therefore, it is recommended that relevant regulatory authorities and Shari’ah supervisory boards (SSB) of these institutions should direct providers of Islamic financial services to comply fully with FAS 1 for fully fledged institutions and FAS 18 for Islamic branches and Windows of conventional financial institutions in their presentations of financial reports to the public. Where there is a challenge to comply on specific matter, the same can be reported to the SSB for exemptions.
———–End————
For further understanding and complying with FAS 1 and FAS 18 requirements, get in touch with the author through kabdallah@abrarconsult.co.ke or via what sap number +254702544111.