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Sunday, 18 November 2012

Pakistan: Islamic banks await framework on profit distribution, pool management mechanism

KARACHI: The Islamic banking industry has been waiting for the issuance of a standardised framework on distribution of profit and pool management mechanism for the Islamic banking institutions so that the procedure of financial reporting and general disclosure could be streamlined, said sources in the banking industry.

The State Bank of Pakistan’s (SBP) authorities have reportedly said that the bank has developed a comprehensive profit distribution and pool management framework in consultation with the industry in order to improve transparency and bring standardisation in the Islamic banking institutions’ practices regarding profit distribution and pool management.

Kazi Abdul Muktadir, deputy governor of the central bank, on an occasion in September had revealed that the framework will be issued soon most probably within the same month and will be instrumental in improving public confidence in Islamic banking, in general, and profit distribution policies and functioning of the Islamic banking institutions (IBIs), in particular.

He also said that the SBP in collaboration with the industry will also develop strategic plan for the industry for the next five years, 2013-17.

The strategic plan aims at making a detailed assessment of the earlier plan (2007-12), as well as the existing environment and will set the strategic direction for the industry, he said.

However, so far, the framework has been upheld with the SBP and no development has so far been made on the working of the strategic plan, said sources.

Interestingly, the central bank in its recently issued Financial Stability Review, has not only admitted that the profit and loss computation and distribution policies of the Islamic banking institutions lack uniformity but hinted that the framework is likely to be introduced and enforced (before the year-end) during the second half of the current calendar year.

The SBP review also said that the Islamic banking institutions are contractually obliged to share profits and losses with the PLS depositors.

A representative of one of the leading full-fledged Islamic banks in Pakistan said that as the Islamic financial industry is in the developing phase, there is no formal policy by the central bank about the financial disclosure and sharing profit and losses information with the saving depositors.

“We have given our output in the form of recommendations on the issue to the authorities of the central bank and have been pushing it to issue clear instructions and framework on profit distribution method for the last few years but it has not been come out yet.” said a banker at an Islamic bank.

Sources said that all the Islamic banking institutions have uniformity in the product and they use Mudarabah for the distribution of profits. They have to be competitive with their conventional counterparts as regard the profit payment is concerned, they said.

They not only fix the profit sharing ratio in between respective IBI (Mudarib) and its depositors (Rabb-ul-Maal) but also assign appropriate sub-profit sharing ratios (weightages) to different depositors based on the amount and duration / tenure of deposits, to distribute profits, said sources.

However, to remain competitive in the market, the IBIs have to sacrifice their profit in favour of some of depositors to remove any heavy fluctuation in between the expected profit and the profit received by a depositor, based on profit sharing ratio and weightages.

Accordingly, the main problem is to how any such fluctuation is removed. Consequently, it is generally said that “IBI have different policies to distribute their profits”, said sources.

Several proposals were taken into consideration by the Shariah advisers to distribute IBIs profits in conformity with the Shariah rulings for removing heavy fluctuations in between the expected profit and the actual profit payment such as introduction of “profit equalisation reserve” and “introduction of pool management”, said sources.

“Profit and loss allocation or pool management function of an Islamic bank is a key area where Islamic bank needs to focus its resources, said Muhammad Faisal Shaikh, head of product and business development , BankIslami Limited.

“Majority of the transaction undertaken by an Islamic bank on liability side of the balance-sheet require application of pool management techniques, he said. Keeping in view the importance of this area, Islamic Banks and the SBP have worked closely in developing framework for pool management, which is expected to standardise profit and loss sharing mechanism of Islamic Financial Institutions,” he said.

“The guidelines for Shariah compliance in the Islamic banking institutions issued in 2008, say that the Islamic banks are encouraged to disclose the general disclosures with the PLS depositors. Instead of encouraging, the central bank must make it mandatory for all the Islamic banks, including Islamic banking windows being operated by the commercial banks in the country,” said a banker.

Most of the banks make financial information public but some of the banks do not follow this, said the banker.

“There is not a level-playing field within the Islamic banks with regard to follow consistent practices on profit distribution and financial accounting. Most of the banks such as Meezan Bank always comply with the Shariah compliance guidelines, providing the additional financial disclosures with the depositors,” said Ahmed Ali, head of Shariah compliance and product development at Meezan Bank.

“We are waiting for the new amendments and regulations on the financial accounting and profit distribution computations, which will make the sector more transparent and competitive,” said Ahmed.

According to the guidelines for Shariah Compliance in the Islamic Banking Institutions 2008, IBIs would follow the financial reporting standards for Islamic modes of financing issued by the Securities and Exchange Commission of Pakistan (SECP) under the Companies Ordinance, 1984.

However for modes / areas not covered by these standards, the Islamic banking institutions are encouraged to use AAOIFI accounting standards.

According to the guidelines in the annual report the Islamic banking institutions are encouraged to disclose overall basis of working of profit distributed to depositors; breakup of their financing by Islamic modes of finance; and remuneration of the Shariah adviser.

In addition, the annual report of conventional banks having Islamic banking branches would include separate balance-sheet and profit and loss statements of their Islamic banking operations.

Additional disclosure in the form of cash flow statement of Islamic banking operations is also encouraged.

About the policy for profit distribution with the PLS account depositors, the guidelines say, Islamic banking institutions would have a policy statement in place, vetted by the Shariah adviser and approved by the board of directors, regarding the policies and procedures to safeguard the interest of the profit and loss sharing-based deposit holders (PLS account depositors). The SBP in its report said that the central bank is in the process of developing a comprehensive Shariah governance framework. The framework will explicitly define the roles and responsibilities of different organs of Islamic banking institutions, including the board of directors, Shariah advisers / committees and executive management for ensuring Shariah compliance.

Presently, Shariah compliance is perceived to be the responsibility of the Shariah advisers only, whereas the board of directors and the executive management assume no such responsibility.

“This, we believe, is contrary to the corporate governance principles as unless the board of directors and the management are not fully aware of the Shariah non-compliance risk, it would be difficult for the Shariah adviser to develop an effective Shariah compliance mechanism in the Islamic banking institutions.

The Islamic banking industry currently constitutes over eight percent of the banking system with a network of 964 branches and over 500 windows across the country.

Presently, Islamic financial industry has five takaful operators and around 30 Islamic mutual funds.

(The International News / 18 Nov 2012)

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