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Regulatory Environment ofIslamic Financial Institutions
Professor Rifaat Ahmed Abdel KarimSecretary-General
Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI)[email protected]
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In my presentation, I will attempt to give:
l An overview of the regulation of Islamic banks
l Information about the work of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB)
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Overview of the Regulation of Islamic banks
In some countries Islamic banks operate side-by-side with their conventional counterparts, while in certain countries the whole banking system comprises only Islamic banks.Conventional banks in most countries are allowed to offer Islamic financial services.
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Some countries have enacted specific laws to regulate the establishing of Islamic banks, while in other countries they are established by the same laws as conventional banks.
In almost all the countries in which they operate, Islamic banks are supervised by their respective central banks.
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The prudential regulation of Islamic banks is carried out either by rules specifically developed for Islamic banks (e.g. Bahrain) or by the same prudential rules that govern their conventional counterparts.
Some countries (e.g. Malaysia) have issued specific rules that regulate the offering of Islamic banking services by conventional banks.
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Two organizations, namely
l Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)
l Islamic Financial Services Board (IFSB)
address the issue of harmonizing best practise with regard to prudential, supervisory, accounting, auditing, corporate governance, ethical and Shari’a matters.
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AAOIFI
Established 1991 Self-regulatory international standard setting organizationPrivate non-profit-making organizationBahrain is the host countryMore than 88 members (institutions) from 22 countries
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AAOIFI’s Standards
Prepared using lengthy due process (about 80 weeks) that involves issuing of exposure drafts and holding of public hearingsPronouncements:
l Accounting standards (20)l Auditing standards (4)l Governance standards (4)l Codes of ethics (2)l Shari’a standards (13)
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Financial Reporting by Islamic Banks
Until very recently almost all Islamic banks were required by the relevant authorities in the countries in which they operate to implement: l International Accounting Standards (IAS) or l National accounting standards, which tend to
be largely based on IAS
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The assumption was, and still is in many countries, that the implementation of IAS or the national accounting standards would
l Enhance the transparency of Islamic banksl Render the financial statements of these institutions
comparable
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What seemed to happen was and still is, Islamic banks and external auditors ended up in a process of interpreting IAS/national accounting standards because they did not cater for the specificities of Islamic banks’ transactions.
This resulted in:l Lack of adequate transparency and comparability of
the financial statements l Lack of proper presentation and adequate
disclosure to reflect the universal banking nature of Islamic banks
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AAOIFI’s Accounting Standards
l Adopt the principles that govern the relevant IAS provided they do not conflict with Islamic Shari’arules and principles.
l Provide accounting treatments which cater for the provisions of the Shari’a contracts that govern the transactions of Islamic banks, but which are not catered for in IAS.
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l Require the following additional information that caters for the specificities of Islamic banks:
lPreparation of specific statements (for example, Statement of Zakah and charity fund).
lPresentation and disclosures of certain information (for example, profit equalization reserve, risk investment reserve)
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Implementation of AAOIFI’s Accounting Standards
l Mandatory in: Bahrain, Sudan, Jordanl Used as guidelines in Saudi Arabial Used to develop local standards in Qatarl Convergence from local to AAOIFI’s
standards in Malaysia
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Corporate Governance & Auditing
Perhaps one of the most fundamental corporate governance issues in any Islamic bank is to assure consumers of its services that its transactions are conducted in accordance with Shari’a rules and principles.
Almost every Islamic bank has attempted to address this issue by appointing an in-house committee of religious scholars, commonly known as Shari’a Supervisory Board (SSB).
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The terms of reference of the SSB vary from one Islamic bank to another. However, almost all SSBstend to perform the following functions with varying degrees:
l Carry out an ex ante review, namely approval of the template of the contracts used by the Islamic bank.
l Conduct an ex post review of a sample of transactions, to ensure that the Islamic bank has carried out the transaction in accordance with the approved terms of the contract.
l Issue a report at the end of the financial period stating whether or not in their opinion the Islamic bank has complied with Shari’a precepts.
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However, until recently, there was no standard process by which the SSB performed its ex ante or ex post review nor was there a standard form for its report.
AAOIFI addressed these issues by promulgating governance standards.
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Furthermore, each SSB issued the Shari'arulings that it considered appropriate based on its interpretation of the underlying Shari'aprinciples.This seems to have resulted in a lack of standardization of the Islamic bank’s transactions and rendered its financial statements non-comparable.
AAOIFI addressed these issues by promulgating Shari’a standards.
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Almost all Islamic banks state in their article and memorandum of association that the bank shall conduct its business in accordance with Islamic Shari’a precepts.
Some external auditors confined their audit of the Islamic bank’s financial statements to the financial aspects of the transactions, while others included in their audit opinion a statement to the effect that they checked the compliance of the bank’s transactions with Islamic Shari’a precepts.
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Lack of compliance with Islamic Shari’a precepts could lead to material misstatement in the financial statements of the Islamic banks.
AAOIFI addressed these issues by promulgating Auditing standards.
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AAOIFI’s Governance Standards
Aim to enhance the role of SSB in corporate governance. Provide guidelines to harmonize the SSB’sstructure and process, including:l Its appointment, dismissal, and the format of its
report and the information it should contain.l Steps that should be followed by the SSB in its
review to form an opinion as to whether or not the bank has complied with Shari’a precepts.
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AAOIFI’s Shari’a Standards
Aim to:l Harmonize Shari’a rulingsl Provide a level playing field of best practicel Enhance the independence of the SSBl Enhance the transparency of the Islamic
bankl Help external auditors in their audit with
regard to the Islamic bank’s compliance with Shari’a precepts.
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AAOIFI’s Auditing Standards
Broaden the scope of the external auditor so that s/he is satisfied with reasonable assurance that the Islamic bank’s transactions comply with Shari’a rules and principles.
Require the external auditor’s report to clearly state in the auditor’s opinion whether or not the financial statements give a true and fair view in accordance with Islamic Shari’a rules and principles and the financial reporting framework.
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Islamic Financial Services Board
IFSB is an association of central banks and monetary authorities, and other institutions that are responsible for the regulation and supervision of the Islamic financial services industry.
Malaysia is the host country of the IFSB
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The IFSB aims to:
Set and disseminate standards and core principles, as well as adapt existing international standards, consistent with Shari’a principles for the regulation and supervision of the Islamic financial services industry, for voluntary adoption by member countries;Promote good practices in risk management in the industry through research, training and technical assistance.
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Thank you for your attention
