Italy: First Islamic bank in Italy to open in 2008

imagesThe first Islamic bank respecting Koranic law, is slated to be inaugurated next year in Italy, the Union of Arab Banks president, Adnan Yousif, the Association of Italian Banks (ABI) president Corrado Faissola jointly announced Wednesday.

The Union of Arab Banks, based in Beirut comprises more than 300 Arab financial and banking institutions, representing the biggest Arab banks in the region.

“The next step should be the creation of a real Italian-Arab banking federation, which in perspective could represent a model to follow for other countries in the European Union”. said Faissola in a press release in ABI’s website.

“The consolidation of dialogue and cooperation opens important opportunities for growth and development not only for the banking sector and for Italy, but for all of Europe, and looking further ahead, for the stabilisation of the entire Mediterranean area and the Middle East”, Faissola said.

Koranic law forbids the payment and collection of interest and the investment in businesses that are considered unlawful, such as activities involving the selling of alcohol or pork products.


Assessing the performance of Islamic Banks


Assessing the Performance of Islamic Banks:

Some Evidence from the Middle East


Abdel-Hameed M. Bashir

Grambling State University


JEL Codes: G21, G24, G15





The study examines the determinants of Islamic banks? performance across eight Middle Eastern countries between 1993 and 1998. A variety of internal and external banking characteristics were used to predict profitability and efficiency. In general, our analysis of determinants of Islamic bank profitability confirms previous findings. Controlling for macroeconomic environment, financial market structure, and taxation, the results indicate that high leverage and large loans to asset ratios lead to higher profitability. The results also indicate that foreign-owned banks are more profitable than their domestic counterparts. Everything remaining equal, there is evidence that implicit and explicit taxes affect the bank performance measures negatively. Furthermore, favorable macroeconomic conditions impact performance measures positively. Our results also show that stock markets are complementary to bank financing




  1. Introduction 

How should policymakers think about Islamic banks? Are they relics of a bygone era, propped up by subsidies and distorting financial-sector competition? Or, are they efficient and focused financial institutions that could, if unleashed, eventually dominate the retail financial landscape? A better understanding of these policy questions requires specific knowledge about the performance and the determinants of efficiency and profitability of Islamic banks. Indeed, the performance evaluation of Islamic banks is especially important today because of the globalization effect. The globalization phenomenon has put Islamic banks in fierce competition with traditional banks in well-developed financial markets. Further, some countries have completely transformed their banking system to the Islamic model.

This paper intends to analyze how bank characteristics and the overall financial environment affect the performance of Islamic banks. Specifically, the purpose of the study is to closely examine the relationships between profitability and the banking characteristics, after controlling for economic and financial structure indicators. The intention is to decide which among the potential determinants of performance appear to be important. By so doing, the paper extends the literature in several ways. First, utilizing bank level data, the paper provides summary statistics pertaining to Islamic banks? sizes and profitability. Second, the paper uses regression analysis to determine the underlying determinants of Islamic bank performance[1]. To this end, a comprehensive set of internal characteristics is examined as determinants of bank?s net non-interest margin and profitability[2]. These internal characteristics include bank size, leverage, loans, short term funding, overhead and ownership. Third, while studying the relationship between banks? internal characteristics and performance, the impact of external factors, such as macroeconomic, regulatory and financial market environment are controlled. Among the external factors controlled, indeed foreign ownership, taxes, and the market capitalization were not been included in previous studies of Islamic banks. Moreover, some of the determinants were also interacted with the country?s GDP per capita to check whether their effects on bank performance differ with different levels of income. Finally, by studying the connection between Islamic banks? performance and the efficiency indicators, this paper contributes to the research on the relationship between Islamic banks? performance and financial development.

The paper is organized in four sections. Section 2 identifies the data sources, and highlights some important indicators in the sample. In section 3, we formulate the predicted model and discuss the possible links between bank performance and the set of internal and external indicators. Section 4 represents the empirical results, while the conclusions are stated in section 5.

2. The Data


The data used in this study are a cross-country bank-level data, compiled from income statements and balance sheets of14 Islamic banks each year in the 1993-1998 period in eight countries[3]. The main data source is BankScope database compiled by IBCA. In so far as possible, the BankScope database converts the data to common international standards to facilitate comparisons. Other data sources include International Monetary Fund?s International Financial Statistics (IFS), and the IFC?s Emerging Markets Database. A brief description of how the variables are constructed, together with summary statistics are given in Table 1.

Table 2 provides helpful insights on averages of non-interest margin and bank profitability for each country in the sample. Because the countries in the sample differ on their levels of development and income distribution, Table 2 also provides averages of some macroeconomic indicators, taxes and stock market capitalization.



Table 2

Macroeconomic and Financial Structure Indicators. Selected Aggregates

Financial Structure averages are calculated for each bank and then averaged over the country?s sample period (1993-98). Data are from BankScope. Macroeconomic indicators for each country are averaged over the sample period. The data source is IMF?s IFS Yearbook 200.

Country GDPPC 
























































































































































































































3- The Model


In this section, we introduce the set of variables that are expected to affect the

performance of Islamic banks. We use capital ratios, leverage, overhead, loan and liquidity ratios, and foreign ownership as proxies for internal measures. Meanwhile macroeconomic indicators, taxation, financial structure, and country dummies are used as external measures. A linear equation, relating the performance measures to a variety of indicators is specified[4]. The subsequent regression analysis starts from estimating the following basic equation:

Mti + (1)

where, Iijt = is the measure of performance (either non-interest return or before tax profit/total assets) for bank i in country j at time t; Bit are bank variables for bank i in country j at time t; Xjt are country variables for country j at time t; Mti are stock market variables in country i at time t, and Cj are country dummy variables[5]. is a constant, and and are coefficients, while is an error term. Although the primary focus of this paper is the relationship between performance and bank internal variables, the inclusion of macro variables, stock market variables, and the country dummies is meant to control for cyclical factors that might affect bank performance. Several specifications of (1) are estimated.

Bank Characteristics


Four measures of performance are used in this study: the net non-interest margin (NIM), profitability (BTP/TA), returns on assets, ROA, and returns on equity, ROE. Meanwhile, seven bank characteristics are used as internal determinants of performance. These supplemental measures are particularly useful for detailed understanding of the factors underlying a bank?s net margin and return on assets. They comprise fund source management (CSTFTA), funds use management (OVRHD and NIEATA), capital and liquidity ratios (EQTA and LOANTA), risk (LATA) and a dummy variable for ownership (FRGN). Each one of these determinants, except the risk variable, was also interacted with GDP to capture the effects of GDP on bank performance. Previous studies of the determinants of bank profitability in the United States found a strong and statistically significant positive relationship between EQTA and profitability. This supports the view that profitable banks remain well capitalized or the view that well capitalized banks enjoy access to cheaper (less risky) sources of funds with subsequent improvement in profit rates (see Bourke, 1989). A positive relationship between the ratio of bank loans to total assets, LOANTA, and profitability was also found from using international database (Demirguc-Kunt and Huizinga, 1997).

In general, Islamic banking operations are characterized by a high degree of financial risks. In the absence of guaranteed returns on deposits, Islamic banks undertake risky operations in order to be able to generate comparable returns to their customers. We use the ratio of total liabilities to total assets (LATA) as a proxy for risk. The ratio is also an indicator of lower capital or greater leverage. Using LATA adds a greater depth in understanding the risks a bank takes when trying to obtain higher returns. When a bank chooses (assuming this is allowed by its regulators) to take more capital risk, its leverage multiplier and return on equity, ceteris paribus, are higher. We expect LATA to be positively correlated with performance measures. On the other hand, in the absence of deposit insurance, high risk-taking will expose the bank to the risk of insolvency. Therefore, the coefficient of LATA may be negative. The ratio of overhead to total assets, OVRHD, is used to provide information on variation in bank costs across the banking system. It reflects employment as well as the total amount of wages and salaries. OVRHD is expected to impact performance negatively because efficient banks are expected to operate at lower costs. Lastly, the binary variable representing foreign ownership, FRGN is expected to affect profitability positively, indicating that foreign banks benefit from tax breaks and other preferential treatments.

To isolate the effects of bank characteristics on performance, it is necessary to control for other factors that have been proposed in the literature as possible determinants of profitability. External to the bank, four sets of control variables are expected to impact performance: the macroeconomic environment, the financial market structure, the regulation indicators, and country (dummy) variables. The current environment and a bank?s specific market will obviously affect its mixture of assets and liabilities. However, introducing these indicators in order to see how they interact with each other, as well as how they affect bank performance, often proves helpful. Three macro indicators are used: GDPPC, GDPGR, and INF. The GDP per capita variable, GDPPC, is expected to have an effect on numerous factors related to the supply and demand for loans and deposits. It is hypothesized in this paper that GDPPC affects performance measures positively. This is so because most of the countries in the sample are characterized as low or middle income countries. In countries with low incomes, banks operate less competitively, resulting in larger profit margins. The growth variable, GDPGR, is expected to have positive impact on performance. The association between economic growth and the financial sector performance is well documented in the literature (see Demirguc-Kunt and Maksimovic, 1996). We used the required reserves of the banking system (RES), the tax rate (TAX), and their interactions with GDP; that is, RESGDP and TXAGDP respectively as proxies for financial regulation. Required reserves do not generate any income to the bank, and are therefore, considered implicit taxes levied by the government for monetary policy reasons. Both implicit and explicit taxes are expected to impact profits negatively[6].

The size of the banking system (BNK), comprising the ratio of total assets of the deposit money bank to GDP, is used to measure the importance of bank financing in the economy. It also measures the size of the economy that is monetized. MCAP and BNK are also interacted with GDP and with each other. MCAP is used BNK. MCAP and BNK may also reflect the complementarity or substitutability between bank and stock market financing. Both variables are expected to impact performance positively. Finally, the total assets (ASST, is used to control for cost differences related to bank size and for the greater ability of larger banks to diversify. The first factor may lead to positive effects if there are significant economies of scale and the second to negative effects if increased diversification leads to lower risks and lower returns.

4. Empirical Results


This section presents and analyzes the regression results. The data from the sample of 14 Islamic banks are pooled for all six years (1993-98) and used to replicate and extend earlier research. Different specifications of equation (1) were estimated. As stated above, in addition to bank-level variables, the explanatory variables used include control variables like financial structure variables, taxation variables, and macroeconomic indicators. The estimation technique used is panel data methods and the White (1980) procedure is used to ensure that the coefficients are heteroskedastic[7].

The results in Table 3 relate to regressing BTP/TA on the set of performance and control measures[8]. Column 1 estimates the relation between profitability and bank characteristics and the taxation variables. The data reveals that both EQTA and LOANTA have strong positive and statistically significant relationships with profitability, confirming previous findings. Intuitively, higher leverage and higher loans to assets ratios predict higher future profits. However, when these variables were interacted with GDP, the signs of the association changes to inverse relationship but remained statistically significant. Short-term and consumer funding, CSTF, has the predicted negative association with PRM, although statistically insignificant. However, when interacted with GDP, its impact on profit became positive. Other meaningful determinants of profitability include NIETA, OVRGDP, FRGNGDP, and LATA. The strong positive association between the risk indicator, LATA, and BTP/TA should be emphasized. A part from revealing the importance of leverage in the practice of Islamic banks, it indicates that Islamic banks have incentives to undertake more risks. Column 1 also shows the negative impact of taxes on profitability of Islamic banks. As expected, Islamic banks pass the higher taxes over to their customers and shareholders in terms of fewer profits.

Column 2 of Table 3 shows the result of regressing BTP/TA on bank level variables. After controlling for the macroeconomic environment, the only bank characteristics impacting PRM are the ownership variable and its interaction with GDP. The impacts of EQTA and LOANTA are now statistically insignificant. Regression 2 also reveals the strong positive impacts of GDPPC and INF on profitability. The financial structure variables were introduced in column 3. Although the market capitalization variable, MCAP, has an inverse but statistically insignificant relationship with BTP/TA, the result shows a strong positive association between BTP/TA and BNK, BNKGDP and MCPBNK. Column 4, which combines all the determinants, shows slight changes in the coefficients. The much higher R2 in columns 3 and 4 suggest that profit is much more stable and predictable than in the previous two regressions.




5. Conclusion


The preceding empirical analysis allows us to shed some light on the relationship between banking characteristics and performance measures in Islamic banks. First, the Islamic banks profitability measures respond positively to the increases in capital and loan ratios. This result is intuitive and consistent with previous studies. It indicates that adequate capital ratios and loan portfolios play an empirical role in explaining the performance of Islamic banks. Second, the results also indicate the importance of customer and short-term funding, non-interest earning assets, and overhead in promoting banks? profits. Third, the results suggest that the tax factors are much more important in the determination of bank performance. The inverse and statistically significant effects of taxes indicate that financial repression is distorting the performance of Islamic banks. The negative effect of the reserve tax indicates the opportunity cost of holding reserves. In fact, since deposits in Islamic banks are treated as shares and accordingly their nominal values are not guaranteed, holding reserves hurt Islamic banks in two ways. One, reserves do not yield any return to the banks and, two, holding reserves requirement reduces the amount of funds available for investment. From a policy perspective, one can argue from the results that Islamic banks should be exempted from the reserve requirement, in particular, because they are not entitled to discount loans or last resort borrowing from their central banks. Finally, it should be acknowledged that the scope of this paper is limited as several Islamic banks are not included and several interesting questions are not answered. Also, because of the size of our sample and many missing observations, our results should be interpreted cautiously. As has been the case of many recent studies, the results are not very robust and may be sensitive to the type of measure of performance used.



Prepared for the Annual meeting of the MEEA/American economic Association annual Meeting, New Orleans, Louisiana, January 4-7, 2001. An earlier version was presented at ERF Annual meeting, Amman, Jordan, October 26-26, 2000. The author would like to participants at both meetings for their valuable comments. The usual caveat applies.


[1] Since both shareholders and depositors in Islamic banks are the residual claimants to the bank?s profits, bank profitability is the designated measure of bank performance.

[2] The literature divides bank profitability determinants to internal and external measures (Bourke, 1989, Molyneux and Thronton, 1992).

[3] The names of the banks, their years of establishment, and countries of origin are given in the Appendix.

[4] No specification test is used here to support using the linear function. However, the linear functional form is widely used in the literature and produces good results(see Short, 1979, and Bourke, 1989).

[5] Three dummy variables, HI, MI, and LI, indicating high income, middle income and low income are used.

[6] Theoretically, Islamic banks? deposits are not supposed to be subject to reserve requirement. Therefore, the direction of effect of RES on profitability is unclear.

[7] The use of panel data has a number of advantages. First, it provides an increased number of data points and generates additional degrees of freedom. Second, incorporating information relating to both cross-section and time-series variables can substantially diminish the problems that arise from omitted variables.

[8] Note that the coefficients for the dummy variables turned to be statistically insignificant, hence are not listed.




Bashir, A. 1999. “Risk and Profitability Measures in Islamic Banks:The Case of Two Sudanese Banks.” Islamic Economic Studies, Vol. 6, No. 2: 1-24.

Berger, A. 1995. “The Relationship between Capital and Earnings in Banking.” Journal of Money, Credit and Banking Vol. 27: 432-456.

Bourke, P. 1989. “Concentration and other determinants of bank profitability in Europe, North America and Australia.” Journal of Banking and Finance 13: 65-79.

Demirguc-Kunt, A., and H. Huizinga. 1997. “Determinants of commercial bank interest margins and profitability: some international evidence.” Working Paper, Development Research Group, World Bank, Washington, D.C.

______________, and V. Maksimovic. 1996. “Stock Market Development and Financing Choices of Firms.” The World Bank Economic Review Vol. 10, No. 2: 341-369.

IBCA. 1997. BankScope Database, CD-Rom. Bureau Van Dyck, New York, N.Y.

IFC. 1997. Emerging Market Database.Washington, D.C. CD-Rom

IMF. 2000. International Financial Statistics Yearbook, Washington, D.C. CD-Rom

Karsen, I. 1982. “Islam and Financial Intermediation.” IMF Staff Papers.

Khan, M. 1986. Islamic Interest Free Banking: A Theoretical Analysis.” IMF Staff Papers

Molyneux, P., and J. Thornton. 1992. “Determinants of European bank Profitability: A Note.” Journal of Banking and Finance 16: 1173-1178.

White, H., 1980. “A heteroskedasticity consistent covariance matrix estimator and a direct test for heteroskedasticity.” Econometrica, Vol. 48, No. 4.

 Source :

Mauritius goes for Islamic banking




Mauritian Finance Minister Rama Sithanen believes that there is a potential demand for Islamic banking and finance in Mauritius – not only from those who follow the Islamic faith but from the rest of the population as well.

“By enlarging the spectrum of financial products, the Shari’ah compliant products should interest all bank customers and will therefore bring healthy competition for existing conventional banking products,” he said.

According to him, Islamic banking will be a completely new concept that can potentially redefine the financial services landscape. “Islamic finance has proved its compatibility with conventional finance worldwide. It embraces principles of justice and cooperation. It will work in Mauritius and can promote economic growth, efficiency, investments and capital access,” he added.

Even it Islamic finance is new to the banking industry in the island state, it is not new to some ot the operators already offering Shari’ah compliant products in other countries.

Source : By Rosenberg, Anna

Publication: African Business

Islamic Finance: Emergence of Sharia-compliant securities indices




What is a stock index?

A stock index represents the aggregate current market value of the publicly traded shares of a varied mix of defined companies. It tracks the changes in the value of a hypothetical portfolio of shares of these companies on a day-to-day basis.

The weight of an individual stock in the overall portfolio is equal to the proportion of the portfolio invested in that stock. The percentage increase in the value of an index is usually equal to the increase in the total value of the stocks comprising the portfolio at that time.

An investor’s dilemma

Investors worldwide have been reaping rewards of such increases for decades and have also suffered with the stock market downturns. However, a large number of Muslim investors had refrained from investing in shares in view of the confusion whether the activity to invest in the shares of public joint stock companies (PJSCs) from the Western world is Sharia compliant or not.

Major event

A most striking and innovative development to address this dilemma took place in the world of Islamic finance during the late 1990s when Dow Jones, the world’s leading stock market index provider, constituted the first Islamic Securities Index in the world with the valid approval and support from a panel of renowned Sharia scholars. The idea, pioneered by Dow Jones, was based upon the Sharia principle of investing Muslim money only in the Islamically permitted trading activities.

Hitherto, Islamic investors were confined to place their funds on traditional and non-exciting products, such as savings and investment accounts with Islamic financial institutions in order to avoid interest. However, the endorsement of the idea of an Islamic index by renowned Sharia scholars provided a much needed fillip in this direction.

Emergence of others

The large-scale acceptability and success of the Dow Jones Islamic Index was followed by the emergence of a series of such other indices and funds, prominent one being FTSE. Today there are more than 100 Islamic indices and funds spread all over the world with an estimated aggregate market capitalisation running into hundreds of billions of dollars. These include high-cap, mid-cap and small-cap indexes, which are further spread into various economic segments and regions.

Synergy with the rest

Islamic indexes have generated great deal of interest amongst non-Muslim investors too due to their synergy with social indexes on ethical grounds. The concept of social index was developed in the U.S. during early 90s. It emphasises upon the slogan ‘invest with values’.

The argument put forward by the supporters of a social index is that the personal values and personal finance should go hand in hand. They say that it is possible that one can achieve financial goals and at the same time help make this world a better place to live by encouraging investment in the ethically appropriate companies.

The avoidance screening in a social index is comprised of the activities including liquor, violation of animal rights, environment pollution, toxic products, gambling, causes for global warming, nuclear field, tobacco and weapons.

Perhaps the cause of social indices is gaining popularity since a 10-year comparison carried out in 2000 revealed that one of the leading social index in the U.S. had outperformed the prestigious S&P 500 index. Today the total size of the social indexes and funds has exceeded $2 trillion.


An Islamic index does not contain securities of the companies producing or trading in alcohol and pork-related products, providing interest-based financial services (banking, insurance, etc.) and are engaged in the entertainment business such as hotels, casinos/gambling, cinema, music, and the other such activities considered unethical in Sharia.

The manufacturers of tobacco and weapons/ammunition, although not clearly forbidden for investment under Sharia, are also excluded from the index under the advice from scholars due to the known harmful impact of these industries on a society.

Other parameters

Following are the other essential parameters, which make a company eligible for an Islamic index:

a) Total interest bearing debt of the company at any point in time should remain below one third of its average market capitalisation during last 12 months.

b) Sum of a company’s cash and interest bearing securities must not be greater than 33 per cent of its trailing 12-month average market capitalisation.

c) The company’s account receivables should remain below 45 per cent of its total assets.

Purpose of screening

It is to ensure that a company’s business practices are not exploitative, unethical or inefficient while dealing with suppliers, customers, creditors and debtors.

The purpose of the first screening is to discourage the company from amassing interest bearing debt beyond a reasonable level. Of course, in a Western environment, it will be naïve to expect that a company will not borrow on interest. However, scholars feel that there should be some cogent controlling measure for it.

Aim of the second covenant is to encourage the company to invest in its trading activities in order to earn real profits rather than to become complacent by relying on effortless interest income.

Furthermore, this measure also ensures that the element of interest earning is kept to the minimum in a company’s net profit, out of which the dividend is declared. Scholars strongly recommend Muslim investors to keep track of the interest earnings in a company’s net income and purge an amount from the dividend in the same ratio.

The third condition clearly tackles the quality of a company’s debtors. On the other hand, by deploying efficient recovery means, a company will be able to rely less on borrowed funds and hence will incur lower interest expense, thereby improving the overall Sharia acceptability for an Islamic investor.


These well thought after measures approved by the panels of high-repute Sharia scholars are religiously monitored on an on going basis by index managers.

A company is removed from the index if it fails to meet any of the above litmus tests. The integrity of an Islamic index is gauged by the frequency of periodic reviews conducted by its Sharia board.

Initially, it was not considered an issue by blue-chip companies who formed part of an Islamic index. However, as the activity in the Islamic market picked up and with the emergence of more Islamic indexes and funds, there is growing urge by these companies to lure the Islamic investor. As such, of late, there has been some thought being given by them towards meeting the said Islamic criteria.

Another factor which is quietly working in favour of Islamic indexes is the recent promulgation of various regulations by the world’s financial regulatory authorities aimed at curbing excessive borrowings by the corporates.


Though not a Sharia requirement, promoters of Islamic indexes and funds have so far tried to play it safe by selecting actively traded stocks from the developed world. Their purpose seems to have an easy access and exit in order to provide greater flexibility to an Islamic investor in this relatively new investment field.

By Sohail Zubairi
The author is the head of risk management at Dubai Islamic Bank

History of Islamic Banking in Pakistan


Islamization of banking and financial system of Pakistan were started in 1977-78. Pakistan was among the three countries in the world that had been trying to implement interest free banking at comprehensive/national level. But as it was a mammoth task, the switchover plan was implemented in phases. The Islamization measures included the elimination of interest from the operations of specialized financial institutions including HBFC, ICP and NIT in July 1979 and that of the commercial banks during January 1981 to June 1985. The legal framework of Pakistan’s financial and corporate system was amended on June 26, 1980 to permit issuance of a new interest-free instrument of corporate financing named Participation Term Certificate (PTC). An Ordinance was promulgated to allow the establishment of Mudaraba companies and floatation of Mudaraba certificates for raising risk based capital. Amendments were also made in the Banking Companies Ordinance, 1962 (The BCO, 1962) and related laws to include provision of bank finance through PLS, mark-up in prices, leasing and hire purchase.

Separate Interest-free counters started operating in all the nationalized commercial banks, and one foreign bank (Bank of Oman) on January 1, 1981 to mobilize deposits on profit and loss sharing basis. Regarding investment of these funds, bankers were instructed to provide financial accommodation for Government commodity operations on the basis of sale on deferred payment with a mark-up on purchase price. Export bills were to be accommodated on exchange rate differential basis. In March, 1981 financing of import and inland bills and that of the then Rice Export Corporation of Pakistan, Cotton Export Corporation and the Trading Corporation of Pakistan were shifted to mark-up basis. Simultaneously, necessary amendments were made in the related laws permitting the State Bank to provide finance against Participation Term Certificates and also extend advances against promissory notes supported by PTCs and Mudaraba Certificates. From July 1, 1982 banks were allowed to provide finance for meeting the working capital needs of trade and industry on a selective basis under the technique of Musharaka.

As from April 1, 1985 all finances to all entities including individuals began to be made in one of the specified interest-free modes. From July 1, 1985, all commercial banking in Pak Rupees was made interest-free. From that date, no bank in Pakistan was allowed to accept any interest-bearing deposits and all existing deposits in a bank were treated to be on the basis of profit and loss sharing. Deposits in current accounts continued to be accepted but no interest or share in profit or loss was allowed to these accounts. However, foreign currency deposits in Pakistan and on-lending of foreign loans continued as before. The State Bank of Pakistan had specified 12 modes of non-interest financing classified in three broad categories. However, in any particular case, the mode of financing to be adopted was left to the mutual option of the banks and their clients.

The procedure adopted by banks in Pakistan since July 1 1985, based largely on ‘mark-up’ technique with or without ‘buy-back arrangement’, was, however, declared un-Islamic by the Federal Shariat Court (FSC) in November 1991. However, appeals were made in the Shariat Appellate Bench (SAB) of the Supreme Court of Pakistan. The SAB delivered its judgment on December 23, 1999 rejecting the appeals and directing that laws involving interest would cease to have effect finally by June 30, 2001. In the judgment, the Court concluded that the present financial system had to be subjected to radical changes to bring it into conformity with the Shariah. It also directed the Government to set up, within specified time frame, a Commission for Transformation of the financial system and two Task Forces to plan and implement the process of the transformation.

The Commission for Transformation of Financial System (CTFS) was constituted in January 2000 in the State Bank of Pakistan under the Chairmanship of Mr. I.A. Hanfi, a former Governor State Bank of Pakistan. A Task Force was set up in the Ministry of Finance to suggest the ways to eliminate interest from Government financial transactions. Another Task Force was set up in the Ministry of Law to suggest amendments in legal framework to implement the Court’s Judgment. The CTFS constituted a Committee for Development of Financial Instruments and Standardized Documents in the State Bank to prepare model agreements and financial instruments for new system.

The CTFS in its Report identified a number of prior actions, which were needed to be taken to prepare the ground for transformation of the financial system. It also identified major Shariah compliant modes of financing, their essentials, draft seminal law captioned ‘Islamization of Financial Transactions Ordinance, 2001’, model agreements for major modes of financing, and guidelines for conversion of products and services of banks and financial institutions. The Commission also dealt with major products of banks and financial institutions, both for assets and liabilities side, like letters of credit or guarantee, bills of exchange, term finance certificates (TFCs), State Bank’s Refinance Schemes, Credit Cards, Interbank transactions, underwriting, foreign currency forward cover and various kinds of bank accounts. The Commission observed that all deposits, except current accounts, would be accepted on Mudaraba principle. Current accounts would not carry any return and the banks would be at liberty to levy service charge as fee for their handling. The Commission also approved the concept of Daily Product and Weightage System for distribution of profit among various kinds of liabilities/deposits. The Report also contained recommendation for forestalling willful default and safeguarding interest of the banks, depositors and the clients.

According to the Commission, prior/preparatory works for introduction of Shariah compliant financial system briefly included creating legal infrastructure conducive for working of Islamic financial system, launching a massive education and training program for bankers and their clients and an effective campaign through media for the general public to create awareness about the Islamic financial system.

The Finance Minister of Pakistan in his budget speech for the FY02 declared the following:
” Government is committed to eliminate Riba and promote Islamic banking in the country. For this purpose a number of steps are under way which are:

1. A legal framework is designed to encourage practice of Islamic banking by banks and financial institutions as subsidiary operations of their main operations;

2. Consultations and exchanges are undertaken with brother Islamic countries and renowned institutions of Islamic learning such as middle eastern countries and Al-Azhar University of Egypt, to learn more about their experiences and practices;

3. Amendments in HBFC Act are being made in line with the directive of the Supreme Court. With these changes, HBFC would be fully Shariah compliant institution, which will play an effective role both in promotion of Islamic financing method but also in the development of the important housing sector;

4. Shariah compliant modes of financing like Musharaka and Mudaraba will be encouraged so that familiarity and use of such products is enhanced and their adoption at a wider scale made possible.
It is government’s intention to promote Islamic banking in the country while keeping in view its linkages with the global economy and existing commitments to local and foreign investors”.

The House Building Finance Corporation had shifted its rent sharing operations to interest based system in 1989. The Task Force of the M/O Law proposed amendments in the HBFC Act to make it Shariah Compliant. Having vetted by the CTFS, the amended law has been promulgated by the Government. Accordingly, the HBFC launched in 2001 Asaan Ghar Scheme in the light of amended Ordinance based on the Diminishing Musharakah concept. A Committee was constituted in the Institute of Chartered Accountants, Pakistan (ICAP), wherein the SBP was also represented, for development of accounting and auditing standards for Islamic modes of financing. The Committee is reviewing the standards prepared by the Bahrain based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) with a view to adapt them to our circumstances and if considered necessary, to propose new accounting standards.

It was decided in September 2001 that the shift to interest free economy would be made in a gradual and phased manner and without causing any disruptions. It was also agreed that State Bank of Pakistan would consider for:

1. Setting up subsidiaries by the commercial banks for the purpose of conducting Shariah compliant transactions;
2. Specifying branches by the commercial banks exclusively dealing in Islamic products, and
3. Setting up new full-fledged commercial banks to carry out exclusively banking business based on proposed Islamic products.

Accordingly, the State Bank issued detailed criteria in December 2001 for establishment of full-fledged Islamic commercial banks in the private sector. Al Meezan Investment Bank received the first Islamic commercial banking license from SBP in January 2002 and the Meezan Bank Limited (MBL) commenced full-fledged commercial banking operation from March 20, 2002. Further, all formalities relating to the acquisition of Societe Generale, Pakistan by the MBL were completed, and by June, 2002 it had a network of 5 branches all over the country, three in Karachi, one in Islamabad and one in Lahore. The MBL now maintains a long term rating of A+ and short term rating of A1+, assessed by JCR VIS Credit Rating Co Ltd, signifying a consistent satisfactory performance.

The Government as also the State Bank are mainly concerned with stability and efficiency of the banking system and safeguarding the interests, particularly, of small depositors. With this concern in mind it has been decided to operate Islamic banking side by side with traditional banking. The approach is to institute best practice legal, regulatory and accounting frameworks to support Islamic banks and investors alike. The year 2002-2003 witnessed strengthening measures taken in the areas of banking, non-bank financial companies and the capital markets.
source : sbp




New Islamic Bank Combines DBS’ Asia Banking Expertise with
Middle Eastern Investors’ Extensive Network

SINGAPORE, 7 May 2007 – DBS Bank (DBS) today launched The Islamic Bank of Asia (IB Asia) after receiving official approval from the Monetary Authority of Singapore for a full bank licence. IB Asia’s founding shareholders include majority stakeholder DBS and 22 Middle Eastern investors from prominent families and industrial groups from Gulf Cooperation Council (GCC) countries.

IB Asia will be incorporated with an initial paid-up capital of USD418 million with DBS contributing USD250 million and holding an initial stake of 60 percent. IB Asia’s second closing with other GCC investors in the coming weeks is expected to increase IB Asia’s capital to USD500 million. With the proposed capital injection, DBS will continue to hold a majority stake with no less than 50 percent plus one share.

IB Asia will be a subsidiary of DBS based in Singapore, and will commence operations this month from its separate ground floor offices in DBS’ headquarter facilities. IB Asia will focus on commercial banking, corporate finance, capital market and private banking services.  

IB Asia will have a nine-member board of directors with His Excellency, Abdulla Hasan Saif, Advisor for Economic Affairs to the Prime Minister, Bahrain, as Chairman.

Mr. Jackson Tai, Vice Chairman and Chief Executive Officer of DBS will serve as Vice Chairman. The other board members are:-

  • Mr. Khalid Abdulla Al-Bassam, Chairman of Bahrain Islamic Bank and former Deputy Governor of Bahrain Monetary Agency
  • Mr. Khalid Abdullah Al-Zamil, Director and Partner of Al-Zamil Group of Companies
  • Mr. Andrew Buxton, Former Chairman of Barclays Bank plc, and a board member of DBS Group Holdings
  • Mr. Lee Hsien Yang, former Chief Executive Officer of SingTel Group
  • Mr. Lim Siong Guan, Chairman of the Economic Development Board of Singapore
  • Mr. Abdullah Tarmugi, Speaker of the Singapore Parliament, and former Minister-in-charge of Muslim Affairs
  • Mr. Eric Ang, DBS’ Managing Director and Joint Head of Global Financial Markets

Mr. Tai said IB Asia will originate and distribute innovative wealth management and capital market instruments for corporate and private banking clients in the Middle East and Asia. He said: “Singapore is becoming a convenient stopover for GCC investors and capital flows bound for Asia. Against this backdrop, The Islamic Bank of Asia is strategically well-positioned not only at the financial crossroads of Asia, but also in Singapore, an Asian capital markets centre renowned for its effective regulatory and corporate governance framework.”

He added that the credibility of IB Asia stems in part from DBS’ partners in the Middle East, the majority of whom are prominent merchant families, as well as the stature of the Shariah Board. He noted the world-wide scarcity of Islamic scholars who are also experts on finance and banking, saying, “We have engaged four of the most respected Islamic scholars to guide our operations – Sh. Nizam Mohammad Saleh Yaqouby, Sh. Dr. Mohamed Ali Elgari , Dr. Abdul Sattar Abdul Kareem Abu Ghuddah and Dr. Mohd Daud Bakar.”

His Excellency Abdulla Hasan Saif said that the diversity and strength of the Middle Eastern shareholders will provide opportunities for IB Asia to tap into the GCC network. His Excellency previously served as Bahrain’s Minister of Finance & National Economy and the Governor of the Bahrain Monetary Agency.

He said: “Middle Eastern investors are seeking new markets and innovative ways to protect and grow their wealth. With our strong Shariah credentials and good understanding of the cultural nuances in the Middle East, The Islamic Bank of Asia will be at the forefront of new market-based ideas to structure and introduce opportunities in Asia that uphold Islamic banking principles.”

Vince Cook, 45, a veteran banker with more than 20 years of banking experience in the Middle East, will be IB Asia’s Chief Executive Officer. He was formerly the General Manager of Qatar National Bank in Doha and prior to that, the Managing Director for Barclays Capital in Dubai covering the GCC market.

The launch of IB Asia follows DBS’ stepped-up participation in the Middle East markets. In the last two years, DBS has placed a significant portion of large, landmark equity IPOs and securitisations in the Middle East. Last April, DBS was among the first few Asia-based banks to receive a banking licence from the Dubai International Financial Centre.

Source :


Dr. Seif I. Tag El-Din,

I. Introduction
The contemporary experience of Islamic banking is hardly more than three decades
old, though it proved to be groundbreaking with far reaching impacts worldwide.
Among the major challenges faced by Islamic banking experts and Shariah Scholars
has been the idea of developing appropriate accounting and auditing standards, to
achieve financial transparency and enhance the quality of financial service to society.

Banking success, in general, depends on the extent of public trust placed in the
financial strength of individual banks, particularly the trust of depositors and
investors. In addition to the paramount importance of financial strength, trust in
Islamic banks relates also to the extent of adherence to Shariah, which, after all, is the
identity card of Islamic banks. One major source of public confidence is the quality
of information issued to the investing public about banks’ ability to achieve both
financial and Shariah-related objectives.

Hence, developing unique accounting and auditing standards for the dissemination of
such information about Islamic banks becomes a necessity. The need for accounting
records as means for trust building is emphasized in the Quran : “…Never get bored
with recording it, however small or large, up to its maturity date, for this is seen by
Allah as closer to justice, more supportive to testimony, and more resolving to doubt,
except when it is spot trade carried out amongst yourselves, then you are not to
blame for not recoding it”, (al-Baqara: 2 82). Even for spot transactions where debt
is not involved, the Quran allows an open discretion for taking records, and that is all
what accounting is about.

The reason why Islamic financial accounting methods and principles have to be
carefully distinguished from their conventional counterparts is the same reason why
Islamic banks and financial institutions has existed in the first place. Prohibition of
interest in financial dealings is the primary reason, but there are various other issues
and fine details which make up for the case of Islamic financial accounting standards.
For a better appreciation of accounting issues, it is appropriate to highlight the basic
financing and investment structure of a typical Islamic bank as adopted by the
accounting standards.

1/1 Core concept of Islamic bank
As a financial intermediary, the basic mechanism of the Islamic bank is to accept
deposits from surplus persons on the liability side and offer financing on the assets
side to the deficit persons. The basic idea is to activate this mechanism on acceptable
Islamic modes which preclude payment or receipt of interest and conform to the jurist
rules of Shariah. Formal definitions of accounting elements will be provided later, as
our intention here is only to highlight the basic mechanism.
Liabilities & Assets. Among other things, liabilities of an Islamic bank consist of
two main categories: the usual interest-free current accounts and saving accounts, and
investment accounts based on the profit-and-loss sharing principle (PLS) between the
bank and depositors. The latter is the Islamic alternative of term deposits in
conventional banks where the principles of Mudarabah and Musharakah are adopted
instead of the interest rate. Assets include, among other things, a broad range of
financings: Murabaha, Ijara, Istisnaa, Salam, Mudarabah and Musharakah. It will be
assumed in this course that the reader is familiar with these modes of financing.

Investment structure: For the purpose of accounting standards, two major categories
of investment activities are defined:

Unrestricted investment accounts and their equivalents: These are funds
received by the Islamic bank from investors whereby the Islamic bank is held free
to invest those funds without prior restrictions, including the mixing of these
funds with the bank’s own investment. In this case, rules of unrestricted
Mudarabah are adopted.

Restricted investments and their equivalents : The bank acts only as manager –
agent or non-participating Mudarib – not authorized to mix his own funds with
those of investors without prior permission of the investors.

Fiduciary service for funds devoted for social purposes: The financial statements
of Islamic bank must also reflect its functions as possible agent of Zakah payment,
manager of charitable funds and Qard Fund.

The above financing, investment and unique religious features have proved to reflect
far reaching implications as regards the preparation and presentation of financial
statements of Islamic banks. The accounting treatment of different Islamic modes of
financing will arouse various issues of recognition, measurement and disclosure.
Similar issues arise with respect to investments, depending on their type, where
investors are allowed to subscribe or withdraw their funds totally or partially during
the period of investment.

1/2 Common grounds with conventional banks
Apart from its detailed characteristics, Islamic accounting shares with their
conventional counterparts the same common process of recognition, measurement and
recording of transactions and fair presentation of rights and obligations Recognition
of rights and obligations must apply to a given period of time tracing all changes of
consummated transactions that may have taken place. Measurement is the
quantification of financial effects of consummated transactions and the impact of
other events during the same period of time. The recording process offers a lucid
classification scheme of financial effects together with other events, in order to show
the results of the entity’s operations and changes in its financial positions including
cash flow. Periodic reports are, then, prepared and issued by the entities to disclose
their financial records during a given period of time.

Information so reported would then assist investors to take the right decisions with
respect to their future dealings with the entity in question. It also assists the entity’s
own management to evaluate its performance and lay future plans for the entity’s
activities and financial services. Governmental agencies benefit a great deal from
such reported information in the process of supervising the banking and financial
sector and evaluating tax policies. Governmental regulatory requirements for
conventional financial institutions are also shared by Islamic entities, like the basic
provision of having adequate banking capital to provide safety for depositors’ money.
Given the provision of adequate capital, success of Islamic banks depends on
compliance with Shariah as well as the financial competence to realize rates of return
commensurate to investment risks assumed.

1/3 Scope of lecture:

Due to the time constraint, we shall focus in this lecture on the following topics:

1. Objectives of financial accounting for Islamic financial institutions
2. Basic assumptions and criteria for Islamic accounting
3. General lay out of Islamic financial statements.

Therefore, accounting standards for the various Islamic modes of financing are
beyond the scope of this brief presentation. The present lecture is based on the
Accounting and Auditing Standards For Islamic Financial Institutions, 1997,
published by AAOIFI (the Accounting and Auditing Organization for Islamic
Financial Institutions). Since its establishment in 1991, the Bahrain-based AAOIFI
has been catering its advisory services as the professional body responsible to develop
suitable accounting and auditing standards for Islamic banks. Additional help can be
obtained from other references Listed at the end.

II. Objectives of financial accounting
To achieve the desired success, accounting standards for Islamic banks should be
developed consistently in relation to the unique objectives of financial accounting for
Islamic banks and institutions. It is for this reason, as well as the need to ensure
consistency among all present and future accounting standards, that the Islamic
objectives have to be clearly specified. The setting of clear objectives for financial
accounting of Islamic banks and institutions, as opposed to their conventional
counterparts, will also assist Islamic banks, in the absence of accepted accounting
standards to make sensible judgements for choice among alternative accounting

The objectives of financial accounting determine the type and nature of information
which should be included in the financial reports in order to assist users of these
reports in making sound decisions. Governments agencies, generally, have the power
to directly obtain the type of information that best serves their needs. This leaves
external users of information limited to the common information contained in the
Islamic banks financial reports, namely: equity holders, holders of investment
accounts, current and saving account holders, other depositors, other dealers with
Islamic banks, Zakah agencies and regulatory agencies. On this basis, the objectives
of financial accounting for Islamic banks and institutions are to achieve the following:

1. Determine the rights and obligations of all interested parties, including rights
and obligations resulting from incomplete transactions and other events, in
accordance with the principles of Shariah and its concepts of fairness, clarity
and business ethics.

2. Subscribe to the safeguarding of Islamic banks’ assets, rights of Islamic banks
and rights of others in an adequate manner.

3. Subscribe to the enhancement of management and Islamic banks’ productive
capabilities, and encourage compliance with the established goals and policies,
and above all Islamic Shariah, in all transactions and events.

4. Provide through financial reports useful information to report users, and thus
enable them to make legitimate decisions in their dealings with Islamic banks.

On the other hand, the objective of financial reports are to provide the following kinds
of information :

1. Information about the Islamic bank’s objectives and the extent of its
compliance with Shariah. And, if the bank is partly engaged in prohibited
dealings, information about the separation of such dealings and how to
dispose of them.

2. Financial information assisting users to evaluate the adequacy of the Islamic
bank’s capital, risks inherent in investment, and degree of liquidity for
meeting the outstanding obligations.

3. Information to assist in the assessment of Zakah on Islamic banks’ funds and
the targets of its dispersal.

4. Information about cash flows, their timing, and associated risks. This will help
users evaluate an Islamic bank’s ability to generate sufficient dividend income
for equity and profits for investment holders.

5. Information to assist in evaluating the Islamic banks’ discharge of its fiduciary
responsibility, to safeguard funds and invest them at reasonable rates of return.
This includes information about investment rates of returns on the bank’s
investments and the rates of return accruing to equity and investment holders.

III. Basic assumptions and criteria for financial accounting :

3/1 A

Accounting unit : As per Resolution No. 65/17, 7th Session of the Fiqh
Academy, Jeddah, 9-14 March, it is possible in Islamic jurisprudence to form
a limited liability company. This provision allows for the treatment of the
Islamic bank as a separate accounting unit from its owners.

On-going concern: In the absence of persuasive evidence to the contrary,
financial accounting assumes the continuation of an entity as an on-going
concern. This has an important implication to Islamic banks as there is not
perceivable time horizon of assets liquidation or investment termination in
case of equity owners and owners of unrestricted investment accounts or their
equivalents. In most cases there is no specific time when actual investment
results would be known. This point will have implications for the issue of

Periodicity: Life of the Islamic bank should be broken into reporting periods
to prepare financial reports that provide information to interested parties about
the performance of the bank.

Stability of purchasing power: Financial accounting uses monetary units as a
common denominator to express basic elements of financial statements.
However, the use of monetary units is subject to inflationary and deflationary
pressures which may significantly affect its purchasing power. For the
purpose of accounting standards such effects are completely ignored.

Qualitative Criteria of accounting information

Usefulness: Usefulness of accounting information must be evaluated in
relation to the objectives of presenting financial statements which are focused
on making their external users make the best out of them. Hence, to be useful
accounting information must target the interest of external users.

Relevance: A close relationship must exist between the financial accounting
information and the purpose for which this information is provided.
Accounting information is relevant if it helps the main users of financial
statements to evaluate the potential outcomes of maintaining, or establishing,
relationships the given Islamic bank, rather than assisting investors to choose
from alternative options. To be relevant, accounting information must satisfy
three main qualities.
Predictive value makes it possible for users to asses the potential
outcome of a current or a new relationship with the bank.
Feedback value assists users to check the accuracy of their prior
predictions, say, about net income.
Timeliness means information is only useful at the time when it is
needed. Optimal frequency of reporting and minimal lag between
successive reports are therefore important criteria for useful accounting

Reliability: This is the quality which permits users to depend on the reported
information with confidence, but reliability does not mean absolute accuracy.
It means that based on all the specific circumstances surrounding a particular
transaction or event, the method chosen to measure/disclose its effects
produces information that reflects the substance of the event or transaction.
The provision of estimates /judgements in accounting applying methods is not
inconsistent with Shariah. Most particularly, reliability should satisfy the
following properties of representational faithfulness, objectivity and

Comparability: Usefulness of accounting information is enhanced by
comparability of bank’s performance over time. This property requires the
adoption of similar methods of measurement/ disclosure in relation to similar

Consistency: Banks should stick as much as possible to the same
measurement/disclosure methods from one period to another, unless there is
genuine call for change ( e.g changing depreciation measurement). In this
case, the new change and its effect should be appropriately disclosed.

Understandability: Accounting information is targeted to common users not
to accountants. The nature of information, the way it is presented and the
technical background of external users are important factors in the preparation
of understandable information. Use of simple classification tools, clear
information headings, juxtaposition of data and statement of net results which
users want to know, would contribute to better understandability.
3/3 Recognition / measurement & revaluation criteria:
Accounting recognition : refers to the timely recording of the basic elements of
financial statements as they take effect, which is the reason why a clear definition of
accounting elements must precede their recognition. It is worth noting that recognition
relates to accounting flows rather than stocks since the stocks will, then, be
automatically recognized. This issue is particularly crucial as regards recognition of
assets acquired under various Islamic modes of financing , profit/loss investment
accounts, and funds ((e.g when should Murabaha profit, or Mudarabah capital, be
recognized ? when should investment profit be recognised, and how is it measured?).
The rules governing recognition and measurement must be appreciated by reference
to Shariah rules.

Accounting measurement: refers to the determination of the amounts at which
accounting elements should be recognized. Measurement of accounting flows requires
the matching of incomings with the corresponding outgoings, separately, for each
independent account during a given period of time, e,g the matching of revenues and
gains with expenses and losses to get the bank’s net income for a given period of

Measurable attributes: Measurable attributes of an asset or a liability fall broadly
into two categories: cash equivalent value and historical cost. The latter stands for
the cash value expected to be realized as of the current date if an asset is sold for cash
in the normal course of business. The formers stands for the asset’s fair value at the
date of its acquisition including amounts incurred to make it usable or ready for
disposition. These two attributes invoke significant implications as regards
measurement of assets acquired under various modes of financing. They also relate to
the issue of revaluation of unrestricted investment accounts and restricted investment

3/4 Issue of Revaluation
Measurement attributes, as defined above, provide for the possibility of adopting cash
equivalent value by the Islamic bank both as a joint investor in the unrestricted
investment accounts and as a manager as in the restricted investment accounts.

Justice consideration: In general, the value the holder of an investment account
expects to realize from his funds is considerably dependent upon the cash equivalent
value he expects to realize if investments were re-valued, or sold, as of the current
date. Yet, the results of investments do not occur at a given point of time. Rather, such
results are earned over the life time of the investments even though the ultimate
results will become certain only at the time when the investments are liquidated.
However, if investments were to be measured at historical costs, recognition of
investment results will only take place at the time of investment liquidation. This

point arouses a strong consideration of justice between holders of investments
accounts since they are allowed to subscribe or withdraw their investments at different
times during the period of the contract. In case of unrestricted investment accounts,
justice has to be observed, not only between holders of unrestricted investments, but
also between them as a group and the equity owners of the bank as a group.

Revaluation of assets/liabilities and restricted investments: Measurement of cash
equivalents expected to be realized or paid require periodic revaluation of assets
liabilities and restricted investments. However, the currently adopted standard is that
“ historical cost shall be the basis used in measuring and recording the assets at the
time of acquisition thereof”. Nonetheless, it is permissible to do the revaluation for the
purpose of presenting supplemental information which may relevant for an existing or
a potential holder of an investment account.

3/5 Preparation and presentation criteria:

Materiality: An item is regarded material – qualitatively or quantitatively – if its
omission non-disclosure or misstatement will result in distortion of the
information being presented in the financial statements and thereby, misguidance
of users. In deciding whether an item is material, its nature and amount must be
taken into account.
Qualitative materiality refers to the nature of given transactions or events
whether it is usual/unusual, expected/unexpected, Shariah compliant/non-
compliant, etc.
Quantitative materiality refers to the relative amount of an item as for
compared with normal expectations, or relative to an appropriate base.

Cost of information: Information is a costly economic resource. Therefore, a
process of cost/benefit analysis must underlie the decision to choose the relevant
information for financial reporting.

Adequate disclosure: Basic information about the bank must be disclosed, as
well as currency used, and accounting policies adopted. More generally, financial
statements, notes accompanying them, and any additional presentations should
contain all material information necessary to make them useful to end users.
Optimum aggregation and written descriptions/clarifications are two important
Highly aggregated data conceals useful detail, and highly detailed data can
be side-tracking and confusing. Optimal aggregation is the middle course
which must be adopted.
Heading captions and amounts must be supplemented information just
enough to clarify their meanings. Supplementary notes to financial
statement is an example.
Based on the above assumptions and criteria, the general layout of financial
statements can now be considered.

IV. General lay out of Islamic financial statements :

Islamic financial statements
Share the same broad classification of conventional financial statements as representations of stocks and flows. The stock concept is typical of the balance sheet which provides a summary of the financial position of an entity at a given point of time. The income statement, on the other hand, provides a summary of the inflow and outflows during a given period of time, as it is measured on accrual basis. The latter is
particularly relevant for assessing the operating efficiency of the entity, but not the sate of cash liquidity. It is for this reason that a cash-basis statement is needed to complement the flow concept of financial statements as opposed to the stock concept.

The set of financial statements of an Islamic financial institutions consist of the

Financial statements reflecting the Islamic Bank’s function as an investor
and its rights and obligation regardless of the objective of investment
whether it is profit oriented or socially oriented. Such financial statements
Statement of financial position
Statement of income
Statement of cash flow
Statement of retained earning or statement of changes in owners’

A financial statement reflecting changes in restricted investments managed
by the Islamic bank for the benefit of others, whether based on Mudarabah
contract or agency contract

Financial statements reflecting the Islamic bank’s role as a fiduciary of
funds made available for social purposes when such services are provided
through separate funds:
Statement of sources and uses of Zakah and Charity fund
Statement of sources And uses of funds in the qard fund.
Statement of financial position:
Disclosure & Definitions
The date of the statement must be disclosed. The statement
should include the Islamic bank’s assets, liabilities, equity of unrestricted
investment account holders and its equivalents, and its owners’ equity. Assets
and liabilities should be combined into groupings in accordance of their
nature, and in order of their relative liquidity, but the conventional division
into current and fixed groups is not recommended. Assets should not be set-off
against liabilities unless there is a religious or legal right and an actual
expectation of set-off (e.g deferred profits in Murabaha shall be set-off against
Murabaha receivables). Separate totals for assets, liabilities, unrestricted
investment accounts and their equivalents, and owners’ equity must be
provided. Other considerations of disclosure will be added to their respective
items below.

The following definitions relate to the broad items of the
statement of financial position.

Assets: An assert is any measurable thing that is capable to generate cash
flows or other economic benefits in the future, individually or in combination
with other assets, of which the Islamic bank has acquired the right to hold, use
or dispose of, as a result of past transactions or events.
Disclosure of assets: The following breakdown of assets should be disclosed
either on the face of the financial statement of financial position or the notes to
financial statements:

1. Cash and cash equivalent
2. Receivables ( Murabaha, Salam, Istisnaa)
3. Investment securities
4. Mudarabah investment
5. Musharakah investment
6. Investment in other entities
7. Inventories (including goods purchased for Murabaha prior to
consummation of Murabaha agreement
8. Investment in real estate
9. Assets acquired for leasing
10. Other investments (disclosure of their types)
11. Fixed assets (disclosure of depreciation for significant asset types )
12. Other assets (disclosure of significant types).

Liabilities: A liability is any measurable present bank’s obligation to another
party to transfer assets, extend the use of an asset, or provide services to that
party in the future as a result of past transactions or events. The Islamic
obligation must not be a reciprocal to an obligation of the other party to the

Disclosure of liabilities: The statement of financial position or its note should
disclose the following liabilities:
1. Current accounts, saving accounts and other accounts with separate
disclosure of each category
2. Deposits of other banks
3. Salam Payable
4. Istisnaa Payable
5. Declared but undistributed profits
6. Zakah and taxes payable
7. Other accounts payable

Equity of unrestricted investment account holders and their equivalents:
At the date of the statement of financial position, equity of unrestricted
investment account holders (and their equivalents) refers to the amount of
original funds received minus withdrawals or transfers to other accounts
plus/minus shares in profits/losses. Because of they are based unrestricted
Mudarabah, unrestricted investment accounts and their equivalents are treated
as elements of the financial position. It is noteworthy that equity of
unrestricted investment account holders and their equivalents is not considered
a liability since there is no obligation on the bank to guarantee original
principals except in cases of proven neglect. Likewise, equity of unrestricted
investment account holders and their equivalents is not considered part of
ownership equity because they do no enjoy voting right or entitlement to
profits generated from the use of the bank’s current accounts.

Disclosure of unrestricted investment accounts/equivalents: The method
used to allocate investment profit/loss between the bank and the unrestricted
investment account holders and their equivalents should be disclosed, whether
the bank acts as Mudarib or agent, should be disclosed. Separate disclosures of
assets jointly financed by the Islamic bank and unrestricted investment
account holders and those exclusively financed by the bank should be
provided in supplementary notes.

Owners’ equity: It is the amount remaining at the date of the statement of
financial position, from the Islamic bank’s assets after deducting the bank’s
liabilities, equity of unrestricted investments and their equivalents and
prohibited earnings if any.

Disclosure of owners’ equity: See statement of changes in owners’ equity
4/2 Income statement :
Disclosure, definition and recognition :
The period covered by the income statement should be disclosed .
To the extent applicable, the following information should be disclosed in income
statements with separate disclosures of investment revenues, expenses, gains and
losses jointly financed by the bank and unrestricted investment account holders
and their equivalents, and those exclusively financed by the bank:

Revenues and gains from investments

(-)Expenses and losses from investments

(=)Income (loss) from investments

(-)Share of unrestricted investment account holders from income (loss)
from investments before the bank’s share as Mudarib

(=)The bank’s share in income (loss) from investments

(+)The bank’s share in unrestricted investment income as Mudarib

(+) The bank’s share in restricted investment profit as Mudarib

(+)The bank’s fixed fee as an investment agent for restricted investment

(=/-) Other revenues, expenses, gains and losses

(-) General and administrative expenses

(=) Net income (loss) before Zakah and taxes

(-) Zakah and taxes ( separate disclosures)

(=) Net income (loss)
Definitions & recognition:
The following definitions and methods of
recognition relate to the broad items of the income statement.

Revenues : Gross increases in assets or decreases in liabilities or a combination
of both during the period covered by the income statement which result from
legitimate investment, trading, rendering of services, including investment
management of restricted investment accounts. This excludes increases in assets
or decreases in liabilities due to investment by, or distribution to owners, deposits
or withdrawals by unrestricted account holders or their equivalents, deposits or
withdrawals by current or non-investment account holders or the acquisition of

Recognition of revenues: Revenues should be recognized at the time when
realized. Realization of revenues pre-supposes the fulfilment of three main
conditions: First, the bank should have earned the right to receive revenue through
a completely consummated process. Second, an obligation must fall on another
party to a remit a fixed or a determinable amount to the bank (e.g share in actual
profit). Third, amount should be known and collectible, if not already collected.
Expenses : They are the reverse of revenues: gross decreases in assets or
increases in liabilities or a combination of both resulting from similar activities as
in revenues. This excludes gross decreases in assets or increases in liabilities
resulting from the same sources as defined for revenues.
Recognition of expenses: Expenses are also recognized when realized, either
because the expense relates directly to the earning of revenues that have been
realized or because indirect cost relating to a certain period covered by the income
statement. The latter costs could either be those providing a benefit in the current
period but are not expected to realize reasonable measurable benefits in the future.
Examples are management compensation, bonuses and administrative expenses
which are difficult to allocate directly to specific services performed by others to
the bank or specific assets acquired by the bank. Or, expenses that represent costs
that will benefit multiple periods, like depreciation of fixed assets. These has to be
rationally allocated to to the periods that benefit from the use of such assets.
Gains and losses: A gain is a net increase in net assets which results from holding
assets that appreciate in value during the period covered by the income statement
or from incidental legitimate reciprocal (e.g sale of assets not acquired for sale) or
no-reciprocal transfers (donations), except for non-reciprocal transfers with equity
owners or holders of unrestricted investment accounts or their equivalents. A loss
is a net decease in net assets which results from holding assets that depreciate in
value during the period covered by the income statement or from incidental
legitimate reciprocal and non-reciprocal transfers (e.g penalties by Central Bank,
or involuntary conversion of assets- theft, destruction, etc), except for non-
reciprocal transfers with equity holders or holders of unrestricted investment
accounts or their transfers.

Recognition of gains and losses: Gains/losses are recognized when realized in
one of two possible situations: completion of a reciprocal or non-reciprocal
transfer resulting in gain or loss, or sufficient evidence indicating reasonably
measurable appreciation or depreciation in values of recorded assets or liabilities.
The latter makes up for estimated unrealized gains and losses resulting from
revaluation of assets and liabilities.

Return on unrestricted investment accounts/equivalents: It is the share
allocated to the holders of these accounts out of investment profits/losses as a
result of their joint participation with the Islamic bank with the financing of
investment transactions during the period covered by the income statement – not
an expense (in case of profit) or revenue (in case of loss).

Net income (net loss): It is the net increase (decrease) in owners’ equity resulting
from revenues, expenses, gains, losses, after allocating the return on unrestricted
investment accounts and their equivalents, for the period. It is the result of all on-
going profit oriented operations of the bank and other events and circumstances
affecting the value of assets held by the bank during the period covered by the
income statement. All legitimate changes in equity are included except those
resulting from investment by owners and distributions to owners.

4/3 Statement of changes in owners’ equity
or statement of retained earnings:
Disclosure and definitions:

The period covered by the statement of changes in owners’ equity or
the statement of retained earnings should be disclosed.

Statement of changes in owners’ equity: Basic elements are net income(loss),
investment by and distribution to owners (non-reciprocal transfers). Investment by
owners is the amount of increase in owners’ equity, while distribution to owners is
decrease in owners’ equity. The former results from the transfer of assets, or
performance of service, or the assumption, or payment by owners of an obligation of
Islamic bank for the purpose of increasing their equity in the bank. The latter results
from transfer of assets by the Islamic bank to owners , or performance of services, or
assumption or payment of the owners for the purpose of reducing their equity in the
bank (e.g dividends).
Disclosure of changes in owners’ equity: The statement of changes in owners’
equity should disclose:

Paid-in capital, legal and discretionary reserves, separately, and retained
earnings as of the beginning of the period with separate disclosure of the
amount of estimated earnings resulting from revaluation of assets and
liabilities to their cash equivalents where applicable.

Capital contribution by owners during the period

Net income (loss) during the period

Distributions to owners during the period

Increase (decrease) in legal and discretionary reserves during the period

Paid-in Capital, legal and other discretionary reserves and retained earnings as
of the end of the period with disclosure of the estimated amount of retained
earnings resulting from the revaluation of assets and liabilities to their cash
equivalents where applicable.

Statement of retained earnings: Basic elements are net income (loss), dividends, and
transfers to other owners’ equity accounts. The latter is a decrease retained earnings
resulting from their transfer to legal or other reserves or to the owners’ capital
Disclosure of changes in retained earnings: The statement of changes in retained
earnings should disclose:

Retailed earnings at the beginning of the period with separate disclosure of the
amount of estimated of retained earnings resulting from the revaluation of
assets and liabilities where applicable

Net income (loss) for the period

Transfer to legal and discretionary reserves during the period

Distribution of profit to owners during the period

Retained earnings at the end of the period with separate disclosure of the
amount of estimated retained earnings resulting from revaluation of assets and
liabilities to their cash equivalence where applicable.

4/4 Statement of cash flows: disclosure & definitions
The period covered by the cash flow statement must be disclosed.
The statement should disclose the net increase (decrease) in cash and cash
equivalent during the given period and the balance of cash and cash equivalent at
the beginning and end of the period. As regards transactions and other transfers
that do not require payment or receipt of cash and cash equivalent should be
disclosed (e.g bonus shares, or acquisition of assets in exchange for shares in the
equity of the bank).

Cash and cash equivalent: Currency local or foreign which is available
immediately as means of transacting business (Deposits with central bank, other
Cash flow from operations: Refers to cash inflows or outflows during the period
as a result of transactions and other events whose effects are reflected in the
income statement of the bank (revenues, expenses, gains, losses) except for gains
or losses resulting from the sale of assets acquired by the bank for its own use.
Cash flows from investing activities: refer to cash outflows as a result of the
acquisition of assets for investment including investment for the Islamic bank’s
own use, and/or cash inflows resulting from sale of assets acquired by the bank for
investment or for its own use.
Cash flows from financing activities: refer to cash inflow as a result of
investment by owners, deposits by holders of unrestricted investment accounts
and their equivalent and deposits of the usual bank accounts (current, saving) and
cash outflows resulting from distribution to owners or withdrawals by holders on
the mentioned accounts.

Statement of changes in restricted investment
and their equivalent:

Definitions & disclosure:

Restricted investment accounts and their equivalents:
Because they are
based on restricted Mudarabah, restricted investments are not assets of the
Islamic bank and should not be reflected in the bank’s statement of financial
position. The bank does not have the right to use or dispose of these
investments except within the conditions of the contract between the bank and
holders of these accounts. The statement must show deposits and withdrawals
by holders of restricted investments and their equivalent as of a given date.
Restricted investment profits/losses before the investment manager share
in profits (losses): It is the amount of net increase (decrease) in restricted
investments before the bank’s share as Mudarib or compensation as an
investment agent, other than the result of deposits/ withdrawals.
The investment manager share in restricted investment profits: If the
bank acts as agent, it gets a fixed percentage regardless of investment results,
but no compensation is given to the bank if it acts as Mudarib.
Recognition of restricted investment profit/loss: Restricted investments
profit/ loses are recognized in terms of realized profits/ losses resulting from
reciprocal and non-reciprocal transfers, or as estimated unrealized
profits/losses resulting from the revaluation of restricted investments.

The period covered by the statement of changes in restricted investments/equivalents
should be disclosed. The statement should segregate restricted investments by source
of financing ( e.g accounts or portfolio units) and by type. Disclosure should include
the following:

Balance of restricted accounts at the beginning of the period, with separate disclosure
for the part of the balance which results from revaluation of restricted investment
accounts to their cash equivalents where applicable.

Number of investment units in each of the investment portfolios and the value per
unit at the beginning of the period

Deposits received or investment units issued during the period

Withdrawals or repurchase of units during the period

Bank’s share in investment profit as Mudarib or fixed fee as investment agent.

Allocated overhead expense, if any.

Restricted investment accounts profits/losses during the period with separate
disclosure of the part resulting from revaluation to cash equivalents where applicable

Number of investment units in each of the investment portfolios at the end of the
period and the value per unit.

Note to the statement of changes in restricted investments and their equivalents should

1. Nature of contractual relationship between bank and owners of restricted investments
– Mudarib or agent
2. Rights and obligations associated with each type of investment account or investment

4/6 Statement of sources and uses of funds in the Zakah
and Charity Fund:

Disclosure & definitions:

The period covered by the statement of sources and uses of funds in the Zakah and
Charity Fund should be disclosed. Disclosure should be made of the bank’s
responsibility for the payment of Zakah on behalf of owners of unrestricted
investment accounts and their equivalents. Disclosure should be made of payments
and uses of funds during the period and available funds at the end of the period.
Sources of funds in the Zakah and Charity fund: Zakah is a fixed obligation
calculated by reference to net assets that have appreciated or have the capacity to
appreciate in value over a specific period of time except for assets acquired for
consumption or used in production. In the case of a limited liability company, Zakah
should be based on the company’s net assets, and the total amount be divided between
owners who should then their Zakah obligations personally. Otherwise, the company
should pay out Zakah on behalf of its owners, if it is so authorized. The bank may
also act as an agent of Zakah or other charitable contributions for its various
accounts’ holders and other parties.
Uses of funds in the Zakah and charity fund: These are the eight categories stated
in the Quran ( al-Tawaba: 56)
Fund balance in Zakah and Charity fund: Refers to outstanding funds which have
not been distributed as of a given date.

4/7 Statement of sources and uses of funds in the Qard Fund:

Qard is a non-interest bearing loan allowing borrower to use the loaned funds for a
specific period of time such that the same amount of loan should be returned to lender
at the end of the period – a means of achieving social objectives.
Sources of funds in the Qard fund: Represent gross increase in funds available from
both external and internal sources for lending during the period covered by the
Uses of funds in the Qard fund: Represent the amount of gross decrease in funds
available for lending during the period covered. It includes new loans granted,
repayments of funds previously provided to the fund by individuals on a temporary
basis, and reimbursements of funds made available to the funds by the Islamic bank
from current accounts or prohibited earnings.
Fund balance in the Qard fund: The outstanding collectible loans and the other
funds not loaned or used for other purposes.

The period covered by the statement of sources and uses of funds in Qard Fund
should be disclosed. The above define items should all be disclosed.


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