Sukuk defaults – Country wise analysis

By : Haifa Al Mahmoud, Malak Bakhsh, Sara Aref

Effat University.

Introduction

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) defines sukuk as certificates that provide the investor the right to own the underlying revenue-generating assets and rights and/or services, besides of the income stream they might yield. Sukuk are normally ruled by English law in cases of dispute or arbitration, owing to its trustworthy law provisions.

Since mid-2000s, Sukuk emerged with growing popularity as a realistic and practical shariah compliant long-term financing tool. Malaysia is the largest country in the world for sukuk market, and is committed to continuously advance its financial services industry to meet the ever growing needs of its stakeholders who include, businesses, investors, and the government. Additionally to appeal on the regional and global market levels. This has led to the Sukuk markets around the world to grow and raise significant sources of capital despite a series of substantial amount of sukuk defaults in the Gulf Corporation Countries (GCCs) had blemished the market’s confidence on sukuk, as well as some Malaysian cases such as of Johor Corporation, Ingress Sukuk, Tracoma Holdings, and Nam Fatt Corporation.

Implications of sukuk default

Sukuk defaults elevated numerous questions about the underlying structures and capability of the sukuk as an alternative source of funding as this is issue very crucial since it affects the welfare of all the involved stakeholders. This has laid down more emphasis on the need to identify default risk in sukuk in order to better supervise and manage its affiliated risks. High degree of certainty was needed concerning the post-default process in sukuk transactions since the risk for a default is inherent in all sorts of transactions. Now, the utmost carefully structured products could flop due to conditions beyond investors’ control.

Therefore, this paper aims to shed light on the issue of sukuk default and its implication on several cases. Also, it attempts to analyze the implication of sukuk default on a country’s reputation, the legal aspect and on the investor’s protection.

Sukuk market

As previously mentioned above, the market for sukuk has developed quickly over the last few years with regards to size, numbers, and complexity. Sukuk is now known as a substitute for conventional bonds and is employed in Islamic financing framework for the last two decades. It provides access to foreign governments and corporations to an enormous and increasing Islamic liquidity pool of funds, other than conventional methods.  

While sukuk are supposed to be more secure than the conventional bonds, since they are performed only on asset backed assets, sukuk are now asserted to have lost trustworthiness as a practicable and worthwhile Islamic long-term project financing instrument. Due to the complexity of their structure and several legal issues, it was difficult to apply a reliable rating process for sukuk. However, from a rating view point, evaluating the risk of the issuer’s innate credit strength is central to the final rating result. This was acknowledged when a series of default events took place.

 

For instance, the period 2003 till 2010 witnessed a series of default in some counties. On top of them is Malaysia with nine big cases, then Pakistan with two and one default event in each of Saudi Arabia. Kuwait, and the USA. Those default cases are: Saad Group’s Golden Belt($650 M), East Cameron Gas ($165.6 M), The Investment Dar Company($100 M), New Allied Electronics Indus-tries ( $ 16.4 M) + Maple Leaf(Rs8 billion), Oxbridge Height ($2.82 M), Hartaplus, Ingress ($ 7.2 M), Oilcorp Bhd ($ 20.6 M), PSSB Ship management (RM40 m), Tracoma Holdings (RM 100 m), M-Trex Corporation (RM 60 m), Englotechs HOLDING (RM 50 M), Straight A’s portfolio (RM 200 M), and Malaysian International TunaPort (RM 240 m ). Based on information from RAM rating agencies, there were 24 recorded default events in Malaysia over the period 2003-2010. Other defaults did follow the ones mentioned earlier. A sample of those defaults will be discussed in the next part in this research along with the reasons that lead to their occurrence.

 

Court cases relating to defaulted sukuk

The first case of default revolves around East Cameron Partners (ECP). The structure of the sukuk was made in the following sequence. The issuer SPV, East Cameron Gas Company (ECGP), which is incorporated in Cayman Islands issued USD165.7 million worth of sukuk. The proceeds of the sukuk would be employed to buy the ORRI from the Purchaser SPV, just after the Funding Agreement for USD$ 113.8 million would be made. The left over sum was to be used for a development plan, standby account, and to purchase put options for natural gas to hedge against the risk of fall in gas prices. Then, the originator paid his share of the capital in the form of a transmission of ORRI into the buyer SPV. The next step was that the purchaser SPV would be holding ORRI in the properties, would then entitled to around 90 percent of East Cameron Partners’ net revenue generated though gas production. The gas and oil production would be sold to two sources with Merill Lynch acting as a backup. The Proceeds of the oil and gas sale would be channeled into an allocation account.  When sukuk reach maturity, the issuer SPV would exchange all the sukuk against the amount left to be transferred to the sukuk holders.

 

Reason of default was because that the originator attempted to wrap the sukuk assets that was royalty interests on oil and gas revenues kept by an offshore special purpose vehicle (SPV), into its domain, while the sukuk issuer had been publicized as bankruptcy tool. Meanwhile, the assets were moved in a seemingly shariah compliant true sale. The court holding was that the originator had already sold the underlying assets in a true sale deal.

The second case was for a 5-year musharakah sukuk was issued by The Investment Dar (TID) with the association of ABC Islamic Bank (Bahrain) in 2005. The sukuk offered 6-month LIBOR plus 2% annual, while the 2006 sukuk issue guaranteed a LIBOR plus 1.25 percent for the first 3 years and LIBOR plus 1.75 percent for the rest of the remaining period, to be paid every six months. The Sukuk issued in 2005 were registered on the Bahraini Stock Exchange whereas the 2006 sukuk were issued and registered in Dubai International Financial Exchanges. The first issue was limited and was established in the Cayman Islands. Next, sukuk are issued by the SPV to sukuk investors, primarily against the proceeds of the sukuk. The second issuance was a trust agreement with sukuk holders, the SPV entered into a musharakah agreement, in which the SPV capitalized the proceeds of the sukuk to hold 48.78 of musharakah capital. Instantaneously, the originator, TID, paid its share by shifting all rights, benefits, and entitlements to the TID vehicles and property to musharakah, valued at $157.5 million valuation as specified by a third party and arranged by the partners, thus acquiring the outstanding 52.22 percent of capital in musharakah. The total amount was invested in the motor vehicles and in property assets. The musharakah assets were converted into 150 units, in which TID acquired 76.83 units and the issuer held 73.17 units. The agreement was that the returns on the underlying assets were to be split among the SPV and TID. For more security for the investment, the originator offered an undertaking to repurchase the SPV portion in the underlying assets at the end of sukuk period or in case of early insolvency. As agreed upon between the originator and the SPV, management of the musharakah would be carried out by the originator, in exchange for a fee and plus an incentive fee in case the musharakah accounts would provide a net profit during a given time. The structure of the sukuk was approved by the shariah boards on each partner side.

Later when the agreement took place, TID defaulted under a $100m sukuk in January 2009. The sukuk was ruled by English law using an offshore SPV and the underlying assets were located in Kuwait. Since the sukuk were asset-based, investors were at the theoretical positon to sell the assets if TID.  Following in March 2010, TID gained court defense under Kuwait’s new financial firmness law that ceased all lawsuits related with insolvency towrds TID. TID subsequently settled with Sukuk holders on a six year period of restructuring.

 

 

Reasons for Default

TID was in good financial condition till 2007. But during 2008, TID reported a net loss of KD 80. 3 million, for the first time since its foundation. Two reasons were behind this situation. First, was the unrealized losses of KD 88.14 million relating to an impairment in the value of investments in associates. Second, was the actual realized losses of about KD 9.3 million on investments, which in the eventually led to the downfall of the company. During late 2008, TID defaulted on its debt obligations as to liquidity problems. Early in 2009,TID entered in a debt restructuring plan.  

 

 

 

The third sukuk default occurred on mid-2009, where a Saudi business company defaulted on periodic disbursements. Consequently, Moody’s lowered the rating of the company to junk grade. Few banks in the Gulf were affected harshly by the Saad sukuk default for of their exposure to the deeply distressed Saudi conglomerates who are Saad Group and Ahmad Hamad Al Gosaibi and Brothers.  

Saad Sukuk Structure was based on lease and sublease contracts. The transaction was structured according to a head lease agreement, Golden Belt 1 Sukuk Company, which is a SPV listed in Bahrain, entered into a long Head Lease Agreement with the chairman of Saad, in which the SPV, as head lessee, obtains some land parcels on lease from the Head Lessor, Mr Al-Sanea, for 25 years maturity. The net takings of the sukuk would be employed to pay the total rental amount due in upfront by the issuer/head lessee to the head lessor. Then, the Golden Belt 1 issues sukuk of $650 million in exchange of the leasehold rights on the land parcels and pays full rental payment upfront to owner of Saad Group. Afterwards, according to a sub-lease agreement, Golden Belt 1 sub-leases the land parcels to Saad for five years in return for half yearly rental payments at LIBOR plus 0.85 percent, which happened to be the same return as paid for the Sukuk that was an Ijara contract. This would lead to Saad transfering the rental amounts to the SPV at the promised rate, which enables the SPV to transfer the rental amount to the sukuk holders accordingly. Once they reach maturity, sukuk are then exchanged by the sukuk holders, Saad transfers the sukuk amount to the SPV. 7. The SPV, subsequently pays out the sukuk amount to the investors.

 

Reasons for Default

Saad company had a huge default amount that was $15.7 billion, comprising its Islamic bonds. Saad was confronted with huge liquidity crisis during 2008 and was not able to service its debt obligations promptly. The originator company was surprisingly providing improper and misleading information that was not never delivered to the regulators. Consequently, the Saudi Arabian Monetary Authority (SAMA) halted Saad group assets on May 2009. Additionally, was accused of dishonesty and fraud and was charged of USD10 for misappropriation of the funds of Algosaibi Investment Holding company, the formal owner of the SPV. As a result, the accounts of Saad in Cayman Islands, which were valued at around $9.2 billion, were frozen by November 2009.

 

The fourth and last sukuk case to be discussed in this research will be Nahkeel sukuk, which was Dubai-based. Nahkeel was a high profile and the largest ever sukuk default case to date. It was issued late in 2006, with maturity of 3 years, which raised a total of $3.5 billion. The sukuk were registered on the Dubai International Financial Exchange. The purpose of the sukuk was to finance a property development project for one project in Dubai, which is Nahkeel Co. PJSC. A SPV was established for this purpose under the name of Nahkeel Development Limited. The originator, Nahkeel Holdings 1, was a subsidiary of Nahkeel World, which was itself owned by another public sector company, Dubai World. Nahkeel Holdings 1, Nahkeel Holdings 2 and Nahkeel Holdings 3 held full ownership in Nahkeel Co. PSJS. The sukuk had the status of a sovereign bond by the rating agency as they were issued by public sector.  Investors then, expected an implicit government warranty for the sukuk. In addition the sukuk had a Moody’s (A1) and Standard & Poor’s (A+) ratings.

 

The Nahkeel sukuk had been issued on an Ijarah manfaa basis, which enabled sukuk holders’ to obtain the leasehold interest of the primary assets without transferring the title of the assets to them via SPV. Thus, Sukuk holders had only the right to the stream of income generated by the assets but not on the assets themselves.

The agreement was structured that the SPV, namely Nahkeel Development, would issue Nahkeel sukuk to raise $3.5 billion to purchase the leasehold interest in definite land, building and other property at the Dubai Waterfront, which was valued at that time at AED 15.5 billion in 2006 by Jone Lang Lassalle. The SPV would then transfer the collections of the sukuk to Nahkeel holding 1 and purchases leasehold rights of the underlying properties from Nahkeel Holding 1, for 50 years. Additionally, the SPV, would lease the sukuk assets to Nahkeel Holding 2 for a period of 3 years. The SPV would upon maturing of the lease period at specific price and with payment of the other half of the rental payments.

By November 2009, Dubai World demanded a restructuring of its $26bn debt. Investors feared that its $4bn Nakheel sukuk would also default. The sukuk was governed by English law and structured using English trust law concepts to bestow only beneficial ownership on the investors in the form of leasehold rights. Significantly, leasehold rights are not deliberated real rights under UAE law, where the assets indirectly owned by the government were located. Eventually, the default was prevented by Abu Dhabi bailout of $5 billion.

 

Reasons for Insolvency/default

On the outbreak of the financial crisis over the period 2007-2009, the macroeconomic condition forced Dubai’s government to seek a standstill for $59 billion debt owed by one of the state-owned companies Dubai World, including Islamic sukuk of 3.5 billion. Several factors interplayed and lead to the factors which caused Dubai World to in effect default, including huge short term borrowings, decrease in oil prices, the explosion of the real estate price bubble because excessive supply of residential and commercial properties. At that time, the value of Nahkeel was not clear. Furthermore, the guarantee of Dubai World became worrying since the holding company itself was additional negatively affected by the financial crisis. Moreover, being a holding company, Dubai World may have superior creditors than sukuk holders. Finally, the sukuk’s default was activated by the exact financial situation of the obligor. It was held that if the majoirty of funds in related parties had been utilized sensibly, the halt demand for at least the Nahkeel sukuk, could have been prevented.

 

Conclusion

Despite the defaults which faced Islamic sukuk in the past years in several countries especially in the gulf however it seems Islamic sukuk are still in demand and actually growing and becoming very popular, perhaps due to the increased regulation. This demand can be attributed to that Islamic sukuk are founded on Shariah principles and on real assets such as real estates.

The overall market sentiment show that many investors and business yet believe in rightly believe that Islamic sukuk have decent investment forecasts and are safer than other forms of investment investments when compared with other conventional instruments..  

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Boustany, Iad Georges, 2006, New sukuk technology, (International Financing Review, Middle East). El-Gamal , Mahmoud A., 2007, Mutuality as an antidote to rent-seeking shari‘a arbitrage in islamic finance, Thunderbird International Business Review.

 El-Hawary, Dahlia, Wafik Grais, and Zamir Iqbal, 2004, Regulating islamic financial institutions: The nature of the regulated, Working Paper No. 3227 (World Bank Policy Research ).

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Hassan , Kamal Abdelkarim , and Muhamad Kholid, 2010, Bankruptcy resolution and investor protection in sukuk markets, (QFINANCE).

Howladar, Khalid 2009, The future of sukuk: Substance over form? Understanding islamic securitization, asset-backed and aaoifi principles, (Moody’s Investors Service).

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Ethics and Social Accounting vs. Islamic Accounting

 by  : Hanan Gabil, Wed Al-Nafie and Wejdan Al-Harbi

In early history of accounting, the first name to describe the system of debits and credits in journals and ledger which in fact still the basics of today’s accounting is called Luca Pacioli, year 1494.

 

Accounting is defined as a valuable knowledge to be performed and it is considered to be the main index for all countries’ economy. Accounting is also an essential part in processing information of business and economy activity into financial statements. In other words, accounting is the universal language of business and economics as well as finance. However, unfortunately, there is still fraudulent and dishonest practices in business and economic activities. Accounting can be divided into 6 categories as follows:

  1. Finance Accounting
  2. Management Accounting

iii.  Auditing Accounting

  1. Taxation
  2. Funds
  3. Forensic Accounting.

 

There is no certain activity that could be possible done without relying on accounting, because accounting deals with information that consists of financial status and profitability of economic enterprises.

 

Islamic accounting has existed since the 1500s and has its own principle that not only can decrease the degree of unexpected activities pertaining to accounting process but also increase the welfare of both internal and external parties of the business. That’s because Islamic accounting has an aspect that has more meaning and value which is a similar aspect of conventional accounting too. It comprises of all values required to the most preferable accounting process. This essay details the differences between Social accounting and Islamic accounting.

 

Ethics

Ethics in accounting has been posed after scandals that had the greatest impact of the recent century such as examining collapse hiding, law breaking, fraud and violating moral standards. This setback drove companies towards a common strategic goal – principles of accounting. Thus, the following four elements of principle are essential in ethics:

  1. Honesty and trustworthiness

This rule requires a complete and honest presentation of relevant financial and non-financial information. Information presented should be adequately transparency and must not be used for an ethical advantage. A high degree of integrity and discretion is essential.

 

 

  1. Objectivity

Objectivity requires all professionals and information to be fair and unbiased. Professional judgment must be free from conflict of interest such as hospitality and family relationship. It is strongly recommended to refrain from personal relationships and accepting gifts on duty.

 

  1. Confidentiality of information

Unless absolutely necessary and required by the relevant accounting and auditing standards, confidential information should not be disclosed or be used to gain any unethical advantage.

 

  1. Professional competence and conduct

Professionals are required to have an appropriate level of academic and work competence, preferably related to their field. Any offers of professional duty for which one does not possess sufficient skills to execute the task effectively should be declined. Professionals must always comply with relevant accounting and auditing standards and perform their duties diligently.

 

According to the ethical code of conduct, having a code does not eliminate fraudulent activities. In fact, it is a guide to accountants which needs to be fully accepted by professionals before it can be effectively adopted into practice. Therefore, there are two additional codes that are incorporated into Islamic accounting:

 

  1. Faith-driven conduct

Under Islamic accounting, self-monitoring is fundamental. Self-monitoring may be defined as being constantly conscious of one’s actions and their accountability before Allah on the day of judgment. It is also important to seek Allah’s satisfaction instead of pleasing people while performing professional duties which are consistent with Islamic values and the Shariah. One must always be diligent and sincere in his work and actions. This also stresses on keeping promises and honouring agreements.

 

  1. Legitimacy

Legitimacy requires all professional duties to be according to the Shariah. Accountability to Allah is given priority over accountability to the management. Professionals must have competent knowledge of the Shariah rules and principles through education and formal training. All business activities and transactions must be Shariah compliant and should be verified for religious legitimacy by professionals who are responsible for executing them.

 

Social Accounting

Social accounting is also coined as Social Responsibility Accounting because of its responsibility to measure and inform the public about the social activities undertaken by the enterprise and their impact on the society. It is the vision of  which a business seeks to make a valuable impact on social operations. In simpler words, social accounting can facilitate the identification and management of social risks.

 

Business is a socio-economic activity and its objective is the welfare of the society. It requires full responsibility for providing solutions for social issues. Therefore, the concept of social accounting is to manage huge amounts of funds at their disposal and invest substantial amounts in social activities so as to nullify the adverse effects of industrialization.

 

 

The benefit of social economy is to act as an evidence of social commitment, fulfill its obligations, and advise the government and the general public to form correct opinions that are just and ethical. However, it does have its limitations. It can be labor intensive if strategic planning has not been set, or also been not useful for benchmarking.

 

Islamic Accounting

In an Islamic society, accounting should establish purposes according to Islamic teachings in relation to contemporary accounting thought. Those which are Shariah-compliant are pursued and those that are not are discarded.

 

Certain Islamic ethical principles have a direct impact on accounting policy and principles.

These principles are derived from the Holy Qur’an and the Sunnah, that stresses on the need for justice, truth, and fairness, and are considered to be a society’s priority and responsibility. This also contains specific standards for accounting practices. In Islamic financing principles, it must follow specific elements which gives it distinctive religious identity. These elements  are:

  • Riba (interest): The payment and taking of interest as occurs in a conventional banking system is explicitly prohibited by the Holy Qur’an.
  • Zakat: The process of repetitive distributions of income and wealth is inherently in Islam to guarantee a fair standard of living for every people especially the poor. Zakat is different from a tax, A tax is an obligation of citizens toward the society, whereas zakat is an obligation of a Muslim not only to society but also to Allah.
  • Haram: Islamic banks cannot finance activities or items forbidden in Islam,

Islamic banks give priority to essential production which caters to the needs of

the majority of the Muslim community.

  • Takaful (joint-guarantee): The only type of insurance that would appear to be lawful according to the Shari’ah insurance.

 

Muslims ought to conduct their business activities according to the requirements of their religion which are moderation, justice, kindness, honesty, spending to meet social obligations. Unfairness and greed should be avoided at all times.

 

Applying Islamic accounting principles leaves a beneficial impact directly and indirectly on the internal and external parties of the business; some of which are highlighted below.

 

  • Less possibilities of unexpected activities by the accountant such as fraud in business and society.
  • The creditor will feel more secure in investing their funds in the business.
  • Financial statement and reporting will facilitate better and more accurate decision making by the users.
  • One of the Islamic accounting purpose is to be concerned about the employees and their families when performing their jobs. It can be useful in reducing poverty and increasing the welfare of the society within the company. This increases the purchasing power of the underprivileged which indirectly contributes to the economic growth.

 

The company also benefits from increased profits, customers’ loyalty, trust, positive brand attitude, combating negative publicity, and having a rightful place in the business world.

 

Conclusion

Overall, accounting is the recording of financial transactions and focuses on presenting the information in financial statements, These reports must be prepared according to accounting principles. Accounting also provides essential information to the management to keep the business financially healthy. It places high importance on ethical values. It is of utmost importance for a business to provide accurate evaluation, truth in operations, clear revenues and expenses.

 

Social accounting differs from Islamic accounting. The general concept of Corporate social responsibility (CSR) is to guarantee sustainability which is forbidden under Islamic accounting Exception is only made if it can be regenerated. CSR activities has a direct impact on the social environment. Therefore, it is required by law for CSR activities and information about its operations to be truthfully disclosed to the general public.

 

Because Islamic accounting obligates businesses to follow the Sharia strictly, it is considered a religious responsibility. Economic responsibility requires financial statements to be viable, profitable and efficient whereas ethical accounting is obliged to respect societal and religious values.

 

Therefore, Islamic accounting is considered to be much more complex than the social CSR concept in terms of providing the economy with accurateness, justice without taking or giving interest.

References:

Lewis, M. K. (2001). Islam and accounting. Accounting Forum,25(2), 103-127. doi:10.1111/1467-6303.00058

 

Yarahmadi, H., & Bohloli, A. (2015). Ethics in Accounting. International Journal of Accounting and Financial Reporting,5(1), 356-360. Retrieved April 27, 2017, from www.macrothink.org/

 

Schneider, B. (2017). Accounting Basics: History Of Accounting. Retrieved April 26, 2017, from http://www.investopedia.com/

 

Mishra, S. (2015). Social Accounting: Concept, Definition, Features and Benefits | Financial Analysis. Retrieved April 27, 2017, from http://www.yourarticlelibrary.com/

 

Islam, M. A. (2015). Social Compliance Accounting Managing Legitimacy in Global Supply Chains. Cham: Springer International Publishing.

 

Asfadillah, C., et al. (2012). The Importance of Islamic Accounting in Modern Era. Cambridge, UK.

 

Comprative analysis of AAOIFI Vs IFSB

Nahlah Aljudaibi, Adwaa S. Melebari and Hanadi Simbawah

Introduction:

Islamic finance has been rapidly grown recent few years nearly 20 percent annual growth in each year (Zeine Zeidane, 2015), The Islamic Financial Services Industry now has assets of over $175billionwith equity of US$15billion. With more than 300 Islamic banks, finance companies, investment banks (Shahul Hameed bin Mohamed IbrahimStandard,2007 )& Poor’s Ratings declare that over all assets held by Islamic financial institutions estimate around $1.8 trillion with probability to increase for double-digit growth over the coming few years to reach about $3 trillion.

Thus the Islamic finance system must adapting a stander accounting system that compliant with sharia rule and has a sharia objective which cares about Din(faith), nafs (life), maal(wealth), nasel(progeny) and aqal (rational). For following these principles and provide stander accounting system to service Islamic finance institutions and  guide the operations of the industry around the world, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) was established since 1991 in Bahrain which was issuing accounting, auditing and Sharia standards for financial reporting at Islamic financial institutions. The another institution that considers as issuing supervisory and regulatory standards and guidelines which are governance standards for Islamic institutions is The Islamic Financial Services Board (IFSB) that established in 2002 in Malaysia.

Before elaborate, the two Islamic accounting stander in details must explain the general principles of Islamic accounting.

 

 

General principles of Islamic accounting;

According to the (Muhammad, 2002), there are three general principles in Islamic accounting

  1. Accountability:

The concept of accountability is that everyone is accountable for his actions on the Day of Judgment.  The accounting man is a person who involves in accounting issue which let him responsible with the mandated and also related parties, forming in financial statements.

  1. Justice

Justice in accounting system has a meaning of honest and cares about ethical and moral value regarding the parties are included in the financial transaction.

  1. Truth:

The measurement and reporting of accounting activity must create justice or fairness for all shareholders and this cannot happen without Truth principle

AAIOIFI:

AAIOIFI is based in Bahrain and operates as an independent international organization with support from some200 institutional members coming from about 45 different countries. Consist of central banks and monetary authorities, financial institutions, accounting and auditing firms, and other institutions that support the international Islamic finance industry.

AAIOFI is a stander for sharia, accounting, auditing, and governance exactly is issued of 88 standers including of 48 Sharia standards, 26 accounting standards, 5 auditing standards, 7governance standards and 2 codes of ethics. The standards are implemented globally even in non-member countries as they are applicable to IFIs worldwide.

The objectives of AAOIFI:

  • To develop accounting and auditing thoughts relevant to Islamic financial institutions
  • To disseminate accounting and auditing thoughts relevant to Islamic financial institutions and its applications through training, seminars, publication of periodical newsletters, carrying out and commissioning of research and other means
  • To prepare, promulgate and interpret accounting and auditing standards for Islamic financial institutions
  • To review and amend accounting and auditing standards for Islamic financial institutions

AAOIFI carries out these objectives in accordance with the precepts of Islamic Shari’a which represents a comprehensive system for all aspects of life, in conformity with the environment in which Islamic financial institutions have developed. This activity is intended both to enhance the confidence of users of the financial statements of Islamic financial institutions in the information that is produced about these institutions, and to encourage these users to invest or deposit their funds in Islamic financial institutions and to use their services.

AAOIFI Standards

Shari’ah Standards

Guidance on Shari’a permissibility and rules for specific Islamic finance products and mechanisms. AAOIFI’s Shari’ah standards are typically issued through a professional and meticulous scholarly methodology (known as the due process). The standards development process follows a number of stages, commencing with the commissioning of consultants to conduct a thorough study on a specific topic or issue that greatly impact the Islamic finance industry. The study involves Shari’ah characterization of the topic in question and the compilation of Fiqh academy fatwas and collective fatwas pertaining to the topic, and it accounts for all relevant practical applications. The exposure draft is then submitted to the respective Shari’ah standards subcommittee which discusses and reviews it. If approved, the consultant will be commissioned to prepare an exposure draft on the same topic or issue. The first exposure draft will then be discussed with the subcommittee prior to submission to the Shari’ah Board for further discussion and elaboration.

Accounting Standards

Guidance on accounting treatment for specific Islamic finance products and mechanisms and guidance on presentation of financial statements for Islamic financial institutions. Accounting standards due to the unique characteristics coupled with the growing demand of IFIs’ products and services so as to facilitate and enhance the credibility and reliability of the financial statements and reports. It is argued that the current standards which are based on conventional framework seem insufficient to guide the IFIs. Currently, the various IFIs apply different accounting standards in their preparation of their accounts due to the absence of Islamic accounting standards (Zaini, 2007). The trend towards the AAOIFI standards has become a pressing issue that has generated heated debate among Organization of Islamic Cooperation countries.

AAOIFI accounting standards have been made part of mandatory regulatory requirement in jurisdictions such as Bahrain, Jordan, Oman, Qatar, Qatar Financial Centre, Sudan, and Syria.

AAOIFI accounting standards have also been adopted by Islamic Development Bank Group, a multilateral institution.

In addition, AAOIFI accounting standards have also been used as basis of national accounting standards in jurisdictions such as Indonesia and Pakistan..

Auditing, Governance and Ethics Standards

AAOIFI auditing, governance and ethics standards are not part of mandatory regulatory requirement for Islamic finance.  Instead, these standards are used voluntarily by leading Islamic financial institutions across all major Islamic finance jurisdictions.

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.

AAIOFI’s Governance Standards aim to enhance the role of SSB in corporate governance. Provide guidelines to harmonize the SSB’s structure 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.

AAOIFI’s code of ethical structure conduct consists of three sections; namely the foundations of accounting ethics, the principles of ethics for accountants, and the rules of ethical conduct for accountants. The foundations of accounting ethics delineate seven basic foundations; namely, integrity, vicegerency, sincerity, piety, righteousness, Allah-fearing, and, accountability to Allah. From these seven foundations, AAOIFI developed six basic ethical principles; namely, trustworthiness, legitimacy, objectivity, professional competence and diligence, faith-driven conduct, and professional conduct and technical standards. Finally, for all six ethical principles, they developed guiding rules for accountants in their professional works.

IFSB:

Islamic Financial Services Board, it’s an international organization that issues guiding principles and standards for association to central bank and monetary authorities and other institutions that are responsible for regulation and supervision of Islamic financial services industry. IFSB was founded in Malaysia 2002 and started operation on 2003. It serves as an International standard-sitting body of regulatory and supervisory agencies to ensure soundness and stability of the Islamic financial services industry in banking, capital market, insurance.

IFSB definesShari’ahgovernance system as a set of institutional and organizational arrangement through which an Islamic financial institution ensures that there is effective independent oversight of Shari’ah compliance over each of the following structures and process:

  1. a) Issuance of relevant Shari’ah pronouncement or resolution. This refers to a juristic opinion on any matter pertaining to Shari’ah issues in Islamic finance given by the appropriately mandated Shari’ah board.
  2. b) Dissemination of information on such Shari’ah pronouncement or resolutions to the operative personnel of the IFIs who monitor the day-to-day compliance with the Shari’ahresolutions vis-à-vis every level of operations and each transaction. However, this task would normally be done by the internal Shari’ah compliance department.
  3. c) An internal Shari’ah compliance review or audit reports that if there is any incident of non-compliance, it should be recorded and addressed and rectified. With regard to this, IFSB-3 sets out that Shari’ah resolution issued by the Shari’ah boards should be strictly adhered to. d) An annual Shari’ah compliance review or audit for verifying that internal Shari’ah compliance review or audit has been appropriately carried out and its findings have been duly noted by the Shari’ah boards.

The IFSB members have increased from 9 in 2003 to 188 members in 2016with 3 membership type:

1)      31 as full members.

2)      22 as associate members.

3)      125 as observer members.

The ISFB consists of:

  • The general assembly, which includes all members of the ISFB
  • The council, which acts as the policy making body of the IFSB and includes the senior executive of each full member of the organization
  • The technical committee, which advises the council on issues and consists of up to 15 persons appointed by the council
  • The working group, which drafts standards and guidelines and reports to the technical committee
  • The secretariat, which acts as the permanent administrative body and is headed by a secretary-general appointed by the council

 

 

The objectives of the IFSB are:

* To promote the development of a prudent and transparent Islamic financial services industry through introducing new, or adapting existing, international standards consistent with Sharî’ah principles, and recommending these for adoption

* To provide guidance on the effective supervision and regulation of institutions offering Islamic financial products and to develop for the Islamic financial services industry the criteria for identifying, measuring, managing and disclosing risks, taking into account international standards for valuation, income and expense calculation, and disclosure.

* To liaise and cooperate with relevant organizations currently setting standards for the stability and the soundness of the international monetary and financial systems and those of the member countries.

* To enhance and coordinate initiatives to develop instruments and procedures for efficient operations and risk management.

* To encourage cooperation amongst member countries in developing the Islamic financial services industry.

* To facilitate training and personnel development in skills in areas relevant to the effective regulation of the Islamic financial services industry and related markets.

* To undertake research into, and publish studies and surveys on, the Islamic financial services industry.

* To establish a database of Islamic banks, financial institutions and industry experts.

IFSB Standards

the IFSB has issued twenty-seven Standards, Guiding Principles and Technical Note for the Islamic financial services industry. The published documents are on the areas of:

  1. Risk Management (IFSB-1)
  2. Capital Adequacy (IFSB-2)
  3. Corporate Governance (IFSB-3)
  4. Transparency and Market Discipline (IFSB-4)
  5. Supervisory Review Process (IFSB-5)
  6. Governance for Collective Investment Schemes (IFSB-6)
  7. Special Issues in Capital Adequacy (IFSB-7)
  8. Guiding Principles on Governance for Islamic Insurance (Takāful) Operations (IFSB-8)
  9. Conduct of Business for Institutions offering Islamic Financial Services (IIFS) (IFSB-9)
  10. Guiding Principles on Sharī`ah Goverance System (IFSB-10)
  11. Standard on Solvency Requirements for Takāful (Islamic Insurance) Undertakings (IFSB-11)
  12. Guiding Principles on Liquidity Risk Management (IFSB-12)
  13. Guiding Principles on Stress Testing (IFSB-13)
  14. Standard on Risk Management for Takāful (Islamic Insurance) Undertakings (IFSB-14)
  15. Revised Capital Adequacy Standard (IFSB-15)
  16. Revised Guidance on Key Elements in the Supervisory Review Process (IFSB-16)
  17. Core Principles for Islamic Finance Regulations (IFSB-17)
  18. Guiding Principles for Retakāful (Islamic Reinsurance) (IFSB-18)
  19. Recognition of Ratings on Sharī`ah-Compliant Financial Instruments (GN-1)
  20. Guidance Note in Connection with the Risk Management and Capital Adequacy Standards: Commodity Murābahah Transactions (GN-2)
  21. Guidance Note on the Practice of Smoothing the Profits Payout to Investment Account Holders (GN -3)
  22. Guidance Note in Connection with the IFSB Capital Adequacy Standard: The Determination of Alpha in the Capital Adequacy Ratio (GN-4)
  23. Guidance Note on the Recognition of Ratings by External Credit Assessment Institutions (ECAIS) on Takāful and ReTakāful Undertakings (GN-5)
  24. Quantitative Measures for Liquidity Risk Management (GN-6)
  25. Development of Islamic Money Markets (TN-1)
  26. Stress Testing (TN-2)
  27. Guiding Principles on Disclosure Requirements for Islamic Capital Market Products (IFSB 19).

Conclusion:

This paper discusses the important role of AAIOFI and IFSB to ensure that the whole activities of financing activities are in line with the Shari’ah. Also the paper including comparison between AAIOFI and IFSB, the country that host it , objectives, members, standards ,rules and regulation.

 

 

References:

Lumpur, K. (2015). IFRS vs AAOIFI : The Clash of Standards ?, (March 2007). Trokic, A. (n.d.). Islamic Accounting ; History , Development and Prospects, 1–6. \Lumpur, K. (2015). IFRS vs AAOIFI : The Clash of Standards ?, (March 2007).

Kingdom, U. (2012). AAOIFI – Governance and Auditing Standards, (September).http://www.ifsb.org/objectif.php

Nawal Kasim, Sheila Nu NuHtay, S. A. S. (2013). Comparative Analysis on AAOIFI , IFSB and BNM Shari ’ ah Governance Faculty of Accountancy. International Journal of Business and Social Science, 4(15), 220–227. Retrieved from http://ijbssnet.com/journals/Vol_4_No_15_Special_Issue_November_2013/28.pdf

The automobile financing using Islamic contracts

by : Fatima Abalhareth

  1. Introduction

Shop around before you make a decision about buying or leasing. Consider the offers from different dealers and several sources of financing, including banks, credit unions, and finance companies. Comparison shopping is the best way to find both the vehicle and the finance or lease terms that best suit your needs as an example of our project today is a vehicle specifically Islamic Vehicle Financing.

This study will attempt to investigate tow big ideas; first what is the Islamic vehicle financing done with the Saudi Arabia Banks. To achieve the objectives of the study, we shall compare between the conventional finance and Islamic finance, especially on the process of vehicle finance on details. Second, we’ll move to the calculation part which is how Islamic banks in Saudi Arabia provide these services in their contracts to enhance the study.

1.1 The Vehicle financing

The vehicle financing is in direct lending, when get a loan directly from a bank. After the agreement to pay, over a period of time, the amount financed, plus a finance charge. Once enter into a contract with a dealership to buy a vehicle, you use the loan from the direct lender to pay for the vehicle. In Other hand, it is in dealership financing, which is another common type of vehicle financing, getting financing through the dealership, and a dealer, enter into a contract where you buy a vehicle and agree to pay, over a period of time, the amount financed plus a finance charge. The dealer may retain the contract, but typically sells it to a bank, finance company or credit union — called an assignee — that services the account and collects your payments.

Before we buy or lease a vehicle should be attention on these 3 points:

  1. Consider Federal and State Laws. b. Determine How Much You Can Afford. c. Monthly Spending Plan. Also, if we want to lease a vehicle must be considered the monthly payments on a lease usually are lower than monthly finance payments on the same vehicle because you are paying for the vehicle’s expected depreciation during the lease period, plus a rent charge, taxes, and fees. But at the end of a lease, you must return the vehicle unless the lease agreement lets you buy it and you agree to the purchase costs and terms.

However, to determine if leasing fits your situation:

  • Consider the beginning, middle and end of lease costs.
  • Compare different lease offers and terms, including mileage limits.
  • Consider how long you may want to keep the vehicle.

For instant:

Term 3 Years – 36 months 5 Years – 60 Months
Purchase Price $31,000 $31,000
Down Payment (20%) $6,200 $6,200
Amount Financed $24,800 $24,800
Contract Rate (APR) 5.00% 5.00%
Finance Charge $1,958 $3,280
Monthly Payment Amount $743 $468
Total of Payments $26,758 $28,080

 

  1. Difference between Islamic & Conventional Financing

The basic difference between Islamic Banking and conventional banking is the contractual relationship. This fundamental difference posed a totally different outlook on what happens after that. The contract between a customer and a conventional bank is simple; a loan where interest is charged upon. But look at an Islamic contract. The contract defines the relationship, the responsibilities, the subject matter, and the sequencing and ownership requirements for the use in an economic transaction. However, the transaction explains the rewards and returns on the completion of the contractual obligation by the regulators of the Shariah Committee; Cause and effect, risks and compensating return, action and rewards. The deployment of Islamic Banking funds is not for charity. It is still a business that should not charge interest. Moreover, the return on Shareholder capital is also important to ensure that capital is continued to be invested into Islamic Banking for it to grow. With growth comes the ability to continue supporting the ummah, the Muamalat defined within Shariah-compliant transactions. The main difference between Islamic Banking and conventional banking is that the concept of justice to customer is not regulatory driven; it is conceptually driven by the idea of Islamic Banking itself. A lot of conventional banking practices are developed to maximize returns while minimizing risk and risk-transference is a key consideration for conventional banks. Regulators have to be vigilant to ensure conventional banking to the line to protect customer’s interests.

  1. ISLAMIC VEHICLE FINANCING Vs CONVENTIONALVEHICLE FINANCING

With the increasing demands of everyday life, vehicle ownership has shifted from a mere luxury to a vital necessity. Purchasing a car is often the second most expensive, yet important purchase, after buying a home. While doing so, an individual has two options available: either to make a hand on hand (cash) purchase or to go for Vehicle financing. However, due to the exorbitant car prices and lack of the funds available, many individuals prefer the latter option and approach the various financial institutions, which provide this facility at different rates.

Vehicle Ijarah’ has been designed according to the principles of Islam and is completely interest-free. Moreover the Ijarah contract and other documentation also comply with Shariah requirements. On the other hand, a conventional car-financing scheme is actually an Interest based loan given by the financial institution and interest is charged on that loan. Also, in conventional car-leasing arrangements, the lease contract is not in compliance with Islamic Shariah and has Riba and other un-Islamic elements in it.

In ‘Car Ijarah’ the asset remains in the ownership and risk of the bank and the customers only pay the rentals for use of the asset; just like house rent. These basic differences are described in detail as the first term is (leasing or financing) that traditional systems provide financing for purchasing car, i.e. In essence, they are giving loan and earning interest. The Islamic car financing – It is not a financing scheme rather it is a lease contract. Ijarah is based on a lease contract. It is not a mixture contract. IJARAH is an Arabic term with origins in Islamic Fiqah, meaning to give something to rent. Leasing is a contract are transferred from the lessor, to another person is the lessee, at an agreed-upon price called the rent, and for an agreed-upon period of time called the term of the lease that is a second term (rental or installment).

Also, the term of (down payment or security deposit) that is in Ijarah the buyer is required to keep a security deposit at the bank. The minimum requirement for security deposit is 20% of the car value and the maximum is 50%. The requirement is different in the case of conventional car financing is a down payment made by the buyer of the car. The amount required for the down payment is 20% of the price plus the installment for the first year. Both the down payment and the security deposit mentioned above are one-time payments. However, the return in the Islamic mode of financing, the buyer has the right to return the car anytime during or at the end of the lease period, but in a conventional car financing the customer cannot return in any case.

  1. The Contracts used for Islamic Vehicle financing

-Murâbaḥah contract; the seller informs the buyer of his cost of acquiring or producing a specified product. The profit margin is then negotiated between them. The total cost is usually paid in installments.

-Ijārah (Lease, lease purchase); A party leases a particular product for a specific sum and a specific time period. In the case of a lease purchase, each payment includes a portion that goes toward the final purchase and transfer of ownership of the product.

Ijārah and murâbaḥah have many similarities and differences. In both financing modes, the bank is not a natural owner of the asset, but acquires it upon receiving a request from its client. Like murâbaḥah, ijārah rentals are paid in installments over time, and are supposed to cover the cost of the asset or the value of an investment for the bank and to provide a fair rate of return on investment. Thus, both contracts create debt. However, in murâbaḥah, the benefits and risks of ownership of the asset are transferred to the client along with ownership, ijārah rentals can be made flexible to reflect changing vehicle business conditions, especially if the rental period is very long. Murâbaḥah and ijārah are easily understood because of their close similarity to conventional financing (installment sales and leasing). Other contracts as Salam (Prepayment, deferred delivery) the buyer pays the seller the full negotiated price of a product that the seller promises to deliver on a future date.

-Istisna’ (Deferred payment, deferred delivery) A manufacturer (contractor) agrees to produce (build) and to deliver a certain good (or premise) at a given price on a given date in the future. The price does not have to be paid in advance (in contrast to Salam). It may be paid in installments or part may be paid in advance with the balance to be paid later on, based on the preferences of the parties.

-Salam and istisna’ are less frequently used debt-based Islamic financing instruments that do not meet the condition of physical possession of the asset for sale; these are the only two exceptions to the principle that one cannot sell a commodity before it comes into existence.

There are four main differences between istisna’ and salam contracts. (i) istisna’ involves the sale of unique manufactured goods as opposed to salam that can be used in standardized goods. (ii) Unlike salam who requires the payment of the full price up front, istisna’ allows for spot, deferred, or even installment payments. (iii) An istisna’ contract can be cancelled unilaterally until the date that the manufacturer starts working on the goods, while the salam contract can be cancelled only before the contract signature. (iv) The time of delivery is fixed in salam, whereas istisna’ can specify a maximum time for delivery after which the purchaser is no longer bound to accept the vehicles.

  1. Islamic vehicle financing by Five Saudi Arabian banks and their products

— Al Rajahy Bank, Car Ijarah is simply a rental agreement under which the car is given to the customer on rent for a period agreed at the time of the contract. The customer is required to deposit an initial amount (security deposit) with the Bank. Upon completion of the lease period the customer has two options, either to return the car and take away the security deposit or take ownership of the car against his security deposit or any other agreed amount via separate sale transaction.

— Bank Al Riyad, Ijarah means lease, rent or wage. Generally, the Ijarah concept refers to selling the benefit of use or service for a fixed price or wage. Under this concept, the Bank makes available to the customer the use of service of assets / equipment such as plant, office automation, motor vehicle for a fixed period and price.

— The National Commercial Bank (NCB), Murabaha is a Shariah-compliant form of financing where the Bank, based on requests from its customers, purchases specific commodities and sells them to the customers at an agreed-upon price equal to the Bank’s cost plus a specified profit margin, which is payable on a deferred basis in agreed-upon installments. The main uses of Murabaha are in residential, commercial real estate, and trade finance.

— Arabi N Bank, Istisna’a is a contract for the acquisition of assets to be manufactured in accordance with the specifications of the one who requests the assets to be manufactured / procured. In this product the Bank can either be the manufacturer/ procurer (Saani) or the party who is seeking the assets to be manufactured/procured (Mustasni). In project finance, the Bank takes the role of Mustasni and agrees with the customer to deliver specified assets for an agreed upon price. The Bank pays for the asset in staged payments. At the same time, the Bank enters into a forward Ijara and leases the assets to be created to the customer with promise to transfer ownership.  The main use of Istisna’a is in project finance combined with forward Ijara to finance the construction of new projects.

–Bank Al Balad, All the above Shariah-compliant financing products are accounted for in conformity with the accounting policies described in these financial statements. They are included in the financing and advances.

  1. Case Study

All banks apply the simple interest formula to calculate the total amount of the loan, then divide the total amount by the number of months. Example: Loan amount is 100000. The profit margin percentage rate is 2%. Number of financing years is 5. The total loan with profit margin is 100000* (1+2%*5) =110000. Monthly installments equals 110000/60=1833.33

Risk Management; in addition to facing common risks with conventional financial institutions, Islamic banks also face their own unique risks. The Shari’ah-compliant nature of assets and liabilities distinguishes them from conventional banks while at the same time exposing them to similar market, credit, liquidity, operational, and legal risks. Notably, differences in opinion among equity risk arise when Islamic banks enter into musharakah and mudârabah partnerships, as providers of funds and they share in the business risk of the activity being financed.  The mark-up risk tends to rank highly for Islamic banks. However, All in all, profit-sharing investment accounts (PSIA), diminishing musharakah, mudârabah, Salam, and istisna’ tend to be considered riskier than murahabah and ijārah. To mitigate risks, Islamic banks use a variety of prudential reserves.

For example, trade-based contracts (murabaha, Salam and istisnaa) and leasing are exposed to both credit and market risks. For example, during the transaction period of a salam contract, the bank is exposed to credit risk and at the conclusion of the contract it is exposed to commodity price risk. However, the unique nature of Islamic financing, with a diverse set of instruments used as sources and uses of funds, calls for the development of new techniques, processes, institutional setup, and procedures to further improve risk management practices and challenge Islamic finance–specific risks.

Further standardization for Shari’ah compliance would benefit Islamic financial institutions. Unlike conventional banking where a unified set of international standards help agents to identify risks associated with the bank’s activities, Islamic financial institutions often face difficulties presenting internationally accepted Islamic instruments to their customers, while it seems challenging to standardize different interpretations of certain religious matters across jurisdictions and Shari’ah scholars.

For example, if a customer is interested in a new car costing Rs. 300,000 for a tenure of five years and is willing to pay a 50% security deposit, the monthly rental would be Rs. 300,000 × 0.014067 = Rs. 4220 per month for five years.

If a customer wants to buy a second hand car, is interested in a car costing Rs.300, 000 for tenure of five years and is willing to pay a 50% security deposit, the monthly rental can be calculated from Table 1.2. The monthly rental would be Rs. 300,000×0.014230 = Rs. 4261 per month for five years. Table 1.3 demonstrates the difference between a Car Ijara and a conventional car lease.

Table 1.1 Rental calculations for new cars

15 0.030399 0.024789 0.021590
20 0.028821 0.023533 0.020515
25 0.027242 0.022277 0.019440
20 0.025664 0.021021 0.018366
35 0.024085 0.019765 0.017291
30 0.022507 0.018508 0.016216
45 0.020929 0.017252 0.015142
40 0.019350 0.015996 0.014067

Security deposit (%)                           3 years                          4 years                                5 years

 

Table 1.2 Rental calculations for used cars

Security deposit (%) 3 years 4 years 5 years
20 0.029412 0.023940 0.020726
25 0.027799 0.022660 0.019639
30 0.026186 0.021379 0.018552
35 0.024572 0.020099 0.017465
40 0.022959 0.018819 0.016378
45 0.021346 0.017539 0.015290
50 0.019732 0.016259 0.014230
 

The Ijara contract is binding under the Sharia’a and does not contain any conditions that make the contract void.

  1. Conclusion

Islamic finance has expanded rapidly and is spreading across many regions. Islamic financial assets grew, on average, about 20 percent annually over the past decade. Despite this growth, Islamic finance still represents a very small share of global financial assets. To this end, several factors still constrain the realization of the full potential of Islamic finance. A few are discussed in this paper, such as lack of liquidity management instruments and underdevelopment of appropriate safety nets, notably Shari’ah-compliant deposit insurance scheme and lender of last resort facilities.

Islamic banks operating in many conventional systems do not have access to Shari’ah compliant tradable short-term treasury instruments to channel excess funds to other Islamic financial institutions. The absence of such instruments restricts growth, forces banks to hold excessive reserves, and also curtails the central bank’s ability to conduct monetary policy operations.

 

 

 

 

 

 

 

  1. Reference list

 

  • Krasicka and Nowak (2012) for more discussion on actions taken by Malaysia to ensure level playing field for the Islamic finance industry.
  • AAOIFI – Accounting and Auditing Organization for Islamic Financial Institutions (1999), Statement on the Purpose and Calculation of the Capital Adequacy Ratio for Islamic Banks, Bahrain: AAOIFI.
  • The National Commercial Bank, Annual Report 2014.
  • Ahmad, Ausaf and Khan, Tariqullah (1997). Islamic Financial Instruments for Public Sector Resource Mobilization, Jeddah, Saudi Arabia: IDB, IRTI.
  • Ahmad, Ausaf and Khan, Tariqullah (eds) (1998). Islamic Financial Instruments for Public Sector Resource Mobilization, Jeddah, Saudi Arabia: IRTI.
  • Sole, Juan, 2007, “Introducing Islamic Banks into Conventional Banking Systems,” IMF Working Paper 07/175 (Washington: International Monetary Fund).
  • Abedifar, P., P. Molyneux, and A. Tarazi. 2013, “Risk in Islamic Banking.” Review of Finance, No. 6 Vol. 17, pp. 2035–2096.
  • Ahmad,Ausaf (1993),‘Contemporary practices of Islamic financing techniques’,research paper no.20,Islamic Research and Training Institute, Islamic Development Bank, Jeddah.
  1. Introduction

Shop around before you make a decision about buying or leasing. Consider the offers from different dealers and several sources of financing, including banks, credit unions, and finance companies. Comparison shopping is the best way to find both the vehicle and the finance or lease terms that best suit your needs as an example of our project today is a vehicle specifically Islamic Vehicle Financing.

This study will attempt to investigate tow big ideas; first what is the Islamic vehicle financing done with the Saudi Arabia Banks. To achieve the objectives of the study, we shall compare between the conventional finance and Islamic finance, especially on the process of vehicle finance on details. Second, we’ll move to the calculation part which is how Islamic banks in Saudi Arabia provide these services in their contracts to enhance the study.

1.1 The Vehicle financing

The vehicle financing is in direct lending, when get a loan directly from a bank. After the agreement to pay, over a period of time, the amount financed, plus a finance charge. Once enter into a contract with a dealership to buy a vehicle, you use the loan from the direct lender to pay for the vehicle. In Other hand, it is in dealership financing, which is another common type of vehicle financing, getting financing through the dealership, and a dealer, enter into a contract where you buy a vehicle and agree to pay, over a period of time, the amount financed plus a finance charge. The dealer may retain the contract, but typically sells it to a bank, finance company or credit union — called an assignee — that services the account and collects your payments.

Before we buy or lease a vehicle should be attention on these 3 points:

  1. Consider Federal and State Laws. b. Determine How Much You Can Afford. c. Monthly Spending Plan. Also, if we want to lease a vehicle must be considered the monthly payments on a lease usually are lower than monthly finance payments on the same vehicle because you are paying for the vehicle’s expected depreciation during the lease period, plus a rent charge, taxes, and fees. But at the end of a lease, you must return the vehicle unless the lease agreement lets you buy it and you agree to the purchase costs and terms.

However, to determine if leasing fits your situation:

  • Consider the beginning, middle and end of lease costs.
  • Compare different lease offers and terms, including mileage limits.
  • Consider how long you may want to keep the vehicle.

For instant:

Term 3 Years – 36 months 5 Years – 60 Months
Purchase Price $31,000 $31,000
Down Payment (20%) $6,200 $6,200
Amount Financed $24,800 $24,800
Contract Rate (APR) 5.00% 5.00%
Finance Charge $1,958 $3,280
Monthly Payment Amount $743 $468
Total of Payments $26,758 $28,080

 

  1. Difference between Islamic & Conventional Financing

The basic difference between Islamic Banking and conventional banking is the contractual relationship. This fundamental difference posed a totally different outlook on what happens after that. The contract between a customer and a conventional bank is simple; a loan where interest is charged upon. But look at an Islamic contract. The contract defines the relationship, the responsibilities, the subject matter, and the sequencing and ownership requirements for the use in an economic transaction. However, the transaction explains the rewards and returns on the completion of the contractual obligation by the regulators of the Shariah Committee; Cause and effect, risks and compensating return, action and rewards. The deployment of Islamic Banking funds is not for charity. It is still a business that should not charge interest. Moreover, the return on Shareholder capital is also important to ensure that capital is continued to be invested into Islamic Banking for it to grow. With growth comes the ability to continue supporting the ummah, the Muamalat defined within Shariah-compliant transactions. The main difference between Islamic Banking and conventional banking is that the concept of justice to customer is not regulatory driven; it is conceptually driven by the idea of Islamic Banking itself. A lot of conventional banking practices are developed to maximize returns while minimizing risk and risk-transference is a key consideration for conventional banks. Regulators have to be vigilant to ensure conventional banking to the line to protect customer’s interests.

  1. ISLAMIC VEHICLE FINANCING Vs CONVENTIONALVEHICLE FINANCING

With the increasing demands of everyday life, vehicle ownership has shifted from a mere luxury to a vital necessity. Purchasing a car is often the second most expensive, yet important purchase, after buying a home. While doing so, an individual has two options available: either to make a hand on hand (cash) purchase or to go for Vehicle financing. However, due to the exorbitant car prices and lack of the funds available, many individuals prefer the latter option and approach the various financial institutions, which provide this facility at different rates.

Vehicle Ijarah’ has been designed according to the principles of Islam and is completely interest-free. Moreover the Ijarah contract and other documentation also comply with Shariah requirements. On the other hand, a conventional car-financing scheme is actually an Interest based loan given by the financial institution and interest is charged on that loan. Also, in conventional car-leasing arrangements, the lease contract is not in compliance with Islamic Shariah and has Riba and other un-Islamic elements in it.

In ‘Car Ijarah’ the asset remains in the ownership and risk of the bank and the customers only pay the rentals for use of the asset; just like house rent. These basic differences are described in detail as the first term is (leasing or financing) that traditional systems provide financing for purchasing car, i.e. In essence, they are giving loan and earning interest. The Islamic car financing – It is not a financing scheme rather it is a lease contract. Ijarah is based on a lease contract. It is not a mixture contract. IJARAH is an Arabic term with origins in Islamic Fiqah, meaning to give something to rent. Leasing is a contract are transferred from the lessor, to another person is the lessee, at an agreed-upon price called the rent, and for an agreed-upon period of time called the term of the lease that is a second term (rental or installment).

Also, the term of (down payment or security deposit) that is in Ijarah the buyer is required to keep a security deposit at the bank. The minimum requirement for security deposit is 20% of the car value and the maximum is 50%. The requirement is different in the case of conventional car financing is a down payment made by the buyer of the car. The amount required for the down payment is 20% of the price plus the installment for the first year. Both the down payment and the security deposit mentioned above are one-time payments. However, the return in the Islamic mode of financing, the buyer has the right to return the car anytime during or at the end of the lease period, but in a conventional car financing the customer cannot return in any case.

  1. The Contracts used for Islamic Vehicle financing

-Murâbaḥah contract; the seller informs the buyer of his cost of acquiring or producing a specified product. The profit margin is then negotiated between them. The total cost is usually paid in installments.

-Ijārah (Lease, lease purchase); A party leases a particular product for a specific sum and a specific time period. In the case of a lease purchase, each payment includes a portion that goes toward the final purchase and transfer of ownership of the product.

Ijārah and murâbaḥah have many similarities and differences. In both financing modes, the bank is not a natural owner of the asset, but acquires it upon receiving a request from its client. Like murâbaḥah, ijārah rentals are paid in installments over time, and are supposed to cover the cost of the asset or the value of an investment for the bank and to provide a fair rate of return on investment. Thus, both contracts create debt. However, in murâbaḥah, the benefits and risks of ownership of the asset are transferred to the client along with ownership, ijārah rentals can be made flexible to reflect changing vehicle business conditions, especially if the rental period is very long. Murâbaḥah and ijārah are easily understood because of their close similarity to conventional financing (installment sales and leasing). Other contracts as Salam (Prepayment, deferred delivery) the buyer pays the seller the full negotiated price of a product that the seller promises to deliver on a future date.

-Istisna’ (Deferred payment, deferred delivery) A manufacturer (contractor) agrees to produce (build) and to deliver a certain good (or premise) at a given price on a given date in the future. The price does not have to be paid in advance (in contrast to Salam). It may be paid in installments or part may be paid in advance with the balance to be paid later on, based on the preferences of the parties.

-Salam and istisna’ are less frequently used debt-based Islamic financing instruments that do not meet the condition of physical possession of the asset for sale; these are the only two exceptions to the principle that one cannot sell a commodity before it comes into existence.

There are four main differences between istisna’ and salam contracts. (i) istisna’ involves the sale of unique manufactured goods as opposed to salam that can be used in standardized goods. (ii) Unlike salam who requires the payment of the full price up front, istisna’ allows for spot, deferred, or even installment payments. (iii) An istisna’ contract can be cancelled unilaterally until the date that the manufacturer starts working on the goods, while the salam contract can be cancelled only before the contract signature. (iv) The time of delivery is fixed in salam, whereas istisna’ can specify a maximum time for delivery after which the purchaser is no longer bound to accept the vehicles.

  1. Islamic vehicle financing by Five Saudi Arabian banks and their products

— Al Rajahy Bank, Car Ijarah is simply a rental agreement under which the car is given to the customer on rent for a period agreed at the time of the contract. The customer is required to deposit an initial amount (security deposit) with the Bank. Upon completion of the lease period the customer has two options, either to return the car and take away the security deposit or take ownership of the car against his security deposit or any other agreed amount via separate sale transaction.

— Bank Al Riyad, Ijarah means lease, rent or wage. Generally, the Ijarah concept refers to selling the benefit of use or service for a fixed price or wage. Under this concept, the Bank makes available to the customer the use of service of assets / equipment such as plant, office automation, motor vehicle for a fixed period and price.

— The National Commercial Bank (NCB), Murabaha is a Shariah-compliant form of financing where the Bank, based on requests from its customers, purchases specific commodities and sells them to the customers at an agreed-upon price equal to the Bank’s cost plus a specified profit margin, which is payable on a deferred basis in agreed-upon installments. The main uses of Murabaha are in residential, commercial real estate, and trade finance.

— Arabi N Bank, Istisna’a is a contract for the acquisition of assets to be manufactured in accordance with the specifications of the one who requests the assets to be manufactured / procured. In this product the Bank can either be the manufacturer/ procurer (Saani) or the party who is seeking the assets to be manufactured/procured (Mustasni). In project finance, the Bank takes the role of Mustasni and agrees with the customer to deliver specified assets for an agreed upon price. The Bank pays for the asset in staged payments. At the same time, the Bank enters into a forward Ijara and leases the assets to be created to the customer with promise to transfer ownership.  The main use of Istisna’a is in project finance combined with forward Ijara to finance the construction of new projects.

–Bank Al Balad, All the above Shariah-compliant financing products are accounted for in conformity with the accounting policies described in these financial statements. They are included in the financing and advances.

  1. Case Study

All banks apply the simple interest formula to calculate the total amount of the loan, then divide the total amount by the number of months. Example: Loan amount is 100000. The profit margin percentage rate is 2%. Number of financing years is 5. The total loan with profit margin is 100000* (1+2%*5) =110000. Monthly installments equals 110000/60=1833.33

Risk Management; in addition to facing common risks with conventional financial institutions, Islamic banks also face their own unique risks. The Shari’ah-compliant nature of assets and liabilities distinguishes them from conventional banks while at the same time exposing them to similar market, credit, liquidity, operational, and legal risks. Notably, differences in opinion among equity risk arise when Islamic banks enter into musharakah and mudârabah partnerships, as providers of funds and they share in the business risk of the activity being financed.  The mark-up risk tends to rank highly for Islamic banks. However, All in all, profit-sharing investment accounts (PSIA), diminishing musharakah, mudârabah, Salam, and istisna’ tend to be considered riskier than murahabah and ijārah. To mitigate risks, Islamic banks use a variety of prudential reserves.

For example, trade-based contracts (murabaha, Salam and istisnaa) and leasing are exposed to both credit and market risks. For example, during the transaction period of a salam contract, the bank is exposed to credit risk and at the conclusion of the contract it is exposed to commodity price risk. However, the unique nature of Islamic financing, with a diverse set of instruments used as sources and uses of funds, calls for the development of new techniques, processes, institutional setup, and procedures to further improve risk management practices and challenge Islamic finance–specific risks.

Further standardization for Shari’ah compliance would benefit Islamic financial institutions. Unlike conventional banking where a unified set of international standards help agents to identify risks associated with the bank’s activities, Islamic financial institutions often face difficulties presenting internationally accepted Islamic instruments to their customers, while it seems challenging to standardize different interpretations of certain religious matters across jurisdictions and Shari’ah scholars.

For example, if a customer is interested in a new car costing Rs. 300,000 for a tenure of five years and is willing to pay a 50% security deposit, the monthly rental would be Rs. 300,000 × 0.014067 = Rs. 4220 per month for five years.

If a customer wants to buy a second hand car, is interested in a car costing Rs.300, 000 for tenure of five years and is willing to pay a 50% security deposit, the monthly rental can be calculated from Table 1.2. The monthly rental would be Rs. 300,000×0.014230 = Rs. 4261 per month for five years. Table 1.3 demonstrates the difference between a Car Ijara and a conventional car lease.

Table 1.1 Rental calculations for new cars

15 0.030399 0.024789 0.021590
20 0.028821 0.023533 0.020515
25 0.027242 0.022277 0.019440
20 0.025664 0.021021 0.018366
35 0.024085 0.019765 0.017291
30 0.022507 0.018508 0.016216
45 0.020929 0.017252 0.015142
40 0.019350 0.015996 0.014067

Security deposit (%)                           3 years                          4 years                                5 years

 

Table 1.2 Rental calculations for used cars

Security deposit (%) 3 years 4 years 5 years
20 0.029412 0.023940 0.020726
25 0.027799 0.022660 0.019639
30 0.026186 0.021379 0.018552
35 0.024572 0.020099 0.017465
40 0.022959 0.018819 0.016378
45 0.021346 0.017539 0.015290
50 0.019732 0.016259 0.014230
 

The Ijara contract is binding under the Sharia’a and does not contain any conditions that make the contract void.

  1. Conclusion

Islamic finance has expanded rapidly and is spreading across many regions. Islamic financial assets grew, on average, about 20 percent annually over the past decade. Despite this growth, Islamic finance still represents a very small share of global financial assets. To this end, several factors still constrain the realization of the full potential of Islamic finance. A few are discussed in this paper, such as lack of liquidity management instruments and underdevelopment of appropriate safety nets, notably Shari’ah-compliant deposit insurance scheme and lender of last resort facilities.

Islamic banks operating in many conventional systems do not have access to Shari’ah compliant tradable short-term treasury instruments to channel excess funds to other Islamic financial institutions. The absence of such instruments restricts growth, forces banks to hold excessive reserves, and also curtails the central bank’s ability to conduct monetary policy operations.

  1. Reference list

 Krasicka and Nowak (2012) for more discussion on actions taken by Malaysia to ensure level playing field for the Islamic finance industry.

  • AAOIFI – Accounting and Auditing Organization for Islamic Financial Institutions (1999), Statement on the Purpose and Calculation of the Capital Adequacy Ratio for Islamic Banks, Bahrain: AAOIFI.
  • The National Commercial Bank, Annual Report 2014.
  • Ahmad, Ausaf and Khan, Tariqullah (1997). Islamic Financial Instruments for Public Sector Resource Mobilization, Jeddah, Saudi Arabia: IDB, IRTI.
  • Ahmad, Ausaf and Khan, Tariqullah (eds) (1998). Islamic Financial Instruments for Public Sector Resource Mobilization, Jeddah, Saudi Arabia: IRTI.
  • Sole, Juan, 2007, “Introducing Islamic Banks into Conventional Banking Systems,” IMF Working Paper 07/175 (Washington: International Monetary Fund).
  • Abedifar, P., P. Molyneux, and A. Tarazi. 2013, “Risk in Islamic Banking.” Review of Finance, No. 6 Vol. 17, pp. 2035–2096.
  • Ahmad,Ausaf (1993),‘Contemporary practices of Islamic financing techniques’,research paper no.20,Islamic Research and Training Institute, Islamic Development Bank, Jeddah.

 

Diploma in Islamic Finance Course 2017

The following list of courses were prepared from the relevant institutions website. Please contact the institutions for further detail. islamic finance courses-1

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Islamic Micro-Finance and SocialResponsibility

2nd Islamic Finance Conference

Islamic Microfinance and Social Responsibility

Jeddah 2016 (IFC2016)

Venue: Effat University – Jeddah- Kingdom of Saudi Arabia

Date: April 20- 21 2016

 

Background of the Conference

The tremendous growth of Islamic finance has proved that Islamic finance is a viable alternative solution for conventional finance. The estimated growth of Islamic finance is around 15% and with $ 1.5 trillion asset worldwide. Islamic Microfinance is still small segment in Islamic finance industry compared to other segments such as Islamic banking and Islamic capital market, etc. Islamic Microfinance is a segment with great potential for growth. It is assessed that Islamic microfinance is 1% of the total Islamic finance. Development of microfinance helps countries to increase their growth and the welfare of the less privileged people in the society. This conference will provide you with opportunities to collaborate with Academics, researchers, government, and practitioners to develop innovative solutions to Islamic micro-financing challenges; and share best practices in this area. This will give participants in this conference the exposure to not only the theory but also the practical applications of Islamic micro-financing and their impact on economic growth.

PROSPECTIVE PARTICIPANTS

The conference is intended for researchers, academicians, regulators, and business entities who are interested in enhancing knowledge and ideas in Islamic Microfinancing.

OBJECTIVES OF THE CONFERENCE

  1. Increase the understanding and awareness of Islamic microfinance and its implementation.
  2. Offer innovative practical solutions related to contemporary challenges on Islamic microfinance.
  3. Provide opportunities to participants share best practices and publish their research on Islamic economics and finance issues.

Strengthen the cooperation on Islamic economics practices among industry, academic institutions, and government.

List of grand themes:

  • Role of Islamic microfinance in social development
  • Entrepreneurship and microfinance
  • Alleviating poverty
  • Socio-economic impact of Islamic microfinance
  • Success stories
  • Miscellaneous topics

REGISTRATION AND ONLINE SUBMISSION: Registration and submission of full paper must be done electronically through the online submission system. Link: http://www.effatuniversity.edu.sa

Abstract Submission: Manuscript should present original idea and not published or submitted for publication in other forums. The abstract should outline the introduction, objectives, methodology, result & analysis, and conclusion. It should not be more than 300 words (MS Word using Times New Roman, 12pt font, maximum of 7 keywords and JEL codes).

Electronic submission of abstract through IFC@effatuniversity.edu.sa email. Author(s) contact information (title, names, affiliations, addresses, telephone numbers, fax numbers and e-mail addresses) must be stated on the first page of paper or abstract.

Paper Publication and Presenter Registration: Every accepted paper must have at least one author registered to the conference by time the paper is submitted; the author is also expected to attend the conference and present the paper. Conference Fees: US$ 200 for participant and US$150 for presenter (US$ 50 for student).

IMPORTANT DEADLINES

  1. Abstract Deadline: March, 10th 2016
  2. Abstract Acceptance Notification: March, 20th 2016
  3. Full Paper Deadline: April, 5th 2016

We look forward to receiving your submissions.

Further details