Financial and Accounting Principles in Islamic Finance

368 Pages·2019·5.88 MB·English

by  Samir Alamad

Samir Alamad
Financial and
Accounting
Principles in
Islamic Finance
Financial and Accounting Principles in Islamic
Finance
Samir Alamad
Financial and Accounting
Principles in Islamic Finance
SamirAlamad
HeadofShariaCompliance&ProductDevelopment
AlRayanBank
Birmingham,UK
ISBN978-3-030-16298-6 ISBN978-3-030-16299-3 (eBook)
https://doi.org/10.1007/978-3-030-16299-3
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I dedicate this work to my mother, Iman, and
my late father, Hamdi, who always
encouraged me, my wife and my daughters.
Preface
ThisbookwasmotivatedbythedesiretofurthertheevolutionofIslamicfinanceand
bankinginthefieldofsocialsciences.Themainobjectiveinwritingthisbookisto
ensurethattheIslamicfinanceindustryisbackedbyarobustliteraturethatwhileit
supportsitsdevelopmentandcontributestoit,itensuresithastheoreticalrootsinthe
academicliterature.ThisistoensureIslamicfinancedeliverswhatitissupposedto
achieve as an alternative financial model, rather than being forced to replicate
conventionalfinance.However,thereisanimportantelementthatshouldbeachieved
first, that is, the human factor. Here, the human factor is those bankers working in
Islamic financial institutions (IFIs), which include all stakeholders, such as banks
shareholders, executives, senior management, managers, Islamic scholars, legal
experts, auditors etc., who are implementing Islamic finance correctly as it should
be without circumventing its values and principles. The other aspect of the human
factorismarketdemand,consumerswhonotonlywanttheirfinancialtransactionsto
adhere to Islamic ethics but also understand the inherent differences in the perfor-
mancesofIslamicfinancialproducts.Withthisinplace,thereisthepossibilitythat
Islamic finance could move to the forefront of the global economic and financial
systemasastable,sustainable,resilientandethicalsocialfinancemodel,whichisthe
higherobjectivethatthisbookaimstoachieve.
This book is not merely an academic work, nor it is a pure practitioner guide;
rather,itisarobustworkthatcombinesboth.Itmarriesrigorousacademicresearch
and theories with practical industry experiences. It is a condensed account of my
own academic and practical experience, which covers working in Islamic financial
services, setting up a Shariah governance system from scratch, developing unique
productportfoliosandadvisingtheUKgovernmentandothernationalandinterna-
tionalinstitutions.Ishareinthisbookaninsideknowledgeandexperiencethatisthe
firstofitskindasanacademic,Islamicfinanceeconomistandapractitionerexpert.
I believe that we are, as stakeholders in the Islamic finance system, part of a
dynamicmovementofthinkers,scholars,researchersandpractitionersdedicatedto
advancingthecauseofIslamicfinance.ThisdoesnotsimplyrefertoIslamicfinance
asameansofavoidinginterestincomeandotherimpermissibleindustries,asmany
participantsatglobalIslamicfinanceconferencesexplaininashallowunderstanding,
vii
viii Preface
failing to explain how and what values and ethical contributions Islamic finance
would offer to society. It saddens me that some self-appointed experts in Islamic
finance diminish the ethical framework of Islamic finance to what a beginner in
IslamicfinancewouldknowandthatIslamicfinancemerelyinvolvesnotinvestinga
list in prohibited activities, such as gambling, arms, alcohol and so on. They fail
miserablytoarticulatehowIslamicfinanceisdifferent,whatvaluesitoffersandhow
itcouldgobeyondconventionalethicalfinance.Imustbehonesthere;Ifeelashamed
whenIhearwhatthoserepresentingtheIslamicfinanceindustrysayanddo,whereas,
in reality, Islamic finance is evolving to respond to the environmental and social
challengesthatwefaceasaglobalcommunity.
OneexampleofthiswasasessionaboutputtingintoactiontheIslamicimperative
to good in society—moving from mandatory Shariah considerations into
recommended,higherprinciples.Thisincludestherulingoncorporatesocialrespon-
sibility (CSR) issued by the Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI). In its ruling on CSR, AAOIFI stresses that all
institutionsneedtohavepoliciesonShariahcompliantcontracts,employeewelfare
andprohibited earnings.Inthat same ruling, theAAOIFIrecommends thatinstitu-
tionsalsohavepoliciesforinvestinginsocialandenvironmentalcauses.
Along those same lines, the Organization of Islamic Cooperation (OIC) Fiqh
Academy explains in a resolution adopted in April 2009 that it is prohibited to
engageinanyactivitythatcausesenvironmentalharm.Thesetypesofadvances,in
thought, show the potential for harmonisation between Islamic finance principles
and international goals for social progress, healthcare and poverty eradication like
those outlined in the United Nations’ Sustainable Development Goals or SDGs.
Many say that it is possible to find an Islamic counterpart to every one of the
17 SDGs. The Holy Qur’an itself speaks of the importance of food, water, safety
andsecurity,allofwhicharecentraltotheSDGs.
The ultimate aim of the SDGs is to end poverty, protect the planet and ensure
prosperityforall.Ifinditencouragingthatthereisatalkofthecentralinstrumentsof
Islamicfinancezakah,waqfandsukukbeingdirectedtowardsthesegoals.Thereare
a few examples of this already being put into practice. A number of socially
responsible investment sukuk are already in place and advance the objectives of
theSDGs.Forinstance,theGlobalAllianceforVaccinesandImmunization(GAVI)
Sukuk,whichfundsimmunisationprogramsintheworld’spoorestcountries,hasa
goaltoperpetuatehealthandwell-being.Additionally,theworld’sfirstgreensukuk
hasbeenissuedinMalaysiaandIndonesia.However,sucheffortsshouldensurethat
the full cycle of Islamic finance is aligned to include product structure, accounting
and reporting that carefully considers the characteristics of various Islamic finance
principles and its requirements. This is what I hope to achieve by this book or, at
least,contributetowardssuchanimportantobjective.
Whether you are an Islamic scholar, regulator, academic, student, finance man-
ager,auditor,Shariahcompliancemanager,riskmanager,Islamicfinanceexpertor
anobserver,thebookisstructuredtobesuitableforeveryreaderandcouldalsobe
used as an academic textbook. My aim for this book is to ensure it benefits all
Preface ix
stakeholders, is accessible to non-experts and is reflected in the structure and
languageusedwithinthetext.
Itakeyouonajourneyinthisbooktoexplorethewayinwhichreligiousrulesact
asadirectiveforaccountingandauditingpracticesinIFIs,duringwhich,Iexamine
theconceptofmoneyanddigitalcurrencywithinthetheoryofmoneyandhowitis
enactedinafaith-basedcontextamiddifferencesofopinionsamongitsactors.This
is an important foundation to explain Islamic accounting, by identifying two core
concepts of today’s money as not being a commodity in contrast to the capitalist
theory of money and therefore how this outcome shapes the faith-based view
regarding the new phenomenon of digital currency (DC). Then, I examine the
concept of paper money within the theory of money and how it is enacted in a
faith-basedlegalframeworkbyidentifyingtwocoreconceptsoftoday’sFiatmoney
asbeingasinglegenusoramulti-generamoney.
I provide an in-depth discussion and analysis of all chapters in this book that
incorporateIslamic jurisprudenceandvariousscholarly views, Islamic commercial
laws,accountingprinciplesandaccountingandinternationalreportingstandards.As
I mentioned, I employ multiple theories in this book and analysis of the empirical
findings to provide substantial theoretical and practical contributions with policy
implications.Ialsoprovideafullandcomprehensiveguidetoafaith-basedaccount-
ingsystemandtofinancialandaccountingprinciplesforIFIsandtheIslamicfinance
industryasawhole.
Thebookconsistsof14chaptersthataredesignedtofollowasmoothandlogical
order to take you through the journey and build your knowledge as you progress
from one chapter to the next. In Chap. 1, I provide the context for the study of
accountingandfinancialaccountinginIslamicfinanceanditsfinancialinstitutions.
The chapter addresses key issues that underpin the context ofthis book, which lay
downthefoundationsforthekeysubjectsIcoverinthisstudy.ThekeyaspectsthatI
highlightherecoverthephilosophyofIslamiceconomicsandfinance,theevolution
anddevelopmentofIslamiclawandjurisprudence,theShariahcodeofconductand
theShariahguidanceandgovernance.
InChap.2,IdealwithamattercloselyrelatedtothesubjectofusuryinIslamic
jurisprudenceandoutlineanotherimportantfoundationinrelationtothestudyofthe
principlesofIslamicaccounting,whichistheessenceoftheShariahrulesregarding
all forms of exchange transactions of paper currency (fiat money) today. The
underlying questions include the following: what money is, how it is viewed, and
what is the Islamic worldview of money. As accounting is all about money and
assets, it is important to understand the theory of money in both its traditional
and Islamic economics contexts. Istheinventionof money not only accidental but
alsoincidentalandnotonlytothedevelopmentofGreekcivilizationinparticularbut
alsotoothercivilizationsingeneral?Whatwerethecausesofthisinvention,or,in
otherwords,whatweretheoriginsofcoinage?
ThenImovetoChap.3toanalysetheviewsofIslamicscholarsonthematterof
whether modern paper money is a single genus or multi-genera banknotes, where
such views are divided into two: the first view considers that paper money is a
multiplegenusaccordingtocountriesofissuance,whilethesecondviewconsiders
x Preface
thatpapermoneyisasinglegenus,regardlessofthenumberofcountriesprintingit
andissuingitandofitsvariousnamesandforms,suchasGBPorUSdollar.Then,I
analyse each view, its argument indicating the reasons for each argument and
implications,basedonIslamicjurisprudence.
ItisthennecessarytounderstandthehistoricaldevelopmentofIslamicaccount-
ing, and this takes place in Chap. 4. In this chapter, I discuss the concept of an
accounting system and its objectives as outlined in the Islamic economics and
finance system under Islamic rule from its inception over 14 centuries ago. More-
over, I examine the historical development that the accounting systems underwent
within the framework of Islamic economics and finance. It explains the most
important types of accountancy, accounting terminology, accounting practices,
accounting roles and internal controls that were known in the Islamic economics
andfinancesystematthattime.IanalyticallyexaminethecomponentsoftheIslamic
accountingsystemintermsofitsprinciples,basisandfoundationalstructure.
After establishing influencing theories and the Islamic worldview about money
andaccounting,IdiscussthepracticalaspectsoftheIslamicaccountingsystemand
divide all Islamic finance principles into four categories. The first category is
discussed in Chap. 5, which analyses the accounting treatment and reporting of
equity-based financial instruments in Islamic finance, such as Musharaka,
Mudaraba, etc. Thereafter, in Chap. 6, I discuss the accounting of the second
category of Islamic finance principles, the sale-based instruments. This category
includes all different types of sales instruments, such as Murabaha, Salam, Ijarah
and many more. Then, in Chap. 7, I discuss the third category, which comprises
debt-based instruments in Islamic finance highlighting its structures, usage in the
Islamicfinancemarketandaccountingrequirements.Thefourthandfinalcategoryis
discussed in Chap. 8. In this chapter, I discussed the charity-based instruments,
which include Takaful and Waqf. I examine their different structures, accounting
treatmentsanddisclosurerequirements.
IgetslightlytechnicalinChap.9butuseeasilydigestibleexamplestodoso.In
this chapter, I examine the International Financial Reporting Standard 9 (IFRS 9)
fromatechnicalperspectiveinlightofthemostcommonandwidelyusedfinancing
instruments that are equity-based in the Islamic finance industry. As part of this
technical analysis of IFRS 9, I identify contractual clauses that are embedded in
equity-based (and other instruments) financial products, such as the home finance
products, and analyse whether cash flows, payment profile, risks and late payment
comply with IFRS 9 tests. I do that to tailor the analysis for Islamic finance
instruments and guide IFIs on how they can embed IFRS 9 in their accounting
processes.
Chapter10providesanothertechnicalanalysisofIFRS9applicationbutthistime
to various sukuk structures. In applying the IFRS 9 standard to sukuk, I focus the
analysis on the economic substance, in addition to other elements. This is done to
establish principles for the financial reporting of financial assets and financial
liabilities that will present relevant and useful information to users of financial
statementsfortheirassessmentoftheamounts,timinganduncertaintyofanentity’s
future cash flows. The application of IFRS 9 to sukuk, however, would, as I
Preface xi
conclude,requireaparticularanalysisinrelationtoIFIsandtheirfinancialreporting
requirements.
IFIsliketheirtraditionalcounterpartarerequiredtopreparecertainanalysisand
documentsthatshouldbesubmittedannuallytofinancialregulatorsandauthorities.
Thosedocumentswouldprovidevariousaccountingandreportingrequirementsthat
show the soundness and healthy operation of an IFI. I start addressing these
documents in Chap. 11 by explaining the scope, requirements and framework of
preparingtheInternalCapitalAdequacyAssessmentProcess(ICAAP)toaccelerate
thechangesmandatedbyBaselIII.ThisalsoimpactsIFIsasitsoperatingapproach,
risk profile and financial impacts are not fully aligned with their conventional
counterparts. Thus, IFIs would be required to tailor their ICAAP to provide a true
reflectionoftheirrequirementsandbusinessimpact.
Chapter12buildsontheanalysisofShariahgovernanceapplicationtothecapital
adequacyassessmenttoaddresstheliquidityassessmentforIFIs.Itanalysesrelevant
aspectsandprovidesacomprehensiveguideofthekeyconsiderations,components
andinfluencingfactorsforliquidityassessmentinrelationtoShariahgovernancein
IFIs.Italsoprovidesaninsightintotheassessmentofrecoveryandresolutionplans
forIFIsandapplicableconsiderations.
Chapter 13 further adds to the discussion in the previous two chapters and
provides an important insight that is essential for its analysis. Stress testing is an
importanttool for risk management intheoperationofIFIs and theIslamic capital
market(ICM).Stresstestingandreversestresstestingshouldbeincorporatedinthe
capitalandliquidityassessmentsasanintegralcomponent.Inthisregard,Ihighlight
thevitalroleofstresstestingforIFIsinthischapter.Ialsodiscussmacroandmicro
stresstesting,theimplicationofstresstestingtoIFIsandparticularconsiderationsin
stresstestingandreversestresstestingforIFIs.IFI’sproductsusedifferentliquidity
risk approaches due to regional, regulatory, legal, product and operational require-
mentsthatmayrequireaparticularapproachtomanagetheassociatedrisks.
Chapters 11, 12 and 13 provide unprecedented in-depth insights of the best
practices for drafting and preparing regulatory documents tailored to the require-
ments of IFIs and a stress testing framework for the survival of IFIs in the face of
possible market shocks. This subject is critical for two reasons: the survival of the
Islamicfinancemodel,whichiscurrentlyunderdeveloped,beinghugelydependent
onitsriskstresstestingmanagementapproachandtheabilitytobeabletomanage
suchmarketshockswithoutcompromisingShariahrequirements.
Finally, in Chap. 14, I share with you my final thoughts and provide an overall
conclusion of this book. I also outline the contributions this book makes towards
IslamiceconomictheoryandpolicyimplicationstotheIslamicfinanceindustryand
itsinstitutions.
Therefore, my efforts in this book aim to explain that the type of information
whichthefaith-basedaccountingidentifiesandmeasuresisdifferent.Conventional
accountingconcentratesonidentifyingeconomiceventsandtransactions,whilethe
faith-basedaccountingmustidentify socio-economicandreligious eventsandeco-
nomictransactions.