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Concepts and Application of Islamic Banking

Mohammad Nesar Uddin FCA, FCMA

Executive Vice President and CFO, IBBL
1.0 Preamble
The rise of Islamic finance and banking around the globe in recent years has been meteoric.
The expansion is not because of mere religious significance but, more importantly, because
of its economic beauty which is reflected in the growth of Islamic banking operation even in
many non-Muslim countries including U.K, U.S.A, Germany, Argentina, Denmark, Luxemburg
and Switzerland. As a consequence, Islamic banking is expanding at around 20% growth
rate throughout world which is much higher than that of conventional banking system. In
Bangladesh, Islamic Banking is growing at an average growth rate of 30% and now
controlling around 20% of the banking system. This segment of Banking Industry also
employs a good number of professionals.
Rapid growth of Islamic banking in an
environment of overwhelmingly dominated conventional finance reveals its operational
efficiency and superiority. Islamic banking operations as well as its accounting aspects are
different than that of conventional one due to obvious reasons. This paper will help to get an
insight of Islamic banking with highlights on related accounting issues.


What Islamic Banking is?

Islamic banking, also known as participatory banking, refers to a system of banking or

banking activity that is consistent with the principles of the Shari'ah (Islamic rulings) and its
practical application through the development of Islamic economics. The principles
emphasize moral and ethical values in all dealings have wide universal appeal having the
following attributes:

The absence of interest-based (riba) transactions

Avoidance of speculations (gharar)
Avoidance of oppression (zulm)
Promotion of socio-economic justice via Zakat
Discouragement of the production of goods and services that are harmful to human

The Organization of Islamic Conference (OIC) defines Islamic Bank as a financial institution
whose statutes, rules and procedures expressly state its commitment to the principles of
Islamic Shariaah and to the banning of the receipt and payment of interest in any of its
Bangladesh Bank defines Islamic Banking as a banking company or an Islamic banking
branch (es) of a banking company licensed by Bangladesh Bank, which follows the Islamic
Shariah in all its principles and modes of operations and avoids receiving and paying of
interest at all levels.
Islamic Banking aims not to earn mere profit but to ensure welfare and distributable justice
to the people. Islamic banks makes best endeavor to eliminate disparity and establish justice
in the economy, trade, commerce and industry, build socio economic infrastructure and
create employment opportunities.

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Difference between profit and interest (Riba)

Interest is the pre-agreed additional amount of money which is paid against principal mainly
for time period without exchange of any commodity or service between the lender and the
borrower. Money here is treated as commodity which is completely against the objective of
creation of money. The factors determining interest is amount of loan time period and rate of
interest. In case of transactions on interest, the principal is guaranteed to remain intact, thus
the lender doesnt take risk of loss of capital. The interest is to be borne only by the
borrower. Sometimes interest is paid or earned both on principal and interest (compounding
interest). Since rate of Interest and time for repayment of principal and interest is
predetermined, lender does not bear any risk.
On the contrary, profit is the amount earned by deploying capital into a business. It may be
earned by way of trading of goods and services or by partnering a business. The factors
determining profit is business condition, demand and supply situation, efforts given on the
business etc. Both buyer and seller or parties involved in business bear the risk. The
principal is not guaranteed. Loss, if any, is borne by the capital provider(s). The profit is
distributed among the capital providers and the parties managing the business. In case of
buying and selling, profit cannot be increased only for time periods, once the price is fixed.
Profit can be earned only once in case of single trade.
However, fixed percentage does not necessarily constitute interest. In case of buying and
selling fixing a percentage of profit is permissible. But fixing an assured return before getting
any result from investment is interest.


Economic demerits of Interest

Interest deflects money from its basic function.
Interest based system may result in exploitation.
Inflation is co-related with Interest.
Interest exerts disastrous effects on the human behavior and the society.
Predetermined rate of return is not justified.
Interest reinforces the tendency for wealth to accumulate in the hands of a few, and
thereby diminishes human beings to concern their fellow people.

2.3 Some Unique Features of Islamic Banking

Operates in line with Shariah principles and for the welfare of the people.
Complete avoidance of interest in all its activities
Doesnt invest only for profit, but looks into need of the society.
Ensures fairness and justice in all sorts of transactions.
Ensures optimum utilization of resources and help to fulfill justified needs of all.
Helps develop the standards of living of the poor.

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Direct participation with trade and commerce through involvement of real assets

Encourage socially desirable enterprises and discourages socially undesirable one

Eliminate disparity among the people and establish economic justice

Ensures flow of recourses from rich to the poor.
Ensures maximum employment and balanced development
The relationship between banker and client is business partner not lender and the

3.0 Islamic Banking in Modern age

The first instance of Islamic banking in modern age came into the picture in Egypt in 1963
titled Mit Ghamr Local Savings Bank. The pioneering efforts by Ahmad El Najjar brought this
bank into existence, whose key principle was profit sharing. By the end of 1976 there were 9
such banks in the country. These banks neither charged nor paid interest but their activities
were mostly limited to trade and industries where these banks invested directly or as
partners of depositors. Hence, functionally these banks were working more as financial
institutions rather commercial banks. Nasser Social Bank (1971) is known to be the first
commercial bank in Egypt, though its charter never made references to Shariah. The first
bank explicitly based on Shariah principles was established by the Organization of Islamic
countries (OIC) in 1974, called Islamic Development Bank (IDB). This bank was primarily
engaged in intergovernmental activities for providing funds for development projects
running into member countries. Its business model involved fees for financial services and
profit sharing financial assistance for projects.





. Mit Ghamr

. Nasser

. Al-Baraka

. Accounting

Local Savings
Bank, Egypt
. Lembaga
Tabung Haji,

Social Bank,
Egypt (1971)
. Islamic
Bank, Jeddah
. Dubai
Islamic Bank,
Dubai (1975)
. Faisal
Islamic Bank,
Sudan (1977)
. Bahrain
Islamic Bank,


. Islami Bank
Ltd, first
Islamic bank
in South-East
Asia (1983)
. Qatar
Islamic Bank
. Dar al Maal
Islamic Trust,

and Auditing
for Islamic
. Islamic
Bank of
Brunei (1994)
. Islamic

. International
Bahrain (2002)
. Islamic
Service Board
. International
Centre for
Education in
Islamic Finance

. ANZ Global
. International
Diagram: 1 Snapshot of Development
of Islamic
around the globe
With time, during the 1970s several Islamic banks came into existence, including the
Islamic Bank (first Islamic private commercial bank, 1975), the Faisal Islamic bank Corporation
of Sudan
(1977) and the Bahrain Islamic bank (1979). Others from the Asia
Pacific region include

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Philippine Amanah Bank (PAB), formulated under presidential decree. Pakistan also had an
established Islamic banking system at the time which unfortunately didnt survive.
Within a decade of the first private bank coming into existence in Dubai, the global industry
had more than 50 such banks. Most banks were a result of private initiatives, whereas the
first concrete government initiative was taken by the Iranian government, when in 1985 no
bank was permitted to give or take interest.
The true phase of development of Islamic financial institutions actually occurred in the
1980s. As part of development, Islami Bank Bangladesh Limited was incorporated in 1983 as
the first Shariah based interest free bank in South and South-East Asia. Earlier initiatives
were more inclined towards interest free Islamic banking, but the emergence of financial
systems has evolved in the 80s. In 1985, the High Council of OIC (Organization of Islamic
Conference) declared takaful (Islamic insurance) as Shariah compliant. The new, wider
spectrum of Islamic finance covers not only banking activities but also capital markets,
capital formation and other financial instruments and intermediaries.
The biggest change in terms of adaptability came in 1991 when the Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI) was established to advise on Islamic
finance standards all over the world. Later, the development of uniform standards was
supported by other organizations such as Islamic Financial Services Board (IFSB) in Malaysia
in 2002.


Islamic Banking around the Globe


Islamic Banking in Bangladesh

Islamic Banking has become an attractive banking system among the Muslim and nonMuslim market participants around the globe. Obviously, this is not only driven by religious
implication but also by economic justification or the benefits it offers. The global market for
Islamic finance at the end of 2011 was worth around $1.3 trillion, according to the UK Islamic
Finance Secretariat. The total value of Shariah-compliant assets has grown by 150% since
2006. Islamic financial institutions are growing at around 20% per annum, which exceeds
that of conventional financial industry. As can be seen over the years, Islamic banking has
gained momentum on a global scale. Financial Institutions all over the world have launched
their own Islamic banking units in trying to keep up with the pace of growing demand for
Shariah compliant products and services. There are more than 300 Islamic banks and
financial institutions in more than 70 countries of Asia, Africa, Europe, and America including
countries like the U.K, U.S.A, Germany, Argentina, Denmark, Luxemburg, Switzerland and
India. Although Islamic Banking is not allowed as per the current regulatory system of India,
a good number of financial institutions claim that they are working as per Islamic principles.

The journey of Islamic banking in Bangladesh was started with the incorporation of Islami
Bank Bangladesh Limited in 1983 which is also the first bank in South-East Asian region.
Later on six other banks were established/converted to operate as Islami bank in the
country. In addition, a good number (around 15) of traditional banks including some foreign
ones have opened Islamic banking branches and windows to cater to the growing demand of
Islamic banking products and services. During the last decade, Islamic banks experienced
phenomenal growth in terms of deposit and investment base.

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Total deposit base of Islamic banks stood at around Tk.240 billion at YE 2011 registering
around 13% market share. The cumulative average growth rate (2005-2011) of deposit of
Islamic banks was more than 30% against industry growth rate (excluding Islamic banks) of
around 20%.

On the contrary, investment base stood at around Tk. 209 billion registering around 18%
market share. The cumulative average growth rate (2005-2011) of investment of Islamic
banks was also more than 30% against industry growth rate (excluding Islamic banks) of
around 14%.


Operational Aspects of Islamic Banking

6.1 Shariah Supervisory Committee

To decide on Shariah issues an Independent Shariah Supervisory Committee is required to
be established in Islamic Banks consisting of prominent Islamic scholars and economic
experts. Each and every product and their modus operandi are required to be approved by
the Committee. On Shariah issues the decision of the committee is final and the committee
is to enjoy full independence for proper functioning of Islamic banking. In an ideal situation

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the Committee also supervise a group of Shariah Auditors who oversees the income
generating and other activities of the bank in line with the Shariah principle.


Mobilization of Deposit:

Islamic Banks focus more on welfare and financial inclusion in deposit mobilization. It
encourages small depositors to save money instead of collecting big deposits from few
customers. As such Islamic banks offer some special deposit products like, Cash WAQF,
Mudaraba Hajj Savings, Mudaraba Mohor Savings, etc. The Mudaraba Depositors agree to
share profit and bear loss on the investment of their deposit. As a result the Bank enjoy
better liberty to invest in risky but more beneficial ventures.

6.2.1 Cost Free Deposit:

Islamic Banks operate this type of account under Al-Wadeah Principle where the bank
commits to refund money deposited with these accounts on the demand of the customers.
On the other hand, the banks takes permission from customers that the bank may utilize
their money. In case of cost free deposit of conventional banks, permission from the
depositors is not taken to utilize their money. No profit is disbursed in these accounts and
the depositors do not bear any loss. This account is as good as amanah

Islamic Mode:
1. Deposit/Amanah


2. Principal as Demanded by the


Conventional Mode:



1. Interest free
2. Principal as Demanded by the


6.2.2 Cost Bearing Deposit:

Islamic Mode: Under Islamic mode, the bank mobilizes deposit under mudaraba principle.
Unlike conventional banks, Islamic banks do not pay fixed rate of interest rather distributes a
certain percentage (say minimum 65%) of its investment-income earned through
deployment of mudaraba fund to the depositors.


1. Funds for
2. Principal + Share in Profit


In the above case, the principle is not guaranteed; losses if any are to be shared by the
contributors of fund Conventional Mode:


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1. Interest based

2. Principal + Interest


6.3 Investment (Loans and Advances in Conventional Terms):

The main objective of investment under Islamic principles is not earning maximum profit,
rather ensuring maximum welfare. For that reason, Islamic banks are to invest in the
projects which create more employment. Investment in import substitute and export
oriented industries help the country to improve the balance of payments. The banks take
risky ventures giving long term benefit instead of short term trading. Islamic banking
activities emphasize flow of resources from the rich to poor thus its prime focus is on micro
and SME investments. Islamic Banks cannot invest in the products which are harmful for the
people and discourages luxurious items. Ensuring distributive justice is the key focus of
Islamic banks and thus investment is mostly need based rather than grid based.
Islamic banks deploy their funds under different modes of financing as permitted by Shariah
which include trade mechanism (bai in Arabic term), partnership mechanism (Shirkat in
Arabic term), and leasing mechanism (Ijara in Arabic term).
6.3.1 Trade Mechanism: Trade mechanism takes place in three modes: Bai-Murabaha
(sale on agreed upon profit), Bai-Muajjal (sale on deferred payment basis) and Bai-Salam
(Purchase of goods on deferred delivery basis) where the bank acts as an economic agent.
Under the mechanism, financial flows are parallel to real flows and claims of the bank on the
clients are not necessarily time variant. The following diagrams depict the difference of
trade mechanism and that of conventional interest based mechanism:

Islamic Mode:

4. Price including profit


3. Goods/Services


1. Cash


Conventional Mode:


1. Loan


4. Principal + Interest



2. Cash

3. Goods

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The above diagrams indicate that there is chance of misuse of fund

(diversion) in conventional system which is not possible under Islamic
mode since bank directly provides goods and services to its clients
6.3.2 Leasing Mechanism: Under leasing agreement, bank receives rent from the lesser
for use of assets owned by it. Hire Purchase under Shirkatal Melk (popularly known as
HPSM) is a derivative product of leasing which is a synthesis of three contracts: Shirkat, Ijara
and Sale. Under the mechanism, the bank and the client jointly provide capital (on preagreed ratio) to buy an asset and client gives installment payments (includes rent and
principal) based on which ownership is gradually transferred to him. In this mechanism
financial flows are also tied to real flows. The following diagrams depict the difference
between Islamic mode and conventional mode:

Islamic Mode:
4. Rental+ Principal


3. Use of Asset+ Ownership


1. Cash

2. Assets


Asset Owner


1. Loan
2. Principal + Interest

2. Rentals

3. Usufruct of

Asset Owner
6.3.3. Partnership Mechanism: Partnership mechanism can also take place in two
modes-mudaraba and musharaka. Under mudaraba mode of financing, bank (here called
Sahib-al-maal) provides fund while client (here called mudarib) provides expertise and
management support for the enterprise. Any profit accrued is shared between two parties on
pre-agreed upon ratios while capital loss (without negligence on the part of the
client/mudarib) is fully borne by the bank (capital provider). On the other hand, under
musharaka mode of financing, both the bank and the client invest capital in a venture and
share profit at a pre-agreed ratio and bear losses in proportion to capital. Unlike traditional
banking system, the banks involve in real economic activity.
2.3.1 Mudaraba Financing in Diagram

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4 .P+SP

1. Fund



3. Capital +Profit

2. Application of Fund +

Client Musharaka Financing in Diagram


2(b) Principal
+Share in Profit


1. Loan




2. Principal +Fixed Interest

1(b) Funds & Effort

2. Loan Capital

3. Capital+ Profit


The above diagram reveals that under Islamic mode the bank directly involve
with the business enterprise which ensures sustainable development while
under conventional mode bank does not directly involve with economic


Islamic Micro Finance

Islamic microfinance (IM) is becoming an increasingly popular mechanism for alleviating

poverty, especially in developing countries around the world. The concept of IM adheres to
the principles of Islam and is a form of socially responsible investment. Investors who use
their wealth for IM projects under Shariah only involve themselves in halal projects which
benefit the community at large.

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The modas operendi in IM is similar to that of conventional NGOs except for collateral free
investments are given to small entrepreneurs based on Shariah mechanism. Unlike other
NGOs, major focus is not given on recovery rather improvement of living standard of poor
people. The projects are closely monitored so that the members are really benefitted. They
are imparted education on literacy, cleanliness and other basic issues of human life. A
portion of the return received from the members are spent for their welfare such as
providing scholarship to their children, giving sanitary latrines, tree plantation, donation for
marriage etc.
In a nut shell, Islamic Micro Finance represents the merging of two growing sectors:
microfinance and the Islamic finance industry. Islami Bank Bangladesh Ltd. contributes more
than 50% of the global market share of Islamic Micro finance under the umbrella of Rural
Development Scheme (RDS) and Urban Poor Development Scheme (UPDS). Although it
contributes only 2% of the total business, around 20% manpower is deployed to provide the


Islamic Instruments in Money Market

6.5.1 Bangladesh Govt. Islamic Investment Bond (BGIIB): Islamic banks cannot
participate in interest based treasury bills/bonds. In order to meet the SLR requirement,
Bangladesh Govt. Islamic Investment Bond (BGIIB) has been introduced in 2004 by the
Ministry of Finance, GOB. The Islamic banks buy the bonds where Bangladesh Bank acts as a
custodian of the fund. Bangladesh Bank invests the fund to different Islamic banks and
Islamic financial institutions. The profit received from the invested fund is distributed among
the contributory banks after deducting 5%-20% of profit to meet expenditure and
reinvestment. The return on BGIIB is not so lucrative since it gives lower return compared to
other instrument.
6.5.2 Islamic Inter-Bank Fund Market (IIFM): Unlike traditional banks, Islamic banks
cannot participate in call money market for overnight lending or borrowing. To remove the
problem, a new type of Shariah based money market instrument called Islamic Inter-bank
Fund Market (IIFM) has been established with the initiative of Bangladesh Bank to meet
overnight liquidity requirement. The IIFM is operated under mudaraba principle where the
fund taken by the bank is considered as mudarabah deposits.
The Islamic Bond Fund of the central bank will act as the custodian of the IIFM and does not
charge any fees for the fund. If any bank has excess fund, it may invest it in the IIFM for
overnight. Another Islamic bank requiring fund may borrow the money from the IIFM for
overnight and returns the principal with profit at the rate of three months' term deposit
which is finally adjusted upon finalization of Financial Statements.


Inter-bank Deposit: Interbank deposit among the Islamic bank and financial
institutions is another mechanism of Islamic money market. These inter-bank deposits vary
from one month to twelve months period. These deposits are taken/given on mudarabah
Steps needs to be taken to introduce some lucrative money market instruments for Islamic
banks to make it more vibrant.

7.0Accounting Aspects of Islamic Banking

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Income Recognition

Income from investments is accounted for on accrual basis except investments under
Musharaka, Mudaraba, Bai-Salam and Bai-as-Sarf modes of Investment. Income from
investment under Mudaraba, Musharaka, Bai-Salam and Bai-as-Sarf modes is accounted for
on realization basis. Because the amount of income/profit from the investment under those
modes cant be ascertained until the amount of income generated from the ultimate
deployment of invested fund at the clients end is determined. Besides, fees and commission
income are recognized when earned.
Islamic banks cannot compute the "interest on interest" popularly known as "compounding
interest". For Islamic banks, unpaid profit shall remain as "profit earned but not yet
paid" and that amount cannot become part of principal amount of the following period.
While creating each deal/investment, in case of Bai mode of investment, profit is added to
the investment cost and the full price is recovered from the clients in installments. Rebate
may be allowed to the clients if the price is paid earlier than pre-fixed time.
Instead of charging interest for overdue periods, Islamic Banks charge compensation at the
same rate at which profit was agreed. Even though this income is Not Halal, Islamic Banks
need to charge this compensation to protect default culture and to ensure recoverability of
the investment thereby protecting the Amanah (i.e. deposits) of the Depositors. The
compensation is not charged on the clients who have suffered loss due to genuine reasons.
At IBBL, the applicability of compensation is determined by an independent review
committee headed by a justice. The realized portion of compensation is spent for charitable
purposes as per ruling of Shariah.

7.2 Distribution of Profit:

Profit distribution system of Islamic Banks is different from other conventional banks both in
terms of sources and calculation. Sources of conventional banks for distribution is certainly
earned from interest on loan and advances. On the contrary, sources of Islamic banks are
profit, not interest, earned on its investment as described earlier. The depositors of Islamic
banks get their share of profit at a predetermined rate (say 65% or 70%) earned from the
investments made which certainly may vary depending on the income earned on
Before distribution, the amount of income requires certification of Shariah and Banks
Statutory Auditors.
Mudarabah depositors of the Bank share income which includes profit and dividend, capital
gains, rent and any other income derived from investment of their Mudaraba Fund. They do
not share any income derived from other miscellaneous banking services where the use of
fund is not involved such as Commission, Exchange, Service Charges and other fees realized
by the Bank. They also dont share income earned from deployment of Banks own fund like

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However, Mudarabah Fund gets priority in the matters of investment over Bank's Equity and
other Cost-free Funds. Bank's Equity and Cost-free Funds are deployed only after full
investment of Mudaraba Deposits.
The gross income derived from investments during the Accounting year, at first, is allocated
to Mudaraba Fund and Cost-free Funds (including Bank's Equity) according to their
proportion in the total investment. Then the gross income from investments applicable for
Mudaraba Fund is distributed to Mudaraba Depositors and Bank according to the predetermined sharing ratio say 65:35 (depositors: bank). The depositors' share (i.e. the
aforementioned 65%) is then allocated to different mode of depositors according to the
eligibility of the depositors. Islamic banks strictly ensures paying at least up to the predetermined sharing ratio at any case but very often pays more than that to keep the return
of depositors competitiveness.

7.3 What is provisional rate in Islamic Banks?

Islami banks calculate a provisional rate based on past experiences, industry trends, macromicro economic policy of the government, growth prospects, and general economic
condition etc. with a clear proposition that the final profit will be declared later and adjusted
accordingly after the end of the year. Monthly profit is accrued and paid to depositors but
subject to adjustment of final rate of profit after the year end. Final rate of profit attributable
to the Mudarabah Depositors can be clearly determined subject to certification of
investment income by statutory auditors as well as Shariah Auditors. After finalization of
final rate of profit, if final profit rate is more than provisional rate of profit paid, then the
additional profit is paid to the Mudarabah Depositors. However, if final profit rate is less than
provisional rate of profit then Islamic Banks usually decide not to take the additional amount
back from the depositors. Since the provisional rate is determined after considering the
above factors, normally the final rate falls around the provisional rate.

8.0 Some unique issues for Islamic Banks:


Treatment of 'Haram' Items:

Islamic Banks all the way try their best to comply fully with Shariah principles but there is
some non-Shariah compliant items in which the Islami Banks are compelled to enter in.
However Islami Banks treat those items as follows:
Interest received from the balances held with Foreign Banks abroad and from Foreign
Currency Clearing Account with Bangladesh Bank are not credited to income, since it is not
permissible as per Shariah. These are utilized for charitable purposes after payment of
Income Tax thereon.
Moreover, Income which is irregular (doubtful) as per Shariah is not included in the
distributable income of the Bank. Bank charges compensation on overdue Bai-Murabaha and
Bai-Muazzal investments. Such compensation is not permissible as per Shariah to take into
regular income of the Bank. Realized amount of Doubtful Income and Compensation are
utilized for charitable purposes. Applicable Income Tax on these items is duly paid to the
Govt. Account.

8.2 Zakat:
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Zakat is paid by the Islami Banks at the rate of 2.58% (instead of 2.50% as the Banks
maintain its Financial Statements following Gregorian Year) on the closing balances of Share
Premium, Statutory Reserve, General Reserve and Dividend Equalisation Accounts as per
guidelines of Shariah.
Zakat is charged in the Profit & Loss Account of the Banks as per Guidelines for Islamic
Banking issued by Bangladesh Bank through BRPD Circular No. 15 dated 09.11.2009. Zakat
on Paid up Capital and Deposits is not paid by the Bank, since it is the responsibility of the
Shareholders and Depositors respectively.
Though Zakat is not usually allowed as expenditure by the Tax Authority, it should be made
tax-free to encourage payment of Zakat by the Institutions which would help reduction of
poverty at a rapid rate. Islamic Banks Zakat should be treated as business expenditure
since they are bound to pay Zakat as per statute to follow Shariah.


Accounting and other standards relevant to Islamic Banks:

Islamic Banks in Bangladesh follow IFRS (International Financial Reporting Standards) as

adopted by Institute of Chartered Accountants of Bangladesh (ICAB). Some other standards
relevant for Islamic Banks are mentioned below:


AAOIFI Standards:

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is an
Islamic international autonomous non-for-profit corporate body that prepares accounting,
auditing, governance, ethics and Shariah standards for Islamic financial institutions and the
industry. It was established on 27 March 1991 in the State of Bahrain and till date AAOIFI has
issued 26 Accounting Standards, 5 Auditing Standards, 7 Governance Standards, 2 Ethics
Standards and 45 Shariah Standards (See Annexure-A). Professional qualification programs
(notably CIPA, the Shariah Adviser and Auditor "CSAA", and the corporate compliance
program) are presented now by AAOIFI in its efforts to enhance the industrys human
resources base and governance structures.
As an independent international organization, AAOIFI is supported by institutional members
(200 members from 45 countries, so far) including central banks, Islamic financial
institutions, and other participants from the international Islamic banking and finance
industry, worldwide.
AAOIFI has gained assuring support for the implementation of its standards, which are now
adopted in the Kingdom of Bahrain, Dubai International Financial Centre, Jordan, Lebanon,
Qatar, Sudan and Syria. The relevant authorities in Australia, Indonesia, Malaysia, Pakistan,
Kingdom of Saudi Arabia, and South Africa have issued guidelines that are based on AAOIFIs
standards and pronouncements."

9.2 IFSB
The Islamic Financial Services Board (IFSB) is an international standard-setting organization,
formed by the central banks of Islamic countries, promotes and enhances the soundness and
stability of the Islamic financial services industry by issuing global prudential standards and
guiding principles for the industry, broadly defined to include banking, capital markets and

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insurance sectors. The IFSB also conducts research and coordinates initiatives on industry
related issues, as well as organizes roundtables, seminars and conferences for regulators
and industry stakeholders.
The Islamic Financial Services Board (IFSB), which is based in Kuala Lumpur, was officially
inaugurated on 3rd November 2002 and started operations on 10th March 2003. It serves as
an international standard-setting body of regulatory and supervisory agencies that have
vested interest in ensuring the soundness and stability of the Islamic financial services
industry. In advancing this mission, the IFSB promotes the development of a prudent and
transparent Islamic financial services industry through introducing new, or adapting existing
international standards consistent with Shariah principles, and recommend them for
To this end, the work of the IFSB complements that of the Basel Committee on Banking
Supervision, International Organization of Securities Commissions and the International
Association of Insurance Supervisors.
As at December 2012, the 184 members of the IFSB comprise 55 regulatory and supervisory
authorities, eight international inter-governmental organizations and 121 market players,
professional firms and industry associations operating in 41 jurisdictions.
Malaysia, the host country of the IFSB, has enacted a law known as the Islamic Financial
Services Board Act 2002, which gives the IFSB the immunities and privileges that are usually
granted to international organizations and diplomatic missions.
Since its inception, the IFSB has issued 19 Standards, Guiding Principles and Technical
Note for the Islamic financial services industry (See Annexure B).


Some other relevant organizations:

Brief introduction of some other relevant organizations is as follows-

The General Council for Islamic Banks and Financial Institutions (GCIBFI) is an international
non-profit organization formed jointly by the Islamic Development Bank and many other
Islamic financial institutions. Operation license was obtained in The Kingdom of Bahrain on
May 2001.
Main objectives of GCIBFI are to:

Create a public awareness of Islamic Shariah concepts, rules and provisions related
to them
Develop the Islamic financial industry

Enhance co-operation among its members

Provide information related to Islamic financial institutions

Cater for the interests of its members and confront the common difficulties and

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10.2 IIFM

International Islamic Financial Market (IIFM) is the international Islamic financial markets
organization focused on the Islamic Capital & Money Market (ICMM) segment of the Islamic
Financial Services Industry (IFSI). Its primary focus lies in the standardization of Islamic
financial products, documentation and related processes at the global level. IIFM is based in
Manama, Bahrain.
IIFM was founded with the collective efforts of the Islamic Development Bank, Autoriti
Monetari Brunei Darussalam, Bank Indonesia, Central Bank of Bahrain, Central Bank of
Sudan and the Labuan Financial Services Authority (Malaysia) as a neutral and non-profit
Besides the founding members, IIFM is supported by its permanent member State Bank of
Pakistan as well as by a number of regional and international financial institutions and other
market participants as its members.
IIFM benefits to the Islamic Financial Services Industry:

Addressing the product and documentation standardization needs of the industry

Providing universal platform by bringing regulatory bodies, financial institutions, law

firms, stock exchanges, industry associations, infrastructure service providers and
other market participants on a common platform through the creation of project
specific global working groups and committees

Facilitate unification, Shariah harmonization and legal reforms in Islamic financial


Shariah Advisory Panel consisting of renowned scholars, hence, ensuring wider

Shariah acceptance

10.3 IICRA
The International Islamic Centre for Reconciliation and Arbitration (IICRA) is an international,
independent, non-profitable organization, and one major infrastructure institutions of the
Islamic finance industry.
The center settles in all financial or commercial disputes and conflicts that arise between
financial or business institutions that choose to apply the provisions of Islamic law ;Shariah
principles, in resolving their disputes. Other than, between these institutions and their
clients or between them and third parties through reconciliation or arbitration.
IICRA has been established:

To respond to the quantitative and qualitative development of the Islamic financial

Industry in the last years.

To fulfill the Islamic financial industry needs in order to be able to settle the disputes
in accordance with the Islamic Shariah laws.

To respond to the peculiarities of the Islamic financial services concerned with the
products and contracts.

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To fill the vacuum of the experts in the Islamic Financial Industry field.

At the regional and international level it can be seen many circumstances that strengthen
the position of the Centre and the factors of the success lie on the approval of the majority
member countries of the Organization for Islamic Conference on the regional and
international accords concerned with the approval of the rulings of the arbitrators, and in
the absence of a specialized international commercial arbitration Centre in the Arab and
Islamic region to settle the Islamic financial transactions.

10.4 IRTI

The Islamic Research and Training Institute (IRTI) is an affiliate of the Islamic Development
Bank Group responsible for leading the development and sustenance of a dynamic and
comprehensive Islamic Financial Services Industry that supports socio-economic
development in Member countries. It was established in 1981 in Saudi Arabia. The institute
has vast history of doing research in the area of Islamic banking and finance.

11.0 Conclusion
The superiority of Islamic baking derives from its involvement of real economic activity.
During nineteen fifties Islamic banking concept was mere a text book word and was limited
to theoretical extravaganza. The sixties was actually the period of experimentation and
Islamic banking started gaining momentum in seventies. The eighties and nineties
constitute the period of consolidation. And now it is coming up as the only just and welfareoriented banking system of the modern world. Islamic banking system has been proved to
be superior and more resilient during the global financial crisis due to their non-involvement
of the toxic assets in the banking system and adherence to real assets in lending which is
directly linked with economic development and prosperity of the country. By their inherent
nature and objectives, Islamic banks focus on moral aspects of financing. Rapid growth of
Islamic banking in an environment of overwhelmingly dominated conventional finance
reveals the system efficiency and superiority of Islamic Banking.


16 | P a g e


Islami Bank Babosta by Mohammad Abdul Mannan, Managing

Director, Islami Bank Bangladesh Ltd.

2. Islamic Microfinance: An Instrument of Poverty Alleviation by

Mohammad Abdul Mannan, Managing Director, Islami Bank Bangladesh
3. Islamic Financial System: Principles and Operations by International
Shariah Research Academy for Islamic Finance (ISBN 978-967-349-1278)
4. Institute of Islamic Banking website
5. Islami Bank: 30 Years of Progress published by
Department, Islami Bank Bangladesh Ltd.

Public Relation

6. Islamic Banking: The Lessons and Challenges in Malaysia & Beyond By

DATO SRI ZUKRI SAMAT Managing Director, Bank Islam Malaysia Berhad
President, Association of Islamic Banking Institutions Malaysia
7. An Alternative Financial System for Inclusive Growth and Sustainable
Development By Md. Abdus Salam, FCA
8. Performance Evaluation of Banking Industry
Comparative Analysis By K. M. Anwarul Islam



9. The Guidelines for conducting Islamic Banking By Bangladesh Bank

10. The World Islamic Banking Competitiveness Report 2011-12-A Brave
New World of Sustainable Growth by ERNST & YOUNG
11. Wikipedia-

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Annexure A

Standards that have been developed by AAOIFI (Accounting and Auditing

Organization for Islamic Financial Institutions)
Accounting standards:

22. Deferred Payment Sale .

1. Objective of financial accounting for

Islamic banks and financial institution

23. Disclosure on Transfer of Assets.

2. Concept of financial accounting for IFIs.

3. General presentation and disclosure in
the financial statements of IFIs.
4. Murabaha and Murabaha to the
purchase orderer.
5. Mudaraba financing.
6. Musharaka financing.
7. Disclosure of bases for profit allocation
between owners equity and investment
account holders.
8. Equity of investment account holders
and their equivalent.
9. Salam and Parallel Salam.

24. Segment Reporting.

25. Consolidation.
26. Investment in Associates.
Auditing standards:
1. Objective and principles of auditing.
2. The Auditors Report.
3. Terms of Audit Engagement.
4. Testing for Compliance with Sharia
Rules and Principles by an External
5. The Auditors Responsibility to Consider
Fraud and Error in an Audit of Financial

10. Ijarah and Ijarah Muntahia Bittamleek.

11. Zakah.

Governance standards:

12. Istisnaa and Parallel Istisnaa.

1. Sharia Supervisory Board:

Appointment, Composition and Report.

13. Provisions and Reserves.

14. General Presentation and Disclosure in
the Financial Statements of Islamic
Insurance Companies.
15. Disclosure of Bases for Determining
and Allocating Surplus or Deficit in Islamic
Insurance Companies.
16. Investment Funds.
17. Provisions and Reserves in Islamic
Insurance Companies.
18. Foreign Currency Transactions and
Foreign Operation.
19. Investments.
20. Islamic Financial Services Offered by
Conventional Financial Institutions.
21. Contributions in Islamic Insurance

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2. Sharia Review.
3. Internal Sharia Review.
4. Audit and Governance Committee for
5. Independence of Sharia Supervisory
6. Statement on Governance Principles for
7. Corporate Social Responsibility.
Ethics standards:
1. Code of ethics for accountants and
auditors of IFIs.
2. Code of ethics for employees of IFIs.

23. Agency.
Shariah standards:

24. Syndicated Financing.

1. Trading in currencies.

25. Combination of Contracts.

2. Debit Card, Charge Card and Credit


26. Islamic Insurance.

3. Default in Payment by a Debtor.

4. Settlement of Debt by Set-Off.
5. Guarantees.
6. Conversion of a Conventional Bank to
an Islamic Bank.
7. Hawala.
8. Murabaha to the Purchase Orderer.
9. Ijarah and Ijarah Muntahia Bittamleek.
10. Salam and Parallel Salam.
11. Istisnaa and Parallel Istisnaa.
12. Sharika (Musharaka) and Modern
13. Mudaraba.
14. Documentary Credit.
15. Juala.
16. Commercial Papers.
17. Investment Sukuk.
18. Possession (Qabd).
19. Loan (Qard).
20. Commodities in Organised Markets.
21. Financial Papers (Shares and Bonds).
22. Concession Contracts.

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27. Indices.
28. Banking Services.
29. Ethics and stipulations for Fatwa.
30. Monetization (Tawarruq)
31. Gharar Stipulations in Financial
32. Arbitration
33. Waqf
34. Ijarah on Labour (Individuals)
35. Zakah
36. Impact of Contingent Incidents on
37. Credit Agreement
38. Online Financial Dealings
39. Mortgage and its Contemporary
40. Distribution of Profit in Mudarabahbased Investments Accounts.
41. Islamic Reinsurance
42. Financial Rights and Its Disposal
43. Liquidity and Its Instruments
44. Bankruptcy
45. Capital and Investment Protection


Standards that have been developed by IFSB (Islamic Financial Services


Published Standards
1. December
Insurance Institutions) offering
only Islamic Financial Services
2. December
Standard for Institutions (other
than Insurance Institutions)
offering only Islamic Financial
Services (IIFS)
3. December
(Excluding Islamic Insurance
Islamic Mutual Funds
4. December
Disclosures to Promote
Insurance (Takful) Institutions
and Islamic Mutual Funds)
5. December
Elements in the Supervisory
Review Process of Institutions

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Insurance (Takful) Institutions
and Islamic Mutual Funds)
6. December
Collective Investment Schemes
7. January
for Sukk,
Securitisations and Real Estate
8. December
Governance for Takful (Islamic
Insurance) Undertakings
9. December
Financial Services
10. December
on Sharah Governance
11. December
Standard on Solvency
for Takful (Islamic Insurance)

12. March 2012: IFSB-12: Guiding

Principles on Liquidity Risk
Management for Institutions

3. December
Guidance Note on the
Practice of Smoothing the
Profits Payout to Investment
Account Holders

13. March

4. March

Stress Testing for Institutions

Guidance Notes
1. March

Connection with the Capital
Recognition of
on Shar'ah-Compliant Financial

Capital Adequacy Standard:
The Determination of Alpha in
the Capital Adequacy Ratio for
Insurance Institutions) offering
only Islamic Financial Services

5. March 2011: GN-5: Guidance

Note on the Recognition of
Ratings by external Credit
on Takful and
ReTakful Undertakings

Technical Notes
2. December
Commodity Murbahah Transac

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1. TN-1: Technical Note on Issues

Services: The Development of
Islamic Money Markets