Islamic Quality of Earnings

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1 Islamic Quality of Earnings Dr. Khaled Aljifri Professor of Accounting United Arab Emirates University Dr. Sunil Kumar K Regional Head Tagetik Middle East & Visiting Faculty at Dubai University Presentation at the 9 th Annual Forum of GCC Accounting & Auditing Organization, May 6-7, 2015, Kingdom of Bahrain

2 Contents Motivation and Rationale Measuring Islamic quality of earnings KK IFI Scoring Model Methodology Results and Discussions Summary and Conclusions

3 MOTIVATION AND RATIONALE

4 Motivation and Rationale The issue of Conventional Vs. Islamic Banks have been raised in the literature. However, issues related to quality of earnings and Islamic products have not yet been much addressed by researchers. This study classifies Islamic banks into three categories: Conservatives, Moderates, and Liberals using Khaled- Khandelwal IFI Scoring Model (KK Model). This study used an index from KK Model to classify the study sample into the three categories. No study has yet classified Islamic Banks into these three categories. This study contributes to the literature in the following: (1) it classifies Islamic banks into three categories, (2) it introduces a new approach for measuring Islamic quality of earnings (IQE) in Islamic banks, and (3) it explores the relationship between earnings quality and Islamic products.

5 MEASURING ISLAMIC QUALITY OF EARNINGS

6 Measurements of Earning Quality (EQ/IQE) EQ = Absence of earnings management. Accruals quality (Dechow and Dichev 2002). Abnormal accruals from the modified Jones (1991) model. Earnings variability (Dichev and Tang 2008, 2009). However, this study determines IQE in Islamic banks mainly based on maintaining pureness and use of core Islamic financial contracts (PLS products) which means the strictness of adherence to Shariah compliance in contracts. Challenge: Different approaches in presenting financial information in the financial statements

7 Suggestion of a New Approach of Measuring EQ/IQE for Banks Permanent Component Core Operating Earnings Risk Sharing Products (1/r) Risk Shifting Products (1) Other Operating Earnings Fees income (1) Commission Income (1) Other Income (1) Transitory Component (1) Value-irrelevant component (0) Determine EPS for a bank Decomposition of the bank s EPS into the above components Multiply EPS for each component with its proposed factor Sum up the results to get IQE

8 KK IFI SCORING MODEL

9 KK IFI Scoring Model Objective : To provide a scoring to the IFIs for classifying them into three categories, viz. Liberals, Moderates, and Conservatives Model developed in about six months after rounds of discussions with senior Islamic bankers in several countries Preliminary results were again discussed with bankers to confirm adjustments and refinements to the model

10 KK IFI Scoring Model Main classes Banking Products Shariah Board Accounting Standards Compliance with CG Legal Aspects Social Responsibility of IFIs Ethical Disclosure and Transparency

11 METHODOLOGY

12 Methodology Data Collection Only full Islamic Banks are considered, banks with Islamic window are excluded. The present results are for Data was collected from two sources: Financial data from the annual reports (manually) which lasted about 9 months Interviews which lasted about a year The choice of banks was based on the availability of the data.

13 Methodology Sample Selection Total number of Islamic Banks 118 Banks excluded for missing annual reports 22 Banks excluded for missing data 16 The final study sample 80

14 Methodology The Sample Liberal Moderate Conservative Total Number Percentage 28% 36% 36% 100% 40% 35% 36% 36% 30% 28% 25% 20% 15% Liberal Moderate Conservative 10% 5% 0% Liberal Moderate Conservative

15 RESULTS AND DISCUSSIONS

16 Types of Islamic Products in the three Groups Descriptions Frequency Percent Conservatives Risk Sharing Products 10 35% Risk Shifting Products 7 24% No Information Available 12 41% Total % Moderates Risk Sharing Products 9 31% Risk Shifting Products 16 55% No Information Available 4 14% Total % Liberals Risk Sharing Products 5 23% Risk Shifting Products 6 27% No Information Available 11 50% Total %

17 Types of Islamic Products in the three Groups Conservatvies 41% 35% 24% Risk Sharing Products Risk Shifting Products No Information Available

18 Types of Islamic Products in the three Groups Moderates 14% 31% 55% Risk Sharing Products Risk Shifting Products No Information Available

19 Types of Islamic Products in the three Groups Liberals 23% 50% 27% Risk Sharing Products Risk Shifting Products No Information Available

20 SUMMARY & CONCLUSIONS

21 Summary & Conclusions This study has made the first step in proposing a new approach in measuring IQE in Islamic banks. This preliminary results show that there is a difference in disclosing the Islamic Products in the three groups. The results suggest that there is a difference in the different types of Islamic Products disclosed by the three groups. Conservatives use more Risk Sharing contracts (products) than Moderates and Liberals. Considering the absence of EM, Conservatives appear to have high quality of earnings compared to Moderates and Liberals.

International Standards for Islamic Finance

International Standards for Islamic Finance AAOIFI Introduction AAOIFI & IFRS - Comparison on structural objectives AAOIFI & IFRS - Categories of accounting standards for Islamic financial institutions