Sindh Bank Ltd SHARIAH COMPLIANCE MECHANISM March 2014 ISLAMIC BANKING DIVISION Page 0 of 60
A-POLICY FRAMEWORK OVERVIEW Sindh Bank Ltd (SNDBL)-Islamic Banking (IB) is committed towards Shariah Compliance as an essential element of its operations. IB will establish a Shariah Compliance & Inter Control Mechanism (SC&ICM) to ensure transactions & operations are carried out in accordance with the injunctions of Shariah. 1- Objectives: The objective is to design a framework which is capable to Identify, Assess, Monitor, Test, and Report Shariah Non-compliance Risk in a consistent manner and advise and facilitate in strengthening related controls and minimizing Shariah non-compliance risk in IB so that following objectives are achieved: a. To maintain confidence in IB operations b. To promote staff understanding and sense of ownership about SC&ICM c. Reduce stances of violations of Shariah Standards and to mitigate non-compliance risk 2- Shariah Non-compliance Risk: Shariah non-compliance risk arises from a bank s failure to comply with the Shariah rules and principles determined by the Shariah Advisor/Shariah Supervisory Committee of the bank and/or the relevant applicable guidelines and regulations from the regulator(s). Shariah compliance is critical to IB s operations and such compliance requirements must permeate in their product and activities. As a majority of the fund providers use Shariah compliant banking services as a matter of principle, their perception regarding IB compliance with Shariah rules and principles carries significant reputational risk. Non-compliance may pose a considerable risk to IB like: a) Forced to withdrawn a product after launch b) Wrongly execution of a transaction c) Misinterpretation of rules & principles d) Threat to image leading to reputational risk e) Failure to achieve strategic objectives f) Financial loss Page 1 of 60
Such risk can be effectively mitigated if proactively identified, measured, and controlled. In order to stay compliant with all applicable Shariah rules, principles and guidelines IB must: I. Proactively pursue the Shariah Compliance by involving all the stakeholders, operational staff and business managers. It is therefore necessary that all staff, irrespective of the position must comply with all Shariah Standards and guidance provided by the Shariah Advisors and regulators in attending their duties. It is the responsibility of IB to conduct training and awareness program. II. Allocate the ownership of compliance to staff. Staff will be personally liable for violation of Shariah. It will be made an integral part of their annual appraisals. III. Assess, test and report compliance and control environment on periodical basis to the management (Head IB and Head Compliance). IV. Identify the gaps for timely remedial action. 3- Scope: The Policy is applicable to all IB operations. It covers, but not limited to: I. Risk Management Guidelines: State Bank of Pakistan (SBP) through IBD Circular No: 01 of 2008 dated 25 th March, 2008 issued Guidelines for Risk Management for Islamic Banking Institutions (IBIs). These guidelines should be considered in addition to the various Risk Management Guidelines issued by SBP from time to time II. Shariah Compliance Guidelines Annexure 1 & 2 of IBD Circular No: 02 of 2008 dated 25 th March 2008, Instructions for Shariah Compliance in Islamic Banking Institutions and Guidelines for Shariah Compliance in Islamic Banking Institutions provides instructions and guidelines on the duties and responsibilities of Shariah Advisor, conflict resolution in Shariah rulings and the function Shariah compliance mechanism and scope of Internal Shariah Audit. III. Accounting and Auditing Organization for Islamic Financial Institution (AAOIFI) AAOIFI Governance Standard No: 3 provide guidelines on objective, scope and mechanism for Internal Shariah Review. The primary objective o Internal Shariah Review is to ensure that the management of the bank discharges their responsibilities in relation to the implementation of the Shariah rules and principles as determined by the bank s Shariah Advisor. Page 2 of 60
4- Owner: SNDBL Islamic Banking is the owner of the Policy and will be reviewed and approved by the Board of Directors. 5- Effective Date and Review: This Policy will be effective from the date of approval from Board of Directors (BoD) and would be reviewed in line with SNDBL policy review requirement or as when considered necessary by the Head Islamic Banking and/or BoD. 6- Independence & Authority of Compliance Function The concept of independence involves four related elements: i- Shariah Compliance & Internal Control function shall have a formal status within the bank & work under Global Compliance. ii- There shall be a Shariah Supervisory Committee and Shariah Compliance Manager (SCM) with overall responsibility for coordinating the management of SC & ICM. iii- SCM should not have other duties where there is a possible conflict of interest between assigned responsibilities and any other responsibilities that they may have. iv- SCM shall have full access to the information, records, to carry out their responsibilities.. Page 3 of 60
B-POLICY STATEMENTS Shariah Compliance is IB top priority for safeguarding the interests of its stakeholders and is the responsibility of every employee and business managers. IB will continuously strive for improving the Shariah Compliance & Internal Control environment and minimizing non compliance risk through effective compliance of Shariah rules and principles, guidelines, and SNB s own policies and procedures. Critical elements of Policy include: i- Commitment for compliance at all level; ii- Compliance at entry level, Shariah vetting of all policies, products, procedures, revisions, instructions, circulars, deposit mobilization & pool mechanism, investment & placement of funds and other offerings; iii- Self assessment system for assessing and identifying Shariah non-compliance risk; iv- Compliance tracking and MIS for monitoring and reporting; v- Awareness, education and training of staff; vi- Shariah Compliance Help Desk facility for assistance; vii- Accountability system for reinforcement. Page 4 of 60
C-SHARIAH COMPLIANCE FUNCTION Annexure 2 of IBD Circular No: 02 of 2008 dated 25 th March, 2008 recommend that IBIs should introduce a Shariah Compliance Mechanism as a part of their control structure. The Shariah Compliance framework may include the following: A system of compliance having special emphasis on Shariah aspects with relevant provisions of existing laws, rules, regulations, policies and procedures related to Islamic banking need to be embedded in the IBI s processes in such a manner that monitoring and reviewing of issues related to Shariah compliance forms part of Internal Control structure. Monitoring and reviewing for Shariah Compliance should cover all activities, products and locations of the IB. The basic purpose of this responsibility is to ascertain whether the transactions, processes and products undertaken by the IB are Shariah compliant and all related conditions are being met, as approved by Shariah Advisor. Access to all necessary documents/information should be provided to Shariah compliance officials in performance of their functions. Irregularities if any, related to Shariah Compliance shall be properly recorded and rectified with the approval of Shariah Advisor. Proper training should be provided to the relevant staff in the area of Shariah Compliance. 1- Structure of Shariah Compliance & Internal Control Mechanism: I. Shariah Supervisory Committee: In SNDBL Islamic Banking there is a Shariah Supervisory Committee (SSC) consisting of a Shariah Advisor and a Member Shariah Supervisory Committee (MSSC) to assist Shariah Advisor for strengthening of Shariah Compliance in IB. Shariah Advisor will lead the committee and has final approval authority. Appointment of Shariah Advisor: a. Appointment of Shariah Advisor, together with its Terms & Conditions shall be approved by BoD Page 5 of 60
b. Terms of Reference of the Shariah Advisor shall be approved by BoD c. Shariah Advisor shall meet the Fit and Proper Criteria for Shariah Advisor as notified by SBP d. Appointment of SA shall require prior written approval from SBP e. Shariah Advisor shall be appointed for a renewable term of three years f. Termination of Shariah Advisor or his removal before the expiry of his term shall be with the approval of authority which has approved his appointment i.e. BoD. g. IB shall be required to notify SBP of any resignation or termination of the Shariah Advisor within 14 days of the date of resignation or termination. IB shall also state the reasons of such termination and alternate arrangements for interim period h. Shariah Advisor shall report to CEO of the bank. i. The fatwa and rulings of the SA shall be binding on the IB. He may, however, advise/issue guidelines on any matter referred to him by the BoD/management Duties and Responsibilities of Shariah Advisor and Member Shariah Supervisory Committee: Shariah Advisor shall review operations of IB on periodic basis in coordination with Member Shariah Supervisory Committee and staff responsible for Shariah Compliance (Shariah Compliance Manager) to ensure that all the products and services being offered by IB conform to the injunctions of Shariah. a. Review & Vetting: Shariah Advisor will review and approve products and procedures, documents & agreements pertaining to products and services offered by IB, whereas MSSC will assist the Shariah Advisor in achieving these objectives. No product or delivery channel will be launched before the Shariah Advisor has signed off on the product or channel program, indicating that they are in line with Shariah rules and principles. As a matter of routine, all Islamic banking products programs & related documents must undergo an annual Shariah revision process or where there are circumstances which triggers the need for more frequent revisions due to changes or amendments in laws or regulations affecting a particular product b. Advising: Shariah Advisor and MSSC will guide IB on matters that may originate from: - Applicable laws, regulations, policies/procedures/shariah Standards - New products & Services - Queries from IB and/or Islamic banking Branches for understanding and clarification Page 6 of 60
- They will also assist IB in developing new products, documents and agreements. c. Educating & Training: Shariah Advisor and MSSC would strive to: - Educate staff & create awareness - Provide help desk facility at IB regarding clarification and/or interpretation of regulatory laws - Provide guidance to other business groups and controlling offices d. Identifying, Measuring and Assessing Shariah Non-Compliance risk: Shariah Advisor and MSSC would: - Identify, document and assess the Shariah non-compliance risk associated with IB s business activities proactively by using Shariah Compliance & Control Self Assessment (SCCSA) System as the main tool for measuring and assessing Shariah non-compliance risk in all areas of operations. - Assess the appropriation of the Bank s policies, procedures and product & services for IB and promptly - Identification of deficiencies, and where necessary, suggest appropriate solutions e. Statutory Responsibility: Shariah Advisor will carry out the following statutory responsibilities: - Shariah Advisor shall prepare a report on the Bank s annual financial statement in respect of its Shariah compliance, which shall be published in the Bank s annual report. The Shariah Advisor shall report that: Whether or not he has examined, on test basis, each class of transaction, the relevant documentation and procedures adopted by IB. Whether or not in his opinion, the affairs of IB have been carried out in accordance with rules and principles of Shariah, SBP regulations and guidelines related to Shariah compliance and other rules as well as with specific fatawa and rulings issued by the Shariah Advisor from time to time; Whether or not in his opinion, the allocation of funds, weightages, profit sharing ratios, profits and charging of loses (if any) relating to PLS accounts conform to the basis vetted by Shariah Advisor in accordance with Shariah rules and principles; Whether or not in his opinion, any earnings that have been realized from sources or by means prohibited by Shariah rules and principles have been credited to Charity Account. Page 7 of 60
- Shariah Advisor will liaison with bank s internal audit to carried out Internal Shariah Audit. The report of the Internal Shariah Audit shall be placed before the Shariah Advisor for advising appropriate corrective action and then before the Audit Committee of the Bank for consideration and appropriate remedial action as advised by the Shariah Advisor. - Coordinate and participate in meetings with SBP - Observe strict fidelity, secrecy and shall not disclose any information relating to the affairs of the Bank and its customers to anybody except in circumstances in which it is in accordance with law. f. Escalation issues Shariah Advisor is required to escalate all issues of non-compliance to Head IB and/or management II. Shariah Compliance Manager (SCM): Shariah Compliance Manager is a coordinator and would maintain strong working relationships with Compliance and Internal Audit, in managing Shariah non-compliance and other risk. SCM would also serve as a focal point for liaison with the regulators for onsite inspection and offsite surveillance. Staff exercising Shariah compliance responsibilities shall have the necessary qualifications, experience and skills to enable him to carry out their duties effectively. Accordingly, SCM should have an overall understanding of Shariah rules and principles and operations of IB Duties Shariah Compliance Manager: - To provide proactive advice to SSC on operations, applicable laws and regulations and bank s policies - To participate in the Shariah review/internal audit process - To participate in the assessment process for new products being introduced - To assist SSC identify and maintain Shariah compliance mechanism and procedures in place - To conduct or arrange training programs for compliance related matters - To ensure updation of Shariah Compliance Manual - To assist Shariah Advisor for identifying and reporting any breaches or suspected breaches by conducting off-site and on-site monitoring - To act as an coordinator between field staff and Shariah Advisor - To plan visit schedules of Shariah Advisor - Review of SCCSA and its submission to the Shariah Advisor and management Page 8 of 60
- Monitoring and tracking transactions, and reporting deviation to the Shariah Advisor - It also provide support to the business through raising awareness and keeping them abreast of changes in the laws, regulation, and policies - It would also track and follow-up on the outstanding issues raised in SCCSA, Internal Shariah Audit or any periodic review conducted by internal/external agencies for resolution - Complying COSO framework - To escalate issues of non-compliance up to Shariah Advisor/SSC and/or Head IB - To maintain records of Fatawas, Shariah rulings and instructions and matters related to SSC - To prepare and manage subsequent amendments in Islamic Banking Schedule of Charges P & CEO SSC Head IB Compliance Compliance SCM STRUCTURE OF SC & ICM 2- Shariah Compliance Set-up: I. Objective: - To proactive pursue the Shariah compliance by engaging all operational staff. Compliance and controls are prime responsibility of operations staff and business managers. - To provide assessment by periodical review through Shariah Compliance & Control Self Assessment Questionnaire (SCCSAQ). SCCSAQ for Murabaha, Ijarah, Diminishing Musharaka, Salam, Istisna, Deposits and Profit Distribution Mechanism and Islamic Export Refinance Scheme (IERS) is appended in the annexure. SCCSAQ on other products will be added and become part of this Policy when they are launched. - SCCSAQ shall provide an opportunity to identify risks as they emerge, timely resolution and reporting for SSC and the management. II. Coverage - SBP regulations, instructions and guidelines for Shariah compliance - Bank s internal control policies and procedures - Shariah standards Page 9 of 60
- Shariah Advisor s rulings and instructions III. Benefits: - Proactive approach in controlling and mitigating Shariah non-compliance risk - Ownership at operational level - Accuracy of information - Timely reporting IV. Shariah Compliance & Control Self Assessment Questionnaire (SCCSAQ): SCCSAQ has been developed (as Annexure) to cover Shariah and relevant regulatory requirement of IB operations, products and documents. Responsibility for filling of SCCSAQ - This would be responsibility of the branch manager, manager operations, manager trade, and manager credit to respond SCCSAQ - All branches would be required to fill up the SCCSAQ according to the predetermined frequency which is at present is on quarterly basis. It would be the responsibility of branch manager to complete SCCSAQ in pre-schedule time - Maximum RTD for any issue cannot be beyond 30 days that is next month end excluding matters for which exceptions from relevant functions has been taken. Quantifiable measurement to compliance On the basis of SCCSAQ, the branches will be awarded Shariah compliance ranking based on the following criteria: Compliance level Parameters Ranking Mostly compliant 91% and above 1 Partially compliant 81% to 90% 2 Marginally compliant 71% to 80% 3 Non compliant 61% to 70% 4 The compliance scorecard would assist in monitoring operations and remedial measures. It would also be used in determining individual performance of managers/staff and would be integrated with the performance appraisal system. Manager who get ranking 3 or below will be cautioned and same will be documented. Page 10 of 60
Risk Categorization of Branches: According to the response branches will be classified in 3 categories to determine the frequency of responding to SCCSAQ: High Risk: HR. Branches having ranking 3 to 4 Moderate Risk: MR. Branches having ranking 2 Low Risk: LR. Branches having ranking 1 HR: Branches in this category would be required to respond SCCSAQ on monthly basis MR: Branches in this category would be required to respond SCCSAQ on quarterly basis LR: Branches in this category would be required to respond SCCSAQ on half yearly basis The scorecard would provide the extent of implementation of the Shariah compliance framework and would assist SSC in targeting its monitoring as well as training efforts and where required escalation of marginally compliant risk areas to the management. The risk assessment system would also used in determining performance of individual officers/ managers and would be integrated with the performance appraisal. Process Flow: Step 1: The branch manager will record exception and reasons and give RTD Step 2: Branches will submit SCCSAQ along with other non-financial data to SCM on or before 20 th of month due for self assessment Step 3: SCM will visit the branches to cross check the responses on sample basis. False/incorrect reporting by the branches will call for disciplinary action. Step 4: Once filled, branch manager will make effort to follow-up/rectification on or before RTDs Exception reporting and tracking a. On-site monitoring - SCM will carry out on-site monitoring on a sample basis to ensure the quality and accuracy of responses by the branch managers to questions, exceptions identified and RTDs - Further compliance team from Bank s Compliance Division may visit the branch to cross check the responses etc Page 11 of 60
- On-site monitoring program will be risk based and conducted by SCM. It is in addition to monitoring by Compliance. b. Off-site Monitoring - Once questionnaire are filled and submitted by the branches, it will be assessed by SCM besides Compliance for following purpose: Branch compliance assessment Exception tracking Risk quantification and Allocating Shariah compliance rankings 3- Internal Shariah Audit: I. Objective: - To ensure that the management of bank and IB is discharging its responsibilities in compliance with Shariah rules and principles; and - To ensure that the system of internal control for Shariah Compliance is effectively implemented and meeting its objectives. II. Internal Shariah Audit Team - The management shall identify a team, responsible for performing Internal Shariah Audit of IB. - The Internal Shariah Audit Team shall comprise of experience staff from Internal Audit, who shall be supported by the SA and/or SSC, and SCM in performing these functions. - Annual plan of Internal Shariah Audit and its frequency will rests with the Internal Audit of the bank III. Report - The report of the Internal Shariah Audit shall be placed first to SA and/or SSC for discussion and then to Audit Committee. - Any disputes or difference of opinion on matters relating to Shariah interpretation between the management and Internal Shariah Auditors shall be referred to the Shariah Advisor for final decision. - The report of Internal Shariah Audit shall contain: Observations on overall control environment Assessment of systems and controls Page 12 of 60
Recommendations for potential improvements Corrective actions to be taken as advised by SA and/or SSC Shariah Compliance & Control Self Assessment Questionnaire (SCCSAQ): Page 13 of 60
1. MURABAHA 1.1. Guidelines 1.1.1. IFAS 1 issued by Institute of Chartered Accountants of Pakistan, defines the term Murabaha as follows: Murabaha is a particular kind of sale where seller expressly mentions the cost he has incurred on the commodities to be sold and sells it to another person by adding some profit or markup thereon which is known to the buyer. 1.1.2. The term, Murabaha is generally applied to transactions where the seller agrees to sell goods on credit and he discloses the price of goods if these were to be sold on cash and the mark-up or profit for selling the goods on credit. The profit may either be a lump sum or may be based on a percentage. 1.2. Shariah conditions 1.2.1. A request letter (on Standard Form) from the buyer to buy goods (the goods) on Murabaha basis is required; 1.2.2. The goods must not fall in the category of the goods declared unlawful (haram) by Shariah; 1.2.3. The goods must not be used for haram activities; 1.2.4. The seller has the title and bears risks and rewards of the goods before the sale takes place; 1.2.5. The buyer acquires the title to the goods and bears risks and reward thereon when the sale takes place. However the seller may secure his debt by way of a charge over the goods. The seller may also acquire any other securities over the debt from the buyer; 1.2.6. There must not be any buy back option in the contract for the seller; 1.2.7. The price of the goods cannot be changed subsequent to the consummation of the sale transaction; 1.2.8. The cost of the goods sold and the profit must be mentioned in Murabaha Agreement. Page 14 of 60
1.2.9. IB appoints the client as an agent to buy the goods on behalf of the IB as entered in an Agency Agreement before the purchase of goods. 1.2.10. Goods allowed under Agency Agreement must be specifically mentioned and permissible under Shariah. 1.2.11. At the time of signing of the Agency Agreement the agent must not have possession of the goods. 1.2.12. IB should make payment directly to the supplier 1.2.13. The subject matter of sale must be in the physical or constructive possession of the IB when he sells it to client on Murabaha basis. 1.2.14. The offer to sale by the bank must be duly approved by the customer. 1.2.15. The Murabaha Agreement must be executed after the customer intimation of receiving the goods. 1.2.16. The total amount of financing must not exceeds the limit approved in Master Murabaha Agreement. 1.2.17. The subject of sale must be a tangible asset. 1.2.18. Murabaha must be executed before consumption of commodity by the customer. 1.2.19. The subject matter of the sale must be specifically known and identified to the buyer. 1.2.20. Any discount offered by the supplier to the bank must be transferred to the customer. 1.2.21. The price and other conditions must not change once agreed between IB and the customer. 1.2.22. Rollover in Murabaha or to charge any profit after due date is not allowable, however, the bank may reschedule the remaining actual amount in installments. 1.2.23. The IB must bear the insurance premium of the goods which may be covered in the Murabaha Price. 1.2.24. In case of joint purchase the customer must notify his share in the consignment prior to request for disbursement of Murabaha. The sharing must be based on Physical Units of commodity covered. 1.2.25. In case of late payment the charity received must be separately accounted in charity account and must be in accordance with the rates specified in the agreement. 1.2.26. Written Murabaha Contract must be executed by the parties clearly specifying the following: a) Description of Tangible Assets b) Murabaha Period Page 15 of 60
c) Cost of goods d) Rate / amount of profit e) Any other important conditions that would exist in avoiding disputes between the parties 1.2.27. All Statutory and Banking Regulation applicable to Murabaha transactions and the requirements of IFAS-8 must be compiled with. 1.3. Source Documents 1.3.1. Internal Shariah Audit and Internal Control will be conducted on the basis of the following documents: 1) SNDBL-Islamic Banking Murabaha Manual 2) Islamic Financial Accounting Standards-IFAS-1 3) SBP IBD Circular No.2 of 2008 4) AAOIFI s Shariah Standard No. 8 5) Shariah Advisor s rulings in respect of Murabaha Page 16 of 60
1.4 SCCSAQ- Murabaha Financing S. No Shariah Standards Related controls Compliance Rating 1-5 Remarks 1 Agreements and transactions flows should be approved by the Shariah Advisor Obtain copies of agreements and process flows and Offer Letters. Refer to respective product manual. 2 Customers should be assigned with specific limit Obtain and see Master Agreements, Sanctioned Advices and Offer Letters duly signed by the customers 3 A request on Standard Application is required from customer. 4 The goods must not fall in the category of the goods declared unlawful (haram) by Shariah; Standard Facility Application Form Check the objective of financing and analyze the customer s business needs 5 The goods must not be used for haram activities; 6 The seller has the title and bears risks and rewards of the goods before the sale takes place; 7 The buyer acquires the title to the goods and bears risks and reward thereon when the sale takes place. However the seller may secure his debt by way of a charge over the goods. The seller may also acquire any other securities over the debt from the buyer; 8 There must not be any buy back option in the contract for the seller; 9 The price of the goods cannot be changed subsequent to the consummation of the sale transaction; 10 The cost of the goods sold and the profit The IB expressly mentions Page 17 of 60
S. No Shariah Standards Related controls Compliance Rating 1-5 Remarks must be mentioned in Murabaha the cost of the Agreement. commodities and profit thereon. 11 The IB appoints the client as an agent to buy the goods on behalf of the IB as entered in an Agency Agreement before the purchase of goods. 12 If the buyer is appointed as an agent to facilitate the transaction, there should be a separate agency agreement with the buyer. If any remuneration is payable to the agent, it should be fixed; 13 Goods allowed under Agency Agreement must be specifically mentioned and permissible under Shariah. 14 At the time of signing of the Agency Agreement the agent must not have possession of the goods. The bank should obtain a purchase order to ensure that the actual sale has not been executed by the customer. 15 IB should make payment directly to the supplier The disbursement must be made directly to the supplier and it is through banking channel. In case of direct payment to the customer IB shall record valid reasons 16 Invoice should be in Bank s name 17 The subject matter of sale must be in the physical or constructive possession of the IB when he sells it to client on Murabaha basis. The Bank obtains declaration of goods received from the customer (agent) before selling the goods to client on Murabaha basis. Page 18 of 60
S. No Shariah Standards Related controls Compliance Rating 1-5 Remarks 18 The offer to sale by the bank must be duly approved by the customer. Offer to sell by the Bank must be signed and dated by the customer. 19 The Murabaha Agreement must be executed after the customer intimation of receiving the goods. The date on invoice must not be later than the date on which the customer makes the declaration. The bank should perform a physical survey to ensure that the customer has received the delivery of the goods. 18 The total amount of financing must not exceeds the limit approved in Master Murabaha Agreement. In Master Murabaha agreement total financing must be within the limit approved by the Bank. 20 The subject of sale must be a tangible asset. Murabaha against debt & receivables are not allowed 21 Murabaha must be executed before consumption of commodity by the customer. There must not be significant delay between taking possession of the goods and giving declaration to the bank by the customer as it increases the risk of consumption of commodity before the execution of the Murabaha Agreement. 22 The subject matter of the sale must be specifically known and identified to the buyer Subject matter of same (i.e. specification about commodity) must be specifically mentioned in order form and agency Page 19 of 60
S. No Shariah Standards Related controls Compliance Rating 1-5 Remarks agreement which will sign by both parties. 23 Any discount offered by the supplier to the bank must be transferred to the customer. 24 The price and other conditions must not change once agreed between IB and the customer. Price and other conditions of the transaction must not be changed once decided in the Murabaha contract. 25 Rollover in Murabaha or to charge any profit after due date is not allowable, however, the bank may reschedule the A Roll over Murabaha Transaction must not occur. remaining actual amount in installments 26 IB must bear the insurance premium of the goods which may be covered in the Murabaha Price. Name of the Insurance / Takaful company with which goods are insured must be mentioned. Insurance Premium of the goods must be borne by the bank however the bank may cover the insurance premium in Murabaha Price. 27 In case of late payment the charity received must be separately accounted in charity account and must be in accordance with the rates specified in the agreement. The charity amount collected at the rate specified in the agreement has been donated to the approved charitable institution as per approved Charity Policy. Page 20 of 60
S. No Shariah Standards Related controls Compliance Rating 1-5 Remarks 28 Written Murabaha Contract must be executed by the parties clearly specifying the following: Given details must be agreed between both the parties. a) Description of Tangible Assets b) Murabaha Period c) Cost of goods d) Rate / amount of profit e) Any other important conditions that would exist in avoiding disputes between the parties 29 IB should place customer s cash security deposit in a PLS account under lien 30 IB will abstain from deriving any financial benefit from the asset that was furnished as security 31 All Statutory and Banking Regulation applicable to Murabaha transactions and the requirements of IFAS-1 must be compiled with. All related conditions that are stipulated in statutory, banking regulation and IFAS-1 is covered in Murabaha agreement. 2. IJARAH 2.1. Guidelines 2.1.1. IFAS-2 defines Ijarah as follows: Ijarah (Lease) is a contract whereby the owner of an asset, other than consumables, transfers its usufruct to another person for an agreed period for an agreed consideration. 2.1.2. An Ijarah transaction has the following characteristics: a) There is an asset of a durable nature; Page 21 of 60
b) There are two parties (or two groups of the parties) in the transaction, i.e., the owner (lessor) of the asset and its user (lessee); c) Owner (lessor) retains the ownership of the asset for the entire lease period; d) There is a financial consideration i.e. rental for the period of the use of the asset. 2.2. Shariah conditions 2.2.1. A promise / request from customer to obtain asset on Ijarah basis; 2.2.2. The asset being leased must be of a durable nature; 2.2.3. The owner must own the asset and retain its ownership for the entire period of the Ijarah, unless it is a valid sublease (a lessee may purchase the goods for the lessor as an agent of the lessor); 2.2.4. In case of a valid sublease, the ownership of the asset must remain with the ultimate lessor for the entire period of the Ijarah; 2.2.5. The asset must not fall in the category of the goods declared unlawful (haram) by Shariah; 2.2.6. The asset must not apparently be used for any haram activities; 2.2.7. The assets should be insured under Takaful; 2.2.8. The rent should only become chargeable when the rights to use the asset are acquired by the lessee. Ernest money/ advance rent may be obtained but must be treated as liabilities by the lessor; 2.2.9. The rent must cease when the lease period expires; 2.2.10. For any asset earmarked for a lessee on the instruction of the lessee but its possession has not been taken by the lessee, the lessor must not either use the asset for his own benefit; or enter into another contract for the same asset with another lessee; 2.2.11. Any charity received for violation of its undertaking in case of delayed payment of the rent must be donated to an approved charity; 2.2.12. The lessee must use the asset in accordance with the terms of the Ijarah contract; 2.2.13. Unless allowed by the Ijarah contract, the asset must not be sublet without the approval from the lessor; Page 22 of 60
2.2.14. In case of sale and lease back of the asset, there should be two separate contracts respectively for the sale and the lease. Both the contracts should be independent and approved by the Shariah Advisor, 2.2.15. Written Ijarah contract must be executed by the parties clearly specifying the following: a) Description of the asset; b) Lease period; c) Permissible uses of the asset by the lessee; d) Rental amount and its mode of payment, the rental amount may either be a lump sum or in periodic installments; e) Restrictions or otherwise on subletting the asset; f) Responsibilities of the lessor to bear the cost in case of any future defect and wear and tear of the asset; and g) Any other important conditions that would assist in avoiding disputes between the parties 2.2.16. The statutory and banking regulations applicable to Ijarah transactions and the requirements of IFAS 2 must be complied with. 2.3. Source Documents 2.3.1. Internal Shariah Audit and Internal Control will be conducted on the basis of the following documents: 1) SNDLB-Islamic Banking Ijarah Manual 2) Islamic Financial Accounting Standards-IFAS-2 3) SBP IBD Circular No.2 of 2008 4) AAOIFI s Shariah Standard No. 9 5) Shariah Advisor s rulings in respect of Murabaha 2.4 SCCSAQ-IJARAH FINANCING S. No Shariah Standards Related controls Compliance Rating 1-5 Remarks Page 23 of 60
S. No Shariah Standards Related controls Compliance Rating 1-5 Remarks 1 Agreements and transactions flows should be approved by the Shariah Advisor Obtain copies of agreements, process flows & Offer Letters. Refer to respective product manual. 2 A promise / request from customer are required to obtain asset on Ijarah basis. Written request on Standard Facility Application from the customer is always obtained. 3 Customers should be assigned with Obtain and see Master specific limit Agreements, Sanctioned Advices and Offer Letters duly signed by the customers 4 The asset being leased must be of a durable nature. Check that the leased assets do not fall in the category of consumables 5 The owner must own the asset and retain its ownership for the entire period of the Ijarah, unless it is a valid sublease (a lessee Bank always owns the asset for the duration of the lease period may purchase the goods for the lessor as an agent of the lessor. 6 In case of a valid sublease, the ownership of the asset must remain with the ultimate Bank always retains the ownership in case of Sublease. lessor for the entire period of the Ijarah. 7 The asset must not fall in the category of the goods declared unlawful (haram) by Shariah. 8 The asset must not apparently be used for any haram activities. Check the objective of Ijarah and business needs of the customer. Assets are always leased for either personal use or legitimate business 9 The assets should be insured under Takaful. Takaful should be in Bank s name Check Takaful premium receipts and the cost should be borne by IB. The cost may be included in pricing. Lessee may be allowed to arrange insurance on account of the lessor and the premium so paid by the lessee shall be reimbursed by Page 24 of 60
S. No Shariah Standards Related controls the lessor. Compliance Rating 1-5 Remarks 10 The rent should only become chargeable when the rights to use the asset are acquired by the lessee. Ernest money/ advance rent may be obtained but must Rent is charged after the delivery of asset. Ernest money/advance rentals are treated as liabilities. be treated as liabilities by the lessor. 11 The rent must cease when the lease period expires / terminated due to any force measure. Rentals are not obtained after the expiry of lease period or on declaration of loss of the asset 12 For any asset earmarked for a lessee on the instruction of the lessee but its possession has not been taken by the Asset is delivered to customer immediately after the bank takes possession lessee, the lessor must not either use the asset for his own benefit; or enter into another contract for the same asset with another lessee. 13 Any charity received for violation of the contract must be donated to an approved charity. Charity received is separately accounted in Charity account and donated to approve charitable institutions. 14 The lessee must use the asset in accordance with the terms of the Ijarah contract. 15 Unless allowed by the Ijarah contract, the asset must not be sublet without the approval from the lessor. 16 In case of sale and lease back of the asset, there should be two separate contracts respectively for the sale and the lease. Both the contracts should be independent The bank surveys the leased asset at predetermined frequency. Approval from the bank is required by the lessee before entering into sub lease Two independent contracts are always prepared in such cases and these are approved by the Shariah Advisor. and approved by the Shariah Advisor, 17 A written Ijarah contract must be executed by the parties clearly specifying the As standard version of Ijarah contract, approved by the Page 25 of 60
S. No Shariah Standards Related controls Compliance Rating 1-5 Remarks following: Shariah Advisor is used to the Description of the asset; Lease period; Permissible uses of the asset by the lessee; Rental amount and its mode of payment, the rental amount may either be a lump sum or in periodic installments; bank Restrictions or otherwise on subletting the asset; Restrictions or otherwise on subletting the asset; Other important conditions that would assist in avoiding disputes between the parties. 18 In case of termination of lease before expiry, there should be a letter from the Check customer s letter in case of premature termination. customer to record the reasons for termination. 19 The IB should comply with all the prevailing statutory and the The bank complies with these requirements. banking/prudential regulations of the country and the IFAS requirements. 20 Unilateral promise to buy/sell the assets upon expiry of the lease should be Check the documents for any conditions thereof. unconditional Page 26 of 60
3. DIMINISHING MUSHARAKA 3.1. Guidelines 3.1.1. Diminishing Musharaka is a particular kind of Musharaka, according to which a Bank and his customer jointly contribute and participate in the ownership of a particular asset or equipment or in a commercial enterprise. The share of the financier is further divided into smaller units according to his share in the joint ownership of the asset. The client starts purchasing the share of the Bank in the joint ownership one by one, as per their mutual understanding at the time of agreement, thus increasing his own share till a time comes when he becomes the sole owner of the property. 3.1.2. The contract of Musharaka can take place between two or more persons with the capital contributed by the partners / shareholders and the profit to be distributed among them according Page 27 of 60
to the rates agreed upon by the partners and losses are borne according to the investment / Capital. 3.1.3. The term Musharaka is normally restricted to a particular type of Shirkah that is, the Shirkat-ulamwal and Shirkat-ul-a mal. 3.1.4. Under Diminishing Musharaka IB and the client willing to buy the asset participate in the joint ownership or Shirkat-ul-Milk 3.1.5. The client uses the asset for his/her business requirement and pays rent to the IBfor using his share in the property. 3.1.6. This proportion allows IB to claim rent according to his proportion of ownership in the property and at the same time allows him periodical return of a part of his principal through purchases of the units of his share. 3.1.7. Termination: Diminishing Musharaka is deemed to be terminated in any one of the following events : a) The customer must undertake to purchase all Musharaka units in case of default committed by the customer in fulfilling any of his/her obligations in case of which IB may terminate his/her agreement by serving a notice on him / her b) If any one of the partners dies during the currency of Musharaka, the contract with him/her stand terminated. His / her heirs in this case, will have the option either to draw the share of the deceased from the business, or to continue with the contract of Musharaka c) If any one of the partners becomes insane or otherwise become incapable of effecting commercial transactions, the Musharaka stands terminated 3.2. Shariah Conditions 3.2.1. Transactions which are not permitted by the Shariah should not been carried out. 3.2.2. The IB and the client will Purchase/ Construct/ specific asset participate in the joint ownership i.e. Shirkat-ul-Milk. 3.2.3. The asset may be in the name of the client. 3.2.4. Diminishing Musharaka can only be created in tangible assets. Page 28 of 60
3.2.5. All terms and conditions as are essential to Ijarah and sale shall be fulfilled in respect of different stages in the process of Diminishing Musharaka arrangement. 3.2.6. In case of purchase of asset, Bank & client enter into Musharaka agreement. In this agreement it is decided to purchase the asset jointly and ratio of investment by each one. 3.2.7. According to the ratio of ownership, each one is responsible for the loss. 3.2.8. IB will divide its own part of asset into units, which is promised by the client to purchase on preagreed price. 3.2.9. In Ijarah Agreement, a lump sum amount of rent is necessary to be fixed for certain period. Rent for the rest of the period, may be linked with agreed Benchmark. 3.2.10. The client uses the asset for his requirement and pays a specific rent to the IB for using Bank s share in the asset with mutual consent. 3.2.11. The client promises separately to purchase the share of IB in the joint ownership, as per their mutual understanding as per its promise he shall purchase the share of IB, till a period comes when customer becomes the sole owner of the asset. 3.2.12. Amount of rent and Musharaka units were calculated in accordance to market value or at a price mutually agreed at the time of acquisition of asset. 3.2.13. Expenses incidental to ownership is borne jointly by the co-owners in the proportion of their coownership. 3.2.14. At the time of purchase of each unit, sale must be affected by the exchange of offer and acceptance at that particular rate. 3.2.15. Each periodic payment against purchase of Musharaka unit shall constitute a separate transaction of sale. 3.2.16. There shall be an agreement of lease between the co owners to lease out ones share in such property to another for an agreed periodic payment in consideration of the use of the formers share by the latter 3.2.17. An undertaking by Client to the effect to purchase the units of IB at a mutually agreed price. 3.2.18. The purchase of different units of the client is affected on the basis of the market value of the asset as prevalent on the date of purchase of the unit, but it is also permissible that a particular price is agreed in the promise of purchase signed by the client. Page 29 of 60
3.2.19. Upon termination of Musharaka the remaining Musharaka units have been purchased by the customer at the outstanding buyout price as provided in the Diminishing Musharaka agreement. Where the customer fails to purchase the remaining Musharaka units within the stipulated time period, the Bank has sole discretion to sell of the Musharaka property and recover its investment. 3.2.20. Written Musharaka Contract must be executed by the parties clearly specifying the following : a) Description of Assets b) Period of purchase of unit c) The payment of rental amount and purchase of units should be based as mentioned in the agreement d) Restriction or otherwise on subletting of the Asset; and e) Any other important conditions that would assist in avoiding disputes between the parties 3.2.21. All agreements must be drawn up in accordance with the sample agreement as approved by Shariah Advisor. 3.2.22. All Statutory and Banking Regulation applicable to Musharaka transactions and the requirements of IFAS-4 must be compiled with. 3.3. Source Documents 3.3.1. Internal Shariah Audit and Internal Control will be conducted on the basis of the following documents: 1) SNB-Islamic Banking Diminishing Musharaka Manual 2) SBP IBD Circular No.2 of 2008 3) AAOIFI s Shariah Standard No. 12 4) Shariah Advisor s rulings in respect of Diminishing Musharaka 3.5 SCCSAQ-DIMINISHING MUSHARAKA-HOUSING S. No Shariah Standards Related controls Compliance Rating 1-5 Remarks 1 Agreements and transactions flows should be approved by the Shariah Advisor Obtain copies of Agreements, process flows & Offer Letters. Refer to respective Page 30 of 60
S. No Shariah Standards Related controls product manual. Compliance Rating 1-5 Remarks 2 A request from customer is required Written request on Standard Facility Application from the customer is always obtained. 3 Customers should be assigned with specific limit Check Master Agreement, offer letter and sanctioned advice. 4 Transactions which are not permitted by the Shariah should not been carried out. Check the objective of financing and customer s business needs. 5 The asset may be in the name of the client. It is mentioned in the Musharaka agreement that owner ship of the property mortgaged is in the name of the customer. 6 Diminishing Musharaka can only be created in tangible assets. Check the nature of the asset. 7 All terms and conditions as are essential to Ijarah and sale shall be fulfilled in respect of different stages in the process of Diminishing Musharaka arrangement. 8 In case of purchase of asset, Bank & client enter Musharaka agreement into Musharaka agreement. In this agreement it is decided to purchase the asset jointly and ratio of investment by each one. 9 In case of purchase of asset Musharaka agreement and Ijarah agreement should be specifies the ratio of investment by both the parties. Date of Ijarah agreement is after the date of made separately. Musharaka agreement. Both the agreement are signed by the parties separately on basis. Page 31 of 60
S. No Shariah Standards Related controls Compliance Rating 1-5 Remarks 10 According to the ratio of ownership, each one is It is stipulated in responsible for the loss. Musharaka agreement that each partner is responsible for loss in the ration of ownership, as per Shariah rules. 11 Bank will divide its own part of asset into units, which is promised by the client to purchase on pre-agreed price In Musharaka agreement client agrees to purchase the units at a pre-agreed price. 12 In Ijarah Agreement, a lump sum amount of rent is necessary to be fixed for certain period. Rent for the rest of the period, may be linked with agreed Benchmark. Fixed and variable portion of rental is ascertained with the rental schedule prepared by the Bank. 13 The client uses the house for his requirement and pays a specific rent to the IB for using Bank s share in the property with mutual consent. 14 The client promises separately to purchase the share of IB in the joint ownership, as per their Ratio of ownership is decided / mentioned in mutual understanding as per its promise he shall Musharaka agreement, purchase the share of the bank, till a period comes when customer becomes the sole owner of the property. such ownership shall be gradually transferred to the customer by the purchasing of such units. 15 Amount of rent and Musharaka units were calculated in according to market value or at a price mutually agreed at the time of acquisition of asset. Rentals and Musharaka units were calculated in accordance with the customer accepted offer letter and a recalculation of both must be performed to verify their accuracy. 16 Expenses incidental to ownership is borne jointly by the co-owners in the proportion of their coownership. Check that such expenses are borne jointly by the co-owners in the Page 32 of 60