Understanding Islamic Finance - Doha Academy of Tertiary Studies

364 Understanding Islamic Finance— the interest income ratio is more than (5) %;— the debt ratio (leverage) is more than (10–33) %;— total illiquid assets are less than 10–33 % of its total assets.If investment is made in the equity of such companies, Haram or interest-related incomewill have to be given to charity and the Sharī´ah boards must ensure its credit to the CharityAccount.The major functions of a Sharī´ah supervisory board in the light of the AAOIFI’s Sharī´ahStandard are given in the appendix to this chapter.Sharī´ah Controls in Respect of Various ModesIn order to ensure Sharī´ah compliance, Sharī´ah boards should specify certain controlsfor modes which respective banks are using, particularly in respect of commonly usedproducts like Murabaha and Ijarah, which are susceptible to being used as back doors tointerest. Murabaha in various goods may involve different aspects needing close monitoring,for example, Murabaha in perishable goods, shares of joint stock companies, particularlywhen the transactions involve dual side agency agreements (the client is appointed agent topurchase the asset on behalf of the bank and also given funds for payment to the supplier),Tawarruq and other by-products of major Islamic modes. We outline internal controls inrespect of some commonly used modes below.Murabaha – Internal Sharī´ah Controls1. The Internal Control Department/Sharī´ah Board should ensure that accounting inMurabaha is made similar to that of a trade transaction instead of a financial transaction.In this respect, the AAOIFI’s Accounting Standard on Murabaha may be consulted orthere could be adaptation keeping in mind the international accounting standards and thelocal business practices. Some banks record only the disbursement of the total amountincluding mark-up. This is against the substance of Sharī´ah-compliant Murabaha.2. To ensure that banks are not involved in rollover of Murabaha transactions, strict internalcontrols should be applied. The price of the goods cannot be changed if the customerdoes not pay on time. Accordingly, there is no prospect for a rollover of Murabahatransactions. Nevertheless, it should also be kept in mind that a master Murabaha facilitythat a bank approves for a client as MoU, entails multiple Murabaha transactions, and ifit is necessary to extend credit, a new Murabaha should be initiated against new goodswith a fresh offer and acceptance and complete process of trade. However, some banksresort to arrangements in which they disburse the amount payable by their client against anew but fictitious Murabaha (only book entries), credit the amount to the client’s accountand then debit his account against the old Murabaha. In some cases, banks might not bemaking even the book entry for the new Murabaha and there might be simple rolloverof the previous Murabaha, including the previous receivables plus mark-up for the newterm. Sharī´ah boards will have to restrict the banks from such operations. Return onsuch rollovers must go to the Charity Account.3. The client who is being paid an amount for purchase of the commodity on behalf of thebank may not purchase the commodity for a long time and use the funds for arbitrage orany other asset that might not be permissible, e.g. for purchase of interest-based securitiesor shares in interest-based companies. Therefore, it has to be ensured that the client