Misconceptions About Islamic Banking (Part 1)

1. "Islamic banking encourages people to take Islamic financing and encourage people to be in debt".

Islamic banks offer Islamic alternative to people who are in need financially. Rather than they take loan with interest, which is prohibited in Islam, Islamic banking provides Halal alternative. Islamic banking is not supposed to "sell" Islamic financing like the conventional banks. Islamic way of marketing plan should be different as we provide solution and assistance to those who are in need rather than promoting customers to take debt.

2. "Islamic banking creates debt similar to conventional bank, hence they are the same"

In substance, Islamic banking creates economic outcome very similar to debt. However, the contract of rights and obligations are based on Bai' i.e. buying and selling at transparent mark-up. Hence, the legal form is markedly different. The profit is not riba. The perception that Islamic financing leads to the same outcome as the conventional bank may not hold truth. Islamic banking provides an arrangement that is more ethical as it is based on mutual need and benefit.

3. "Islamic banking treated debtors similar like conventional bank including harassing customers who are not able pay back on time or failure to pay"

Islamic banking is expected to treat customers and debtors differently. If they are unable to pay, they are normally given opportunity to restructure their financing and debt. The Islamic bank may give them more time or reduce the installment to assist the customers. However, if the customers are hardcore debtors then the Islamic bank has the right to repossess the asset as the customers have  mutually agreed when they signed the agreement to take the Islamic financing. Islamic debt collection policy should enable both the customers and the banks to be protected according to Shari'ah. In Islam, the role of debtors and creditors is to make sure that both parties fulfill their rights and obligations according to the agreed contracts.

Shari'ah Audit: The Way Forward

Shari'ah audit for Islamic financial institutions (IFIs) is an emerging practice. Shari'ah audit is important to provide Shari'ah assurance rather than just Shari'ah compliance. It is crucial to ensure credibility and enhance integrity of IFIs. Shari'ah Governance Framework (SGF 2011) has charted the path for Shariah audit in Malaysia. Many IFIs have started embarking on Shari'ah audit. Some are still struggling to practice as Shari'ah audit needs the understanding and the expertise of both the financial services and the Shari'ah.

The shift of focus from internal compliance to independence assurance is a requirement and no longer an option. It is not enough to claim that they are Shari'ah compliance without a robust practice of Shari'ah assurance through internal or/and external audit. More importantly now is the importance to link Shariah assurance and Shari'ah risk management. The SGF 2011 does not address this critical link sufficiently. I believed the next step of development is to develop a robust methodology for risk identification, risk measurement, risk mitigation etc. for Shari'ah non-compliance risk.

At the end of next month, there will be a conference to be organised by Institute of Internal Auditors Malaysia on Shari'ah Audit. They have requested me to write an article to promote the conference in the Edge. Hopefully, I will be able to write a piece of my thought soon. I intend to write on the importance of linking Shari'ah audit and Shari'ah risk management. The link is to ensure proper management and reporting of Shari'ah risk management (pre event) and Shari'ah audit (post event).    

Attributes of Good Research and Good Researcher

Last week, I shared with my PhD students at IIUM Institute of Islamic Banking and Finance (IIiBF) a topic on Attributes of Good Research and Good Researcher. Here, I summarized the main points of my presentations.

Attributes of good research:
1. Undertake a comprehensive and critical literature review
2. Well conceived research objectives
3. Theoretically sound research hypotheses or propositions
4. Well developed research design and theoretical framework
5. Valid and reliable research method and analysis
6. Useful and well written research findings

Attributes of good researcher:
1. Clear and sincere intention
2. Love of knowledge
3. Disciplined and good time manager
4.Good aptitude and creative minds
5. Equip with necessary research skills
6. Ambitious

I discussed the above attributes in a proper context with the following quotations:

"And Allah has brought you forth from your mother’s womb knowing nothing – but He has endowed you with hearing, and sight, and minds, so that you might cause to be grateful”(Al-Qur’an, An-Nahl, verse 78)

“Seek knowledge from the cradle to the grave” (Prophet Muhammad SAW)

“Longing for knowledge is eternal” (Einstein)

It is important to appreciate research and knowledge in our short time in this temporary world. Let us contribute to mankind and the Ummah to the best of our ability and effort. 

  

Is there a theory of Islamic accounting? (Part 2)

In the previous posting, I argued that a theory of accounting can be of two possibilities i.e. what it should be and what it is. "What it should be" in a conventional methodological approach is a normative theory. We need to develop Islamic accounting theory from the sources of Islamic knowledge i.e. the Qur'an, the Sunnah, and other sources of Shari'ah. Hence, it will be hypothethical but founded on the Islamic belief system. The way to develop it might be in qualitative and persuasive way.

Islamic accounting theory needs to be founded on Islamic accountability theory. We need to distinguish Islamic accountability from the conventional counterpart which mainly centred upon the agency theory. It does not mean that the agency theory with the theorisation of agency cost and moral hazard will not be relevant, however, the conventional agency theory is argued as insufficient to explain the accountability relationship. It is superficial to only view i the context of principal and agent only. In Islamic accountability theory, we need to theorise the Islamic concept of Hamblumminallah rather than just Hablumminannass. We also need to bring in the Islamic concept of Khalifah (vicegerency), Amanah (trust) and Taklif (individual responsibility) and theorise the relationship of accountability in the Islamic way.

With the richness and very distinguished Islamic accountability theory, we should be able to theorise the role of accounting as a mechanism to ensure financial, managerial and public accountability. Modern corporations and institutions need a much more comprehensive and equitable accountability theory. Islamic accounting then will function as "what it should be" in the context of Islamic accountability relationships. We can even link the theory with the functions of Islamic financial institutions such as Islamic banks. These institutions, in theory, should be founded on Islamic accountability theory rather that the western's principal-agent relationships in the conventional sense. Hence, the Islamic accountability of Islamic institutions should in turn shape (or may be create) Islamic accounting theory.

In the next few months, my intention is to write and develop a normative theory of "what Islamic accounting should be" in the form of an academic paper. I need to spend more time to theorize the Islamic accountability from the rich heritage of Islamic concepts. I hope many aspirants PhD candidates willing to work in this area. It is dry and challenging by certainly thought provoking. May Allah SWT guide us.


      

Is there a theory of Islamic accounting? (Part 1)

Accounting theory is a difficult subject even for accounting professors. Practitioners normally avoid theory as they are too concerned with practices. For accounting students, accounting theory is a boring and dry subject. Many accounting degree programmes and professional accounting qualifications are not really teaching accounting theory. However, accounting theory is important as theory provides the foundation for practice. Sometime practices change the theory. Conventional accounting has been in search of accounting theory for more than 50 years and yet the theory of accounting (even if there is) is still debatable and developing.

In a simple term, accounting theory is an explanation and a justification of "what accounting is" and what "accounting should be". It provides a framework of thinking and principles to guide practice. Hence, Islamic accounting is an explanation and justification of what "Islamic accounting is" and what "Islamic accounting should be".

For what "Islamic accounting is", my suggestion is we need to examine the practice of accounting especially in the contemporary Islamic institutions such as Islamic banks and Zakat institutions. In theory, these institutions are guided by the Islamic worldview and the Shariah. From the study of these institutions we need to be able to derive a theory of Islamic accounting.

For what "Islamic accounting should be", my suggestion is we need to study the main source of guidance for the Muslims i.e. the Qur'an to derive some broad principles that can guide accounting practice. For example, the implications of verse 282 Surah Al-Baqarah on the accounting theory development should be studied and explained thoroughly. We also need to study the body of knowledge of Shari'ah, Usul Fiqh and Fiqh Muamalat to draw some guidances as well.

Finally, who need to initiate, study and spend their life time to undertake the above important tasks?  

My latest papers from 2011

 In case anyone is interested and needs a softcopy, please email me at abdulrahim.iium@gmail.com. Make sure you introduce yourself. Sharing knowledge is so important to enhance the Islamic accounting and finance theory and practice.

1.   “A Framework to Analyse Efficiency and Governance of Zakat Institutions”, Journal of Islamic Accounting and Business Research, Vol.2 No.1, Emerald: UK, 2011 (with Norazlina Abdul Wahab).

2.      “Determinants of Customers’ Intention to Use Islamic Personal Financing: The Case of Malaysian Islamic Banks”, Journal of Islamic Accounting and Business Research, Vol.2 No.1, Emerald: UK, 2011 (with Hanudin Amin, Stephen Laison Sondoh & Ang Magdalene Chooi).

3.   “Enhancing Integrity of Islamic Financial Institutions in Malaysia: The Case of Shariah Audit Framework”, ISRA Journal, Vol.3 No.1, 2011.

4.     Management Accounting Systems in Islamic and Conventional Financial Institutions in Malaysia”, Journal of Islamic Accounting and Business Research, Vol. 2 No. 2, Emerald: UK, 2011 (with Siti Zaleha Abdul Rasid & Wan Khairuzzaman Wan Ismail).

5.    “Management Accounting and Risk Management in Malaysian Financial Institutions” (with Siti Zaleha Abdul Rasid), Managerial Auditing Journal, Vol.26 No.7, Emerald: UK, 2011. [SCOPUS]

6.      “Efficiency of Zakat Institutions in Malaysia: An Application of Data Envelopment Analysis” (with Norazlina Abdul Wahab), Journal of Economic Cooperation & Development, Vol. 33, No.1, Statistical Economic and Social Research and Training Centre for Islamic Countries (SESRIC), Turkey, 2012.

7.   “Productivity Growth of Zakat Institutions in Malaysia: An Application of Data Envelopment Analysis” (with Norazlina Abdul Wahab), Studies in Economics and Finance. Vol. 29 No. 3, 197 – 210, 2012. [SCOPUS]

8.   “The Efficiency of Islamic and Conventional Commercial Banks in Malaysia” (with Suraya Ahmad), International Journal of Islamic and Middle Eastern Finance and Management. Vol. 5 No. 3, 241 – 263, 2012.

9.    “Theory of Islamic Consumer Bahaviour: An Empirical Study of Consumer Behaviour of Islamic Mortgage in Malaysia” (with Hanudin Amin & Dzuljastri Abdul Razak), Journal of Islamic Marketing, Emerald UK, 2013.

10.  “Determinants of Efficiency of Zakat Institutions in Malaysia: A Non-Parametric Approach” (with Norazlina Abdul Wahab), Asian Journal of Business and Accounting, Vol. 6, No.2, 2013. [SCOPUS]

Substance Over Form (Part 2)

Should Islamic financial transactions reflect the legal form or the economic substance? My honest opinion both are importance. However, for Islamic financial transactions the legal form determine the Shariah compliant of the transactions. Economic substance may seem similar to conventional but the legal form is markedly different. The previous example on Islamic investment in Islamic banks indicates just that.

Another classic example is in the case of Islamic financing. Islamic financing instruments normally revolved around the concept of buying and selling such as bai muajal, bai bithaman ajil or bai at-tawarruq. Economic substance of Islamic financing is very similar to conventional loan. The profit on loan is interest but in the case of Islamic financing it is purely profit. However, Islamic financing involved buying and selling of asset at transparent mark-up. There are contracts of purchasing and selling of assets involved. The relationship is buyer and trader as compared to conventional loan borrower and lender. Conventional loan is simply money lending with interest.

This leads to a question whether Islamic financing is like a conventional loan. From the economic substance it may appear to be similar as the flow of funds has almost the same impacts but from the legal form it is obviously not. This leads to my argument that Substance Over Form as an accounting principle cannot be adopted for Islamic financial transactions. The concept that should be used is Form Over Substance. I have discussed 2 examples already, should we discuss more....?

Substance Over Form (Part 1)

One of the most important fundamental principles of modern accounting and financial reporting is the impact of the economic substance should be reflected rather than the legal form. The economic substance reflect the purpose of the financial transaction or the economic consequences truly and fairly. The legal form is secondary important because it only accounted the legal or the technical aspect of the transaction.

The best example is when a motor vehicle company purchase motor vehicle for business purposes i.e. for sale. The substance that should be reflected is purchase of stock of goods for sale. However, if the company purchase a motor vehicle to be used by the company or by the management then the economic substance is fixed asset purchase. Even though the legal form is the same, the economic substance should be different due to different purposes of the purchases.

In the case of Islamic financial transaction, when an investor put their money in the Islamic bank let say based on a Mudarabah contract,  the economic substance is the same like conventional deposit. However, the legal form is different. Conventional deposit is a lending transaction and the bank pays the depositor interest. In the case of Islamic and Mudarabah investment, it is a relationship between the investor (Rabbul Mal) and the bank (Mudarib). The profit earned by the Islamic bank is then shared with the investor and it is not an interest payment.

From the above example, if Islamic financial transactions used Substance Over Form principle then we missed out the legal form that make up the transaction. Legal form must be reflected to distinguish the accounting treatment of Islamic investment from interest-based lending. The profit must also be distinguished from interest income that reflect the different underlying principle of Islamic financial transactions.

To be continued...