SBP issues instructions to improve transparency in IBIs
KARACHI: The State Bank of Pakistan (SBP) has issued detailed instructions for Profit and Loss Distribution and Pool Management in Islamic Banking Institutions (IBIs) in order to improve transparency and disclosures and bring standardisation in IBIs’ profit and loss distribution policies and practices.
Instructions are applicable with immediate effect and Para IV of annexure-II of IBD circular 2 of 2008 stands withdrawn.
Provisions of BPRD circular 7 of 2008 regarding minimum rate of return on savings deposits as amended from time to time shall no more be applicable on IBIs.
Failure to comply with SBP instructions shall invoke penal action under the provisions of Banking Companies Ordinance, 1962, said IBD circular 3 of 2012 issued to the presidents/chief executives of all Islamic Banks and all conventional banks having Islamic banking branches.
As per SBP instructions, each pool of deposit established by IBIs would act like a virtual enterprise having explicitly demarcated sources of funds, ownership of specific assets and income and expenses.
The profit earned on the financing and investments made through such pool of deposits will be shared between IBIs and the depositors as per pre-agreed profit sharing ratio.
In case of loss, the same will be borne by the depositors in proportion of their investments unless caused by the negligence and misconduct by the IBIs in managing the depositors’ funds.
SBP’s detailed instructions for Profit and Loss distribution are- IBIs shall have a well-defined profit and loss distribution and pool management framework for creation of one or more pools of assets to be financed by different types of Mudaraba-based (individual, corporate or financial institutions) deposits.
The framework shall interalia specify the objectives, investment strategy, and risk characteristics of each pool. It shall also explicitly define the basis for allocating different types of deposits to different pools and assigning weightages to each deposit category of a particular pool.
The framework shall be approved by the Shariah Advisor and Board of Directors (BoD) of the IBI and a duly approved copy of the same shall be submitted to Islamic Banking Department, SBP within three months of issuance of these instructions.
Changes (if any) warranted in the framework shall also be approved by Shariah Advisor and BoD under intimation to SBP within 15 days of such change(s).
All the pools to be created by the IBI shall be in conformity with the aforementioned framework and shall be created through a memorandum signed by the authorised senior executive to be defined in the framework documenting the objectives, investment startegy, tenor (if any), the risk and reward features, Profit Sharing Ratio (PSR), weihgtages and basis thereof.
The allocation of income and expenses to different pools shall be made based on pre-defined basis and accounting principles/standards.
The direct expenses shall be charged to respective pool, while indirect expenses including the establishment cost shall be borne by IBIs as Mudarib. The direct expenses to be charged to the pool may include depreciation of Ijarah assets, cost of sales of inventories, insurance/Takaful expenses of pool assets, stamp fee or documentation charges, brokerage fee for purchase of securities/commodities etc, impairment/losses due to physical damages to specific assets in pools etc.
However, this is not an exhaustive list, IBI pool management framework and the respective pool creation memo may identify and specify these and any other similar expenses to be charged to the pool.
The general and specific provisions created against non-performing financings and diminution in the value of investments as under prudential regulations and other SBP directives shall be borne by the IBIs as Mudarib. However, write-offs of financings and loss on sale of investments shall be charged to respective pool along with other direct expenses.
The losses on financings and investments due to misconduct/negligence/breach of contract by IBI shall not be charged to the pool; the IBI as Mudarib shall be responsible for absorbing such losses.
In case of comingling of IBI’s equity with depositors’ fund in a pool, the Net Income/ loss of Pool shall be allocated between IBI’s equity and the depositors’ fund in proportion to their respective share in pool.
Profit and loss on the Mudaraba based deposits shall be computed and distributed on the basis of average balance in the depositor’s account during the profit computation period.
The PSR between depositors (Rabbulmal) and IBIs (Mudarib) shall be decided and announced at least 3 working days before the beginning of period concerned.
No downward revision in the PSR agreed with the depositors (particularly the term depositors) at the time of acceptance of deposit shall be made during the deposit tenor.
In case such a revision is necessary the depositors shall be allowed to withdraw their investments without any deduction / forfeiture of profits /penalties etc.
The Mudarib share shall be admissible only on profit allocated to depositors’ funds from the pool’s net income (please see the Profit Computation and Distribution Process Flow at Annexure-I). Mudarib share shall not exceed 50 percent of the Distributable Profit.
The weightages to different categories of deposits in a pool shall be assigned based on parameters/criteria defined in the pool management framework.
The weightages shall be announced at least 3 working days before the beginning of period concerned and shall not be changed during the period.
The maximum weightage to the Mudaraba based deposit of any nature, tenor and amount shall not exceed 3 times of the weightage assigned to saving deposits. The remunerative current accounts shall not form part of Mudaraba based deposits for the purpose of this clause.
IBIs shall explicitly mention in their profit distribution and pool management framework, the treatment and remuneration basis for premature/early encashment of term deposits during the period concerned.
IBIs may maintain Profit Equalization Reserve (PER) from Net Income of Pool i.e the gross income less direct expenses and losses if any.
The monthly contribution into PER will not exceed 2 percent of Net Income, and the accumulated balance of PER shall not exceed 30 percent of Islamic Bank’s Equity or Islamic Banking Fund (IBF) of Islamic Banking Division of Conventional banks
50 percent of the balance available in PER shall be reflected as liability and remaining 50 percent as reserve in the books of the IBI.
The funds of PER shall only be invested in Shariah compliant SLR eligible securities and the returns earned on these funds will also be credited into the PER account. The profit sharing ratio for IBI as Mudarib shall not be more than 10 percent for managing PER.
IBI may forego up to 60 percent of its Mudarib share as Hiba to meet the market expectation in case of lower than expected/market returns earned by the pool. However, the IBIs maintaining PER will reduce their Muadrib share only if the PER is insufficient to improve the profit payouts to the depositors.
This Hiba by the IBI shall however, be distributed across the board to all the deposit categories in a pool.
IBIs will gradually phase-out the practice of offering special or individual Hiba to the priority customers. Therefore, special or individual Hiba for CY 2012 will be frozen to previous year’s level in absolute terms i.e upto the actual amount of special or individual Hiba during CY 2011, upto 50 percent in 2013, upto 25 percent in 2014 and zero percent in 2015.
As the credit and market risk of the financing and investment portfolio is to be borne by depositors being Rabbulmal in the Mudaraba arrangement with the IBI, there may be scenarios where the pool may incur losses primarily due to unusually large write-offs and/or significant losses on sale of the pool’s investments. Thus to absorb/off-set such losses IBIs may create the Investment Risk Reserve (IRR) to cover the future investment losses and develop models and basis to determine the size of the IRR and the periodic contributions to be made to build up the IRR. Till the development of the model, IBIs may contribute towards IRR an amount up to 1.0 percent of the profit available for distribution amongst the pool’s depositors after deduction of Mudarib share in every profit period. The IRR, if any created and maintained shall be reflected as liability by IBIs.
The funds of IRR shall only be invested in Shariah compliant SLR eligible securities and the returns earned on these funds will also be credited in the IRR account. The profit sharing ratio for IBI as Mudarib shall not be more than 10 percent for managing IRR.
The losses, if any, incurred by the pool shall be covered from the balance available in IRR.
The clauses related to IRR shall be made part of account opening form or any other document for this purpose.
The distribution of profit and loss to the depositors on the basis of these instructions shall be subject to verification/audit jointly by the Shariah Advisor and External Auditor.