Shall The Islamic Banking Institutions In Bangladesh Be Allowed To Recognise “Compensation” Or A Part Of It As Income In Their Statement Of Profit Or Loss?

 


21 July, 2020   565 views   Mezbah Uddin Ahmed
Banking Perspective   Islamic Economics

 

Islamic Economic Forum Bangladesh

 

بسم الله الرحمن الرحيم

الحمد لله رب العالمين، والصلاة والسلام على أشرف الأنبياء والمرسلين نبينا محمد وعلى آله وصحبه أجمعين

 

Discussion Topic 01/2020:

Shall the Islamic Banking Institutions in Bangladesh be Allowed to Recognise “Compensation” or a Part of it as Income in their Statement of Profit or Loss?

 

Written by

Mezbah Uddin Ahmed

(MIBF, FCCA, CIPA, CSAA)

Based on the discussion held at Islamic Economic Forum Bangladesh

21 July 2020

 

 

About Islamic Economic Forum Bangladesh

The Islamic Economic Forum Bangladesh is a specialised group on WhatsApp founded with the objective of carrying out academic discussion on different issues related to Islamic economics and finance with particular focus to Bangladesh. The purpose of the discussions is not to issue Shariah rulings or fatwas on the subject under discussion, but to review critical issues, to freely exchange views, and to call up the latest opinions, fatwas, articles and information on the subject. Currently, the Forum consists of members from different countries, but all with Bangladeshi origin. The members include Shariah committee members, experts, practitioners, economists, academics, researchers, consultants, auditors and regulators. Any remark shared in the Forum is considered as the member’s personal and not necessarily representative of his/her affiliate entity.          

Background

Several members of Islamic Economic Forum Bangladesh recently engaged in a discussion on whether the Islamic banking institutions (IBIs) in Bangladesh shall be allowed to recognise “compensation” as an income in their Statement of Profit or Loss. The discussion was initiated amid the concern that some IBIs in Bangladesh are actively considering the possibility of recognising this as income[1], which would be contrary to the traditional practice of recognising this directly as liability.    

Traditionally, the IBIs in Bangladesh impose a charge on overdue investments under sale mode. This charge is referred to as “compensation” in the Bangladesh Islamic banking industry. This amount is not included in investment income, rather directly recognised as a liability in the Statement of Financial Position with the objective of channelling out to charitable purposes. The shareholders or the depositors of the IBIs do not benefit from this amount. The IBIs in Bangladesh has been in unanimous agreement on this practice, although there is no regulatory requirement imposing this practice.

 

Figure 1: Current Practice of “Compensation” Recognition by IBIs in Bangladesh

Due to COVID-19 ensued economic condition, there is a substantial rise in delays and defaults in payment by bank customers. All banks are suffering from this, but for IBIs the suffering is greater. This is because the conventional banks can recognise any additional charge as income, but the IBIs cannot. Hence, the IBIs are facing greater pressure in maintaining their profitability. The heavy reliance on sale-based investments also placed the IBIs in difficulty as they cannot reprice the sold goods to increase receivables. As of 31 December 2019, near to 70% of IBI investments are in murabahah and muajjal­ mode.

The balance of “compensation account” in the books of IBIs is significant, which if recognised as income would substantially increase profitability of the bank. This prospect made management of some IBIs to look into the possibility of recognising “compensation” as income.

The members of Islamic Economic Forum Bangladesh discussed different possibilities of recognising “compensation” as income in light of Shariah principles and international practices. These possibilities and the outcome of the discussion is provided below.

 

AAOIFI and Malaysia’s Position on “Compensation”

AAOIFI

AAOIFI in its Shariah Standard No. 3 Procrastinating Debtor states that it is not permitted to stipulate any financial compensation for loss of income (opportunity loss) in respect of a delay by a debtor in settling his debt. However, the procrastinating debtor is liable for legal and other expenses incurred by the institution in order to recover his debt.

Furthermore, in Shariah Standard No. 8 Murabahah, AAOIFI is very specific in stating that “it is not permissible to extend the date of payment of the debt in exchange for an additional payment in case of rescheduling, irrespectively of whether the debtor is solvent or insolvent.” Moreover, if the debtor is insolvent, AAOIFI stated to grant a grace period.[2]

However, AAOIFI allows to take an undertaking from customers to donate in the event of a delay in paying instalments on their due date. Accordingly, an Islamic bank may take an amount of money (as lump sum or percentage of debt) from a customer who delayed payment of instalment on the due date, on the basis that the amount will be donated to charitable purposes. This is allowed as a preventive measure of wilful delays by customers. AAOIFI stipulates that this additional payment made by the customer shall not be used for the institution’s benefit.

 

Figure 2: Treatment of Charges and Charity Payments as per AAOIFI Standards

Malaysia

Bank Negara Malaysia and its Shariah Advisory Council allow imposing a late payment charge in the case of late payment by customers of their financial obligations resulted from exchange contracts (such as sale and lease) and qard.

The late payment charge is divided into two parts, whereby ta’widh represents compensation that can be recognised as income, and gharamah represents penalty that cannot be recognised as income and shall be channelled to charities. The shareholders and depositors benefit from the ta’widh earned.

Ta’widh represents the actual loss suffered by the IBI due to customer’s default. However, it shall not be more than 1% of the overdue amount. Furthermore, the combined late payment charge (ta’widh plus gharamah) that can be imposed by the IBI is subject to the approval of Bank Negara Malaysia.

The examples of actual loss provided by the Shariah Advisory Council in its resolution includes additional expenditure, such as cost for issuing notices and letters, legal fees and other related costs.[3]

 

Figure 3: Treatment of Late Payment Charge by IBIs in Malaysia

The Possibility of Recognising “Compensation” or a Part of it as Income in Bangladesh Context

In the Bangladesh context, the industry term for late payment charge is “compensation”. There is no segregation in it for compensation for actual loss or penalty for charitable purpose. Traditionally, the whole amount is channelled to charity and the industry thus far is in unanimous agreement on impermissibility of recognising this as income.   

Nonetheless, in exploring the possibility of recognising this “compensation” as income, several proposals are put forward for discussion of Islamic Economic Forum Bangladesh members. The proposals and the concluding remarks of the Forum members are provided below.

Proposal 1: 

The “compensation” amount will be recognised as income as a whole. However, the IBIs will disclose to their shareholders and depositors on the ratio of Shariah non-permissible portion in their income. It will be the individual’s responsibility to dispose the Shariah non-permissible portion from their income.

This option has been categorically rejected as this will mimic the conventional banks and destroy the identity of Islamic banks.  

Proposal 2:   

To follow the Malaysian approach, i.e. to identify the actual loss suffered by IBIs and recognise only that portion as income. The remaining amount will be recognised as liability to channel out to charities.

This option also has been strongly rejected by the participants in the discussion. The basis for the rejection is that:

Malaysia has a strong and well-structured Shariah governance system at the Central Bank level and at the individual Islamic bank level. However, in the case of Bangladesh the Central Bank does not have any supervision in terms of Shariah compliance of IBIs. The Shariah governance of IBIs at individual bank level also varies from one bank to another. Furthermore, researches identified severe weakness in Shariah governance of some of the IBIs.   

Hence, there is a great possibility of abusing the system if the IBIs are allowed to recognise part of the “compensation” amount (i.e. late payment charge) in the name of actual loss.[4]

If a few banks adopt this system, then there is a high likelihood that other banks will follow. Given the current weak Shariah governance culture in some of the banks and absence of regulatory intervention, all the IBIs shall be restrained from adopting this option. Otherwise, it is likely to greatly harm the Islamic banking industry of Bangladesh in the long run.

Moreover, several members with Shariah expertise commented that the majority of Shariah scholars do not agree with the Malaysian approach. 

Furthermore, the actual loss likely to represent only a very small amount as it may include only the cost for issuing notices and letters, legal fees and other related costs. Recognising such costs as income will not substantially address the problem that the IBIs in Bangladesh is currently facing. Hence, to avoid greater harm, no part of the “compensation” amount shall be recognised as income.    

Proposal 3: 

To recognise “compensation” as liability as it has been traditionally practiced. No part of it will be recognised as income in the Statement of Profit or Loss. The balance in the “compensation account” will be used to provide financial assistance to customers who are in real financial difficulty.

There were mixed reactions regarding this proposal.

A member commented that an IBI currently providing such support to their customers who are in financial difficulty. However, another member strongly rejected this approach as the “compensation” fund is not independent from the bank’s management. This poses a great risk of abusing the fund, which may include writing off debts of wilful defaulters just because of their close relationship with the bank’s management.

Another member commented that if the “compensation” fund is maintained within the bank then the bank’s management will always have a desire to capture the fund and try to find excuses to deviate from its intended use.

It was also highlighted that it is not right for IBIs to use this money to conduct charitable activities under their name as it is equated to their self-promotion, i.e. bank is (indirectly) benefitting from the “compensation” amount. Fundamentally, the bank shall not be benefitted from this money in any way. Accordingly, one member strongly emphasised that the IBI shall not be benefitted from the “compensation” fund in any way.

Hence, it is highly recommended that the “compensation” fund shall leave the bank’s book the soonest possible. (One member commented that that this should be a must.)

One member commented that if the “compensation” fund is maintained within the bank’s book and the bank’s own clients are benefitted from this fund then this shall be treated as a qard from the “compensation fund” to the bank’s investment pool, and the amount shall be reimbursed to the fund in the future.   

Proposal 4:   

To set up a sperate independent entity to manage the “compensation” fund for charitable purposes including providing assistance to those who are in financial difficulty. All or some of the IBIs may reach an agreement to set up such an entity.

Although this proposal was praised, but few members pointed out that there is no legal basis for requiring IBIs to channel their “compensation” fund into such an independent entity.

 

Figure 4: A Proposed Model to Channel “Compensation” Fund

 

Recommendations

Based on the discussion, following recommendations are made regarding treatment of “compensation”:

  • The Shariah governance environment of IBIs in Bangladesh is not as strong or well-structured as Malaysia. If any part of “compensation” is allowed to be recognised as income, then there is a great risk of exploiting this opportunity. Furthermore, recognition of any part of “compensation” as income will be highly controversial from the Shariah perspective. Hence, considering the Shariah and reputational risks, the IBIs in Bangladesh should not be allowed to recognise any part of “compensation” as income. 
  • The Shariah committee members of IBIs shall be briefed on the risks of recognising “compensation” as income so that they can take an informed decision.  
  • The IBIs do not have any right over the “compensation” amount in the first place. Hence, they shall abandon any wish or plan to be benefitted from it in any way.
  • The balance of “compensation account” shall leave IBI books without any delay. The IBIs shall formulate their financial recovery plan taking in mind that this amount does not belong to them and they have no right over it.
  • The balance of “compensation account” shall be separately identified in the CSR activities as this money does not belong to the IBI and in no way should benefit it.
  • The use of term “compensation” shall be revisited as it provides a misleading impression of the item.
  • Bangladesh Bank or the Central Shariah Board for Islamic Banks of Bangladesh (CSBIB) shall come up with a guidelines and disclosure requirements for amounts received as “compensation”, so that the industry practice is standardised. Any opportunity for a misbehaving bank to be a gainer should be ceased.  

 

It is commented that the IBIs shall not bring conventional mindset into Islamic banking. Otherwise, they will face the same fate as the conventional banks at the time of crisis. For IBIs to show resilience at the time of crisis, they shall focus on their fundamentals. The IBIs shall also embark on product diversification so that they have flexibility in different economic conditions. Furthermore, to protect depositors and investment returns, takaful models to be considered and investment risk reserves could be maintained. The immediate measures that the IBIs may take include attracting cost-free qard deposits and issuance of sukuk.  

 

Admin Panel of Islamic Economic Forum Bangladesh

 

Mufti Abdullah Masum (CSAA)

 

 

Founder, IFA Consultancy Ltd.

Deputy Mufti, Jamiya Sharyeah Malibag, Dhaka

Mezbah Uddin Ahmed

(MIBF, FCCA, CIPA, CSAA)

 

Researcher, International Shari’ah Research Academy for Islamic Finance (ISRA), Malaysia

Mufti Yousuf Sultan

(MSc, CSAA, CIFE)

 

 

Co-Founder, IFA Consultancy Ltd.

AAOIFI Master Trainer

SC Malaysia Registered Shariah Adviser

 

[1] A member commented that two fully fledged Islamic banks and one conventional bank (Islamic window/branch) has already started to recognize “compensation” as income. However, this could not be verified independently.

[2]AAOIFI Shariah Standards are available at: https://aaoifi.com/shariaa-standards/?lang=en

[3] Bank Negara Malaysia Guidelines on Late Payment Charges for Islamic Banking Institutions, available at: https://islamicbankers.files.wordpress.com/2013/12/guidelines-on-late-payment-charges-for-islamic-banking-institutions.pdf

Resolution of Shariah Advisory Council of Bank Negara Malaysia, available at: http://www.sacbnm.org/wp-content/uploads/2018/03/81.E.pdf

[4] A member commented that such abuses are already happening. However, this could not be verified independently. If true, such activities are strongly condemned.

 

Disclaimer:

The content of this document is based on the discussion held in Islamic Economic Forum Bangladesh. The views expressed here are solely those of the forum members in their private capacity and do not in any way represent the views of their affiliated institutions.  


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