The adoption of Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) Shariah standards by the United Arab Emirates' Islamic finance industry is a “landmark” development that will lead to standardisation across a highly fragmented sector, analysts said.
The Central Bank of the UAE announced in July that full-fledged Islamic banks, Islamic windows of conventional banks, and finance companies offering Shariah-compliant products and services will be required to comply with AAOIFI Shariah standards from September 1.
“The adoption of AAOIFI standards is definitely a step in the right direction and will help to achieve standardisation of Shariah compliance in the UAE,” Mohamed Damak, Senior Director and Global Head of Islamic Finance at S&P Global Ratings told Salaam Gateway.
Islamic finance products in the UAE have historically adhered to AAOIFI standards, said the head of Shariah legal and financial consultancy Dar Al Sharia, a subsidiary of Dubai Islamic Bank, the UAE’s biggest standalone Shariah-compliant bank.
Still, the formal move to adopt AAOIFI standards is a “landmark development” that will help push standardisation and benefit the Islamic finance industry not only in the UAE, said Dar Al Sharia Chief Executive Officer Mian Nazir.
“The adoption of standards is expected to pave the way for standardisation of Islamic finance products and services and further enhance the confidence of outside entities dealing with UAE-based Islamic financial institutions with respect to Shariah compliance of products and services,” Nazir told Salaam Gateway.
The move will also facilitate a higher degree of standardisation of the Islamic finance industry across markets, he added.
“We expect to see closer integration and cooperation between markets where the regulators are choosing AAOIFI compliance as the way forward for Shariah compliance,” said the head of the Shariah advisory firm.
According to AAOIFI, its standards—which include accounting, auditing and Shariah—are fully or partially adopted or in the process of being adopted in more than 19 countries. They are also used as recommended guidelines or referenced by regulatory bodies in more than seven nations.
Echoing Nazir and Damak, Khalid Howladar, Managing Director of risk, rating and Islamic finance advisory firm Acreditus, said any move towards standardisation is positive for a “highly fragmented industry”.
“The standards cover some key areas that need strengthening – such as governance, ethics as well as accounting and audit. Some of these principles would also be of value to non-Islamic institutions,” Howladar added.
Nazir and Damak also expect standardisation to benefit consumers.
“The implication of the same standards across the board will be beneficial for the customers in the sense that it reduces the risk of perception of being non-compliant with Shariah,” said Damak.
“We expect these regulations to help foster and grow consumer confidence in Islamic banking products and services,” Nazir said.
GAIN FOR SUKUK MARKET
As the implementation of AAOIFI standards will support the standardisation of Shariah interpretations, this would in turn benefit the sukuk market, according to Damak.
According to S&P, the volume of sukuk issuance is set to drop to between $70 billion and $80 billion in 2018 compared to $97.9 billion in 2017, primarily due to lack of standardisation and global liquidity becoming more expensive and scarce.
“Standardisation is the main issue that the sukuk market has been facing for the past few years. With a lack of standardisation and the complexity related to sukuk issuance, a lot of issuers have decided to go the conventional route,” Damak said.
The standardisation for sukuk is on two fronts: legal documentation and Shariah interpretation, said Damak, adding that standardisation of Shariah interpretation can be achieved with the use of the AAOIFI standards.
Another challenge before the Islamic banking sector is related to asset quality indicators.
“We have seen an increase in Stage 2 loans (loans that have experienced repayment difficulties or for which there was a significant deterioration in the credit quality of the counterparty),” said Damak.
“We think because of that and given the adoption of IFRS 9 or FAS 30 for banks reporting under AAOIFI standards, cost of risk for the Islamic banks will continue to increase. That will have a negative impact on their profitability. This is not that different from our expectation for the conventional banks in the UAE in particular and the GCC in general,” added Damak.
IFRS 9 and FAS 30 are accounting standards and not Shariah standards. FAS 30 is the equivalent of IFRS 9 for Islamic banks reporting under AAOIFI standards, explained Damak.
“Under these [accounting] standards, banks are required to take the expected loss (12 months for Stage 1 and lifetime losses for Stage 2 and 3),” said Damak.
Howladar believes the central bank’s September 1 deadline for the adoption of AAOIFI Shariah standards is a challenge for financial institutions.
“There are almost 50 standards covering multiple aspects of audit, accounting, governance, ethics, etc. It would probably take six months at least to train internal staff, let alone implement new processes and procedures. If implemented fully, I would expect it to increase operational and compliance costs,” said Howladar.
Analysts Salaam Gateway contacted said it was very difficult to provide an estimated cost for gap analysis and remedial measures with regard to AAOIFI compliance since it may differ from institution to institution.
Nazir clarified that the central bank has set two deadlines: September 1 to conform with the AAOIFI Shariah standards, and December 31 to conduct and submit a gap analysis of existing products and services suites.
“Islamic banks in the UAE are very much capable of handling both [deadlines],” said Nazir.
“However, Islamic finance advisory firms are expected to play a significant role in the latter, if not both.”
Dar Al Sharia is holding workshops to help relevant stakeholders, from internal Shariah control committee members to lawyers, develop an understanding of AAOIFI’s Shariah standards.
“It is imperative that the human capital of each Islamic bank is equipped with tools to make the process of product development efficient. In light of the new requirement, we feel that the key stakeholders in the product development process need to understand the AAOIFI Shariah compliance perspective,” Nazir said.
“This will enhance utilisation of time spent and efforts of various departments and will result in costs savings for the institution in addition to the acceleration of the product development cycle.”