* Islamic banks adapting to IFRS accounting rules
* All major Islamic financial products affected
* Potential impact on credit ratings, profitability
By Bernardo Vizcaino
Nov 28 Reconciling accounting standards and
religious principles is challenging Islamic banks and regulators
as they adapt to new international book-keeping rules due to
come into force in 2018.
The new rules, known as IFRS 9, will leave their mark on all
major products used by Islamic banks - from simple savings
accounts to Islamic bonds - and impact their bottom-lines.
Banks around the globe are gearing up to implement IFRS 9
from January 2018, posing a particular challenge for many
Islamic finance contracts as they change the way financial
assets are classified and measured, requiring lenders to book
expected losses in advance.
The problem for most Islamic financial products is that
their accounting treatment can often diverge from the actual
economic substance of a transaction, a key concept behind IFRS
This has prompted the Bahrain-based Accounting and Auditing
Organisation for Islamic Financial Institutions (AAOIFI) to set
up a working group to look at ways to revise its rules for
Islamic financial institutions, which now hold assets worth
around $2 trillion.
AAOIFI issues guidelines that are followed wholly or in part
by Islamic financial institutions across the world, so its
efforts would help align the industry to global practices.
The working group is revising AAOIFI's accounting standard
for provisions and reserves and developing a new one for
impairments and expected losses, secretary-general Hamed Hassan
Merah told Reuters.
These changes will be discussed at a workshop in Jordan on
Dec. 14 and at a meeting of AAOIFI's accounting board starting
on Dec. 26, with an exposure draft expected to be released for
public comment early next year, Merah said.
AAOIFI will also look at amendments to its standard for
investment accounts and a new standard covering Islamic
derivatives such as waad and khayar, Merah added.
LACK OF GUIDANCE
A potential clash with Islamic principles could make IFRS
implementation tricky for Islamic banks when it comes to
accounting of provisions and impairments.
"We still see diverging practices in a number of aspects,"
Abdelilah Belatik, secretary-general of the General Council for
Islamic Banks and Financial Institutions, a Bahrain-based
non-profit organisation, said.
"Some of these different practices are due to regulatory
reasons, and in other cases to the lack of guidance."
Islamic banks' credit ratings, profitability and the cost of
funding to customers could be affected by IFRS, Hamad Abdulla
Eqab, chairman of AAOIFI's accounting board, said during the
organisation's annual conference earlier this month.
For instance, while IFRS 9 requires recognition of expected
losses, AAOIFI rules only permit recognition of incurred losses.
Islamic law does not allow customers to be charged for a
future event or a future loss, said Eqab, who is also group
chief financial officer at Albaraka Banking Group.
Another issue related to IFRS 9 is how some Islamic finance
transactions are classified, such as murabaha and musharaka.
Murabaha is a cost-plus-profit arrangement widely used to
structure Islamic loans, while musharaka is a partnership
contract where two or more parties share profits according to a
They could be deemed trading activities depending on the
specific details of each contract, Belatik said.
Islamic bonds, or sukuk, may also be affected. A popular
sukuk structure is a sale and lease-back contract known as
ijara. However, some sukuk could be classified as leases and
therefore fall under a different standard, IFRS 16.
(Editing by Andrew Torchia and Alexander Smith)