(PDF) Islamic Banking: Concept and Methodology

Islamic Banking And
Finance (Case Study Of
An Islamic Bank)

Table of Contents
INTRODUCTION...........................................................................................................................1
TASK...............................................................................................................................................1
1. The extent of disclosure of information in the annual reports of the Islamic banks:...............1
2. Way the annual report of the Islamic Bank same or different when compared with the
annual report of a conventional bank:..........................................................................................2
3. Financial analysis of KFH an Islamic Bank and comparison of performance with
conventional bank HSBC, UK:....................................................................................................5
CONCLUSION................................................................................................................................7
REFERENCES................................................................................................................................8

INTRODUCTION
Islamic banking is also known as non interest banking which is based upon the law of
Sharia and guided by Islamic economics. Some of its modes includes different aspects such as
Mudarabah, Wadiah, Musharaka, Murabahah abd Ijara. In such type of financial system
government does not charge any interest and tax but the citizens and organisations have to pay
Zakat to the legal bodies of country (Abedifar, 2015). Finance related transaction under this
system are slight different from ethical investing. This project report is mainly based upon
Islamic accounting. Two different organisations are being compared on the basis of their
accounting systems under this assignment. One of them is Bank of Kuwait and another one is
HSBC. Along with this various other topics such as disclosure of information in annual reports,
difference between reporting system of Islamic and conventional banks etc. are being discussed
in this report.
TASK
1. The extent of disclosure of information in the annual reports of the Islamic banks:
Disclosure are essential part of annual report because disclosure provided in annual report
assist in defining the main objectives of matter stated in report and acts as a supporting element
for data or information. In the context of annual report of Islamic Banks disclosures are made by
banks from the perspective of stakeholders. In order to determine extent of disclosure of
information in annual reports of Islamic bank first step is Identification; In annual report
disclosure are made as per their level of importance and seriousness of matter. For this banks
identify information and their level to provide disclosures and sequence. Second step
is ;Clarification of items and categorizing items into VD and RD: Here VD represents voluntary
items and RD represents regulated items (Arshad, Yusoff and Tahir, 2016). Banks with
maximum numbers of items considered as based index. Disclosures are compulsory for regulated
items where as disclosure for voluntary items are not compulsory. RD s are disclosure that are
necessary because of imposition of government regulations where as VD s are made for better
representation of any signifiant matter. Bank classify all disclosure requirement as RD and VD.
Third and last step is providing specific and relevant information in under disclosure. Any
general information disclosed in annual report irritates users of annual report.
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In this context in Islamic banks like Kuwait Finance House made their most of
disclosures as per Shari`ah and Islamic principles. Bank has obligation to provide disclosure in a
way that it ensure about compliance of rules provided in Shari'ah. Beside this Islamic banks are
required to disclose religious and socio-economic facts. In these banks along with AAOIFI
standards and IFSB' standards, Shari`ah requirements are required to be followed in annual
report. Disclosures in these banks does not focus towards only economic facts. In Islamic banks
disclosure with regards to assets are specifically made but assets are disclosed at current market
and selling price, and historical value of assets are ignored (Beck, Demirgüç-Kunt and
Merrouche, 2013). Overall disclosures requirements are made in annual report while fulfilling
requirements stated in Shari'ah with regards to different disclosures. As per Islamic law and
religious rules in these banks no interest given or taken by Islamic banks so there is no interest
income and expense is disclosed in annual report of these banks. However in Islamic banks
Zakat calculations are disclosed. Zakat is refers to a king of tax or obligation which is required to
be donated by individual on his wealth for charitable purpose. In banks Zakat is collected by
account holders. There is a specific requirement of disclosure of Zakat calculation in annual
report of banks. The normal level of percentage of Zakat in respect of wealth from cash, gold and
equities is approx 2.5% of total value.
The Islamic banks use the participation of equity to generate profit without charging any
interest and it is recorded in the final accounts of banking sector companies such as Bank of
Kuwait. As interest is not charged by the banks so they do not have any source of income. In
order to resolve this problem banks keep their accounts confidential and try to reduce risk of
financial losses. All the incomes and expenses are not disclosed to the general public and for all
the banks it is very important to meet requirements of Shari'ah because it is vital for the business
entities which are adopting it. It is also considered as the most progressive banking systems in
Malaysia because it helps banks to grow faster. Now a days big banking sector organisations
such as Bank of Kuwait are adopting it in order to attain higher profits and generate good
incomes (Demiralp and Demiralp, 2015).
2. Way the annual report of the Islamic Bank same or different when compared with the annual
report of a conventional bank:
Reporting and disclosure requirements are almost same for banks across the world. But
manner, type or extent of disclosures made by banks may differ from one country to other
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country but ultimate objective of making disclosure is to provide true and fair of information and
data described in annual report. Financial statements, annual report and other related disclosures
of banks of Islamic countries are quite different from disclosures made under conventional
banks. It is required for Islamic companies engaged in providing banking services like Kuwait
Finance House to follow separate and distant rules and regulations, guidance and ordinance
while doing various reporting and accounting practices. Recently standards are issued by
Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and Islamic
Financial Services Board (IFSB) which are vary different from standards followed by
conventional banks such as HSBC, UK. Islamic banks are required to follow more additional
rules/ regulations as compared to conventional banks. Islamic banks follows IFSB standards,
AAOIFI standards etc. and beside these standards they also follows Shari`ah requirements which
are not required to be followed by conventional banks (Demiralp and Demiralp, 2015). As
compared to normal banking companies, more complex legal requirements are complied by
Islamic banks such as IFSB standards, AAOIFI standards, etc. Moreover, in Islamic banks nature
and extent of various activities compelled them to follow distinct or different reporting and
accounting systems. Due to this Islamic banks are required to make disclosure about information
that are not required for conventional banks. Following are the point which provides a discussion
on difference in annual report of of the Islamic Bank same or different when compared with the
annual report of a conventional bank:
Points Kuwait Finance House HSBC UK
Aim of Disclosure The main aim of Disclosure
practices in case of KFH, is to
give appropriate and relevant
information but not financial data
only, to various users, in order to
make them able to ensure that
bank conducting regularly their
operations within the criteria and
limits as stated in Islamic
Shari’ah.
In case of HSBC UK, main
objective of Disclosure practices is
to expedite informed decisions and
final aim is to effectively allocate
available scarce resources to their
profitable uses for which HSBC
allows information competence in
market without operating within
Islamic Shari’ah.
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2. Disclosure
Standards
AAOIFI standards, Shari`ah
requirements and IFSB standards
etc. are generally complied by
KFH.
On other hand Standards circulated
by IASB & FASB are also
complied by HSBC UK, but not the
Shari`ah requirements.
3. Nature of
Disclosure
In KFH's annual report Nature of
stated disclosure is conceptualized
that is purely based on Islamic
principles and Shari`ah (Ferhi and
Chkoundali, 2015).
Nature of Disclosure as provided in
annual report of HSBC is
conceptualized but all disclosures
are according to the principles of
secularism and capitalism.
Direction of
Disclosure
Disclosure practices applied in
annual report of KFH are directed
and managed towards
community and society.
In HSBC annual report disclosure
practices mainly
directed towards own interest of
bank.
Disclosure of
Value of Assets
In annual report of KFH for
disclosure of assets Market/selling
price is preferred instead of
historical cost, specifically in case
of Zakat calculation.
In HSBC just opposite to KFH
Historical cost is preference
instead of market or selling price
for disclosure of asset value.
Volume of
Disclosure
Annual report of KFH focuses on
full disclosure in order to fulfil
any particular and reasonable
demand in respect of information
as per the principles stated in
Shari’ah.
HSBC in their annual report
focuses on limited disclosure
subject to needs of users or public
interest.
Disclosure
Consistency
Here Disclosure consistency
ensured by Islamic Shari’ah.
Here HSBC maintain Disclosure
consistency as per GAAP.
Disclosure Period KFH's annual reports are
prepared periodically but banks
calculates Zakat as per lunar year.
HSBC provides annual report and
performance on periodically/
annually basis to its users.
Unit of Disclosure In KFH's annual report for Zakat
calculation and other relevant
On other hand HSBC provides
only disclosure monetary value
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matters disclosures are made as on
Quantity basis and monetary
basis.
based.
Transactions
Disclosed
In KFH's annual report
transactions and events are
disclosed.
Where as HSBC Discloses only
economic transactions and events
in his annual report and disclosure
regarding religious and socio-
economic are ignored (Samad,
2016).
3. Financial analysis of KFH an Islamic Bank and comparison of performance with conventional
bank HSBC, UK:
Financial performance is one of the primary indicator that reflects that business
operations are conducted in such manner that all the business objectives are achieved as per
planning. Financial performance of an organisation is analysed with the performance of business
that is stated in the financial statements of a particular year. Bank is the governing body of the
financial system in the country. In case study information regarding “Kuwait Finance House”
bank is given. When financial statements of bank for last two years are compared then it can be
noted that bank has performed better (Hassan, 2010). This statement can be proved by the fact
that operating income that is generated by performing business activities is at growing stage and
is continue to grow. In the past two years increasing in income is recorded and in respect to that
increase in expanse is recorded but hike in income is more then expense which is positive sign
for good financial performance. Operating income of the year 2016 is 659650 and that has
grown up to 713280 this means that operations are performed in the predetermined manner to
achieve business objectives. To check the financial performance of the business it is also seen
that how well the balance sheet of the organisation reflecting the results. Balance sheet of
Kuwait Finance House bank is reflecting an improvement in the amount of assets. Amount of
cash flow has reduced in the current year and this is because of more investments are made in
fixed assets and dividends is paid to shareholders in the current financial year is more then
previous years.
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The hike in the assets in the past two years is from 164999353 to 17357981 dinar. As
banks are not allowed to make more investment in the fixed assets because this spoils main
objective of business to manage financial system in the country. Financial performance of the
bank is well as increment in operating profits, assets and amount of equity invested has grown
well (Iqbal and Molyneux, 2016).
When financial performance of the HSBC bank which is largest conventional bank of the
country is evaluated then it is seen that there is reduction in the new revenue of the organisation
in the year 2016. In the year 2017 a hike ids noted in the amount of new revenue but still it is less
then its past year net profits of 70037. It is seen that cash flow of the organisation is quite well
because in the year current year it has grown from the past year. Their is hike in the total assets is
recorded for HSBC that reflects positive financial performance (Morrison, 2015).
Their is difference in performing operating activities of both the banks and that leads to
differ in the method of earning through performing operating activities. As HSBC is a
conventional bank that charges interest to consumers and this is one of the primary source of
their income. Rate of interest charged to consumers is high then interest paid. When information
regarding Kuwait Finance House bank is recorded then it is seen that operating activities of bank
don not involve any interest income. Instead of interest “Zakat” is charged from consumers
which is a tax amount that needs to be paid to rise funds. This creates difference in the financial
performance of banks as charging interest and Zakat gives difference in operating incomes of
both the business organisations. When financial comparison of the bank is done country wise
then it is seen that bank which is regional and developed to provide services to specific country
will attract more consumers (Khorshid, 2012). Together with this another reason of attracting
more operations to Kuwait Finance House is because of not charging any interest amount. As
Kuwait Finance House is one of the largest bank in the country in terms of its operations and
providing services to large number of consumer group. When size of operations are high then it
leads to generation of more revenue for business. Consumers in Kuwait has more belief in
Kuwait Finance House bank and try to deal with the bank more and more and do not prefer any
other bank. Financial performance with the high amount of business operations give boost to the
financial performance of the bank. When both the banks are compared then it is seen that Kuwait
Finance House bank has performed better the HSBC in Kuwait. As high amount of operating
profits and increment of cash flow with rise in total assets in the business is recorded which is
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more then the compared bank. This helps in improving image of the Kuwait Finance House
bank in the eyes of general public and high amount of profits are generated through more and
more amount of operations that ultimately resulted in benefit through economies of scale
(Lebdaoui and Wild, 2016).
CONCLUSION
From the above project report it has been concluded that Islamic accounting is the form
of accounting in which there is no compulsion of paying tax and interest to the government. Only
Zakat is being paid by people and companies that are adopting this system. There are various
types of differences in the accounting system of conventional and Islamic banks. One of them is
related to tax and interest which is not required to be paid. It is very important for the banking
sector organisations which are adopting Islamic banks to meet requirements of Shari'ya in order
to execute business activities in appropriate manner.
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REFERENCES
Books and Journals:
Abedifar, P. and et.al., 2015. Islamic banking and finance: recent empirical literature and
directions for future research. Journal of Economic Surveys. 29(4). pp.637-670.
Arshad, M. U., Yusoff, M. E. and Tahir, M. S., 2016. Issues in Transformation from
Conventional Banking to Islamic Banking. International Journal of Economics and
Financial Issues. 6(3S) pp.220-224.
Beck, T., Demirgüç-Kunt, A. and Merrouche, O., 2013. Islamic vs. conventional banking:
Business model, efficiency and stability. Journal of Banking & Finance. 37(2). pp. 433-
447.
Demiralp, S. and Demiralp, S., 2015. The rational Islamic actor? Evidence from Islamic banking.
New Perspectives on Turkey. 52. pp.3-27.
Demiralp, S. and Demiralp, S., 2015. The rational Islamic actor? Evidence from Islamic
banking. New Perspectives on Turkey. 52(12). pp. 3-27.
Ferhi, A. and Chkoundali, R., 2015. Credit Risk and Efficiency: Comparative Study between
Islamic and Conventional Banks during the Current Crises.Journal of Behavioural
Economics, Finance, Entrepreneurship, Accounting and Transport. 3(1). pp. 47-56.
Hassan, K. M., 2010. [PDF]. Available through: http://www.sesric.org/imgs/news/image/585-
paper-1.pdf. [Accessed on 16th November 2016].
Iqbal, M. and Molyneux, P., 2016. Thirty years of Islamic banking: History, performance and
prospects. Springer.
Khorshid, A., 2012. Global Financial Crises and its effect on Islamic Finance. [Online].
Available through: http://www.academyuk.org/index.php/global-financial-crises-and-its-
effect-on-islamic-finance-2. [Accessed on 16th November 2016].
Lebdaoui, H. and Wild, J., 2016. Islamic Banking and Financial Development.Review of Middle
East Economics and Finance. 12(2). pp. 201-224.
Morrison, S., 2015. Islamic Banking and Financial Crisis: Reputation, Stability and Risks Edited
by Habib Ahmed, Mehmet Asutay and Rodney Wilson. Journal of Islamic Studies. 26(1).
pp. 103-107.
Samad, A., 2016. Are Islamic Banks' Non-bank Deposits Shock Resistant? A Comparison with
Conventional Banks: Evidence from Bahrain. Journal of Applied Finance and
Banking. 6(5). pp. 107-119.
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