Shariah Compliance Framework at Meezan Bank Limited

Suleman Muhammad AliVice PresidentMeezan Bank Limited+92-300-2762632

Ahmed Ali SiddiquiExecutive Vice PresidentMeezan Bank Limited+92-300-2178738

Product Development & Shariah Compliance

Outline

• Islamic Banking in Pakistan

• Evolution of Meezan Bank

• Shariah Compliance Framework at MBL

Islamic Banking in Pakistan: A Success Story

Highlights of Islamic Banking in Pakistan

• Conventional Banking interest declared haram by Shariat Appellate Bench of Supreme court of Pakistan in a historic decision in 1999.

• SBP Islamic Banking Department was established on 15th

September 2003.

• Separate Shariah Board of the Central Bank

• Fit & Proper Criteria for Shariah Advisor

• Targeted share in first five year strategic plan achieved.

• Second 5 Year Strategic Plan issued by the Central bank for the year 2013-2017

• Introduction of Islamic Export Refinance (Musharakah based)

• Long Term Financing Facility under the mode of Mudarabah to be launched by SBP

• Shariah Compliance Guidelines issued by IBD SBP

• Standardized Shariah Governing Framework for IBIs

• Issuance of Shariah Standards for ‘Sharikat ul Milk and Diminishing Musharakah’ in 2013

• Specific Pool Management Guidelines for IBIs

• Amendments in Financial Reporting for Islamic Banks

• Adoption of AAOIFI Standard – New Accounting Entries for Islamic Modes of Financing

• Adoption of AAOIFI Shariah Standards for▫ Murabaha▫ Ijarah ▫ Istisna

• GoP Ijarah Sukuk is currently worth approximately PKR 300 Billion

Key Statistics

Market Share Approx. 10%Total Deposits 706 BillionTotal Assets 837 BillionTotal Financing & Investment 626 BillionAnnual Deposit Growth Rate 59.6%Full Fledged Islamic Banks 5Islamic Banking Windows 18

* Source: State Bank Islamic Banking Bulletin

Islamic Banking Branches

3.8

4.8

5.9

7.2

8.4

10

0

2

4

6

8

10

12

2007 2008 2009 2010 2011 2012

% o

f Tot

al b

anki

ng

Growth of Market Share for Islamic banks

Islamic Banking Growth Trend

Deposit Growth of Islamic Banking

0

100

200

300

400

500

600

700

800

2007 2008 2009 2010 2011 2012

147202

283

390

521

706

Amount in billions of Rupees

Years

Deposit growth of Islamic banking

Deposit

Islamic Banking Vs Conventional Banking

MEEZAN BANK LIMITEDPremier Islamic Bank

Evolution of Meezan Bank• In 1997 Al-Meezan Investment Bank was established as

the first Islamic Investment bank in Pakistan.

• In 2001 the Shariah Supervisory Board was established

at Al-Meezan Investment Bank led by Justice (Retd.)

Muhammad Taqi Usmani as chairman.

• In 2002 Meezan Bank acquired the Pakistan operations

of Societe Generale and concurrently Al Meezan

Investment Bank converted itself into a full fledged

Islamic commercial bank.

• In 2003 Meezan Bank establishes itself as the pioneer of

Islamic Banking in Pakistan and quickly establishes

branches in all major cities of the country.

• In 2005 Meezan Bank becomes the first customer of

Takaful in the country

• Auto Finance Industry leader with more Rs 5 bn

automobiles

• Developed and launched Sukuks under various

Structures:

▫ Airtime based Sukuk

▫ Shirkatul Aqd based Sukuk

▫ Diminishing Musharakah Sukuk

▫ Istisna Wakala based Sukuk

▫ Hybrid Sukuk (Musharakah- Wakalah- Ijarah)

▫ Project Finanicng Sukuk based Wakalah & Ijarah

6 10 1628

62

100

166

201222

275

310

0

25

50

75

100

125

150

175

200

225

250

275

300

325

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Num

bers

67%

60%

75%

121%

61%

66%

21%

24%

10%8thLargest banking network in

Pakistan

12%

53%

78%

65%

51%

58%

29%

43%

30%

31%

2 0

1 1

5,079 7,757 13,770 22,769

34,449

54,582 70,234

100,295

131,070

170,030

230,413

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

200,000

220,000

240,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Rup

ees i

n m

illio

ns

35%

12thLargest (deposit wise) Bank in Pakistan

Deposits

(35%)

65%

(4%)5%

87%44%

59%

61%

106%

Estim

ated

3%

Bud

get

223 214 224 419

604

963

621

1,025

1,650

3,391 3,508

- 200 400 600 800

1,000 1,200 1,400 1,600 1,800 2,000 2,200 2,400 2,600 2,800 3,000 3,200 3,400 3,600 3,800

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Rup

ees i

n m

illio

ns

Profit After Tax

Meezan Bank33%

Islamic Windows of Conventional Banks

30%

Other Islamic Banks37%

Market Share

Shariah Compliance Framework at MBL

Product Development & Shariah Compliance (PDSC)

• MBL has one of the largest Product development and Shariah compliance departments in the region

• The mandate of PDSC department is to ensure Shariah compliance through research, innovation, audit and Shariah trainings.

Product Development & Shariah Compliance (PDSC)

• PDSC department is divided into following functional segments/ clusters:

Product Structuring

and Research

Shariah Compliance

Shariah Audit

Product and

Shariah Training

Charity Management

Product Development & Shariah Compliance (PDSC)

Shariah Supervisory

Board

Shariah Advisor

Head of PDSC

Retail Product

Development

Product Structuring

and Research

Shariah Compliance

FunctionShariah

AuditShariah Training

Charity Management

Total Strength of the department: Approx 35

16 members 2 members4 members7 members5 members

Product Structuring and Research

Product Structuring & Research (PSR)

• The objective, scope and mandate of PSR is as follows:▫ Develop financial products and services to fulfill

previously unfulfilled financial needs as per shariahguidelines

▫ Refine, modify and redefine existing financial products▫ Provide custom made shariah compliant financial

solutions to Corporate, Commercial and SME clients▫ Develop Liquidity management and treasury related

products

Product Structuring & Research (PSR)

• Product developments is done at MBL keeping in mind the following parameters:▫ Customer’s business cycle▫ Tenure (short term or long term)▫ Existing alternatives present in the market▫ Rate of financing (fixed or variable)▫ Payment flexibility (possibility of early repayment)▫ Tax concerns▫ Accounting treatment▫ Regulatory aspect▫ Risk mitigation measures▫ Mode and nature of the Assets involved▫ Basic Shariah Principles

Product Structuring & Research (PSR)

• Once the idea and the structure of a new product is finalized the same is presented before the Shariah Advisor.

• The Shariah Advisor may either approves, declines or suggests modification in the product.

• In some cases the shariah advisor may not approve or decline the product but rather give instructions for the presentation of the same in the next Shariah Supervisory Board (SSB) meeting

• The SSB will then take the final decision on the product.

Shariah Compliance

Shariah Compliance Function (SCF)• The objective, scope and mandate of the SCF

function is to ensure and monitor Shariahcompliance related to:▫ Corporate, Commercial and SME financings/assets of

MBL. ▫ Investment banking transactions related to sukuk,

syndicated financings.▫ Funding, Financing, Investment, Foreign Exchange

related as well as other activities conducted by the Treasury department of the bank.

▫ Deposit products and profit distribution.▫ Other policies and procedures of the bank for instance

related to HR, Marketing, Admin, etc.

Shariah Compliance Function (SCF)

• SCF ensures Shariah Compliance through the following major operational tasks:▫ Shariah Compliance Review▫ Coordination with SSB▫ Development of bank wide policies, procedures an

guidelines for ensuring Shariah compliance.▫ Shariah Training

Shariah Compliance Function (SCF)

SHARIAH COMPLIANCE FUNCTION

CREDIT PROPOSAL

REVIEW

INDUSTRY VISITS/MEETING

WITH CLIENTSPROCESS FLOW

REVIEWDELAYED

DECLARATION REVIEW (DDR )

FORTNIGHTLY MURABHA

REVIEW THR OUGH MURABAHA

MONITORING SHEETS(MMS)

PAYMENT MODE REVIEW

Shariah Compliance Review (SCR) –Step 1

• Every financing proposal related to the following areas is required to go through the SCR by PDSC before offering the facility to the customer:▫ SCRof Financing limits for Corporate/SME/Commercial

Clients▫ SCR of restructuring transactions, takaful claim

settlement, enforcement of security, court settlements and other issues

▫ SCR of Guarantees▫ SCR of Trade Finance▫ SCR of Charity Claims▫ SCR of Sukuk and Syndications▫ SCR of Treasury

Shariah Compliance Review• At the time of initial Limit approval Shariah Suitability Review is

conducted with the focus to conclude whether the proposed products are feasible in terms of ensuring shariah compliance

• The review is done keeping in mind the following characteristics:▫ Nature of financing requirement▫ Nature of Assets ▫ Customer business process▫ Inventory Holding Period of assets ▫ Storage capacity of Customer▫ Risk transfer mechanism of industry▫ Cash flow cycle of customer.▫ Nature of Customer’s business: Retailer, Wholesaler, Manufacturer,

Vertically integrated group etc.▫ Other customer specific information.

Shariah Compliance Review• The details of the characteristics above mentioned are

retrieved through following methods:

▫ Reviewing Nature of Business of Customer▫ Tenure of Facility▫ Discussion with RM▫ Discussion with Customer▫ Industry Knowledge

• Upon this review if PDSC holds the opinion that facilities proposed in the credit proposal are not practical as per Shariah based on the criteria mentioned above, then PDSC will not approve the limit and will propose a different solution/Product to the Business unit.

Shariah Compliance Review – Step 2• After the initial review a Product Specific Review (PSR)

is conducted for each product for which a limit is proposed in the credit approval

• The objective of PSR is to devise a mechanism/ guideline/ process flow for fulfilling customer’s financing need while adhering to the requirements of Shariahtaking into consideration the customer’s business characteristics.

• Process flows are designed of each mode used to provide financing keeping in mind the Business Processes of the customer.

Shariah Compliance Review

• For each customer a separate Process Flow is devised.

• Hence Murabaha Process Flow for a textile concern will be different from that designed for sugar mill, leather tannery, fibre producer, power station, etc.

Shariah Compliance Review

• In case of Murabaha Shariah Compliance is ensured by keeping the following checks:▫ Direct Payment to Suppliers▫ Minimum gap between disbursement and payment to suppliers▫ Declaration to be made within the completion of Minimum

Inventory Holding Period▫ Separate identification and storage of goods▫ Invoices to be issued in the name of MBL▫ Receipt of Goods Receiving Evidence▫ Telephonic and Physical verification▫ Purchase, production and sale cycle.

Shariah Compliance

• In case of Istisna/ Tijarah Shariah Compliance is ensured by keeping the following checks:▫ Proper specification of goods is mentioned in the written offer▫ GRN to be executed for the same specification of goods as

mentioned in the written offer▫ Settlement to be done only through actual sale proceeds▫ Physical inspection of goods to be done at the delivery▫ Proper identification of goods to be done at the time of delivery▫ Separate storage of istisna goods before sale to third party▫ Purchase, production and sale cycle

Shariah Compliance

• In case of DM/ Ijarah Shariah Compliance is ensured by keeping the following checks:▫ Proper identification of Musharakah/Ijarah Assets▫ Asset price to be ascertained through revaluation before

disbursement▫ Asset tagging through stickers or plates to be done on

Musharakah/Ijarah Assets▫ SLB transactions are allowed only in exceptional cases where

proper justification is provided

Shariah Compliance Review- Step 3

• After the Product Specific Review (PSR) is completed and transaction process flow is finalised, Business units are given a go ahead for the execution of the process flow.

• Each year an Annual Review is done of all the financing customers to whom any financing facility is offered.

• Transactional documents are reviewed of randomly selected transactions in order to ensure shariahcompliance

• In 2012 approximately around 1300 financing proposals were reviewed by the Shariah Compliance team.

Shariah Compliance Review

• In case of Murabaha following documents are reviewed▫ Latest Account Statement

▫ PDSC approved Process Flow

▫ Murabaha Monitoring Sheet (MMS)

▫ Order Form

▫ Declaration and Murabaha Contract

▫ Invoices/ Goods Receiving Evidence

▫ Payment evidence

Murabaha Monitoring Sheet (MMS)Monthly Murabaha Status SheetFor the Month: March, 2005.Branch : PNSC (Corporate)

Declaration Outstanding

CBD-650/05 A Auto Spare pa D 7-Feb-05 8-Feb-05 20-Feb-05 5-Sep-05 210 1 13 12 CBD-650/05 B Sugar cane D 8-Feb-05 9-Feb-05 10-Feb-05 7-Aug-05 180 1 2 1 CBD-650/05 C Cotton D 9-Feb-05 10-Feb-05 11-Feb-05 9-Jun-05 120 1 2 1 CBD-650/05 D Rice D 10-Feb-05 11-Feb-05 12-Feb-05 9-Aug-05 180 1 2 1

Report Date

CBD NO.

Sub-Decaration

Date

(S)

Customer Name

Subject Matter

Date of Disbursem

ent

(D)

Invoice Date

(I)

Payment Mode (Direct /

Indirect)

Declaration Gap

(S-D)

Difference b/w Declaration & Invoice Dates

(S-I)

Maturity Date

(M)

Tenor / No of Days

(M-D)

Purchase Gap

(I-D)

Shariah Compliance Review

• In case of Istisna/ Tijarah following documents are reviewed▫ Last PDSC approved Process Flow

▫ Written Offer

▫ Goods Receiving Note

▫ Notice to Sale

▫ Confirmation of sale of Goods

Shariah Compliance Review

• In case of DM following documents are reviewed

▫ Last PDSC approved Process Flow

▫ Units Sale Receipt

▫ Any other appendices

Shariah Audit

Shariah Audit

• The objective of Shariah Audit is to ensure execution oftransactions as per the guidelines laid out by Productdevelopment and Shariah compliance team.

• The Shariah audit team reports directly to the ShariahSupervisory Board.

• In the year 2012 Shariah Audit of over 250 branches wasconducted

• Based on the Shariah audit report, branches are assignedratings

Shariah Audit

PRE AUDIT PLANNING

AUDIT EXECUTION

OPINION FORMATION

AUDIT FOLLOW-UP

Shariah Audit2012 2011

Total No. of Branches in Bank 310 270

Total No. of Branches 270 214

Percentage 87% 79%

Excellent 4 4Above Average 73 63Average 178 138Below Average 13 8Poor 2 NIL

Shariah Audit

• Once Shariah audit of the branch is completed auditobservations are raised.

• In case of financing branches if an audit observation israised on transactions of a particular customer, and ifthose observations are of serious nature with respect toshariah compliance then Charity may be imposed.

• Based on the seriousness of the audit observations,shariah audit may refer the case to shariah complianceteam for the revision of the process flow.

• Until the process flow is revised no future disbursementmay be made.

Product and Shariah Training

Shariah Training

• The objective of training is to impart Shariah and product

knowledge to the employees and customers of the bank so that

Shariah Compliance is ensured in each and every transaction.

• At MBL different modules of trainings are designed in order to cater

to different kind of audiences.

• The period of training may vary from one day to even 4 months

based on the complexity of the course.

• Trainings may be focused on a single product or may cover the

entire ambit of Islamic Finance.

Shariah TrainingS.No Area Specific Training Modules Duration

1 Orientation 2 Day2 Advance Islamic Finance Course 6 Days3 Islamic Banker Certification - Level 1 to Level 3 4 Months4 Murabaha and Trade Finance Products 2 Days5 Diminishing Musharkah in Commercial Property 1 Day6 Running Musharakah Half Day7 Diminishing Musharakah and Ijarah 1 Day8 Istisna/Tijara Training Module Half Day9 Shariah Concepts: Treasury & FI Products Half Day

10 Equity Based Modes Training Session: Mudarbah & Musharkah 1 Day

11 Deposit Products Training Module Half Day12 Basics of Islamic Financial Accounting - AAOIFI Guidelines 1 Day13 Video Training session 2 Hrs

Shariah Training

External Training

Charity Management

Charity Management

• At MBL Charity Management is done through IhsanTrust

• Ihsan Trust was founded on 7th Day of January 2010

• It is basically the operator of Ihsan Trust Fund which is a Waqf made through a separate Waqf Deed

Charity Management• Educational & Skill

Development

• Rural Development

• Health & Hygiene

• Immediate relief to the affectees of any natural disaster/ calamity

• Rehabilitation and other community building services

• Qarz-e-Hasna

• Establishment and operation of orphanages

• Providing funds for the marriage of girls from poor families

• Assist indebted poor people

• Microfinance

Charity ManagementThe sources of the fund are:

• Meezan Bank Ltd (Charity account/fund)

• Al Meezan Mutual Fund

• Other Islamic Banks

• Donations

• Excess funds in the high yielding shariah compliant investments avenues.

Some major highlights• Sponsor of IBA’s National Talent Hunt Program• The Citizens Foundation Intermediate

Scholarship Program• Qard-e-Hasna Facility at▫ IBA▫ LUMS▫ NUST Business School▫ Agha Khan University▫ Riphah International University▫ International Islamic University

Some major highlights

• Scholarships given to students to pursue studies in foreign institutions including INCEIF

• Donations to Hospitals▫ Indus Hospital▫ SIUT▫ Shaukat Khanum memorial cancer hospital▫ Afzaal Memorial Thalassemia Foundation▫ Childrens Cancer Hospital

JazakAllah

Ahmed Ali SiddiquiExecutive Vice PresidentMeezan Bank Limited+92-300-2178738

Suleman Muhammad AliVice PresidentMeezan Bank Limited+92-300-2762632