Meezan Bank Limited (in the past known as Al-Meezan Investment Bank Ltd.) is a public listed company came into existence in January 27, 1997.In August 1997 Investment banking license has been issued to Meezan Bank under SRO 585-(1)/87, and started business in September 1997. In January, 2003 Meezan Bank was granted a full-fledged commercial banking license only committed to Islamic Banking.
Head office of the bank is situated in Karachi and the rest of the branches are sited across the country i.e. Karachi, Lahore, Faisalabad, and Islamabad. The bank has 37 branches all over the world and total employees working in the bank is 986. In the Accounting and Audit Organization for Islamic Financial Institutions (AAOIFI) the Meezan bank was the first financial institution in Pakistan to obtain membership.
The bank has total paid-up capital of (Pak) Rs. 2037 from an authorised equity capital of Rs. 3 Billion. The bank is publicly traded so the shares can be traded on the Karachi Stock Exchange. Meezan Bank Limited (MBL) is sponsored by primary financial institutions based in Pakistan, Kuwait, Bahrain and Saudi Arabia, offering innovative Shari'a compatible products which is designed to meet customers need
The bank strives itself to make available the efficient commercial banking, services and products which can also be tailor-made to adapt to customer needs. With a high professional team devoted to the source of the Islamic finance, the Bank has prepared as one of the Islamic main important Bank in the country.
4.1.1 Mission Statement:
To be a leading Islamic bank, offering a one-stop shop for innovative value added products and services to our customers within the bounds of Shariah, as well as enhancing the stakeholders' value by an organizational culture being based on learning, fairness, consideration for individual enterprise and acievement
4.1.2 Credit Rating:
The JCR-VIS Credit Rating Co. Ltd. (JCR), an affiliate of Japan Credit Rating Agency, Ltd, Japan has graded The JCR-VIS Credit Rating Co. Ltd. (JCR), a member of Japan Credit Rating Agency, Ltd, has sorted the Bank's long-term entity rating at A+ with A+ with constant out looked, where as the short term rating was graded at Al+, which is the highest likely in this category.
4.2 Sources of Funds
4.2.1 Current Account
Current accounts run in support of their customers by all the Islamic Banks: individuals and corporations. The accounts are managed for the safe keeping of deposits and for the comfort of clients The difference between routine operations banks and Islamic banks is very little in the magnitude the operation of current accounts is enclosed. However, become the first qualities of these accounts, as served, by Islamic banks, are described as:
Current accounts manage which can be commonly known as call deposits or either demand deposits. These deposits can be opened both of individuals or companies, in domestic or in foreign currency if the bank is certified to functioned in the foreign exchange market and holding of current balances in foreign currency is legal according to the law.
The account holder is not permitted to receive any share of profit or any other return in any form and the full return of these deposits on demand are guaranteed by bank.
To the banks is allowed to use account holder's fund at own danger of the bank. So, if there is any profit which arises from the use of the capital, it adds up to the bank's capital and if any loss originating, it is also born by the bank
No conditions exist in relation to deposits and withdrawals.
Account holders keep the right to draw cheque on their accounts.
Minimum amount required to open current account is Rs. 10,000.
Demand deposits/ current accounts treat as Qard Hasan by Meezan Bank. According to this view, deposited money in these accounts is a benevolent (or interest free) loan (Qard Hasan) from the depositor to the bank. The bank is free to use these funds at its own risk without any return to the depositor and without any approval because in the case of Qard Hasan, the debtor does not need the explicit permission of the creditor to use the borrowed capital. The debtor does owe the creditor only the borrowed principal amount. This condition is fulfilled as the amount deposited in these accounts is fully underwritten by the bank. The customary banks do not pay interest to current account holders. So, there is no need to convert the operation of current account into any Islamic way of the financing.
4.2.2 Saving Deposits
Meezan Bank operates savings deposits based on Mudarabah where the customer treat as investor (Rab-ul-maal) and the bank is manger (mudarib) of funds deposited by customers. The funds received by the bank from the customer are assigned a deposit pool. The Bank uses the funds from the pool to grant finance to the customers under Islamic states, which include but are not limited to, Murabaha and Ijara.
Minimum amount require for open the savings account is Rs. 10,000. The profit on this account are calculated and paid monthly. Profit is distributed at the gross income level. Bank calculates gross income after deducting direct costs and expenses incurred in generating that income.
Gross Income of the deposit pool are shared between the Bank and customers based on pre-determined profit sharing ratio which is announced at the beginning of the period. The sharing ratio for the Banks profit 80% of Gross Income and Depositors ratio is 20% of Gross Income. The profit which is allocated between the account holders is based on the predefined weightings, announced at the beginning of the each month. When at some stage of the month the average deposit falls lower than Rs. 10,000, the depositors are not entitled to any gain/loss on the account. In case of loss occurs, under the Mudarabah rules the depositor pool have to bear the loss in the proportions of investment of depositors.
Various types of saving accounts operate by Meezan Bank for the different types of customers, i.e. Riba-free U.S dollar saving account and Karobari Munafa Account (business profit account).MBL has offered Riba-free dollar saving account to the customers who are interested in a foreign currency based investment opportunity. It can be opened with the minimum amount of $ 100 under an agreement which is called Mudaraba .
Karobari Munafa Account is specifically designed for the large corporate and entities which are controlled by the Government of Pakistan. It allow customers to earn huge profits on surplus cash balances. It has no preset transaction limits and comes with a range of free packaged benefits. Minimum balance required to open is Rs. 1 million. There is no restriction on deposits and withdrawals. The profit which is calculated on such account is the daily product basis.
4.2.3 Investment Deposits:
Investment deposits which are operated by Islamic banks are similar to the term deposits or time deposits in the conventional banks. Investments deposits are also known as participatory account or Profit and Loss Sharing (PLS) accounts. Conventional banks operating fixed term deposits based on the interest, while the Islamic banks operate investments accounts which are based on profit sharing. Islamic banks provide the profit sharing ratio to the depositors rather than the predefined fixed rate of return on depositors' investments. How much profit each depositor does make that depends on the final outcome of the bank's own investment. MBL operates investment deposits on the based on Murabaha (discussed earlier in this chapter).
Four types of investments certificates are offered by MBL for its customers which can be distinguished on the basis of tenure. These investment certificates include Meezan Aamdan (Income) Certificate (MAC), Meezan Providence Certificate (MPC), Monthly Murabaha Certificate (MMC) and Dollar Murabaha Certificate (DMC).
MAC is a long-term deposit certificate with a high monthly profit planned for the individuals and the corporations seeking regular stream of monthly income. The minimum amount required for the investment is Rs. 100,000. Yet, senior citizen and widows can be opened such account with the minimum amount of Rs. 50,000. Such kinds of certificates are available in 51/2 years and 7 years time. Depositors do have the option to withdraw their amount before the certificates maturity time. This option is not obtainable in term of deposits which are offered by the conventional banks.
MPC is a long term investment certificate which can be customized to meet the demands of corporate and business concerns for the purpose of investing their Provident, Pension funds and Gratuity. The investment which is required for MPC is Rs. 1,000,000 and is available in the time period of 2, 3, 5 and 7 years. As like the MAC, the depositors have the option to withdraw the amount before the end of the MPC. To be eligible for such investment is requirement is, registered or unregistered Employee Provident / Gratuity / Pension fund, and having the function based in Pakistan.
Mechanism of profit calculation
It will be of interest to note here that the council of the Islamic ideology approved the idea in Pakistan in his report on the removal of interest of the economy, in principle to introduce a system of weights to split profits to different providers of the capital being based on whether the capital is redeemable or non-redeemable and within the redeemable capital between the capital which is redeemed in a short period and that which is redeemed after a longer period. The idea has already been moved and net profits in the practise; of the bank in Pakistan are assigned to the remunerable obligations in different relations which keep their relative maturities by view. The smallest weight is granted to special notification deposits followed by saving account and all deposits by other banks . The same principle of that: Differentiation is followed within the category by time deposits where in the highest; weightage is accorded to deposits of five years: or more and smallest to deposits for three months. Highest weightage under all remunerable obligations is assigned to the equity. The logical result weightage in Pakistan of accepted system has been that, as a result of the differences in the composition from liabilities and net profits, different banks offer various rates of the return on different categories of deposits, even if the average maturity structure is the same. (Ahmad, in 2005).
For the profit sharing calculation, below is an example of MBL saving accounts profit rates among the periods of July 01, 2010 to July 31, 2010 and weightages for the month of august used by MBL.
MBL gives different kind of finances to its clients. Diminishing Musharaka is one of them, according to this concept; the bank and his customer contribute either in a joint commercial project or in the shared ownership of a property or equipment. The financiers share are divided into various number of units and these units will be purchased by the customers one by one from the bank periodically, thus increasing his own share till all the units of the bank are purchased by customer.
In this case study only, Meezan Easy Home Finance scheme will be discussed to explain the rules and regulations of Diminishing Musharaka; as it is mostly popular scheme under diminishing Musharaka contract among the customer. MBL provide easy home financing on the basis of diminishing Musharaka. In diminishing Musharaka, the bank and its customer either contribute in a joint commercial project or either in the joint ownership of a property or equipment. The financiers share are more divided into several number of units and these units purchased by the customers one by one from the bank regularly, thus increasing his own share till all the units of the bank are purchased by customer.
Meezan easy home finance is a joint ownership of a property between the bank and its customer, where bank allows financing up to 85%. On the monthly agreement of the payments to Bank, one component is for the use of the home (rent), and other for the equity share. The total monthly payment is reallocated regularly by the partnership to reflect the customers growing equity and to allocate increasing amounts to his investment. Once when customer has made the full investment, which was agreed, he becomes the sole owner with a free and clear title to the property.MBL offers four different kinds of finances in home financing scheme which includes Easy Buyer, Easy Builder, Easy Renovate and Easy Replace. MBL Easy Buyer finance is available from Rs 300,000 to Rs 40 million. This finance is available in tenure of 3 to 20 years. Bank investment ratio varies from 70% to 85% depends on the group of customers, for instance, finances available to salaried person is up to 85%, business persons and self employed professionals can take financing up to 70% and up to 75% is available to Non-Resident Pakistanis (NRP) to buy a house.
Easy Builder finance is available for the residential construction, purchase of land or Enhancement of an already constructed residential bungalow. Amount of finance and tenure available in MBL Easy builder is same as in MBL Easy Buyer. MBL provides the Easy Renovate and Easy Replace scheme on the same basis but the amount is different.
4.3.2 Ijara
By law, the leasing contract is not sales of the object, but rather sales of the usufruct (the right to use the object) for given span of time.(Amin El- Gamal, 2000). The principal difference between convention lease and Islamic lease is that the leased asset must be owned by the leasing agency during the lease period. Thus, while leasing an automobile from dealers or car manufacturer may in principle is permitted.
In most cases banks play the role of intermediate between the car manufacturers / trader and customer, by providing loans for the present value of lease payments and charging customers an interest on this loan. This would use forbidden interest. Muslim lawyers have provided an Islamic alternative to conventional lease-purchase agreements (called in Arabic Ijara).
Car Ijara is one of the Pakistan first ' interest free ' auto financing being based on the Islamic financing way of Ijara (Islamic leasing). This product is ideal for persons who look for the auto financing, an interest-founded transaction avoiding There are some differences between the conventional car leasing and Meezan Islamic car leasing which are as follows:
Car Ijara in Meezan Bank is a rental car agreement, according to which the Bank buys the car and rents it out to the customer for the term of 3 to 5 years, which was settled at the time of the contract. All risks related to ownership lie with the Bank whereas, risks related to all usage lie with the user. When the lease period completes the ownership of the car gets by the customer against his security deposit. Under Islamic Shari'a, all rights related to ownership and liabilities must lie with the owner while rights related to all usage and liabilities should lie with the user. A conventional lease contracts do not make a distinction among the natures of these liabilities and places all liabilities on the user of the asset, contradiction to Islamic Shari'a.
Legally (in accordance to Pakistan's Law and Regulations), all leasing entities required to insure the assets which are leased. In same manner, Meezan Bank also insures its leased assets. However, Meezan Ijarah Agreement states that clearly the bank will only be used conventional Insurance as long as Takaful, which is Islamic product for insurance is not available. As Takaful becomes available in Pakistan, Meezan Bank will change to Takaful and stop using the conventional Insurance. At the moment Meezan Bank Limited (MBL) is insuring its vehicle in Karachi through Takaful and as soon the Takaful is offered in other cities we will switch to Takaful.
If the rent is not paid, an extra monetary amount is charged, 'in their income' in most of the contemporary financial leases. This amount is considered as Riba which is extra and is Haram. Under Ijarah, possibly the Lessee may be asked to accept, that in any case if he fails to pay out the rent on its due date, he will be liable to pay certain amount to a charity, which is administered through the Islamic Bank. The bank maintains a charity fund only for this purpose while this may restrict the amount and disbursement for charitable purposes.Meezan Bank Ltd. Basic rules of Ijara has been illustrated in Appendix A.
4.3.3 Istisna'
Istisna'a is a transaction of sale where they are dealing with a commodity before it exists. This is like an order for the manufacturer to manufacture an exact commodity for the purchaser. It is then Manufacturer who uses his materials to manufacture the essential goods.
In istisna'a, there must be a fixed price with the consent of all involved parties All other specifications which are essential for the commodity must also be fully resolved. Under Istisna' financing may also be provided for construction of the houses. If the client owns the land and seek financing for the construction of a house, the financier might also undertake to construct the house based on Istisna'. If the client does not own the land and wants to purchase that, the financier can provide him with a constructed house on a specific piece of land.
Istisna' could also be used for similar projects such as installing air conditioner plant in the factory of the client and building a bridge or a highway. The modern BOT (buy, operate and transfer) agreements may be formalized through an Istisna' agreement as well. So if the government plans to build a highway, it may enter into a contract for Istisna' contract with the builder. The price of Istisna' can be the right of the builder to run the highway and collect toll charges for a given period.
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4.3.4 Murabaha
Murabaha is one of the most common modes of financing by MBL. Murabaha is a particular kind of sale in which the seller mentions the cost of the commodity purchased expressly, and sells it to someone else in this regard by adding some profit. As a result, Murabaha is not an interest given on the loan; it is a sale of a commodity for cash/deferred price.
Murabaha involves the purchase of a commodity from the bank on behalf of the client and the sale it back to the latter on the basis of cost plus profit. Under this arrangement, MBL disclose the cost and profit margin to the client. In other words, instead of giving the money in advance to the borrower and the MBL will buy such goods from a third party and the sale of such goods to the customer at an agreed price. Meezan Bank Limited ( Rules for Mrabaha has been given as Appendix 'B').
4.3.5 Salam
In Salam, the seller agrees to supply certain goods to the buyer at some point in future and in exchange of an advanced price fully paid in the case. The price is in cash, but with the deferred supply of purchased goods
MBL uses this mode of financing especially to finance the agricultural sector.
Purpose of use:
To fulfil the need of small farmers who need money to grow their crops and feed their families until the time of harvest. When Allah declared Riba haram, the farmers can not take usurious loans. Therefore Holy Prophet allowed them to sell the agricultural products in advance
To meet the demand of traders for import and export. In the framework of Salam, it is to allow for traders to sell the goods in advance so that after receive them in cash price, they can easily conduct business in line. Salam is beneficial to the seller because the price can be received in advance, furthermore also useful to the buyer because the price is lower than the price in spot sales as compared to Salam.
The permissibility of Salam is an exception to the general rule that prohibits forward sale and therefore it is subject to strict conditions.
CHAPTER 5 : ANALYSIS AND DISCUSSION
CHALLENGES FACED BY ISLAMIC BANKS
(Meezan Bank Ltd.)
5.1 Institutional Aspects
5.1.1 Accounting Standards
Globally, Conventional banks have same sort of accounting standards. Consolidated balance sheets of the banks are published by Central banks as well as supervise them on the regular basis without having any difficulty. As a result, Islamic banks accounting policies are dissimilar. So, when the balance sheets or profit and loss accounts are compared it becomes very difficult to compare. Furthermore, the concepts used in the balance sheets and profit and loss accounts are not well defined.
Several Islamic banks have established an organization named The "Accounting and Auditing Organization for Islamic Financial Institutions" (AAOIFI), under the supervision of the Islamic Development Bank,to introduce standardization in the accounting practices of the Islamic institutions. The Accounting and Auditing Organization for Islamic Financial Institution is composed of a supervisory committee and a Council of financial accounting standards, who will prepare, issue and amend accounting standards of Islamic banks and financial institution who agreed already to meet the criteria set up by the board. Meezan Bank Ltd is a member of AAOIFI which allows to follow the same standards which has been used in other Islamic Banking Organizations
5.1.2 Proper Institutional Framework
Each system does have its own institutional requirements. Islamic banks need to support a many institutions/ arrangements for the performance of different tasks as they are without exception. In all over the world Islamic banks are trying to take advantage from the institutional framework which mainly encourages traditional banking. On the other hand these banks need their own institutional sustainability according to the needs. To Build a proper institutional setup is of serious challenge for MBL.
5.1.3 Lack of Equity Institutions
In Long term finances would be needed for all businesses. In traditional banking services, bonds over the long term and equities normally accomplish the requirements. The securities markets and institutions specialized in equity carry out this function of providing long term bonds and equities. Beside the general public, these long term investments are also provided by investment banks, mutual funds, insurance companies and pension funds. Since then, Islamic banks do not deal with interest-bearing bonds. Therefore, the need for equity markets is much higher. Unluckily, the security markets are not well established in most Muslim countries, which is expected field of Islamic banking.
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5.1.4 Establishment of Organized Secondary Financial Markets
If secondary financial markets exist the banks succeed. The commercial banks invest in very financial assets which are short term, because they can convert these financial assets into cash quickly at very low cost of conversion. There are several elements of a secondary financial market: financial instruments, dealers and financial institutions.
Secondary markets establishment can help Islamic banks to achieve a great deal; and make their assets more liquid and attractive to savers.
5.1.5 Need for Market for Short-term Placements of Funds
The Islamic banks especially exist as single entities. The commercial banking force is extracted from taking all banks collectively. Inter bank transactions between Islamic banks in most countries are nominal because of the small number of Islamic banks in those countries.
Islamic banks would require short-term instruments where they can profitably invest for shorter periods. Other traditional banks lent millions of dollars even for one day. They can be calculated based on the interest per day. Now Islamic banks are in much better position with regard to unexpected liquidity demands as compared to conventional banks, because large numbers of their deposit is fixed tenure. Even a large proportion of depositors choose fixed tenure deposits having the choice to withdraw any time. Hence, Islamic banks do require short-term financial instruments and institutional establishment for their placement.
5.2 Operational Aspect:
5.2.1 Shari'a Issues
Islamic banking and finance rules are prepared in the light of Islamic Shari'a; thus new product cannot be adopted as long as the new product will be cleared by Shari'a scholars. Every Islamic bank have their own Shari'a boards or Shari'a advisors. The Shari'a boards are responsible to make sure that the products offered by the banks are incompliance with the Islamic Shari'a. Barely a few of these scholars have a formal training in the field of modern finance ((Iqbal, Ahmed and khan, 1998). There are plenty of ways used by Scholars to acquire background which is necessary information before issuing a fatwa.
One way is to study an issue in meetings and workshops attended by each of the Shari'a scholars as well as the financial experts. The meeting of Fiqh academies, and the most famous between them is the OIC Fiqh Academy in Jeddah, play an important role in this regard. There is no experience required for Shari'a scholars' in the field of finance, and this method of group ijtehad plays an important role in protecting against serious mistakes in the adoption of instruments which are questionable.
Furthermore, different banks Shari'a Boards could issue altered rulings on similar practices that may cast doubt in the minds of their clients. An agreed standard of Shari'a by an independent body will have a long-term impact in assuring customers of Shari'a compatibility of the contracts as well as actual operations. Such guidelines will have an important role in wake of western banks entering into Islamic banking.
5.2.2 Teaching, Training, Research and Development
Education, training and research are an essential part of development in any discipline. This fact becomes even more important in the field of Islamic banking and Islamic finance as this banking system is emerging in all parts of the world. Still there is a shortage of scientists and researchers who acquire a working knowledge of the Islamic Fiqh and the modern economics and finance. Chief executives and managers are not trained very well in the use of Islamic finance. As a result need for training, education and research is so vital to the success of the emergence of Islamic banking and its function in society. So far, very little has been done to address such problems.
Some universities in Muslim countries such as, Malaysia and Saudi Arabia, Egypt and Pakistan who have started few courses to graduate their students with dual specialization. However, their studies are not still enough in quality and expertise that can produce quality managers. Barely any graduates able to find a place in the Shari'a Board of the Islamic Bank. Research and development in the sector that would need any financial support, so far any Islamic bank does not individually or as a group spend enough money for this purpose.
The future of Islamic banking and finance depends critically on teaching, training and research in the specialization required. Also there is a need to arrange short courses of Shari'a scholars in economics and finance and some courses which are similar for economists in Islamic Shari'a. Efforts in this area need to be improved to several times of current levels
5.2.3 Lack of Profit Sharing Finance
There are two types of Islamic financial transactions. One is based on profit sharing and the other is based on fixed charges on capital. Both of these types offer finance through the provision of purchase and sale of real commodities. When compared to traditional financial transactions, these are based on lending and borrowing of money for a fixed charge or fee (interest). However, it remained on the existing profit-sharing based finance in the Islamic banks operations. Firms from the perspective of those financial contracts which do not impose restriction, and to encourage reinvestment of earnings in the firm's growth are more favourable. While on the other hand, from bank's point of view, the costs of placing funds on profit-sharing basis are slightly higher than fixed return placements.
Mostly, the financing modes used by the banks are dominated by the fixed return modes such as Murabaha and Ijara (leasing). It is clear that such modes are different from interest-based modes because the transactions made through real commodities
5.2.4 Defaulters and the Issue of Compensation and Penalties
Islamic banks are able to set aside the issue of moral hazard and adverse selection through fixed return modes of financing. However, the use of debt rather than equity landed into a serious problem. Murabaha deals generate debt obligations against the buyers. When the buyers default on payment to him, it's not allowed for the bank to charge anything extra because that would mean taking Riba. For this reason, there is a built in incentive for immoral buyers to default. Islamic scholars have addressed this problem and agreed that sanctions could be imposed against defaulters, both physical and financial.
5.2.5 Illiquidity of Assets
Mostly, Islamic mode of financing based on equity and so far Ijara is the only successful product offered by Islamic banks, they still lack in development of other products. Attempts have been made for the development of negotiable instruments on the type of Ijara and Salam but there is still a need for considerable improvement. The development of Islamic secondary market lies in wider equity based on financial instruments and securitisation of some existing modes.
5.2.6 Short-Term Asset Structure
Banks prefer short-term investments because they work on the small reserves basis. They must have the ability to quickly liquidate their assets in case they need. In case of Islamic banks short-term structure of assets becomes more vital because the Murabaha, which is the major source of finance, is a short term contract. Though it can be designed for longer period of terms but whose main objective is to invest in projects which are short term. As Murabaha is comprised of large proportion of investments in Islamic banks so the structure of their assets is already short term.
5.2.7 Competition
In last few years, Islamic banks have already faced an increasing competition from the conventional banks that are entering now in Islamic banking. Islamic banks have attracted finances from clients who are of strong religious belief. Many of the giants of international banking are practicing Islamic banking techniques such as Chase Manhattan, Citibank, ANZ Grindlays, Klienwort Benson along with others such as Union Bank of Switzerland, Girozentale of Australia, the ABC International. In addition to these, in many Muslim countries, a lot of commercial banks are offering Islamic banking services. Bank Misr in Egypt and National Commercial Bank in Saudi Arabia have opened their Islamic Branches. In Malaysia, commercial banks permission has been given to open Islamic banking windows as well
With an increase in competition and the emergence of multinational banks in the market of Islamic banking there is a fear that whether or not commercial banks will follow the rules of the codes of Islamic banking? The market is extremely lucrative to commercial banks so it is very likely that conventional commercial banks might not follow correctly and faithfully the rules of Islamic banking. All Islamic banks have Shari'a board that is responsible for reviewing its operations and contracts and ensure that they conform to the requirements of Shari'a, while conventional banks do not have this kind of boards and also there is a fear that conventional banks may not be able to maintain separate accounts for their Islamic banking operations. They may mix up the money from Islamic accounts and permissible return may be obtained by riba.
There will be always doubts about the performance of Islamic banks, under competitive conditions there is a room for product differentiation. Large numbers of customers have been attracted by Islamic Banks who are strong enough in religious principles. Still there are serious concerns about the Shari'a compatibility of certain practices with Islamic banks. These concerns will be by the entry of western banks
