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 9.
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.
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 stipulated ratio.
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.
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