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Accounting Requirements of Takaful Operators

Kazi Md. Mortuza Ali

Director General

Bangladesh Institute for Professional Development (BIPD) & Chief Consultant of Prime Islami Life Insurance Limited

Email: mortuzaalimd@yahoo.com

1. Introduction

Takaful is an alternative form of conventional insurance based on the concept of trusteeship and

cooperation inspired by the beliefs of the followers of Islamic teaching. Muslim societies in different parts of the world are now practising Takaul scheme as their own way of sharing financial responsibilities to

assist each other. They have invented an Islamic way of mutual assistance to deal with uncertainties of life.

Takaful is a social scheme based on the principles of brotherhood, solidarity and mutual assistance. It provides mutual financial aids and assistance to those who are members of the takaful scheme and

voluntarily agree to contribute a certain amount of money for that purpose. It is a mutual agreement among the participants of the scheme. This has its origin from the concept of collective sharing of

individual’s loss. Takaful, is being practised now as an alternate of conventional insurance system and is

bounded by Islamic principles, rules and the laws of Islam (Shariah).

Takaful is an Arabic word stemming from the verb “kafal” which means to take care of ones needs. Under this scheme, the members or the participants in a group agree to jointly guarantee themselves

against loss or damage caused by specified perils. The entire group would assist the incumbent person

from the fund they have created to alleviate (indemnify) his loss and or to provide him with financial help. Takaful is a legally binding agreement between all the participants of the scheme to pay any of the

members who suffer a loss as specified in the takaful certificate (policy). Takaful scheme has been evolved from the teachings of Islam i.e. on the basis of the Quaran and the Sunnah (Traditions of

Prophet Muhammad). The Quran says:

“Help ye one another in righteousness and piety, but help ye not one another in sin and rancour”. (The

Quran 5:2) The Prophet Muhammad (P.B.U.H) said: “The believers, in their affection, mercy and sympathy to each other, are like the body, if one of its organs suffer and complains, the entire body

responds with insomnia and fever” (Muslim)

Takaful, generally means joint guarantee. It is an understanding among a group of people (called the

participants) who agree to reciprocally guarantee each other financially should any event (as defined in the contract) occur. The basic objective of a Takaful contract is to pay from a common fund, which is set

up by the participants of the scheme. The fund thus created may be managed by the participants

themselves or through professionals or by a registered Takaful Operator. The fund is created by the equitable contributions of the participants. The Takaful operators can be registered under the relevant

Companies Act or Cooperative Societies Act, Societies Registration Act or by Takaful Act. In order to ensure that a Takaful scheme operates within the principles of Islamic teachings, the transactional

aspects of the system is subjected to Islamic contractual laws. Hence, Takaful contracts are based on the

principles of Mudarabah, (limited partnerships) which means profit and loss sharing.

The fundamental basis of Takaful scheme is that its operations do not involve any element which is not approved by the Shariah (Laws of Islam). Therefore, it is necessary that the Takaful operators should

establish and maintain Takaful fund for the class or each of the Takaful schemes carried on by the

operators. The assets comprised in the fund shall be applicable only to meet such part of the operators liabilities and expenses as is properly so attributable. The assets of the Takaful fund shall be kept

separate from all other assets of the operator. This means that the fund of the entrepreneurs of a Takaful company should not be amalgamated with the Takaful fund created by the participants of a

Takaful scheme.

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When a Takaful scheme is operated on the basis of mutual or on the basis of cooperative principles, any

surplus or deficit of the Takaful operation has to be shared by the participants, or the members themselves. But when a Takaful scheme is being operated on commercial basis, the surplus of Takaful

operation has to be shared between the operator and the participants in accordance with the principles of Mudarabah. The sharing of such surplus may be in a ratio as agreed between the contracting parties.

The participants are entitled to a share of surplus as the providers of the fund and the operators are

supposed to have a share of the surplus as the entrepreneur and managers of the fund.

When a contract is made between the operator of a Takaful life scheme and the participants of that scheme, the concept of Tabarru (donation) is incorporated in it. This means a participant will agree to

relinquish a certain amount of Takaful contributions to fulfil his obligation of mutual help and joint guarantee should any of the fellow participants under the scheme suffer a loss caused by specified perils

and or hazards of life.

The sharing of surplus between the operator and the participants has to be made as per ratio fixed in

the agreement. The operators are to strive prudently in order to ensure that the funds which are being managed by them are protected against undue overexposure and creates some surplus for distribution,

since the operators are entitled to a share of surplus out of Takaful operations.

The operation of Takaful practices is supervised by an independent body called the Shariah Supervisory

Board or Council. The Board advises the Takaful operators on the day to day operational matters in order to ensure that the Operator does not involve in its operation any element, which is not approved by the

Shariah principles. The establishment of a Shariah Supervisory Board is a prerequisite before the commencement of the Takaful operation. The Board prescribes the necessary requirements for

acceptability of different modes of transactions of the Talkaful operators from the Shariah point of view

and provide the operators a clear perception of the relevant rules and principles of Shariah.

How Takaful suits in Islamic Economic System?

In majority of the Muslim countries, Takaful has emerged as a profit sharing business venture between

the Operator and the individual members of a group of participants who desire to reciprocally guarantee each other against certain loss or damage that may be inflicted upon any one of them. However the aims

and operations of a Takaful business venture should not involve any element which is contrary to Islamic principles and law of financial transactions. Takaful has grown not only as an innovative financial instrument, but also on religious principles. The purpose of religion is the well being of mankind. Islam as a religion seeks to

order human life so as to make it actualise the pattern intended for it by its Creator. Islam is not only a religion but an ideology in the sense that the Shariah, its law has given the

Muslims a pattern of life with which to order their lives.

The Shariah is comprehensive, embracing all human activities, defining man’s relations with

God and with his fellow men. The Shariah grew out of the attempts made by early Muslims as they confronted immediate social and political problems to devise a legal system in keeping with

the code of behaviour called for by the Quran and the Hadith. The purpose of Islam is always to inject morality into the fabric of human relations. How the Muslims earn its

livehood, how he spends his wealth and how his wealth is to be disposed of after his death

all these are the stuff of Islam. In Islam, the human aspect is more important than the material one. It relies more on moral, ethical and human aspects than on the material aspects.

This is something unique in the Islamic Economic system.

Prophet Mohammad (P.B.U.H) said,

“ One who eats to his hearts contents, while his neighbor starves, is not a Mumin“ (faithful) Helping neighbours, poor relations and the distressed contribute to an exploitation free society

based on the principle of brotherhood.

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Understanding fundamental principles of Islamic Economic System is necessary in order to have

a better understanding of the role of Takaful and its suitability in the Islamic Economy. For example, right of private ownership accorded by Islam is not absolute and unconditional. The

ownership is a kind of trust only. An individual may privately own and manage any kind of wealth, but he can not do with them whatever he likes. He is to regulate the uses of wealth

as per the Shariah Law. An individual can make joint investment to earn profit from his

investment. Takaful is a means whereby investments of surplus funds are made by the Operators and profits are distributed to the Participants i.e. to the owners of the capital.

Another fundamental principle of the economic system of Islam is that it stands for equitable

distribution of wealth. Islam encourage people to be selfless helpers for one another by

arousing in them feelings of sympathy. Takaful is a system where people are encouraged to contribute money for mutual help in times of need. Thus Takaful comes in for help of

distressed fellow by means of mutual cooperation and joint guarantee.

The Islamic Economic system combats the accumulation of wealth and its concentration in the

hands of a small minority. The Islamic Law of inheritance provide for the shifting and distribution of wealth in a manner unknown in other legal and economic systems. It divides the

estate of the deceased over a wide range of beneficiaries and not on a single heir to the exclusion of other. The nominee in a family takaful scheme is only a trustee and the policy

money need to be distributed to all the heirs.

Some of the key differences between conventional insurance and takaful are shown in the following

table:

Points Insurance Takaful

Principles Not necessarily Shariah based Shariah Compliance is must.

Contract Buying/Selling Contract Tabarru & Mudharabah Contract

(Donation & Partnership).

Company Guarantor to meet liability Fund Manger/Trustee of Fends.

Guarantee Given By Company Participants mutually guarantee for

each other by creating tabarru

fund.

Indemnity/financial Aid Company’s Fund is debited Relevant Takaful Fund is debited

Investment Interest based mainly Interest based investment is not

allowed

Shariah Supervision Not required Required

Why Shariah based Accounting?

The emrgence of Islamic banks and Islamic financial institutions(IFIs) as relatively new organizations and the great challenge they face to successfully serve the societies in which they operate, have led them,

together with specialists in Sharia’a and in accounting, to seek the most appropriate means through

which accounting standards could be developed and implemented in order to present adequate, reliable, and relevant information to users of the financial statements of such organizations. The presentation of

such information is critical to the economic decision making process by parties who deal with Islamic financial institutions and whould also have a significant effect on the distribution of economic resources

for the benefit of society.

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The principles of Shari’a strike a balance between the interests of the individual and society. It is known

that investment is the foundation of economic activities in any society. However, not every individual is capable of directly investing his own savings. Accordingly, Islamic banks and family takaful operators

(Islamic life insurance companies) paly an important role by acting as a vehicle to attract the savings of individuals and investing those savings for the benefit of the individual and society.

However, to induce individuals to invest through savings with their Islamic banks and insurers it is essential that such individuals develop atrust in the ability of Islamic financial institues to realize their

investment objectives. In the absence of trust in the ability of Islamic banks and insurers and insurers to invest efficiently and in full compliance with Shari’a, many individuals may refrain from investing through

Islamic financial institues.

The interest in developing financial accounting standards for Islamic banks started in 1987. In this

respect, several studies have been prepared. These studies have been compiled in five volumes and deposited in the Libarary of the Resarch and Training Institute of the Islamic Development Bank.

The outcome of these studies has been the formation of the Financial Accounting Organization for Islamic Banks and Financial Institutions which was registered as a not-for-profit organization in the

Kingdom of Bahranin on 27/03/1991 A.D. Since its inception this Organization has continud the efforts to

develop accounting standards. Periodic meetings of the Executive Committee for Planning and follow Up have been held with the aim to implement the plan approved by both the Supervisory Committee ( the

supreme authority of the Organization) and by the Financial Accounting Standards Board for Islamic Banks and Financial Institutions. In this respect, the Committee has retained the service of several

consultants on Shariah and experts and practitioners of accounting, and bankers.

This standard defines the financial statements that should be periodically published by Islamic financial

institutions including takaful oerators. This standard also establishes the general principles for the presentation of information and defines certain information that should be disclosed in the financial

statements of Islamic financial institues in order to achieve the objectives of accounting and financial reports within the limitations of financial accounting.

The objectives of financial accounting and reporting determine the type and nature of information which

should be included in financial reports, in order to assist users of these reports in making decisions. Therefore, the objectives of separate financial accounting is to focus on the common information needs

of users of financial reports. To do so the takaful operators must identify the users of the information in

the first place.

It is necessary to determine the rights and obligations of all interested parties in accordance with the

principles of Shari’a and its concepts of fairness, clarity and compliance with ethical values. This will contribute to the enhancement of the managerial and productive capabilities of the takaful operators and

encourage compliance with its established goals and policies and, above all, compliance with Shari’a in all transactions and events. Further, through financial reports, useful information to users of such repots

will enable them to make decisions in their dealings with takaful operators.

This information should be provided principally for assisting the user in evaluating the adequacy of the Takaful Operators capital to absorb losses and business risks; assessing the risk inherent in its

investments; and evaluating the liquidity position and the liquidity req uirements for meeting its

obligations and its operational requirements.

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Three important reasons underpin the development of the Conceptual Framework and separate financial

accounting standards for IFIs:

a) To establish a common framework for accounting and financial reporting and to help demonstrate to the common users of that the entities they are associated with comply, in form

and in substance, with the principles and rules of the Shari’s in their financial and other dealings.

b) The relationship between IFIs and the parties that deal with them differs from the relationship of

those who deal with conventional entities, insurance firms, mutual funds, and other organizations. Unlike conventional entities IFIs are prohibited from the use of interest in their

investment and finacing transactions and from entering into highly speculative transactions and

also prohibited from entering into transactions that are not permissible by the Shiari’a. For instance, whereas conventional entities borrow and lend money on the basis of interest, IFI

mobilizes funds through investment accounts on the basis of Mudaraba (i.e., sharing of profit between the investor who provides the funds and the IFI which provides the effort) and invests

these funds in Shari’a-compliant assets or instruments.

c) The information needs of the common users of finance reports of IFI are unique and specific,

and, accordingly, the financial reports of such entities must reflect the nature of the ralationships established with such entities and the transactions, events or conditions involving such entities.

Purposes of financial accounting in Takaful operation

The main objective of financial accounting of a takaful company is to provide information through

periodic reports about the financial performance, its financial position, the results of operations and cash flows, assets etc. This is necessary, because the takaful operator is responsible for fund management in

a fiduciary capacity.

The financial statements are the main type of reports provided by financial accounting. However,

depending of the type of entity (family, general, health, micro, group, liability takaful) and the country in which it operates, the elements could be different and additional statements would be needed to meet

the requirements of the regulatory authority and objectives of reporting.

While preparing financial statements, the common information needs of users should always be taken into consideration with respect to the qualitative and quantitative importance of the information

contained in those financial statements.Information that is qualitatively or quantitatively important and or

relevantly material should be presented.

Conversely the information that is not important and material may not be presented.Materiality and adequate disclosare are inter –related and relate also to the concepts of relevance and reliability. If the

information is material, it should be disclosed and at the sametime, information that is not disclosed is

presumed to be immaterial. Materiality and adequate disclosure relate to relevance and reliability

Financial accounting as a process of measurement and communication frequently involves judgments. In making these judgments consideration of materiality, play an essential role. In general, an item is

regarded material if its omission, nondisclosure or misstatement would result in distortion of the information being presented in the financial statements. In deciding whether an item is material or not,

its nature and its amounts both be taken into consideration.

Objectives of financial accounting and financial reports may be summarized as follows:

a) Determining the rights and obligations of all interested parties (stakeholders) of a takaful company.

b) Contributing to safeguard the assets and rights of all stakeholders.

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c) Contributing to the enhancement of the managerial and productive capabilities of the takaful

operator. d) Providing financial reports with useful information to make decisions by the stakeholders.

e) Complying with the Shariah guidelines in all transactions and events and recording of prohibited earnings/expenditures if any.

Determining the time frame of reports

Generally, for every commercial and noncommercial organization, financial accounting and auditing

principles should aim to provide an accurate credible information to help the present and potential users of the financial reports. The financial accounting principles need to identify the procedures to be followed

to ensure accuracy and credibility. To achieve the purpose, the following processes be followed:

a) Determining the time frame of revenue, expense, profit & loss in the income statement and timing of recognition of assets and liabilities. The basic principle for revenue recognition is that revenue should be

recognized when earned. The earning process should be complete or virtually complete within the

recognized time frame. This means the amount of revenue should be known and should be collectable with reasonable degree of certainty, if not already collected.

b) Assets and liabilities or financial rights and obligations be recognized or de-recognized when they

satisfy certain criteria. De- recognition is the removal of an asset or liability that no longer meets the

recognition criteria

c) The basic principle of expense recognition is occurrence either because the expense relates directly to the earning of revenues that have been realized and recognized or because it relates to a certain period

covered by the income statement. Expenses that have no direct relationship to revenues but do have a

direct relationship to the periods during which revenues are recognized fall in two categories:

i) Expenses representing costs that provide a benefit in the current period but are not expected to provide reasonably measurable benefits in the future. Such expenses, for example,

management compensation and administrative expenses should be recognized when incurred.

ii) Expenses that represent a cost incurred by the takaful company is expected to benefit

multiple periods (Furniture’s & fixtures) should be allocated in a rational and systematic manner to the expected period of benefit (depreciation)

There are measurement attributes of assets and liabilities that should be measured for financial

accounting purposes. For example, assets attributes that may be selected for measurement in financial

accounting may include the acquisition cost of the asset, the net realizable value/cash as of the asset as of a given date.The assets replacement cost as of a given date or any other relevant attribute. The

choice of the attributes that should be measured for financial accounting purposes should be guided by the relevant qualitative characteristics of the resulting information provided to users of financial

statements.

The historical cost of an asset refers to cash or its cash equivalent paid or received or the fair value of

the consideration given to acquire the asset. The historical cost of a liability refers to the amount received by the takaful company when the liability was incurred or cash equivalent expected to be paid.

Fair value is the value representing estimate of the amount of cash or cash equivalent that would be

received for an asset sold or amount of cash or cash equivalent paid for a liability extinguished or

transferred in an orderly transaction between a willing buyer and a willing seller at the measurement date. Fair value at the date of acquisition refers to the price paid by the takaful company to purchase the

asset. When all the conditions required for the measurement of fair value (relevance, reliability etc.) are present, measurement or this attribute would be suitable as a basis for accounting measurement of a

takaful company.

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Measurement of the realizable value or fair value expected to be realized or paid require the periodic

revaluation of outstanding assets, liabilities or other elements of financial statements. The measurement attribute is not relevant in all circumstances and, should therefore be adopted only when it enhances the

credibility and usefulness of the element, as well as it is practicable and verifiable with a reasonable degree of accuracy. To ensure reliability, the takaful operators need to (a) consider all relevant available

information (b) apply logical and appropriate valuation methods and (c) relate to objectivity and

neutrality in the choice of values.

Standards for quality accounting

Financial statements of a takaful company should be prepared on the basis of high quality accounting

standards and financial accounting process which in turn lead to high quality financial reporting

information that is useful for making decisions. The usefulness of information must be evaluated in relation to the objectives of presenting financial statements. The decision making objectives of

presenting financial statements leads to the overriding criterion by which the alternative accounting methods or disclosure choices can be evaluated.

The specific characteristics that would make the information useful for decision making need to be defined. Also, transparency is deemed to exist when there is adequate and appropriate disclosues.

Adequate disclosures means that the financial statements should contain all material information necessary to make them useful to their users. There are two main aspects to appropriate disclosure (a)

proper aggregation of accounting data and (b) appropriate description and clarification.

Accounting information in the financial statements ought to be relevant and fulfill the following

qualitative requirements:

a) The information should enable the user to predict the potential outcome of a current or new relationship with takaful company.

b) The information should enable the user to verify the accuracy of the prior prediction and make adjustments.

c) The information be made available before it loses its capacity to influence decisions. Optimal

frequency of financial reporting and minimal lag are important criteria of useful accounting information.

d) The information provided should be understandable, clear and concise so that it transpires meaningful

to users of financial statements and not just to accountants.

Accounting methods of a takaful company should be consistent with Shariah principles which permits the persuasive evidence in the absence of conclusive evidence. Reliable accounting information should have

the following qualities:

a) The information should reflect a faithful representation of what it purports to represent.

b) The information should have the common information needs of its users without bias or unfair

information advantage given to any one group.

c) The information be presented in accordance with its substance or an economic phenomenon as well as the legal form.

d) The information in the financial reports must be complete within the bounds of materiality and cost.

e) The information should be consistent from one period to another period and similar measurement/ disclosure methods be used to similar events.

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Takaful company has to follow an overall strategy and business model encompassing funds belonging to

the shareholders as well as funds mobilized from the policyholders (participants). In general takaful, the operator does not accept funds in the form of investment, yet they deal in substantial funds belonging to

participants in a fiduciary capacity. The takaful operator has the authority by the contractual arrangement business model being followed to develop the strategy or investment policy in relation to

the investment of policyholders funds (which should not be amalgamated with shareholders fund).

Accounting &Auditing Organization for Islamic Financial Institutions (AAOIFI), Bahrain has developed several standards to be followed by the Islamic financial institutes. These standards provide the detail

analysis of accounting & auditing guidelines for Islamic financial institutions in the following relevant areas:

a) General presentation and disclosure in the financial statements b) Mudarabah and Musharaka Financing

c) Provisions and reserves.

d) Investment of funds e) Investments guidelines along with investment in sukuk, shares and similar instruments etc.

A takaful company needs to establish principles, standard or guidelines for the auditors. The auditor’s

report should contain a clear written expression of opinion on the financial statements taken as a whole. Standard measure of uniformity in the form and content of the auditor’s report is desirable because it

helps to promote the readers understanding and to identify unusual circumstances when they occur.

Auditor’s Responsibilities

The auditor’s responsibility is to audit the financial statements in order to express an opinion as to

whether the statements have been prepared by national/ international standards, statutory requirements and the Shariah standards. The report should include a statement that the audit was planned and

performed to obtain reasonable assurance about whether there are any financial misstatements.

The auditor’s report should clearly state as to whether the financial statements give a true and fa ir view in accordance with Islamic Shariah Rules and principles as determined by the Shariah supervisory

council/Board and also whether the statements comply with statutory requirements.

An auditor may not be able to express an unqualified opinion when there is a limitation on the scope of

the auditors work or there is disagreement with management regarding the implementation of Islamic Shariah Rules and principles as determined by the Shariah council. In such a situation it will lead to a

qualified opinion or a disclaimer of opinion. An adverse opinion may be expressed when the effect of a disagreement is so material and pervasive to the financial statement that the auditor concludes that a

simple qualification of the report is not adequate to disclose the misleading or incomplete nature of the financial statements.

Whenever, the auditor express an opinion that is other than unqualified, a clear description of all the substantive reasons that is other than unqualified, a clear description of all the substantive reasons

should be included in the report and unless impartible a quantification of the possible effects on the financial statements. The auditor may disagree with management about matters such as the

acceptability of accounting policies selected, the method of their application or the adequacy of

disclosures in the financial statements. If such disagreements are material to the financial statements, the auditor should express an opinion which may be adverse or qualified.

While testing for Sharia compliance, the auditor shall obtain sufficient appropriate evidence that provides

the auditor with reasonable assurance that the takaful company has complied with Islamic Sharia rules and compliance. The auditor shall be knowledgeable about Islamic Shariah rules and principles.

However, the auditor shall not be expected to provide interpretation of these rules and principles.

The responsibility of the auditor is to form an opinion on whether the transactions of the takaful operator

are in compliance with the rulings and guidance issued by the Shariah council/Board. As part of his own scope of work, the auditor shall review available documents to ensure that all types of products offered

by the takaful operator have been subject to a review by the Shariah Board and shall satisfy himself that

the Shariah supervisory board (S.S.B) has found these products to be in compliance with Shariah Rules and principles.

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The primary responsibility for the prevention and detection of fraud and error lies with those responsible for the corporate governance and management of the takaful company. However, the auditor when

planning and performing the audit procedures and evaluating and results thereof shall consider the risk of material misstatements resulting from fraud and error. The fact that an audit is carried out may act as

a deterrent but the auditor is not and cannot be held responsible for the prevention of fraud and error.

The auditor should be held responsible for negligence and misconduct if reasonable efforts are not seen to have been made in designing and planning the audit in order to detect fraud and error.

An auditor may also be responsible if he does not take any necessary action to report it to the

appropriate authority. The auditor needs to asses that management has developed an appropriate system of internal control that shall also include compliance with Shariah rules and principles.

The auditor shall obtain written statements from management that it has complied with all the Shariah rulings and guidelines and it has disclosed and raised all matters of concern known by management

relating to the fraud and error. The auditor shall also obtain all fatwas, ruling and guidelines given by the S.S.B

There are two principles which are used for the management of funds a) Management on a Mudaraba basis b) Management on the agency (Wakala) basis. Both the methods are allowed in Shariah. There is

another form that combines the two methods. In the Mudaraba method the management fee of the Mudarib (takaful operator) is specified as a share of profit made by the Fund. In case of agency method,

the management fee is specified for the agent (takaful operator) as a fixed lump sum amount or as percentage of the amount underwritten. Under the third method, the takaful operator receives a basic

fee plus a specified performance fee based on certain fixed rates of return being achieved. Like other

forms of investments, Takaful Funds be managed in accordance with the Islamic rules and principles. The guidelines provided by Accounting & Auding Organisation of Financial Institutions (AAOFI) in this

respect are as follows:

a) Regulation of relationship between shareholder, policy holder, operator and other counteracting parties.

b) Selection of the assets represented by the shares/units. c) The Fund cannot be invested in interest bearing deposits, or raising interest bearing loans,

conventional, insurance transactions, intoxicants, gambling, pornography, unlawfull foods and drinks.

It is the responsibility of the respective Sharia Councils to examine all the documents relating to Fund

investment to ensure Shariah compliance. The following financial statements be maintained for the fund and need to be verified by the auditor:

a) Statement of Net Asset

b) Statement of portfolio investments c) Statement of operations

d) Statement of Cash flows

e) Statement of Financial Highlights f) Statement of Receivables

Applicable International Accounting Standards

Islamic Financial Services Board (IFSB) is an international standard setting organization which was

inaugurated in November, 2002 at Kuala Lumpur Malaysia, and became operational in March, 2003 As on

2015, it has total strength of 188 members out of which 61 are supervisory and regulatory authorities, eight, inter-governmental and international organizations and more than one hundred (119) are market

& professional players in over 45 jurisdictions. The organization promotes and enhances the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding

principles for the sectors providing Islamic financial services which includes banking, insurance (takaful),

capital markets, sukuks, (Islamic bonds) etc. The IFSB conducts research and coordinates initiatives on industry related issues. It also organizes roundtables, seminars and conferences for regulators and

industry stakeholders. Towards this end the IFSB works closely with relevant international, regional and national organizations.

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Objectives of IFSB are as under:

• To promote the development of a prudent and transparent Islamic financial service industry through

introducing new, or adapting existing, international standards consistent with Shariah principles, and

recommending these for adoption.

• To provide guidance on the effective supervision and regulation of institutions offering Islamic financial products and to develop for the Islamic financial service industry the criteria of identifying, measuring,

managing and disclosing risks, taking into account international standards for valuation, income and expense calculation, and disclosure.

• To liaise and cooperate with relevant organizations currently setting standards for the stability and the

soundness of the international monetary and financial systems and those of the member countries.

• To enhance and coordinate initiatives to develop instruments and procedures for efficient operations and risk management.

• To encourage cooperation amongst member countries in developing the Islamic financial services

industry.

• To facilitate training and personnel development in skills in areas relevant to effective regulation of the Islamic financial services industry and related markets.

• To undertake research into, and publish studies and surveys on, the Islamic financial services industry.

• To establish a database of Islamic banks, financial institutions and industry experts.

• Any other objectives which the General Assembly of the IFSB may agree from time to time.

As on 2015 the IFSB has issued 24 Standards, Guiding principles, Guidance and technical Notes for the

Islamic financial services industry. The standards and guidelines proposed by the IFSB follow a lengthy due process which involve, among others the issuance of exposure draft and where necessary, the

holding of a public hearing. The IFSB is actively involved in the promotion of awareness of issues that are relevant or have an impact on the regulation and supervision of Islamic financial organizations by

conducting seminars, workshops, conferences training and dialogue in different countries.

The IFSB in an effort to guide the takaful industry towards a stable and sound financial environment

published its first two standards in December 2010. The first standard IFSB -8 provides the industry with guiding principles on the appropriate governance framework for a takaful operator. The second standard

IFSB 11 provides a framework for ease of management of the takaful/ Islami insurance and the

regulatory body.

Solvency supervision of a takaful operation and other related documents were published by the IFSB is IFSB-10 (Shariah governance system). IFSB -9 (Principles on conduct of business for Islamic financial

service) also provide guidance in the areas of Shariah governance systems of takaful operators. Another important standard is IFSB – 14 which provides the standards on risk management for takaful (Islamic

insurance) undertaking. The principles and recommendation set forth in IFSB – 14 are intended to help

understand the risks to which a takaful operator is exposed and to provide minimum standard for the development of a risk management framework.

Objectives of AAOFI

AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) formerly known as

Financial Accounting Organization for Islamic Banks and IFIs was established in Feb, 1990 in Algiers and registered in March, 1991 at Bahrain as a corporate non- profit organization. A very good number of

institutional members and practitioners supports AAOIFI. There are around 200 members from forty

countries over the globe. It comprises of a General Assembly, a Board of trustee, an Accounting & Auditing Standards Board Governance and Ethics Board and a Shariah committee. The core objectives for

the formulation of this corporate body are as follows:

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To develop auditing and accounting thoughts and principles for IFIs (Islamic Financial Institutions) and

to craft and construe auditing and accounting standards.

To prepare, promulgate and interpret accounting standards for IFIs and to apply them in these

institutions through various means like trainigs, publications, seminars and varios other relevant means.

To evaluate review and amend any changes in the accounting and auditing standards if and when

needed.

To Approach the regulators of the IFIs or instituions offering finncial service to the customers to apply

the Auditing and Accounting standards published by AAOIFI.

The objectives of the AAOIFI are carried out in consonance with the Shariah rulings and the main

purpose of these objectives is to enhance the trust of the users of the financial reports of the IFIs as well as to encourage them to invest in IFIs and get facilitated with their services. Accountig and Auditing

organization for Islamic Finance Institutions (AAOIFI) has so far issues a total of 94 Standards-consisting of 54 Shari’a Standards, 26 Accounting Standards, 5 Auditing Standards, 2 Codes fo Ethics and 7

Governance Standards. The vision of the organization is to guide Islamic financial markets operation and

financial reporting on sharia principles and rules and to provide with a standard that can support growth of the industry. The mission of AAOIFI is standardization and harmonization of international Islamic

financial practices and financial reporting in accordance to shariah.

These standards give guidance on, amongst others, presentation of financial statements for Islamic financial Institutions (IFIs), accounting treatment for specific Islamic finance products and mechanisms,

external auditing of IFIs, and Shari’a compliance and supervision processes and framework for IFIs.

Challenges of AAOIFI & IFSB

As a primary objective (as evident from name itself), AAOIFI developed auditing standards for the

industry. AAOIFI’s auditing standards have been reemphasizing the requirements of International Standards on Auditing, except for the difference that these standards require (and somehow guide,

though not comprehensively) the external auditor to provide an opinion on the entity’s compliance with

Shariah rules and principles. However, later it was realized that the prime objective that AAOIFI wants to achieve is through governance standards rather than auditing standards.

AAOIFI, with regard to its governance standards, among others, is facing a precarious situation. The

level of adoption of its standards is not quite good, as yet. A few countries do not adopt these standards

altogether, whereas a few have made their own regulations in line with AAOIFI’s standards. These standards have not been incorporated into proper regulatory framework by any central bank or

regulatory authority.

Adoption of governance standards has only been mainly on voluntary basis by Islamic financial

institutions and their regulatory authorities. IFSB though an Islamic finance infrastructure body, issues global prudential and governance standards and guiding principles for the industry, broadly including

banking, capital markets and insurance sectors. IFSB is a body of regulators themselves, hence, it is the standard-setter of the first choice for them. AAOIFI’s standard development work has been slow.

It is important to note that in case of Shari’ah standards the level of acceptability and voluntary adoption

is very high even if these are part of regulatory framework in a handful of countries only. In case of

governance standards it is not at that level, yet it can be said that in addition to the countries that have adopted the AAOIFI governance standards, they are also used as principle based guidance for a few

countries and standard setters in addition to those who have adopted it.

After 25 years of AAOIFI’s commencement of operations, it is now a very crucial stage for AAOIFI,

particularly with regard to its technical standards development role. As far as Shari’ah standards development role is concerned, it has strong enough presence and enjoys market leadership in the

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industry. This includes both situations i.e. the regulatory support in various jurisdictions and voluntary

adoption / use as a guidelines in a vast majority of IFIs. However, the status and original role of technical standard setting, including that of governance standards, AAOIFI has lagged way behind its

previously supplementary role of Shari’ah standard setting.

Both AAOIFI and IFSB should focus on the key areas where guidance is needed and should avoid

unnecessary contradictions with other standards setters. Accordingly, AAOIFI should consider to : Review / revise the existing governance standards; Develop guidelines and standards for internal and

external Shari’ah audits / reviews. These will be by far more useful for the IFIs and their auditors / Shari’ah auditors. Develop ethical standards for IFIs. Set in motion the development of new Shari’ah

governance and control standards.

For different standards, there might be a different number of workshops required. In certain cases,

however, a workshop may be avoided if the respective committee and the executive team conclude that additional market insights or expert views are not required during the process.

This however, does not apply in case of public hearings, which shall take place in all situations.

The workshops will involve regulators, accountancy bodies, standard development institutions, research

institutions, academicians, professional firms other relevant professionals and key stakeholders within the industry. Wherever possible, and to the maximum extent possible, workshops will include participation

across the globe.

Why we need standards?

There must be honesty, integrity, trust and reliability involved in all sorts of financial transactions. The role of IFSB & AAOIFI is to provide an unswerving podium to converse the problems and concern faced

by IFIs and focus on the development of Islamic accounting, governance and other relevant standards. Their role is also to cater the needs and requirements of multiple countries with respect to their

infrastructure and policy environment.

IFSB provides a comprehensive framework to the IFIs and all the other institutions dealing in Islamic

financial services to promote and inculcate the importance of Islamic finance. It provides the significant inputs from the experts of the industry who are usually member of these standard setting bodies.. It

provides regulations which are usually referred as mandatory or advisory services for meeting a specific

requirements. The standards provided by IFSB are with the intent to frame regulations through different regulatory bodies, modify and amend them with respect to the countries’ requirement, update and issue

new standards on various products from time to time to ensure that the Islamic financial services across the globe are regularized and standardized.

Although the involvement of regulators is very critical in the development of the standards to justify the

role of these standard setting bodies but their goal is comprehensive and as the demand for Islamic

finance is increasing, which bring more practicable reasoning of their valuable role in the industry. The functions of the standard setting bodies especially the AAOIFI and IFSB are to harmonize and converge

all the standards under one roof. These bodies (IFSB & AAOIFI) significantly add values to the Islamic money market, capital markets, banks, takaful operators and other relevant areas of Islamic finance like

corporate governance, capital adequacy and supervisory review process.

The regulators role for applying the standard setting bodies does not look very dominant and still there is

an extensive room for improvement. Since these bodies are playing their part in harmonizing the Islamic finance, other institutions must also perform in consonance with them to promulgate the idea of

standardization among the Islamic finance industry. The global growth of Islamic banking and insurance is taking advantage of the diversity and flexibility in the fiqh opinions (often referred to as Shariah) to

meet the challenges of growth.

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While the flexibility in fiqh opinion is presently contributing to global growth, it may soon become a

constraining factor in the global growth of the industry if the challenges arising out of the use of diversity and flexibility in fiqh are not properly recognized and taken care of. This is the area where Shariah

standard setting bodies must perform their role in indulging and diversifying the Islamic financial services industry and should come up with the diversity in the Fiqh ruling and make their impression in the arena

of market players. The AAOIFI and IFSB need to be more efficient globally as well as their significance

must be incumbent with the idea that the standardized procedures and guidelines must be in consonance with the Shariah and business requirements.

The takaful industry is currently not transparent enough on details of Shariah application. AAOIFI and

IFSB are performing their roles and they kept emphasizing on the transparency in the financial reporting of the financial institution to gain more trust and social capital from the investors. Shariah scholars who

understand and disagree with some declared applications chose to remain silent as an expression of

respect for other Shariah opinions but it is not the Shariah scholars who needs to enforce compliance of these standards rather, the Regulators must govern and set conditions to the takaful operators for the

implementation of the standards.

Responsibilities of takaful operators under regulatory framwork

The regulatory authorities in different countries have identified takaful as one of the avenues which can

be used to increase insurance penetration to the Gross Domestic Product (GDP) of respective countries. Therefore, several countries have already introduced separate Takaful Act, Takaful Rules/ Regulations

and or Takaful guidelines. The regulatory framework is essential for takaful operator for enhancing

financial inclusion and to ensure that takaful operators do not face any problem and they can operate in a level playing field. The required legal and regulatory framework need to provide guidance on elements

that are specific to the operations of takaful. The regulatory framework be operative in conjunction with other related laws/ rules/ regulations or guidelines and circulars. It is also necessary to ensure that

Shariah principles are being followed by the takaful operators.

The objective of regulatory framework is to clearly set the duties and responsibilities of takaful operators and to provide a frame work for the establishment and growth of takaful business. Takaful regulatory

framework should also set the basic requirements and standards for operation and disclosure to protect the internest of participants and other stakeholders. Ultimate aim of the regulatory framework is to

promote prudent management of the takaful funds in order to enhance financial resilience. The

framework should promote fairness and transparency to protect the interest of participants and it should ensure the appropriateness of fees and charges imposed on the participants own fund tabarru/ takaful

fund. The regulatory framework should also provide guidelines to impart good governance and risk management practices.

The regulators ought to provide regulatory framework which specify the duties and responsibilities of the

company Board, the Shariah Board, and operators senior management including Chief operating officer, Chief of internal audit & compliance, Chief financial officer, Chief of risk management and Chief executive

officer. It is the responsibility of the Board to ensure overall effectiveness of takaful operators management. It will put in place an effective over sight framework that continuously asses the

effectiveness of policies and produces of the management of takaful funds. The BOD shall have to

ensure strong corporate governance processes in order to enable the takaful operators to effectively discharge their fiduciary duties towards participants and all other stakeholders.

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Concluding Remarks

Compliance of Shariah rules is the essence of takaful. Structurally, takaful company is a combination of stock company and mutual organization. However, there are significant variations in takaful operation in

comparison to stock companies and mutuals/cooperatives engaged in insurance business. Mutuals,

cooperatives and the conventional companies are not supposed to comply with Shariah guidance, which a takaful operator must abide by. On the surface, takaful appears to be similar to mutual insurance,

however, the vast majority of takaful companies operate as stock companies. The key difference is that takaful operators must have a Shariah Board to supervise and monitor the operations of takaful

regarding Shariah compliance.

Takaful is guided by the Shairah law of “Muamalat” (Commercial law). Therefore, belief in religion of Islam is not a precondition for participants, executives, shareholders and so on. But this does not mean

that the stakeholders can remain ignorant or indifferent about the applicable Shariah laws and their implications in the takaful operations. One can not be Shariah compliant, unless he/she is conversant

with Shariah knowledge. Furthermore, all the stakeholders must be willing to be Shariah compliant.

Operation of takaful business purely on business motive cannot fulfill the desires of vast majority of Muslims throughout the world. A Shariah compliant takaful operator cannot charge or earn interest and

they must not invest in non Shariah compliant assets. To avoid confusion among the Muslim population, there should be a consensus among Shariah scholars as to how takaful is to be structured and

implemented under Shariah guidelines. In this respect, local Shariah scholars must try to agree among themselves and then to come to consensus regarding structure and operational guidelines.