pakistan accountant-jan 07

Ac c o u n t a n tMagazine of the Institute of Chartered Accountants of Pakistan

The Pakistan July-August 2007

I s l a m i cE c o n o m i c

S y s t e m

I s l a m i cE c o n o m i c

S y s t e m

3 Editor's Letter

5 President's Page

6 Faith and Finance

9 Islamic Finance - Emerging Challenges of Supervision Dr. Shamshad Akhtar

12 The Facets of Islamic EconomyAbdulwahid, FCA

14 Financial CorruptionSadia Kaleem, ACA

16 Wealth DistributionNadia Azhar, ACA

18 AgricultureMehreen Wahid

20 The Rise and Fall of Structured Credit Danish Ahmed Siddiqui, ACA

23 Credit Risk Management Abdul Razzaq, ACA

28 Reverse Mortgage Loan in India Dr. Pradeep Kumar Singh

32 Open Letter - Why it is Important to Maintain Audit Quality

34 View Point: In Conversation with Richard Dyson, President ICAEW

In-House37 The Fall of The Soviet Union and The Rise of Russia

39 People

42 World in Focus

43 Books

Students’ Section

44 What is a Corporate Credit Rating

July- August 2007Issue # 3Vol # 41

C o n t e n t s

The Pakistan Accountant can be downloaded from Institute’s website at www.icap.org.pkThe views expressed here do not necessarily represent the official policy of the Institute.

EDITORIAL OFFICE

Publications Coordinator Asad Shahzad

PresidentImran Afzal, FCA

Vice PresidentsRafaqat Ullah Babar, FCAShaikh Saqib Masood, FCA

MembersShahzad Hussain, FCANasim Hyder, FCASyed Shahid Husain Jafri, FCAFarrukh Viqaruddin Junaidy, FCARazi-ur-Rahman Khan, FCARashid Rahman Mir, FCAAhmad Saeed, FCAAsad Ali Shah, FCAAbdul Rahim Suriya, FCAMohammad Abdullah Yusuf, FCASyed Mohammad Shabbar Zaidi, FCAArif Mansur (Deceased)Dr. Faizullah Khilji (Retired)

Executive DirectorMoiz Ahmad, FCA

SecretaryF. H. Saifee, FCA

The Pakistan AccountantChartered Accountants Avenue, Clifton, Karachi-75600 (Pakistan) Phone: 9251636-39 Fax: 9251626 E-mail: [email protected] Website: www.icap.org.pk

Chairman and Chief EditorAbdul Rahim Suriya, FCA

MembersAbdulwahid, FCAAbdul Rab, ACAAdnan Ahmad Mufti, ACAAhmad Saeed, FCAAhsan Ghaffar Mehanti, ACAAsif Jamal, FCAFaisal Habib, FCAFaisal Imran Hussain, ACAFazal Mahmood, FCAHena Sadiq, ACAJehan Zeb Amin, ACAJunaid Haji Zikar, ACAKashif Ilyas, ACAM. Arshad Siddiqui, FCAMuhammed Amin Bhimani, ACAMuhammed Mahmood Marfatia, ACAOmar Mustafa Ansari, ACARaheel Abbas Rizvi, ACARahil Rafiq, ACAShakil Akhtar Qureshi, FCASophia Ahmed, ACA

PUBLICATIONS COMMITTEE

Ac c o u n t a n tAc c o u n t a n tThe Pakistan July-August 2007

Cover Story An Islamic economic system seeksto implement an economic system

based on the equitable distribution ofwealth, payment of zakat, and

banking without interest. The launchof Islamic bonds in the internationalmarket that comply with a variety of

Shariah based criteria, and therecent rise in Islamic financial

products and services offered in theWest, further establish the growing

popularity of Islamic finance andeconomics.

THE COUNCIL

The Pakistan Accountant 3July-August 2007

Editor's LetterThe fact that conventional financial

institutions all over the globe arenow recognizing Shariah compliant

products as a valid category of their overallinvestment portfolios signals the growingmaturity of the Islamic financial sector.Swiss and German banks are making effortsto implement elements of Islamic finance intheir systems. The Japanese Governmenthas recently announced issuance of sukukbonds for infrastructure development,which indicates that Islamic financialproducts are attracting non-Muslims andeven corporations seeking new means ofacquiring capital.

The first Islamic bond was sold by ShellMalaysia in 1990. Since then, the demandfor sukuk has skyrocketed.To date, mostsukuk have been corporate, but the potentialfor a sovereign Islamic bond market couldbe huge. The UK Treasury and Japanesegovernment are preparing to launch debutsovereign sukuk in 2008 representinggrowing worldwide popularity in Shariah-compliant debt issuance.

The global outstanding sukuk issues totaledUS$82.2 billion by the end of July 2007,and close to 62 percent of these weredenominated in Malaysian ringgit. T h egrowth of the sukuk market is expected torise from US$600 million in 2002 to astaggering $70 billion in 2007, andaccording to ratings firms Bloomberg andStandard & Poor's, will rise to $100 billionin 2010. The growing popularity of sukukowes itself to the fact that sukuk offer ashare in the proceeds of a business venturerather than paying out interest. Sukukreplace coupons by payouts and are backedby tangible assets.

In order to maintain its popularity thissector must now seek integration in thee m e rging and developing economies ofSoutheast and South Asia. 'The Malaysianmarket accounts for most outstandingsukuk, but interest is growing in the rest ofAsia, obviously in jurisdictions such asIndonesia and Pakistan.' This recentstatement by the Assistant Vice President ofMoody's Corporate Finance is ampleevidence of the fact that Pakistan's potentialas a center for Islamic finance is growing.

Dr Ishrat Hussain, former Governor, StateBank of Pakistan, and Chairman of theNational Commission for GovernmentReforms in Pakistan has noted that 'Islamicfinance has to become part of global financeto survive, or risk catering only to a nichemarket.' The Muslim world, includingPakistan, must concentrate all efforts toimplement and integrate an Islamicfinancial market into local markets. IfIslamic finance is to become a majoralternative in the global financial market, itmust constantly innovate and modify itselfto conform to global standards.

In Pakistan's context, policy stability, soundregulatory framework, strong economicfundamentals, a thriving private sector andadvanced communication infrastructurewill be needed to boost the growth of theIslamic fund management industry in thecountry..

Abdul Rahim Suriya

The Pakistan Accountant 5

President's PageThe Islamic banking and finance industry has

seen tremendous growth in the recent years -not just in Pakistan or other Muslim countries

but in fact through out the world. Currently, overUS$400 billion worth of funds are being managed bythis industry via approximately 250 Islamic banks andinstitutions operating across the globe - a 45 foldgrowth since 1982 - and the figures are continuing toimprove at an impressive rate of fifteen to twentypercent per annum.

The products offered are not just used by the Muslimpopulation, but an increasing number of non-Muslimsare also being attracted to the ethical values of theseproducts as more and more investors begin to realizethat ethics and profitability in banking and finance donot have to be mutually exclusive. The productsoffered by the industry are also revolutionizing frombeing Shariah compliant products to Shariah basedproducts. Introduction of such products has enabledthe industry to seek its unique identity and to providea credible alternative to conventional bankingproducts.

In order to keep up with the growing demand forIslamic financial products, conventional banks arebranching out towards Islamic products, while Islamicbanks are continuing to expand their product base.The Development Bank of Singapore (DBS) hasrecently established its Islamic banking and financesubsidiary, the Islamic Bank of Asia, to focus onwealth management and capital market instrumentsfor corporate and private banking clients in theMiddle East and Asia. The Reserve Bank of India(RBI) is exploring the possibility of setting up Islamicbanks in India as a viable alternative to commercialbanks, to attract even the non-Muslim majority to parktheir funds with these banks. The Unit Trust of India(UTI) is already running a $250 million fund forMuslim Non Resident Indians (NRIs) in the Gulf.

Realizing the growing popularity of Islamic Banking,the central banks and other regulatory authoritiesthroughout the world are trying to incorporate theproducts offered by this industry into their regulatoryframework. In 2005, in an effort to align the Islamicand western fund concepts, the UK Tr e a s u r yintroduced similar tax treatment and relief for Islamicmortgages based on Ijara and Musharaka and forprofit rates on Islamic savings accounts, as thoseenjoyed by conventional products. This important stepby the UK Treasury has considerably improved the

attractiveness of the industry in the UK.London, today is becoming the centerof Islamic finance outside of Gulf.

Important steps are being taken inPakistan as well to increase theacceptability of Islamic banking bythe masses. State Bank of Pakistan(SBP) has played an active role instreamlining the adoption of Islamic Standards andhas issued instructions and guidelines for Shariahcompliance in Islamic Banking institutions from timeto time. The Institute's Committee on Accounting andAuditing Standards for Interest Free Modes ofFinancing and Investments has developed twoStandards - IFAS 1 Murabaha and IFAS 2 Ijarah -which have been notified by the Securities andExchange Commission of Pakistan (SECP).

Standards on 'Diminishing Musharaka', 'Profit andLoss Sharing on Deposits' and ‘General Presentationof Financial Statements of Islamic FinancialInstitutions’ are also being developed to help theindustry.

The future of Islamic banking and finance looksbright. Strong, sensible regulation and continuedgovernmental support would ensure sustainablegrowth of the industry. There is a need for rapidconvergence of regulatory and auditing standards forIslamic banking and their products. We need bigger,more consolidated, convergent Islamic banks that canhandle larger projects and compete successfully giventhat the emphasis in a non-interest based bankingsystem is not so much on the size of the collateral thanon the viability and success of the project itself. Inorder to compete globally, Islamic banks will have tolook beyond short-term trade finance towards long-term equity financing. Of course, this would requireexpertise beyond conventional banking and theinstitutional infrastructure to support the growth ofIslamic financial instruments.

Given the enthusiasm being show by all concerned wecan hope for a better tomorrow of Islamic banking inPakistan.

Imran Afzal

July-August 2007


Islamic finance is essentially a contract-based system offinancing, practiced according to the Islamic principlesprescribed in the Shariah known as Fiqh Al-Muamalat (orIslamic Commercial Jurisprudence). Islamic banking andFinance (IB&F) operates on the principle of sharing ofboth profit and loss by the borrower.

The first modern Islamic savings bank was set up byAhmad El Najjar in the Egyptian town of Mit Gharnr in1963. By the year 1967, nine such banks were operativein Egypt, investing mostly in trade and industry, withoutcharging or paying interest, and sharing their profits withtheir depositors. These banks were essentially savingsinvestment institutions. In 1971 The Nasir Social Bankwas declared the first interest-free commercial bankthough the bank's charter made no reference to IslamicShariah law.

In 1974 the Organization of Islamic Countries (OIC)established the Islamic Development Bank (IDB) toprovide interest free, fee based financial services andprofit sharing financial assistance to member countries.The mid 70s witnessed the establishment of severalIslamic banks in the Middle East, notably the DubaiIslamic Bank (1975), the Faisal Islamic Bank of Sudan(1977), the Faisal Islamic Bank of Egypt (1977), and theBahrain Islamic Bank (1979).

Malaysia is another country with a strong presence ofIslamic banking and financial system alongside aconventional banking system working in a competitiveenvironment. The share of Islamic banking operations inMalaysia grew from zero in 1983 to above 8 percent ofthe total financial system in 2003. The Government hasplans to enhance this share to 20 percent by the year2010. Standard & Poors has assigned a BBB+ rating tothe US$600 million Shariah compliant Sukuks (trustcertificates) issued by Malaysia Global Sukuk Inc. BankNegara Malaysia (BNM) has announced issue of newIslamic Bank licences to foreign players. The FinancialSector Master plan maps out the liberalization ofMalaysia's banking and insurance industry in threephases during the next decade.

Origins of Islamic Banking in PakistanIn Pakistan the legal framework of the country's financialand corporate system was amended on June 26, 1980 topermit issuance of a new interest-free instrument ofcorporate financing named Participation Term Certificate(PTC). An Ordinance was promulgated to allow theestablishment of Mudaraba companies and floatation ofMudaraba certificates for raising risk based capital.Amendments were also made in the Banking CompaniesOrdinance, 1962 (The BCO, 1962) and related laws to

Cover Story

Faith and FinanceThe Evolution of Islamic Banking and Finance (IB&F)


Cover Story

include provision of bank finance through PLS, mark-up inprices, leasing and hire purchase.

Separate interest-free counters started operating in all thenationalized commercial banks, and one foreign bank(Bank of Oman) on January 1, 1981to mobilize deposits on profit andloss sharing basis. From July 1,1982 banks were allowed to providefinance for meeting the workingcapital needs of trade and industryon a selective basis under thetechnique of Musharaka.

By January 1985 domestic bankswere operating both 'interest-free'and 'interest-based' windows. FromJuly 1, 1985 all commercial bankingin Pak Rupees was made interest-free. However, foreign currencydeposits in Pakistan and interest onlending of foreign loans continuedas before. In November 1991 theFederal Shariat Court (FSC)declared the procedure adopted bythe banks, based largely on mark-up with or without buy-backarrangement, as un-Islamic. T h eGovernment and some banks/DFIspreferred appeals to the ShariatAppellate Bench (SAB) of theSupreme Court of Pakistan.

On December 23 1999, the ShariatAppellate Bench (SAB) of theSupreme Court of Pakistan gave itslandmark judgment banning interestin all its forms and directed that lawsinvolving interest would cease tohave effect finally by June 30, 2001with exemption for dealing with foreign parties. Thusensued the partial transformation of Pakistan's financialsystem from interest based to Shariah compliant. Islamicbanking and finance have since been operational inPakistan parallel to conventional banking.

SBP's Commission for Transformationof Financial System (CTFS)The Commission for Transformation of Financial System(CTFS) was constituted in January 2000 in the StateBank of Pakistan under the chairmanship of I.A. Hanfi, aformer Governor State Bank of Pakistan. According to the

Commission, it was essential for the introduction of aShariah compliant financial system to have a legalinfrastructure conducive to the working of an Islamicfinancial system through launching a massive educationand training program for bankers and their clients, and

through an effective mediacampaign to create publicawareness about the Islamicfinancial system.

The CTFS constituted a Committeefor Development of FinancialInstruments and StandardizedDocuments in the State Bank toprepare model agreements andfinancial instruments for the newsystem.

A Taskforce was set up in theMinistry of Finance to suggest waysto eliminate interest fromGovernment financial transactions.Another Taskforce was set up in theMinistry of Law to suggestamendments in legal framework toimplement the Court's judgment.This Taskforce proposedamendments in the House BuildingFinance Corporation (HBFC) Act tomake it Shariah compliant byshifting back its rent sharingoperations to a non-interest basedsystem. The amendment waspromulgated, and in 2001 HBFClaunched its Asaan Ghar Schemebased on Diminishing Musharakah.A Committee was constituted in theInstitute of Chartered Accountantsof Pakistan (ICAP), wherein the

State Bank of Pakistan (SBP) was also represented, fordevelopment of accounting and auditing standards forIslamic modes of financing. The Committee is reviewingthe standards prepared by the Bahrain based Accountingand Auditing Organization for Islamic FinancialInstitutions (AAOIFI) with a view to adapt them to ourcircumstances and if considered necessary, to proposenew accounting standards.

In September 2001 it was decided that the shift to interestfree economy would be made in a gradual and phasedmanner and that the State Bank of Pakistan wouldconsider:

July-August 2007

A Committee was

constituted in the Institute

of Chartered Accountants of

Pakistan (ICAP), wherein

the State Bank of Pakistan

(SBP) was also represented,

for development of

accounting and auditing

standards for Islamic

modes of financing. The

Committee is reviewing the

standards prepared by the

Bahrain based Accounting

and Auditing Organization

for Islamic Financial

Institutions (AAOIFI) with a

view to adapt them to our

circumstances and if

considered necessary, to

propose new accounting

standards.


Cover Story

w setting up subsidiaries by the commercial banks for thepurpose of conducting Shariah compliant transactions;

w specifying branches by the commercial banksexclusively dealing in Islamic products; and

w setting up new full-fledged commercial banks to carryout exclusively, banking business based on proposedIslamic products.

Accordingly, the State Bank issued detailed criteria inDecember 2001 for establishment of full-fledged Islamiccommercial banks in the private sector.Al Meezan Investment Bank receivedthe first Islamic commercial bankinglicense from SBP in January 2002 andMeezan Bank Limited (MBL)commenced full-fledged commercialbanking operation from March 20,2002.

Private sector Islamic banks havebeen established and existingcommercial banks have establishedsubsidiaries and stand-alone branchesto conduct Islamic banking. The StateBank of Pakistan houses a full fledgedIslamic Banking Department and aShariah Board comprising two Shariahscholars and three experts in banking,accounting and legal framework toadvise the SBP on Shariahcompliance.

Subsidiaries & Stand-alone Islamic BankingBranches (IBBs)In January, 2003 the State Bankissued BPD Circular No. 01 outliningdetailed instructions on setting up ofsubsidiaries and stand-alone branchesfor Islamic Banking by existingcommercial banks. The criteria forsubsidiaries are almost similar to thecriteria for setting up scheduled Islamiccommercial banks with emphasis oncomplete segregation of accounts ofIslamic banking subsidiaries and the parent banks doingconventional banking. The subsidiaries shall haveminimum paid up capital of Pak Rs. 1,000 million that isequal to the capital requirement for full-fledgedcommercial banks.

The criteria for opening stand-alone branches pertain tofinancial strength of the applicant bank as evident from itscapital base, adequacy of its capital structure, record of

earning capabilities, future earning prospects of the bank,managerial capabilities, bank's liquidity position, trackrecord of the bank's adherence to prudential regulations,credit discipline, quality of customer services and theconvenience and the needs of the population of the areato be served by the proposed branches.

SBP's Musharakah based IslamicExport Refinance Scheme (IERS)State Bank of Pakistan has introduced a Musharakah-based Islamic Export Refinance Scheme (IERS) to meetthe export financing requirements of banks conducting

operations under Islamic Modes.Islamic Banking Institutes (IBIs)can avail this facility under bothparts of SBP's Export FinanceScheme (EFS). The frameworkof the IERS is based on theconcept of Profit & Loss Sharing.The State Bank shares theactual profit of the Musharakahpool of the Islamic Bank.However, in case the actual profitof the pool is more than ongoingrates under conventional EFS,the excess profit so received bySBP would be credited to theTakaful fund, a reserve fund tobe maintained by SBP u n d e rIslamic modes for risk mitigationthat would be used to meetfuture losses arising onimplementation of IERS.

Future of IslamicBankingWith the refining of Islamicfinancing techniques and theneed for infrastructuredevelopment in Muslimcountries, Islamic banks are nowparticipating in Shariah-compliant retail products tohighly complex structuredfinance and large-scale projectlending including power stations,

water plants, roads and bridges.

While functioning within the framework of Shariah, Islamicbanks can perform a crucial task of resource mobilization,their efficient allocation on the basis of both PLS(Musharakah and Mudaraba) and non-PLS (trading andleasing) based categories of modes and strengtheningthe payments systems to contribute significantly toeconomic growth and development.

July-August 2007

While functioning

within the framework

of Shariah, Islamic

banks can perform a

crucial task of resource

mobilization, their

efficient allocation on

the basis of both PLS

(Musharakah and

Mudaraba) and non-

PLS (trading and

leasing) based

categories of modes

and strengthening the

payments systems to

contribute significantly

to economic growth

and development.


I. Background Diversification and structural transformation in financialsector has been accompanied by increasing integrationamong different segments of the financial sector. Thetraditional boundaries between banks and non-bankfinancial institutions are eroding and we are witnessingthe growth of universal banking and/or mergers amongdifferent segments of sectors.

This trend has its benefits but has associated risks aswell. Supervisors face a dual challenge. On one hand,supervisors are promoting financial diversification andconsolidation to achieve market development andinnovation. On the other hand, supervisors have toposition themselves to recognize the new dimensions andtypes of risks and encourage appropriate risk mitigation.These considerations have triggered world wide debateon how to effectively supervise different segments offinancial sector in conglomerate and universal structure.

So far these debates had been concentrated aroundconventional banking but now it is widely gripping theworld of Islamic Finance (IF). Stronger inter-dependencies among different segments of IF areemerging largely because Islamic Financial Institutions(IFIs), in principle, have features and inherentcharacteristics and more compulsion, than conventionalbanking, to conform to universal banking or to evolveinter-linkages among different market segments.

II. Factors driving cross-sectorlinkages and interdependencies First and foremost, IFIs' depositors/borrowers desire toconduct financial transactions that are Shariah compliant.It can be assumed that a person preferring to bank withan Islamic bank will also seek to use other faith-basedfinancial services such as Takaful and Islamic mutualfunds. This faith-driven feature in itself forces andincentivizes IFIs to offer, along side bank-based services(i.e. deposit and loans), a wide range of financial services.As a result, Islamic banks end up undertaking non-corebanking activities such as fund management, capitalmarket operations, securitization, leasing, and housingfinance. This has enhanced the degree of integrationbetween various segments of IF. For example: Islamicbanks are likely to be strongly integrated with the Shariahcapital markets since on credit portfolio side, Islamicbanks do not have the same investment avenues asthose available to their conventional counterparts. Theoutcome is that Islamic banks either end up taking largeexposure in the capital markets directly or acquiresubsidiaries which primarily engage in such businesses.

Second differentiating aspect is the nature of contractualarrangements that drive deposits mobilized byconventional banks as compared to Islamic banks.Conventional bank deposits are interest based contracts

Cover Story

Islamic Finance -Emerging Challenges of Supervision

D r. Shamshad A k h t a rG o v e r n o r, State Bank of Pakistan

July-August 2007

As traditional boundaries between banks and non-bank financial institutions

erode, supervisors face a dual challenge of promoting financial diversifiction,

on the one hand, and encouraging appropriate risk mitigation on the other.


Cover Story

with guaranteed interest return whereas Islamic banksraise deposit on a profit and loss sharing basis in either aMudaraba or Musharaka structure. Mudaraba/Musharakacontracts transform the Islamic banks' deposits intoessentially a fund management product (althoughcurrently most regulators recognize these as equivalent toconventional deposit contracts) and this impacts thecorresponding asset portfolio. There is a need thereforethat Islamic banks acquire assets on a PLS basis as welland eventually move beyond fixed return products, likeMurabaha and Ijara. This pushes an Islamic bank towardsuniversal banking since in order to manage the portfolioprofitability; it needs to invest across sectors inbusinesses based on Shariah principles, like equity andSukuks in the capital market and trade contracts likecommodity Murabaha, Musharaka, Ijara and Takaful.

Thirdly, further development of Islamic banking itselfdepends on concurrent development of Islamic capitalmarket. For instance, development of Islamic debt marketis key to the provision of adequate liquidity support whileproviding additional investment avenues. Likewise,Takaful development is critical to provide insurancecoverage to Islamic banking products, like auto andconsumer financing, while strengthening secondarycapital and Islamic bond markets by being a major buyerof Islamic instruments. It is the confluence of these factorsthat have induced regulators to encourage and IFs topromote rapid and deeper financial inter-linkages andintegration.

III. Supervisory challenges posed bycross-sector developments It is some of these above considerations that haveaugmented strategic alliances and linkages of varioustypes among IFIs, both within country and cross borders.As such, IFIs are evolving either as part of a globalfinancial concern or as a domestic bank acquiring orestablishing subsidiaries and/or the two arms, i.e. Islamicand conventional banks coexist. Moreover, as theconventional parts of financial institutions move towardscross-sector integration, their Islamic counterparts (eitheras specialized window or as independent entities) willalso follow eventually.

While it has by now been well established that there aresignificant benefits of enhanced integration and inter-linkages or conglomeration in IF, such as the economiesof scale, operational synergies and effective use of scarcehuman resource, there are definitely certain risks1. In thisarea, I would like to offer few basic observations.

Firstly, it is inevitable that enhanced exposure of Islamicbanks into capital markets exposes them to the volatilityin associated businesses. Likewise, conglomeration,whether through universal banking or through parentsubsidiary model2, exposes them to a variety of issuessuch as contagion risk, regulatory arbitrage, high groupexposures, conflict of interest etc.

These risks apply equally to both Islamic andconventional modes of finance. However, Islamic bankshave thus far not erected firewalls, like conventionalbanks, to separate legally, financially and manageriallytheir investment and commercial banking activities.Obviously these risks pose a challenge to the supervisorsand necessitate that appropriate changes be made in thesupervisory regime.

Secondly, Shariah compliance issues necessitate takinga more aligned view across IF businesses as user ofIslamic products may be oblivious of ideologicald i fferences as well as varying perceptions andinterpretation of the Shariah advisors or boards and/or byregulators. Since institutions being supervised by oneregulatory authority may be offering products ofinstitutions being supervised by a different regulatoryb o d y, this could introduce complications and thechallenge of ensuring uniform Shariah compliance acrossfinancial institutions and products.

T h i r d l y, traditionally different segments have beenregulated by their specialized supervisory authorities.These authorities have adopted risk managementprinciples and supervisory stances which are strictly inline with the risk profile of supervised sectors in isolation.With sector integration, supervisors have to coordinateclosely in policy formulation and regulation as well as on-site supervision. They have to coordinate creation ofnecessary firewalls, remove moral hazards and governthe degree of cross segment exposure. This may evencall for institutional restructuring through merging varioussupervisory bodies into a single entity or for closercoordination between supervisors through creation of athird coordinating body.

IV. Sector inter-linkages of Pakistan'sIslamic finance system In Pakistan, besides offering trade loans, like Murabaha,Islamic banks are offering equity and quasi equityproducts, such as Musharaka and diminishingMusharaka, and investment banking activities such asloan syndication, structured finance, etc. The six fullfledged Islamic banks with a network of 108 branches andanother 58 stand alone Islamic branches of 13conventional banks have registered phenomenal growthand as of April 2007, the Islamic banking sectorconstituted 3.3 percent of total banking assets. In view ofthe equity based nature of Islamic banking and lack ofShariah compliant financial instruments, central bank hasallowed Islamic banks a relatively higher exposure (35percent direct and 10 percent future of their equity) incapital markets compared to conventional banks (20percent direct and 10 percent future). In addition, theState Bank of Pakistan (SBP) has relaxed statutoryreserve requirement (SLR) for Islamic banks at 8 percentversus industry norm of 18 percent.

July-August 2007


Cover Story

Furthermore, Islamic banks are allowed to nurture parent-subsidiary/affiliate model whereby Islamic banks are byand large setting up asset management companies,brokerage firms and, now, Takaful businesses. Thus farthe supervision of IFIs is bifurcated, with Islamic banksbeing regulated by SBP and non-bank IFIs, namely,Modarabas, Islamic mutual funds, Takaful companies andsecurities operations under the regulatory oversight ofSecurities and Exchange Commission of Pakistan(SECP).

Sector specific supervisory approach is alsocharacterized by varying regulatory requirements vis-à-vis operational matters, governance framework andShariah compliance across the range of IFIs. T h ed i fferences extend to minimum capital requirementsranging from Rs.6 billion for Islamic banks (by the year2009), Rs.500 million for family Takaful operators (by theyear 2011), Rs.300 million for general Takaful operators(by the year 2011) and Rs.30 million for Islamic fundmanagers to Rs.2.5 million for Modaraba managementcompanies. The low capital base of financial institutions,engaged in the business of Takaful or fund management,poses a significant risk to the solvency of financialconglomerates that characterize the Islamic financialmarkets. In terms of financial reporting, Ta k a f u lcompanies are not required to circulate quarterlyaccounts among shareholders whereas all other Islamicfinancial institutions are required to do so in terms of thelegal and regulatory framework.

The segregated supervisory approach has resulted incarving of legal framework specific to each sector for bothconventional banks and IFIs3 but eventually there is aneed for addressing the idiosyncratic nature of IF industry,products and market players. Moreover, with regard to IF,both the regulators are following different approachestowards Shariah compliance in the institutions regulatedby them. SBP requires Islamic banks to appoint Shariahadvisors according to a prescribed fit and proper criteriaand a Shariah Board has been constituted at the level ofSBP to deal with issues relating to Shariah interpretationand compliance among Islamic banks. SECP's approachvaries across different segments of IF.A Religious Board,constituted by the government, is responsible forapproving the prospectus of each Modaraba containingthe types of business to be conducted, management, etc.While the Religious Board has a significant role, there isno requirement for Modarabas or their managementcompanies to appoint Shariah advisers at individual fundlevel. Islamic mutual funds and Takaful operators, on theother hand, are required to appoint Shariah Council/Boardsbut no explicit fit and proper criteria has been laid down byS E C P in this regard. SECP is also authorized to appoint aCentral Shariah Board under the Takaful Rules, 2005,which has not been established as yet. The greatest challenge resulting from different Shariahcompliance practices followed by Islamic banks, Modarabas,Takaful companies, etc. is the reputational risk faced by IFIs

and misperceptions in the minds of public about Shariahcompliance. This issue, therefore, needs to be addressedthrough coordination amongst the supervisors.

Another issue arises from overlapping supervisoryjurisdiction. The Banking Company Ordinance allowsbanks to act as Modaraba management companies forfloatation of Modarabas. In terms of ModarabaCompanies Ordinance, Modarabas can be formed toconduct any type of business, which is permitted underShariah, be it trading, manufacturing, airline, financing,leasing, services, etc. and these are regulated by SECP.Due to overlapping regulatory jurisdictions, banks arefloating modarabas through separate subsidiaries4

resulting in higher administrative, set up and regulatorycosts. For sometime (from 1991-1997), these Modarabaswere under the regulatory control of SBP, but the powersrelating to licensing, winding up, etc. were retained bySECP; consequently the regulatory authority has beenreverted to SECP. Again, this highlights the need for crosssector regulation of IFIs.

Eventually there is a need to develop mechanisms foroversight of financial sector in an integrated manner.Besides coordination and cooperation among regulators,there is a need for consolidated supervision framework forfinancial institutions, guidelines for consolidated publicfinancial statements and application of regulatoryprudential limits on group wide basis and coordination toexamine the intra group linkages with industrial andcommercial entities. While conventional and Islamicfinancial industry would have to adopt similar approachesto integrated supervision, it has to be recognized that thelatter is a relatively nascent industry and hence thetargets should be modified to match the ground realities.

V. Conclusion IFSB's ten year roadmap has highlighted the cross sectornature of IFIs and the resultant need for supervision toevolve accordingly. It is in recognition of these factors thatIFSB has sought to broaden its membership to securitiesand insurance supervisory authorities as Full Members ofIFSB. IFSB's efforts for developing Islamic regulations aswell as accounting, auditing and governance standardswill facilitate adoption of unified principles for thedevelopment, operation and regulation of Islamic financialservices.

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1. Financial Sector Regulation: Issues and Gaps, IMF 2004

2. Universal Banks: First structure is of universal bank, in which all financial operations

are conducted within a single corporate entity. The second model is the parent-

subsidiary or operating subsidiary model, in which operations are conducted in and

regulated as subsidiaries of another financial institution, usually (but not

necessarily) a bank. Finally, in a holding company model activities are conducted in

legally distinct entities, each with separate management and capital but all owned

by a single financial or sometimes (unregulated) non-financial institution

3. Fund management, as used here, refers to management of Islamic mutual funds

and Modarabas.

4. A number of banks have formed subsidiaries and floated modarabas like NBP, HBL,ABL, Habib Metropolitan Bank, etc. No Islamic bank has yet floated a Modaraba.

July-August 2007


By the middle of the 20th century, many Muslim countrieshad been freed from the shackles of colonial rule. Thesecountries were looking for development and improvementin every field, specially their economies. Beingpredominantly Muslim, they were naturally inclined toadopt the Islamic Economic System. Consequently, a lotof literature was produced in a short time on the subjectof Islamic Economics.

Several institutions, universities, and research centersare involved in carrying out research work on variousaspects of an Islamic Economy. This article summarizessome of the key issues in an Islamic economy.

Economics, as one of the social sciences, needs to resortto history in order to derive the long-term trends ofeconomic variables. History provides economics with twomajor indispensable aspects, namely, the history ofeconomic thought and the history of economic units suchas individuals and firms. Little has been done to presentthe history of Islamic economic thought. There is nodocumented 'Economic Theory of Islam' and not muchformal writing in the area of Islamic economics. This isunfortunate and the need of the hour is to bring to light theeconomic theories of great Islamic thinkers.

The first attempt to demarcate the boundaries between

the economic philosophy of Islam and subsequenteconomic theories was made by Al_Sadr in 1964,followed by Muhammad Najatullah Siddiqi in 1971.

Islamic BankingIslamic banking is the most popular and well-knowninstrument of Islamic economics. It is prevalent in bothMuslim and non-Muslim countries. Main reason for itssuccess is the belief of Muslims that the profits derivedare interest free and allowed in Islam. If there is anydefect or fault in this, the onus is on the religious scholarswho are certifying them as Shariah compliant.

Muslims in the oil producing and developed countrieshold substantial cash and liquid assets. To attract theirdeposits conventional banks have also established theirbranches or at least counters for Islamic banking.

Many Muslim scholars have argued that borrowing forexpansion of business is a commercial deal and theborrower must pay some share of the profit to the lender.Profit sharing in a business is a sharing in the net profit.

Islamic bankers and scholars do not openly define thefactors involved in interest bearing. They try to convincecustomers that every sort of financing scheme providedby these titled Islamic banks falls within the gambit of

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The Facets ofIslamic Economy

Several institutions, universities, and research centers are involved incarrying out research work on various aspects of an Islamic Economy.This article summarizes some of the key issues in an Islamic economy.

Abdulwahid, FCA


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Islamic banking, which is not the fact. They also claim thatany agreement between the borrower and lender alsomakes it Islamic. Over a period of time, measures takento promote Islamic banking have not been very ethical.For instance, in 1979, when profit loss sharing (PLS)banking accounts were introduced to replace SavingsBank (SB) accounts in Pakistan, the rate of profit for thefirst half year was 9 percent per annum which went ondecreasing till it came down to 1 percent last year. Whatcould be the justification for such a big dip. Was thismerely a ploy to attract the public towards PLS by offeringa very high rate of profit?

Theory of Consumption This theory has developed in the capitalist economy. Inthe Islamic way of life, social values and consumerideology are much different. Islamic economists havecriticized the prevailing theory of consumption, but havefailed to provide an alternative. This theory can be split upinto three parts:

a. Rationalization of consumer behaviour b. Concept of goods and services c. Ethical considerations for Muslim consumers

Consumer behaviour in the West developed on the basisof utility, capitalism, and with an eye on commercialsuccess and concentration of wealth.

The theory of consumption in capitalism is based onmaximum acquisition. The traditionalism of consumer inan Islamic system has the following elements:

(i) Concept of Progress Islam does not allow for selfishness and the conceptof success depends on the welfare of every oneirrespective of their financial or social status. Islamdoes not restrict material progress, but desires thateveryone's basic necessities be met.

(ii) Concept of Wealth: Wealth in Islam is only God given. Holy Qur'anprovides us with a unique concept of products andcommodities; the word “Al Tayabat” meaning good,pure, clean and wholesome things has appeared inQuran 18 times, the second word “Ar-arizq” reportedin Holy Qur'an 120 times, means godly or divine. Itmeans that all commodities are God given.

(iii) Ethics of Consumption: All the consumables are God given and for everyone.It is only by chance that few are holding more thantheir share. In Qur'an, Allah rejects the argument thatthe rich do not owe to the poor.

Theory of Production The production theory in a capitalist economy encouragesproduction from cheaper sources, with highest possibleprofit margins. In a socialist economy, production shouldbe based on the requirements of the public. In Islamiceconomics, it is a combination of both; production shouldbe based on the requirement of the masses at a costaffordable to them.

Motives of Production Islamic view of man and universe is that man shouldderive all possible advantages from God's universe.There are two ways to regularize these, first by ethics andsecondly by legislation. Ethics are teachings of Islam fromQur'an and Sunnah, while legislation is man made in theform of rules and regulations. Every entrepreneur wantsto make profit and if he does not follow the ethics of theQur'an and Sunnah, government is bound to limit hisprofit.

Objectives of Production Under an Islamic economy, a Muslim producer shall notmake a heavy profit; his goal is the Hereafter. This hasthree important implications:

a. Moral values as established in the Holy Qur'an -prohibited items and industrial activities that are notallowed are specified.

b. Social aspect in the production process anddistribution of benefits in the most equitable mannerare the prime economic objectives.

c. The problem is not shortage of production or supply,but human inefficiency in reaping the full benefits ofGod's benevolence. Islam recognizes the right of theless able in the wealth of those who have greaterability or the opportunity to produce greater wealth(Mirakhor,1989).

Macro Economics Islam has the most efficient system of Macro Economics.Zakat can alleviate poverty. Qarze Hasna or Interest freeloan can meet the financial requirements of all. Interest /profit on capital is included in the cost of production. If itis reduced, cost shall be reduced and prices will comedown for the benefit of the public.

The Islamic system of economics is based upon thebalance between personal benefit and the benefit ofsociety as a whole.

July-August 2007


Like other religions Islam also dislikes and loathes frauds,

financial scandals, cheating, bribery, or taking undue

advantage of one's position. According to Sunnah:

"Bribe payer, receiver and the middle man, all shall go to

Hell."

No country is completely free from the evil of corruption.

Generally speaking, the poorer a country the morecorrupt it is. A political system, which is unrepresentative

and unaccountable, makes it worse. Corruption does not

mean bribery alone.

To counter this problem in Pakistan, the federal andprovincial arms of the National Accountability Bureau

(NAB) are functioning. They deal with cases referred to

them. These cases generally involve huge amounts of

money and are against government officials, politicians

and businessmen.

Financial Corruption is not a new phenomenon. In thedays of Akbar, the great Mughal Emperor, one of hiscourtiers was notorious for corruption. After receivingnumerous complaints against him, Akbar assigned thecorrupt man the duty of counting the waves of the River

Jamuna near Delhi. Akbar then forgot about thisassignment. After two years the emperor happened tovisit the site and was surprised to see a big palace on thebank of the river, while the corrupt man was stillperforming his duty of counting the waves of the river. Theemperor appointed an investigation committee, as isdone these days after some unsavory incident hasoccurred, to investigate the matter. Next day he was toldthat people crossing the river, washing their clothes,taking baths, cleaning their buffaloes, and passing boatsetc. had to pay a few coins, because by their acts theywere disturbing the waves, while according to theemperor's orders, the waves had to be correctly counted.

Financial corruption at lower level, involving pettyamounts of cash, may be on account of the followingreasons:

1. Income is limited while expenditure is unlimited.People resort to corruption to meet their needs.

2. In old age, future is neither safe nor secure, and soeveryone plans to save for the future. When pensionmay be the only source of income and needs would goup- medical expenses, higher food costs, daughters'marriages, house rent if currently living in government

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FinancialCorruption

Sadia Kaleem, ACA


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provided housing, would become an extra financial

burden. This uncertain situation may induce some

people to resort to corruption.

3. Undue comparison with others. People compare

themselves with others in many aspects, say

ownership of mobile phones, cars, clothes, residence,

furniture, electronic equipment and even in the number

of servants, drivers, babysitters, maid servants,

guards, gardeners etc. that they employ. People may

resort to financial corruption to meet their exaggerated

needs.

A person may pay bribe for the following reasons:

1. In government offices, there is pending work at every

desk and so every visitor is asked to come after four or

five days. The visitor has spent time and money on

conveyance and so to save that expense at a later

date, he would be willing to pay the bribe.

2. Sometimes a public person is in urgent need of a

matter and has to pay bribe as urgent service charges.

3. To receive undue favours - to outclass others and to

get what they are not entitled to.

Now the question arises where and how these corrupt

people keep their unlawful bribe collection. The following

might be used singly or jointly with one another:

1. The first use of bribe money is at home, in domestic

expenditure on both consumable and durable items.

Consumable items are not visible to outsiders while the

durable items come to the knowledge of the public or

at least to visitors, guests and relatives.

2. Prize bonds. At present prize bonds are for maximum

of Rs 40,000 each, purchasable and sellable at the

bank counter without any questions asked.

3. Other bearer items like shares, with open transfer

deed, foreign exchange viz. euro, dollar, sterling

pound, and yen etc.

4. Real estate is the main item where the value of

property shown is hardly 20 to 25 percent of the actual

value and therefore 75 to 80 percent is paid off the

record i.e. through black money.

5. Benamis and Power of Attorneys are the other modesof investment of black money. In big towns, smallhouses and bearer files for plot schemes exchangehands. These are also financed by black money.

6. Illegal money collected through financial corruption isalso a source of capital, out of which new businesses,industries, buildings are acquired or expanded.

To control bribery or palm greasing, following measuresmay be considered:

1. Bearer investments (prize bonds, shares with bearertransfer deeds, bearer real estate documents etc.)should be totally discontinued.

2. Every citizen with wealth, at present market valueabove a figure, say in Pakistan, Rs. 1 million, mustcompulsorily declare his wealth on the closing of thegovernment financial year whether his income isexempted from income tax or not, like agriculturists.Such persons should also file their expenditurestatements for the year.

3. Lockers should be made transparent to the taxauthorities.

4. Money laundering is the main source of movement ofblack money. Foreign exchange agents are very muchavailable almost in every country. Their transactionsare not recorded. Bank accounts in foreign countries,specially Switzerland, also need to be checked.

5. Size of currency notes should be bigger and thicker.Credit Cards and Debit Cards should be encouragedand their usage should be made common. Any bankcharges should be on the seller and not the cardholder.

6. For real estate, owners should be allowed to declarethe actual value of their property and the rate of stampduty and court fees be reduced proportionately.

7. Currency notes of big denomination should bediscontinued.

8. Cheque payments should be made reliable and safe.

July-August 2007

Sadia Kaleem, ACA, is also Chartered Secretary

(England) and has passed Chartered Cost &

Management, UK.


By and large, the main source of wealth is inheritance.Other sources could be windfall, and an individual's ownlabour and hard work.

According to Islamic teachings the factors of productionare to be paid immediately and equitably. Therefore,Islamic principles of factors' pricing are basically based onthese teachings, and are geared towards avoidingconcentration of wealth in few hands.

In the early days of Islam, Hazrat Usman (RTA) was avery successful and wealthy businessman who madegood profits from his business deals. As such it can besaid that Islamic principles do not prohibit creation oraccumulation of wealth, provided it is through clear andclean business deals.

Islam desires equity in the distribution of wealth.However, in-equality is not taken care off by functionaldistribution of income, but is through transfer payments,that is, the transfer of income and wealth from the well-offpeople to those living below the poverty line. T h ephilosophy is that wealth is created by Allah and belongsto Him. The right to property granted to a person is just adelegation by Allah, its Owner, to His agent (man), andthe agent has to use it only as per His orders andinstructions.

Distribution of wealth, in Islam, is through three types oftransfers:

1. Compulsory 2. Recommended 3. Inheritance

1. Compulsory transfers: There are several compulsorylevies, ranging from 20 percent of the output (Ushr) to2.5 percent of wealth (Zakat). Sadaqah tul Fitr,although very negligible in value, is also a compulsorylevy for the benefit of poor on Eid ul Fitr.

w Zakat: It is a well-known subject among Muslims.No doubt, different scholars have different views onvarious provisions of Zakat such as assets on

which Zakat is levied and assets exempted fromZakat. There is also some difference of opinionabout who is eligible for Zakat, and the method ofdistribution and disposal of Zakat. In the HolyQuran, the order to the Prophet (PBUH), who wasalso the chief of government, was:

" Take from their wealth to clean it."

This practice of centralized collection continued forabout seven centuries. After Chingez Khanconquered Baghdad, Zakat came to be disbursedthrough mosques, and is now mostly paidindividually.

In the Quran, Allah's directive to the government isto collect Zakat. In Pakistan, it is in practice formore than 25 years, but the public's perception isthat it is not being properly distributed.

w Ushr: It is levied not on wealth, but on production.Its dictionary meaning is one-tenth. On agriculturalproduction by own cultivation it is mostly one- tenth,and if it is due to rain then one-fifth. Similarly,fishing, mining, fruit gardening, sea products, etc.are also liable to Ushr at different rates of up to 20percent.

Zakat is to be distributed among:

w poor persons; w miskeen, who are poor, but don't look like fakirs; w employees of Zakat collection and administration; w converts to Islam to foster friendship and

cooperation that might strengthen Islam and newlyconverted Muslims;

w for the purpose of freeing slaves; w those under debt and loan; w in the way of Allah, which may include printing and

distribution of Islamic literature, publicity, salaries ofIslamic movement workers, etc.;

w wayfarer

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WealthDistribution

Nadia Azhar, ACA


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Ushr collection is to be utilized for providing financialassistance and food to the poor.

1. Recommended transfers: Apart from zakat Muslimshave been directed by the Prophet (PBUH) to not eat afull meal if their neighbor is hungry. There is no limit onpayment to meet such needs. Such payments are notout of mercy or kindness but are the right of the needyand poor.

Hazrat Ali (RAT), the fourth caliph, put it in the followingwords:

"Allah has ordained that the rich are to pay out of theirwealth to the extent which is sufficient for the needs ofthe poor, so that if they do not find food or clothing, orstruggle (unsuccessfully for their living) it would bebecause the rich are not doing their duty, and Allah willtake them to task on the Day Of Judgment and willpunish them.

2. Inheritance: In the Holy Quran and Sunnah, distributionof inheritance and its ratio and proportion are given indetail.

According to Sunnah, if a pious man dies withoutproper distribution of his inheritance, all his good deedsshall go to waste. On the other hand, a man with notmany good deeds to his credit, or who is not of areligious persuasion, shall go to Heaven if hedistributes his inheritance properly.

In different religions and cultures, different ways ofdistribution of inheritance are practiced. In one, only theeldest son is entitled to the whole wealth of the deceased.In the other, only sons are entitled to it while daughtersare deprived of it. In Islam, the Quran outlines theprinciples as follows:

"Allah enjoins you concerning your children's(inheritance), to the male (son), a portion equal to thatof two females (daughters); but if there be onlydaughter, two or more, two-thirds of what the deceasedleaves is theirs; and if there be one, for her is the half.For his parents, to each of them is the sixth share ofwhat he leaves, if he has children; but if he has no childand (only) his parents inherit from him, for his mother isthe third; but if he has brothers (or sisters), to hismother is the sixth, after (payment of a bequest, hemay have bequeathed, or a debt); your parents andyour children, you don't know which of them is nearerto you in benefit; this is an ordinance from Allah. Allahis surely all-knowing and all-wise."

The heirs may be grouped in various ways and theprinciples of distribution amongst them are mostlyexplained in the Holy Quran. Parents should notdifferentiate among their children. They are allowed to giftthem. They can also make bequest in favour of a personnot a legal heir, not more than one-third of his assets. Allthese conditions are imposed to avoid concentration ofwealth in a few hands.

State and Wealth Distribution:Our Prophet (PBUH) was the head of the governmentalso and so all directives and instructions to him are alsoto be followed by Muslim governments.

In the last fourteen centuries, the financial position,importance of money, sources of income, concentrationand collection of wealth, social status, rights of neighborsand family members have all changed.

Looking towards other religions, we see that in all threereligious books followed by the Jews and Christians, asthey exist today, the direction of God is to bring 10 percentof the income to one's own household. It appears that thisformula was the basis of introducing the income tax as thenoble men, two or three centuries ago, in this field wereJews or Christians and they must have derived theformula for charging income to meet governmentexpenses, from these Holy Books.

It is the responsibility of the government to reduce thedifference in income and wealth of the rich and poor bylevying taxes on income and wealth, except those assetson which Zakat has been paid.

Islam does not impose any restriction on setting upfactories and business units that are not against publicinterest and Islamic teachings. Government may alsohave some industries in the public sector, particularlypublic utilities, defense industries, heavy industries, etc.where private establishments are risky or are againstpublic interest. To achieve this objective government mayprohibit certain industries for the private sector and evennationalize some of the private established industriesthrough payment of compensation, which it considers tobe run well under the public sector.

The basic needs of the public are the responsibility of thegovernment. According to Hazart Umar (RAT) everyonehas equal rights in the wealth of the community. Poor,unemployed, handicapped etc. are the responsibility ofthe government. According to the second Caliph, he (theCaliph) will be questioned on the Day of Judgment, if adog dies of hunger on the side of the River Nile.

Conclusion: Concentration of wealth is not allowed in Islam. Poor,unemployed, widows, handicapped etc., as per Islamicteachings, have a right to the wealth of the rich people.Laws of inheritance, compulsory collection of Zakat, othermoral obligations, as per Islamic teachings, are to meetthe requirements of the poor, which at present is beingundertaken by various NGOs in different fields anddifferent areas. However, in an Islamic economy the basicresponsibility to maintain equity in income and wealth fallson the government.

July-August 2007

Nadia Azhar ACA is also ACCA. She is a partner in a professional firm.


The main ingredient for agriculture is land since withoutland there can be no agriculture.

At the beginning of human civilization, population waslittle and land was in abundance so there was no questionof ownership of land. Till a few centuries ago, cultivationon any land was not a problem i.e. whosoever cultivated,harvested, and whatever one sowed or reaped.

Man is not the creator of anything. Allah has createdeverything for him. Ownership is a trust vested in theowner by God. According to Surah Al-Baqarah:

“He it is Who created for you all that is on earth. (2:29)

On earth will be a dwelling place for you and anenjoyment for a time (2:36)

Who has made the earth a resting place for you and thesky as a canopy and sent down water from the sky andbrought forth therewith fruits as a provision to you. (2:22)”The Holy Quran describes the personal and individualownership of everything consumable or durable orproductive.

In short, Allah has created all these for the benefit ofhuman beings and not only for the owner. Islam permitsall types of commercial activities and creation of wealth,but does not allow for it to be held for the benefit of

oneself only. The poor of the nation are also theresponsibility of the rich and they have a right to theirwealth.

Land is of different types viz. owners' land, trust land,government land, uncultivated land, bordered land,surrendered land, and residential area.

1.Owners' Land It is owned by someone, inherited, or purchased or itsownership is due to any other reason.

2. Trust Land It is land which the owner has assigned for charitablepurposes, for example, education, mosque, publicity,Islamic workers, etc.

3.Government Land It is land that is owned, controlled and retained bygovernment.

4.Uncultivated Land It is away from the cultivated area

5. Bordered LandIf someone raises the borders by constructing astonewall around an area by preserving it for himself forcultivation at a later date.

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AgricultureMehreen Wahid


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6.Surrendered Land If any cultivator or owner is not in a position to keep itup, he may surrender it for the use and benefit ofothers.

7.Residential Area It is the part of the village which has been used forresidential purposes like school, playground, hospitaland such other amenities.

No doubt individual or a group of persons on joint basiscan own the land. However, it should be used for thebenefit of general public and its use must not beharmful to others.

Sharing CultivationIf one owns the land and the other cultivates it, it is calledSharing Cultivation. Several verses of Sunnah are in itsfavour and some are against it.

Land taken on rent for agriculture is different from otherassets taken on rent. There can be unforeseen damagesthat can destroy the total crop. If it is rain cultivated areaand there is no rain, there will be no production and so thetenant will be totally in loss. The land which iswaterlogged or saline, in other words, is not fit forcultivation. Letting it out on rent is not allowed. If there isno crop for reasons beyond the tenant's control, no rentshall be payable. Fixing of rent subject to certainconditions is not justified. Similar to other assets on rent,land rent should also be free from the condition of earningprofit by the tenant. The tenant may sell the product athigh profit, low profit, at cost, or at loss. It does not affectthe owner or the rent agreed. The cost of natural acts likefloods, locust swarms, or insecticides destroying the cropin full or in part is borne by the tenant. It is up to thelandlord to forego or discount the rent.

In certain cases, land revenue, water charges, agriculturaltaxes, etc. are payable on the land so rented out. It maybe clarified at the time of making the rent agreement as towho shall bear how much of these taxes.

According to the scholars the Prophet (PBUH), himself,cultivated on sharing basis. Thereafter several examplesof such cultivators by his followers are confirmed. Thereare many types of cultivation on sharing basis, some ofwhich are:

1. Landowner provides only land while the farmer useshis owns seeds and equipment. According to ImamHanifa, it is not allowed but Imam Muhammad andImam Abu Yusuf allow it. Imam Malik and ImamShafaee disallow it.

2. The other type is that the landlord provides the seedsalso and the product is shared at an agreed ratio.Hanafi scholars confirm it. Imam Muhammad and

Imam Abu Yusuf are also in favour of it, but Imam AbuHanifa and Imam Shafaee do not consider it proper.Maliki scholars allow it with some more conditions.

3. The third situation is when land is of owner, cultivationis by farmer, both provide seeds and agriculturalequipment and the product is shared at an agreedratio. Imam Shafaee has not allowed it. Imam Malikallows it with some more conditions.

4. The fourth position is when the land, seeds andequipment all are provided by the landlord and thefarmer puts in labour only and the crop is shared at anagreed ratio. Imam Hambal, Imam Abu Yusuf andImam Muhammad support this situation but Imam AbuHanifa, Imam Malik and Imam Shafaee do notconsider it proper.

5. According to the scholars following Imam Malik, landrent, labour wages and rent of agricultural equipmentshould all be fixed in terms of money beforehand. Bothprovide equal quantity of seeds and when the crop isready they shall first get compensation for itemsprovided as agreed and in cash. Then the balanceshould be shared as agreed.

The basic conditions for sharing cultivation as plannedare:

a. Land is fit for cultivation;

b. Area is fixed;

c. Situation and location of the land is defined;

d. Farmer should have a free approach to the site;

e. The period should be fixed, at least sufficient for anentire crop. Agreement may be for the crop if not forthe fixed period i.e. from sowing to harvesting.

Sharing agriculture is just like Modaraba where one hascapital and the other is working on it. But the difference isthat in shared farming the capital which is land will neverbe lost. While in Modaraba, the whole investment may belost. Landlords are sure to get some profit but not to sharethe losses, while in Modaraba the financier may have toloose his capital.

According to Sunnah and the practice of our Prophet(PBUH), ownership of land is allowed. Cultivation onsharing basis which is very much beneficial for poorlandless farmers is also allowed in Sunnah and Fiqh.

July-August 2007

Mehreen Wahid, is a CA finalist.


In recent months financial markets of the world witnessedanother episode of credit related problems. While this is notsomething completely new or unexpected, this is peculiar inthe sense that the markets had largely ignored the warningsigns flashed near the end of the last year by various bankswhen they issued profit warnings on the back of expectedlosses from the sub prime lending in the US.

The wave started in the US by March this year and,despite reassurances from the Federal Reserve (Fed),continued to grow stronger as the economic data startedto show signs of economic slow down. It continued to gainmomentum and by June Merrill Lynch sold collateral torecover its investments in two hedge funds managed byBear Sterns that had invested in securities backed by subprime loans. However, US markets still remained positiveof the future and Dow Jones gained 2.2 percent on 6August despite the country's 10th largest mortgage lenderAmerican Home Mortgage Investment Corporation's filingfor Chapter 11* bankruptcy protection on the same date.The reason for the filing was inability of the company torenew existing funding or raise new funds for its business. ----------------------------------------------------------------------------* Chapter 11 is a chapter of the United States BankruptcyCode under which a troubled business or its creditors canfile with a federal bankruptcy court for protection. AChapter 11 filing is usually an attempt to stay in businesswhile the court supervises the 'reorganization' of thecompany's contractual and debt obligations.

The fear of losses from the sub prime credit started tomanifest itself into a liquidity crunch as investors decidedto cut their losses and move on to other sectors whichlooked more promising. On 8 August a $4.9 billion mergerdeal was put off because the acquirer suffered a billiondollar losses in its mortgage subsidiary which facedproblems in financing its operations. On 9 August BNPParibas stopped valuing its three funds and suspended allwithdrawals by investors considering the evaporation ofliquidity. Goldman Sachs's largest fund reported 26%losses in 2007, later it announced that another if its fundslost 28% of its value in one week and was bailed out byinvestors who put in $3 billion. By this time investors hadstarted to move away from the credit market, share pricesof mortgage lenders and investors in those lendersaround the world fell and liquidity started to dry up. Thecrisis hit Europe and reached as far as Japan and China,stressing the global nature of the economy.

As could have been predicted, the Fed, European CentralBank (ECB) and Bank of Japan (BOJ) stepped in to bailout the markets and injected billions in the bond marketsto provide much needed liquidity. The Fed went as far ascutting the discount rate by 50 basis points while keepingthe Fed rate same and temporarily allowing Citibank andBank of America to support their investment banking armsusing the federally insured retail bank money.

The Rise and Fall ofStructured Credit

How the Sub Prime Mortgage Crisis in the USbecame a global financial crisis

Danish Ahmed Siddiqui, A C A


The crisis posed a threat to the global economy and hashighlighted various market related issues and the debatemay lead to interesting conclusions. Many have blamed iton the sustained level of high liquidity in the market whichwas supported at least in part by the structured credit andmarkets, a lack of market's detailed understanding of therisks of structured credit products and the role of ratingagencies in incorrect pricing of the structured creditproducts.

Fostering liquidityThe recent liquidity crunch in the markets has ironicallybeen attributed by some to a prolonged period of highliquidity in the market which was fostered by low interestrates, growth in the foreign exchange reserves of thegrowing Asian economies and healthy corporate sector.Low interest rates encouraged consumers to borrowspecially as house prices increased consistently over thelast few years. This created demand for credit whichmight not have been met equally by the supply if it wasnot for a lack of profit opportunities elsewhere in the debtmarket. As the booming Asian economies invested theirforeign exchange reserves in the risk free USGovernment bonds they drove the prices up and loweredthe yields which made them less attractive for the profitseeking investors. In search of profits, investors turned torisky alternatives which put a similar pressure on theprices and yields of the non investment grade debt andsoon the spread between the investment and noninvestment grade bonds narrowed to a level where thereturns on non investment grade bonds no longer seemedattractive. The financial markets responded to thissituation by creating structured products that promisedbetter returns.

A liquid market searching for profitable venues respondedpositively to these structures. A key feature of thesestructures was the ability to issue investment grade debtbacked by non investment grade assets whichencouraged banks to flex the lending criteria applied toretail borrowers which in turn helped to sustain theliquidity in the economy despite the rate increases in2006.

Many of these structures are set up by larger banks whichalso provide some contingency liquidity line or guaranteeto help these through difficult conditions. However, if thesituation becomes very bad, as has been noted recently,the level of liquidity support required may affect the ratingdowngrades or compulsory winding up under theinvestment agreements. In some cases the parent maynot be willing or able to provide the support.

As a short term measure, central banks took steps toprovide liquidity by injecting funds, cutting rates andallowing deviations from the regulations. However, ifmacro economic factors that lead to the higher liquiditye.g. emerging market growth and corporate profits stillremain positive investors may soon be lured again intoinvesting in high yield assets - probably a different classof assets, but may as well be in the structured productsafter the prices reflect the fundamentals and there isbetter awareness of the true exposures.

Promise of returnsStructured credit products generally offered high returnscompared to other instruments with the same rating andalso allowed investors to take derivative exposure butpresent it as investment in bonds in their accounts. The

July-August 2007

Sub prime Mortgage Crisis in USw The sub prime mortgage financial crisis refers to the sharp rise in foreclosures in the sub prime mortgage

market that began in the United States in 2006 and became a global financial crisis in July 2007. Rising interestrates increased newly-popular adjustable rate mortgages (ARMs) and property values suffered declines fromthe demise of the housing bubble, leaving home owners unable to meet financial commitments and lenderswithout a means to recoup their losses.

w The effects of the meltdown spread beyond housing and disrupted global financial markets as investors, largelyderegulated foreign and domestic hedge funds, were forced to re-evaluate the risks they were taking andconsumers lost the ability to finance further consumer spending, causing increased volatility in the fixedincome, equity, and derivative markets.

w Sub prime woes have been blamed for causing the U.S. dollar to continue its decline.

w Sub prime mortgage refers to a loan to a borrower who does not qualify for market interest rates because ofpoor credit history, or the inability to prove that he has enough income to support the monthly payment on theloan for which he is applying. Since the borrower is considered sub prime, lenders charge a greater interestrate to make up for possible default on the loan. Sub prime loans or mortgages are risky for both creditors anddebtors because of the combination of high interest rates, bad credit history, and murky financial situationsoften associated with sub prime applicants.


ease of selling a structured credit product encouragedlenders to create more assets which, combined withcontinually rising house prices in the US lead to relaxedattitudes towards credit risks in respect of mortgages.Lenders accepted higher loan to value ratios and higherloan to income multiples when issuing mortgages. Lastlythey tapped into the sub-prime sectorwhich means lending money toindividuals with bad credit history orlow income.

Rising interest rates environment overthe last few months, coupled with highrepossession rates and a declininghousing market meant low recoveryrates and high losses for themortgage lenders. Lending to the sub-prime sector in some aspects issimilar to a bet on the real estate thanpure credit lending. The bet was thathouse prices will continue to rise inthe US and current expectations ofthe housing markets in the US offerno comfort as the prices are fallingand might take a long time to get backto the levels seen in the recentmonths.

Fairer values and truerexposuresMarket's uncertainty as to the trueexposures of the market participantsto the sub-prime lending alsocontributed to the chaos. T h i shighlighted the need for better andtimely disclosures on risk exposuresespecially for complex structures.

Accounting standards allow the use ofvaluation models if a market price isnot available. Although variousdisclosures are required to explain the assumptions andmodels used to determine the values, these disclosuresmight not have attracted due attention in the past. Thismay change and investors may demand moreexplanation of the “management judgement” applied indetermining the fair values and risk estimates.

Rating agenciesRating agencies have survived the criticism for qualityand relevance of the information they provide. This crisishas aggravated it for them as they downgraded billions ofdollars of securities in July in the middle of the crisis.Questions have been raised about the models used bythe agencies to assign investment grade ratings tosecurities that had sub prime backing and why they didnot downgrade these securities earlier. US Senate is

interested in the answers and this may lead to newlegislations.

Rating agencies maintain that they have to observe thedata before they take any downgrade actions and arelikely to support their ratings.

This has also focused attention on therisk management tools used by theissuers, investors and ratingagencies. This crisis may force themarket to invest in new systems andmodels to more accurately measureand report the credit risk.

Market adjustmentsThe crisis has jolted the financialmarkets and if investors' confidence inthe structured credit does not return,banks may have to find alternativeways to fund their assets or reducetheir funding needs by cutting supplyof credit.

Basel II will remove some of theincentives for taking assets off -balance sheet; this factor combinedwith investors wary of the traditionalstrucutures may force financialengineers to come up with newimproved structures of investmentvehicles or conduits.

Credit structures as an asset classallow investors to short credit,something which cannot be easilyachieved otherwise. Therefore, theseare not likely to fall out of favour withthe investors. However, the structuresmay need to address credit and otherrisk issues in a different manner ando ffer a much higher yield tocompensate for the perceived risk.

There may be additional regulations issued to addressinvestor concerns. Investment bankers are generallyagainst regulations and favour a free market; however,when there is a crisis they want the central bank to stepin and bail them out. In this recent episode, central bankshad to provide billions of dollars in order to support themarket. In order to avoid a repeat they may want to putsome checks in place.

The recent episode is likely to last for a short to mediumterm which is likely to lead to changes in investor attitude,risk management practices, funding structures, ratingprocesses and regulations. Financial markets are likely tocome out of this crisis better and stronger but it will takesome time before they get there - and when they get thereit may be a slightly different world.

July-August 2007

Many of these structures

are set up by larger

banks which also

provide some

contingency liquidity

line or guarantee to help

these through difficult

conditions. However, if

the situation becomes

very bad, as has been

noted recently, the level

of liquidity support

required may affect the

rating downgrades or

compulsory winding up

under the investment

agreements. In some

cases the parent may

not be willing or able to

provide the support.


In the past decade, rapid innovations in financial marketsand the internationalization of financial flows havechanged the face of banking almost beyond recognition.Technological progress and deregulation have bothprovided new opportunities for and increased competitivepressures among banks. In the late 1980s, marginsattained from traditional banking business began todiminish and capital adequacy requirements began toincrease. Banks have responded to these new challengeswith vigor and imagination by forging ahead into newarenas. The growth in international financial markets anda greater diversity of financial instruments have allowedbanks wider access to funds. At the same time, marketshave expanded, and opportunities to design newproducts and provide more services have arisen. Whilethe pace of these changes appears to be quicker in somecountries than in others, banks everywhere are generallybecoming more involved in developing new instruments,products and services, and techniques. Tr a d i t i o n a lbanking practice - based on the receipt of deposits andthe granting of loans - is today only one part of a typicalbank's business, and is often its least profitable. Newinformation-based activities, such as trading in financialmarkets and income generation through fees, are now themajor sources of a bank's profitability. Financialinnovation has also led to the increased marketorientation and marketability of bank assets, in particularthrough the introduction of concepts such as loan swapsand sales. This process has been achieved using assets

such as mortgages, automobile loans, and export creditsas backing for marketable securities, a process known assecuritization. The correlation between different types ofrisk, both within an individual bank and throughout thebanking system, has increased and become morecomplex.

These developments have increased the need for andcomplicated the function of risk measurement,management, and control. The quality of corporategovernance of banks has become a much debated topic,and the approach to regulation and supervision haschanged dramatically. Within an individual bank, the newbanking environment and increased market volatility havenecessitated an integrated approach to asset-liability andrisk management techniques.

Amid changing banking environment, worldwide, theState Bank of Pakistan (SBP) has also recognized theimportance of risk management within financialinstitutions and has issued a set of guidelines on RiskManagement vide BSD Circular No. 7 dated August 15,2003, with an advice to the financial institutions to makeconcrete efforts to implement these guidelines in letterand spirit.

The risk management framework envisaged four majorcategories of risks that the banks are exposed to; vis-à-vis credit, market, liquidity and operational risks.

Credit RiskManagement

Guiding Principles for Implementation

Abdul Razzaq, ACA


Since asset base of the financial institutions primarilycomprises loans and advances, management of creditrisk within the banks is of utmost importance for thesefinancial institutions.

Credit or counterparty risk - defined as the chance that adebtor or financial instrument issuer will not be able to payinterest or repay the principal according to the termsspecified in a credit agreement - is an inherent part ofbanking. Credit risk means that payments may bedelayed or ultimately not paid at all, which can in turncause cash flow problems and affect a bank's liquidity.Despite innovation in the financial services sector, creditrisk is still the major single cause of bank failures. Thereason is that more than 80 percent of a bank's balancesheet generally relates to this aspect of risk management.The three main types of credit (counterparty) risk are asfollows:

w personal or consumer risk;w corporate or company risk;w sovereign or country risk.

Because of the potentially dire effects of credit risk, it isimportant to perform a comprehensive evaluation of abank's capacity to assess, administer, supervise, enforce,and recover loans, advances, guarantees, and othercredit instruments. An overall credit risk managementreview will include an evaluation of the credit riskmanagement policies and practices of a bank. Thisevaluation should also determine the adequacy offinancial information received, from a borrower or theissuer of a financial instrument, which has been used bya bank as the basis for investing in such financialinstruments or the extension of credit and the periodicassessment of its inherently changing risk.

Credit risk management in a financial institution primarilyconstitutes the following essential elements:

(a) Clearly defined lending policies(b) Credit portfolio quality review(c) Credit risk management policies(d) Policies to limit or reduce credit risk(e) Asset classification(f) Loan loss provisioning policy

(a) Clearly defined lending policiesFormal policies laid down by the board of directors inall pertinent areas are important. However, these areperhaps the most critical with regards to bank'slending function, which requires that the bank mustadopt a sound system for managing credit risk.

A lending policy should contain an outline of thescope and allocation of a bank's credit facilities andthe manner in which a credit portfolio is managed,i.e., how loans are originated, appraised, supervised,and collected. A good lending policy is not overlyrestrictive, but allows for the presentation of loans tothe board that officers believe are worthy of

consideration but which do not fall within theparameters of written guidelines. Flexibility mustexist to allow for fast reaction and early adaptation tochanging conditions in a bank's earning assets mixand market environment.

Considerations that form the basis for sound lendingpolicies include the following:

w Limit on total outstanding loans A limit on the total loan portfolio is usuallyexpressed relative to deposits, capital, or totalassets. In setting such a limit, factors such as creditdemand, the volatility of deposits, and credit risksshould be considered.

w Geographic limitsThese are usually a dilemma. If a bank lacksunderstanding of its diverse markets and/or doesnot have quality management, geographicdiversification may become a reason for bad loanproblems. On the other hand, the imposition ofstrict geographical limits can also create problems,particularly in the case of regions with narroweconomies. In any case, a bank's business marketshould be clearly delineated and commensuratewith its market knowledge and managerial and staffexperience. Bank officers should be fully aware ofspecific geographical limitations for lendingpurposes, an aspect that is particularly relevant fornew banks.

w Credit concentrations A lending policy should stimulate portfoliodiversification and strike a balance betweenmaximum yield and minimum risk. Concentrationlimits usually refer to the maximum permittedexposure to a single client, connected group,and/or sector of economic activity (e.g., agriculture,steel, or textiles). This is especially important forsmall, regionally oriented or specialized banks. Alending policy should also require that allconcentrations be reviewed and reported on afrequent basis.

w Distribution by category Limitations based on aggregate percentages oftotal loans in commercial, real estate, consumer, orother credit categories are common. Policiesrelated to such limitations should allow fordeviations that are approved by the board.

w Type of loansA lending policy should specify the types ofloans and other credit instruments that the bankintends to offer to clients and should provideguidelines for specific loans. Decisions about typesof credit instruments should be based on theexpertise of lending officers, the deposit structure of

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a bank, and anticipated credit demand. Types ofcredit that have resulted in an abnormal loss shouldbe controlled by senior management or avoidedcompletely.

w MaturitiesA lending policy should establish the maximummaturity for each type of credit, and loans should begranted with a realistic repayment schedule.Maturity scheduling should be determined inrelation to the anticipated source of repayment, thepurpose of the loan, and the useful life of thecollateral.

w Loan pricingRates on various loan types must be sufficient tocover the costs of funds, loan supervision,administration (including general overhead), andprobable losses. At the same time, they shouldprovide a reasonable margin of profit. Rates shouldbe periodically reviewed and adjusted to reflectchanges in costs or competitive factors. Ratedifferentials may be deliberately maintained eitherto encourage some types of borrowers to seekcredit elsewhere or to attract a specific type ofborrower. Guidelines for other relevant procedures,such as the determination of fees on commitmentsor penalty interest rates, are also an element ofpricing policy.

w Lending authority It is often determined by the size of a bank. Insmaller banks, it is typically centralized. In order toavoid delays in the lending process, larger bankstend to decentralize according to geographicalarea, lending products, and/or types of customers.A lending policy should establish limits for alllending officers. If policies are clearly establishedand enforced, individual limitations may besomewhat higher than would normally be expected,depending on the officer's experience and tenurewith the bank. Lending limits could also be basedon group authority, which would allow a committeeto approve larger loans. Reporting procedures andthe frequency of committee meetings should bespecified.

(b) Credit Portfolio Quality ReviewOne of the essential elements of credit riskmanagement framework is the ongoing monitoring ofquality of the credit portfolio. Such quality checks areperformed on frequent basis so as to cover all thefacilities disbursed during the year, except thosemanaged on portfolio basis such as consumer loans.

When feasible, the loan portfolio review shouldnormally include a random sampling of loans so thatapproximately 70 percent of the total loan amountand 30 percent of the number of loans are covered.It should also consider at least 75 percent of the total

loan amount and 50 percent of the number of allforeign currency loans and of all loans with maturitiesgreater than one year. In addition, a detailed creditportfolio review should include the following:

w all loans to borrowers with aggregate exposurelarger than 5 percent of the bank's capital;

w all loans to shareholders and connected parties;

w all loans for which the interest or repayment termshave been rescheduled or otherwise altered sincethe granting of the loan;

w all loans for which cash payment of interest and/orprincipal is more than 30 days past due, includingthose for which interest has been capitalized orrolled over;

w all loans classified as substandard, doubtful, or loss.

In each of these cases, a loan review should considerdocumentation in the borrower's file and involve adiscussion of the borrower's business, near-termprospects, and credit history with the responsible creditofficer. When the total amount due exceeds 5 percent ofa bank's capital, the analysis should also consider theborrower's business plans for the future and the potentialconsequences for debt service capacity and principalrepayment. The specific objective of these reviews is toassess the likelihood that the credit will be repaid, as wellas whether or not the classification of the loan proposedby the bank is adequate. Other considerations include thequality of collateral held and the ability of the borrower'sbusiness to generate necessary cash.

Beyond loans, interbank deposits are the most importantcategory of assets for which a bank carries the credit risk.This category may account for a significant percentage ofa bank's balance sheet, particularly in countries that lackconvertibility but allow their citizens and economic agentsto maintain foreign exchange deposits.

(c) Credit Risk Management PoliciesCredit risk is the most common cause of bankfailures, causing virtually all regulatory environmentsto prescribe minimum standards for credit riskmanagement. The basis of sound credit riskmanagement is the identification of the existing andpotential risks inherent in lending activities. Measuresto counteract these risks normally comprise clearlydefined policies that express the bank's credit riskmanagement philosophy and the parameters withinwhich credit risk is to be controlled. Specific creditrisk management measures typically include threekinds of policies. One set of policies includes thoseaimed to limit or reduce credit risk, such as policieson concentration and large exposures, adequatediversification, lending to connected parties, or over-

July-August 2007


exposures. The second set includes policies of assetclassification. These mandate periodic evaluation ofthe collectibility of the portfolio of loans and othercredit instruments, including any accrued and unpaidinterest, which expose a bank to credit risk. The thirdset includes policies of loss provisioning, or themaking of allowances at a level adequate to absorbanticipated loss - not only on the loan portfolio, butalso on all other assets that are subject to losses. Theassessment of a credit risk management functionshould consider loans and all other extensions ofcredit (on- and off-balance-sheet) to ensure that thefollowing factors are considered:

w the level, distribution, and severity of classifiedassets;

w the level and composition of non-accruing,nonperforming, renegotiated, rolled-over, andreduced-rate assets;

w the adequacy of valuation reserves;w management's ability to administer and collect

problem assets;w undue concentrations of credit;w the adequacy and effectiveness of, and adherence

to, lending policies and credit administrationprocedures; and

w the adequacy and effectiveness of a bank'sprocess for identifying and monitoring initial andchanging levels of risk, or risk associated withapproved credit exposure.

(d) Policies to limit or reduce credit riskBank regulators have traditionally paid closeattention to risk concentration by banks. A regulator'sobjective in credit risk management is to preventbanks from relying excessively on a large borroweror group of borrowers, but not to dictate to whombanks may or may not lend. Modern prudentialregulations usually stipulate that a bank should notmake investments, grant large loans, or extend othercredit facilities to any individual entity or relatedgroup of entities in excess of an amount thatrepresents a prescribed percentage of the bank'scapital and reserves. Most countries impose asingle-customer exposure limit of between 10 and 25percent of capital, although in some jurisdictions itmay be as high as 30-40 percent. The BaselCommittee on Banking Supervision hasrecommended a maximum of 25 percent, with theintention of reducing it to 10 percent as soon as thisis practical.

Lending to connected parties (commonly known asrelated party lending) is a particularly dangerousform of credit risk exposure. Related parties typicallyinclude a bank's parent, major shareholders,subsidiaries, affiliate companies, directors, andexecutive officers. This relationship includes the

ability to exert control over or influence a bank'spolicies and decision-making, especially concerningcredit decisions. An additional concern is whethercredit is based on market terms or is granted onterms that are more favorable with regard to amount,maturity, rate, and collateral, than those provided tothe general public. Most regulators establish limitsfor aggregate lending to related parties, typicallystipulating that total lending to related parties cannotexceed a certain percentage of tier 1 or totalqualifying capital. If such a limit has not beenestablished by prudential regulations, a bank shouldbe expected to maintain one as a matter of boardpolicy. A prudent banking practice would require allloans to related parties to be approved by the board.

Another dimension of risk concentration is theexposure of a bank to a single sector of the economyor a narrow geographical region. This makes a bankvulnerable to a weakness in a particular industry orregion and poses a risk that it will suffer fromsimultaneous failures among several clients forsimilar reasons. This concern is particularly relevantfor regional and specialized banks or banks in smallcountries with narrow economic profiles, such asthose with predominantly agriculture-basedeconomies or exporters of a single commodity.

Renegotiated debt refers to loans that have beenrestructured to provide a reduction of either interestor principal payments because of the borrower'sdeteriorated financial position. A loan that isextended or renewed, with terms that are equal tothose applied to new debt with similar risk, shouldnot be considered as renegotiated debt.Restructuring may involve a transfer of real estatefrom the borrower to the bank, receivables or otherassets from third parties, a debt-to-equity swap in fullor partial satisfaction of the loan, or the addition of anew debtor to the original borrower. A good practiceis to have such transactions approved by the boardof directors before concessions are made to aborrower. Bank policies should also ensure that suchitems are properly handled from an accounting andcontrol standpoint. A bank should measure arestructured loan by reducing its recordedinvestment to a net realizable value, taking intoaccount the cost of all the concessions at the date ofrestructuring. The reduction should be recorded as acharge to the income statement for the period inwhich the loan is restructured. A significant amountof renegotiated debt is normally a sign that a bank isexperiencing problems. An exception to this generalapproach applies in a market environment of fallinginterest rates, when it may be in the interest of bothdebtors and creditors to renegotiate the originalcredit terms.

July-August 2007


(e) Asset classificationAsset classification is a process whereby an asset isassigned a credit risk grade, which is determined bythe likelihood that debt obligations will be servicedand debt liquidated according to contract terms. Ingeneral, all assets for which a bank is taking a riskshould be classified, including loans and advances,accounts receivable, investments, equityparticipations, and contingent liabilities. A s s e tclassification is a key risk management tool. Assetsare classified at the time of origination and thenreviewed and reclassified as necessary (according tothe degree of credit risk) a few times per year. Thereview should consider loan service performance andthe borrower's financial condition. Economic trendsand changes in respective markets and the price ofgoods also affect evaluation of loan repayment. Theevaluation of certain classes of smaller loans,h o w e v e r, may be based only on repaymentperformance, in particular small consumer loanssuch as residential mortgages, installment loans, andcredit cards. Assets classified as "pass" or "watch"are typically reviewed twice per year, while criticalassets are reviewed at least each quarter. In someadvanced banking systems, banks use more thanone rating level for assets in the pass category. Theobjective of such a practice is to improve the qualityof portfolio analysis and trend analysis to be able tobetter differentiate among credits of different types,and to improve the understanding of the relationshipbetween profitability and the rating level. Banksengaged in international lending face additional risks,the most important of which are country, orsovereign, and transfer risks.

Transfer risks are the difficulties that a borrowermight have in obtaining, the foreign exchangeneeded to service a bank's loan. The classification ofinternational loans should normally include bothcountry and transfer risk aspects. A bank may beasked to provide for international loans on a loan-by-loan basis, whereby the level of necessary provisionsis increased to accommodate additional risk.A l t e r n a t i v e l y, a bank may determine aggregateexposures to country and transfer risks on a country-by-country basis, and provide special reserves toaccommodate for risk exposures. Additionally, foreigncurrency risk aspects may also affect loanclassification in cases where a debtor has borrowedin one currency but generates cash flow in anothercurrency. In effect, the foreign currency risk aspectmagnifies the credit risk taken by a bank. Such casesare especially relevant in emerging marketeconomies or in economies where the domesticcurrency is unstable and/or lacks full convertibility.The loan classification should, in such cases, alsoinclude considerations related to the likelihood ofcurrency devaluation, the ability of the debtor to

cover or hedge the risk of devaluation, or the debtor'scapacity to adjust product or service pricing.

(f) Loan loss provisioning policyAsset classification provides a basis for determiningan adequate level of provisions for possible loanlosses. Such provisions, together with general lossreserves that are normally counted as tier 2 capitaland are not assigned to specific assets, form thebasis for establishing a bank's capacity to absorblosses. In determining an adequate reserve, allsignificant factors that affect the collectibility of theloan portfolio should be considered. These factorsinclude the quality of credit policies and procedures,prior loss experiences, loan growth, quality ofmanagement in the lending area, loan collection andrecovery practices, changes in national and localeconomic and business conditions, and generaleconomic trends. Assessments of asset value shouldbe performed systematically, consistently over time,and in conformity with objective criteria. They shouldalso be supported by adequate documentation.Policies on loan-loss provisioning range frommandated to discretionary, depending on the bankingsystem. The tax treatment of provisions also variesconsiderably from country to country, although manyeconomists believe that provisions should be treatedas business expenses for tax purposes. In countrieswhere the legal framework for debt recovery is highlydeveloped, such as the United States, studies havedemonstrated that approximately 10 percent ofsubstandard assets eventually deteriorate into loss.The percentages for doubtful and loss classificationsare approximately 50 percent and 100 percent,respectively. In developing countries where the legalframeworks and traditions for debt collection may beless effective, provisions in the range of 20 to 25percent of substandard assets may be a morerealistic estimate of loss potential.

Robust MIS supportE ffectively managing credit risk in today's bankingenvironment is extremely important for the institutions.Effectiveness of the credit risk management framework isdependent on the level of understanding of the highermanagement of the institutions engaged in day-to-dayrisk management responsibilities. In addition to theprecise understanding of the framework, implementationof the risk measurement and monitoring tools requiresrobust MIS capable to generate management reports,which may then be utilized for monitoring of the limits andcompliance with the predefined policies on bank widebasis. Traditional banking softwares, which were mostlyincapable of generating countrywide information on timelybasis, are no more useful, if institutions are to implementrisk management framework in letter and spirit and to stayalive in this rapidly changing financial sector.

July-August 2007


Rationale for RMLs: With unstable interest rate movement, it becomes difficultto earn these days by investing in traditional instruments.Alternatively, investing in riskier instruments, which offerhigher returns as compared to traditional instruments isnot advisable for people at this stage of life. They simplycannot afford to gamble with their hard-earned money.Moreover, not all of them are fortunate enough to havesufficient deployable funds for investment and majority ofthem do not receive any pension. At present, there areonly two main sources of obtaining cash against one'shouse, either by selling it or borrowing against the house.In the former, when the house is sold, one has to moveout, while in the latter case, the person would have tomake monthly loan repayments, both of which might notbe feasible in old age.

With the fall in returns on savings due to the soft interestrate regime and increased longevity, Reverse MortgageLoans (RMLs), enabling senior citizens to earn a steadyincome by pledging their homes for a comfortable living,have recently been introduced to the Indian financialmarket. Unlike life insurance, where a person paysthroughout life to get a lump sum amount at the end,reverse mortgage, a loan against home, enables a personto get payment either in lump sum or on monthly basis oras customised by borrower and requires no repayment tilldeath. A recent World Bank study found that only 10 per

cent of the population had any sort of social coverage inIndia, which indicates that nearly 90 percent of thepopulation has no formal social security. National HousingBank commissioned a research that found there were3.87 million house-owning individuals above 65 years ofage in India in March 2006.

Reverse mortgage loan requires no repayment for as longas the 'principal resident' lives in the house, but must berepaid in full, including all interest and other charges,when the last living borrower dies, sells the house, orpermanently moves away. Reverse mortgage loan (RML)would be better suited for those issueless senior citizensso that after their death, the lender could dispose it in themarket. Unlike the situation in India where people needmoney for maintaining a comfortable living due to thereduced employment prospects after retirement, in theUS, these type of mortgages typically go to the oldestborrowers living in the most expensive homes. Accordingto industry experts, it is the right time that the concept isbrought into India, especially when real estate is showinghealthy signs of recovery.

International Profile(Reverse Mortgage (known as lifetime mortgage in theUnited Kingdom) is now a well exposed financial productin countries like USA, UK, Canada, France, Japan,Australia, Singapore and various other countries.) A

Reverse Mortgage Loan (RMLs) in India:

With the fall in returns on savings due to the soft interest rate regime andincreased longevity, Reverse Mortgage Loans (RMLs), enabling senior citizensto earn a steady income by pledging their homes for a comfortable living, haverecently been introduced to the Indian financial market.

Dr. Pradeep Kumar Singh

Rationale, Concept and Application


banker named Nelson Haynes of Deering Savings & Loan(Portland, ME), Maine issued the first known reversemortgage in 1961 USA. He delivered this product to NellieYoung, the widow of his high school football coach. In theUS, the government launched the first RM product in1991 through a government undertaking to buildconfidence in the product. Reverse mortgages were laterused in other areas of USAas well, but it was not until theeighties that their existence received widespreadpopularity and government endorsement. Today, thereare a host of both state insured reverse mortgages as wellas privately funded products.)

RML: The ConceptIndian finance minister introduced the idea of reversemortgage in the 2006-07 Budget. To understand theconcept of reverse mortgage, first let us understand whata regular mortgage is. In a regular mortgage, a borrowermortgages his new/existing house with the lender(Banks/PLI) in return for the loan amount (which in turn heuses to finance the property); the same is charged at aparticular interest rate and runs over a predeterminedtenure. The borrower then has to repay the loan amountin the form of EMIs (equated monthly installments), whichcomprise of both principal and interest amounts. Theproperty is utilized as a security to cover the risk of defaulton the borrower's part. Under Reverse Mortgage loan(RML) citizens aged 60 years and above will be able topledge their house and derive a monthly income or a lumpsum for 15 years while living in it. If you go for the lumpsum amount, you can deposit it in a bank, withdraw fromyour account according to your requirements and keepearning interest on the balance. It is mainly meant for'home rich' senior citizens who are otherwise cash-poor.Reverse Mortgage works like a traditional mortgage loan,only in reverse direction. A borrower does not makeregular payments to a lender; instead he receives

payments from the lender. The National Housing Bank(NHB), a subsidiary of the Reserve Bank of India (RBI),has prepared the operational guidelines on reversemortgage loan.

Under the new scheme, a senior citizen, who owns ahouse, can be given a loan up to 40 percent of the marketvalue of his house, if he is in the age group of 60-65years. If the borrower's age is between 66-70, he canavail loan up to 50 percent of the market value. Similarly,for people belonging to the age group of 71-75, loans ofup to 55 percent of the market value of the house will begiven. For the age group of above 75 years, loans up to60 percent the house will be offered. Borrowers can optfor receiving the money as fixed monthly payment also. Inthis case, the entire amount will be paid in the form ofannuity (a sort of monthly income) for 15 years, which willbe fixed, irrespective of the age at which borrowers takethe loan.

In terms of receiving the loan amount, the borrower canopt for monthly, quarterly, annual or lump sum paymentsor payments at any other point in time as per hisrequirement Also, a revaluation of the property has to beunder taken by the bank/HFC once every 5 years.H o w e v e r, before resorting to sale of the house,preference will be given to the owner or his heirs to repayor prepay the loan amount, along with the interest, and toget the mortgaged property released. Lenders are entitledto retain only the amount loaned by them and any surplusover and above the original loan amount belongs to theborrower's children or legal heirs since the amount owedon a reverse mortgage can never exceed the value of thehome at the time the loan is extinguished. The amountreceived through reverse mortgage is considered as loanand not income; hence it will not attract any tax liability, oraffect Medicare benefits.

July-August 2007

How Does RML Workw Reverse Mortgage Loan (RML) allows senior citizens to mortgage their residential property to a bank or a

housing finance company while retaining the right to stay. The house owner who mortgages gets a steadyincome to meet old age exigencies.

w According to the draft RMLguidelines issued by the National Housing Bank (NHB), a subsidiary of the ReserveBank of India (RBI), the house owners who have crossed 60 years of age will be allowed to seek loan up to 60per cent of the value of the residential property which they need not repay.

w The house owners can opt for monthly, quarterly or annual payments to supplement their income. They mayalso prefer one time payment or a committed line of credit from the bank/Housing Finance Company (HFC) tobe used in times of need. According to the draft guidelines, the income, which a house owner receives bymortgaging his house, will go up with revaluation of property which has to be undertaken by the bank/HFCevery five years.

w The bank/HFC will recover the loan along with interest on death of the owner or expiry of mortgage period byselling the house and remit the excess amount to the owner or his heirs. The owners will also have the right torepay the loan to discharge the mortgage.


This kind of mortgage avoids the necessity of the seniorcitizen selling his property and, thereby, losingpossession of the property during his life time. It is quitelikely that whatever income they are having by way ofpension or interest would be losing in value due toinflation, making it inadequate for their living, so thatreverse mortgage offers a solution for aged citizens withthe house they live in. They can continue to live in thehouse till death and if the agreement is so worded, till thedemise of oneself or their spouse, whichever is later.

In India, PNB is one of the first state-run banks to launchthe product. Corporation Bank has signed up with thecountry's largest insurer, Life Insurance Corporation ofIndia, to jointly launch a reverse mortgage product soon.Dewan Housing Finance Company Ltd. introduced thefirst Reverse Mortgage product named “Sakhsam”, in2006. Of late, ICICI has launched a new product in thissegment.

RMLs and Taxation IssuesFollowing are the main taxation issues involved in RMLs:

1. As for the tax planning angle, such a person who hasto mortgage the property for his living expenses is notlikely to have any tax liability, especially in the light ofexemption up to Rs. 1, 95,000 for senior citizens above65 years of age. Since what he receives is a mereloan, even if he receives it in instalments, it should notbe taxable.

2. There would be liability only, if the property issurrendered for an annuity, which is always taxable.

3. For the lender (banks/FIs), there is no saving in tax, astax would have to be paid on interest on accrual orcash basis.

Issues and Challenges for RMLsLegal issues: Various legal issues arise in case of RMLs.In case of a simple housing loan product now we have theSecuritization Act to take care of defaults. In case ofreverse mortgage, the legal heirs may not agree todispose off the property though they may be reluctant tosettle the debt with lenders or may not have the funds todo so. In that situation a separate law is required toprotect the RML lenders.

Social issues: It is one of the common phenomena, thatjoint families are still widespread in many parts of India,although their numbers have reduced. In many cases, theculture of joint families continues even afternuclearisation. In this scenario, many parents would stillprefer to leave their house to their children rather than liveoff it. Social status and emotional attachment is one of thechallenges for RMLs.

Regulation and Transparency issues: RML productsrequire solid regulation and transparency. In India it isbetter to permit those banks and PLIs for RML that havegood track record of financial dealing and they areparticular about transparency in their transactions. Atleast they should disclose their entire scheme to theborrowers before the RML agreement, i.e. their loanamount, interest rate, any variation in future etc.

Financial issues: For banks and HFCs it is a bigchallenge to maintain level of capital as per theirrequirement, because in traditional mortgage everymonth they are getting some amount as instalment ofloan and it will provide liquidity to the banks. But in caseof RMLthey have to pay monthly instalment of loan to theborrowers and after a long period of time (after 15 yearsor more) they will get entire amount back. During thisperiod management of capital as per the requirement isone of the big challenges for the Banks /HFCs.

July-August 2007

Disadvantages of RMLs:w Reverse mortgage fees can be high, although the fees are often rolled into the loan and not paid upfront. A

reverse mortgage can cost thousands more than a conventional mortgage.

w It's important to calculate the cost of a reverse mortgage against what you would gain, because once you entera reverse mortgage agreement, the mortgage company essentially owns your home.

w In reverse mortgage plans it is better to discuss with legal and financial advisors, and family members, beforemaking a decision. Because home ownership is often a person's most valuable asset, getting a reversemortgage is essentially the same as spending the money you'd expect to leave to your heirs.

w Be sure that the older homeowner is thinking clearly when making this decision because having a suddenarrival of cash can be a heady experience and it would be a shame to waste it or become the victim of a scam.

w Reverse mortgages are often seen as a last resort if the homeowner needs cash and there are no other options.

31The Pakistan Accountant

Accounting issues: For the banks /HFCs, accounting ofRML product is also one of the big issues. In case of RMLbanks and financial institutions are earning interest everyyear but they are entitled to the entire amount (principaland interest) after 15 years or more. Now the question is whether interest of banks will be taxable on accrual basisor cash basis. If it is taxable on accrual basis interestearned by banks every year will be treated as income andit will be taxable. At the time of final disposal of agreemententire amount paid by the borrowers is exempted fromtax. But another issue is that at final disposal if receivableamount is less than the total due (principal and interest)then what will be the accounting adjustment for the loss.Under cash method entire interest will be treated asincome at the time of final disposal and during the RMLtenure interest will not be treated as income. In thatsituation at the time of final disposal of loan total interestearned will be treated as income and it is a huge burdenof tax for the banks and HFCs.

Interest rate regulations and fluctuations: Interest rateregulation is one of the major issues among banks. Fromlast two years interest rate on conventional mortgage loanhas increased from 7.5 percent to 11 percent which isvery crucial for borrowers, because their EMIs (equatedmonthly instalments) /duration of the loan increasessubstantially. How PLIs (Primarily Lending Institutions)mange their interest rate fluctuations, is equally importantto senior citizens, because they are not in a position tocancel their RML and pay the entire principal and interestaccrued so far.

ConclusionThe extent to which the potential of reverse mortgagegets realised in India will depend a lot on the guidelinesthat will govern it. The government must ensure that onlythe most credible institutions are allowed to offer RMproducts; that they keep interest rates and servicecharges reasonable, with no hidden increase of rate thatwould make the entire loan due immediately.

“'The success of RML will depend on the governmentrecognising RMs as part of its own welfare obligation andensuring they are not taxed as income in the hands ofindividuals. In India initial seekers of RM are likely to beindividuals who have no family support or prefer to liveindependently rather than worry about inheritance laws orleaving assets for their heirs. It is advisable to ensure thatregulations are structured to prevent any harassment ofsenior citizens through unreasonable propertymaintenance conditions, stoppage of monthly paymentsor the threat of eviction from their homes. The productmust be developed with adequate sympathy and arealisation that the very ages of these borrowers preventthem from fighting long battles in consumer courts.”

References: NHB (2007): Operational Guidelines for ReverseMortgage Loan, Published by National Housing Bank,

1. Vaidyanathan V (2004): Pension issues andchallenges, Management Review, Sep., Indian Instituteof Management, Bangalore Sept

2. Kapila Raj and Kapila Uma (2002): A Decade ofEconomic Reforms in India, Academic Foundation,New Delhi.

3. Bhalla V.K. (2004): “Investment Management”,S.Chand and Sons, New Delhi.

4. Economic Times: 18 March 2006

5. Bhattacharjee Kalyan (2007): Reverse Mortgage - Anovel financial product for elderly people, T h eManagement Accountant, May.

6. www.nhb.org.in

July-August 2007

Dr. Pradeep Kumar Singh teaches Commerceat the Mahatma Gandhi Government ArtsCollege, Pondicherry India.

The Pakistan AccountantAdvertisement Tariff (Four Colors)

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While there has been an improvement in the overall qualityof documentation on the files we review, we have found ona number of occasions that these were lacking in thes u fficiency of documentation to support key auditjudgments. If key judgments are not properly recorded at thetime, there is a substantial risk that the rationale may beincomplete and that it will not be possible for our reviewersto see from the documents on file the rationale behindjudgments. Also, if the firms' own audit files do not contain acomprehensive record of thekey judgmental aspects of theaudit alongside compliance-related information, this may bedetrimental to the on-the-jobtraining of audit staff. Weremind the firms that a focus onkey audit judgments is centralto the principles-basedapproach to auditing inP a k i s t a n .

In smaller firms, there is oftenan absence of any real systemof quality control. Too often, the“system” is such that completefaith is placed on the engagement partner to ensure thatevery audit is done to a high standard of quality, without anydouble checks. For sole practitioners, the process of havinga double check within the firm is an inherent limitation.H o w e v e r, for sole practitioners, the ISQC 1 allows to appointexternal persons for the purpose of “Engagement QualityControl Review” and “Monitoring”.

H o w e v e r, there is an important caveat. Even in firms with amore effective system of quality control, we sometimes findindividual engagements with serious deficiencies, meaningthat the performance of the engagement is significantlybelow what is required by professional standards. T h i smeans that the key individuals assigned to the engagementhad failed to do their job as well as they should have.

We recognize that audit partners and managers are busyprofessionals doing a difficult job. That is the truth, but notan excuse. Surgeons are also busy professionals doing ad i fficult job, but one expects them to do their best each time,especially when one is at the sharp end of their scalpel.

What can be done to improve audit quality at the individualengagement level? More rigorous auditing standards arepart of the answer. For example, the recently revised ISA230 on Documentation is a very timely change by IFAC.Documentation is not about ticking boxes on a checklist. Itis primarily about documenting what the auditor did inresponse to the principal risks and uncertainties that areconfronted in every audit. The discipline of setting down forposterity the important judgments made during the audit

often improves the clarity ofthought and quality of judgments.Considering the enhanced role andthe importance of 'AuditDocumentation' placed under therevised ISA 230, the DPSC&E hadissued Circular No. 3 dated 15November 2006 to all practicingmembers.

It is important to highlight thatgradual but relentlessimplementation of ISAs will requiremany audit firms, particularly Smalland Medium Size Practices(SMPs), to substantially change

the way they do audits. Many smaller firms do not yet fullyrealize the implications of the changing audit scenario. Butthey have the option to mobilize their resources throughNetworking or Mergers. Alternatively they might have todrop their audits of listed / public sector entities andconcentrate more on audit of smaller companies and non-audit accounting services, tax, general financialconsultancy etc.

The Institute is working tirelessly and actively to addressthe challenges facing the audit profession, especially inassisting Small and Medium Sized Practices (SMPs) togear up for assimilating and integrating their practices withglobal accounting standards through Networking andMergers. We acknowledge that the best firms are the onesthat maintain comprehensive records of key auditjudgments central to the principles-based approach toaudit, where firm leadership has established highparameters for quality, where performance is measuredagainst established benchmarks, and where there is lowtolerance for preventable quality lapses.

Open Letter

Why it is Important toMaintain Audit Quality

International Standard onAuditing (ISA) 230 (Revised),

“Audit Documentation,” shouldbe read in the context of the“Preface to the International

Standards on Quality Control,Auditing, Assurance and

Related Services,” which setsout the application and authority

of ISAs.

Source: Directorate of Professional Standards Compliance & Evaluation (DPSC&E)

34The Pakistan AccountantJuly-August 2007

Richard Dyson,President ICAEW

In ConversationWithIn ConversationWithRichard Dyson,

President ICAEWInstitute of Chartered Accountants in England & Wales (ICAEW)


ICAEW President Richard Dyson was on a whirlwindvisit to Karachi in August to sign a Memorandum ofUnderstanding with ICAP under which ICAP qualified

Chartered Accountants will be eligible to gain the ACAqualification through work experience and examinations.The MOU will enable both Institutes to work together tostrengthen bilateral accounting ties, enhance cooperationand share information and best practices with each otherin order to develop the profession.

Unfazed by the sweltering Karachi heat, Richard Dysonsat down in the President's Room at ICAP to discussstrategy and good governance.

Richard Dyson foresees the ICAP- ICAEW relationshipdeveloping positively over time. The welcome that he andhis team received and the enthusiasm shown by theaccounting community in Pakistan were veryencouraging. 'It shows that quality in both education andprofession are important to all those involved. A smembers of the International Federation of Accountants(IFAC), both ICAEW and ICAP need to work closely toshare best practices and to promote issues like corporategovernance in the public interest,' Dyson added.

Dyson believes ICAP is doing a good job in terms ofmaintaining professional standards and quality. 'For manyyears, ICAPwas mainly perceived as an organization thathanded out initial qualifications, but now its role hasevolved into one that is supportive and collaborative,especially its emphasis on Continuing ProfessionalDevelopment (CPD) for its members which is the onlyway to keep professional accountants updated andabreast of the changes in legislation and internationalaccounting standards.' Over 25 percent of ICAPmembersare employed overseas which speaks of ICAP's highquality standards

Dyson left a full time career as national risk managementpartner at Ernst & Young to take over the top job atICAEW. He had been involved in the affairs of the ICAEWfor more than two decades, initially as President of theManchester Society of Chartered Accountants from 1995-96, and later as member of ICAEW's Council to which hewas elected in 2001 as member for the Manchesterconstituency.

Dyson specializes in investigation and forensic work andfrom 1982-2001 was responsible for building up duediligence and forensic accounting services practices forErnst & Young. Dyson is also the Chairman of theConsultative Committee of Accountancy Bodies (CCAB)which is the umbrella body for the six UK professionalbodies, an observer on the Financial Reporting Council,and a member of The Takeover Panel which is anindependent body, established in 1968, to ensure fairtreatment for all shareholders in takeover bids.

Dyson says 'accounting is perceived as some sort ofblack art' which is why 'political recognition of accountingas an economic fundamental has not gone far enough.'He quotes Arthur Levitt* who warned that publishedaccounts would no longer be trusted unless companiesprovide meaningful disclosure to shareholders, andinsisted that integrity of information precedes competitiveadvantage. One way to do this is to 'ensure consistencyof audit quality across borders,' Dyson adds. ----------------------------------------------------------------------------* Arthur Levitt was the longest serving Chairman (1993-2 0 0 1 ) of the United States Securities & ExchangeCommission. Widely hailed as pro-investor, he later cameunder fierce criticism for failing to act against the 1990sbull market a b u s e s .

July-August 2007

View Point


View Point

Needless to say, without high quality financial informationand high quality audit the profession will be unable tomeet future business needs. 'I think the financial scandalsof the late 80s and early 90s and more recently Enron,Worldcom and Parmalat have shaken public confidence.But these do not represent the profession as a whole,which thrives on public welfare and the trust reposed in it.I think that when qualified Chartered Accountants carry ontheir duties efficiently, it will increasingly instill publicconfidence in their role as key players in the economy.'

Dyson has often lamented the fact that the cumulativeweight of regulation is overburdening the audit professionas it detracts professionals from their work and wouldinevitably have an adverse effect on audit quality. 'I thinkit is a major risk. The constraints imposed upon theprofession are great. We need to reduce the complexity ofour practices and guidelines. The level of regulation isputting off quality professionals from audit as it createsunnecessary complexity for accountants. We need toregenerate the audit profession by unburdening it fromoverregulation. While I recognize the importance ofindependent oversight I believe there is an increasedpressure of documentation which isn't necessarily veryproductive. It restricts the use of judgment and makes theaudit profession less attractive.'

Dyson is concerned that the delay in convergence ofIFRS and US GAAP may not be serving the stakeholderswell. He believes that unless the rules based, classactions based litigation culture in the US changes 'we willend up with two sets of accounting standards that canwork in parallel', but not one set of similar standards thatcan 'assist the understanding of potential investors andimprove confidence in reporting.'

Paul Grant wrote in Accountancy Age that the 'MBAqualification poses a bigger threat to the ICAEW than

competing Institutes.' How would the Presidentof ICAEW like to respond to that? 'I think it is afair comment,' answers Dyson. 'However, I'd liketo point out that the A C A is a broaderqualification and different in its approach to theMBA. MBAs do a lot of case studies but don'tput them in to practice the way CAs do.'

Richard Dyson is charting an ambitious courseto recast the 127 year old Institute as a savvy,socially responsible global organization. ICAEWguides members on CSR reporting. 'We need tolead by example,' Dyson says. The ICAEW hassignificantly dropped its energy consumptionand started double sided printing. The Instituteintends to set up best practice in this regard andpublicize what they are doing within the Instituteso that it is emulated outside. 'Unfortunately notmany Chartered Accountants are aware of theimpact of CSR, though the younger member ismore interested in initiating debate on issuesinvolving economic, environmental and socialperformance. I believe that unless the captainsof industry realize and embrace the importanceof CSR we can't get much ahead.'

Members working within industry are often distanced fromtheir Institutes and express little interest in their activities.To a question whether professional Institutes are moreinclined towards members in practice than members inbusiness, Dyson's answer is an emphatic 'No!' Shouldn'tthe Institutes then come up with ways to deal with varyingrequirements of members in practice, business, publicsector and those based internationally? 'Absolutely!When I talk to members I get the distinct feeling many ofthem question the Institute's (ICAEW) relevance to them.We've set up a number of advisory boards to ensure thatthe Institute continues to reflect their needs. As part of theFinancial Capabilities Initiative, members in businessvolunteered to conduct a pilot program in secondaryschools in Midlands, UK to introduce school children tothe profession. This is a good example of the involvementof younger business members in Institute activities, andwe intend to reciprocate.'

'In this regard a professional magazine also contributesgreatly to bridge the gap between the Institute and itsmembership. The new and improved version of theICAEW magazine has a circulation of over 150,000copies and is part of a two-pronged strategy by theInstitute to target members in business. 'The other aspectis to get out and about and meet up with members withwhom we've lost touch,' Dyson acknowledges.

The President is a strong advocate of ContinuingProfessional Development (CPD) both as part of lifelonglearning and for maintaining professional accountants'edge. The underlying message to Chartered Accountantsis not to be complacent.

July-August 2007

Rana Mustansir, for ICAP


'The best way to destroy the capitalist system is todebase the currency.'

Nikolai Lenin, 1870 to 1924, founding member of theSoviet Union

The purpose of socialist planning according to Marxistaspirations was to entirely eliminate the market and planthe economy as a serfdom. Stalin, Trotsky and Leninenvisioned a Union of Soviet Socialist Republics (USSR)based on a system of state ownership and administrativeplanning. The focus of Soviet economy was always heavyi n d u s t r y. Soviet Union was among the top threemanufacturers of basic and heavy industrial products.From the Stalin era through the late 1980s the Sovieteconomy was managed through a series of Five YearPlans which failed to deliver results since a climate ofpolitical persecution and fear stopped producers andconsumers to share reliable input and output informationwith the planners. As a result industrial units either overproduced leading to accumulation, or under producedleading to shortages, specially in consumer goods, whichcame to be sold on the black market. While Soviet Unionbecame the world's leading producer of oil, coal, naturalgas and minerals, the economy slowed down drasticallyat the enterprise level with worker alienation, lack ofinnovation, and bureaucratic interference.

During the 1950s, the Soviet ruble was considered a 'softcurrency', almost impossible to be exchanged for hardcurrency, since the Cold War had induced internationalisolation of the Soviet Union. As a result, the Soviet Union

sold commodities in exchange for US dollars. Thosedollars could not be deposited in conventional Americanbanks on the likelihood that the US government wouldfreeze those accounts in the event of a confrontationbetween the two superpowers. Eventually, those dollarswere deposited in European banks which issued a telexaddress code called 'euro-bank'. These deposits wouldbe the start of the eurocurrency market.

When Leonid Brezhnev died in 1982 the state of theSoviet economy had reached crisis proportions. Until thelate 1980s government was dominated at all levels by thePolitburo which formulated economic policy and plannedand executed major investment projects. MikhailGorbachev took office in March 1985 and spoke of theneed to effect 'deep transformations in the economy' andthe whole Soviet social system through his policies ofp e r e s t r o i k a (economic restructuring) and g l a s n o s t(openness or political liberalization). Perestroika usheredin the legalization of cooperatives and other semi-privatebusinesses, and the de-monopolization and legalizationof price controls, but glasnost revealed dirty state crimesundermining public confidence in the state's ability to leadthem out of poverty. Hundreds of thousands of politicalprisoners were languishing in the Gulag which becameknown as a mechanism for repressing political oppositionto the Soviet state. Organized crime which had prevailedin the communist nomenclature became rampant. In 1988Mikhail Gorbachev told the Central Committee of theCommunist Party that except for vodka sales and the saleof Soviet oil, the economy had not grown for twenty years.

In-House

The Fall of The Soviet Union and The Rise of Russia

How Economic Policy Can Break and Remake A Superpower


In-House

Meanwhile, to the utter chagrin of Gorbachev, the liberalswere rising under the colorful Boris Yeltsin, then speakerof the Russian Parliament. Supported by Boris Yeltsin,calls for independence from Moscow's rule grew louderfrom the Baltic Republics of Estonia, Lithuania and Latviawhich had been annexed into the Soviet Union by JosephStalin in 1940. Nationalist movements also took hold inother Soviet republics such as Ukraine, Georgia andAzerbaijan. Perestroika and glasnost which had openedup the Soviet state to the western world, eventually led tothe disintegration of the empire.

The 'Washington Consensus', a familiar term indevelopment policy, became the basis for thetransformation of socialist economies after the fall of theSoviet Union. The Consensus broadly recommends fiscaldiscipline, tax reform, trade liberalization, privatization ofstate enterprises, and deregulation. Yeltsin becamePresident by popular vote in 1989 and introduced hisambitious 'shock therapy' reform program to accelerateprivatization and allow prices to float in order to movequickly towards a market economy. Privatizationprogressed but without increase in production, inflationand currency devaluation skyrocketed. Russia receivedUS$40 billion from the IMF and other international lendingorganizations. Most of these funds were allegedlyembezzled by Yeltsin 'insiders' and deposited in foreignaccounts.

Thus ensued the August 1998 financial crisis when theYeltsin government defaulted on its payment of debtscausing financial markets to panic and the ruble tocollapse. By December, 12-month inflation had reached84 percent compared to a target of 8 percent. GDPshrankby 4.9 percent. Russia faced high public debt and lowinternational liquidity.

Following the 1998 crisis Russia experienced a dramaticrecovery. Macroeconomic policy goals shifted towardsmaintaining a competitive real exchange rate andsustainable public debt, facilitated by devaluation anddebt restructuring.

Yeltsin retired abruptly on December 31, 1999handpicking his successor Vladimir Putin, aformer KGB spy who, interestingly, hadconducted economic espionage in Dresden inthe Soviet bloc in East Germany until theCommunist regime there collapsed. T h echaracteristic feature of Putin's reign has beenauthoritarianism. Seventeen years in thenotorious KGB are reflected in his 'manageddemocracy' style with its set parameters ofwhat is permitted, and what is prohibited. Oneof the first steps he took as president was toreform an inefficient tax system by introducinga 13 percent flat tax on personal income,increasing real revenues from Personal IncomeTax by 25.2 percent in the first year. However,an IMF study showed that sharp increases inRussian GDP growth and tax revenue after theintroduction of the tax were not the result of tax

reform, but of the sharp rise in oil prices, growing internaldemand and strong real wage growth.

Putin has followed a reformist program from the beginningof his term. His economic program was aimed at placatingWestern lenders, on the one hand, with deregulationproposals and by doing away with Soviet-style bureaucracythat hampers private commerce, while strengthening stateintervention in the economy. Despite restrictions on foreigninvestment, an improving overall business environment hasled to increased inflows of Foreign Direct Investment (FDI).The new leadership and strategic shift in economic policyhas been a critical factor in Russia's rebound.

The ideological consensus among Russian elite is: There isno alternative to a market economy. Russia's principalmeans of power projection should be economic, not military.

To further consolidate Russia's economic stance, VladimirPutin has recently appointed Elvira Nabiullina as EconomicsM i n i s t e r. The new minister is regarded as a low-keyacademic from a think tank that drafted President Putin'seconomic program seven years ago. Her predecessor,German Graf, was widely unpopular for his pro-We s t e r nfree market economic reforms. Analysts in Russia arewelcoming the move as an effort by Putin's government tofight corruption and strengthen financial controls overgovernment policy.

Vladimir Putin is considered a hero by the Russian people,but is barred by the constitution to run for a secondconsecutive term as president. Victor Zubkov, who headedRussia's anti money laundering agency for six years wasnamed Prime Minister in a surprise move, and is beingconsidered a strong candidate for the presidency.

July-August 2007


In-House

Pe o p l eJurgen E. Schrempp: Former CEO, DaimlerChrysler

Legacy of A Chief Excutive

Jurgen Schrempp was theinfamous architect of thefailed Daimler-Benz and

Chrysler Corp merger in 1998.Daimler-Benz is the maker ofMercedes-Benz automobilesand trucks and Germany'slargest industrial conglomerate.Chrysler is America's thirdlargest automaker. Schrempp'svision was to makeDaimlerChrysler the world'sleading automobile manufacturer. To do this, he mergedDaimler and Chrysler in 1998, and took important stakesin Asian carmakers Mitsubishi and Hyundai in 2000.

As Chairman of Daimler, Schrempp had initially won apower struggle with Mercedes-Benz Chairman HelmutWerner for a Mercedes-Benz Daimler reintegration as partof a reorganization approved by the Daimler-Benz A GBoard of Directors. The move gave Schrempp morecontrol over the profitable Mercedes unit which had beenan independent division since 1989.

In 1998, with Schrempp as CEO, Daimler-Benz A Gannounced its US$36 billion acquisition of the ChryslerCorporation. The deal became the biggest industrialtakeover in history, and the biggest acquisition of anAmerican company by a foreign buyer. The merger wasdestined to reshape the United States automobile industryby uniting America's third-largest car maker withGermany's renowned producer of luxury cars and heavyduty trucks.

For Daimler-Benz the merger promised immediate access

to the North American mass market for automobiles

without diluting the upscale image of its Mercedes-Benzbrand. It would also give the German company production

capacity outside Germany, where worker wages and

benefits are among the highest in the world.

But the fact remained that other big automotive mergershad not worked well in the past, and the partners in this

marriage differed starkly in culture and product. Chrysler

built middle-class Jeeps, vans and pickup trucks, and had

a negligible European presence. Daimler-Benz was elite

and European. Company officials in Germanyacknowledged that it would be too dangerous to head too

far in the direction of middle-class sedans under the

Mercedes name.

Though Daimler-Benz was expected to be the dominantpartner in the merger, Schrempp and his associates

pitched the deal to investors as a 'merger of equals'. The

new company called DaimlerChrysler was incorporated in

Germany with headquarters in Michigan and Stuttgart,

while Daimler-Benz's shareholders owned the majority ofthe shares. It was agreed that the company would be

jointly run for a number of years by Jurgen Schrempp, the

chief executive of Daimler-Benz, and Robert J. Eaton,

Chrysler's chief executive. Schrempp could take control

after their joint term.

July-August 2007


Schrempp, 53, was aggressive, strong-willedand competitive. He had put Daimler through aradical overhaul since he took over as

Chairman in 1995. Eaton was a low-key manager.The success of the merger depended on how well thetwo chief executives would get along.

In their book Taken for a Ride: How Daimler-BenzDrove off with Chrysler, authors Bill Vlasic andBradley A. Stertz describe the Schrempp-Eatonrelationship:

'…The Chrysler executives thought Eaton appearedintimidated by Schrempp. Their public appearanceshad taken on a set character. Eaton spoke first,generally on broad topics such as the economy orglobal consolidation. Schrempp tackled the hardbusiness issues, laying out DaimlerChrysler'sagenda, promising that profits would grow faster thanrevenue. But more than the substance diff e r e d .Schrempp was a natural-born speaker, entertainingand assertive, his confidence palpable in every word.Schrempp didn't exactly intimidate Eaton. Heoverwhelmed him. Eaton didn't cower. He abdicated.'

Another important reason for the failed merger wasthat the two cultures never meshed, and expectedsynergies did not materialize. Also in Taken for aRide:

'German and American teams flew back and forth,huddling on projects to share accounting techniques,computer software, and diesel engines. The Post-Merger Integration team sequestered itself in awindowless fourth-floor office in Auburn Hills,painstakingly reviewing hundreds of practices thatcould be standardized. The dialogue wasconstructive as often as frustrating, yet the greatdivide between the Germans and the Americansseemed as deep as it was wide. They didn't just makecars differently. They lived in separate worlds.'

Schrempp's case became the basis for apaper titled Managerial Legacies,Entrenchment and Strategic Inertia thatinvestigated a firm's decision to retainor fire a poorly performing CEO whenthe CEO's strategy has long term cashflow implications beyond his tenure.

Stock prices had been falling steadily since January1999. On May 5, 1998, the day before the mergerstory broke, Chrysler stock traded at $41.38.Nineteen months after the euphoria of theChrysler/Daimler deal, that share was worth $41.27as DaimlerChrysler stock.

In October 2000, in an interview to the Financial Times,Schrempp admitted that the merger was never a merger oftwo equal companies as originally presented, but rather a

takeover of Chrysler by Daimler-Benz. Schrempp's statementcaused a riot. As a consequence, the reclusive Americanbillionaire investor Kirk Kerkorian, the largest holder ofDaimlerChrysler stock at the time of the merger with a 13.75percent stake, filed a billion dollar fraud lawsuit against thecompany contending that the US$36 billion transaction thatcreated DaimlerChrysler was in reality an acquisition ofChrysler, and had deprived him of the $1.2 billion premium hewould have demanded under an outright takeover. Kerkorianalleged that Schrempp misled him in to believing that it was a'merger of equals' while deceiving shareholders and theSecurities & Exchange Commission.

By late October, Schrempp's credibility had fallen drastically.He was quoted as saying, 'Originally Chrysler was supposedto make a $3.79 billion profit in 2000. In July the expectationwas reduced to about $3.03 billion. In October to about $2.11billion. And now we are talking about less than two billion, andI fear we haven't yet seen the end.' By the end of November2000, leading German and US investors were calling forSchrempp's resignation.

By February 2004, the DaimlerChrysler Board wasdeliberating whether to extend the embattled Schrempp'scontract which was set to expire in 2005. German newsmagazine S t e r n depicted Schrempp as isolated andsuggested that he could be ousted if the company did notbecome solidly profitable soon.

In July 2005, after years of poor performance and againstgeneral opinion, the Board terminated Schrempp's contract.On January 1, 2006, after ten years as the head of thecompany, Jurgen Schrempp was succeeded by Chryslerfrontman Dieter Zetsche. Zetsche's cost-cutting strategieshad successfully restored profits when he was director atChrysler. The BOD decided to abandon the firm's worldwidestrategy in favor of a refocus on the firm's core competencies.

In February 2007, DaimlerChrysler announced they wereinterested in selling the Chrysler Group, the US arm ofDaimlerChrysler. In April 2007, Kirk Kerkorian made a failed$4.58 billion bid for the group. In May, 80.1 percent of theChrysler Group was sold to the private equity firm CerberusCapital Management for $7.81 billion.

Schrempp's case received worldwide attention, so much sothat it became the basis for a paper titled M a n a g e r i a lLegacies, Entrenchment and Strategic Inertia* t h a tinvestigated a firm's decision to retain or fire a poorlyperforming CEO when the CEO's strategy has long-term cashflow implications beyond his tenure, i.e. he leaves behind alegacy. The aim of this paper was to explore how managerscreate legacies in the firms they manage. The failure of theDaimlerChrysler merger demonstrated that while globalizationholds promise, it is also fraught with unforeseen andinundating problems.

July-August 2007

*Managerial Legacies, Entrenchment and Strategic Inertia by Catherine Casamatta @ University of Toulouse & Alexander

Guembel @ University of Oxford and Said Business School.


Pakistan Is an Emerging Market for SukukAccording to Moody's Corporate Finance, Pakistan hashuge potential as a sukuk (Islamic bond) market. Thoughstill in a nascent stage as compared to Malaysia, thePakistan market is expected to grow significantly over thecoming years. Moody's believes the prospects formarkets in sukuk and Islamic financing in general are veryencouraging in Asia.

Pakistan Sees Significant Improvement in Tax Collection

Pakistan's tax revenue during the last financial year (July-June) reached an all time high of Rs.825 billion(US$13.75 billion). The government hopes to raiserevenues in this financial year to more than Rs.1 trillion(US$16.66 billion) which is unprecedented in thecountry's fiscal history. This has been due mainly to a newtax regime with increased reliance on taxpayers to solicitinformation. However, the optimism surrounding thechanging taxation culture in the country is dampened bythe fact that currently taxpayers form a mere one percentof Pakistan's total population of 165 billion.

Subprime Crisis in US Causes Global TurmoilGlobal financial markets faced a real crisis last month asa result of the subprime mortgage loan problems in theUnited States. The problem emerged in the US with theannouncement early August of the bankruptcy ofAmerican Home Mortgage Corp. and the retrenchment of7,400 employees. Its shares had dropped from $36.4 to$0.28 within a year. As fears spread across Europe,Japan and Australia, the US Federal Reserve pumped intwo payments, the European Central Bank over 100billion euros and the Central Bank of Japan over $8 billionto avoid the collapse of global financial markets. This wasfollowed by further action from the central banks in China,Malaysia and Australia.

World Bank Sees Strong Global GrowthAt the recent Asia Pacific Economic Cooperation meeting,World Bank President Robert Zoellick said that 'theunderlying fundamentals for growth and developmentremain quite strong', but the credit squeeze in financialmarkets is forcing investors to reevaluate the amount ofrisk they want to take on. He also said the Asian bankingsector was now better capitalized to withstand shocksthan during the Asian financial crisis of 1998, but manyAsian countries needed to develop their capital marketsto attract much-needed foreign investment.

Telepresence Takes OverVideoconferencingHewlett-Packard, Cisco and several other technologyfirms have started selling a spruced up version ofvideoconferencing called 'Telepresence'. Users stillcommunicate via live audio and video feeds, but thespeed and quality of transmission have increased withmultiple screens in order to create the illusion that theparties to a conversation are actually sitting across a tablefrom each other. Rooms, furniture and wallpaper are oftenidentical to aid the illusion. In order to give people thefeeling that they are making eye contact, multiplecameras and enormous computing power are involved.The delays in sight and sound are kept below 250milliseconds (the threshold at which the human brainstarts to notice) so that people can interrupt each othernaturally.

HP charges US$350,000 for every room it rents out fortelepresence. Cisco charges up to $299,000 per room.Research firm Frost & Sullivan says despite their highcost telepresence systems quickly pay for themselves bykeeping travel bills down and saving time andenvironmental costs. It forecasts that the global marketfor telepresence will grow by 56 percent a year to reach$1.24 billion by 2013.

In-House

World In Focus


Greenspan Speaks

For decades Alan Greenspan was known as the financial oracle whose cryptic statementshad the power to move markets across the world. His words can still cause tremors, butnow, in his first major book, he finally speaks in his own voice. Charming and clear, TheAge of Turbulence tells a surprisingly personal story of his remarkable career and takes abrilliant look at the state, and the future, of the world economy.

[email protected] US$ 20.99

Super CrunchersWhy Thinking-by-Numbers Is the New Way to Be SmartIan Ayres

Today, number crunching affects your life in ways you might never imagine. In this livelyand groundbreaking new book, economist Ian Ayres shows how today's best and brightestorganizations are analyzing massive databases at lightening speed to provide greaterinsights into human behavior. They are the "Super Crunchers." From Internet sites likeGoogle and Amazon that know your tastes better than you do, to a physician's diagnosisand your child's education, to boardrooms and government agencies, this new breed ofdecision makers is calling the shots. And they are delivering staggeringly accurate results.Gone are the days of solely relying on intuition to make decisions. Super Crunchers.

shows us the benefits and risks, who loses and who wins, and how super crunching can be used to help,not manipulate us.

Paperback US$16.50

The Three Signs of a Miserable Job: A Fable for Managers and their EmployeesPatrick Lencioni

Patrick Lencioni, business guru and bestselling author, is on a mission to create widespread job satisfactionin a world full of workplace misery. In The Three Signs of a Miserable Job, he tells the tale of a high-flying,but dissatisfied executive who ditches power and perks for career bliss as a pizzeria manager! In thisunusual and inspiring story, Lencioni shows how career happiness (or misery) depends on the manager-employee relationship.

[email protected] US$16.47

In-House

July-August 2007


Credit Rating is an assessment of the credit worthiness of individuals and corporations. It is based uponthe history of borrowing and repayment, as well as the availability of assets and extent of liabilities.

It is the process of providing independent objective assessments of the credit worthiness of companies andcountries through a credit ratings agency which helps investors decide how risky it is to invest money in aspecific company, investing instrument, or market, as well as decide which companies and which countriesare good investment opportunities.

The three top credit ratings agencies for the investment world are Moody's, Standard & Poor's (S&P's), andFitch IBCA. Ratings are a measure of an entity's ability and willingness to repay debt. The ratings rangefrom highest credit quality to default or junk. Triple A (AAA) is the highest credit quality and C or D is thelowest or junk quality. There are different degrees of each rating, which, depending on the agency, aresometimes denoted by a plus or negative sign or a number.

“AAA” rating signifies the highest investment grade and means that there is very low credit risk. "AA"represents very high credit quality; "A" means high credit quality; and "BBB" is good credit quality. Ratingsthat fall under "BBB" are considered to be speculative or junk.

Credit rating is a useful tool as a good investment rating elevates the status of a company, a security, or acountry to global standards, and helps them attract foreign investment and boost a nation's economy. ASovereign Credit Rating signifies a country's overall ability to provide a secure investment environment,which is the first thing institutional investors will look at when making a decision to invest in that country. Acountry with a good sovereign credit rating will, therefore, get more prominence.

Students’ Section

What is a CorporateCredit Rating

July-August 2007

pakistan accountant-jan 07

Documents

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