Charity Funds in Islamic Banking Institutions (IBI) - A Conflicting Policy

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1. 48 Journal of Islamic Banking and Finance April – June 2019 Charity Funds in Islamic Banking Institutions (IBI) – A Conflicting Policy By Munir Mansuri Abstract Islamic banking and finance is quite a new phenomenon in finance industry. It is aimed to cater to those who want to engage in banking without interest. Almost around five decades old now, the faith based banking idea now is not in its infancy age anymore, but is still in the developing stage. In the light of experiences gained during past few years, it is right and due time for the policy makers, regulators specially, to review their policies to see whether the journey is in the right direction or not. Status of achievement of desired objectives should be the top criteria to assess the performance, progress of Islamic banking operations, Islamic banking institutions and allied set ups. The policy of creation and maintaining charity funds by IBIs is one important area that needs regulators' attention and review as it has some conflicts of interests. The funds, not belonging to IBIs, may be used for their benefits. Unnecessary delay in distribution of amounts available in charity funds (a period of two years), creates serious doubts and addressable concerns. Therefore, situation needs policy review, whether to continue with the current practice i.e. to be maintained by IBIs or to consider setting up a separate independent and national level fund to collect and manage such charity amounts in more prudent, effective and useful heads. This write-up addresses this issue and proposes a third party arrangement to manage such charity funds.  Author: Ahmed Munir Ahmed Mansuri, working in Central Bank of Oman, as senior banking officer, Islamic Banking Department. Worked as Head of Sharia Division, Islamic Banking Department, State Bank of Pakistan and as visiting faculty in various higher education institutions. Provided training to employees of local and other banks. E-mail: munirl957@yahoo.com
2. Charity funds in Islamic Banking Institutions (IBI)April - A Conflicting Policy Journal of Islamic Banking and Finance – June 2019 49 Keywords: Charity Fund, Islamic Banks, Shariah Supervisory Boards, Shari’ah Compliance, Corporate Governance 1. Introduction Islamic banking is unique in its nature and different from its interest based conventional counterpart in all aspects including objective, concept, basis, and practices.  As an instrument of Islamic economic system, Islamic banking is supposed to work for the achievement of overall goals of the Islamic economic system. On the top of these objectives is a fair distribution of wealth and resources among all members of the society (concentration of resources in few hands is undesired in the Islamic way of economic life).  The Islamic banking designed with a view to save the society from evil exploitative effects of Riba (interest). Islamic banking is based on the concept of sharing risks and rewards and undertaking productive economic and business activities to earn through Sharia permissible modes/operations. Its basis is compliance with Sharia principles and rules. Practices include offering Sharia permissible, liability and asset side, banking services including deposits and financing facilities (and investment banking services). In order to ensure all aspects mentioned above, all relevant authorities (including government and regulators) are required to play their desired roles. Government is to pave the way by formulating the laws and regulators to develop required regulatory frameworks. Desired objectives can only be achieved if the roles and responsibilities of all relevant institutions are defined properly and played effectively, with full commitment at all levels. Islamic banking being in practice for last about more than four decades needs a thorough review of its all aspects. Though undertaken under the banner of faith/Sharia sensitive stakeholders seem not yet convinced of its Islamicity. The system seems to be serving the objectives of the conventional economic system i.e. the capitalism so far. Streamlining the IB policies, operations and products and services with desired objectives is required. 2. A Regulatory Policy that Needs Reconsideration The objective of this write up is to divert the attention of authorities towards an important “mis-taken” policy decision by the regulators i.e. creation and management of Charity Fund by Islamic Banking Institutions. 2.1 Need for Charity Fund Contrary to interest-based loans, Sharia does not allow any addition on debt/loan when paid back/repaid. Two types of earnings of Islamic Banking activities cannot constitute income of an Islamic banking or financial institution i.e. i) income from Shari’a non-compliant sources
3. Journal of Islamic Banking and Finance April – June 2019 50 and ii) charity (as penalties and late payment charges) received from clients in default or overdue cases etc. i. There is a possibility of Shari’a non-compliance while undertaking Islamic banking activities/operations by an IBI. As a result, the deal may become void or defective (‫)ﺑﺎﻃﻞ أو ﻓﺎﺳﺪ‬. In case of defective or partial non Sharia-compliance, a part of income and in case of the void, total income generated through such activities is treated Haram (non-permissible). 2. Delay or default by the customer in payment of (debt) dues of banks is a common practice. Conventional interest based banks charge interest for the delayed period (while IBIs cannot charge any extra amount over and above the actual amount of debt/loan as Sharia does not allow any addition on debt/loan when paid back/repaid if not paid in time.). If there is no deterrent, IBI customers will be advantageous in case of delay or default and the bank will suffer. 3. In order to ensure timely payment/repayments of debt (without getting the advantage of the time value of money) in such cases, was resolved by the Sharia scholars by suggesting to put a penalty clause in the contract (between bank and customer). The stipulation allows the IBI to recover from the customer an amount calculated at a predetermined percentage per day or per annum as a compulsory contribution to charity fund(‫ )ﺻﺪﻗﺔ‬constituted by the IBI. As per regulatory instructions, this contribution (‫ )ﺻﺪﻗﺔ‬to charity fund should not be treated as income of the IBI. (It is stated further that IBIs can approach competent courts for the award of damages, if any, at the discretion of the courts, determined on the basis of direct and indirect costs incurred, other than opportunity cost). In compliance with regulatory instructions Islamic Banking Institutions create and maintain a Charity Fund in which income from Shari’a non-compliant sources or penalties and late payment charges received from clients in default or overdue cases etc. The instructions issued by the regulators with regard to Charity Funds generally include the following: i. Sharia Supervisory Boards are made responsible to supervise the inflows and outflows of the Charity Fund. ii. IBIs are instructed to deposit the funds available in Charity funds in a Shari’a compliant remunerative account at the discretion of the Shari’aboard/advisor. iii. As a rule, the amount in charity Fund has to be utilized for charitable and social welfare purposes in accordance with the policy devised by the iv. iv. In order to avoid misuse and conflicts of interests Ibis should ensure that no amount of charity fund is directed to or utilized by persons or institutions
4. Charity funds in Islamic Banking Institutions (IBI) April - A Conflicting Policy Journal of Islamic Banking and Finance – June 2019 51 directly or indirectly connected with the IBI, its Management, the Board of Directors, the SSB members and spouses and dependents. v. IBIs are required to maintain proper accounts and records regarding all transactions relating to the Charity Fund and to disclose the inflows and outflows of the Charity Fund in their annual reports. vi. IBIs are required to utilize the amounts available in the Charity Fund within the same accounting year (i.e. 12 months) and further relaxed for a period of another year. Effectively a period of two years is given generally to keep sadaqah amounts in the bank. Creation of such charity fund is essential in view of the having a deterrent to avoid undue delays in payments by the customers and to utilize income from Sharia noncompliant transactions of IBIs. However, the management of this fund with IBI may have many concerns/repercussions. It is for consideration of the regulators/authorities to revisit their said policy on the following ground: a. First- the amount in charity fund does not belong to IBIs and are not for (and should never) be for the benefit of IBIs (in any way). b. The sources of this Fund include i) income from Shari’a non-compliant sources and ii) charity as penalties and late payment charges received from clients in default or overdue cases etc. c. Secondly-possibility of conflict of interests in this arrangement should not be disregarded, in view of the following: i. In order to avoid misuse and conflicts of interests, regulators assign the responsibility of ensuring compliance to IBIs, which has no rationale. Individual financial interests may affect the integrity of the staff, though may not be a question in general. Policies on conflicting arrangements should be developed/adopted carefully. Interests of staff dealing with charity fund or Sharia compliance and members of SSBs are attached with IBI in the form of salaries, fringe and other benefits. They may compromise matters in consideration of banking business growth to add to their benefits. ii. This view is based on the observations during the past two decades. Business promotion seems to be the focus and general approach of SSBs in decision making during the history of its past around two decades of practice, instead of caring for objectives of Sharia. Review of Islamic banking products depicts the compliance level of SSBs’ Fatawa with objectives of Sharia. In most of the cases Sharia objectives seem to be compromised while approving banking products and services. Whether agreed or not, based on some genuine grounds, there is a general mistrust of people on Islamic banking practices and products. It includes SSBs compromising role and approach in reviewing and approving Islamic banking products. Decisions of SSBs
5. Journal of Islamic Banking and Finance April – June 2019 52 on Commodity Murabaha, Sale and Lease back or buy back, fixed rate based Wakalah, the widespread use of expected rates of returns/profits (on deposits and investments) to follow conventional fixed rate approach are some examples where objectives of sharia seem clearly to be compromised. There is always a possibility that interests of decision makers may influence/affect fatwa and decision on declaring an economic activity “Sharia compliant” or “Sharia noncompliant”. a. Assigning the responsibility to manage collection and distribution of such amounts to IBIs is an extra burden. To perform this extra function, IBIs need extra efforts and staff. This adds certainly to their costs, which ultimately affects their profits. i. It is required from IBIs to ensure that no amount of charity fund is directed to or utilized by persons or institutions directly or indirectly connected with the IBI, its Management, the Board of Directors, the SSB members and spouses and dependents. However, there is a possibility that the above requirement avoided in the name of larger business interests of the bank. Use of these funds by IBIs for their publicity, attract deposits, and promote a business cannot be ignored. Possibilities of conditional waivers, by the bank, on payment of late payment charges may dilute the original idea behind introducing this requirement. It is observed that IBIs indirectly use these funds in their benefits. Distribution of charity fund amounts is used in publicity campaign as an act of kindness to the society. b. IBIs are required to deposit the funds available in Charity funds, in a remunerative account (the position of IBI may be of a Mudarib or Wakeel of Charity Fund). IBIs generally do not follow this regulatory instruction. c. There is no proper reliable mechanism to check conflicts of interests and undue and unwanted favors, despite the IBIs are required to maintain proper accounts and records regarding all transactions relating to the Charity Fund and to disclose the inflows and outflows. As a rule, IBIs are required to utilize the amounts available in the Charity Fund within the same accounting year (i.e. 12 months) and further relaxed for a period of another year. However effectively a period of two years is given generally to keep sadaqa amounts in the bank. Why IBIs need two years to distribute sadaqa, is surprising. Giving a period of two years to IBI for distribution of these amounts finds no justification. Keeping the amounts under their control of IBIs seems not advantage-free. 3. Conclusion and Recommendations Charity funds collected and managed by banks themselves are prone to misuses (managed by IBIs-total prudent use seems not possible).Heads of outflows are generally non-productive (charitable institutions and Madaris may use these funds for a timely need like food and clothing etc.)
6. Charity funds Journal in Islamic of Islamic Banking Banking Institutions and Finance (IBI) -April A Conflicting – June 2019 Policy 53 In order to avoid any concerns, including Shari’ah and conflicts of interests, the authorities, especially the regulatory bodies, should revisit their current policy with respect to the creation and maintenance of charity funds by IBIs. Instead, a national level separate, independent and the well-organized fund can be set up for this purpose. The central bank or ministry of religious affairs can manage the proposed fund or it may work as totally an independent central body. With the same sources of funds and objectives, independent management including non-aligned ulema and persons of good repute from other fields can be appointed to run the Fund. In order to get a better image and best results and to avoid conflicts of interests, the Fund should not include any one of the staff, management or SSB members of any IBI/IFI in its management. The country is in need of dams to overcome water shortage in the country. These funds, in consultation with the ulema, can also be considered to be used for the great common national interest. Proper, prudent and more productive use of funds can be ensured through proposed independent “Fund” management. The government may use these funds in long lasting projects for the benefits of the public like the construction of dams, development of national level productive projects, hospitals and educational institutions in under developed areas. Bibliography Farook, S., Kabir Hassan, M., &Lanis, R. (2011). Determinants of corporate social responsibility disclosure: The case of Islamic banks. Journal of Islamic Accounting and Business Research, 2(2), 114-141. Hassan, A., & Salma Binti Abdul Latiff, H. (2009). Corporate social responsibility of Islamic financial institutions and businesses: Optimizing charity value. Humanomics, 25(3), 177-188. Maali, B., Casson, P., & Napier, C. (2006). Social reporting by Islamic banks. Abacus, 42(2), 266-289. Mohammad, M. T. S. H. (2011). Towards an Islamic social (waqf) bank. International Journal of Trade, Economics and Finance, 2(5), 381.