Shariah Compliance Framework at Meezan Bank Limited

Shariah Compliance Framework at Meezan Bank Limited Ahmed Ali Siddiqui Executive Vice President Meezan Bank Limited +92-300-2178738 Suleman Muhammad Ali Vice President Meezan Bank Limited +92-300-2762632 Product Development & Shariah Compliance

Outline Islamic Banking in Pakistan Evolution of Meezan Bank Shariah Compliance Framework at MBL

Islamic Banking in Pakistan: A Success Story

Highlights of Islamic Banking in Pakistan Conventional Banking interest declared haram by Shariat Appellate Bench of Supreme court of Pakistan in a historic decision in 1999. SBP Islamic Banking Department was established on 15 th September 2003. Separate Shariah Board of the Central Bank Fit & Proper Criteria for Shariah Advisor Targeted share in first five year strategic plan achieved. Second 5 Year Strategic Plan issued by the Central bank for the year 2013-2017

Introduction of Islamic Export Refinance (Musharakah based) Long Term Financing Facility under the mode of Mudarabah to be launched by SBP Shariah Compliance Guidelines issued by IBD SBP Standardized Shariah Governing Framework for IBIs Issuance of Shariah Standards for Sharikat ul Milk and Diminishing Musharakah in 2013 Specific Pool Management Guidelines for IBIs

Amendments in Financial Reporting for Islamic Banks Adoption of AAOIFI Standard New Accounting Entries for Islamic Modes of Financing Adoption of AAOIFI Shariah Standards for Murabaha Ijarah Istisna GoP Ijarah Sukuk is currently worth approximately PKR 300 Billion

Key Statistics Market Share Approx. 10% Total Deposits 706 Billion Total Assets 837 Billion Total Financing & Investment 626 Billion Annual Deposit Growth Rate 59.6% Full Fledged Islamic Banks 5 Islamic Banking Windows 18 * Source: State Bank Islamic Banking Bulletin

Islamic Banking Branches

Islamic Banking Growth Trend Growth of Market Share for Islamic banks 12 10 10 % of Total banking 8 6 4 3.8 4.8 5.9 7.2 8.4 2 0 2007 2008 2009 2010 2011 2012

Deposit Growth of Islamic Banking Deposit growth of Islamic banking 800 706 700 Amount in billions of Rupees 600 500 390 521 Deposit 400 283 300 200 100 147 202 0 Years 2007 2008 2009 2010 2011 2012

Islamic Banking Vs Conventional Banking

MEEZAN BANK LIMITED Premier Islamic Bank

Evolution of Meezan Bank In 1997 Al-Meezan Investment Bank was established as the first Islamic Investment bank in Pakistan. In 2001 the Shariah Supervisory Board was established at Al-Meezan Investment Bank led by Justice (Retd.) Muhammad Taqi Usmani as chairman. In 2002 Meezan Bank acquired the Pakistan operations of Societe Generale and concurrently Al Meezan Investment Bank converted itself into a full fledged Islamic commercial bank.

In 2003 Meezan Bank establishes itself as the pioneer of Islamic Banking in Pakistan and quickly establishes branches in all major cities of the country. In 2005 Meezan Bank becomes the first customer of Takaful in the country Auto Finance Industry leader with more Rs 5 bn automobiles

Developed and launched Sukuks under various Structures: Airtime based Sukuk Shirkatul Aqd based Sukuk Diminishing Musharakah Sukuk Istisna Wakala based Sukuk Hybrid Sukuk (Musharakah- Wakalah- Ijarah) Project Finanicng Sukuk based Wakalah & Ijarah

325 300 275 250 8 th Largest banking network in Pakistan 21% 10% 24% 275 12% 310 Numbers 225 200 175 150 121% 61% 66% 166 201 222 125 100 60% 75% 100 75 50 25 0 67% 62 28 6 10 16 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Rupees in millions 240,000 220,000 200,000 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 - Deposits 12 th Largest (deposit wise) Bank in Pakistan 53% 5,079 7,757 78% 13,770 65% 22,769 51% 34,449 58% 54,582 29% 70,234 43% 100,295 31% 131,070 30% 170,030 35% 230,413 2 0 1 1 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Rupees in millions 3,800 3,600 3,400 3,200 3,000 2,800 2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 - Profit After Tax 61% 1,650 44% 59% 65% 87% 963 1,025 5% (4%) (35%) 604 621 419 223 214 224 106% 3% 3,391 3,508 Estimated Budget 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Market Share Islamic Windows of Conventional Banks 30% Meezan Bank 33% Other Islamic Banks 37%

Shariah Compliance Framework at MBL

Product Development & Shariah Compliance (PDSC) MBL has one of the largest Product development and Shariah compliance departments in the region The mandate of PDSC department is to ensure Shariah compliance through research, innovation, audit and Shariah trainings.

Product Development & Shariah Compliance (PDSC) PDSC department is divided into following functional segments/ clusters: Product Structuring and Research Shariah Compliance Shariah Audit Product and Shariah Training Charity Management

Product Development & Shariah Compliance (PDSC) Shariah Supervisory Board Total Strength of the department: Approx 35 Shariah Advisor Head of PDSC Retail Product Development Product Structuring and Research Shariah Compliance Function Shariah Audit Shariah Training Charity Management 5 members 7 members 16 members 4 members 2 members

Product Structuring and Research

Product Structuring & Research (PSR) The objective, scope and mandate of PSR is as follows: Develop financial products and services to fulfill previously unfulfilled financial needs as per shariah guidelines Refine, modify and redefine existing financial products Provide custom made shariah compliant financial solutions to Corporate, Commercial and SME clients Develop Liquidity management and treasury related products

Product Structuring & Research (PSR) Product developments is done at MBL keeping in mind the following parameters: Customer s business cycle Tenure (short term or long term) Existing alternatives present in the market Rate of financing (fixed or variable) Payment flexibility (possibility of early repayment) Tax concerns Accounting treatment Regulatory aspect Risk mitigation measures Mode and nature of the Assets involved Basic Shariah Principles

Product Structuring & Research (PSR) Once the idea and the structure of a new product is finalized the same is presented before the Shariah Advisor. The Shariah Advisor may either approves, declines or suggests modification in the product. In some cases the shariah advisor may not approve or decline the product but rather give instructions for the presentation of the same in the next Shariah Supervisory Board (SSB) meeting The SSB will then take the final decision on the product.

Shariah Compliance

Shariah Compliance Function (SCF) The objective, scope and mandate of the SCF function is to ensure and monitor Shariah compliance related to: Corporate, Commercial and SME financings/assets of MBL. Investment banking transactions related to sukuk, syndicated financings. Funding, Financing, Investment, Foreign Exchange related as well as other activities conducted by the Treasury department of the bank. Deposit products and profit distribution. Other policies and procedures of the bank for instance related to HR, Marketing, Admin, etc.

Shariah Compliance Function (SCF) SCF ensures Shariah Compliance through the following major operational tasks: Shariah Compliance Review Coordination with SSB Development of bank wide policies, procedures an guidelines for ensuring Shariah compliance. Shariah Training

Shariah Compliance Function (SCF) SHARIAH COMPLIANCE FUNCTION CREDIT PROPOSAL REVIEW INDUSTRY VISITS/MEETING WITH CLIENTS PROCESS FLOW REVIEW DELAYED DECLARATION REVIEW (DDR ) FORTNIGHTLY MURABHA REVIEW THR OUGH MURABAHA MONITORING SHEETS(MMS) PAYMENT MODE REVIEW

Shariah Compliance Review (SCR) Step 1 Every financing proposal related to the following areas is required to go through the SCR by PDSC before offering the facility to the customer: SCRof Financing limits for Corporate/SME/Commercial Clients SCR of restructuring transactions, takaful claim settlement, enforcement of security, court settlements and other issues SCR of Guarantees SCR of Trade Finance SCR of Charity Claims SCR of Sukuk and Syndications SCR of Treasury

Shariah Compliance Review At the time of initial Limit approval Shariah Suitability Review is conducted with the focus to conclude whether the proposed products are feasible in terms of ensuring shariah compliance The review is done keeping in mind the following characteristics: Nature of financing requirement Nature of Assets Customer business process Inventory Holding Period of assets Storage capacity of Customer Risk transfer mechanism of industry Cash flow cycle of customer. Nature of Customer s business: Retailer, Wholesaler, Manufacturer, Vertically integrated group etc. Other customer specific information.

Shariah Compliance Review The details of the characteristics above mentioned are retrieved through following methods: Reviewing Nature of Business of Customer Tenure of Facility Discussion with RM Discussion with Customer Industry Knowledge Upon this review if PDSC holds the opinion that facilities proposed in the credit proposal are not practical as per Shariah based on the criteria mentioned above, then PDSC will not approve the limit and will propose a different solution/product to the Business unit.

Shariah Compliance Review Step 2 After the initial review a Product Specific Review (PSR) is conducted for each product for which a limit is proposed in the credit approval The objective of PSR is to devise a mechanism/ guideline/ process flow for fulfilling customer s financing need while adhering to the requirements of Shariah taking into consideration the customer s business characteristics. Process flows are designed of each mode used to provide financing keeping in mind the Business Processes of the customer.

Shariah Compliance Review For each customer a separate Process Flow is devised. Hence Murabaha Process Flow for a textile concern will be different from that designed for sugar mill, leather tannery, fibre producer, power station, etc.

Shariah Compliance Review In case of Murabaha Shariah Compliance is ensured by keeping the following checks: Direct Payment to Suppliers Minimum gap between disbursement and payment to suppliers Declaration to be made within the completion of Minimum Inventory Holding Period Separate identification and storage of goods Invoices to be issued in the name of MBL Receipt of Goods Receiving Evidence Telephonic and Physical verification Purchase, production and sale cycle.

Shariah Compliance In case of Istisna/ Tijarah Shariah Compliance is ensured by keeping the following checks: Proper specification of goods is mentioned in the written offer GRN to be executed for the same specification of goods as mentioned in the written offer Settlement to be done only through actual sale proceeds Physical inspection of goods to be done at the delivery Proper identification of goods to be done at the time of delivery Separate storage of istisna goods before sale to third party Purchase, production and sale cycle

Shariah Compliance In case of DM/ Ijarah Shariah Compliance is ensured by keeping the following checks: Proper identification of Musharakah/Ijarah Assets Asset price to be ascertained through revaluation before disbursement Asset tagging through stickers or plates to be done on Musharakah/Ijarah Assets SLB transactions are allowed only in exceptional cases where proper justification is provided

Shariah Compliance Review- Step 3 After the Product Specific Review (PSR) is completed and transaction process flow is finalised, Business units are given a go ahead for the execution of the process flow. Each year an Annual Review is done of all the financing customers to whom any financing facility is offered. Transactional documents are reviewed of randomly selected transactions in order to ensure shariah compliance In 2012 approximately around 1300 financing proposals were reviewed by the Shariah Compliance team.

Shariah Compliance Review In case of Murabaha following documents are reviewed Latest Account Statement PDSC approved Process Flow Murabaha Monitoring Sheet (MMS) Order Form Declaration and Murabaha Contract Invoices/ Goods Receiving Evidence Payment evidence

Murabaha Monitoring Sheet (MMS) Monthly Murabaha Status Sheet For the Month: March, 2005. Branch : PNSC (Corporate) Report Date CBD NO. Customer Name Subject Matter Payment Mode (Direct / Indirect) Date of Disbursem ent (D) Invoice Date (I) Sub- Decaration Date (S) Maturity Date (M) Tenor / No of Days (M-D) Purchase Gap (I-D) Declaration Gap (S-D) Difference b/w Declaration & Invoice Dates (S-I) Declaration Outstanding CBD-650/05 A Auto Spare pa D 7-Feb-05 8-Feb-05 20-Feb-05 5-Sep-05 210 1 13 12 CBD-650/05 B Sugar cane D 8-Feb-05 9-Feb-05 10-Feb-05 7-Aug-05 180 1 2 1 CBD-650/05 C Cotton D 9-Feb-05 10-Feb-05 11-Feb-05 9-Jun-05 120 1 2 1 CBD-650/05 D Rice D 10-Feb-05 11-Feb-05 12-Feb-05 9-Aug-05 180 1 2 1

Shariah Compliance Review In case of Istisna/ Tijarah following documents are reviewed Last PDSC approved Process Flow Written Offer Goods Receiving Note Notice to Sale Confirmation of sale of Goods

Shariah Compliance Review In case of DM following documents are reviewed Last PDSC approved Process Flow Units Sale Receipt Any other appendices

Shariah Audit

Shariah Audit The objective of Shariah Audit is to ensure execution of transactions as per the guidelines laid out by Product development and Shariah compliance team. The Shariah audit team reports directly to the Shariah Supervisory Board. In the year 2012 Shariah Audit of over 250 branches was conducted Based on the Shariah audit report, branches are assigned ratings

Shariah Audit PRE AUDIT PLANNING AUDIT EXECUTION OPINION FORMATION AUDIT FOLLOW-UP

Shariah Audit 2012 2011 Total No. of Branches in Bank 310 270 Total No. of Branches 270 214 Percentage 87% 79% Excellent 4 4 Above Average 73 63 Average 178 138 Below Average 13 8 Poor 2 NIL

Shariah Audit Once Shariah audit of the branch is completed audit observations are raised. In case of financing branches if an audit observation is raised on transactions of a particular customer, and if those observations are of serious nature with respect to shariah compliance then Charity may be imposed. Based on the seriousness of the audit observations, shariah audit may refer the case to shariah compliance team for the revision of the process flow. Until the process flow is revised no future disbursement may be made.

Product and Shariah Training

Shariah Training The objective of training is to impart Shariah and product knowledge to the employees and customers of the bank so that Shariah Compliance is ensured in each and every transaction. At MBL different modules of trainings are designed in order to cater to different kind of audiences. The period of training may vary from one day to even 4 months based on the complexity of the course. Trainings may be focused on a single product or may cover the entire ambit of Islamic Finance.

Shariah Training S.No Area Specific Training Modules Duration 1 Orientation 2 Day 2 Advance Islamic Finance Course 6 Days 3 Islamic Banker Certification - Level 1 to Level 3 4 Months 4 Murabaha and Trade Finance Products 2 Days 5 Diminishing Musharkah in Commercial Property 1 Day 6 Running Musharakah Half Day 7 Diminishing Musharakah and Ijarah 1 Day 8 Istisna/Tijara Training Module Half Day 9 Shariah Concepts: Treasury & FI Products Half Day 10 Equity Based Modes Training Session: Mudarbah & Musharkah 1 Day 11 Deposit Products Training Module Half Day 12 Basics of Islamic Financial Accounting - AAOIFI Guidelines 1 Day 13 Video Training session 2 Hrs

Shariah Training

External Training

Charity Management

Charity Management At MBL Charity Management is done through Ihsan Trust Ihsan Trust was founded on 7th Day of January 2010 It is basically the operator of Ihsan Trust Fund which is a Waqf made through a separate Waqf Deed

Charity Management Educational & Skill Development Qarz-e-Hasna Rural Development Health & Hygiene Immediate relief to the affectees of any natural disaster/ calamity Rehabilitation and other community building services Establishment and operation of orphanages Providing funds for the marriage of girls from poor families Assist indebted poor people Microfinance

Charity Management The sources of the fund are: Meezan Bank Ltd (Charity account/fund) Al Meezan Mutual Fund Other Islamic Banks Donations Excess funds in the high yielding shariah compliant investments avenues.

Some major highlights Sponsor of IBA s National Talent Hunt Program The Citizens Foundation Intermediate Scholarship Program Qard-e-Hasna Facility at IBA LUMS NUST Business School Agha Khan University Riphah International University International Islamic University

Some major highlights Scholarships given to students to pursue studies in foreign institutions including INCEIF Donations to Hospitals Indus Hospital SIUT Shaukat Khanum memorial cancer hospital Afzaal Memorial Thalassemia Foundation Childrens Cancer Hospital

JazakAllah Ahmed Ali Siddiqui Executive Vice President Meezan Bank Limited +92-300-2178738 Suleman Muhammad Ali Vice President Meezan Bank Limited +92-300-2762632