Principles of Islamic banking and finance/PIBF202/Structure and operations/Role of AAOIFI

Bahrain and Malaysia were the two countries that were relatively more active to create a niche and leading role in the growth of Islamic banking industry. Bahrain agreed to home Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). This premier organization was established in accordance with the Agreement of Association that was signed by Islamic financial institutions on 26 February 1990 in Algiers. It was registered on 27 March 1991 in the State of Bahrain. Its mission is “Standardization and harmonization of international Islamic finance practices and financial reporting in accordance to sharia”. The Islamic Financial Services Board (IFSB), which is based in Kuala Lumpur, was officially inaugurated on 3 November 2002 and started operations on 10 March 2003. Malaysia, the host country of the IFSB, has enacted a law known as the Islamic Financial Services Board Act 2002, which gives the IFSB the immunities and privileges that are usually granted to international organizations and diplomatic missions. In this section, we will discuss the role and achievements of AAOIFI in the growth and expansion of Islamic finance industry.

AAOIFI

"AAOIFI, established in 1991 and based in Bahrain, is the leading international not-for-profit organization primarily responsible for development and issuance of standards for the global Islamic finance industry. Amongst its most remarkable achievements is the issuance of 94 standards, so far, in the areas of Shari’ah, accounting, auditing, ethics and governance. Its standards are adopted by central banks and regulatory authorities in a number of countries, either on a mandatory basis or as basis of guidelines. AAOIFI is supported by numbers of institutional members, including central banks and regulatory authorities, financial institutions, accounting and auditing firms, and legal firms, from over 45 countries. Its standards are currently followed by the leading Islamic financial institutions across the world and have introduced a progressive degree of harmonization of international Islamic finance practices."

The Genral Assembly of AAOFI is the highest authority of the organization which consists of all participating members currently numbering around 200. The General Assembly is composed of all founding, associate, supporting and observing members and regulatory and supervisory authorities of different member countries. It selects the members of Board of Trustees consisting of 19 members mainly representing AAOIFI institutional members.

1. Up to ten members representing Islamic financial institutions, including a maximum of five from the founding members and those who exercise the same rights as the founding members.

2. Up to two practicing members in accounting and auditing whose professional work relates to Islamic financial institutions. One member from the users of financial statements of Islamic financial institutions.

3. Up to three members representing regulatory and supervisory authorities referred to in paragraph 3/3 of Article 3 of this Statute.

5 Up to two members from Shari’ah Fiqh.

The crucial job of the Board is the appointment of AAOIFI’s standards boards – i.e.

1. Shari’ah Board,

2. Accounting and Auditing Standards Board,

3. Governance and Ethics Standards Board.

The members of these different boards are allowed to do their work independently. Neither the Board of Trustees nor any of its sub-committees including the Executive Committee, interferes directly or indirectly in the work of the above Boards of AAOIFI or direct them in any manner.

Shari'ah Board

In order to ensure representation of all sectors within the Islamic finance industry, and to diversify backgrounds and experiences of board members, the composition of the ASB is as follows:

Up to 12 members who also serve on Shari’ah Supervisory Boards of Islamic financial institutions.

At least 3 members who do not serve any Islamic financial institution in any capacity – over the nominating period and for the entire term of the board – but may serve central banks, regulatory authorities, governmental bodies, or not-for-profit organisations.

Accounting Board

In order to ensure representation of all sectors within the Islamic finance industry, and to diversify backgrounds and experiences of board members, the composition of the new AAB comprises:

1. Up to 4 members representing Islamic financial institutions (commercial banks, investment banks, insurance, financing companies, etc.).

2. Up to 4 members representing accounting and auditing firms.

3. Up to 3 members representing central banks and regulatory authorities. At least 1 member representing academicians (universities and educational institutions).

4. Up to 3 members representing national accounting boards, national accounting or auditing professionals’ bodies, national stock exchanges, and international or multilateral organisations.

5. No more than 2 members from the same accounting and auditing firms, or same institutions –including subsidiaries and affiliates– regardless of the sector being represented.

Governance and Ethics Board

In order to ensure representation of all sectors within the Islamic finance industry, and to diversify backgrounds and experiences of board members, the composition of the new AGEB comprises:

1. At least 5 members representing Islamic financial institutions (commercial banks, investment banks, insurance, financing companies, etc.).

2. Up to 5 members representing accounting and auditing firms, and professionals in the field of governance, risk management, compliance (GRC).

3. Up to 3 members representing central banks, regulatory authorities, and international or multilateral organisations (such as the World Bank, IMF, IFSB, etc.).

4. At least 1 member who is a Shari’ah scholar (and does not serve at the same time on AAOIFI Shari’ah Board).

5. At least 1 member representing academicians (universities and educational institutions).

Standards Development and Revision Processes

In carrying out the standards development and revision processes of AAOIFI standards, the relevant standards board will be working with AAOIFI General Secretariat and, if deemed necessary, external consultants. The relevant standards board may also form committees or working groups, in coordination with the General Secretariat, to assist with the board’s work programs.

Such committees or working groups may comprise representatives of the relevant standards boards together with other representatives of the international Islamic finance industry stakeholders.

The standards development and revision processes can be summarised as follows:

(a) Work program or agenda

The relevant standards board, in coordination with the General Secretariat, will draw up a tentative work program or agenda to include potential new standard to be developed, or existing standard to be reviewed. In preparing the work program or agenda, suggestions and feedback from the international Islamic finance industry as well as members of AAOIFI standards boards will be collated. The work program or agenda is to be updated whenever necessary.

(b) Preliminary study or research

When a new standard is to be developed, or an existing standard to be reviewed, a preliminary study or research will be prepared. The preparer of the preliminary study or research may be members of the General Secretariat or/and external consultant/s.

The preliminary study or research is subject to discussions with the relevant committee or working group (if applicable) and the relevant standards board.

(c) Consultation note

Subsequent to the preliminary study or research, a consultation note will be prepared by members of the General Secretariat or/and external consultant/s to give include an outline on proposed major points of a new standard, or proposed major changes to an existing standard.

The consultation note is subject to discussions with the relevant committee or working group (if applicable) and the relevant standards board.

When the relevant standards board has agreed with the consultation note, it will then be released to the international Islamic finance industry and beyond, for comments and suggestions. The consultation note may also be submitted to technical workshops, public hearing meetings or/and similar forum.

Comments and suggestions received will need to be considered when developing an exposure draft of the standard.

(d) Exposure draft

Subsequent to the consultation note, an exposure draft of a new or revised standard will be prepared by members of the General Secretariat or/and external consultant/s. The exposure draft shall be prepared in the same format as a final standard.

The exposure draft is subject to discussions with the relevant committee or working group (if applicable) and the relevant standards board.

When the relevant standards board has agreed with the exposure draft, it will then be released to the international Islamic finance industry and beyond, for comments and suggestions. The consultation note will also be submitted to technical workshops, public hearing meetings or/and similar forum.

Comments and suggestions received will need to be considered when updating the exposure draft (which may be subject to further discussions with the industry) and when developing the final standard.

(e) Final standard

Subsequent to the exposure draft, a final new or revised standard will be prepared.

The final standard is subject to discussions with the relevant committee or working group (if applicable), and approval by the relevant standards board.

Upon approval by the relevant standards board, the final standard is then issued to the international Islamic finance industry and considered binding (taking into account effective date of the standard).

Announcement on the issuance of the standard will be made, amongst others, through press releases and on AAOIFI website.

It should be noted that all issued standards are subject to continuous review. Revision to the standards will be carried out, through the above processes, as and when necessary.

Compliance with AAOIFI Regulations

The standards issued by AAOIFI are not binding and the degree their implementation depends on the directives given by the competent authorities of the member countries such as central banks. Some countries, Pakistan and Malaysia for example, have shown more seriousness in this regard. The shari'ah standards may remain somewhat controversial due to the supremacy of a particular school of thought in a member country although there seems to be a movement towards uniformity even if the process is slow.

As for accounting standards, some academics have criticized the approach adopted by AAOIFI. AAOIFI establishes Islamic accounting standards by testing the current concepts in conventional accounting against shariah. However, some scholars prefer the use of normative-deductive approach i.e., all concepts and objectives of accounting should be in accordance to shariah principles. Indeed the approach taken by AAOIFI is much easier and not entirely incorrect. For example, Sulaiman (2003) supports the normative-deductive approach arguing that Islam has its own unique requirements and rules and that that the objectives of Islamic accounting are quite different from that of the conventional accounting, making the latter less relevant to IFIs. However, she also clarifies that Muslims should not reject everything from the West as long as it adheres to the shariah. AAOIFI believed that not all conventional accounting issues violate the shariah requirements (Napier; 2007). By using this approach, the AAOIFI is considering the methods being used in the conventional accounting and is deciding whether the concepts are against the Islamic requirements. Only if the concepts are not available in the conventional systems or contradict with the Islamic tenets, then, the AAOFI would develop a new suitable method. .

The AAOIFI triggered controversy in 2008 when it claimed that more than 80% of sukuk (Islamic bonds) issued did not comply with Sharia principles and tightened the standards that sukuk must meet to comply with Sharia. However, despite this announcement sukuk are still being issued that may not comply with their strict standards. .

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