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Development in Islamic Banking: a Financial Risk-Allocation Approach

During the recent years, Islamic economic system has gained an increased development. For instance, banking system has adopted a mechanism based on the principles of borrowing, lending and investment. As a result, the article analyzes the recent development of Islamic banking system, its peculiarities and challenges (Khan & Bhatti, 2008).

The process of the establishment of Islamic banking system began in the middle of the 1940s. Great amount of banks in the Middle East appeared under the influence of the influx of petrodollars, which took place at the end of 1970s. In addition, due to the favorable socio-economic conditions, such as high international oil prices, the banking system has become one of the fastest growing elements of the financial sector of the Middle East countries. Therefore, in 2006, there were approximately 300 Islamic banks worldwide that possessed capital investments of 800 billion dollars. During the last decade, Islamic banking infrastructure has also received its development. As a result, among the biggest hubs of Islamic banking system, there are Bahrain and Malaysia. Finally, Islamic banking is being integrated into the European and Western markets (Khan & Bhatti, 2008).

Islamic banking paradigm has a number of peculiarities. For instance, it is based on the equity, that features zero-based interest, share economy, equal participation, and existence of joint ventures and mutual funds. In addition, interest based intermediation is replaced with the profit and loss sharing, as well as interest-free intermediation. On the contrary to the conventional criteria of the funding, Islamic model is not based on the borrowers’ creditworthiness. The existing wealth is utilized in order to produce more wealth, goods, and services. Finally, Islamic players conduct business activities with weaker partners to support the small and medium enterprises and ensure sustainable economic growth. There are also charitable funds that support the disadvantaged groups.

Islamic banking system is based on the instruments of “mudarabah (joint venture), musharakah (equity participation), murabaha (deferred payment sale), ijarah (leasing), bai salam (advance payment) and bai istisna (procurement engagement)” (Khan & Bhatti, 2008). All those instruments are aimed at the elimination of the interest from the banking system and economy in general. According to mudarabah banking, a bank receives funds from the depositors on the basis of the risk-sharing arrangements. According to musharakah instruments, a bank provides the depositors’ funds to a joint enterprise with the client, who can conduct all the activities. Murabaha foresees the appliance of the process of buying particular goods from a bank by a client. A bank initially receives goods from the supplier and after adding profit margin sells goods to a client. However, the instrument violates the religious principles of Islam. Ijarah instruments reflect traditional lease financing, but the leaser is also responsible for the damage and repair of the leased asset. Bai salam and bai istisna instruments determine that a seller has to pay in advance for the delivered goods.

Despite rapid development, the Islamic banking system faces a number of problems. among the most serious issues, that have to be addressed, there are as excess liquidity, lack of experts and human resources in the banking sphere, prevalence of various accounting standards, inadequate risk management, shortage of corporate governance, as well as absence of research and development activities.

Do Islamic Societies Need their Own Accounting and Reporting Standards?

Traditionally, Islamic economy has experienced an influence of ta number of peculiarities during its development, different form the Western economic model. As a result, Islamic economy has gained a number of peculiarities, including the absence of interest in business transactions and presence of charity shares. Consequently, there is a necessity to develop accounting and reporting standards suitable for Islamic environment.

According to the Quran, interest and usury are prohibited, because of their exploitation nature, concentration of wealth in the hands of few, and possible damage to the society. That is why the attitude towards appliance of the interest in the Islamic economy varies. It is determined by the fact that modern economy is largely based on the interest, such as private ownership, that facilitates economic development and contributes to the establishment of the productive sectors. As a result, if the usage of interest is prohibited under Islamic laws, its appliance should be driven to a minimum. At the same time, Islamic businesses are encouraged to conduct activities with the international community. Moreover, competition between the companies is allowed in order to provide the benefits to the consumers.

The main goal of the accounting and reporting standards is to social and economic costs of assessing the alternatives. Islamic reporting standards include the cost-based methods such as the preparation of the profit and loss statement, balance sheet, and statement of cash flows. The differences between Islamic and Western standards include the presence in Islamic economy several categories, such as the obligation to pay the poor or appliance of a non-interest-bearing loan for charity. Thus, there is a necessity in the development of the policies that best accommodate the interests of the players of the economy, with the minimum cost involved. In Islamic economy, trade operations are mainly conducted through the instruments of contracts (Mirza & Baydoun, 1999).

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Accounting and reporting system has to meet religious requirements of Islam, as well as provide Islamic companies an opportunity to interact with other international players. Accounting and reporting standards have to be broad and flexible. Complex systems are more likely to impose additional expenses on businesses. In addition, the standards have to be aimed at reflecting contracting environments and providing information about socio-economic developments. The analysis of the company’s activities has to include the information on the financial operations, current matter of state, and the historic development of the financial policies. According to the position, disclosed in the article, the most suitable method of the accounting standards for Islamic economy is the historical cost accounting (Mirza & Baydoun, 1999). Thus, the article underlines the necessity of the development of the accounting and reporting standards that reflect the peculiarities of Islamic economy and society.

Islamic Corporate Reports

The article underlines that the religion plays a significant role in the development of Islamic economy. At the same time, some of the Islamic societies adopt Western economic traditions. As a result, there is a necessity of the development of the financial statement that will reflect Islamic values, known as Islamic corporate reports (ICRs). Among the religious impact on Islamic economy and development of businesses, there are the lack of the distinction between secular and religious spheres, the prohibition of interest and usury and its influence on the business organizations, importance of the obligation to support poor.

One of the key concepts that has to be excluded from the Islamic accounting theory is the time value of money. In addition, Western and Islamic traditions use different approaches towards the accounting systems. As a result, the Islamic corporate report is based on a number of determining features such as the prevalence of religion in socio-economic life, providing of equal opportunities for the businesses, adherence to the gaining of reasonable profit instead of maximization of profit, ensuring of full disclosure in order to satisfy every demand for information, and increased focusing on the community, which participates in economic activities (Baydoun & Willett, 2000).

As a result, the article provides an opinion that the Islamic corporate report should have a number of peculiarities. First, ICRs should encompass value balance sheet as well as historic cost balance sheet. Second, an income statement has to be replaced by a value-added statement. Third, in order to describe Islamic economic environment, certain processes and features, such as zakat and qard, have to be included into the corporate reports. As the Islamic economy is based on the principles of equity and full disclosure, ICRs have to include cash flow statements. Finally, ICRs should meet the requirements of the religion and social philosophy.

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