December 2012 – by Samer Abou Zaghla

AN Islamic Bank Image source: http://islamicbankinginfo.blogspot.com/

Contents

• Background• Products and Services• Financial Highlights• Risk Management • Capital adequacy and BASEL II/IFSB

requirements• Personal Finance – Through SalamMain Source of Information: Bank’s website and Bank’s Financial statements and Annual reports

Background• The purpose of this presentation is to study A Pioneer

Islamic Bank that is considered One of the most important private commercial Islamic Banks since establishment.

• The study will cover the various categories of services and activities undertaken by the bank as an Islamic financial intermediary.

• This analysis, also, examines the relation between the theory of Islamic banking and the real practices and highlights the dichotomies, if any.

• The name of the Bank has been left intentionally anonymous for reasons of privacy protection.

Key Strategies

Retail Banking •Strive to offer a world class services to individual consumers•Product Innovation oriented towards the needs of Bank's customers

Corporate Banking •Focus on trade activities and working capital finance•Alliances with regional and international Islamic institutions

Treasury •Product innovation such as derivatives•Higher quality fixed income book

International Banking

•Penetration across new markets•Explore more corporate banking services for international business

De-risking of Balance Sheet

•Reduce Bank's direct exposure to CRE assets•De- risking Bank's direct equities portfolio

Products and Services

• Personal Banking offers products and services to retail investors and have separate branches for ladies.

• Wealth Management offers Shari’ah Compliant investment management services for HNI and companies.

• Business Banking offers working capital and trade financing to SMEs.

• Corporate Banking offers products and services for large corporates as well as public sector and governments.

• Treasury sector has three main business lines i.e. foreign exchange, Sukuk and Islamic derivatives dealings.

Products &

Services

Funding Products

Non-For-Profit accounts

Retail and Business current accounts:• Current accounts with

regular features attached to them such as: free Cheque book, ATM card, free internet banking…etc.

• No return is payable based on Qard concept

Profit-Sharing accounts (PSIAs)

• Savings accounts: Profits are added on a quarterly basis to the customer balance subject to the maintenance of a minimum balance in local and foreign currencies. Account offers 1.00% profit rate based on Mudharabah.

• Investment Deposit accounts: Flexible deposit tenures of 1, 3, 6, 9 or 12 months with the advantage of automatic roll-over facility. Account offers a variety of profit rates (2.78% - 3.03%) based on Mudharabah.

Financing Products - Retail

• Home Finance – Ijarah based: Under this financing scheme the Bank lets the home to its customer for a rent for a pre-determined period. At the end of the financing period the Bank transfers the ownership title to the Customer. This scheme is used for completed homes.

• Home Finance - Forward Ijarah based: Customers who wish to acquire a property under construction can avail a forward dated Ijarah contract wherein the customer enters into a lease agreement with the Bank for a property to be delivered at a future date. The Bank will take over the developer's payment schedule and all payments will be made directly to the developer over the construction period. The payments to the Bank start after the home is handed over to Customer.

• Property Finance – Murabaha based: In this transaction, the Bank will purchase a land or building and sell it to customer at a pre-agreed profit. In both cases customer can pay the Bank through fixed monthly installments.

Financing Products – Retail cont’d

• Auto-Finance – Murabaha based finance.• Personal Finance – Salam Finance: This product is

based on the Islamic financing structure of Salam, which is a sale contract whereby the purchaser (the Bank) pays the price in advance, and the seller (customer) delivers goods with certain specifications and certain quantity on agreed future dates.

• Personal Finance – Goods Murabaha under this scheme the Bank purchases the goods and sells them to customer on Murabaha basis.

Financing Products – Corporate• Istisna: Istisna is a sales contract whereby The Bank agrees to deliver a

commodity or an asset at a pre-determined future time at an agreed price. Istisna is widely used by Islamic banks and financial institutions to finance the construction of real estate related activity like buildings, warehouses, showrooms, shopping malls, residential towers and villas, as well as manufacturing activity like aircrafts, ships, machines and equipment, etc.

• Ijarah: Ijarah is an effective and practical financing tool allowing businesses to acquire their equipment and machinery through leasing, instead of outright purchase, thus reducing the heavy burden of capital expenditure. The leasing period normally ranges from 3-7 years, with the lessee having the right to purchase the leased asset at the end of the Ijarah period.

• Murabaha: Murabaha is a sale contract that fixes the price of certain goods or items required by a customer, including a pre-agreed profit margin.

Financing Products – Corporate cont’d

• Musharika: is a partnership in which the Bank participates in financing new or existing projects and shares the capital and returns. Alternatively, the Bank may contribute to the ownership of specified assets on a permanent or a non-permanent basis provided that the profit is shared in accordance with an agreement between the Bank and the customer.

• Mudharaba: is a partnership between the Bank and a company for a pre-agreed period. The Bank can invest in either a new or existing company - both parties agree in advance to the percentage profit to be received by the Bank.

• Trade Services: This service covers the issuance of LCs and LGs by the Bank for its customers.

Overall Business Distribution – 1st Half 2012

Total Financing amounted to 53,237 Million

Consumer Banking Financing amounted

to 28,762 million (54%)

Wholesale Banking Financing amounted

to 24,475 million (46%)

Total Deposits amounted to 68,288 Million

Consumer Banking Deposits amounted

to 21,034 million (31%)

Wholesale Banking Deposits amounted

to 47,254 million (69%)

Financial Highlights – Uses of FundsUses of Funds in in '000' 2007 % 2008 % 2009 % 2010 % 2011 %

Cash with Central Bank and other Banks 6,101,377 7% 8,169,644 10% 12,963,869 15% 13,603,756 15% 15,995,415 18%

International Murabahat (short term) 16,279,701 19% 1,640,601 2% 1,204,959 1% 0 0% 0 0%

Islamic Financing and investing assets 40,534,848 48% 52,659,011 62% 49,924,941 59% 57,171,067 64% 51,586,088 57%

Investments 16,336,037 19% 17,515,760 21% 15,511,915 18% 13,150,326 15% 16,931,254 19%

Other assets 4,477,281 5% 4,102,848 5% 4,040,792 5% 5,306,166 6% 5,494,297 6%

Fixed Assets 630,667 1% 668,753 1% 657,795 1% 653,086 1% 581,410 1%

Total Assets 84,359,911 100% 84,756,617 100% 84,304,271 100% 89,884,401 100% 90,588,464 100%

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100,000,000 Assets Structure

Fixed Assets

Other assets

Investments

Islamic Financing and investing assets

International Murabahat (short term)

Cash with Central Bank and other Banks

Financial Highlights – Average Asset CompositionFrom comparing the chart with the Industry averages we can deduce the following:• The Islamic financing and

investing asset forms the biggest portion of the Bank’s assets with an average of 58% of total assets over the five years period in comparison to the industry average of 50%.

• The investments including Islamic Sukuks are forming 18% of the total assets in comparison to 20% as an industry average.

• The liquid assets on average forms 13% over the 5 years period, however it reached 18% in the year of 2011 in comparison to 30% as an industry average.

Cash with Cen-tral

Bank and

other Banks;

13%

Inter-na-

tional Murab

ahat (short term);

5%

Islamic Financing and investing assets; 58%

Investments; 18%

Other assets; 5% Fixed Assets; 1%

Average Composition of the Bank's Assets

2007-2011

Funds Assets15% of total funds:

Shareholders’ equity45% of total funds:

Current accounts30% of total funds:

PSIAs5% of total funds:

Sukuk & other term finance certificates issued

5% of total funds:Reserves Statutory Reserves Profit Equalization

Reserves Investment Risk

Reserves* Source: Dr. Tariqullah Khan’s Material

50% of total assets:RECIEVEABLES FROM FINANCING

70% Murabahah• 15% Istisna’• 10% Ijarah• 5% Others

20% of total assets:INVESTMENT OPERATIONS

• 15%: Portfolio of goods, real estate and durable assets

• 5%: Medium and long-term private investments in company shares

30% of total assets:TREASURY OPERATIONS

Indicative composition of funds and assets of a typical Islamic bank

Financial Highlights – Financing Activities Structure • Apart from 2010 and

2011 Murabaha was the major financing activity undertaken by the bank in the first three years of our period.

• The Ijara financing activity has increased over the 5 years period with peak in the years of 2010 and 2011.

• The Bank has introduced the Salam personal finance only in 2010 and increased by about 100% in 2011 in comparison to the previous year.

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Financing activities structure

WakalaMudarabaMusharakaCredit CardsSalamIjaraIstisna'Murabaha

Financial Highlights – Financing Assets Composition Comparison

The Bank’s – Average Composition of Financing and Investing Assets

Industry – Average Composition of Financing and Investing Assets

Murabaha; 35%

Is-tisna'

; 13%

Ijara; 25%

Salam

; 2%

Credi

t Cards

; 1%

Musharaka; 14%

Mudaraba; 9% Wakala; 2%

Murabaha; 70%

Istina'; 15%

Ijara; 10%

Others ; 5%

Financial Highlights – Sources of FundsSources of Funds in'000' 2007 % 2008 % 2009 % 2010 % 2011 %Customers' Deposits 65,175,594 77% 66,328,677 78% 64,195,503 76% 63,447,070 71% 64,771,317 72%

Due to Banks & Financial Institutions 2,241,322 3% 3,331,101 4% 1,449,051 2% 4,409,427 5% 4,052,433 4%

Sukuk Financing 2,754,750 3% 2,754,750 3% 2,415,034 3% 4,176,015 5% 4,173,983 5%

Medium Term Wakala Finance 0 0% 0 0% 3,752,543 4% 3,752,543 4% 3,752,543 4%

Other liabilities 3,393,586 4% 3,449,532 4% 3,370,804 4% 3,679,923 4% 3,543,355 4%

Accrued Zakat 129,542 0% 143,166 0% 140,536 0% 146,336 0% 121,076 0%

Total Liabilities 73,694,794 87% 76,007,226 90% 75,323,471 89% 79,611,314 89% 80,414,707 89%

Shareholders' Equity 10,665,117 13% 8,749,391 10% 8,980,800 11% 10,273,087 11% 10,173,757 11%

Total Liabilities & Owners' Equity 84,359,911 100% 84,756,617 100% 84,304,271 100% 89,884,401 100% 90,588,464 100%

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100,000,000 Sources of Funds Composition

Shareholders' Equity

Accrued Zakat

Other liabilities

Medium Term Wakala Finance

Sukuk Financing

Due to Banks & Financial Institu-tions

Customers' Deposits

Financial Highlights – Customer Deposits Composition• Investment deposits form the

major part of the Bank’s customers’ deposits with an average percentage of about 60% of the total balance for the 5 years period with comparison to 40% of total customers’ deposits as industry average.

• Current accounts and savings accounts (Demand deposits) come in the second and third places with average percentages of about 24% and 16% respectively (total 40% with comparison to 60% of total customers’ deposits as an industry average). 0

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Customers' Deposits Breakdown

Margin AccountsInvestment DepositsSavings AccountsCurrent Accounts

Financial Highlights – Sources of Funds Composition Comparison

The chart below demonstrates a comparison between the Bank’s average percentages of sources of funds over the 5 years period and the industry averages in that regard.

Customers' Deposits Due to Banks & Financial Institutions

Sukuk Financing &other term finance

Reserves Shareholders' Equity0%

10%

20%

30%

40%

50%

60%

70%

80% 0.75

0.05 0.05

0.15

75%

4% 6% 4%

11%

Sources of Funds Composition – the Bank vs. Industry averages

Indutry Avregage DIB

Financial Highlights – Income Statement

Income Statement in '000' 2007 % 2008 % 2009 % 2010 % 2011 %

Income from Islamic financing and investing 3,214,483 54% 3,204,840 61% 3,322,857 65% 3,221,695 76% 3,448,506 69%

Income from Islamic Sukuk 0 0% 551,101 10% 703,539 14% 376,260 9% 517,332 10%

Income from International Murabahat 627,136 10% 266,208 5% 51,478 1% 36,313 1% 83,133 2%

Income from Investments 912,189 15% 65,243 1% (1,590) 0% (326,690) -8% 67,587 1%

Commissions and FX income 798,327 13% 872,127 17% 752,169 15% 687,030 16% 700,587 14%

Income from investment properties 328,970 5% 212,119 4% 79,297 2% 104,664 2% 85,432 2%

Other Income 126,869 2% 98,723 2% 225,165 4% 146,424 3% 130,837 3%

Total Income 6,007,974 100% 5,270,361 100% 5,132,915 100% 4,245,696 100% 5,033,414 100%

Total Expenses (1,770,456) - (1,940,497) - (2,174,593) - (2,247,310) - (2,583,409) -

Profit before Depositors' Share & Tax 4,237,518 - 3,329,864 - 2,958,322 - 1,998,386 - 2,450,005 -

Depositors' Share in profit (2,356,014) - (1,777,672) - (1,739,197) - (1,435,631) - (1,386,808) -

Net profit before tax 1,881,504 - 1,552,192 - 1,219,125 - 562,755 - 1,063,197 -

Income Tax (Expense)/Deferred 14,148 - 2,135 - (6,844) - -3,492 - -6,782 -

Net Profit for the year 1,895,652 - 1,554,327 - 1,212,281 - 559,263 - 1,056,415 -

Financial Highlights – Main Income Components• The chart shows the main

components of the Bank’s income over the 5 years period in terms of their percentages to the total income.

• Income from Islamic financing and investing assets represents the main source of income with average percentage of about 65% over the 5 years period.

• Income from treasury activities comes in the second place with average of about 15% over the 5 years.

• Wotrth noting that income from financing and investing assets has included the income from Sukuk investments amounting to about 513 million in 2007, this income has been restated in the subsequent years and appeared in the income statement as a separate item.

-20%

0%

20%

40%

60%

80%

100%

120%

Other Income

Income from investment properties

Commissions and FX income

Income from Investments

Income from International Murabahat

Income from Islamic Sukuk

Income from Islamic financ-ing and investing

Financial Highlights – Income from Financing and Investing Assets• Income from Murabaha always

forms the biggest portion of the total income from item (Islamic financing and investing assets) with an average percentage of contribution of about 38% over the 5 years period.

• However, we can notice that in 2011 the income from Ijara has slightly exceeded the income from Murabaha with percentages of 30% and 28% respectively. This is mainly due to the major increase in the income from home finance Ijara (591 million in 2011 in comparison to 189 million in 2010).

• Income from the newly introduced Salam has increased from being contributing only 2% to the total financing and investing income in 2010 to contributing 8% to the same item in 2011.

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Others*WakalaMudarabaMusharakaSalamIjaraIstisna'Murabaha

Risk Management

• Types of Risks:– Credit Risk– Operational Risk– Market Risk– Liquidity Risk

• Risk Management Structure:– Board of Directors– Risk Management Committee– Risk Management Department– Asset and Liability Management Committee

Capital Management

• The Central Bank requires all banks operating in the country to keep a minimum of 12% capital adequacy ratio since June 2010.

• The Central Bank gives the banks the option to use Basic Indicators approach or the Standardized approach of Basel II for operational risk. The Bank has chosen to use the Standardized approach.

• The Central Bank also requires Banks to apply the Standardized approach of Basel II since November 2009 for other types of risks i.e. credit and market risks.

Capital Adequacy Ratios – under Basel II requirements

Type of Capital AED '000' 2010 2011

Teir 1 Capital 10,369,692 10,575,662

Teir 2 Capital 14,051,603 13,736,836

Risk Weighted Assets

Credit Risk 73,395,388 70,353,269

Market Risk 1,986,235 1,174,630

Operational Risk 3,772,256 3,745,404

Total Risk Weighted Assets 79,153,879 75,273,303

Capital Ratios 2010 2011

Tier 1 Capital Ratio 13% 14%

Total regulatory Capital Ratio 18% 18%

Medium-term Wakala finance 3,752,543 3,752,543

• The table shows that the bank’s tier 1 capital is well-above total capital requirement as per IFSB/Basel II requirement of 8% total capital requirement.

• Also, we can see that DIB’s total capital ratio reached 18% in 2010 and 2011.

• This is mainly due to the reclassification of medium-term Wakala finance item (government deposit of 7 years tenure) from customers’ deposits to tier 2 Capital.

Salam Finance• In Salam personal-finance process the

customer enters into a Salam contract with the Bank, in which the bank come to an agreement with the customer to buy from him/her on credit certain quantity of sugar for a predetermined price with an upfront payment from the Bank to the customer on signing the agreement. The contract also determines the delivery date of the sugar by the customer.

• On or just before the delivery date the Customer buys the agreed quantity of sugar from a merchant specified by the Bank and sends a notice to the merchant to deliver the sugar to the Bank.

• The payment to the supplier for the purchase of the sugar is made automatically by the Bank since the customer gives the bank standing instructions on his account to remit the funds into the merchant’s account with the Bank.

• The merchant delivers and buy-back the sugar to/from Bank on books through debiting and crediting the commodity accounts.

On Contract date: Cash from Bank to

customer for future delivery of sugar

On Delivery date:customer purchases sugar

from supplier and replenishes account with

the Bank

The Bank transfers funds from customer's account to supplier's

account with the Bank

Supplier delivers the sugar to the Bank

(most likely on paper only) in the books

Bank resells sugar to the supplier (most

likely on paper only) and get back the funds