Palestine Monetary Authority

Palestine Monetary Authority

Instructions No. (5/2013)

To all Islamic Banks operating in Palestine

Date: Wednesday, 20 March 2013

Subject: Regulation of Islamic Banks' Operations and Sharia Supervision

Based on the provisions of Chapters Three and Four of the Banks Law No. (9) of 2010, and in pursuit of the Authority's goal to develop the operating environment for Islamic banks, the following instructions and controls governing the operations of Islamic banks are hereby issued:

1. Activities and Operations of Islamic Banks.
2. Financing Controls.
3. Controls on Equity Investments.
4. Controls on Land and Real Estate Investments.
5. Dedicated (Restricted) Investment.
6. Profit Distribution and Loss Bearing Policy.
7. Non-Sharia Compliant Gains.
8. Reserves.
9. Sharia Supervisory Board.
10. Resident Sharia Auditor.
11. General Provisions.

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Supervision and Inspection Directorate
Palestine Monetary Authority

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Ramallah - Al Bireh P.O.Box 452 - Tel.: 02-2409920 - Fax: 02-2409922 Gaza - P.O. Box 4026 - Tel.: 08-2825713 - Fax: 08-2844487 E-mail: info@pma.ps www.pma.ps Ramallah - Al Bireh P.O. Box: 452 - Tel.: 02-2409920 - Fax: 02-2409922 Gaza - P.O. Box: 4026 - Tel.: 08-2825713 - Fax: 08-2844487

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(1/5) Activities and Operations of Islamic Banks

Islamic banks shall conduct all their operations and activities in accordance with the provisions and principles of Islamic Sharia, and as adopted by the bank's Sharia Supervisory Board, including the following:

a. Accepting deposits of all types, whether with returns or without.

b. Providing Islamic financing in all its forms and types.

c. Ijarah and Ijarah wa Iqtina (Leasing ending with ownership).

d. Buying and selling money market instruments, for their own account or on behalf of clients.

e. Providing clearing, settlement, collection, money transfer, and payment instruments services.

f. Buying and selling foreign currencies.

g. Issuing and managing payment instruments and checks of all types.

h. Providing safekeeping services and managing precious assets, including securities, subject to obtaining approval from the competent regulatory authorities.

i. Providing services as a portfolio manager, financial advisor/agent, or consultant.

j. Providing Islamic banking advisory services to clients.

k. Providing Islamic Takaful (Islamic banking insurance) services as an agent, subject to obtaining prior written approval from the Authority.

l. Providing financial information services.

m. Providing e-banking services.

n. Managing underwriting operations on behalf of others, subject to obtaining prior written approval from the Authority.

o. Acting as a trustee in social services, providing Qard Hasan (benevolent loans), and managing funds designated for social purposes.

p. Acting as an executor to manage estates and execute wills in accordance with Sharia provisions.

q. Establishing companies in various fields, especially those required for Islamic banking activities, subject to obtaining prior written approval from the Authority.

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(2/5) Financing Controls

1. Each bank must establish a financing policy that includes procedures, authorities, controls, and tasks for granting, renewing, monitoring, evaluating, and managing financing risks, and must be approved by the bank's Board of Directors.

2. The bank's financing policy must include a progression of different Islamic financing structures, aligned with the bank's nature, objectives, and its contribution to economic development.

3. Banks are committed to disclosing clients' current accounts only temporarily according to specific controls and standards approved by the Sharia Supervisory Board, and banks are prohibited from collecting any profits on current account transactions.

4. The bank's total investments in international financing structures (Murabaha, Istisna, Ijarah, Salam) must not exceed 20% of the bank's capital base.

5. Banks must obtain approval from the bank's Sharia Supervisory Board for any investment outside Palestine in international financing structures and Sukuk.

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(3/5) Controls on Equity Investments

1. Each bank must establish an investment policy that includes procedures, authorities, and controls for deploying the bank's funds into financial investments according to their types and purposes, managing associated risks, and must be approved by the Board of Directors.

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(4/5) Controls on Land and Real Estate Investments

1. A bank may own real estate or land for investment purposes, provided their value does not exceed 20% of the bank's capital base. Fixed assets used for managing bank operations and assets acquired against non-performing financing are not included in the aforementioned percentage.

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(5/5) Dedicated (Restricted) Investment

1. The bank must deploy funds related to dedicated investment in the same field for which they were designated.

2. The dedicated investment portfolio must not exceed 40% of the bank's capital base.

3. Restricted investment balances (dedicated investment) are exempt from mandatory reserve requirements.

4. The bank must disclose to holders of dedicated investment accounts the risks of this investment and its non-liability for bearing losses and results thereof. It must be proven that the investor exceeded limits, was negligent, or violated contract terms. The contract must clearly state the investor's awareness of all investment risks and their full responsibility for the investment results.

5. The bank must clarify the contract's share of returns and any fees collected by the bank, and the contract must also state the expected return for the client.

6. Dedicated investment accounts must be managed in separate accounts from other client accounts, showing transactions for each account by date, currency, trades, and investment results.

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(6/5) Profit Distribution and Loss Bearing Policy

• 1- The bank must prepare a policy for profit distribution and loss bearing between equity holders and investment account holders, detailing the mechanism followed by the bank in distributing profits between them, and the general principles followed by the bank in bearing administrative and general expenses, management fees, Sharia Supervisory Board fees, provisions, and where they go upon cancellation.

• 2- Prior written approval from the Authority must be obtained for the profit distribution and loss bearing policy before it is approved by the bank's Sharia Supervisory Board and Board of Directors.

• 3- When preparing the policy, the following must be adhered to:

  a. Financial fines imposed on the bank due to negligence and violations are borne by the bank (equity holders).

  b. Deducting Board of Directors and Sharia Supervisory Board fees from equity holders' profits.

  c. Deducting the value of fixed assets and investments (funded from equity) from participating shareholders' rights in generating income.

  d. Treating revenues, expenses, and losses related to financing and joint investment operations separately from those related to other services provided by the bank, and similarly for dedicated investment revenues, expenses, and losses, where a separate account is opened for each project.

  e. The bank bears losses resulting from violations and negligence arising from the actions of Board members and bank employees, and cases of fraud and breach of trust.

  f. The possibility of increasing the profit share of investment account holders at the expense of shareholders on a voluntary donation basis, subject to obtaining approval from the bank's General Assembly, in case it is determined that the realized return rate for investment account holders is lower than the prevailing market rate.

• 4- Disclosing the profit distribution and loss bearing policy between equity holders and investment account holders in accordance with accounting and auditing standards and controls for Islamic financial institutions.

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(7/5) Non-Sharia Compliant Gains

• 1- Non-Sharia compliant gains refer to all gains realized by the bank from sources or methods prohibited by Islamic Sharia provisions and principles. The bank must exercise special care regarding avoiding them from its operational results and activities, separating them, and determining methods of disposal.

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(8/5) Reserves

1. Legal Reserve

The bank is committed to deducting 10% of its annual net profits for the legal reserve account, and annual deductions continue until the legal reserve equals the paid-up capital.

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(9/5) Sharia Supervisory Board

2. Risk Reserve

a. It is the reserve formed to face undefined risks, calculated as a percentage of net direct financing plus a percentage of net indirect financing, according to the following ratios:

• 2% of direct financing.
• 0.5% of indirect financing.

b. Direct financing refers to all financing structures such as Murabaha, Ijarah, Mudaraba, Salam, Istisna, Musharaka, Sukuk, bank acceptances, and any other products appearing on the balance sheet that comply with Islamic Sharia provisions.

c. Indirect financing: refers to commitments and undertakings provided by the bank to a third party on behalf/agency of the client under a contractual agreement between the bank and the client. Commitments and undertakings are convertible to direct liabilities with financing impact upon claim realization.

d. The risk reserve is evaluated semi-annually, and the reserve is increased from the profit distribution account/(shareholders' share), and is not recorded as an expense in the income statement. This reserve accrues to shareholders upon liquidation.

e. Disclosure of the risk reserve is recognized within surrounding risks, and is included in the second tier of capital (Tier 2) of the capital adequacy ratio according to Basel Committee regulations, capped at 1.25% of total risk-weighted assets.

f. No part of the risk reserve may be used for any purpose except with prior written approval from the Authority.

3. Cyclical Fluctuations Reserve

a. A reserve is established to face various types of risks, called the cyclical fluctuations reserve, where 15% of the bank's net profits after taxes are deducted annually for this reserve, and annual deductions continue until the reserve balance equals 20% of the paid-up capital.

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Ramallah - Al Bireh P.O.Box 452 - Tel.: 02-2409920 - Fax: 02-2409922 Gaza - P.O. Box 4026 - Tel.: 08-2825713 - Fax: 08-2844487 E-mail: info@pma.ps www.pma.ps Ramallah - Al Bireh P.O. Box: 452 - Tel.: 02-2409920 - Fax: 02-2409922 Gaza - P.O. Box: 4026 - Tel.: 08-2825713 - Fax: 08-2844487