ACKNOWLEDGEMENT

First of all I am very thankful to ALLAH-RAB-UL-IZZAT who gives me such power, knowledge and ability to accomplish my goals. With out His kind help I was unable to do this report. I am grateful to our teacher Sir Abdul Rehman Zaki for teaching us this course of Islamic Financial system. His versatile knowledge in this discipline and unique teaching style has developed our knowledge and cleared many ambiguities. I am very grateful to him for assigning this challenging presentation, which will further help me in evaluating many interrelated dimensions in establishing quality control systems in any business. Finally, I am thank to our other professors and teachers who has taught us in different fields as finance, marketing, management and other areas of specialization and made us able to think differently as an intellectual and specially to those who has directly or indirectly supported us with their assistance and guidance to compose this project report and accomplish broader vision to visualize things. MAY ALLAH, THE ALMIGHTY BLESS ALL THE PERSONALITIES WHO HAD DIRECTLY OR INDIRECTLY HELPED ME TO ACHIEVE MY GOALS

Objective of the Project The main objective of my project is to clear the basic differences between Islamic and conventional system I will try to discuss the real face of both systems in depth. Thats why my discussion will around these things: How Islamic Banks manage their assets and liabilities what is the main sources and uses of funds what are the main and core similarities & dissimilarities between Islamic bank and conventional bank. 1)Comparison between conventional and Islamic banking system: Companies selected for study We selected two banks first is Faysal banks taken as the conventional banks representative and

Second one is Meezan bank as representative of Islamic banks,

Faysal Bank Faysal Bank Limited was incorporated in Pakistan on October 3, 1994, as a public limited company under the Companies Ordinance, 1984. Currently, the Bank's shares are listed on the Karachi, Lahore and Islamabad Stock Exchanges Faysal Bank is engaged in Commercial, Consumer, Corporate and Islamic Banking activities The bank is principally engaged in providing consumer, corporate and investment banking services to its customers. The bank offers a wide range of consumer banking products and services which include deposit accounts, car loans, home loans and other consumer loans. It also provides treasury and capital market services and cash management services to its customers. Balance Sheet of Bank Assets Loans and advances to customers Cash and cash balances with other banks Investments in associates, subsidiaries and joint ventures Liabilities Customers deposits Due to banks and other financial institutions Other liabilities

Financial assets held for Sundry creditors trading Cash and cash balances Equity and reserves with the central bank MEEZAN BANK LTD MEEZAN was established as an Islamic Investment Bank in 1997 as AL MEEZAN INVESTMENT BANK LTD. First Islamic Commercial Banks license was awarded to Al Meezan Investment Bank in year 2002, They bought the local operations of Socite General (French Bank) 03 branches In 2009, Branch network of six dedicated Islamic banks increases to 480 branches (including subbranches) Meezan Bank having a 42% share of the Islamic Banking branch network in the country . 201branches in 54 cities across the country. Over 5.5% of the total Banking industry. PRINCIPLES BASIS OF ISLAMIC FINANCE Prohibition of RIBA Alkharaj-o-bildhaman (entitlement to profit is associated with corresponding risk)-Risk Sharing, i.e. No Risk, No Gain.
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 Prohibition of sale of goods before acquiring ownership Prohibition of sale of food stuff before possession Prohibition of debt for debt Avoidance of Gharar (uncertainty) Time value measured only through Price or Rent. Debt contracts can be made / traded but without discount. Risk can be distributed through forward Trading / Contracts by way of Salam & Istisna. Asset Liability Management Assets liability management is very important phenomena in banks earning strategy even in Islamic banking system, all the investments contributions to this effects to be used even on and off-balance sheet components in ALM. The risk taking is the key determinant for the banks either conventional or Islamic to portfolio or ALM. BALANCE SHEET STRUCTURE OF ISLAMIC BANK.

Objectives of Asset Liability Management : To manage the portfolio in a manner consistent with the banks investment policy. To obtain the desired earning while holding risk at acceptable levels. To maintain adequate liquidity at a cost consistent with earnings goals. On and Off-balance sheet investments are considered in ALM.
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Techniques of ALM Matching Techniques. Swap Techniques. Futures as a Hedging Technique. Options as Hedging Techniques. Effective Portfolio Management ALM - Pillars ALM Information Systems. MIS Information availability Accuracy Adequacy Expediency ALM Organization. Structure and responsibilities Level of top management involvement ALM Process. Risk Parameters Risk Identification Risk Measurement Risk Management Current Ratio The current ratio highlights the firm ability to cover short term liabilities with its current assets. Current Ratio = Current Assets / Current Liabilities Interpretation: The current ratio of Faysal bank & Meezan Bank for the year 2010, 2011 & 2012 is, 2.36, 2.06 & 1.64,
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1.79, 1.61 & 1.56 respectively, compared to standard ratio 2:1 this of Meezan Bank ratio is then Faysal Bank Faysal Bank Meezan Bank Particulars 2010 2011 2012 2010 2011 2012 Current Assets 138,762,462135,594,508176,797,87866,145,59683,395,555121,56 Current Liabilities 58,877,320 65,763,583 108,009,07936,967,00251,844,22877,699 Current Ratio 2.36 2.06 1.64 1.79 1.61 1.56

Sales to Working Capital = Sales / Working Capital In this ratio we compare the working capital or net current assets with sales which are part of the revenue. Interpretation: The average turnover in working capital of Faysal Bank is 19% & Meezan Bank have 20% this shows the profitability of working capital of Meezan Bank is slightly high then Faysal Bank. Faysal Bank Meezan Bank Particulars 2010 2011 2012 2010 2011 2012 Sales 11,610,78113,404,13216,957,8754,573,752 6,803,213 10,102,060 Working Capital 79,885,14269,830,92568,788,79929,178,59431,551,32743,862,129 Sales To Working Capital 0.15 0.19 0.25 0.16 0.22 0.23
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Working Capital = Current Assets Current Liabilities Arithmetically it is the difference of Current Assets and Current Liabilities. Interpretation: The working capital ratio of Faysal Bank limited is higher which indicates that Faysal bank has have sufficient resources to meets its current obligations as compare to Meezan Bank Limited. Faysal Bank 2010 138,762,462 58,877,320 79885142

2011 135,594,508 65,763,583 69830925

2012 176,797,878 108,009,079 68788799

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Balance Sheet Meezan Bank Limited 2010 2011 Rs.In ,000 2012 Horizontal Analysis 20102011 2012 Rs.In ,000

ASSETS Cash and balances with treasury banks 5,644,028 5,763,710 8,387,432 100 102.12 148.61 Balances with other banks 3,729,549 1,344,974 5,260,467 100 36.06 141.05 Due from financial institutions 8,850,000 18,108,000 34,499,500 100 204.61 389.82 Investments Financings Operating fixed assets 10,535,186 14,286,949 23,290,309 100 135.61 221.07 34,576,339 39,768,481 44,188,066 100 115.02 127.80 1,032,963 1,880,515 2,416,375 204,172 100 182.05 233.93 -

Deferred tax asset Other assets LIABILITIES Bills payable Due to financial institutions Deposits and other accounts

- #DIV/0!

2,810,494 4,123,441 5,935,413

100 146.72 211.19

67,178,559 85,276,070 124,181,734 100 126.94 184.85 1,192,160 1,057,017 1,249,210 2,415,606 4,008,496 8,468,425 100 88.66 104.79

100 165.94 350.57

54,582,353 70,233,875 100,333,051 100 128.68 183.82 --11

Sub-ordinate loan Liabilities against assets subject to finance leases Deferred tax

Balance Sheet Faysal Bank Limited 2010 2011 ASSETS Rs.In ,000 Cash and balances with treasury banks 6,872,032 8,927,524 Balances with other banks 3,708,451 876,780 Lending's to financial institutions 7,078,102 2,861,401 Investments

Horizontal Analysis 2012 8,427,202 508,795 15,017,826 20102011 2012 100 129.91 122.63 100 23.64 13.72 100 40.43 212.17 100 95.67 179.16 100 102.76 104.58 100 105.25 110.84 - 100.00

31,553,108 30,186,168 56,531,338

Advances 87,346,401 89,758,789 91,346,001 Operating fixed assets 2,514,959 2,646,978 2,787,617 Deferred tax assets net 1,279,918 Other assets LIABILITIES Bills payable 2,406,927 Borrowings from financial institutions 9,995,855 1,536,517 1,465,451 2,204,368 2,983,846 4,966,716

100 135.36 225.31

141,277,421 138,241,486 180,865,413 100 97.85 128.02 100 63.84 60.88 100 130.33 350.00
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13,027,468 34,985,766

Deposits and other accounts

102,067,422 102,776,793 123,655,188 100 100.70 121.15 999,600 4,103 2,483,355 6,641,542 999,200 6,977,069 100 99.96 99.92 100 52.42 100 92.27 100 95.54 100.37

Sub-ordinated loans 1,000,000 Liabilities against assets subject to finance lease 7,827 Deferred tax liabilities - net 2,691,466 Other liabilities 6,951,421

125,120,918 127,469,378 168,082,674 100 101.88 134.34 NET ASSETS 16,156,503 10,772,108 12,782,739 REPRESENTED BY Share capital Reserves 5,296,445 3,567,033 5,296,445 3,790,023 1,049,519 6,090,911 4,030,056 1,215,179 100 66.67 79.12 100 100.00 115.00 100 106.25 112.98 100 70.83 82.01 100 97.98 109.58 100 10.95 24.89 100 66.67 79.12

Unappropriated profit 1,481,668 Surplus on revaluation of assets 5,811,357

10,345,146 10,135,987 11,336,146 636,121 1,446,593

16,156,503 10,772,108 12,782,739

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Conclusion/Findings Liquidity position of Faysal Bank Limited is higher then Meezan Bank Limited this indicates that Meezan Bank Limited has higher leverage. Both financial institutes should improve their current ratio & working capital position in financial year 2011. The analysis shows that its lower down gradually. Net profit margin of Meezan Bank Limited is higher then Faysal Bank Limited. Gross profit margin of Meezan Bank Limited is higher then Faysal Bank Limited so we would like to suggest Faysal Bank should improve its Gross Profit margin to meet the expenses efficiently and set a sight profit for shares holders. The Operating income margin of Faysal Bank Limited is higher then Meezan Bank Limited which indicates that Faysal Bank Limited generates higher income by its own operation as compare to Meezan Bank Limited. The Long Term debt to long term liabilities ratio of Meezan Bank Limited is higher then Faysal Bank Limited because Faysal bank limited employed its funds in short term activities more then Meezan Bank Limited Meezan Bank Limited has a good market perception due to continuous declaration of dividends but on the
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other hand Faysal Bank limited did not declared dividend in financial year 2009. The three years average price / earning ratio of Meezan Bank Limited 13.97 while the Faysal Bank Limited has 7.78 % this indicates the Meezan Bank Limited has much potential in stock as compare to Faysal Bank Limited. The operating cash flow to total debt ratio of Meezan Bank Limited is little higher then Faysal Bank Limited Recommendations With the assistance analyses of financial reports we would like to recommend both financial institutes should over come their pit falls, flaws and deficiencies. Meezan Bank limited should improve its current ratio. The Meezan Bank Limited Net Profit Margin is higher then Faysal Bank Limited. The Faysal Bank Limited should improve its profitability ratio by efficiently use its resources. Similarly the price earning ratio & dividend payout ratio of Meezan Bank Limited is higher then Faysal Bank this highlights good return on investment as well good market perception. Faysal should also pay dividend consistently through generate the profit by improving its operation. We would also like to recommend that financial institute should much promote the business activities and provide financial assistance to industry which will be reduce the un employment, inflation and increase productivity of Pakistan SIMILARITIES & DISSIMILARITIES There are two major difference between Islamic Banking and Conventional Banking:
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 Conventional banking practices are concerned with "elimination of risk" where as Islamic banks "bear the risk" when involve in any transaction. When Conventional banks involve in transaction with consumer they do not take the liability only get the benefit from consumer in form of interest whereas Islamic banks bear all the liability when involve in transaction with consumer. Getting out any benefit without bearing its liability is declared Haram in Islam. Differences between Islamic and Banking System Conventional System Islamic System Money is a product besides Real Asset is a medium of exchange and product. Money is store of value. just a medium of exchange. Time value is the basis for Profit on exchange of charging interest on capital. goods & services is the basis for earning profit. Interest is charged even in Loss is shared when case, the organization suffers the organization losses. Thus no concept of suffers loss. sharing loss. While disbursing cash The execution of finance, running finance or agreements for the working capital finance, no exchange of goods & agreement for exchange of services is must, goods & services is made. while disbursing
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funds under Murabaha, Salam & Istisna contracts. Due to non existence of goods Due to existence of & services behind the money goods & services no while disbursing funds, the expansion of money expansion of money takes takes place and thus place, which creates inflation. no inflation is created. Due to inflation the Due to control over entrepreneur increases prices inflation, no extra of his goods & services, due price is charged by to incorporating inflationary the entrepreneur. effect into cost of product. Bridge financing and long Musharakah & term loans lending is not Diminishing made on the basis of Musharakah existence of capital goods. agreements are made Rather, they are disbursed on after making sure the the basis of Windo Dressed existence of capital project feasibility and good before credibility of the disbursing funds for a entrepreneur. capital project. Q no 2) Comparison of balance sheet of a bank internally having both Islamic and conventional business..

Accounting Analysis
Accounting Convention
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Management

of

Bank

Alfalah

Ltd.

prepares

its

financial

statements by following

historical cost convention of accounting. on the revalued

Instead of certain fixed assets which are stated

amounts and investments available to sale are valued at fair market value. The amounts are stated in the Pakistani currency which is banks presentation and functional currency. The figures are rounded nearest to thousand.

Key Accounting Policies of Bank Alfalah

1. Cash and Cash Equivalents
Cash and cash equivalents are comprises of the cash, balances with treasury bank and other banks and call lendings which are made for the sake of cash flow statements.

2. Sale and Repurchase Agreements

Bank Alfalah makes certain purchase/ (sale) investments under agreements of resell/ repurchase investments at a certain future agreements which are date at a fixed price. The investment

purchased are not recognized because bank has no control over them while investments which are sold are duly recorded. The amount paid for purchase of agreements is recorded under lending to financial institutions and proceeds from sale of investment agreements are recognized under borrowings.

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3. Investments
Bank has classified its investments under three titles and that are:

a. Hold

for trading: These investments are short term

investments which bank has kept for generating profit by the fluctuations in price of securities and interest rate etc.

b.Held

to maturity: These are the investments which have

fixed or determinable payments and bank has intention to keep them till maturity.

c. Available
maturity.

for sale: These are the investments which do

not fall under the title of Hold for trading and Held for

4. Advances a. Loans and Advances:

Bank states Loans, advances and lease investments net of provisions against non performing advances. Provisions of are specific and general nature for operations in Pakistan

made in accordance to the rules and regulations which have been defined by the State Bank of Pakistan. The advances to overseas customers are of the customers country. handled under the prevailing rules

b. Finance Lease Receivables:

In lease, Bank transfers the entire risks and rewards incidental to the owner of the assets. Bank recognizes the receivable and present value of the lease payments under a

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shows them under the title of advances to customers in the balance sheet.

5. Fixed Assets:
Fixed assets are categorized into two classes. Accounting Policies regarding these classes have been discussed below:

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a.Tangible Assets:
Fixed assets except office premises are recorded at cost less accumulated depreciation and accumulated impairment losses, if any. Office premises are recorded at revalued amount less accumulated depreciation. Depreciation on the fixed assets is charged on straight line method. Depreciation is estimated while keeping the amount of residual value of the assets (if any) in the mind. Maintenance cost and repair charges are charged to the income and subsequent costs are stated as carrying value of the asset or under separate head whichever is appropriate, if their period of benefits extends more than one accounting period. Office premises are revalued by the professionals so as to eliminate the effect immateriality from the fair value of the assets. Surplus from the revaluation is stated as surplus on revaluation of the fixed assets and deficit is deducted from the previous value of the surplus on revaluation of fixed assets. The value which exceeds from the incremental depreciation charged to the assets is transferred to the unappropriated profits. Gain and losses are transferred to income except those which are related to surplus. Those are directly transferred to unappropriated profits.

b.Intangible Assets

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Intangible assets which have finite life are stated on the balance sheet on the cost less accumulated amortization and impairment losses, if any.

Amortization on the intangible assets is charged on straight line method on a rate which is reviewed on the balance sheet in order to eliminate the factor of immateriality.

The other intangible assets which have infinite life are stated on the cost less impairment losses if any.

6. Impairment
Value of assets is reviewed if there is any sign of the impairment. If indication of assets impairment exists then asset are revalued and resulted impairment losses are recognized on the financial statements. Impairment losses are charged to the profit and loss account except those losses which arise from the revaluation of the assets. Impairment losses which arise from the revaluation of the assets are adjusted against the value of the surplus on revaluation of the assets.

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7. Taxation
Taxation policies have been synthesized by classifying taxation into two deferred taxes. categories i.e. current tax and

a.Current tax
Current tax is recognized in the profit and loss account and estimated on the taxable income by applying stated tax rate and any adjustment of tax payable of the previous year.

b.Deferred Taxes
Deferred taxes are stated by applying the balance sheet liability method on the differences which are resulted on the value of assets used for reporting purposes and the value which is presented for the tax estimation. Deferred tax asset is only recognized to the extent to which future taxable income is expected and tax credit can be availed. The amount of deferred tax is reduced to the extent to which it is not possible that tax credit can be availed. Bank recognizes deferred tax asset/ liability that arise from the deficit and surplus on revaluation of the fixed assets and it is adjusted against the related deficit/ surplus in order to compliance with the IAS-12 Income Tax. Deferred tax liability which results from the temporary differences which are associated with exchange translation reserves of foreign branches and where the timing

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difference can be controlled, is not recognized in the financial statements.

8. Employee Benefits a. Defined Benefit Plans

Bank manages an approved funded gratuity plan for eligible employee whose association with bank is five or on actuarial more years. Contributions to the fund are made

recommendation basis. Projected Unit Credit Method is used for actuarial valuation. Actuarial gains and losses exceeding 10% of higher actuarial liabilities or plan assets are stated Gratuity is payable to over the average life of the employees.

staff after the qualifying period of service.

b. Defined Contribution Plan

Bank is managing an approved provident fund scheme for permanent employees to month. which both employees and bank contribute 8.33% of the basic salary of the employees every

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9. Revenue Recognition a. Advances and Investments

Mark up income on advances, investments and profits on Musharika and yield on instrument. Mudaraba investments are recognized on account are the effective on Debt securities purchased time proportion basis while taking into

discount or premium and their discount or premium is amortized to profit and loss over the period of its maturity by using the effective yield method. Dividend income is recognized at the time when banks right to receive has been established.

b. Leasing Finance
Bank uses the financing method for the accounting of the leasing and Ijarah financing.

10. Foreign Currency Translation a. Functional and Presentation Currency

Bank values the items included in its financial statements in term of Pakistani currency.

b. Transaction and Balances

Transactions in the foreign currency are translated into Pakistani currency by using exchange rate on the date of currency transactions. Gains and losses due to foreign accounting period.

translation are settled to profit and loss statement at the end of

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c. Commitments
Commitments are outstanding forward foreign exchange contracts which are translated at forward rates applicable to their respective maturities.

d.Foreign Operations
Assets and liabilities of foreign operations are translated into Pakistani currency are loss. at prevailing exchange rate at balance sheet date. Translation gains and losses stated in the equity and their disposal is made in profit and

11. Dividends

and

Appropriation

to

Reserves
Dividends and appropriation to reserves are reported as liability on the balance approved by the BOD. sheet when they are

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12. Segment Reporting

Bank reports primarily in the segment format. Banks segments are those directly. Bank Alfalah has provide products or services and are subjected to risks and rewards the following segments:

a. b. c. d.

Trading and Sales Retail Banking Commercial Banking Corporate Finance

13. Geographical Segments

a. Pakistan b.Asia Pacific (including south Asia) c. Middle East

14. Related Party Transactions
Parties are considered related parties when they have ability to control and transactions on the influence same terms. the decision of the party other parties. BAL is executing the related

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Potential Red Flags and BALs Counter Measures

1. Credit Risk
Credit risk arises to due to borrowers inability to repay the principal as well as the amount of the interest. BAL has considered it very seriously; it has migrated to BASE-II as per SBP guidelines. Bank has developed procedural manual of cross check the figures in order to cop up with the credit management function more the risk. In order to make the risk

sophisticated in the future, bank is trying to improve risk models and credit process infrastructure.

2. Credit Concentration Risk

Credit concentration risk arises due to concentration of exposure of credit under various categories. In order to eliminate the credit concentration risk, SBP has prescribed

regulatory limits of maximum exposure to single and group of borrowers. BALs annual credit risk plan describes the maximum exposure to an industry which restricts the credit concentration risk of an industry. BAL has also risk by developed an internal rating system that allows the RMD to monitor the giving grades (which ranges from 1-12, grade 10-12 rating is for defaulters) to customers/ borrowers.

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3. Market Risk
Market risk is the risk of losses which results due to unfavorable fluctuations of the market prices. It arises due trading activities of the banks treasury. It also includes the investments and structural positions of the banks. BAL has cop up years. this risk by calculating 2 Value at Risk on daily basis while using historical data of calculate the capital charge for market risk as well.

Also banks RMD (Risk Management Department)

4. Foreign Exchange Risk

Foreign by setting exchange and risk results the due to unfavorable and

fluctuations of the exchange monitoring

rate. BAL manages this risk dealer, currency

counter party limits for on and off balance sheet financial instruments. On and off balance sheet instruments are of the the contracts which are the resultant outcome

import and export transactions. BAL is regulating and monitoring currency risk against prescribed enforceable limits by SBP.

5. Interest Rate Risk

Interest rate risk arises due to fluctuations in the value of the financial instruments due to changes in the market interest rate risk due to interest rate. Bank is exposed to

asset-liability mismatch and maturity mismatch. In order to ensure that the BAL is managing risk within limits, Asset and Liability Management Committee (ALCO) is monitoring liabilities on regular basis. the re-pricing of assets and

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BALs interest rate risk is in prescribed limits due to repricing.

6.

Liquidity Risk
Liquidity risk arises due to inability of bank to meet short

term obligations. BALs

ALCO is responsible for managing

the liquidity position and for formulation of the strategy and oversight of the asset liability function on a regular basis. The BOD of bank has approved a comprehensive management policy which stipulates the early warning indicators of liquidity risk and maintenance of unforeseen liquidity risk. various ratios. Bank is

also maintaining contingency funding in order to cop up the

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Ratio Analysis Liquidity Ratios:

Liquidity ratios are the measure of the firm's ability to meet its short term obligations.
Liquidity Ratio Current Ratio Sales to working capital Working Capital 2005 1.02 1.22 20,249,3 11 2006 1.06 1.38 15,276,5 29 2007 1.1 0.85 30,128,8 84 2008 1.06 1.57 19,741,3 02

Interpretation:
Bank Alfalah has managed very consistent liquidity ratios. It can be revealed by the ratios individually. Like current ratio of the bank is managed at an average of the 1.06. Sales to working capital ratio, has shown an inclining trend over the years except year 2007.

Leverage Ratios
Leverage ratios tell us about the capital structure of the company.
Leverage Ratios TIE ratio Debt to total assets Debt to Equity 2005 1.2 0.95 23.14 2006 1.16 0.95 24.91 2007 1.27 0.95 22.71 2008 1.08 0.95 22.72

Interpretation
TIE ratio of the bank is an average is at about 1.178 throughout the last four years. It reveals that banks operating income is 1.178 times more than its debt obligations. It is very evident from the leverage ratios that bank is using extensive leverage for its operations.

Profitability
Profitability ratios are the measure of the performance of the company. 31

Profitability Ratios Net profit Margin Operating income margin Return on assets Return on equity

2005 11.26% 0.74 1.41% 23.20%

2006 8.31% 0.69 1.27% 16.60%

2007 12.10% 0.59 1.01% 22.50%

2008 4% 0.54 0.04% 8.90%

Interpretation
Profitability ratios have revealed that the bank performance has inconsistent behavior and in 2008 it was at the worst position it ever had. The performance is badly affected in the
Activity Ratios Total assets turnover Sales to fixed assets Account receivables turnover 2005 0.06 2.19 11.79 % 2006 0.07 2.017 15.76 % 2007 0.07 2.16 16.05 % 2008 0.08 2.25 29.60 %

last few years. And it is result of the extreme wave of the terrorism and changed political scenario.

Activity Ratios
Activity ratios tell about efficiency of the bank. . These ratios are also called asset utilization ratios. It tells us that how efficiently assets are utilized.

Interpretation
Activity ratios point out the worst efficiency of the bank. Our banks all the activity ratios are very low, which reveals that the bank is not utilizing its assets efficiently. The company has to improve or increase its sales, so that it can improve its asset utilization. 32

MARKET RATIOS: Market measures tell the performance of the company in the market.

Market Ratios DPS EPS P/E ratio Dividend payout ratio Dividend yield Book value per share

2005 0 2.56 3.21 0 0 2.43

2006 0 3.525 2.83 0 0 2.11

2007 0 4.815 2.07 0 0 2.11

2008 1.21 1.627 6.14 0.74 0.121 1.82

Interpretation:
If we see the DPS we can say that company is not announcing dividends consistently. Earning per share has increased from 2005 to 2007 but in 2008 it is quite low. Market performance of the bank is not quite promising. Book value is showing a continuous trend of declining. Bank has to work over its portfolio and has to diversify it.

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Horizontal Analysis

34

Interpretation Historical analysis has been done by using the historical data. In this estimation is done by dividing the present amount of the item with amount of the item in prior years.

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Horizontal Analysis
Bank Alfalah Limited Income Statement Horizontal Analysis
(2005Description Net Sales (200607) (200708)

06) 73.04 % 43.61

21.67 % 87.26 % 30.33 %

20.41 % 13.13 % 14.05 % 22.32 % 49.09 % 25.67 % 28.15 % 60.43 % 0.00% 0.00% 0.00% 0.00% 64.89 % 0.00% 58.43 % 71.86

Other Income Total Revenues Cost of Goods Sold Provisions Total Direct Expenses Selling, General & Administrative

% 68.48 % 111.42

% 9.11% 84.18 239.91 % 110.06 % 36.23 % % 19.24 % 40.06 % 76.76

Operating Income Interest Expenses Foreign Exchange (Loss) Gain Associated Company (Loss) Gain Other Non operating (Loss) Gain

0.10% 0.00% 0.00% 0.00% 0.00% -

% 0.00% 0.00% 0.00% 0.00% 74.95 % 0.00% 77.58

Income Tax Expense Reserve Charges Income Before Extra Ordinary Items Provisions Brought forward

6.73% 0.00%

3.56% 119.32

% 49.62

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%
Revaluation of assets Minority Interests Net Income

% 5.71% 0.00% 62.64 %

% 0.00% 0.00% 3.34%

4.84% 0.00% 42.07 %

Vertical Analysis

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Vertical Analysis
Bank Alfalah Limited Income Statement
Vertical Analysis Description Net Sales Other Income Total Revenues

2005 2006 2007 100.00 100.00 100.00 % 18.33 % 15.22 % 23.42

2008 100.00 % 16.90 % 116.90 % 65.49 % 11.41 % 76.90 % 34.22 % 5.78% 0.00% 0.00% 0.00% 0.00%

% % % 118.33 115.22 123.42 % 58.83 % % 71.88 % 3.30% 75.18 % 27.93 % 12.11 % 0.00% 0.00% 0.00% 0.00% 3.79% 0.00% 8.32% % 64.46 % 9.22% 73.68 % 32.15 % 17.59 % 0.00% 0.00% 0.00% 0.00% -

Cost of Goods Sold

Provisions

3.10% 61.93 % 35.47 % 20.93 % 0.00% 0.00% 0.00% 0.00% 7.03% 0.00% 13.90 %

Total Direct Expenses

Selling, General & Administrative Operating Income Interest Expenses Foreign Exchange (Loss) Gain Associated Company (Loss) Gain Other Non operating (Loss) Gain Income Tax Expense Reserve Charges Income Before Extra Ordinary Items

5.45% -1.59% 0.00% 0.00% 12.14 % 10.95 4.19% 15.63 %

Provisions Brought forward

7.02%

8.90%

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Revaluation of assets Minority Interests Net Income

0.20% 0.00% 21.13 %

0.12% 0.00% 17.34 %

0.10% 0.00% 23.18 %

0.08% 0.00% 19.90 %

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Valuation
Projected statements

41

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Residual Income Model

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Free Cash Flow

free cash flow model

Description cash flow from operating activities less dividend less capital expenditure Free cash flow 2005 34,877,8 85 360,000 1,799,19 5 32,718,6 90 2006 7,852,3 62 0 3,542,3 12 4,310,0 50 2007 2008 39,645,3 2,499,6 25 06 0 975,000 1,074,3 969,185 14 38,676,1 40 450,292

FV = pv(1+i)^n 450292=32718690(1+g) ^3 450292/32718690=(1+g )^3 g = -0.76 WACC= w1ke+w2kd(1tax) 3.7955

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Q no 3) What are the mechanism and accounting treatment of each mode of Islamic financing?

Mechanism:

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Q no 4 ) what are the alternative products of conventional banking system available in Islamic banking ?
Islamic Financial Institutions (IFIs) are operating in the same society where conventional banks are operating and perform all those functions which are expected from a financial institution. IFIs are assisting business world by providing all the services required to run the economy smoothly, however, the philosophy and operations are different. In this section I will analyze the operations and products of IFIs in comparison with traditional

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conventional banks. Any financial system is expected to assist in running the economy by providing the following services grouped in two headings. First; Savings mobilization from savers to entrepreneurs and Second; Provision of general utility services including transfer of funds, facilitation in international trades, consultancy services, safekeeping of valuables, and any other service for a fee. There is no restriction on provision of such services by IFIs as for the service is not against the Sharia. However there exists difference in mechanism of funds mobilization from savers to entrepreneurs as described following. Savings mobilization consists of two phases i.e. accepting deposits and extending financing and investments. 3.1. Deposits Deposits are collected from savers under both type of institutions for reward irrespective a bank is operating under conventional system or Islamic system. The difference lies in agreement of reward. Under conventional system reward is fixed and predetermined while under Islamic deposits are accepted through Musharaka and Mudaraba (appendix B) where reward is variable. Under conventional banking return is higher on long-term deposits and lower for short-term deposits. Same is the practice in Islamic banking to share profit with depositors. Higher weight for profit sharing is assigned to long-term deposits being available to bank for investing in longer term projects yielding superior returns and lower weight for short-term deposits which cannot be invested in long term projects. The only difference in conventional and Islamic system lies in sharing of risk and reward. Under conventional system total risk is born by the bank and total reward belongs to it after servicing the depositors at fixed rate while under Islamic system risk and reward both are shared with depositors. Reward of depositors is linked with outcomes of investments made by IFIs. Under Islamic financial system only those IFIs will be able to collect deposits who can establish trust in the eyes of masses hence leading to optimal performance by financial industry. So for IFIs working in Pakistan have succeeded in establishing their credibility in the eyes of savers as depicted in table 2 (appendix A) an increasing trend of deposits collection (SBP,2010). 3.2. Financing and Investments The second phase in savings mobilization process is extension of credit facility to business and industry for return. Both types of institutions (Islamic and Conventional) are providing financing to productive channels for reward. The difference lies in financing agreement. Conventional banks are offering loan for a fixed reward while

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IFIs cannot do that because they cannot charge interest. IFIs can charge profit on investments but not interest on loans. In conventional banking three types of loans are issued to clients including short term loans, overdrafts and long-term loans. Islamic banks cannot issue loans except interest free loans (Qarz e Hasna) for any requirement however they can do business by providing the required asset to client. In following paragraphs I present the comparative working of different products (financing scheme) of both systems. 3.2.1. Overdrafts/Credit Cards etc. Conventional banks offer the facility of overdrawing from account of the customer on interest. One of its form is use of credit card whereby limit of overdrawing for customer is set by the bank. Credit card provides dual facility to customer including financing as well as facility of plastic money whereby customer can meet his requirement without carrying cash. As for facility of financing is concerned that is not offered by Islamic banks except in the form of Murabaha (which means IFI shall deliver the desired commodity and not the cash) however facility to shop/meet requirement is provided through debit card whereby a customer can use his card if his account carries credit balance. Under conventional banking a customer is charged with interest once the facility availed however under Murabaha only profit is due when the commodity is delivered to the customer. Furthermore in case of default customer is charged with further interest for the extra period under conventional system however extra charging is not allowed under Murabaha. Third under conventional system customer can avail the opportunity of rescheduling by entering into a new agreement to pay interest for extended period which is not the case under Murabaha. IFIs can claim only the original receivable amount agreed in initial contract. Another practical issue under Murabaha is how to deal with intentional defaulters. Different options are lying with IFIs including to blacklist the defaulter for any further financing facility, to stipulate in the contract that in case of default all installments will be due at once, to stipulate in the contract a penalty shall be imposed but the same shall not form income of IFIs rather it will go in charity (Usmani, 2002). 3.2.2. Short term loans Short term and medium term loans are provided to customer to meet working capital requirements of firm by conventional banks. Working capital is required by firms to invest in inventories and accounts receivables and meet the expenses. As for inventory investment is concerned that is provided by Islamic banks through Murabaha.

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As for meeting of day to day expenses of business is concerned financing is provided through participation term certificates where by profit of a certain period (e.g. quarter, six month, one year) is shared by IFIs on prorata basis. However financing through participation term certificates is not as easy as a short term loan from conventional bank due to risk involved for IFIs in the transaction. Firm seeking short-term facility from IFIs has to prove the viability of the project/business to the satisfaction of investor.For meeting the working capital requirements of nonprofit organizations to date there is no arrangement under Islamic financial system. Personal consumption loans are also not issued by IFIs how ever any individual of sound financial position can acquire anything for his personal use under Murabaha financing whereby a certain percentage of profit is added on cost by IFIs. Murabaha financing is very useful for short to medium term financial requirements of business/nonprofit organizations and individuals. Murabaha financing is asset based financing and anyone can request to an IFI for provision of an asset generally used for Halal (lawful) purposes. By default under Islamic financial system IFIs cannot lend cash for interest (only exception is Qarz e HasnaCharity loan). One of the features of Murabaha is in case of delay in payment by customer IFI cannot ask for extra amount as time value of money like conventional banks. However penalty is imposed on defaulter if stipulated in original contract of Murabaha duly signed by the customer but same cannot be included in the income of IFI. This penalty must be spent for charitable purposes. Under Murabaha scheme of financing facility is linked with assets which leads to economic stability and creates linkage between real and financial sector. It is not zero sum game because utility is created through services and products and not by mere building the blocks of wealth through dealing in paper money. Although Murabaha is being used by IFIs successfully and have succeeded in meeting short to medium term requirements of firms by providing a successful replacement of conventional loans yet certain differences exist in both type of financing. First is one cannot get cash under Murabaha. Second asset is purchased by IFI initially then transferred to customer hence IFI participate in risk. Third refinancing facility is not available under Murabaha. Fourth in case of default price of the commodity cannot be enhanced however penalty may be imposed if stipulated in original contract of Murabaha however same cannot be included in income of IFI. Fifth only those assets can be supplied by IFIs under Murabaha whose

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general and/or intended use is not against the injunctions of Sharia (e.g. supply of a machine to produce liquor) 3.2.3. Medium to long term loans Medium to long-term loans are provided for purchase or building of fixed assets by firms to expand or replace the existing assets. Under Islamic financial system requirement of firms and individuals are fulfilled through Murabaha, Bai Muajjal and Istasna (discussed in appendix B). Another financing option for long-term financing is profit sharing under Musharaka and Mudaraba (discussed in appendix B). Although financing under Murabaha, Bai Muajjal and Istasna is very much look like conventional loans with the only difference of provision of asset and not cash to client however differences exist in the contracts which alter the nature of risks and returns. Financing under Musharaka and Mudaraba is challenging for IFIs and firms as well. Under Sharia based financing schemes firms have to prove the viability/profitability of the project/business to the satisfaction of IFIs to get the finance because risk of losing the amount is involved. 3.2.4. Leasing Leasing is relatively recent source of financing whereby usufruct of an asset is transferred to lessee for agreed amounts of rentals. Under leasing ownership may or may not be transferred. Same facility is provided by IFIs under agreement of Ijara. Under Ijara asset is provided to customer for use with out transfer of ownership for a specific period of time in exchange for agreed rentals. Ownership of asset can be transferred to customer through mutual agreement at the completion of lease term. All ownership risks are born by IFIs during Ijara tenure. Certain differences exist in the transaction under both systems. First is rental under Ijara are not due until asset is delivered to the lessee for use. Second additional rent cannot be demanded in case of default except a penalty (if stipulated in original contract of lease) which is not the income of IFI. Third during period of major repair rent cannot be demanded by IFI. Fourth if asset is lost or destroyed IFI cannot claim further installments hence all risks of ownership are born by IFI. 3.2.5. Agricultural Loans Agricultural loans include both types of loans short-term as well as long-term. Short-term loans are required by farmers for seeds and fertilizers and long-term loans are required to develop additional lands and purchase of equipments. Normally farmers return these loans after selling the finished crops. Conventional banks are providing credit facility by charging interest. Same facility is provided by IFIs to the farmers under Bai Slam, Bai Murabaha Musharaka and Mudaraba (discussed in appendix B). Under Bai Salam cash is provided to farmers for

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purchase of seeds and fertilizers however this is not loan rather purchase of finished crops to be delivered by farmers. For purchase of equipments Murabaha facility is used and for development of additional land Musharaka and Mudaraba is used by IFIs. To get finance for land development farmers have to convince the IFIs about profitability of the venture due to risk involved in the transaction. 3.2.6. House financing Housing finance/Mortgages is the more secured form of financing for both conventional banks and IFIs. Under conventional system loan is provided for interest while under Islamic financial system facility is provided through diminishing Musharaka. Under diminishing Musharaka house is purchased jointly by IFI and customer. IFI rents out its share in property to customer for an agreed amount of rent. Share of financier is divided in units of small denomination. Customer pays the installments to IFI consist of rentals plus purchase price of a unit. Stake of customer in property is increasing while of IFI is decreasing with payment of every installment. Finally with the payment of last installment stake of IFI reaches to zero and property is transferred in the name of customer. Diminishing Musharaka model can help out in avoiding the real estate crisis (like of 2008) because when market value of property decreases both IFI and customer suffers according to their share in property and whole burden is not shifted on customer alone. Hijazi, & Hanif (2010) have raised certain questions about the existing practice of IFIs working in Pakistan and needs to be addressed by policymakers, Sharia boards and management of IFIs. 3.2.7. Investments In order to maintain liquidity conventional banks have many avenues including government securities, shorter term loans and money at call and short notices, leasing companies bonds, investment in shares etc. Interestingly mandatory reserve maintenance by conventional banks with central banks is also rewarded in the form of interest. Conventional banks can also create liquidity by issuing the bonds against their receivables. Commercial banks are also protected by central bank by providing liquidity in rainy days for interest. Interbank deposits are also rewarded in the form of interest by commercial banks.For IFIs avenues are very limited to create required liquidity at the same time to earn some revenue by investing in short term and liquid securities. IFIs cannot invest in government securities, short term loans, bonds and money at call and short notices because of interest based transactions. Mandatory reserve with central bank is maintained by IFIs but they are not rewarded like conventional banks.

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Looking towards central bank in rainy days to maintain liquidity is also not as straightforward due to interest demand of central bank. IFIs cannot demand interest on interbank deposits. As for investment in market able securities are concerned again IFIs are not free to invest in any equity security due to two reasons. First Halal business of the underlying firm is required. Second financial operations of underlying firm should be interest free. Keeping in view the dominance of conventional banking and existing business practices one can conclude safely that a very negligible number of firms meet both conditions. The much appreciable job has been done by Almeezan investment management limited (AIML) a subsidiary of leading Islamic bank in Pakistan (Meezan bank) in this regard. A list of Sharia compliant securities is being maintained and updated every six monthly out of which 30 companies are selected for Kse Meezan Index (KMI). KMI was established in June 2008.IFIs can invest only in those securities which are declared Sharia compliant securities through filtering of Sharia compliance criteria. Listing here the major conditions to qualify a security as Sharia compliant is worth mentioning as follow. Meeting of following tests is required to declare a security as Sharia compliant (KMI2008). First the core business of the company should be Halal (not prohibited by Islamic Law such as liquor, pork and pornography etc). Second illiquid assets should be equal to 20% of total assets of the company. Shares of a company merely dealing in liquid assets are not Sharia compliant hence IFIs cannot invest. Third ratio of all interest based debts including preferred stock should be less than 40% of total assets of the company. Fourth ratio of non Sharia compliant investments to total assets of the company should be less than 33%. Fifth revenue from non compliant investments should be less than 5% of total revenue of the company and even then IFIs are required to purify their earnings by spending this non compliant revenue as charity. Finally market price per share should be greater than the net liquid assets per share. Recently IFIs have created an avenue to meet their liquidity requirement in the form of Skuks (Islamic Bonds) whereby servicing is fixed like conventional bonds however such types of Skuks can be issued against Ijara receivables. Under Ijara Skuks initially asset is given on rent to the customer for an agreed period and rentals while ownership remains with IFI. To meet liquidity requirements IFI issues Skuks (bonds) to the investors equal to the value of asset, hence ownership of the asset is transferred to Skukholders. While it is known the rentals of

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the asset so the return on investment is predetermined and known with certainty to the investors. Skuks of Murabaha cannot be sold except at par being sale of loans. Other types of Skuks (Musharaka etc) are not carrying fixed return although tradable in secondary security market. Underlying principle in issue of Skuks is that illiquid assets should dominate in the portfolio against which Skuks are issued. Under Islamic financial system Skuks are ownership certificates and not mere debt securities hence all risks and rewards are shared by Skukholders.

4. Conclusion

Islamic financing is working within the Sharia frame work following certain restrictions including following. First IFIs cannot provide finance for an activity which is prohibited by Sharia (Islamic law) irrespective of its profitability and economic viability e.g. business of liquor, pork and pornography. Second IFIs cannot lend any amount in cash for interest however need is fulfilled either through supply of required asset or through profit and loss sharing. Consequently certain financial needs of some sections of the society are ignored in financing including personal loans and working capital requirements of not for profit organizations. Third under Islamic financial system when financing is provided under profit and loss sharing although profit can be shared as per agreement between the parties involved however loss must be shared according to capital contribution/ownership. Islamic banking is not as foreign to business world as it is perceived by certain quarters. It is a business very much like conventional banking within certain restrictions imposed by Islamic law. All business needs are being fulfilled by IFIs in efficient ways through Murabaha, Ijara, Bai Muajjal, Bai Salam, Istasna, Musharaka and Mudaraba. Two features of Islamic financial system are worth mentioning. First is linkage between financial and real sector as IFIs cannot extend credit facility without having support from real sector.Financing is either made through sharing risk and reward or must be asset backed. Second a unique feature of Islamic financial system is in the form of Mudaraba which can play role of catalyst for transforming society into prosperity by extending capital facility to skilful persons lacking capital. Under Mudaraba mode of financing partnership between capital and skill is formed hence it can be used to provide self employment to jobless skilful citizens.Islamic banking is not a mere copy of conventional banks as perceived by certain Muslims. It has its own way of doing business and all operations are duly certified by Sharia experts ranging from Sharia advisor to Sharia boards and finally Islamic Fiqh Academy (IFA). Portfolios of IFIs are dominated by Sharia

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compliant modes of financing and negligible investments are being made under Musharaka and Mudaraba. Sharia based modes of financing which can create a real difference in the society are not getting momentum in the operations of IFIs. Hanif, & Iqbal, (2010) have identified the hindrances (e.g. profit manipulation, riskiness of financing under sharing, lack of awareness, widespread conventional banking, lack of skilled human resources etc.) in the way of popularity of Sharia based financing and concluded that existing accounting and business frame work is not conducive for application of Musharaka and Mudaraba.Islamic banks are doing business in a nonconductive environment which makes operations challenging. IFIs cannot claim interest on their balances with other banks, on mandatory cash reserve maintained with central bank, cannot invest in government securities, interest based bonds, cannot claim time value of money from defaulters, bear risks in sale and lease transactions, can only invest in Sharia compliant securities and not in all available equities and finally have to compete with conventional banks in deposit servicing as well as in financing. In spite of these difficulties growth of Islamic financial system world over in general and marvelous growth of 76% (average annual) in Pakistan in last six and half years suggests a bright and promising future of this financing system. Two issues at hand demands attention of policy makers immediately including a separate law of Islamic banking to regulate the industry and implementation of accounting standards issued by Auditing & Accounting Organization of Islamic Financial Institutions (AAOIFI) for preparation of annual reports of IFIs.

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