Islamic Window: Commingled Income and Cost Allocation

Classification. A commission earned from a conventional insurance agency is not generated by a Shariah-compliant activity. It is Shariah non-compliant income (SNCI), even though the agency contract may be lawful under Pakistani company law.

Treatment. The amount must not remain in the Islamic window's income and must not be distributed to investment account holders. It should be:

1. Separated from the Islamic pool.
2. Paid to charity, with the charity and purpose approved by the Shariah Advisor.
3. Disclosed in the Shariah compliance report and, where material, in the annual financial statements.

If already distributed. If the Rs 4.2 million has already increased the profit paid to depositors, the bank must purify the amount. It can do so by deducting an equivalent amount from the bank's own share or by contributing an equivalent amount to charity, so that depositors are not enriched by non-compliant income.

Root cause. The agency arrangement should be reviewed. Either the Islamic window should stop earning conventional insurance commission, or the income should be booked outside the Islamic pool with clear segregation.

Judgement. The CFO's 'one legal entity' argument does not make the income Shariah-compliant. Segregation is a Shariah requirement, not a legal-formality argument.

Overhead allocation. Costs allocated to the Islamic window must be fair, documented and based on actual usage or a reasonable cost driver. Charging 8% of overheads when the window's assets are 5.5% overstates the window's costs. The effect is to reduce the profit attributable to investment account holders and benefit the conventional shareholders. That is a breach of the bank's fiduciary duty as Mudarib and may amount to wrongful transfer of value between pools.

Remedy. Recalculate the allocation using a defensible basis, credit the difference to the Islamic pool, and disclose the correction. If the over-allocation has already reduced depositors' profit, compensate the pool.

Fixed 9% placement. A fixed return on surplus cash placed with a conventional treasury pool is not a Shariah-compliant profit. Economically it is a loan with a predetermined return, which is Riba. Calling it a transfer price does not change its substance. The conventional pool also holds interest-bearing assets, so a profit-sharing arrangement with it would not cure the problem unless the underlying assets are Shariah-compliant and the arrangement is a genuine Mudarabah or Wakalah.

Alternative. The Islamic window should place liquidity in Shariah-compliant instruments: commodity murabaha within approved limits, Sukuk, or interbank Wakalah with Islamic banks, on a profit-sharing basis.

Judgement. Both the allocation and the placement are non-compliant and must be corrected.

Immediate remediation.

1. Reverse the Rs 4.2 million from the Islamic income account and transfer it to charity.
2. Recalculate the overhead allocation and credit the difference to the investment pool.
3. Stop the fixed 9% placement and move the liquidity to approved Shariah-compliant instruments.
4. Quantify any loss to depositors and make them whole.

Governance.

• The Shariah Advisor should issue a written finding, require a rectification plan with deadlines, and verify completion.
• The board or its audit committee should review the finding, because the issue involves controls and fiduciary duty, not only product documentation.
• Internal audit should add the Islamic window's income and cost allocation to its regular testing.
• Staff in finance and treasury should be trained on fund segregation.

Reporting. The qualified quarterly report should not be suppressed. The matter should be reported through the Shariah governance channels and, where required, to SBP. The annual report should disclose the SNCI and its disposal.

Judgement. The bank should treat this as a control failure. If the CFO's position prevails, the Shariah Advisor may have to consider whether the window can continue to certify compliance.