1

Shariah Supervisory Board in Islamic Finance

Maas Riyaz Malik

massriyaz_2005@yahoo.com

International Center for Education in Islamic Finance

This project paper is a partial fulfillment of Module SH1002 of Part I of

Certified Islamic Finance Professional (CIFP)
INCEIF
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March, 2010

Abstract

The Islamic financial institutions are swiftly spawning their presence around the world. They
have responded to the opportunities presented by this rapidly growing new customer segment
with a range of Shariah-compliant products. Shariah supervision is an essential component of
Islamic finance that ensures the validity of financial products and transactions of these
institutions. Shariah supervisory boards in Islamic financial institutions are entrusted with the
task of supervision. The paper explores various aspects of Shariah supervisory boards including
purpose, duties and responsibilities and applicable laws. The information was collected using a
library research where books, journals, articles and online resources were used. The paper further
discusses governance issues of the Shariah standard board that could jeopardize its credibility.
Finally, paper highlights the need for harmonization of Shariah board opinions across the
industry that is vital for further growth.
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Contents
1. Title page 1

2. Abstract 2

3. Contents 3

4. Introduction 4-5

5. An overall view of Shariah Supervisory Board

5.1. What is Shariah supervision? 6
5.2. The Purpose of SSB 6-7

5.3. Roles and functions of SSB 7

6. Laws relating to SSB in Malaysia 8-9
7. Duties and responsibilities of SSB & IFI
7.1. Shariah Supervisory Board 9-10
7.2. Islamic Financial Institution 11-12
8. Essential Elements of Shariah Supervisory Board
8.1. Composition 12-13
8.2. Qualification 13-14
8.3. Communication 15
9. The Corporate Governance and related issues 16
9.1. Independence 16-17
9.2. Confidentiality 17-18
9.3. Competence 18
9.4. Consistency 18

9.5. Disclosure 19
9.6. Cost of Maintaining SSB 19-20
10. Standardization of SSB Opinions
10.1. Issue of Non-Standardization 21-22
10.2. Harmonization of Opinions 22-25
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11. Models of Shariah Governance from Selected Countries 25-27

12. Conclusion 28

13. References 29-30

4. Introduction

In an era that economic booms, bursts and calamities occurred, Islamic banking and
finance has developed to an unprecedented level. As an alternative for conventional practice of
banking and finance it offers a range of products based on the syariah. Interestingly, Islamic
finance is viewed by modern banking practitioners as a viable solution to weather the financial
crises and promote justice. The rapid development of these institutions in the last few decades
has attracted the attention of both Muslims and non-Muslims. Today Islamic finance institutions
provide products and services from deposits to sukuk. The potential growth of this sector is
enormous. Wharton University published article (2004) outlines that Islamic banking has gone
from almost nothing to an industry with assets of hundreds of billions of dollars and half of the
consumer market and 10% of the assets under management in countries such as Malaysia.
In line with syariah principles Islamic financial institutions are engaged in product
development activities to cater the needs of a wide range of parties. It is essential for these
institutions to innovate and operate within the ambits of shariah. Hence, need of the supervision
is an integral part of any financial institution that deals in the name of Islamic finance. The
safeguard to make Islamic financial institutions perform their dealings according to the Islamic
laws comes when there is a legitimate control body in the institution (Lahsasna). It is vital for
such institutions to form a Shariah Supervisory Board (SSB) consists of fiqh muamalat experts to
guide their transactions in accordance with the principles of Shariah. Malaysia and several other
countries have passed laws to govern the formation and functions of SSB. Therefore, SSB
undoubtedly forms the most important and influential entity in any Islamic financial institution.
These functions will be discussed thoroughly in line with established laws in Malaysia.

In his article Suleiman outlines that Islamic banking represents a radical departure from
conventional banking, and from the viewpoint of corporate governance, it embodies a number
of interesting features since equity participation, risk and profit-and-loss sharing arrangements
from the basis of Islamic financing. The corporate governance framework in Islamic Finance
Institutions (IFIs) mainly comprises of SSB, syariah audits and adequate internal controls.
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Center to such a framework is SSB, which provides the backbone to IFI’s operations. Author
Suleiman, also describes that the SSB is vital for two reasons. First, to ensure transactions of
Islamic banks are in line with Islamic law. Should the SSB report that any management
departure from Shariah law, institution would quickly lose the confidence of the majority of its
investors and clients. Second, some Islamic scholars argue that strict adherence to Islamic
religious principles will act as a counter to the incentive problems. Therefore, SSB is trusted
with the duty to score a balance between those two ends by upholding Shariah principles and
minimizing transaction costs. The presence of a Shari’ah board in Islamic banks was
determined as a prerequisite for admission into the International Association of Islamic Banks
(Rammal,2006)

As in the case of many legitimate control bodies, SSB has also met with various
challenges. The professional ethics, coordination and unification of opinions are vital for
board’s credibility. Author Lahsasna, highlights the shortage of experts in both shariah and
finance which need to be produced by Muslim states. In the latter part of this paper it is
intended to discuss governance and non-standardization issues. It is expected that paper will be
able to highlight number of vital aspects pertaining to SSB.
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5. An overall view of Shariah Supervisory Board

Shariah supervision is the single most important element that distinguishes between a
conventional and an IFI. It is the only way of certifying that its services, products, and operations
are actually Shariah-compliant. In the emerging Islamic financial sector, therefore, Shariah
supervision is not a matter to be taken lightly. The corporate governance is the theme of SSB.

5.1 What is Shariah supervision?

While it may be convenient to explain Shariah supervision as a religious audit but its
scope is far more comprehensive. In essence, Shariah supervision is the process of ensuring that
a financial product or service complies with Islamic legal precepts and principles, either by its
conforming (to one degree or another) to a recognized Islamic legal norm or by its not violating
the same (DeLorenzo). Ideally, Shariah supervision will be a part of an Islamic product or
service from the time of its development, to its launch, and throughout the period it is offered. At
the stage of research and development, or of drafting contracts or offering memorandums,
Shariah supervision, in one form or another, should be an active participant. According to
DeLorenzo by including Shariah supervision and advice at the earliest stages, management may
save costly legal fees that may be required at a later stage if elements of the proposed business
contracts need to be modified to comply with Shariah principles and precepts.
Moreover, once a product is launched, Shariah supervision may take the form of ongoing
monitoring through periodic audits. Such audits may be undertaken by means of site visits,
document reviews, or consultation with management at regular intervals.

5.2 The Purpose of SSB

The most obvious and immediate purpose of Shariah supervision is to certify for
practicing Muslim consumers and clients that the financial product or service being offered to
them is acceptable from an Islamic legal perspective and is therefore lawful to them
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(DeLorenzo). Such certification according to author DeLorenzo, is generally documented in a

formal fatwa (Shariah position paper), may be thought of as a form of due diligence.
The primary beneficiary of Shariah supervision will be Muslim consumers or investors
who may not have necessary skills or knowledge to evaluate the Islamic banking products in the
light of Shariah teachings. It also supplies form of guarantee and advocacy that money being
invested in the IFIs is duly used in compliance with Shariah rulings and haram elements are
eliminated. From the view point of corporate governance, IFIs embody a number of interesting
features since equity participation, risk and profit loss sharing arrangements from the basis of
Islamic finance. SSB functions as an extra layer of governance in IFIs in order to bring
transactions under strict conformity with the Islamic law and expectations of Muslim
community.

5.3 Roles and functions of SSB

As a legitimate control body SSB consists of a number of members chosen among well
qualified men of Islamic jurisprudence and comparative law. The education and qualification of
these members will be dealt in a later section of this paper. The credibility of the Islamic banking
activities is highly dependent on the credibility of the Shariah advisers. Author Rahman notes
that the credibility of Shariah advisers may also depend on the perceptions and confidence of the
bank managers in their role. In order to ensure the modern application of banking system is in
line with Shariah requirements, it is strongly stressed that the objectives of the establishment of
Islamic Bank are to achieve Falaah (Rahman, 2006). The objectives of Islamic banks may
therefore differ greatly from the conventional bank's objectives. Therefore, in order to ensure
compliance to the Syariah, IFIs use the service of well-verse Shariah scholars.

6. Laws relating to SSB in Malaysia

The laws governing the functions and operations and other matters of SSB have been
detailed in several Acts and guidelines provided by regulators. The Takaful Act (Malaysia) 1984
is one of the acts of parliament aimed at controlling insurance practices in Malaysia. A financial
institution licensed under the Banking and Financial Institutions Act 1989 (BAFIA) required to
comply under relevant laws. Bank Negara Malaysia has provided a set of guidelines clearly
aimed at the SSB. It will be important to discuss the application of these guidelines issued by the
Islamic Banking and Takaful Department of central bank of Malaysia.
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Bank Negara Malaysia (BNM) has prepared the Guidelines on the Governance of Shariah
Committee for the Islamic Financial Institutions that regulates the governance of Shariah
Committee of an Islamic financial institution.
In the Part B of guidelines, under establishment of Shariah Board it outlines the following
requirements:
Every Islamic financial institution is required to establish a Shariah Committee. In the
case of a BAFIA IBS bank, it may establish one Shariah Committee for the banking
group. However, if a takaful operator is part of that group, the tactful operator must
establish its own separate Shariah Committee, due to the legal requirement under the TA.
(Guidelines on the Governance of Shariah Committee for the Islamic Financial
Institutions, p.3)
The guidelines clearly uphold the establishments of the SSB in align with relevant laws
governing the respective institution. For instance a single committee is not allowed to act on
behalf of both takful and Islamic bank that part of one group.
Regarding the appointment and reappointment, Part C of the guidelines provides
following.
The Board of Directors of an Islamic financial institution upon recommendation of its
Nomination Committee shall appoint the members of the Shariah Committee. The
appointment and reappointment of a Shariah Committee member shall obtain prior
written approval of Bank Negara Malaysia. The appointment shall be valid for a
renewable term of two years.
(Guidelines on the Governance of Shariah Committee for the Islamic Financial
Institutions, p.3)

BNM guidelines also provide detailed provisions on the restriction imposed on the serving
syariah board members. The Part D of the provides that

(a) In line with section 16B(6) of the Central Bank of Malaysia Act 1958, an Islamic
financial institution is not allowed to appoint any member of the SAC to serve in its
Shariah Committee; and
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(b) To avoid conflict of interest and for reasons of confidentiality within the industry, an
Islamic financial institution shall not appoint any member of shariah Committee in
another Islamic financial institution of the same industry. For this purpose, Islamic
financial institutions which are regulated under the IBA, BAFIA and DFIA are classified
as of the "Islamic banking industry", whilst Islamic financial institutions that are
regulated under the TA are classified as of the "takaful industry". Memberships in other
categories of industry are excluded from the restriction.
(Guidelines on the Governance of Shariah Committee for the Islamic Financial
Institutions, p.6)
With regard to the reporting structure, the Shariah Committee will report functionally to
the Board of Directors of the Islamic financial institution. This reporting structure reflects the
status of the Shariah Committee as an independent body of the Islamic financial institution.

7. Duties and responsibilities of SSB & IFI

7.1. Shariah Supervisory Board

All Shariah Committee members are expected to participate and engage themselves actively in
deliberating Shariah issues put before them. The BNM document that lays down guidelines for
Syariah board stipulates following duties and responsibilities of the Syariah Committee:

To advise the Board on Shariah matters in its business operation

The Shariah Committee shall advise the Board on Shariah matters in order to ensure that the
business operations of the Islamic financial institution comply with Shariah principles at all
times.

To endorse Shariah Compliance Manuals

The Islamic financial institution shall have a Shariah Compliance Manual. The Manual must
specify the manner in which a submission or request for advice be made to the Shariah
Committee, the conduct of the Syariah Committee's meeting and the manner of compliance with
any Syariah decision. The Manual shall be endorsed by the Shariah Committee.
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To endorse and validate relevant documentations

To ensure that the products of the Islamic financial institutions comply with Shariah principles in
all aspects, the Shariah Committee must endorse the following:
i) the terms and conditions contained in the proposal form, contract, agreement or other legal
documentation used in executing the transactions; and
ii) the product manual, marketing advertisements, sales illustrations and brochures used to
describe the product.

To assist related parties on Shariah matters for advice upon request

The related parties of the Islamic financial institution such as its legal counsel, auditor or
consultant may seek advice on Shariah matters from the Shariah Committee. The Shariah
Committee is expected to provide assistance to them so that compliance with Shariah principles
can be assured completely.

To advise on matters to be referred to the SAC

The Shariah Committee must advise the Islamic financial institution to consult the SAC on any
Shariah matters which have not been resolved or endorsed by the SAC.

To provide written Shariah opinion

The Shariah Committee is required to record any opinion given. In particular, the Committee
shall prepare written Shariah opinions in the following circumstances:
i) where the Islamic financial institution make reference to the SAC for advice; or
ii) where the Islamic financial institution submits applications to Bank Negara Malaysia for new
product approval in accordance with guidelines on product approval issued by Bank Negara
Malaysia.

To assist the SAC on reference for advice

The Shariah Committee must explain the Shariah issues involved and the recommendations for a
decision. It must be supported by relevant Syariah jurisprudential literature from the established
sources. The Syariah Committee is also expected to assist the SAC on any matters referred by
the Islamic financial institution. Upon obtaining any advice of the SAC, the Shariah Committee
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shall ensure that all SAC's decisions are properly implemented by the Islamic financial
institution.

7.2 Islamic Financial Institution

To ensure the smooth running of the Shariah Committee, an Islamic financial institution is
responsible: -
To refer all Shariah issues to the Shariah Committee
The Islamic financial institution must refer all Shariah issues in its business operations to the
Shariah Committee for advice. The submission for an advice or a decision must be made in a
comprehensive manner for an effective deliberation by the Shariah Committee. This will include
explaining the process involved, documents to be used and other necessary information.

To adopt the Shariah Committee's advice

The Islamic financial institution is required to adopt and take necessary measures for
implementation of Shariah Committee's advice.

To ensure that product documents be validated

The Islamic financial institution shall obtain validation of the Shariah Committee relating to
Shariah issues in all product documentations.

To have a Shariah Compliance Manual

The Islamic financial institution shall ensure that the Shariah Compliance Manual referred to in
Paragraph 20(b) is endorsed by the Shariah Committee.

To provide access to relevant documents

The Islamic financial institution must provide necessary assistance to the Shariah Committee.
The Shariah Committee must be given access to relevant records, transactions, manuals or other
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relevant information, as required by them to perform their duties. For this purpose, the Shariah
Committee members are granted exemptions from the secrecy provisions under the respective
legislations.

To provide sufficient resources

The Islamic financial institution must provide the Shariah Committee with sufficient resources,
such as budget allocation, independent expert consultation, reference materials and trainings. It is
also the duty of the Islamic financial institution to familiarize the Shariah Committee on its
operation and business.

To remunerate the members of the Shariah Committee accordingly

The Board shall determine the remuneration of the Shariah Committee members (through its
Remuneration Committee). The remuneration shall commensurate and reflect the roles and
functions of the Shariah Committee.

8. Essential Elements of Shariah Supervisory Board

8.1 Composition
Shariah supervision may be performed by an individual supervisor/advisor, or by aboard
of supervisors/advisors,commonly known as a Shariah Supervisory Board (Lahsasna).IFI could
choose a board or a single advisor. However, such a choice should take several factors in to
considerations before deciding a number. Chief among these factors is the product or operation
itself. An Islamic home financing alternative, for example, is a complex affair and will
undoubtedly benefit from the collective opinions of a diversified Shariah Board (DeLorenzo).
The same will be true of a commercial or investment banking operation. An Islamic mutual fund,
on the other hand, may require a single supervisor, especially if it has licensed itself to an index
provider like the Dow Jones Islamic Market Indexes (DeLorenzo). An actively managed fund,
however, even if it is licensed to an index, may require more than one supervisor. These are
considerations that have to do with the nature and requirements of the supervision itself. If the
IFI intends to operate in international arena, for instance in South Asia and Gulf region it would
be better to appoint members from each region (DeLorenzo).
However Ramal (2006), points out that a Shariah board should be formed of a number of
members chosen from among Jurists and men of Islamic jurisprudence and of comparative law
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who have conviction and firm belief in the idea of Islamic Banks. To ensure freedom of initiating
the board’s opinion, members of the board must not be working as personnel in the bank, and are
not subject to the authority of the board of directors. Prudence dictates that there be at least three
supervisors for any Islamic financial undertaking (Lahsasna). Moreover, experience has shown
that at least one of the members needs to reside in the same country or region as the operation, so
as to be readily available for consultation, even on short notice (Lahsasna) . In some cases, too, a
Shariah supervisor will maintain an office and keep regular hours at the bank or financial
institution.

8.2 Qualification

The proposed member of the shariah committee shall be an individual. In Malaysia, the
proposed member of the shariah committee shall at least have qualification possess necessary
knowledge, expertise or experience in the following areas (Lahsasna).
a) Islamic jurisprudence (Usul al-fiqh)
b) Islamic Transaction/ commercial law (Fiqh al-muamalat)

The qualification to serve in SSB may differ among countries. In Pakistan, the qualification is
emphasized in a rigorous manner and require following (Hassan):

Educational Qualification
a) Degree from any recognized Waffaqul Madaris(Darse-e-Nizami)with a minimum of
2ndClass Bachelor Degree with Economics;
b) Degree from any recognized Waffaqul Madaris(Darse-e-Nizami)with Takhassus Fil
Fiqh and sufficient understanding of banking and finance; or
c) Post Graduate Degree in Islamic Jurisprudence / Usuluddin, LL.M (Shariah), etc from
any recognized university with exposure to banking and finance
Experience and Exposure
a) Must have at least 3 years experience of giving Shariah rulings;or
b) At least 5 years experience in research and development in Islamic banking and
finance
c) Reasonable knowledge of Arabic and English languages is necessary
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Additionally, State Bank of Pakistan, at its sole discretion, can give relaxation in respect
of educational qualification and experience in exceptional cases where the person is otherwise
qualified for giving Shariah rulings on banking and financial matters (Hassan).
Obviously, a Shariah supervisor will be someone with a background in the classical
Shariah sciences. In particular, however, supervisors need to have studied the fiqh al mu`amalat
or rules concerning transactions developed by the classical jurists and expanded upon by later
generations of Shariah scholars. Most Shariah supervisors have produced academic work or
studies on one aspect or another of these rules. In addition, such a background presupposes
facility in the classical Arabic language and the ability to deal directly with legal texts, glosses,
and commentaries in that language.
In Addition to all this, an understanding of modern finance, markets, and economics is
also clearly required. Finally, an effective Shariah supervisor must be familiar with international
Business practices (`urf) and have an appreciation for regulatory environments. For these
reasons, the English language is especially important. One more point that should be kept in
mind is the supervisor’s ability to work with a team, oftentimes in a cross-disciplinary and cross-
cultural environment. Generally speaking, today’s Shariah supervisors possess the qualifications
and characteristics discussed above. In addition, many Shariah supervisors have benefited from
the exposure afforded by multiple board membership.
Then, while at the present time there are no standard qualifications for Shariah
supervisors, it is to be hoped that, in the future, and as the Islamic financial sector grows,
graduate level programs will be developed for the specific purpose of preparing new generations
of scholars with all of the requisite skills. At present, however, the number of people qualified to
serve as Shariah supervisors is limited. Author Lahsasna suggest that in regard to preparing
scholars for a future in Shariah supervision is twofold. Firstly, Islamic financial operations may
appoint, in addition to its full Shariah Board members, junior members who will participate in
discussions, prepare memos and briefs, take notes, and perform research and other tasks for the
Shariah Board, but who will not have full status as voting Shariah Board members. Secondly,
junior members may be appointed on a rotating basis, such that each will serve, much like a law
clerk for a serving judge in the United States, for a period of one year. By means of this rotating
arrangement, many scholars will have an opportunity to learn first hand about the workings of
Shariah supervision.
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Moreover, as junior members become increasingly more familiar with modern business
norms and practices, it will become easier for them to analyze situations and think through
options, with the result that their contributions to the work of the Shariah Supervisory Boards
will become increasingly valuable. Obviously, such junior members will be compensated for
their efforts, though not at the same level as the full board members.

4.3 Communication

An essential element in the success of any undertaking is communication. This is equally

true in regard to Shariah supervision. To begin with, there must be clearly delineated lines of
communication between management and Shariah supervision. Oftentimes, an Islamic financial
institution will appoint one of its executives, whether from business operations, finance, or legal,
to act as liaison with the supervision. This person will be responsible for coordinating and
Documenting regular meetings, arranging for the requirements of Shariah supervision, following
up on decisions and suggestions, and processing and channeling communications to and from
supervision. When board members live on different continents and work in different time zones,
the work of such a coordinator can be challenging.

9. The Corporate Governance and related issues

In the modern business world, corporate governance is regarded as an essential element

that upholds the accountability and transparency. History shows many scandals and bankruptcies
in the absence of proper corporate governance structures. It is paramount in Islam to conduct
business activities in line with shariah parameters that ensures the good governance is practiced
in the business. SSB is a clearly a part of this process that ensures IFI does not deviate from its
prime objectives. Good governance is crucial to the ability of a business to protect the interests
of its stakeholders. These interests may extend beyond the purely financial to the stakeholders’
ethical, religious, or other beliefs. In the case of an institution offering Islamic financial services,
its operations are required to be carried out in compliance with the principles of Shariah (Grais
and Pellegrini, 2006). A corporate structure that enables a financial institution to implement good
governance through Shariah-compliant operations is therefore essential for the stability and
efficiency of Islamic financial services.
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The SSB that is a very part of corporate governance has seen some inconsistencies. This
could impede the confidence on IFIs operations if not addressed properly. Following is a
discussion that highlights major issues related to SSB.

9.1 Independence

The independence of the SSB from management is highly essential. Generally members
of the SSB are appointed by the shareholders of the bank, represented by the Board of Directors
(Grais and Pellegrini, 2006). As such, they are employed by the financial institution, and report
to the Board of Directors. Their remuneration is proposed by the management and approved by
the Board. According to Grais and Pellegrini, (2006) the SSB members’ dual relationship with
the institution as providers of remunerated services and as assessors of the nature of operations
could be seen as creating a possible conflict of interest. There seems to exist a potential for
conflict of interest (Rammal, 2006). The concern is that members of the SSB may legitimize
dubious operations to ensure that they remain active on the board. In principle, SSB members are
required to submit an unbiased opinion in all matters pertaining to their assignment. However,
their employment status generates an economic stake in the financial institution, which can
negatively impact their independence. The opinions of the SSB may, for example, prohibit the
bank engaging in certain profitable transactions or impose a reallocation of illicit income to
charity, resulting in a poorer overall financial performance. Under these circumstances, the bank
managers may be tempted to use their leverage to influence SSB members, producing what is
commonly referred to as “Fatwa shopping” (Grais and Pellegrini, 2006) . In practice, the risk of
such conflict of interest is mitigated by the ethical standards of the SSB members, and the high
cost that a stained reputation would inflict on them and on the financial institution.
Generally, members of SSBs are highly regarded Shariah scholars and guardians of its
principles. Therefore, a less than truthful assessment and disclosure of Shariah compliance by an
SSB would seem to be highly unlikely. In the event that it does occur and comes to light, it
would seriously damage the concerned scholars’ reputation and the prospect for further recourse
to their services. Similarly, managerial interference in compliance assessments can lead to a loss
of shareholders’ and stakeholders’ confidence. Management may be penalized and face
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dismissal. All that being said, and the heavy costs of untruthful assessments notwithstanding, a
potential conflict of interest is inherent in existing corporate arrangements regarding SSBs.
The recommendation of AAOIFI is that Shariah supervision must serve at the pleasure of
the company’s Board of Directors, and not be subject to management. Under such an
arrangement, the Board will be free to approve or disapprove of what management does, or
proposes to do, solely on the basis of Shariah/legal considerations (DeLorenzo). This is not to
say that a Shariah Board will automatically become a barrier in the side of management. On the
contrary, most Shariah Boards operate in the spirit of cooperation and accommodation. Vizcaino
(2009) makes a valid view by informing the following:

Specifically, some observers and practitioners (INCEIF for instance) recommend that
separate entities should be used for the Shariah setup and Shariah review. The fact that it
is called a review (rather than an audit) gives rise to questions of how enforceable and
critical a Shariah Board might be - in particular when there are breaches (of
standards/rules) or deviations (from principles/ guidelines). Similarly, there are
circumstances where the body that drafts the procedures/manuals then proceeds to
audit/review the same, such “self-review” questions the independence and impartiality of
the process (p. 1)

9.2 Confidentiality
The issue of confidentiality is intertwined with that of independence. Often, some Shariah
scholars sit on the SSBs of more than one financial institution. This association with multiple
IIF’s may be seen as strength in as much as it could enhance an SSB’s independence in respect
of a particular institution. However, it does give the particular individual access to proprietary
information of other, possibly competing institutions. There are confidentiality concerns and
potential conflicts of interest if inside information from one financial institution is used by
another (Wilson, 2009). Thus SSB members may find themselves in another type of potential
conflict of interest. Findings show that three specific Scholars are members of 26% of all Shariah
boards in the GCC. There is also differing levels of activity between Scholars (from a total of
121 studied): approximately 56 Scholars holding less than 3 board positions, whereas the top 10
Scholars hold on average more than 25 board positions (Vizcaino, 2009) . In the current practice,
Malaysia has attempted to deal with this issue by discouraging jurists from sitting on the SSB of
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more than one IIFS. While this eliminates confidentiality concerns, the practice poses other
potential problems.
First, it would exacerbate lack of competence where there is a scarcity of Fiqh al-
Muamalat jurists (Grais and Pellegrini, 2006). It may prevent the formation of an efficient labor
market for Shariah audit, by decreasing the economic appeal of the profession (Grais and
Pellegrini, 2006). Authors Grais and Pellegrini, (2006) state that it may create a symbiotic
relationship between the auditor and the financial institution that could undermine impartiality.
The potential conflict arising between SSB and external auditors’ disagreements has been the
discussion of the industry. external auditors are necessary since they act as an external control
body that ensures that the financial institutions are adhering to Shariah (Usmani 2001). In studies
conducted by Algaoud and Lewis (1997, 1999) it was revealed that the Islamic banks had no
formal interaction between the SSBs and the external auditors.

9.3 Competence
The third issue relates to the nature of the competence required of SSB members. Due to
the unique role that they are called upon to fulfill, SSB members should ideally be
knowledgeable in both Islamic law and commercial and accounting practices (Fiqh al-
Muamalat). In practice, it would appear that very few scholars are well-versed in both disciplines
(Grais and Pellegrini, 2006). The issue has been addressed by including members from different
backgrounds in most SSBs. However, the combination of experts rather than expertise creates
the challenge of overcoming different perspectives as well as the risk of potential failure of
communication. Over time, the demand gap for combined Shariah and financial skills is likely to
be reduced through public policy and normal labor market operations.
Progress in this direction is already noticeable in countries where the Islamic financial
industry is well established. Authors Grais and Pellegrini (2006) findings show that the
Securities Commission of Malaysia has certified a total of 27 individuals and 3 companies
eligible for Shariah advisory on unit trust funds, for a total of 24 companies offering such
funds.18 However, in countries where Islamic finance is less developed, other transitional
arrangements may be needed.

9.4 Consistency
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The fourth issue concerns consistency of judgment across banks, over time, or across
jurisdictions within the same bank. In essence the activities of SSBs are in the nature of creating
jurisprudence by the interpretation of legal sources. It should therefore not be surprising to find
conflicting opinions on the admissibility of specific financial instruments or transactions.
Nevertheless, as the industry expands, the number of conflicting fatwas on the permissibility of
an instrument is likely to increase. This could undermine customer confidence in the industry
and have repercussions on the enforceability of contracts.
9.5 Disclosure
Another issue relates to disclosure of all information relating to Shariah advisories. In
addition to the positive aspects of thus empowering stakeholders, disclosure could be the means
to addressing some of the issues discussed in the preceding paragraphs. A transparent financial
institution would ideally disclose the duties, decision making process, areas of competence, and
the composition of its SSB, as well publish all fatwas issued by the SSB. This would strengthen
stakeholders’ confidence in the credibility of SSB assessments. The quality and transparency of
financial reporting and disclosure in the Islamic finance industry differs significantly from one
regulatory jurisdiction to another (KPMG, 2007). There is a general concern in the market and
among those interviewed that IFIs, with the notable exceptions of those operating in the U.K.,
Malaysia, Bahrain and perhaps Turkey, should have more rigor in their disclosure and financial
reporting, especially to the general market (KPMG, 2007).
In addition, public disclosure of such information would provide a forum for educating
the public, thus paving the way for a larger role for market discipline in regard to Shariah
compliance. Finally, it would decrease the costs that external agents may face in assessing the
quality of internal Shariah supervision.

9.6 Cost of Maintaining SSB

Many quarters of public question the high cost of maintaining shariah boards which will
be passed on to the customers. This has contributed to increase in cost of Islamic banking
products. SSB is an alien element in banking that distinguishes Islamic banks from rest of the
system. Such pricing practices could be justified by stressing the costs of shariah compliance,
which include the fees paid to shariah board members, the costs of convening board meetings
and the legal charges in structuring Islamic financial products (Wilson, 2009). However, high
 20

costs incurred in top-down supervision process by Islamic banks have made them less
competitive in the financial market.

Pricing is usually broken down into two components in Islamic funds and products (Vizcaino,
2009):

 Structuring: for instance in considering an investment fund, this one-off fee can range
from US$20,000 to US$60,000 (median of US$40,000) for preparing the structure, legal
documentation, issuance of fatwa, etc.
 Review: for the supervisory and monitoring function to ensure that the fund complies
with Shariah principles, this retainer fee can range from US$20,000 to US$55,000
(median of US$40,000). Thus, some recent Islamic fund launches have seen
approximately US$80,000 spent on the first year of operation alone.

There are other quotes available and it must be noted that full-fledged Shariah boards will
require payment for each board member (sometimes along the lines of US$ 25,000 to US$
50,000 per advisor) and other expenditure such as travel expenses and ancillaries will have to be
absorbed as well (Vizcaino, 2009) . The range of costs is wide since there are multiple products
to be considered. For instance, if a single vehicle is setup then a single (and in some cases
external) Shariah advisor would suffice, whereas if a master-feeder type structure where to be
considered (with subsequent sub-funds being launched) then a more comprehensive SSB should
be considered to look into the underlying structures and issue a Shariah compliance certificate
for all the underlying assets/funds. In this case having an SSB for every single fund may be more
expensive.

Furthermore, there are additional products/services that might be required and that should be
taken into account as well, a case in point being Shariah screening mechanisms. In certain
instances stock screening will be an integral part of the investment process, and some advisors
might not be able to provide this specific service or there might be more sophisticated screening
from specialized providers.

Nevertheless, pricing is in practice expected to broaden: on one hand one must consider the
growing calls for country Shariah and on the other you have advisory consultancies increasingly
engaging in more complex structures which are more expensive.
 21

10. Standardization of SSB Opinions

10.1 Issue of Non-Standardization

There have been critics of the lack of standardization of the fatwa of different shariah
boards, and even an assertion that it can result in shariah arbitrage (El Gamal 2006). There is
little evidence of such arbitrage in practice, and indeed it could be regarded as implausible that
the sort of bank clients or investors wanting shariah compliance would shop around for the least
restrictive fatwa. However, bank management, often get the fatwa they want approved, most
notably in the case of sukuk, where some scholars have been having second thoughts about
structures they previously approved. These issues will be considered later in the section on
sukuk. In the UAE consideration is being given to the introduction of a new law establishing a
higher Shariah Council which could oversee the work of the shariah boards of the seven Islamic
banks now operating in the country (Elewa 2008). This would be similar to the Malaysian
system, where there are national shariah boards serving both the Central Bank and the Securities
Commission.6 Only these bodies have the power to issue fatwa, the remit of the shariah boards
of each financial institution being confined to ensuring that activities within the institutions
comply with the fatwa.
This contrasts with the position in the GCC, where in the absence of national shariah
authorities, the boards of each financial institution can issue their own fatwa. Inevitably there are
conflicting fatwa reflecting different interpretations of shariah as each board preserves its power
to make independent pronouncements. Appointments to shariah boards in the GCC are usually
the responsibility of the board of directors of each institution, which will approve the terms and
conditions of service, including remuneration. Normally qualifications in fiqh muamalat will be
 22

required, together with some knowledge of banking and finance, but there is no accreditation
system.
By contrast, in Malaysia all those appointed to the shariah boards of Islamic banks have
to apply to the central bank and obtain accreditation. There is no comparable system in the GCC,
where some argue that the lack of standardization has caused confusion and uncertainty,
although, as indicated above, it has also resulted in healthy discussion, which in many respects
has been helpful for Islamic financial development. In reality, however, the diversity of opinions
is less widespread than might be expected. The General Council of Islamic Banks and Financial
Institutions sampled about 6000 fatwas, and found that 90% were consistent across banks. The
fact that over one hundred Shariah scholars around the world issued these fatwas would suggest
an overall consistency in the interpretation of the sources (Grais and Pellegrini, 2006). Further,
this high degree of consistency between the fatwas would also point to a substantial
independence of SSBs. Nevertheless, as the industry expands, the number of conflicting fatwas
on the permissibility of an instrument is likely to increase. This could undermine customer
confidence in the industry and have repercussions on the enforceability of contracts. Scholar
Elawleed (2007) highlights the following:
The absence of a universally accepted central religious authority is largely a result of the
lack of uniformity in religious principles applied in different Islamic countries across the
world. Shariah boards at individual banks have their own way of defining what is and is
not Islamic banking. This results in different transactions being interpreted differently
and causes uncertainty about what is the acceptable way to do business in the Islamic
banking and finance system. Furthermore, because of this lack of consistency, an
accurate assessment of risk for both the financial institution and the customer can be
difficult to make.

The differences in interpretation of Shariah laws also means that one Islamic bank may
not be able to “copy” another Islamic bank’s products, and this can stifle the growth and
integration of Islamic finance at both national and international levels. Lack of standardization is
also a contributory factor in the sluggish trading levels on the Sukuk market. It prevents investors
from knowing what risks they are assuming when they invest and increases the costs associated
with Sukuk issuance.

10.2 Harmonization of Opinions

 23

Conformity among the Shariah supervisory boards of IFIs is urgently required through
standardization that will extend the possibility of concept and application in the industry.
Establishing Shariah boards at a global and central bank level is needed to accelerate and
develop some standard guidelines on the conduct of Islamic financial transactions.
Standardization will help avoid contradictions or inconsistencies between different Fatwa rulings
and their application by these institutions (Elawleed, 2007).

One of the distinctive goals of the existing bodies pertaining to Islamic finance is the
standardization of Shariah practices within their jurisdictions. Countries such as Kuwait,
Malaysia or Pakistan have taken significant actions in this respect, while others have not
followed this route (Grais and Pellegrini, 2006). The standardization of Islamic instruments may
be a major determinant in ensuring the enforceability of Islamic financial contracts in disputes
brought before civil courts that are not legally bound by the Shariah. Accordingly,
standardization of practices would support property rights of involved stakeholders as well as
sustain the development of IFIs in non-Islamic countries route (Grais and Pellegrini, 2006).
However, the practice of centralized SSBs creates the possibility that one IIFS group operating in
different jurisdictions may have products deemed Shariah compliant in one place and not in
another. In addition, regulators in non Islamic jurisdictions would consider that matters relating
to the Shariah are not in their purview.

An important factor is the mutual recognition of financial standards and products across
jurisdictions. The progressive harmonization of Shariah, in this respect, needs to be viewed as a
step towards greater international financial integration (Elawleed, 2007). Moreover, supervision
and regulation at the national and regional levels are necessary safeguards against potential
improper practices, which can cast doubt on the credibility of all participants. Shariah scholars
from around the world should contribute towards greater understanding and international
convergence (Elawleed, 2007). Such convergence and harmonization can only happen with
greater engagement among the regulators, practitioners and scholars in Islamic finance in the
international community.

The existence of a unified Shariah board via council representing different Islamic
schools of thought, nationally and internationally, would facilitate the conformity of different
types of financial services to Islamic law (Elawleed, 2007). This would also define cohesive
 24

rules to expedite the process of introducing new products. The early engagement of a Shariah
supervisory board in the creation of a new Sukuk is of utmost importance so as to build a solid
Islamic foundation. It also paves the way for speedier creation of the Sukuk. It is crucial that the
Shariah board actively participates in the creation of Sukuk, in addition to its supervisory role
(Elawleed, 2007).In order to promote a global standard for Islamic finance instruments, there are
a couple of key steps that must be taken.The Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) has taken the lead by preparing Shariah standards. These have
been adopted by a number of government authorities and central banks, which provides an
avenue for Shariah compliance as well as product innovation.

Collective efforts towards international collaboration among major Islamic financial regulatory
bodies such as the Islamic Financial Services Board (IFSB), AAOIFI and the central banks in
Islamic countries is important in strengthening the fabric of Islamic finance.

Islamic finance instruments, particularly Sukuk, are becoming an increasingly important

consideration – for both Muslims and non-Muslims – from the perspective of investment and
product innovation. Shariah boards need to keep up with the growth and sophistication of the
industry and make sure they are as effective as possible. Author (Elawleed, 2007) make
following recommendations:

 More training in economics, investments and legal issues related to investments and
product innovation. The lack of knowledge about modern economic and legal issues can
weigh down the ability of Shariah scholars to issue well-informed rulings on financial
products and investment activities.
 Placing specialized Shariah scholars on separate Shariah boards for different projects to
work more efficiently on projects best suited to their particular areas of expertise. This
process will ensure that the right scholars in the right numbers develop, certify and
supervise the financial products and services endorsed by Islamic financial institutions.
 Shariah boards should be independent from financial institutions in order to ensure
transparency and efficiency when giving opinions on proposed contracts and transactions.
 Shariah advisors should work closely with financial institutions and lawyers in
developing new Islamic financial instruments.
 25

 There is a nagging concern about the availability of suitably qualified Shariah advisors.
Their numbers need to be increased. This will allow more Shariah-compliant
transactional procedures and more time for advisors to spend with economists and
investment practitioners to develop new Islamic financial products.
 Financial institutions need to develop operating procedures to ensure that no form of
investment or business activity is undertaken that has not been approved in advance by
the religious board.
 From the outset of structuring a Sukuk, Shariah advisors should scrutinize to ensure that
the product concept and its process flow is fully implemented according to Shariah.
Shariah advisors and lawyers should work hand in hand to thoroughly review the terms
and conditions of the Sukuk contract.

Flexibility is a major strength of Islamic finance, and this implies that a broad variety of
products can be tailored to each client’s needs. The differences in rulings by different Shariah
boards is advantageous in a way, as it brings about more innovation and creates new room for
Sukuk structures and Islamic finance instruments. In the process of providing remedies, the
principles of Shariah are not to be compromised, as they are essential to a dynamic market.

11. Models of Shariah Governance from Selected Countries

Having discussed the operations, practices and issues of SSB in Malaysian context, a
concise discussion of the SSB model in other countries would be utterly helpful. This will shed
some light on the differences in practices in some prominent Muslim countries that Islamic
finance has become a major drive. Following are some of the exisiting models of SSB (Hasan).

Pakistan Model
 The establishment of Shariah Board at the State Bank of Pakistan (SBP)
 Shariah Board is the sole authority in matters pertaining to Islamic finance
 Requirement for the establishment of Shariah advisor for the Islamic financial institution
 Any member of Shariah Board at the SBP is allowed to serve as Shariah advisor of a
financial institution(different from Malaysian situation)
 Restriction imposed –a Shariah advisor is allowed to serve only one financial institution
 No division of industries as in the Malaysian situation has been made
 26

Kuwait Model
• Kuwait is practicing self regulation of Islamic financial institutions
• There is no Shariah Advisory Council at the Central Bank of Kuwait
• Section 10, Chapter 3, Central Bank of Kuwait Law 32/1968 provides that every Islamic
financial institution shall have its own Shariah Supervisory Board
• In the case of conflict of opinions among members of the Shariah Supervisory Boards
concerning a Shariah ruling, the Board of Directors of the designated Islamic FI may
transfer the matter to the “Fatwa Board” in the Ministry of Awqaf and Islamic Affairs
(this is not compulsory)
• The Fatwa Board in the Ministry of Awqaf and Islamic Affairs shall be the final authority
on the matter
• This Fatwa Board is an external body to the Central Bank of Kuwait
• No restriction is mentioned/found in the law
• From the existing practice, it can be said that there is no restriction for the members of
the Fatwa Board to serve in any Islamic financial institution. Similarly, there is also no
limitation to serve as a member of Shariah Supervisory Board of more than one Islamic
financial institution

Bahrain Model
• Establishment of National Shariah Board of the Central Bank of Bahrain –to serve and to
verify the Shariah compliance of its own products only
• All other Islamic financial institutions shall establish “Shariah Supervisory Committee”
and comply with the AAOIFI's Governance Standards for Islamic Financial Institutions
No. 1 and No. 2
• No restriction for the member of National Shariah Board to serve any financial
institution, also no limitation to serve only one institution

U.A.E. Model
• Establishment of “Higher Shariah Authority” to supervise Islamic banks, financial
institutions and investment companies (Art. 5, Federal Law No. 6 of 1985)
 27

• This Authority shall be accorded the final authority in Shariah matters in Islamic banking
and finance
• Formation of Shariah Supervision Authority at the financial institution level (Art. 6 of the
same Law)
• Nothing is mentioned about any restriction

Qatar Model
• Practicing self regulation of Islamic banks
• No Shariah Advisory Board at Central Bank of Qatar. But has “Supreme Shariah
Council” attached to Awqaf Ministry –any issue can be directed to the Council for
clarification
• Central Bank of Qatar appoints Shariah scholars to solve any problem encountered on
case-to-case basis
• No restriction on Shariah advisors to be a member of Shariah Board in more than one IFI.

Table 1
 28

Extracted from: Corporate Governance and Shariah Compliance In Institutions Offering Islamic Financial Services
(Wafik Grais and Matteo Pellegrini, 2006).

Above table shows the regulatory framework implemented by the country’s central banks
as regards to the various aspects of SSB. Monetary authorities in all mentioned countries have
implemented the terms of reference in order to set the right precedence to the industry by
establishing SSB. However, countries do not have a uniform regulations for the shariah advisory
for own reasons. For example, except for Jordan and Kuwait other countries in the table 1 do not
specify the decision making of SSB. On the other hand, except for Malaysia and Indonesia other
countries specify the number to serve in the SSB.

12. Conclusion
The increasing popularity of Islamic finance in the aftermath of financial crisis is an
interesting phenomenon. Both western and Islamic schools claim that Islamic financial system
 29

could have averted such a crisis amid its shariah framework. The center to operations of any IFI
is its Shariah supervision. Indeed it’s a very part of corporate governance in modern IFI’s.
Shariah supervision will be an essential part of an Islamic product or service from the time of its
development, to its launch, and throughout the period it is offered. At the stage of research and
development, or of drafting contracts or offering memorandums, Shariah supervision, in one
form or another, should be an active participant.
The supervision is periodically carried out by the banks Shariah supervisory body. It is an
independent body distinguished from the board of directors that ensures bank is in line with
shariah rules. This enables the Muslim investors to identify the financial institutions that are
permissible to invest their money. The objectives of Islamic banks may therefore differ greatly
from the conventional bank's objectives. Therefore, in order to ensure compliance to the Shariah,
IFIs use the service of well-verse Shariah scholars.
In Malaysia, Bank Negara Malaysia has actively participated in drawing regulations and
guidelines to direct the functions of SSB. It has detailed out various aspects of SSB in IFIs. As an
essential element of corporate governance, SSB is expected to function in the best interest of its
stakeholders that seek for consistent shariah compliance. However issues exist as to its
independence, consistency, confidentiality, competency, disclosure and high costs. These issues
question the operations of SSB and need to strengthen the governance structure of IFIs.
With different shariah boards announcing diverse standards, IFI’s have attracted some
criticism due to non-standardization of opinions. Scholars have called for harmonization of
opinions that will promote uniformity among the IFIs’. The mutual recognition of financial
standards and products across jurisdictions is vital. Thus conflicting fatwa could disturb the
progress of industry where integrity is the center of Islamic finance. The progressive
harmonization of Shariah, in this respect, needs to be viewed as a step towards greater
international financial integration. Moreover, many countries that operate well established
Islamic financial sectors have introduced regulations to guide the function of SSB. These
regulations could be in different approaches but attempt to strengthen the SSB.

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 30

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