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Shariʿah Governance System in Islamic Financial Institutions: New

Issues and Challenges

Article  in  Arab Law Quarterly · January 2013

DOI: 10.1163/15730255-12341254

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Shariah
Shariah supervisory system supervisory
in Islamic financial institutions system
New issues and challenges: a comparative
analysis between Southeast Asia models 333
and GCC models
Rihab Grassa
Higher Institute of Accountancy and Entrepreneurial Administration (ISCAE),
La Manouba, Tunisia

Abstract
Purpose – The aim of this paper is to review the different steps of development of Shariah
governance system and to discuss the different practices of Shariah governance in Islamic financial
institutions internationally.
Design/methodology/approach – The paper has a particular focus on the other contributions of
relevant literature and existing laws and regulations for Islamic financial institutions which provides a
reflective synthesis on practical work of Shariah governance system across different jurisdictions.
Findings – The main attention of this paper is Islamic financial institutions and a key issue arising is
that the typical structure, functions, duties and responsibilities are different from country to country.
Practical implications – The paper put forward various suggestions to the regulatory authorities
and to the Islamic Financial Services Board to enhance the Shariah governance system and to
standardize the different practices of Shariah governance worldwide.
Originality/value – The originality and the value of the paper lie in its critical review of current
Shariah governance practices worldwide. As well, some key issues pertaining to Shariah governance
in Islamic financial institutions are addressed to encourage further investigation by academics and
practitioners in the field.
Keywords Malaysia, Islamic financial institutions, Indonesia, GCC countries, Shariah governance,
Shariah supervisory board
Paper type General review

1. Introduction
Islamic finance is particular kind of finance generating distinct corporate governance
challenges. Islamic finance is based on Islamic principles and the activities of Islamic
financial institutions (IFIs) must be compliant with Shariah principles. Shariah
governs all IFIs’s aspects which adds additional values to the existing corporate
governance structure.
Today with the quick steps of growth of Islamic financial system worldwide,
corporate governance of IFIs is assuming developing considerably. Shariah is a unique
characteristic of Islamic finance, the need for an efficient Shariah supervisory system
for IFIs is considered as a crucial requirement to ensure the development and the
stability of the Islamic finance industry. Indeed, the success of any Islamic finance Humanomics
Vol. 29 No. 4, 2013
system in any country depends largely on the belief of the stakeholders that all pp. 333-348
components of the system must comply with Shariah principles and rules q Emerald Group Publishing Limited
0828-8666
(Hassan, 2010). DOI 10.1108/H-01-2013-0001
HUM To guarantee that all operations made by the IFIs are Shariah-compliant, the services
29,4 of religious boards comprising Shariah scholars known as Shariah boards (SBs) are
employed. The SB is considered as one of the most important components of Shariah
governance system in IFIs. The board plays a dual role of supervision and consultation
in the IFIs. The SB influence profoundly the day-to-day practices of Islamic finance and
the activities of the IFIs by providing advice and opinions.
334 Over the past few years, many countries have developed a comprehensive
governance framework for Shariah issues responding to the needs of IFIs. However, it
has been remarked that due to the absence of a well conceptualized framework, these
regulations are essentially based on respective countries’ needs and experiences.
Today, with the increasing presence and the rapid growth of the Islamic finance
worldwide, Shariah supervisions are facing news issues and challenges. The
development of a comprehensive Shariah governance framework seems to be needed
today more than before.
While many practitioners and researchers insist on the need for a sound and
efficient Shariah supervisory system to insure the wellbeing of IFIs, it has nevertheless
remarked that only few studies have discussed this issue. In view of the shortage in
literature on corporate governance in Islamic finance, this study aims to explore and
analyze the state of Shariah supervisory systems and practices in two leading Islamic
finance regions: namely the GCC and the Southeast Asian regions. Moreover, this
paper investigates the Shariah supervisory system in IFIs and the issues and
challenges facing the installment of a robust Shariah supervisory system.
Our discussion has demonstrate that different Shariah supervisory practices in IFIs
across these two regions have reveal many gaps. Today these gaps rise new issues and
big challenges to promote an effective Shariah supervisory system in IFIs. Most of
these issues are related to the roles and duties of the higher Shariah authorities
operating at the national level and the attributes of scholars setting at the institutional
SBs. In another hand, the discussion has demonstrate that even if Southeast Asia
model of Shariah supervision seems to be most efficient and effective in achieving the
Shariah compliant purpose than the GCC model, it cannot be considered as a perfect
model. A lot of works are required to improve it.
The paper is organized as follow: Section 2 discuss previous literature review on
Shariah governance and Shariah supervisory system in IFIs. Section 3 presents a
comparative analysis of Shariah supervisory system in Southeast Asia and GCC countries.
Section 4 discuss the new issues and challenges facing Shariah supervisory practices in
GCC and Southeast Asia countries today. Section 5 presents concluding remarks.

2. Literature review on Shariah governance in IFIs

2.1 Corporate governance in Islamic perspective: theoretical foundation
Parallel with the rapid growth of Islamic finance and the increasing presence of IFIs
worldwide, corporate governance has received a considerable attention in Islamic
finance. The extensive development of Islamic finance globally raises the issue of how
corporate governance in Islamic finance is different from conventional one and how it
must be designed. Many previous studies have discussed this issue (Choudhury and
Hoque, 2006; Ibrahim, 2007; Hasan, 2007; Abu-Tapanjeh, 2009; Magalhães and
Al-Saad, 2010; Saif Alnasser and Muhammed, 2012).
 Oppositely to the Western academic schools where corporate governance is aligned Shariah
with the interest of shareholders (Anglo-American model) or the interest of other supervisory
stakeholders (Franco-German model) (Macey and O’Hara, 2003), corporate governance
in Shariah compliant business may adopt a totally different or a modified version of system
stakeholder model of corporate governance. The first model of corporate governance in
Islamic finance is based on the principle of Shurah (consultation) where all stakeholders
share the same target of Tawhid and the oneness of Allah (Choudury and Hoque, 2004). 335
Through the Tawhid and Shurah model, corporate governance in Islamic finance is
governed by four key principles: Tawhid unity of knowledge via interactive, integrative
and evolutionary process to the interacting environing factors, the principle of fairness
and justice, the principle of productive engagement of resources in social and economic
activities and the principle of recursive intention amongst the above stages
(Choudhury, 1989).
Despite that Tawhid and Shurah based approach provides an epistemological
foundation of corporate governance in Islam, the approach seem to be unclear how it
could be implemented in the corporate governance system of IFIs (Hasan, 2007). In
practice, most o the IFIs follow a modified version of stakeholders-oriented governance
model based on the episteme of rationalism and rationality (Iqbal and Mirakhor, 2007;
Chapra and Ahmed, 2002). According to stakeholder approach of corporate governance
in Islamic economic system, the principal objective of the firm is to maximize the welfare
of all stakeholders and not the shareholders alone. The stakeholder approach of
corporate governance in IFIs is based on two principal concepts of Shariah principle of
property rights and contractual obligation. It stresses the importance of protecting the
interests of all stakeholders. Under the stakeholder approach, the SB is considered as a
unique governance structure promoting the Shariah-compliance of all activities and
aspect of IFIs. The board of directors is responsible to protect the financial interest of
shareholders. Others stakeholders have a responsibility to perform all their contractual
obligations. The regulatory and supervisory authorities, considered as part of
stakeholders, provide an appropriate regulatory and supervisory environment
(Iqbal and Mirakhor, 2007; Chapra and Ahmed, 2002).

2.2 Shariah governance in IFIs: concept and definition

Shariah governance is a unique characteristic of corporate governance in financial
architecture and it is concerned with the religious aspects and the Islamicity of the
activities and conducts of IFIs (Hassan, 2010). According to IFSB, Standards 10 (2009)
“Shariah governance system refers to the set of institutional and organizational
arrangements through which an IIFS ensures that there is effective independent oversight of
Shariah compliance”. This definition give incite about the importance of institution of the SB
as a crucial component of the Shariah governance system in IFIs ensuring the Shariah
compliance of all its activities. Hence, Shariah governance refers to a system conducted by
Shariah principles and controlled by an effective religious board to insure that the activities
of IFIs are in accordance with the Shariah principles and conducts. For this purpose,
IFIs have to set up an internal Shariah system to insure the Shariah compliance of the
activities of the institution. This internal body can be constituted by a simple SB or extended
to an internal Shariah system composed of a SB and an internal Shariah review unit or
department to support SB in performing its function (Hassan, 2010).
HUM 2.3 Historical development of Shariah governance
29,4 In the beginning of the Islamic finance practice, there was no special body responsible
to advise, supervise or monitor IFIs on issues relating to Shariah matters. The
establishment of the first modern Islamic banks (Mit Ghamr in 1963, the Nasser Social
Bank in Egypt in 1972) was made without setting up any Shariah body as part of its
internal corporate governance structure (Malkawi, 2010). Moreover, in the
336 commencement of the Dubai Islamic Bank and the Islamic Development Bank in
1975, both of them did not have any permanent Shariah department in their banks. To
resolve Shariah issue related to their activities, they have established a relationship
with several scholars for consultation on their activities, transactions, products and
services as well as asking fatwas for specific questions and transactions (Kahf, 2004).
In general we can say that the activities of the banks did not diverge much from the
Islamic Shariah, even if in 1985, when the Organization of the Islamic Conference (OIC)
Fiqh Academy responded to a list of questions submitted two years earlier, the IDB
had to revise some of its standing policies to make them Shariah-compliance
(Kahf, 2004). These practices still the same until 1997 for Dubai Islamic Bank date of a
major change in management that took place following of a financial scandal and
which called for a restructuring of the bank. The new bank management established,
for the first time, a Shariah consultative committee in 1999. However, the Islamic
development bank has established a Shariah Supervisory Board only in 2003
(Kahf, 2004).
The setting of an internal Shariah governance structure: a Shariah Supervisory
Board in IFIs started with the establishment of Faisal Islamic Bank of Egypt in 1976. The
bank was the first IFI that had created an internal religious board for the Shariah
purposes. The board contains selected scholars on Fiqh El Moamlat from Egypt. This
practice was then followed by Jordan Islamic Bank and the Faisal Islamic Bank of Sudan
in 1978, the Kuwait Finance House in 1979, and the Bank Islam Malaysia Berhad in 1983
(Malkawi, 2010). From that moment, the development of the Islamic financial industry
has been accompanied with the involvement of famous Shariah scholars setting in their
internal SB.
To strengthen the concept of the Shariah governance in IFIs, the International
Association of Islamic banks (replaced with the General Council for Islamic Banks and
Financial Institutions (GCIBF) in 1999) has set up its SB[1]. In the meantime, the OIC
countries known as the Council of the Islamic Fiqh Academy preserve the power to
issue fatwas rulings including matter related with Islamic financial transactions
(Malkawi, 2010)[2].
In 1999 the Accounting and Auditing Organization of IFIs (AAOIFI) has published
and adopted the first Shariah governance standard for IFIs (stadard1) related to the
SSB: appointment, composition and report. Until today, the AAOIFI has developed a
comprehensive framework for corporate governance of IFI composed of seven
governance standards. These standards cover different area:
(1) the SSB composition, report and appointment;
(2) the Shariah review;
(3) the internal Shariah review;
(4) the audit and governance committee for IFI;
(5) the independence of the Shariah supervisory board;
 (6) statement on governance principles for IFI; and Shariah
(7) corporate social responsibility, conduct and disclosure for IFIs. supervisory
In 2006, the Islamic Financial Service Board (IFSB) has published the first corporate system
governance standard for IFIs (the IFSB3). The standard was a Guiding Principles on
Corporate Governance for Institutions offering only Islamic Financial Services
(Excluding Islamic Insurance (Takâful) Institutions and Islamic Mutual Funds. The 337
guidelines covered four areas: a general governance approach of IFI, the rights of
investments account holders, the compliance with Islamic Shariah principles and the
transparency of financial reporting in respect of investment accounts. Three years
later, the IFSB has published the second corporate governance standards IFSB3.
However, this one was published to serve as principles on governance for Takâful
companies (Islamic insurance companies).
With the strong diversity in the implementation of Shariah governance in IFI all over
the word, a higher standard of Shariah governance seems to be needed. That is why, in
December 2009, the IFSB has published the third corporate governance standards
(IFSB10). This one was developed to be used as guiding principles on Shariah governance
systems for institutions offering Islamic financial services and cover the different areas of
Shariah governance system like qualification of the SB, role and duties, etc.

2.4 The importance of Shariah supervisory system in IFIs: the SB

Islamic finance is based on Shariah law and all IFIs’ activities must be compliant with
Islamic rules and principles. The risk of Shariah incompliance may have serious
consequences on the continuity of the activities of the IFIs in particular and the
development of the Islamic financial system in general. That is why, the need for an
efficient Shariah supervisory system is considered as one of the vital element promoting
the stability of the Islamic financial sector. With this aspiration, corporate governance in
IFIs has to set institutional arrangements to supervise the Shariah-compliant aspects of
their activities. One of the most powerful institutional arrangements is known as the SB
which plays a crucial role in all Shariah aspects of the IFIs: supervision, monitoring,
auditing and issuing rules and fatwa.
In parallel with the increasing growth of Islamic finance globally and the complexity
of the Islamic finance products and services The SB has become the most important
component of the Shariah governance system in Islamic finance that has a deep
influence on the day-to-day practice of Islamic finance in IFIs (Hassan, 2010). Setting a
SB assure stakeholders that the IFIs drive their business in accordance with Shariah
(Grais and Pellegrini, 2006). The purpose of the SB is to guarantee that the IFI operate in
conformity with Islamic law and Shariah principles. This board, as part of the internal
governance structure of the institution improves the credibility of the institutions in the
eyes of its customers, shareholders, stakeholders [. . .] and bolstering their Islamic
credentials (Rammal, 2006). The SB is crucial for two reasons. First, those who deal with
an Islamic bank want to be assured that the activities of the IFIs are confirm to Shariah
principles. In fact, if the board reports that the management of the bank has violated the
Shariah, the Islamic bank 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 outlined
above. The Islamic moral code will prevent Muslims to behave against ethic which
HUM will minimize the transaction costs arising from incentive issues between, shareholders,
29,4 managers and debt holders. In effect, Islamic religious ideology acts as an incentive
mechanism that reduces the inefficiency arising from asymmetric information and
moral hazard (Suleiman, 2000).

2.5 The SB: player, role and responsibilities

338 SB is a unique structure of governance in Islamic financial system entrusted with the
duty of directing, reviewing, supervising the activities of IFIs to insure Shariah
compliance. The International Council of Fiqh Academy has defined the SB under the
decision number 177(19/3) regarding the role of SB in regulating the operations of
Islamic banks as:
A group of specialist scholars in the field of Islamic jurisprudence, particularity transactional
jurisprudence ( fiqh mu’amalat), whose number will not be less than three and chosen among
those who have the aptitude and knowledge with regard to the practical reality, whose work
is to pronounce the verdicts and revise whatever that needs to be revised, in order to confirm
and ensure that all transactions conducted by the IFIs comply with the rulings and
fundamentals of the Shariah, and to publicize the decisions to the public, and its decision
must upheld by the IFI.
A central characteristic of IFIs is ensuring Shariah conformity in all her transactions and
activities. To assure stakeholders, IFIs generally set up a body known as SB (Grais and
Pellegrini, 2006). The purpose of the SB is to guarantee that the IFIs operate in
conformity with Islamic law and Shariah principles. SB is made up of a number of jurists
who provide explanation in regards to any questions that the financial institutions may
have (Usmani, 2001). The SB consists of Shariah advisers who are hired by the Islamic
bank. This board, as part of the internal governance structure of the institution improves
the credibility of the institutions in the eyes of its customers, shareholders, stakeholders
[. . .] and bolstering their Islamic credentials (Rammal, 2006).

2.6 Different Shariah supervisory systems and practices

Over the past few years, a lot of progress has been made to strengthen Shariah
governance framework. Many countries attempted to develop a comprehensive
governance framework for Shariah issues for IFIs.
In the absence of a well conceptualized framework, these regulations are basically
based on respective countries’ needs and experiences. Different jurisdictions have
varying approaches demonstrating diverse practices and models of Shariah
governance system. Some of them opt for a greater involvement of regulatory
authorities, and developed a comprehensive regulatory framework governing Shariah
supervision and practices at both the national and the institutional. Others favor less
involvement of regulatory authorities and have adopted a regulatory framework for
Shariah governance only at the institutional level. Others countries prefer to not give
any specific regulation for Shariah governance practices and leave it to the voluntary
initiative of the IFIs and the influence from the market.

3. A comparative analysis of Shariah supervisory system in Southeast

Asia and GCC countries
With the increasing presence of IFIs worldwide and the rapid growth of Islamic finance,
a lot of progress has been made to strength Shariah supervisory system in IFIs.
Different jurisdictions have developed varying approaches demonstrating diverse Shariah
practices and models of Shariah supervisory system. Some of them opt for a greater
involvement of regulatory authorities, others favor otherwise (Hassan, 2010). We
supervisory
propose in this section to investigate two model of Shariah supervisory system system
characterizing two leading region in Islamic finance: the Southeast Asian model (known
mainly in Malaysia and Indonesia) and the GCC model.
339
3.1 Shariah supervisory system for IFIs in Southeast Asia countries
The modern Islamic finance exist in Southeast Asia countries in its early stages. Many
initiatives have marked the development of Islamic finance in Southeast Asia region in
general, such as the establishment of the first IFI in the world known as Tabung Haji
(The Pilgrimage Fund) in Malaysia in 1969, the first Islamic bank in Malaysia also in
1983 and the initiatives to become an international Islamic finance hub.
Parallel to the successful development of Islamic finance and the huge growth of
Islamic financial assets in the region, Southeast Asian countries have developed a
unique Shariah supervisory model to insure the stability of the Islamic financial system.
The model is characterized by the existence of dual Shariah control bodies: a higher
Shariah authority setting at the national level and internal SBs setting at the
institutional level. As part of the effort to streamline and harmonize the Shariah
interpretations among IFIs, Central banks and securities commissions in Southeast Asia
countries have established a National Shariah authority. The roles and the duties of the
national SB differ from country to country. However, in general and in practice, the
national SB has to act as the higher Shariah authority body in the country to guide and
advice the central bank or the securities commission on Shariah matters related to
Islamic financial operations and services. In addition, the national SB has to resolve
Shariah issues concerning Islamic banking and finance and analyze Shariah compliance
of new products/schemes submitted by IFIs. Some countries give more responsibilities
and powers to the higher Shariah authority, otherwise (Grassa, 2013) (Scheme 1).
For the Malaysian case, in the main objective to reinforce the role of SB setting in
IFIs and to harmonize the Shariah interpretations among IFIs, the Bank Negara
Malaysia – the central bank of Malaysia – has created the Shariah Advisory Council
(SAC) on Islamic Banking and Takaful on 1 May 1997. The council act as the highest
Shariah authority for Islamic banks, Takaful companies, Islamic financial business,
Islamic development financial business, or any other IFIs which is based on Shariah
and supervised by Bank Negara Malaysia (Hassan, 2010). The main purposes of the

Role: Advise the central bank/ National Level (Central

security commission National Bank, Security Commission)
Shariah authority

Advise on Shariah matter

Cheek the Shariah conformity
of new Islamic financial products
Role: Supervise and advise the Istitutional Shariah Boards Institutional
IFIs on Shariah matters Level (IFIs)
Scheme 1.
Shariah supervisory
model for IFIs in
Southeast Asia countries
HUM SAC is to provide Shariah guidelines to IFIs operating in the country and to advise the
29,4 central bank on any Shariah issue relating to Islamic financial business or transactions
of Bank Negara Malaysia besides other related entities. Moreover, the SAC has to
validate all Islamic banking and Takaful products/services offered by IFIs to
guarantee their compliance with the Shariah principles and guidelines (BNM)[3].
In the recent banking Act 2009, the role and tasks of the SAC was more reinforced.
340 Today, the SAC is recognized and the sole authoritative body responsible on
Shariah issues concerning Islamic banking, Takaful operations and Islamic finance.
Whereas the decisions of the SAC shall prevail over any contradictory ruling provided
by any SB or committee instituted in Malaysia, the court and arbitrator are also
required to refer to the decisions of the SAC for any proceedings relating to Islamic
financial business, and such rulings shall be obligatory and in case of Shariah disputes
relating to Islamic financial transactions, the SAC is the first reference used by the
Malaysian courts and the Regional Center for Arbitration in Kuala Lumpur[3].
The SAC is constituted of prominent Shariah scholars, jurists and market
practitioners qualified and having a large experience in Islamic banking, Islamic
finance and economics and especially in Shariah law. To preserve the independence of
the SAC, members of the SAC cannot be members of others Shariah committee of
financial institutions.
On the institutional level, every IFI has to establish its independent internal
Shariah committee. According to the Islamic Financial Services Act of 2013,
the Shariah committee is responsible to advise the institutions on Shariah matter and
Shariah compliance of the Islamic financial operations. In 2004, Bank Negara Malaysia
has issued a Guidelines for Shariah Governance framework for IFIs in the main purpose
to regulate Shariah governance, uniform Shariah practices and create and extend the
pool of competent Shariah personnel in IFIs. The guidelines set out the rules, regulations
and procedures in the establishment of a Shariah committee, the role, and scope of duties
of the committee as well as the relationship between the institutional the institutional
Shariah committee and the SAC of the central bank (Grassa, 2013).
Like the Malaysian model of Shariah supervision for IFIs, the Indonesian model is
characterized by the existence of a dual Shariah supervisory bodies. The first one is
setting at the national level and recognized as the National Shariah Council (DSN). The
second one is setting at the institutional level and known as the SB.
The DSN is formed by Indonesian Council of Ulemas in 1999 and setting in Bank
Indonesia – the central Bank of Indonesia – as an independent body responsible to
issue Shariah rulings on products and services offered by IFIs. The DSN has to assist
Bank Indonesia in: interpreting fatwa of Majlis Ulamas of Indonesia concerning
Shariah banking, providing input in the framework of implementing fatwa into Bank
Indonesia regulations and undertaking development of Shariah banking industry. The
central Bank of Indonesia issues regulations for Islamic financial products based on
fatwas issued by the DSN.
On the institutional level, every IFI has to establish a SB to supervise the
Shariah compliance of all operations made by the IFI. To ensure greater Shariah
supervision, Bank Indonesia has set up “fit and proper” criteria which include a test for
new members of the SB that cover understanding of Shariah principles and knowledge
on Islamic banking and finance in general. Besides, according to Islamic banking
regulation (2004), every six months SB have to submit independently a report on the
finding of Shariah supervision to the Board of Directors, the Board of Commissioners Shariah
and the National Shariah Council and Bank Indonesia. supervisory
3.2 Shariah supervisory system for IFIs in GCC countries system
The Shariah supervisory system in GCC countries is different from that observed in
Southeast Asia countries. Only Bahrain has opted for a national SB setting in the Central
Bank of Bahrain (CBB). The other GCC countries, except Saudi Arabia, have delegated 341
the power of higher Shariah authority to another government body such the ministry of
Awqaf and religious affairs or the ministry of justice and Islamic affairs (as the case of
Kuwait, UAE, Qatar). Even if it exists, the power of the higher Shariah authority is
restricted to give advice in case of conflict of opinion between SB members on problems
related to Shariah interpretation or to advise the central bank on Shariah matter as the
case of Bahrain. The national Shariah authority in GCC countries do not exercise any
supervision on Shariah practices at the institutional level. The Shariah supervisory
system in GCC countries is based essentially at the institutional level (Scheme 2).
Shariah supervisory system for IFIs vary in GCC region from country to country.
The kingdom of Bahrain has developed a comprehensive regulatory framework
governing Shariah supervisory practices at both national and institutional level.
Qatar, UAE and Kuwait have adopted a regulatory framework for Shariah supervision
only at the institutional level. However, Saudi Arabia prefer to not give any specific
regulation for Shariah supervisory practices and leave it to the voluntary initiative of
the IFIs and the influence from the market. Indeed, the development of Islamic finance
in Saudi Arabia is considered as very distinctive. There is no specific legal framework
for IFIs and are subject for the same regulatory framework as conventional financial
institutions. Since that, Shariah supervisory system for IFIs in Saudi Arabia is
self-regulated approach, influenced by the market and the voluntary initiatives taken
by several IFIs to develop their internal Shariah supervisory system (Hassan, 2010).
For the case of Bahrain, since its early stages, the kingdom has been considered as a
hub of Islamic finance in the GCC region. The CBB has developed a comprehensive
regulatory framework known as the Rule Book of the CBB to assure the development
and the stability of the Islamic financial sector.
Regarding the Shariah supervisory system, Bahrain is characterized by the
existence of a dual Shariah supervisory board at both national and institutional level.
Indeed, the CBB has established the National Shariah Advisory Board in the central
bank to verify the compliance of the activities with Shariah principles (Hassan, 2010).

Central Bank Advice on Shariah

matters
of Bahrain National Shariah Advisory Board (Bahrain)
Higher Shariah
Ministry of Awqaf and religious affairs (Kwait) Authority
Ministry of justice and Islamic affairs (UAE, Qatar)

Advise in case of conflict of opinion

between SB members in Shariah
matter Scheme 2.
Shariah supervisory
systems in IFIs
Institutional Shariah Boards in GCC countries
HUM Nerveless the board do not have any authority upon the other institutional SB setting
29,4 in the IFIs and cannot exercise any power on the IFIs (Hassan, 2010).
On the institutional level, the CCB rule book require IFIs to create an independent
internal Shariah supervisory board consisting of at least three Shariah scholars and
complying with AAOIFI’s governance standards for IFIs Nos 1 and 2.
In UAE, Shariah supervisory system is regulated by the Federal Law No. 6 of 1985
342 concerning Islamic banks, financial institutions and investment companies. Under
which, IFIs have to institute their SB composed of a minimum of three members whose
names must be declared to the “Higher Shariah Authority”. The Higher Shariah
Authority is created under the Ministry of Justice and Islamic Affairs to undertake
higher supervision over Islamic financial industry and to ensure legitimacy of their
transactions according Shariah and to offer opinion on matters which these agencies
my come across while conducting their activities and all opinions made by the higher
authority shall be binging on the all Islamic financial industry (Grassa, 2013).
In Kuwait, the Shariah supervisory system for IFIs in Kuwait is regulated under the
Article 93 of the Central Bank of Kuwait (CBK) Law 32/1968. Under this article, IFIs,
through its general assembly, have to appoint an independent Shariah supervisory
board composed of not less than three members. The law require the general assembly
of the IFIs to specify the formulation, powers and working of the SB. Nevertheless, the
law do not prescribe the existence of a national SB at the national level. But in case of
conflict of opinion between the SB members on matter related to Shariah
interpretation, the law indicate that the issue must be transferred to the Fatwa
Board in the Ministry of Awqaf and Islamic Affairs which shall be the final authority
on the matter (Hassan, 2010).
The Shariah governance system in Qatar is regulated under the banking law of the
Central Bank of Qatar. The law regulate both Islamic and conventional financial
institutions. Under which, every IFIs has to establish its SB comprising of at least
two members specialist in Fiqh al mualamalat. The law give also a general overview
about the duties and independence of the SB. To guarantee a better
Shariah governance, Qatar Financial Center (QFC) give, under The Islamic Financial
Rulebook (ISFI), further instructions in term of Shariah governance for IFIs registered
with QFC.
Otherwise, like UAE and Kuwait, the Central Bank of Qatar has not opted for a
national SB. However, the banking law stipulate that in case of conflict of opinion
between SB members, the issue must be transferred to the “Supreme Shariah Council”
attached to Awqaf Ministry which shall be the final authority on the matter.

4. Discussion: Shariah supervisory practices: new issues and challenges

Different Shariah governance regulatory frameworks and Shariah supervisory
practices in IFIs across GCC and Southeast Asia countries have reveal many gaps.
Today these gaps, which rise new issues and challenges for an effective Shariah
governance system for IFIs, are considered as big challenges for Islamic finance to
strengthening the trust on Shariah governance in IFIs in the eyes of the Muslim
community worldwide. Most of these issues are related to the roles and duties of the
higher Shariah authorities operating at the national level and the attributes of scholars
setting at the institutional SBs.
4.1 New issues and challenges for Shariah supervisory practices at national level Shariah
In general the Shariah supervisory practices at the national level reveal two major supervisory
issues. The first one concerns the absence or the weak supervision of the higher
Shariah authority upon the other institutional SB setting in the IFIs. The second one is system
related to the nature of the responsibilities (supervisory/advisory) of the higher SB.
4.1.1 Absence or weak supervision of the higher Shariah authority. While Southeast
Asia countries – namely: Malaysia and Indonesia – have established a higher Shariah 343
authority at the national level in the main purpose to standardize fatwa and harmonize
Shariah practices in IFIs; many GCC countries have give these responsibilities to other
government body such the ministry of Awqaf and religious affairs or the ministry of
justice and Islamic affairs (as the case of Kuwait, UAE, Qatar). Nevertheless, the duties
and roles of the higher Shariah authority are different from region to region and from
country to country.
In Malaysia, the SAC of Bank Negara Malaysia is responsible to advice on matters
relating to Islamic banking, Takaful, or any other Islamic finance area that is supervised
and regulated by the central bank. As well, the council is responsible to examine and
endorse the validity of application of Shariah in Islamic financial products which are
submitted by IFIs. The board has also to issue Shariah resolutions and decisions relating
to their relevant jurisdictions from time to time and publish it. Moreover, the SAC is able
to make pronouncements; respond to inquiries and proposals from Islamic financial and
encourage innovation through progressive guideline formulation.
In Indonesia, the National SB in the Bank of Indonesia has to assist the central bank
in interpreting fatwa of Majlis Ulamas of Indonesia related to Shariah banking,
providing input in the framework of implementing fatwa into regulations and
undertaking development of Shariah banking industry. As well, to control Shariah
practices in IFIs.
For the case of GCC countries the role and the responsibility of the higher Shariah
authority is completely different. In Bahrain, even that the CBB has established a
National Shariah Advisory Board the role of this body is only limited in advising the
central bank on Shariah matter. However, the higher Shariah authority in UAE, Qatar,
Kuwait act only in case of conflict of opinion regarding Shariah ruling between
Shariah scholars at the institutional level.
In the most of cases, the higher Shariah authority does not act as an effective control
mechanism to supervise the Shariah ruling and Shariah products at the institutional
level which can have in turn bad consequences on the stability of Islamic finance
industry. The absence or the weak monitoring and control at a national level allow the
development of new doubtful products or interest-based products under the ruse that
they are Shariah-compliant products. As well as, it can permit the diffusion and
circulation of strange fatwas which in turn can threat the credibility of Islamic financial
products in the eyes of the Muslim community, hence the development and the stability
of the Islamic finance sector in general.
4.1.2 Supervisory/advisory role of the high Shariah authority. One of the main
purpose of the creation of a Shariah body at the institutional level is to ensure the
Shariah compliance in all operations and activities of the IFIs, which make them
different from conventional ones.
Many regulatory authorities have given different names for the national
Shariah body. In Malaysia is called the SAC, in Indonesia is named the National
HUM Shariah Council and in Bahrain is called the National Shariah Advisory Board. These
29,4 different nominations reflect indirectly the mains roles and responsibilities of this
body. Given the name of advisor or advisory to the national Shariah body that is reflect
indirectly that the board have essentially an advisory function and then IFIs and the
bank management have the option of taking and accepting advice or not, which in turn
can blame the effective role played by the national Shariah authority as higher body
344 responsible to supervise Shariah practices at institutional level. Hence, the credibility
of the national Shariah authority as a higher Shariah authority in the country
responsible to supervise Shariah practices at national level, can be hampered in the
eyes of Muslim community.

4.2 New issues and challenges for Shariah supervisory practices at institutional level
Today, many new issues and challenges faced Shariah supervisory practices at the
institutional level. Most of this issues are related to the SB attributes and the
effectiveness of Shariah supervision.
4.2.1 Absence of comprehensive regulatory framework governing SB attributes and
Shariah practices. While Southeast Asia countries have tried to develop a
comprehensive regulatory framework governing SB compositions and practices, GCC
countries have not made a lot of progress in the matter. However, in the both cases, many
issues have not be solved yet.
Different jurisdictions in the different GCC and Southeast Asia countries stress that
SB must consist on Shariah scholars specialised in Fiqh al Muamalat (Islamic
Commercial Jurisprudence). However, today, the financial system becomes more and
more complicated and sophisticated. That is why it is very important that SB must
comprise professional bankers and accountants.
As well, financial system is strongly dependent to the computer system, a specialist
in information technology must be present in all SB meeting. SB members need to
reassure that the delivery systems are sufficient to record the transactions.
In another hand, most of regulatory frameworks across GCC and Southeast Asia
countries do not require a minimum number of meetings for the SB to discuss issues
related to operations and Shariah products/services offered by IFIs. There is no
mandatory or statutory requirement for the number of meetings to be held which can
be a bad signal for the efficiency of SB. Best practice would fix the minimum number of
meeting for SB and would require SB to meet periodically.
4.2.2 Repeat of names of Shariah scholars in many SB. The second issue that
institutional SB face today, is the repeat of names of Shariah scholars in many SBs
especially in GCC countries.
Unlike Malaysia and Indonesia how have limited the numbers of membership of
scholar in SBs of IFIs in the country[4], GCC countries still quite about this issue.
Regulatory and supervisory authorities in GCC countries have not made any restriction
to limit the presence of scholars in the SBs of various IFIs. According to Unal and Ley
(2008), three specific Scholars are members of 26 percent of all SBs in the GCC countries
and 68 percent of all SB positions are shared by only 11 active scholars.
We cannot deny that the presence of some scholars in the SB of several IFIs can have
positive impacts on the performance and efficiency of the SB by gaining access to
more operations and transactions which could in turn enhance the knowledge
and the experience of scholars and permitting to develop new Islamic finance
products and services. Nevertheless, the excessive repeat of some names of scholars in Shariah
many SBs over IFIs can be explained in many times for commercial purposes to attract supervisory
clients and to boost confidence on the respect of Shariah in all the activities of the IFI.
Which can have opposing consequences and decrease considerably the confidence and system
the credibility of the efficiency of the SB; hence the credibility of the IFIs and which in
turn could lead to a lack of confidence on the Islamic financial system in general in the
eyes of its customers. 345
4.2.3 Absence of external Shariah review. Most of regulatory frameworks in GCC
countries and Southeast Asia countries have not made any requirement about an
external Shariah review. Today, with the increasing development of Islamic finance
worldwide and the sophistication of Islamic products and services, the need for an
effective external Shariah audit seems to be very important at present more than before.
In fact, Shariah compliance is a unique characteristic of IFIs, the non-respect of Shariah
guidelines present a risk that could threat the continuity of the activities of IFIs and can
have a bad consequence on the entire Islamic financial system. The risk can be threat the
legal aspect, the image of the IFIs, the reputation of the IFIs in the market as well the
credibility of the Islamic finance in the eyes of its clients. That is why; a sustainable
external Shariah audit seems to be critical to the strength of the Islamic financial system.
4.2.4 Absence of young Shariah scholars in the SB. The majority of SBs are dominated
by some names of Shariah scholars. The absence of young Shariah scholars can be a
serious problem that may hinder the performance and the efficiency of futures SBs. Young
Shariah scholars must be present in every SB meeting to learn from the experience of
knowledgeable scholars which can promote the efficiency of Shariah governance system
in the future and in turn the growth and the stability of the Islamic finance industry.

5. Conclusion
The need for an effective Shariah supervisory system for IFIs seems to be vital today
more than before in order to strengthen the credibility of Islamic financial system in the
eyes of Muslim community. An efficient Shariah governance adds additional values to
the existed corporate governance framework. It inculcates transparency, trust, ethical
behavior, credibility, values underlying faith and beliefs and Akhlaq (Nathan and
Ribieri, 2007). Failure to implement a solid Shariah supervisory system could
inevitably lead to serious consequences for Islamic finance industry.
Over the past few years, a lot of progress has been made to strengthen Shariah
supervisory system. Many countries attempted to develop a comprehensive governance
framework to resolve Shariah issues in IFIs. In the absence of a well conceptualized
framework, these regulations are basically based on respective countries’ needs and
experiences. Different countries have opted for varying approaches demonstrating diverse
practices and models of Shariah supervisory system. Some of them opt for a greater
involvement of regulatory authorities, and developed a comprehensive regulatory
framework governing Shariah supervision and practices at both the national and the
institutional level. Others favor less involvement of regulatory authorities and have
adopted a regulatory framework for Shariah governance only at the institutional level.
Others countries prefer to not give any specific regulation for Shariah governance practices
and leave it to the voluntary initiative of the IFIs and the influence from the market.
In this paper we tried to examine two Shariah supervisory model observed in two
leading Islamic finance regions: the GCC countries model and the Southeast Asian
HUM countries model (known mainly in Malaysia and Indonesia). Our discussion has
29,4 demonstrate that different Shariah supervisory practices in IFIs across these two
regions have reveal many gaps. Today these gaps rise new issues which are considered
as big challenges for an effective Shariah supervisory system for IFIs. Most of these
issues are related to the roles and duties of the higher Shariah authorities operating at
the national level and the attributes of scholars setting at the institutional SBs.
346 In another hand, the discussion above has demonstrate that even if Southeast Asia
model of Shariah supervisory looks to be most efficient and effective in achieving the
Shariah compliant purpose than the GCC model, it cannot be considered as the perfect
Shariah supervisory model. A lot of work is needed to improve this model.
In conclusion, the findings of our paper proposes three major suggestions to build
an efficient Shariah supervisory system. First, national Shariah authorities need to
play an even more important role in monitoring and ensuring a well-adapted
governance practice in IFIs. Second, the existing Shariah governance framework needs
further improvement in order to reinforce the development and growing of Islamic
finance industry. Third, international and national Islamic financial organizations need
to do more effective work to establish an effective Shariah governance system.

Notes
1. This Cairo, Egypt based institution was established in 1977 and it has the official support of
the IDB, the OIC, the central banks and monetary agencies of Muslims countries. The IAIB is
active in providing a forum of cooperation amongst IFIs, promoting concept of Islamic
banking and finance, provide research, consultancy and training.
2. The Council of Islamic Fiqh Academy is a subsidiary body of the OIC, created by the Third
Islamic Summit Conference held in Makkah al-Mukarramah in January 1981.
3. www.bnm.gov.my/index.php?ch¼ 7&pg¼ 715&ac¼ 802
4. In Malaysia, the regulation concerning Shariah governance prohibits Shariah committee
members to be at the same time members in Shariah committee of another IFIs with the
same industry. In addition, members of the SAC cannot be members of SBs of IFIs.
In Indonesia, members of the SB may only hold concurrent positions as SB members at not
more than two others banks and two IFIs.

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Wilson, R. (2008), “Shariah governance systems for financial institutions”, Proceeding of the Xth
Durham Islamic Finance Summer School organized by the University of Durham, Durham.
HUM Appendix
Islamic finance law:
29,4 (1) Bahrain:
.
CBB rulebook, Volume 2: Islamic Bank.
(2) Indonesia:
.
Bank Indonesia, Laws for Islamic Banking introduced in 1992 and amended in 1999.
348 .
Act of the republic of Indonesia number 21 of 2008 concerning Shariah (Islamic)
banking.
(3) Kuwait:
.
Central Bank of Kuwait Law No. 32 of 1968 as amended by Law No. 130 of 1977.
(4) Malaysia:
.
Bank Negara Malaysia, Islamic Banking Law 1983.
.
Bank Negara Malaysia, Takaful Act, 1984.
.
Bank Negara Malaysia, Islamic Financial Act, 2013.
.
Bank Negara Malaysia, BNM/RH/GL_012_3, Shariah Governance Framework
for IFIs.
(5) Qatar:
.
Central Bank of Qatar, Under the Instructions to Banks 2008.
.
QFC, Islamic Finance Rulebook (2009).
(6) UAE:
.
Central Bank of UAE, Federal Law No. (6) of 1985 Regarding Islamic Banks,
Financial Institutions and Investment Companies.

About the author

Rihab Grassa is Auditor and Islamic Finance Expert in a BIG four Audit firm, as well as external
Associate Researcher for the Higher Institute of Accounting and Administration, University of
Manouba, Tunisia. She has published a wide variety of academic papers and conference
proceedings and has presented topics related to Islamic banking, Islamic finance, economic
growth, financial development, Sukuk market, risks, Shariah governance, etc. Rihab Grassa can
be contacted at: rihab_grassa@hotmail.fr

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