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10 1108 - Imefm 02 2013 0021
10 1108 - Imefm 02 2013 0021
www.emeraldinsight.com/1753-8394.htm
IMEFM
6,3 Sharia governance in Islamic
banks: effectiveness and
supervision model
226
Hichem Hamza
Graduate School of Business, University of Manouba, Tunis, Tunisia
Abstract
Purpose – The Sharia governance is topic that has generated much interest in the literature of
Islamic banking industry. The Sharia supervision plays an essential role in the governance of Islamic
banks. The Sharia Board (SB) which is peculiar to Islamic banks is considered as the principal
component of the Sharia governance framework. The purpose of this paper is to examines the link
between Sharia compliance, the form of Sharia supervision and the effectiveness of Sharia governance.
Design/methodology/approach – This paper compares two model of Sharia governance
framework, the first is the decentralized model in the Gulf Cooperation Council (GCC) and the
second is the centralized model in Malaysia.
Findings – The independence of the SB in their mission of supervision and the consistency of Sharia
ruling are the principal components of an efficient Sharia governance structure. Centralized Sharia
governance system, basically in Malaysia, seems to be beneficial to the industry in term of
effectiveness and credibility of the Islamic banks.
Research limitations/implications – The research focuses exclusively on the qualitative analysis
about the SB and Sharia governance in Islamic countries.
Practical implications – The model of centralization is able to strengthen the position and the
independence of SB and can better examine the subjects of divergences between the whole of the SB in order
to promote, in the long term, the consistency of Fatwas and interpretations between banks and regions.
Originality/value – To the best of our knowledge few studies have examined this subject in a
comparative discussion between MENA and Southeast Asia region. This paper contributes to the
literature on Sharia governance by considering the difference between these two regions in term of
supervision model of Sharia rules and principles and its application in Islamic banking.
Keywords Sharia Board, Sharia governance, Sharia supervision, Islamic banking regulation, Islam,
Banking
Paper type Research paper
1. Introduction
Islamic banks (IB) have the responsibility to ensure the compliance with the Sharia rules
of their products, instruments, operations, practices and management. The compliance
with the Sharia principles will be achieved by having a proper Sharia governance
framework. In this sense and in the aim of credibility, IB have established their own
Sharia Board (SB) usually comprised of a panel of Sharia scholars. The Sharia
governance which refers to all the elements about the active role of SB and compliance
with Sharia is strongly fundamental for IB. The compliance with the Sharia and the
International Journal of Islamic and
Middle Eastern Finance and implementation of Sharia governance is encouraged by international institutions of
Management regulation like Accounting and Auditing Organization for Islamic Financial Institution
Vol. 6 No. 3, 2013
pp. 226-237 (AAOIFI) and Islamic Financial Services Board (IFSB).
q Emerald Group Publishing Limited Today, some observers criticize the genuine morality of Islamic finance and
1753-8394
DOI 10.1108/IMEFM-02-2013-0021 condemn the non-compliance of some Islamic products and operations. In fact, failure
to meet the underlying principles of the Islamic finance would give rise to Sharia Sharia
risk and damage the credibility and the reputation of the Islamic banking industry. governance in
The credibility of IB is linked to the influence of SB in the banking decisions and the
consistency in the Sharia interpretation. Is there a code of ethical responsibility of Islamic banks
the SB? Does the SB have a real power on the financial operations rules? Does the IB
make a control on the consistency of the various decisions of the SB?
The non-compliance can be attributed to the passive role of the SB in the Sharia 227
governance scheme. The members of SB, appointed and remunerated by the IB, play
only the role of advisory bodies. They do not have the necessary authority to accomplish
the task and implement decisions and this can be explained by their dependence with the
management. Also, it should be noted that the diversity of backgrounds and the different
schools of jurisprudence of SB members as well as the regional context and
national regulatory environment in which the members of the SBs function can create
inconsistency in the interpretation of Sharia and may thus prevent the harmonization of
product and financial operations.
This situation has leaded some countries to develop Sharia governance through the
reinforcement of regulation and supervision of IB. In fact, the independence of the SB in
their mission of supervision and the consistency of Sharia ruling can contribute to an
efficient Sharia governance structure. The regulation of Sharia governance in IB aims
to preserve the credibility of the industry. The existence of efficient Sharia governance
enhances the stakeholders’ confidence in the IB’s products and activities. In Malaysia
and in the Gulf Cooperation Council (GCC), both are the great centers of the Islamic
finance, the structure and regulation of Sharia governance in IB is not the same. In
Malaysia, the SB governance is based on centralized model while in GCC countries we
find a decentralized model.
The main objective of this paper is to examine the effectiveness of Sharia governance
in the IB in a context regulation change. Our idea is to make a conceptual relationship
between Sharia compliance, the form of Sharia supervision and the Sharia governance
of IB. In this relationship, the essential role is done by the internal and the external SB.
The aim is to examine the role of SB in enhancing the Sharia compliance of IB through
the Sharia supervision and the impact on Sharia governance and credibility.
This paper is divided into two main sections. Section 2 identifies critical issues
about the risk of Sharia non-compliance and examines the independence of SB and the
consistency of Sharia interpretation as fundament of Sharia governance effectiveness.
Section 3 discusses the regulatory framework of the Sharia governance model in some
Islamic countries. The last section concludes the discussion.
Sharia Governance in
Islamic banks
Sharia
Sharia Review
Governance in
Committee Committee
Islamic Banks
Fatwa issued by IB U U U U U
Existence of review U U U U U
committee
Presence of scholars in U U U U U
other IB
Nomination of Sharia U U U U U
scholars by IB
Table I. Authority of Sharia The national Ministry of Higher The Islamic Fiqh
Sharia governance conflict SB in Central Awqaf and Sharia Ministry Academy
regulation in the GCC Bank Islamic Affairs Authority of Awqaf
of dispute resolution becomes more problematic, this will gives rise to inconsistencies Sharia
in the fatwas across SB, or even over time in the same SB. governance in
Islamic banks
3.2 The centralized model
The centralized approach is based on central SB, attached to the Central Bank, which
rules on the conformity of products and activities of all the IB. Each IB shall have its
own SB, but it must comply with the rules set by the central SB. The existence of a SB 233
in the Central Bank will reduce the differences of interpretation, provided that the
Central Bank does not try to impose his own opinions but to crystallize the views
through open debate (Chapra and Khan, 2000).
A centralized Sharia governance model is practiced in Malaysia, Pakistan and
Sudan. In Malaysia, the central financial authorities are the Central Bank, Bank Negara
Malaysia, and the Securities Commission. Two Sharia governance structure has been
established, comprising a Sharia Advisory Council (SAC) at the Central Bank of
Malaysia for both financial authorities and a Sharia Committee in each IB. The Sharia
standards followed are those of the SAC of Bank Negara Malaysia and of the Securities
Commission. These standards are influenced externally by both the Sharia standards
of the AAOIFI, the Islamic Fiqh Academy (Mujma’al fiqh il islamy) of the OIC in
Jeddah, the IFSB standards and internally by the opinions of Malaysian SB members
with certain opinions particular to Malaysia (Gintzburger, 2010). The review and audit
of Sharia compliance is done by the IB to support Sharia Committee.
In Malaysia, the Islamic Banking Act 1983 and Takaful Act 1984 require the
establishment of an independent Sharia Committee within each IB with a minimum of
three and a maximum of seven Muslim religious scholars[3]. The first Sharia
Committee was set up in 1983 by Bank Islam Malaysia Berhad (BIMB) which started
its operations as Malaysia’s first IB on 1 July 1983.
According to the Financial Stability and Payment Systems Report (2010), the SAC was
established in 1 May 1997 as the highest authority and sole reference on all Sharia matters
pertaining to banking and takaful. The SAC is responsible for all Sharia compliancy
matters and also for validating all Islamic banking and takaful products to ensure their
compliance with Sharia. The Sharia Committee will refer to the SAC for its resolutions on a
Sharia issue. The SAC serves as the final arbiter in the interpretation of Sharia principles
on Islamic banking and takaful matters and practices. The aim is to ensure uniformity and
harmonization of Sharia interpretations and strengthening the regulatory framework and
promoting good governance within the Islamic financial sector.
Apart from the central SAC, Sharia Committee at the IB level remains the most
important governance mechanism to ensure compliance with Sharia. The IB need to
receive approval from the financial authorities to appoint any Sharia scholars as SB
members. Both the SAC in the Central Bank and the Sharia Committee have set the
standard for any Sharia matters and governance for the operations of the IB. The
authorities have a monitoring system to check Sharia compliance and governance in
order to protect the interest of the Sharia framework, the shareholders and stakeholders
of the IB as well as their customers (Gintzburger, 2010) (Figure 3).
In December 2004, Bank Negara Malaysia issued the Guidelines on the Governance
of Sharia Committee for the IB outlining the role, scope of duties and responsibilities of
a Sharia Committee and its members and the relationship and working arrangement
between the Sharia Committee at individual institutions and the SAC at the
IMEFM
6,3 Sharia Advisory Council
(SAC)
Islamic
Islamic
Sharia
Banks
Banks
Sharia Audit
234 Committee Gouvernance Committee
AAOIFI IFSB
BNM Standards
Figure 3. Governance Guidelines
Sharia governance Standards
standards
Source: Bin Hasan (2007)
national level. Only the SB of Bank Negara and the Securities Commission can issue
fatwa, the role of the Sharia Committee of IB is to ensure that this fatwa is implemented
with respect to the contracts offered. Members of the SBs of Bank Negara and the
Securities Commission cannot serve on the boards of Islamic financial institutions and
vice versa. For reasons of confidentiality, Sharia Committee members can only serve as
a member of Sharia Committee in one financial institution in the same industry (Islamic
banking and takaful are considered as different industries).
Similar to Malaysia, Pakistan also has established a SB at Central bank, which is the
sole authority in matters pertaining to Islamic finance with the power to issue fatwa. It
has also required the establishment of a Sharia advisor for each IB. In 2008, the State
Bank of Pakistan issued a detailed instructions and guidelines for Sharia compliance in
Islamic banking institutions[4]. According to these instructions, SB or advisors should
be appointed by the board of directors in the case of a domestic bank, or by the
management in the case of foreign IB having branches in Pakistan. Any member of SB
at the State Bank of Pakistan is allowed to serve as Sharia advisor for only one
financial institution. In the case of conflict of opinions, disagreement or disputes among
Sharia advisors members, it should be referred to the State Bank of Pakistan’s SB
which is the final authority and their decisions are compulsory (Table II).
In Sudan, the government has developed continuously the Islamic finance since the
establishment of the first Sharia-compliant bank, the Faisal Islamic Bank in 1978. In
1984, the banking and financial industry changed its practices to conform with Sharia.
Similar to Malaysia, the government established in 1992 a SB at Central bank called the
4. Conclusion
Sharia compliance allows the IB to consolidate their differentiation factor compared to
conventional financial institutions and support their reputation and credibility. The
reinforcement of the SB role in the IB is necessary and allows strengthening of the Sharia
decision-making process. This role should be emphasized on control and review to
ensure compliance with Sharia rules. In this sense, regarding their tasks, the
appointment and the remuneration of the SB members should be done by another body
like central bank or government to ensure the independence of the SB which is crucial for
credibility. Also, the divergence of interpretations or inconsistency between the SBs of
IB can affect the credibility of the industry. It is requesting a standardization of Sharia
ruling and uniformity in Islamic financial and banking products within the same
regulation and among various regions.
The Sharia governance frameworks reflect a difference in the approach of
governance and regional variations in the application of Islamic finance contracts.
IMEFM In the GCC countries, the decentralized approach is often applied where each IB has its
6,3 SB which is independent from the Central Bank authority. With this approach it is
difficult to achieve consensus in Sharia interpretation and to manage properly the
existing interest’s conflicts. In Malaysia basically, the centralized approach knows
advances in term of fatwa and review and seems to give harmonization to the industry.
The Central Bank of Malaysia, Bank Negara, has tightened Sharia rules for IB by
236 requiring them to set up Sharia review, audit and risk management functions to
reinforce compliance. In Africa, only Sudan has a Sharia governance framework which
is based on centralized approach like in Malaysia. The existence of decentralized and
centralized approaches in the same time can increase significantly the regional
differences in the application of Islamic finance contracts. This situation is harmful to
the credibility of Islamic industry and need more coordination between main players.
The model of centralization is able to strengthen the position and the independence
of SB and can better examine the subjects of divergences between the whole of the SB
in order to promote, in the long term, the consistency of fatwas and interpretations
between banks and regions. The existence of a model of centralization becomes
obvious and starts taking place in several countries. In this model, the question now is
about the cooperation between the internal SB (micro-supervision) and the central SB
(macro-supervision). In this sense the creation of council of all SB of all the IB in a
country can harmonize Sharia governance practices in collaboration with the Central
Bank.
Notes
1. The AAOIFI had provided standards on Sharia Supervisory Board, Sharia Review and
Internal Sharia review under its Governance Standard (GSIB, 1999 and 2008).
2. Principle 3.1 of the IFSB Guiding Principles on Corporate Governance (IFSB-3, 2006).
Principle 7.1 of the IFSB Guiding Principles on Risk Management (IFSB-1, 2005).
3. Pursuant to Section 3 (5) (b) of the Islamic Banking Act 1983 (IBA 1983) for Islamic banks,
Section 124 (7) of the Banking and Financial Institution Act 1989 (BAFIA 1989) for Islamic
Banking Scheme Banks, Section 8 (3) (a) Takaful Act 1984 (TA 1984) for Takaful operators
and Section 16B of the Central Bank of Malaysia (Amendment) Act 2003 (CBA 2003) for
Central Bank of Malaysia.
4. State Bank of Pakistan, Instructions for Sharia Compliance in Islamic Banking Institutions,
Karachi, Annexure 1 of IBD Circular Nos. 1 and 2 of 2008.
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Further reading
Chapra, M.U. (2008), “The global financial crisis: can Islamic finance help minimize the crisis in
the future?”, paper presented at the Forum on the Global Financial Crisis Held at the
Islamic Development Bank, Jeddah, Saudi Arabia, October.
IFSB (2010), Islamic Finance and Global Financial Stability (Report), IFSB, Kuala Lumpur.
Corresponding author
Hichem Hamza can be contacted at: hichemhamza@yahoo.fr