Corporate governance in Islamic financial
institutions: the issues surrounding
unrestricted investment account holders
Rodrigo Magalha˜es and Shereen Al-Saad
Rodrigo Magalha˜es and
Shereen Al-Saad are
based at Kuwait-Maastricht
Business School, Salmiya,
Kuwait.
Received August 2010
Accepted February 2011
DOI 10.1108/14720701311302404
Abstract
Purpose – It has been observed that the practices of corporate governance in Islamic financial
institutions (IFIs) do not sufficiently address the rights of unrestricted investment account holders
(UIAHs). Given that such account holders are generally the ones who bear the risk of the performance
of the investment pool, the purpose of this paper is to investigate the relationship between corporate
governance practice and the safeguarding of the interests of UIAHs as major stakeholders.
Design/methodology/approach – A qualitative research methodology is applied to a sample of 16
managers from 12 Islamic financial institutions from Kuwait, Bahrain, UAE and Malaysia. A theoretical
model built around the GC principles featured in the King report underpins the research design.
Findings – The findings reveal that the current practices implemented by IFIs in protecting the rights of
UIAHs are not effective enough, in the light of standard corporate governance principles. It was also
found that lack of responsibility, accountability and independence in decision making, as corporate
governance principles, is contributing to the ineffectiveness of current practices in the investigated
IFIs.
Research limitations/implications – The major limitation of the research is the small size of the sample
used. Hence, the work reported here must be considered as exploratory and a further study employing
a larger sample is recommended as future research.
Practical implications – A number of recommendations for corporate governance practice in IFIs
aimed at the unique relationship between IFIs and UIAHs are put forward.
Originality/value – The originality and the value of this paper rest on its topic which, to the best of the
researchers’ knowledge, has not been investigated empirically before. Hence, the authors believe it
will be of value not only to academics but mostly to practitioners in IFIs.
Keywords Kuwait, Bahrain, United Arab Emirates, Malaysia, Financial institutions, Islam,
Corporate governance, Investments, Islamic financial institutions, Effectiveness, Protecting, Maximizing
Paper type Research paper
1. Introduction
The initial wave of oil revenues in the early 1970s and the growth of petrodollars gave
momentum to the growth of Islamic finance and many reputable Islamic banks were
established, including Nasser Social Bank Cairo in 1972, the Dubai Islamic Bank in 1975,
Kuwait Finance House in 1977, Faisal Islamic Bank of Sudan in 1977 and Dar Al-Maal Al-
Islami in 1980 (Van Greuning and Iqbal, 2008). In the beginning of 1980s, three Muslim
countries – Iran, Pakistan and Sudan – transformed their entire financial sector to be
completely Islamized. The step was considered as of great importance to the global
developments of Islamic banking (Bhatti and Khan, 2008).
Currently, Islamic Finance is one of the fastest growing industries with double-digit annual
growth rates for the past 30 years. There are more than 250 financial institutions in over 45
countries, in an industry which has been growing at a rate of more than 15 per cent per annum
for the past five years, with estimated annual earnings of $350 billion, compared with a mere $5
billion in 1985 (Van Greuning and Iqbal, 2008). There are more than 284 Islamic
VOL. 13 NO. 1 2013, pp. 39-57, Q Emerald Group Publishing Limited, ISSN 1472-0701 j CORPORATE GOVERNANCE j PAGE 39
 Financial Institutions operating in 38 countries, and this does not include conventional
banks offering Islamic financial products and services (Dusuki, 2008). The success of the
Islamic financial system can be measured by the number of conventional banks that have
established their own ‘‘Islamic windows’’ not only in countries dominated by Muslim
populations, but also in rest of the world. A number of conventional Western financial
institutions went beyond the ‘‘Islamic windows’’, and opened whole Islamic subsidiaries.

El-Gamal (2005) suggests that the activities of Islamic financial institutions affect the welfare of
more than 20 per cent of the world’s population and for this reason the governance of such
institutions is becoming highly visible. Thus, the credibility of their CG practices is becoming
crucial for their effective growth, development, and social acceptance. However, it has been
observed that such practices do not sufficiently address the rights of investment account holders
and specifically the unrestricted investment account holders (UIAHs) in view of the fact that it is
the investor alone who bears the financial risks of his or her investments (Archer et al. 2010).
There seems to be a deficiency in the protection of investment account holders as equity
holders, in terms of board representation but also as depositors, in terms of principal-guarantee
(El-Gamal, 2005).

This paper reports on an investigation into the effectiveness of current corporate

governance practices of a sample of Islamic financial institutions with increasing
international representation. The primary foci of the research project are the IFIs’ corporate
governance practices and their effectiveness (or lack of it) in safeguarding the interests of
the UIAHs. Given the UIAHs’ central role in bearing the risk of the performance of the IFI’s
investment pool, they are arguably the major stakeholders of the Islamic financial industry.

2. Corporate governance from an Islamic perspective

Islam is a faith that relates to all aspects of life, and it includes a value-based system that
gives high priority to the recognition of justice and fairness to all humans. The main
characteristic of the Islamic economy is its aim to create a just, honest, fair and balanced
society as envisioned by Islamic ethical value. Islamic law (Shariah) states that Islamic
businesses must be conducted and founded on ethical norms and social obligations, and
also must be grounded on the moral framework of the Shariah (Ahmad, 2000). The holy
Quran and Hadith and the teachings of the Prophet Mohammed (PBUH) have extensively
stated and supported all the fundamentals behind corporate governance, by stressing the
importance of values, ethics, and morals for the welfare of a society ‘‘Each one of you is a
guardian, and each guardian is accountable to everything under his care’’ (Prophet
Mohammed, PBUH).

The beliefs of Muslims regarding the accountability of their actions in this world and
beyond have strong implications on how the application corporate governance is
perceived, especially in financial services. The main challenges that has faced the Islamic
financial industry from its inception was how to transform conventional financial products
and instruments into Islamically friendly ones, taking into account the prohibition of any
payment of interest ‘‘Riba’’. Also, there has been a need to adapt CG principles to Shariah
requirements, and to the teachings of the holy Quran and Sunnah. The Islamic Financial
Services Board (IFSB) and the Accounting and Auditing Organization for Islamic Financial
Institutions (AAOIFI) have stepped in and issued well-known CG guiding principles for
Islamic financial institutions.

Shariah law, prohibits Riba (interest), Gharar (speculations) and the trading of money.
Hence, in order to ensure that the operations and activities of Islamic Financial Institutions
are in compliance with Shariah rules and principles, a Shariah Supervisory Board (SSB)
must be in existence in all IFIs. This Board has the task of reviewing and evaluating newly
introduced products and services in order to ensure compliance with Shariah. In this
manner, Shariah endorses a stakeholder-oriented model of corporate governance, in the
light of Islamic principles (Van Greuning and Iqbal, 2008). However, Islamic finance does
introduce distinctive challenges for CG, one of the key challenge being the need of
stakeholders (in our case account holders) to be confident that the Islamic financial

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institutions are in fact efficient, stable, and trustworthy providers of financial services
(Bhatti and Bhatti, 2010).

2.1 Principles of corporate governance

According to the OECD (2004), there is no single model of good corporate governance
given that CG practices vary widely from nation to nation and from company to company.
The differences arise from predominantly dissimilar social values, various ownership
structures, and different business circumstances and competitive conditions (Gregory,
2000). Additionally, corporate governance frameworks depend on the development of legal
systems, and regulatory and institutional environment. Several reports from different
countries have approached corporate governance from the perspective of safeguarding
shareholder interests. Examples are the Cadbury Report (1992), the Combined Code
(1998), the Combined Code on Corporate Governance (2003, 2006), the Greenbury Report
(1995) and the Higgs Report (2003).

Originally published in 1994, the King Report 2002 advocates an integrated approach to
good governance in the interests of a broad range of stakeholders. This report takes a
very comprehensive approach establishing fundamental principles of good financial,
social, ethical and environmental practice (Mallin, 2007). In emphasising the concept of
triple bottom line (i.e. economical, environmental and social aspects), the King Report re-
emphasises the notion that generating profits for the shareholders is not the only concern
of a company’s purpose (du Plessis. et al., 2005). It highlights seven core principles of
corporate governance, namely:
1. discipline;
2. accountability;
3. fairness;
4. independence;
5. responsibility;
6. transparency; and
7. social responsibility.

Given its strong stakeholder orientation, this report presented a very appropriate model for
studying CG practices and their impact on UIAHs, in our sample of Islamic Financial
Institutions.

2.2 Basic Islamic financial instruments

Islamic banking is essentially based on the idea of interest (Riba) prohibition, while allowing at
the same time, trade and profit-loss-sharing arrangements. It is mainly ‘‘an equity-based system
featuring zero-interest, share economy, equity participation, joint ventures, mutual funds,
leasing, innovation with profit and loss sharing (PLS) and interest-free intermediation’’ (Bhatti
and Khan, 2008, p. 42). The Riba prohibition has led to extensive discussions about creating
substitutes to the contemporary interest-based products of financial intermediation. The main
two profit and loss sharing instruments, which are mentioned frequently in the literature on
Islamic finance, are the Mudharabah and the Musharaka contracts. They are considered central
pillars of the current Islamic banking framework.

The focus of this paper is mainly on the Mudharabah contracts, which can be summarised as a
contract between the capital provider ‘‘Rab-al-Mal’’ and a skilled entrepreneur ‘‘Mudharib’’ who
manages the business. Profit generated by such a business or activity is shared in accordance
to pre-agreed ratios, while losses, if any, are to be borne solely by the provider of capital unless
caused by the Mudharib’s negligence or violation of the terms of the agreement (IFSB, 2007).
(El-Hawary et al., 2004) states that the Mudharabah contract forms the basis of mobilisation of
funds from depositors, with the IFI as the Mudharib and the depositor as the Rab-al-Mal. It also
forms the basis of employment and investment of these funds with the IFI now as the Rab-al-
Mal and the entrepreneur as the Mudharib. The

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 difference between the profit-share received from the entrepreneur (Mudharib) under the
first contract and the profit-share paid to the depositors (Rab-al-Mal) under the second
contract constitute the source of profits for the Islamic Financial Institution. Figure 1
illustrates the Mudharabah contract process.

2.3 Key stakeholders of Islamic financial institutions

According to Ghayad (2008, p. 209) CG can be defined as the ‘‘set of relationships

between a company’s management, its Board, its shareholders and other stakeholder’’.
That author also emphasises the importance of attaining and ensuring justice and equality
to all stakeholders through transparency and accountability. Resolving the conflict of
interest among all stakeholders is one of the most important issues of Islamic corporate
governance. In order to understand how corporate governance practices in Islamic
financial institutions are fulfilling their obligations toward their stakeholders, first we have to
identify the key stakeholders.

Van Greuning and Iqbal (2008) have grouped the stakeholders of Islamic finance industry
into three different categories; the internal stakeholders, the different interest groups, and
the institutions created to regulate and monitor the activities of Islamic financial institutions.
For the purpose of our research, we will be concentrating on the first category which is the
‘‘internal stakeholders’’. Table I describes such internal stakeholders.

The most important stakeholder that every Islamic financial institution should take into
account is Islam itself (Chapra and Ahmad, 2002). Therefore, Islamic financial institutions
have a huge responsibility to perform well, in order to protect the image of Islam in the eye
of the public. Depositors constitute a very significant group of the stakeholders given that,
in reality, they provide the largest portion of the banks’ operating (Archer et al.
2010)..There are three main categories of deposit accounts offered by almost every
Islamic financial institution:
1. Current sccounts.
2. Restricted investment accounts.
3. Unrestricted investment accounts.

Figure 1 The Mudharabah contract process

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Table I IFI’s key stakeholders
Internal stakeholder Roles and responsibilities

Bank regulators and supervisors The facilitators in the process of risk management and the
responsible of creating and maintain a healthy and sound
environment through a solid risk management framework
Board of directors They are the steering wheel of the institutions through
setting the strategic direction and establishing the
operational policies
Executive management Those are appointed by the Board of Directors and
responsible for putting into practice Board’s policies
Audit committee and internal auditors They are responsible of the execution of Board’s risk
management function
External auditors They have a crucial role in assessing the risk taken by the
financial institution based on the financial information
provided
Shariah boards Their responsibilities are vital when it comes to protecting
stakeholders’ rights and to make sure that the financial
institution’ activities are compliant with Shariah principles
Public and depositors Who are accountable for their decision of investment and to
do so they require the financial institutions to be more
transparent in disclosing their financial information
Shareholders They are the owners of the financial institutions and they are
the one who appoints the people that would take care of the
Corporate Governance process

Source: Van Greuning and Iqbal (2008)

Each category raises different corporate governance issues, but those of unrestricted
investment account holders (UIAHs) are perhaps the most challenging. For the purpose of
this research we will concentrate only on the unrestricted account holders.

The unrestricted investment account holders enter into a Mudharabah contract with the
Islamic financial institution under which the financial institution manages the UIAHs’ funds
and shares with them returns, according to a predetermined ratio. The funds paid in are
placed in investment pools and the profits on investments, if any, are distributed at
maturity according to the profit and loss sharing (PLS) ratio specified in the contract. Under
this agreement, the UIAHs are the only ones who bear the risk of the performance of the
investment pool, except for gross misconduct on the part of the institution (Grais and
Pellegrini, 2006a, b, c, d).

2.4 The issues surrounding unrestricted investment account holders (UIAHs)

The key issue concerning UIAHs is the fact that holders of such accounts lack the power
to control the bank’s involvement in certain types of investment activity. The management
of the IFIs has the complete freedom in commingling depositors’ funds with shareholders’
funds for investment in the same pool, in spite of the different risk tolerances and appetites
among the different providers of funds. The management then reports these investments
and their outcomes in IFI’s balance sheets and income statements. The result is the
elimination of operational transparency, and the creation of possible conflicts of interest
with respect to the potential deviation of risk appetite between the two types of capital
providers (El-Hawary et al., 2004).

Another issue relating to the UIAHs is the practice by most IFIs to smooth profits over time.
This smoothing of profit is done through a special reserve called a Profit Equalisation
Reserve (PER), which acts as a mean for hedging against unexpected future low income
distributions (Archer et al. 2010). The Islamic financial institution appropriates funds to
PER from the profit distributable to UIAHs and to shareholders, before the distribution of
profits among the financial institutions’ depositors and investors (Schoon, 2009). PER is
used at the IFI’s discretion to pay a return to UIAHs in years when income is low and is a
tool for maintaining a competitive return among its rivals.

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 Such practices impede the transparency and reliability of financial information, and
severely constrain the investors from evaluating the bank’s actual performance. Moreover,
such arrangements are sometimes reported as equity; while at other times are reported as
liabilities. Others report them as off-balance sheet item, which allows them to hide any
negative information related to investment accounts, such as losses because of
misconduct or negligence (Abdel Karim, 2001). The only way for any financial organisation
to protect the interests of its stakeholders is to have a reliable governance structure. The
interests of stakeholders are not merely limited to the financial benefits, but consist also of
other ethical and religious principles that represent a significant value to the stakeholders.
The same applies to IFIs, where stakeholders are very much expecting their relationships
with those financial institutions to be framed and structured in compliance with the law
Shariaha law (Grais and Pellegrini, 2006a, b, c, d).

3. Research design
3.1 Research question
The research question which has guided our work was as follows:

RQ. How effective are the current practices of corporate governance in Islamic
financial institutions in protecting and maximizing the interest of unrestricted
investment account holders as a major stakeholder?

3.2 Theoretical framework

In order to approach the research question we have created a research model (Figure 2)
primarily based on the King report (du Plessis et al., 2005). All seven principles of this report
have been used, with the exception of the principle of ‘‘social responsibility’’. This principle was
dropped in view of the fact that our research focuses on contractual stakeholders (i.e. UIAHs) as
opposed to community stakeholders. According to the King Report, the

Figure 2 Theoretical framework showing corporate governance principles being applied

to the basic Islamic finance business model

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principle of social responsibility deals with the awareness and the responsiveness of
companies towards social issues, ensuring that they act in a non-discriminatory, non-
exploitative and responsible manner with regard to environmental and human rights issues
(du Plessis. et al., 2005). Thus, given its contents it was thought that this principle lacked
relevance within the scope of our research aims.
The model features the basic business model of all IFIs, with the Mudharaba contract linking the
UIAHs and the IFIs on one side, and the IFI’s shareholders on the other side. Around the
business model, the six key corporate governance responsibilities of IFIs are represented.

Describing now the variables in the model, the first is ‘‘Fairness’’, one of the main pillars of
Islamic finance. Fairness is all about acknowledging and respecting the rights of the
stakeholders equally. In our model we are aiming at evaluating how fair the managers of
IFIs are in acknowledging the rights and interests of UIAHs, in relation to the best practices
issued by AAOIFI (2009) as well as to IFSB standards and principals (IFSB, 2007). From
our interpretation of the recommended standards, we have identified two main factors that
influence fairness. They are:
1. protecting shareholder and stakeholder rights; and
2. the empowerment of UIAHs.

‘‘Responsibility’’. This element is about the responsible behaviour of the management of

IFIs in its relationship not only with the shareholders whom they are accountable to, but
with all stakeholders of the IFI including the UIAHs. It is also about how the management
will put in place all the means and resources required to guarantee the success of the
financial institution and welfare of all its stakeholders. In order to approach this factor, the
level of management responsibility in addressing the rights of UIAHs and dealing with the
agency responsibility that lies on their shoulders was examined.

‘‘Accountability’’. An element that is recognised by almost every CG model, accountability

is about ensuring the ethical content of the practices carried out by the management of
IFIs. While the element of responsibility is geared more toward the behaviour of individuals
involved in the management, accountability is about the mechanisms and business
processes that have been set to make managers accountable for their decisions and
actions taken in managing the company and its resources. The existing mechanisms and
business processes that allow the investors to query and assess the actions of the Board
and its committees is one factor which creates a culture of accountability. This works by
exerting pressure on the Board and its committees to ensure that the strategies and
objectives they set for management will work accordingly to the interest of UIAHs. Another
important factor related to accountability is management efficiency, which is the heart of
our research problem. Management efficiency means the balancing between the returns
and the risks associated with shareholders’ and stakeholders’ investments, considering
that different group have different risk appetites and different investment strategies.

‘‘Discipline’’ is the fourth element of the model. It emphasises the commitment and
adherence of the company and its management to ensuring that the universally recognised
CG principles and practices are being carried out in a correct and proper manner. In our
research, in addition to assessing the extent to which practices are adhering to good
governance and international standards, we are also evaluating the extent to which the
management of IFIs are ensuring compliance with Islamic laws and regulations.

Another element which almost every CG framework recommends is ‘‘Transparency’’. By

disclosing the necessary information and presenting the true state of the company, IFIs are
granting to the stakeholders (in our case the UIAHs) a clear picture which enables them to
make informed decisions about their investment. Customer awareness, timely disclosure of
adequate information and the ease with which potential customers can make meaningful
analysis of a company’s actions, are all categories which allowed us to determine the level
of transparency the IFIs in our sample.

The last element in our model is ‘‘Independence’’. This element is concerned with the
prevention of any possible conflict of interests that may arise from the excessive influence of

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 a party over the management of the company when trying to serve their own interests and
benefits. From here the need arises to appoint external parties to the Board, as well as to
create Board committees, in order to ensure neutrality. We believe this is a major factor in
assessing a financial institution’s practices in dealing with UIAHs. This can be achieved by
examining the practices for minimizing or avoiding potential conflicts of interest, as well as
the mechanism the institution is applying to ensure the objectivity and independence of
decision making in issues affecting UIAHs.

3.3 Sampling, data collection and data analysis

The target population of our research were the top management of Islamic financial
institutions, such as chief executive officers (CEO), general managers, or any executives
responsible for coordinating and integrating the implementation of the governance policy
framework in the IFI. From this population, a sample was selected using a non-probability
sampling approach. A purposive or judgmental sample selection technique is most suited
when the topic requires the use of very small samples and the subjects are best selected
according to the judgement of the researchers. (Saunders et al., 2007). The key criterion
for selecting the sample of 16 managers was homogeneity in terms of functional
responsibilities. Hence, the sampling focussed mainly on decision makers and the
executives who are responsible for implementing CG processes in IFIs in Kuwait, Bahrain,
UAE and Malaysia.

The main data collection methods used for this research were participant observation and
semi-structured interviews. The participant observation part consisted of a number of visits
to four IFIs by one of the authors, aimed at observing directly the interactions between
clients and front-line staff. This was achieved through direct questions to the front-line staff
by taking on the role of a potential customer. The objective of this part of the research was
to enquire and to gain first-hand knowledge about the current processes and procedures
used by the IFIs in question in promoting and explaining unrestricted investment accounts
(UIA) as a product to their clients.

Semi-structured interviews were used since our data collection categories were known in
advance. The interview questions were conceived in a way as to cover the six CG
principles shown in the research model (see the Appendix, Table AI). Open-ended
questions were also included in the interviews, thus allowing as much information as
possible to be collected regarding the relationship between IFIs and UIAHs.

As a first step in requesting the interviews, the chief executive officers and general
managers of the selected institutions were contacted through e-mail, explaining the aims of
the project and requesting face-to-face interviews with the relevant managers within the
area of CG. A total of 50 requests were sent to 12 Islamic banks in Kuwait, Bahrain, UAE
and Malaysia. After extensive follow-up, only seven successful face-to-face meetings and
nine e-mail responses were achieved. The low rate of response can be attributed to the
sensitivity of the topic as well as the difficulty in approaching the executives in charge.

Data analysis was carried out through categorisation and unitizing of data (Saunders et al.,
2007). The categories were established a priori from a detailed analysis of the main CG
principles as shown in Figure 2. Every interview was broken down into units (unitizing) and
each unit was then attached to its relevant category. The data in the next section is
presented in accordance with the analytic categories shown in Table II.

4. Findings
4.1 Direct observation exercise
The key findings based on the direct observations of four Islamic banks were as follows:

B The responses from the IFIs varied from encouraging and knowledgeable to
disappointing and unsophisticated, sometimes lacking in sufficient know-how about
Islamic products and their unique features.

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Table II ‘‘Data analysis categories’’
CG principles Date analysis categories

Transparency Customer awareness Timely disclosure and adequate Ease of access to information and
information analysis for potential customers
Fairness UIAHs empowerment Shareholders and stakeholders rights
protection
Discipline Adherence to good governance and Compliance with Islamic laws and
international standards regulations
Accountability The existence of the mechanisms that The efficiency of management in
allow the investors to query and balancing between return and risk
assess the actions of the Board and its associated with shareholders and
committees stakeholders investments
Independence Minimize or avoid potential conflict of Appointments of committees and Mechanism which ensures the
interest external parties objectivity and independence of
decisions making
Responsibility Agency responsibility Responsible behaviour

B Most of the observed banks emphasised the uncertainty of the exact rate of return but
did not provide enough information about the associated risk for the client, within the
Mudharabah contract.
B Most of the banks provided a written opening account agreement with all the terms and
conditions that govern the Mudharabah agreement. Yet, the account officers did not
take any time to explain verbally the detail of the ambiguous features of this agreement.
B All of the observed banks stated that only the quarterly published audited financial
information was available for the UIAHs as a mean to evaluate the performance of the
investment pool.

4.2 Structured interviews

Results are presented in accordance with the data analysis categories in Table II.

Transparency. 4.2.1.1 Customer awareness. In relation to the customer awareness

aspect, almost all of the banks within our sample confirmed advising the UIAHs about their
contractual rights and risks before signing for an UIA with the bank. They confirmed doing
it either through their employees or through their written terms and conditions. However,
some of the respondents did not seem to place much emphasis on ensuring that the
clients actually understood what they were signing. The following comment from one of
respondents illustrates this point:

At the end of the day we receive a form signed by the client. Whether he understood it or not
that’s difficult to know.

The interviews showed that the majority of respondents believed that information about
asset allocation, and the mechanics of smoothing returns should be publicly available,
especially if the company is shareholding and listed. But, on the other hand, many were
reluctant to consider profit calculations and investment strategies as public information and
they preferred to keep it confidential since it reflects the internal strategies of the bank.
Some respondents believed that because the bank is entrusted to manage the funds in a
wise manner, and to ensure keeping investors satisfied, there is no need to disclose this
information. Moreover, two interviewees stated that the detail of the bank’s investment
strategies should remain confidential especially in order to avoid it falling into the hands of
the competition. One respondent stated that such information could be revealed to
depositors on request.

In relation to the adoption of the practice of ‘‘smoothing the returns’’, the interviews revealed that
more than half of the banks use the ‘‘Special Equalisation Reserve’’ (PER) technique to smooth
the returns for their UIAHs. One of the respondents admitted that the practice is unfair if one
thinks of those UIAHs who have liquidated their accounts before getting back

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 their distributions under the PER. However, after weighing the costs and the benefits, the
latter are much higher, and for this reason his bank considers PER to be an acceptable
practice. According to another respondent, the main reasons behind the creation of such a
reserve is to allow Islamic banks to compete with conventional banks, there being no
conflict between such reserves and the ethical principles of Islamic banking.

Six of the interviewees were totally against the practice of smoothing the returns. They
believe that it is an unfair practice, stating that returns should be distributed as fairly as
possible, and based on earnings. The following quote confirm this idea:

The bank is not using PER because that is not in compliance with the international accounting
standards and because, basically, you are manipulating your profits and this is not allowed
(. . .) There is a serious conflict between the IFRS standards and the Islamic standards and I
am personally not supporting it (PER).

4.2.1.2 Timely disclosure. With this part of the interviews we were trying to understand
what kind of information our respondents thought should be revealed and provided to
UIAHs. The results demonstrate that the majority of respondents believed that the
quarterly audited financial reports with detailed explanations of each item were sufficient
information for UIAHs. Only one respondent stated that the banks should explain to UIAHs
the way of calculating profit rates, Mudarabah fees, as well as the ways in which assets
are allocated. In contrast, another respondent stated that the bank should only present
what AAOIFI, IFSB and the Shariah Supervisory Board mandate.

In order to understand if the banks recognise the rights of UIAHs and put them on an equal
footing with collective investment schemes’ participants, the respondents were asked to
state the main similarities and differences between collective investment schemes (CIS)
and unrestricted investment accounts as regards the process of monitoring the
performance of participants’ investments. According to the majority of respondents, there
are more differences than similarities. The two are totally different types of products and
should be treated differently, regarding either contractual or accounting aspects. The
differences were attributed mainly to the high level of risk CIS customers were taking in
comparison with UIAHs. Some respondents said that the key difference is that CIS
participants have better access to their investments.

Some of the respondents related the differences mainly to the governance issues, since
CISs and UIAs are governed by different authorities – CIS are governed by the Securities
Commission while IAH are governed by the Central Bank. Most of the respondents
concurred that the published quarterly audited financial information is more than enough in
terms of reporting for the UIAHs.

4.2.1.3 Ease of access to information and analysis. Our inquiry into the accessibility to
information as a means of giving potential customers the possibility of evaluating the
performance of IFIs revealed that almost all of the respondents believed that sufficient and
adequate information is available either through their bank’s web site, financial statements
or through published reports by rating agencies. One of the respondents declared:

The bank’s website is a rich database for potential investors. They can access and assess the
bank’s financial position through its periodic and Annual Reports. Also, the website contains
statements by management which give an idea about the investment strategies, risk
management and many other related information.

4.2.2 Fairness. 4.2.2.1 UIAHs empowerment. Almost all of the interviewees acknowledged
the power of unrestricted investment account holders in their relationship with Islamic
financial institutions, although recognizing that this power is limited to withdrawals or
moving of funds to where they expect to get higher returns and receive better services.
One of the respondents said:

Every customer has power, if they are not happy with the services and the financial returns they
are getting they can withdraw their money and that would badly affect the bank (...) The days
are gone where you can make a fool out of a customer.

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;On this topic, the majority of our respondents were against the notion of granting UIAHs
the power of representation on the Board. The justification given by nearly all of the
respondents was related to administrative difficulties, specifically on the issues of
nomination and selection. They also emphasized strongly the dangers of interference of
UIAHs in the banks’ management or strategic decision making. Only three respondents out
of 16 agreed and encouraged the idea of empowering UIAHs with the right of
representation on the Board, however, it was also emphasized that although this might be
good in theory it will be difficult to implement in practice. For some, agreement to the right
of representation on the Board was based on the condition that the appointment should be
done through the central bank, in order to avoid the hassles of nomination, selection and
competency. One respondent stated:

The issue is how to appoint the representative. If the central bank will take care of the
appointment it will be fine, otherwise it would be more of a hassle in getting a representative on
the BOD, especially finding out if the elected representative is competent enough to be on
BOD. This is a very heavy job.

4.2.2.2 Rights protection and appointment of committees. On this point, the majority of
respondents said that they do not have established governance committees and more
than half stated that they are handling the issues of governance via risk and audit
committees. The rest asserted that such issues are handled through the Board of
Directors. As an example, one of the respondents stated that:

No, and I don’t think it’s necessary to create such a [governance] committee if you have the
right structure. We have the audit and the risk management committees working independently,
so why create yet another committee? By doing so we are creating an unnecessary layer, while
it is the responsibility of the regulator. The Board members are too busy because they are
members of so many companies. I don’t think this is going to be practical.

Only one of the banks in our sample had an established governance committee
responsible for channeling of all governance matters to the Board of Directors.

4.2.3 Discipline. 4.2.3.1 Good governance. The part of the investigation about corporate
governance standards revealed that all of the banks in the sample are complying with
IFRS and BASEL II standards. The reason behind this compliance is that central banks
have made it compulsory for all banks to do so. A good number of banks comply with IFSB
and AAOIFI Standards in order to ensure compliance with Shariah requirements, whereas
only three banks declared their compliance with all the four of them; namely OECD, IFRS
and BASELII, AAOIFI and IFSB.

4.2.3.2 Compliance. Almost all of the respondents named the existence of Shariah
Supervisory Board within the corporate governance framework as the key differentiator
between the structures of corporate governance in conventional banks and those of
Islamic banks. The majority stated that the current Islamic corporate governance is
structured in parallel to conventional ones with some slight differences. The following
quotation from one of the interviewees illustrates the idea:

The only difference is the existence of the Shariah Supervisory Board (SSB) to ensure that all
products and activities are fully compliant with Islamic Shariah rules.

Only five out of the respondents have named the position of the investment account holders,
whether restricted or unrestricted, as another difference in corporate governance in
conventional banks as compared to those of Islamic banks, besides the existence of SSB.

Accountability. 4.2.4.1 Query and assess. The majority of respondents expressed negative
views regarding the right of UIAHs to query and assess the actions of the Board and its
committees, mainly based on the premise that they are not shareholders. If they are not
shareholders they are not entitled to be present at the annual general meetings. Moreover, it
also was affirmed that there are financial or non-financial performance measures available to
UIAHs investors, which would enable them to assess the business of the bank. Such measures
are available through annual audited financial reports. One of the few

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VOL. 13 NO. 1 2013 CORPORATE GOVERNANCE j PAGE 49
 respondents who acknowledged the right of UIAH to question the management and
escalate the complaints to the central bank in the event of unsatisfactory resolution, said:

UIAH may raise any queries to the management, and grievances can also be forwarded to the
Central Bank in the event of unsatisfactory resolution.

Balancing between return and risk and conflict of interest. Through this particular category
we were trying to understand if Islamic financial institutions are aware of the rising conflict
of interest between depositors and shareholders; and how this issue is being tackled. Only
four of our respondents acknowledged that a conflict of interest does exist between the
Islamic financial institution and the UIAHs due to the nature of the agreement governing
the relationship. For instance, an interviewee said:

There is kind of conflict of interest, as a matter of fact there is partnership relation with
depositors (...) investment account holders are not liabilities and neither are they fully
recognized as equity, they are hanging in-between.

On the other hand, the majority of respondents claimed that there are different interests
between UIAHs, who seek a low-risk investment with steady returns and shareholders,
who prefer a more aggressive and robust investment strategy offering higher returns with
more risk. According to such respondents, this does not have to be seen as a conflict of
interest, but rather as a difference in investment strategies. A respondent said:

Both investment account holders and shareholders seek maximum profit. Through well outlined
strategic programs and better executive management, legitimate interest and rights of both
parties could be fairly maintained.

Objectivity and independence. The interviews revealed that only three in our sample of
banks employ a range of mechanisms to ensure objectivity and independence of decisions
making in relation to the investments of UIAHs. The majority of the respondent banks used
general statements such ‘‘the adequate protection of the UIAHs investments’’ or ‘‘the
disclosure of relevant and material information to the UIAHs’’ without any specific
mechanisms to back them up. Four banks ensure objectivity and independence by forming
an investment committee for collective decision making. The rest of the banks follow
different approaches, namely credit committees, risk committees or the one pool approach.

Interestingly, one of our respondents stated that his/her central bank has a significant role
in protecting the funds of UIAHs by restricting Islamic banks to investing the funds of
UIAHs in the safest possible ways, but in doing so the central bank is assuming the same
role as in conventional banking. This respondent stated:

The central bank puts high restrictions on dealing with UIAHs funds. Thus, we have to go with
very low risks in investing their funds (such as giving loans and making placements with other
banks) and this is the way of conventional banking.

Agency responsibility. Nearly all of the respondents confirmed that the management of the
Islamic banks are completely conscious of their agency responsibility. However, one of the
respondents made an interesting comment regarding the type of awareness, as being
based more on theoretical knowledge rather than on actual practical experience:
They do understand this responsibility and looking it from a theory angle all Board members and the
senior management have been given enormous training in Shariah principles and in their roles and
responsibilities towards shareholders, investment account holders or other depositors (...) Most of the
senior management and Board members understand the responsibility but most of them have a
theoretical rather than a practical knowledge of these issues.

Responsible behavior. The findings reveal that the majority of respondents do not recognise the
right of UIAHs to monitor the performance of their investments. It was stated by several that
UIAHs are not in a position to impose monitoring procedures on the management since they
willingly entered into unrestricted Mudharabah agreements with the bank. However, some
respondents did state that UIAHs do have the right to monitor the performance of their

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funds because this is an issue of ownership of funds. Even though such mechanisms for
monitoring performance do not exist in most banks, one respondent thought it would be
harmless to grant them this right:

Currently we don’t have such a mechanism within the bank. (. . .) But it is a suggestion to be
considered for the future and there is no harm in providing them with whatever information is
needed.

Other respondents acknowledged the right of UIAHs to monitor funds, but limiting such
right to the available information through periodic audited financial statements.

5. Conclusions
Despite its rapid growth, Islamic finance as an industry is still in its infancy stage. This is
clearly reflected in our results. IFIs are still trapped in an international financial system that
is mainly tailored to supporting conventional financial institutions. Looking at Islamic
financial products and services, we can easily say they are replicas of their conventional
versions, but with some changes, so as to make them Islamically acceptable.

5.1 Corporate governance principles

Regarding the corporate governance principles identified in the research model in Figure
2, we can draw the following conclusions:

B One of the most important objectives of CG is to ensure ‘‘fairness’’ to all stakeholders.

This is also true for Islamic finance, where the notion of fairness is envisioned and
deeply inscribed in Shariah rules and principles. However, in our research it was
demonstrated that IFIs are lacking in the fairness principle, in their relationship with
UIAHs. They are not recognising the right of UIAHs to be treated as equity holders. On
the other hand, our research has revealed that although the managements of IFIs are
fully aware of their agency’s responsibility toward UIAHs in managing their funds, their
behaviour in practice is not ‘‘responsible’’ enough in acknowledging the rights of UIAHs.
B According to good CG practices, IFIs should ensure ‘‘accountability’’ toward both
shareholders and stakeholders through all the tools and mechanisms to at their disposal. Our
results reveal that although the rights of UIAHs to monitor funds are already being protected
by the central banks of some Gulf countries (for example in Bahrain) we have found that the
managements of IFIs are biased in their accountability towards equity holders to the
detriment of UIAHs. Moreover, the means that are being deployed to avoid conflicts of
interest are not effective enough. The literature on the topic clearly indicates that conflicts of
interest exist between equity holders and UIAHs. This makes ‘‘independence’’ in decision
making a vital principle in the governance of IFIs. Our findings, however, reveal that the
investment strategies of IFIs are focused on the interest of equity holders and do not properly
take into account the interest of UIAHs.

B Most of the CG recommended practices highlight the importance of ‘‘transparency’’ in

presenting the true state of the institution. Our investigation demonstrates that in
general, the IFIs in our sample are transparent when it comes to the basic requirements
imposed by regulators. Similarly, IFIs have to adhere to international standards as well
as to Islamic recognised standards, in order to ensure the ‘‘discipline’’ aspect of good
CG. In our investigation we have found, however, that when it comes to acknowledging
the rights of UIAHs, discipline seems to break down.

5.2 The issues surrounding UIAHs

On the issues surrounding the UIAHs, the main topic of this paper, our conclusions are
centred on the Mudharabah contract. The agreement between UIAHs and IFIs grants the
former the role of investors, with the condition that any profits will be shared with the IFI
while any risks will be borne solely by the UIAH. In spite of such a condition, the behaviour
of management of IFIs is not in appreciation of the notion that the UIAH is an investor.
Rather, it is clear that for many IFIs that those account holders are still under the definition
of ‘‘conventional depositors’’.

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 Iqbal and Llewellyn (2002, p. 57) concur that ‘‘The Mudharabah contract seems to be inherently
characterized by agency problems’’. Such contracts are phrased in a way as to protect the IFI
and take most responsibilities regarding UIAHs off their shoulders. Thus, any losses arising from
investments and businesses under the Mudharabah contract will be borne solely by the UIAH,
unless such losses are due to the gross mismanagement of funds. But how to prove a
mismanagement of funds if the UIAHs have no right to query or assess the management of IFI
or how to prove the low performance of the investment pool if the management is smoothing
returns through profit equalisation reserves? Shariah Supervisory Boards are more concerned
with the implementation of broad Shariah principles, rather than ensuring the eligibility of the
investments underlying UIAs. On the other hand, the main terms and principles governing
Unrestricted Investment Accounts provide basic assurance to the investor. Hence, we believe
that the problem starts with the Mudharabah contract itself since it misses out important
governance aspects aimed at protecting the rights of UIAHs.

Unsurprisingly, the outcome of our investigation is that the current practices adopted by
our sample of IFIs are not effective enough in protecting the rights of UIAHs, in the light of
standard CG principles. If the same practices were geared toward conventional depositors,
their interests would be effectively protected and maximized. However, aligning UIAHs with
their conventional equivalent and treating them in the same manner is inappropriate and
even conflicts with some basic CG principles. As shown in our results, the main
contributors to the ineffectiveness of the current practices by IFIs are the lack of
responsibility, accountability, and independence in decision making which, in turn, are
causing shortcomings in the application of other principles which should govern the
relationships between the IFIs and the UIAHs.

5.3 Limitations and further research

The work reported in this paper must be considered as exploratory in nature, the sample
being too small to allow any kind of generalisation of the findings to wider populations.
However, the authors feel that they have given an important contribution to the literature on
corporate governance in Islamic finance by moving the discussion forward on this topic
through field work and analysis of empirical data. Our findings may be regarded as a pilot
to serve as the basis for further research employing a larger sample and possibly using a
quantitative methodology. Another suggestion for further research would be to carry out an
in-depth study of UIAHs, in order to find more about their motivations and especially why
they choose to stay with an IFI which does not seem to be effective enough in protecting
their rights and their investments.

6. Recommendations
Based on our findings we offer a number of recommendations which we believe would
improve the unique relationship between IFIs and UIAHs.

Given the distinctive issues concerning CG for IFIs, the establishment of dedicated
corporate governance committees with the task of monitoring and overseeing the
implementation of the governance framework, including looking after the interests of the
stakeholders, seems to be a must. Such committees would undertake the protection of the
right of UIAHs, and would guarantee their fair treatment, especially if they are non-
executive members. Another recommendation concerns the Mudharabah contract. As
discussed earlier, this agreement lacks the elements that empower UIAHs to query the
management of IFIs about the performance of their investments. Such an important piece
of governance needs to be revised and amended according to the best CG practice, of
course without violating the underlying Shariah principles.

Islamic financial institutions are haunted by the fear of displaced commercial risks caused by
their depositors withdrawing their funds and investing them elsewhere. This fear forces IFIs to
adopt the practice of smoothing the returns through the establishment of profit equalisation
reserves (PER). The utilisation of PER appears to be a significant obstacle to transparency and
fairness. Therefore, it would seem wise to cease such a practice given that

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it misleads UIAHs about the true performance of IFIs. As a replacement, IFIs might
reimburse UIAHs with grants from the IFIs’ own returns, a practice already being
implemented by some IFIs. If the IFI opts to use PER, then it should allow the holders of
unrestricted investment accounts to redeem their contributions prior to leaving the financial
institution.

The role of regulators. We believe that regulators should play a more significant role in
protecting the right of UIAHs and in minimizing conflicts of interest. Central banks and
monitoring agencies should establish specialized laws and Islamic regulatory divisions as
well as their own Shariah Supervisory Board to look after issues mainly concerning IFIs.
They should also make Islamic CG standards issued by IFSB and AAOIFI mandatory for
IFIs. Regulatory bodies should impose a governance structure apt at protecting the rights
of UIAHs and if such a structure is implemented correctly, it might substitute the need for
representation of UIAHs on the Board. In order to mitigate the problem of conflicts of
interest between the UIAHs and equity holders, it is crucial that IFIs stop commingling the
funds of shareholders and UIAHs in the practice of one pool. Avoiding such practice would
enhance the element of transparency as well as of independence in CG.

Finally, we recommend that IFIs concentrate on the education of Directors (executives and
non executives) regarding their responsibilities toward stakeholders. The issue of
successful Islamic CG does not depend only on the governance structure but also on the
competency of the people within the structure. They should be knowledgeable enough
about the nature of Islamic finance and its products, which in turn would enhance current
managerial attitudes towards UIAHs.

References
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banks’’, The International Journal of Accounting, Vol. 36 No. 2, pp. 169-93.

Accounting and Auditing Organization for Islamic Financial Institutions (2009), Governance Standard
for Islamic Financial Institutions, No. 6, Bahrain.

Ahmad, K. (2000), ‘‘Islamic finance and banking: the challenges and prospects’’, Review of Islamic
Economics, No. 9, pp. 57-82.

Archer, S., Karim, A.A.R. and Sundararajan, V. (2010), ‘‘Supervisory, regulatory, and capital adequacy
implications of profit-sharing investment accounts in Islamic finance’’, Journal of Islamic Accounting
and Business Research, Vol. 1 No. 1, pp. 10-31.

Bhatti, M. and Bhatti, M.I. (2010), ‘‘Toward understanding Islamic corporate governance issues in
Islamic finance’’, Asian Politics & Policy, Vol. 2 No. 1, pp. 25-38.

Bhatti, I. and Khan, M. (2008), ‘‘Development in Islamic banking: a financial risk-allocation approach’’,
The Journal of Risk Finance, Vol. 9 No. 1, pp. 40-51.

Chapra, U. and Ahmad, H. (2002), Corporate Governance in Islamic Financial Institutions, Islamic
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du Plessis, J.J.D., McConvill, J. and Bagaric, M. (2005), Principles of Contemporary Corporate

Governance, Cambridge University Press, New, York, NY.

Dusuki, A.W. (2008), ‘‘Understanding the objectives of Islamic banking: a survey of stakeholders’
perspectives’’, International Journal of Islamic and Middle Eastern Finance and Management, Vol. 1
No. 2, pp. 132-48.

El-Gamal, M. (2005), ‘‘Islamic bank corporate governance and regulation: a call for mutualisation’’, Rice
University, available at: www.ruf.rice.edu/,elgamal/files/IBCGR.pdf (accessed 12 July 2009).

El-Hawary, D., Grais, W. and Iqbal, Z. (2004), ‘‘Regulating Islamic financial institutions: the nature of
the regulated’’, World Bank Policy Research Working Paper 3227, World Bank.

Ghayad, R. (2008), ‘‘Corporate governance and the global performance of Islamic banks’’,
Department of Business and Economics, Lebanese University-CNAM, Beirut, Lebanon.

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 Grais, W. and Pellegrini, M. (2006a), ‘‘Corporate governance and Shariah compliance in institutions
offering Islamic financial services’’, World Bank Policy Research Working Paper 4054, World Bank.

Grais, W. and Pellegrini, M. (2006b), ‘‘Corporate governance and stakeholders’ financial interest in
institutions offering Islamic financial services’’, World Bank Policy Research Working Paper 4053,
World Bank.

Grais, W. and Pellegrini, M. (2006c), ‘‘Corporate governance and stakeholders’ financial interests in
institutions offering Islamic financial services’’, World Bank Policy Research Working Paper 4052,
World Bank.

Grais, W. and Pellegrini, M. (2006d), ‘‘Corporate governance in institutions offering Islamic financial
services – issues and options’’, World Bank Policy Research Working Paper 4051, World Bank.

Gregory, H.J. (2000), The Globalization of Corporate Governance, Weil Gotshal & Manges LLP, New
York, NY.

Islamic Financial Services Board (IFSB) (2006), Guiding Principles on Corporate Governance for
Institutions Offering Only Islamic Financial Services, Islamic Financial Services Board, Kuala Lumpur.

Islamic Financial Services Board (IFSB) (2007), Disclosures to Promote Transparency and Market
Discipline for Institutions Offering Islamic Financial Services, Islamic Financial Services Board, Kuala
Lumpur.

Iqbal, M. and Llewellyn, D.T. (2002), Islamic Banking and Finance: New Perspectives on Profit
Sharing and Risk, Edwin Elgar, Aldershot.

Mallin, C. (2007), Corporate Governance, Oxford University Press, New York, NY.
OECD (2004), OECD Principles on Corporate Governance, OECD, Paris.

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Van Greuning, H. and Iqbal, Z. (2008), Risk Analysis for Islamic Bank, The World Bank, Washington DC.

Further reading
Malaysia International Islamic Financial Centre (MIFC) (2009), available at: www.mifc.com/index.
php?ch ¼ menu_know_fun&pg ¼ menu_know_fun_und&ac ¼ 13&ms ¼ 2 (accessed 1 October 2009).
Solomon, J. (2007), Corporate Governance and Accountability, John Wiley and Sons, Chichester.

Yin, R.K. (2003), Case Study Research Design & Methods, Applied Social Research Methods Series,
Sage, Newbury Park, CA.

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 Appendix

Table AI Data collection instrument

Main CG
principles Effective factors Interview questions

Transparency Customer awareness 14. Does the bank advise the UIAHs of their contractual rights and risks
before opening an investment account with the bank? And does that
include profit distribution and allocation policies?
16. Do you think the following should be public or internal pieces of
information in relation to Investment Accounts? And why?
Investment accounts profit calculation
Asset allocation
Investment strategies
Mechanics of smoothing returns (if any)
12. Does the bank adopt the practice of ‘‘smoothing the returns’’ for their
UIAHs and shareholders by using a special type of reserves such as ‘‘Profit
equalization reserve’’? Do you think this is an acceptable practice?
‘‘Smoothing the returns’’: IIFS generally put in place reserve funds with the
stated objectives of providing a cushion of resources that can be used to
weather adverse developments in the investment portfolio (Grais and
Pellegrini, 2006)
‘‘Profit equalization reserve (PER)’’: PER is the amount appropriated by the
IIFS out of the Mudharabah income, before allocating the Mudharib’s
share, in order to maintain a certain level of return on investment for IAH
and to increase owner’s equity (IFSB, 2006)
Timely disclosure and adequate 15. What kind of information you think should be disclosed to IAHs about
information their investments? And how often?
11. If we compare between the participants in Collective Investment
Schemes and IAHs in the process of monitoring the performance of
their investment, what are the similarities or differences, according to
the practice of this bank?
‘‘Collective investment scheme’’: an open end collective investment
scheme that issues redeemable units and invests primarily in transferable
securities or money market instruments. For the purposes of these
Principles, it excludes schemes investing in property/real estate,
mortgages or venture capital (OECD, 2004)
Ease of access to information and 13. What is the information the bank makes available to potential investors
analysis for potential customers for them to rely their investment decisions on? And how accessible is
that information?
Fairness UIAHs empowerment 9. What is the power of UIAHs in their relationship with Islamic Banks? For
example, ‘‘Displaced Commercial risk’’ which is the threat of
depositor’s fund withdrawal, that drives Islamic banks to use their profit
equalization reserve to smooth rates of return paid to investment
account holders, ensuring their competitiveness against rates paid by
other Islamic and conventional banks (El-Gamal, 2005)
10. Do you think IAHs should be given the power of representation on the
BOD? Please explain.
Shareholders’ and stakeholders’ rights The BOD of each IIFS, as the ultimate internal policy-maker, shall be
protection responsible for steering the establishment of governance policy
framework. The BOD shall set up a Governance Committee,
compromising at least three members, to coordinate and integrate the
implementation of the governance policy framework by working together
with the management, the Audit Committee and the Shariah Supervisory
Board; and to provide the BOD with reports and recommendations based
on its findings in the exercise of its functions (IFSB, 2006)
3. Is there a Governance committee among the committees of the BOD?
If yes, what its main roles and responsibilities? And who does it
consists of?
If no, who is coordinating and integrating the implementation of the
governance policy framework in the bank?

(Continued)

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 Table AI
Main CG
principles Effective factors
Discipline Adherence to good governance and
international standards
Compliance with Islamic laws and
regulations
Accountability The existence of the mechanisms that
allow the investors to query and assess
the actions of the Board and its
committees
The efficiency of management in
balancing between return and risk
associated with shareholders and
stakeholders investments
Independence Minimize or avoid potential conflict of
interest
Appointments of committees and
external parties.
Mechanism which ensures the objectivity
and independence of decision making
Responsibility Agency responsibility
Responsible behaviour
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Interview questions
2. What are the corporate governance standards the bank is following?
For example:
OECD (Organization for Economic Co-Operation and
Development)
BASEL II (A set of banking regulations put forth by the Basel
Committee on Bank Supervision)
IFSB (The Islamic Financial Services Board)
AAOIFI (The Accounting and Auditing Organization for Islamic
Financial Institutions)
Corporate Governance refers generally to the legal and organizational
framework within which, and the principles and processes by which,
corporations are governed (du Plessis et al., 2005). It is a defined set of
relationships between a company’s management, its Board of Directors,
its shareholders and other stakeholders (IFSB, 2006)
1. How do the corporate governance frameworks for Islamic banks
differ from the conventional banks?
7. Are there any existing mechanisms that allow the investors to query
and assess the actions of the Board and its committees?
UIAHs are generally seeking a low-risk investment with stable returns
(employing a ‘‘defensive’’ investment strategy), whereas shareholders
may favour a more aggressive and robust investment strategy offering
higher returns with more risk. This may lead to a conflict of interest when
IAH funds and shareholders’ funds are commingled. (IFSB, 2006)
8. What do you think of this statement? And how would the bank avoid
the conflict of interests in this case?
‘‘already dealt with under (Accountability)’’
8. What do you think of this statement? And how would the bank avoid
the conflict of interests in this case?
‘‘already dealt with under (Fairness)’’
3. Is there a Governance committee among the committees of the
BOD? If yes, what are its main roles and responsibilities? And
who does it consists of?
If no, who is coordinating and integrating the implementation of the
governance policy framework in the bank?
6. Which mechanism is the bank employing to ensure the objectivity
and independence of decisions making in relation to issues affecting
IAHs? ‘‘e.g. an internal guideline that sets out:
The eligibility of the IIFS employees who are responsible for
managing investment accounts operated by the IIFS;
The adequate protection of the UIAHs investments, including the
case where the UIAHs’ funds are commingled with shareholders’
funds;
The disclosure of relevant and material information to theU IAHs; and
A proper and disclosed basis for profit allocation and investment
policies to be based on the risk expectations of the IAH. (IFSB,
2006)‘‘
‘‘Agency responsibility’’: The Islamic contracts ‘‘Mudaraba’’ and ‘‘Mucharaka’’
used by the Islamic banks represent an agency relation, in the one hand,
between the depositors and the Islamic bank and in the other hand, between
the Islamic bank and the companies in the case of Mucharaka contract. It is
involving a complex agency problem, the bank’s management acts as an
agent for the shareholders, while the bank as a Mudarib acts as an agent for
the investment account holders (Ghayad, 2008)
4. Are the management of the bank and its BOD aware of their agency
responsibility? And how that affects their investments’ strategies and
decisions, in its dealing with UIAHs?
5. Does the bank recognize the rights of IAHs to monitor the
performance of their investments?
About the authors
Rodrigo Magalha˜es is currently Professor of Information Systems and Organization at the
Kuwait-Maastricht Business School in Kuwait, where he has also held the post of
Academic Director. KMBS is a private graduate school associated to the Maastricht School
of Management in The Netherlands. He was formerly with the School of Management and
Economics at Catholic University of Portugal, for about 15 years. He holds a PhD
(Information Systems) from The London School of Economics, an MBA from Sheffield
University, an MA (Information Science) from Leeds Metropolitan University, UK and a BA
(Psychology) from the University of Natal, South Africa. He has published extensively in
the areas of information systems management, organizational change, knowledge
management, organization learning, business process management, e-HRM and e-
learning. Rodrigo Magalha˜es is the corresponding author and can be contacted at:
rodrigo@kmbs.edu.kw
Shereen Al-Saad received her Bachelor degree in Management Information Systems from
the University of Bahrain. She has nearly ten years’ experience in various national and
multinational companies including AlAqeela Investment, EDS, Standard Chartered Bank,
and Bahrain Telecom Company ‘‘Batelco’’. She recently received her MBA degree with
distinction in Strategic Management from Maastricht School of Management, The
Netherlands. She is currently in the investment field, working on restructuring and rescuing
a defaulted Investment company. She has also developed an interest in the improvement
and development of Islamic finance.

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