Shari’ah Governance

Prof. Habib Ahmed

Durham University Business School

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Presentation Plan

• Shari’ah Governance—Introduction

• Shariah Governance Framework

• Issues in Shari’ah Governance

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Introduction• Mission of Islamic finance— ‘meet the stakeholders

desire to conduct financial business according to the principles of Shari’ah’

• Ultra vires (beyond powers)—’if a corporation enters into a contract that is beyond the scope of its corporate powers, the contract is illegal’

• To ensure Shari’ah compliance—need structures and processes to ensure Shari’ah requirements are fulfilled from the perspectives of different stakeholders

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Islamic Finance—Stakeholders (1) • Stakeholders

– Shareholders

• Represented by Board of Directors

• Objective earn profit by providing Shari’ah compliant services

– Depositors/Investors

• Provide bulk of the funds

• Objectives: good services, competitive returns, compliance with Shari’ah principles

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Islamic Finance—Stakeholders (2)

• Community

– Muslims from all walk of lives

– Objectives: A just and equitable industry serving the needs of all

• Regulators/Supervisors

– Public body

– Objectives: systemic stability, soundness of the financial system, and protection of stakeholders not taken care at the organizational level

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Shari’ah Requirements (1)

• Legal

– Shari’ah compliant products

• All products of IFI should be compliant with principles and goals of Islamic law

– Shari’ah compliant operations

• Ensuring contractual conditions and stipulations (e.g., profit-loss sharing)

• Treatment of interest, penalty, early and late payments, payment of zakah, etc.

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Shari’ah Requirements (2)

• Social Objectives—fulfilling maqasid-al Shari’ah– Growth & justice

– Social dimensions—promote social welfare

– Shari’ah compliance vs. Shari’ah based

• Credibility and Trust in the System– Fin. institutions— ‘fiduciary trustee’ on behalf of

depositors & investors

– Stability and performance of the industry depends on trust and confidence

– Credibility of the industry depends on conduct of business according to the spirit and principles of Shari’ah

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Stakeholders & Requirements

Requirements

Stake Holders

Shari’ah

Compliant

Products

Shari’ah

Compliant

Operations

Fulfil

Maqasid

Credibility &

Trust

Shareholders ? ?

Depositors/Investors

?

Community

Regulators ? ? ?

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Levels of Importance of Islamic Banks Objectives

Not imp.

at all

(%)

Not

imp.

(%)

Do Not

Know

(%)

Imp.

(%)

Very

imp.

(%)

Mean

Prohibition of riba0.0 1.0 5.2 24.9 68.8 4.61

Provide Shari’ah-

compliant products0.0 0.6 4.6 29.1 65.6 4.60

Promote sustainable

development0.2 1.0 16.6 50.3 31.9 4.13

Contribute to social

welfare0.6 2.9 15.7 50.1 30.6 4.07

Alleviating poverty 0.6 4.8 23.7 45.3 25.6 3.90

Maximising profits 2.1 11.1 16.1 50.3 20.3 3.76

Source: Mohd Nor (2012) (total respondents 477, Malaysia)

Expectations of Stakeholders

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101010

Shari’ah Issues in Operations of Banks

• Other than products, ensure Shari’ahcompliance of the following:– Processes of contracts executed properly– Accounting entries– Penalty income – Interest income– Profit-sharing with depositors– Payment of zakah?– etc.

• If there is income from non-Shari’ahcompliance, it needs to be excluded from bank’s income

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Shari’ah Risks & Implications• Short-term implications of Shari’ah risk

– Some clients may move to other banks• Three types of clients in Islamic banks

– Income from non-Shari’ah compliant transactions excluded from bank’s income (if there is Shari’ahaudit)

• In the long-term, the reputation and credibility of the industry can be at stake

• How do we know about Shari’ahcompliance risks?– Shari’ah Audit– Disputes– Perceptions of people

Presentation Plan

• Shari’ah Governance—Introduction

• Shari’ah Governance Framework

• Issues in Shari’ah Governance

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Shari’ah Governance: Scope

• Shari’ah governance depends on organisational arrangements and regulatory regimes

• Some stakeholders have control and authority over the IFI, others do not have direct influence

• Some regulatory authorities provide framework for Shari’ah governance, others leave it up to the financial institutions

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IFSB—Shari’ah Governance Standards for IFIs (1)

• Shari’ah Governance Standards (2008) include four aspects at organisational levels:– Issuance of Shari’ah pronouncements (done by

SSB)– Ensure compliance with Shari’ah pronouncements

(done by in-house Shari’ah compliance unit)– Internal Shari’ah compliance review & audit (done

by internal Shari’ah review/audit unit) – Annual Shari’ah compliance audit (to ensure

internal Shari’ah audit carried out properly)

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IFSB—Shari’ah Governance Standards for IFIs (2)

• Role of Regulators—no ‘single model’ or ‘one-size-fits-all’ is prescribed

• Suggests establishing Governance Committee (members from Audit, SOs, and independent non-executive director) to protect interests of other stakeholders

– No such Committee exists in IBs

• No clear policy related to fulfilment of other Shari’ah requirements

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Shariah Compliance Management Functions

• Liaise with SSB– Shariah Secretariat/Department: Deal with Shariah matters

and deal with Shariah Supervisory Board

• Shariah Review Function– Shariah Compliance Unit: Review business operations

regularly to ensure Shariah compliance

• Risk Management – Risk Management Unit: Identify, measure, monitor, report

and control Shariah non-compliance risk

• Shariah Audit Function– Audit Department: Provide independent overview and

objective assessment of Shariah compliance

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Product Development and Shari’ahCompliance

• Role of Shari’ah Governance in different phases of Product Development

– Idea Generation & Acceptance

• Shari’ah approval of concept paper

– Converting Concept into Product

• Shari’ah Approval of documents & process flow)

– Launch and Commercialization

• Shari’ah audit

Types of Shari’ah Bodies

• Shari’ah Organs/Bodies exist in different forms

1. Shari’ah Department/Unit (in the bank)

2. Advisor (external to the bank)

3. Shari’ah Supervisory Board (SSB) (in the bank)

4. Professional Shari’ah Advisory Firms

5. National Supervisory Authority

6. International Fiqh bodies

• Depending on the regulations and size of the organization, different types of Shari’ah bodies exist

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SSB at Organizational Level

• SSB established by IFIs as an independent body

– to ensure the ‘Islamic’ character of Islamic finance

– Credibility of operations

• SSB roles and Shari’ah Requirements

– Primary input in product approvals

– Shari’ah compliant operations?

– Fulfilling the goals of Shari’ah (maqasid)?

– Credibility and trust in the system?

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Presentation Plan

• Shari’ah Governance—Introduction

• Shari’ah Governance Framework

• Issues in Shari’ah Governance

Credibility of SSB?

Doubts about Credibility of Shari’ah Board Members

True True to Some

Extent

Not True No Answer

19 3 8 6

52.7% 8.3% 22.2% 16.7%

Enhancing the credibility of SSB would require having a regulatory framework for Shari’ah governance

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Source: ISRA (2015)

Shari’ah Regulatory Regimes

• Shari’ah Regulatory Regimes can be classified according to following:– Existence of national framework for Shari’ah

governance• Law/regulations related to Shari’ah Issues

• Active National Shari’ah Authority

– Degree of control of national framework over organizational Shari’ah governance

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Framework for Organisational Shari’ahGovernance

• TOR of Organizational Shari’ah Organ (SO)– Shari’ah Unit/Department, duties and role of SSB members,

issues related to SSB members

• Shari’ah/Fiqh related issues– Harmonize Shari’ah interpretations; Ensure compliance with

Shari’ah principles (Shari’ah Audit)

• Product clearance– Product clearance; Permissible modes of

financing/investment; Require a Shari’ah compliance manual

• Operational issues– Shari’ah audit, ensure information disclosure; use of charity

fund; Islamic banking windows (separation of funds and risks)23

Regulatory Shari’ah Governance Framework for SSB: Malaysia

• To be responsible and accountable for all Shari’ah decisions, opinions and views provided by the Shari’ah Committee members;

• To advise the board management and the Islamic financial institution regarding their business operations to ensure that the daily activities are in compliance with the Shari’ah;

• To endorse Shari’ah policies and procedures prepared by the Islamic financial institution;

• To endorse and validate any documentations involved in daily activities, including the terms and conditions of the transactions the Islamic financial institution engages in;

• To assess the work carried out in the Shari’ah review and audit; • To assist legal counsels, consultants or auditors by giving advice

pertaining to Shari’ah matters.

24Source: ISRA (2013)

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Shari’ah Risk—Diversity of Fatwas

• Diversity in fatwas• Different schools of thought—different interpretations

• Different scholars—different rulings

• Same scholar—different rulings?

• ‘Fatwa shopping’ (Gresham’s law)

• Diversity in fatwas creates • Uneven playing field

• Reputation risks and credibility of Islamic finance

• Create difficulties in cross-border transactions

• Hamper the global growth of Islamic banking

Differences of Shari’ah OpinionTawarruq

Views S-East Asia Middle-East N. Africa Europe Total

Permissible 0 2 1 0 3

Not

Permissible

2 7 11 1 21

No Answer 7 4 1 0 12

Total 9 13 13 1 26

Guarantee FeeViews S-East Asia Middle-East N. Africa Europe Total

Permissible 2 7 1 0 10

Not

Permissible

3 2 11 1 17

No Answer 4 4 1 0 9

Total 9 13 13 1 26

26Source: ISRA (2015)

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Harmonization of Shari’ah: National Level

• Market driven Shari’ah governance– No mechanism to ensure harmonization of fatwas– Harmonization may settle for efficient products that

dilutes Shari’ah requirements

• National level standardization of Shari’ah rules may require regulatory overview

– Central Shari’ah Boards

• Malaysia, Pakistan, Indonesia

– Shari’ah parameters

• Malaysia, Pakistan

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Harmonization of Shari’ah: International level

• International level (AAIOFI Shari’ah standards)

– Not binding

– Only five countries have adopted AAOIFI Shari’ah (Bahrain, Pakistan, Qatar, Sudan and Syria )

• Resistance towards a global Shari’ah body

Questions?habib.ahmed@durham.ac.uk

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