Relevance of the application of institutional theory in Shariah governance of Islamic banks

Yusuf Karbhari,Md Mizanur Rahman,Md Kausar Alam

doi:10.1108/prr-05-2020-0015

Yusuf Karbhari, Md Mizanur Rahman + Show 1 more

Open Access

https://doi.org/10.1108/prr-05-2020-0015

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Abstract

Purpose Prior studies on Islamic finance provide a limited linkage between organizational theory and the complex Shariah governance framework embraced by Islamic banks worldwide. This paper aims to show the relevance of the application of “institutional theory” in the Shariah governance framework of Islamic banks. Design/methodology/approach This study applied library research to investigate the application of institutional theory in the Shariah governance framework of Islamic banks. The authors also critically reviewed prior empirical and review papers for accomplishing the research objectives. Findings Based on the critical review, the authors found that institutional theory is the most influential in progressing Shariah governance as it contributes toward the organizational image, helps to achieve religious legitimacy, and inspires a more robust regulatory environment. In addition, a well-designed Shariah governance framework is driven by institutional theory and that could assist in providing guidelines, strategies and procedures for Islamic banks to better conduct; monitor and control their social, religious and accountability obligations. The authors also highlighted the societal, economic and legal environment of Islamic banks in relation to the propositions of institutional theory. They emphasize that a well-designed Shariah governance framework driven by institutional theory could assist in providing guidelines, strategies and procedures for Islamic banks to better conduct, monitor and control their social, religious and accountability obligations. Research limitations/implications This study highlights institutional theory to serve best the development of operational strategies and structures of Islamic banks including the roles, functions and powers of the various stakeholders including regulators and those involved in the Shariah governance process of Islamic banks. The authors recognize the institutional theory to perform a key role in enriching the structural framework of Islamic Financial Institutions. This study is heavily dependent on prior research rather than empirical investigations. The authors did not cover other Islamic finance areas (such as Islamic insurance, Islamic microfinance and Halal industries). Thus, future researchers can apply institutional theory in Shariah governance practices and implementations of setting up rules by the regulators and respective institutions. Originality/value To the best of the authors’ knowledge, this is the first study that attempts to show the importance of the application of institutional theory in Shariah governance of Islamic Banks. Thus, this study, therefore, adding a novel dimension to the literature by arguing why institutional theory, is more pronounced (as compared to the other theoretical frameworks) in the formation and discharge of the roles, powers and functions by the different governance organs (such as regulators, the board of directors, management and Shariah supervisory board) operating in this unique corporate governance landscape.

Highlights

Seeing the global popularity of Islamic finance in Muslim jurisdictions over the past few decades, it is plausible to suggest that Islamic organization’s governance processes and structures are more complex than the conventional corporate governance systems
The Accounting and Auditing Organization for Islamic Financial Institution (AAOIFI) and International Financial Services Board (IFSB) explicitly outlined a framework for Shariah governance framework requiring Islamic banks to implement appropriate structures and processes to ensure that their operations are in absolute conformity with religious beliefs (Iqbal and Mirakhor, 2004; Grais and Pellegrini, 2006a; Kamla and Alsoufi, 2015; Ullah et al, 2016; Karbhari et al, 2018; Alam et al, 2020a)
This study highlights institutional theory to serve best the development of operational strategies and structures of Islamic banks including the role, function and power of the various stakeholders including regulators and those involved in the Shariah governance process of Islamic banks

Summary

Introduction

Seeing the global popularity of Islamic finance in Muslim jurisdictions over the past few decades, it is plausible to suggest that Islamic organization’s governance processes and structures are more complex than the conventional corporate governance systems. Without effective governance mechanisms in place, Islamic Banks cannot deliver the religious and ethical legitimacy that usually the stakeholders require. For this reason, the Accounting and Auditing Organization for Islamic Financial Institution (AAOIFI) and International Financial Services Board (IFSB) explicitly outlined a framework for Shariah governance framework requiring Islamic banks to implement appropriate structures and processes to ensure that their operations are in absolute conformity with religious beliefs (Iqbal and Mirakhor, 2004; Grais and Pellegrini, 2006a; Kamla and Alsoufi, 2015; Ullah et al, 2016; Karbhari et al, 2018; Alam et al, 2020a). When examining religion’s influence on business, raises some important questions because contemporary business systems have their roots firmly entrenched in the Western Enlightenment movement and positivist thought, with the “secular” being separated from the “sacred” and the “normative” discarded from the “discourse” (Gambling and Karim, 1991; Hamid et al, 1993; Tinker, 2004; Carmona and Ezzamel, 2006)

Objectives

Conclusion