The impact of the board of directors and the Shariah board on the financial soundness of Islamic banks

Abstract

PurposeThe purpose of the study is to examine the relationship between the board of directors (BODs) and the Shariah board (SB) and assess its impact on the financial soundness of Islamic banks (IBs).Design/methodology/approachThe authors use a regression model to test the effects of the relationship between the BOD and the SB on the financial soundness of IBs by applying a panel data set of 61 IBs, covering 18 countries from 2008 to 2014. The dependent variable is the Z-score indicator. To test the robustness of the results, the authors use dependent variables other than the Z-score [A rating of Capital adequacy (C), Asset quality (A), Management (M), Earnings (E), Liquidity (L), and Sensitivity (S) (CAMELS)] for 2018.FindingsThe results show that meetings between directors and SB members significantly reduce the financial soundness of IBs. The relationship between the BOD and the SB increases conflicts of interest and agency costs. However, a representation of the SB at the BOD meetings and vice versa does not affect financial soundness. The Accounting and Auditing Organization for Islamic Financial Institutions and the Islamic Financial Services Board corporate governance standards do not require the presence of the SB representative at the BOD meetings or vice versa, which justifies the results.Practical implicationsThis study attempts to fill gaps in the literature by investigating the impact of meetings between the SB and the BOD on the financial soundness of IBs across the world. The results suggest that the BOD’s frequent interference in the affairs of the SB can have adverse effects on IBs and should be avoided.Originality/valueThe authors depart from the previous literature by using three new characteristics that link the BOD to the SB. Methodologically, the authors use three new measures to evaluate this relationship and its effect on the financial soundness of IBs. This study is unique because it explores the comparative impacts of the presence of a SB representative at the BOD meetings and a director at the SB meetings and meetings between the two governing boards of IBs.