Shariah Supervisory Board Research Articles

An evaluation of corporate governance practices of Islamic banks versus Islamic bank windows of conventional banks

PurposeThe purpose of this paper is to explore the perceived importance of management about various corporate governance dimensions being practiced in the Pakistani Islamic banking context.Design/methodology/approachAHP is applied to analyze the corporate governance indexes and its dimension of five Islamic banks and 12 conventional banks which are providing Islamic banking facilities (Islamic bank window) throughout Pakistan. These dimensions included board of directors (BOD), Shari'ah supervisory board (SSB), audit, investment account holders (IAH), and information disclosure & transparency.FindingsThe study reveals that the most significant dimensions which affect the corporate governance in Islamic banks are BOD and SSB, while the significant factors for Islamic banking windows are almost all dimensions of corporate governance. The correlation, regression, and ANOVA tests are applied to check the contributions of various factors of corporate governance mechanisms. These results indicate that there is a significant difference between Islamic banks and Islamic banking windows regarding the BOD and SSB. On the other hand, no significant difference is seen for the rest of the factors. The dissatisfaction level of customers reduces with the increase in the audit and BOD governance and all other factors have no impact in the case of Islamic banking windows; whereas in Islamic banks, in addition to audit and the SSB, information disclosure also significantly reduces the dissatisfaction level of customers. The concern of customers decreases significantly with the increasing level of IAH in the case of Islamic banking windows whereas in the case of Islamic banks a significant impact is seen for BOD, information disclosure, audit and IAH, but improvement in the governance of these rather increases the concern of customers toward compliance of Shari'ah and SSB has no contribution towards the concern of customers.Originality/valueThis study has practical significance for conventional and Islamic banking policy makers for understanding the requirements of their stakeholders and aligning them with the fundamentals of Shari'ah compliance according to the guidelines provided by the code of corporate governance so as to get better insight into the relationship between customers' motives behind using Islamic banking products.

Corporate governance disclosure in the annual report

PurposeThe purpose of this paper is to explore disclosure on corporate governance mechanisms in annual reports of Islamic commercial banks in Indonesia.Design/methodology/approachEmploying a sample comprising seven Islamic commercial banks in Indonesia, the present study constructs the so‐called Corporate Governance Disclosure Index (CGDI) to score the banks' disclosure level. Corporate governance mechanisms addressed in this study include Shariah Supervisory Board, the Board of Commissioners, the Board of Directors, board committees, internal control and external audit, and risk management.FindingsIt is revealed that Bank Muamalat and Bank Syariah Mandiri, the county's two largest and oldest Islamic commercial banks, score higher than their peers. Disclosure of the sample banks on some dimensions, such as board members and risk management, is found to be strong. On the other hand, disclosure on internal control and board committees tends to be weak.Practical implicationsThis study shows that the average disclosure level among the sample banks is relatively low. Hence, this result has important implications for the enhancement of corporate governance disclosure of Islamic banks, thereby wider acceptance and enhanced reputation could be gained.Originality/valueThis paper is believed to be among the first to explore the practice of disclosure on corporate governance mechanisms among Islamic commercial banks. Additionally, it focuses on Indonesia, the largest Muslim country that has a different institutional setting from that in other Muslim countries.

Analysing the Role of Shariah Supervisory Boards in Islamic Financial Institutions

SSB (or in some Islamic financial institutions known as shariah committee), is one of the most important governance mechanism of an IFI to ensure compliance with shariah. Compliance with shariah is the distinctive characteristic of an IFI as compared to conventional financial institutions. Acknowledging this importance, the Accounting and Auditing Organization for Islamic Financial Institution (AAOIFI) has provided standards on SSB, shariah review and internal shariah review under its governance standards (AAIOIFI, 1999). At present in line with shariah principles several Islamic financial institutions are engaged in product development activities globally to cater the needs of a wide range of parties. However, considering the essentiality for these institutions to innovate and operate within the ambits of shariah, need of the shariah supervision cannot be over stated. The safeguard to make Islamic financial institutions perform their dealings according to the Islamic laws comes when there is a legitimate control body in the institution. Hence, it is vital for such institutions to form a shariah supervisory board (SSB) comprising on fiqh al-muamalat experts to guide their transactions in accordance with the principles of shariah. Malaysia and several other countries have passed laws to govern the formation and functions of SSB. In fact, SSB undoubtedly forms the most important and influential entity in any Islamic financial institution.The paper in hand attempts to discuss these functions in detail and tries to shed a little light on established laws in Malaysia regarding regulations of SSB and operations of Islamic financial institutions.

Do Islamic Banks Employ Less Earnings Management?

In this paper, we examine 1) whether Islamic banks are less likely to manage their earnings, and 2) how the corporate governance system, especially Shari’ah Supervisory Boards (SSBs), impacts the earnings management behaviors within Islamic banks. Using a sample of Islamic Banks and a matched non-Islamic Banks in the ERF region, we find that first; Islamic Banks are less likely to conduct earnings management as measured by both earnings loss avoidance and abnormal loan loss provisions. Second, there is no significant difference between Islamic Banks with and without SSBs in terms of earnings management. Third, several SSB characteristics and board characteristics, such as SSB size, Auditing Organization for Islamic Financial Intuitions (AAOIFI), and outside board members, are important determinants of the earnings management for Islamic Banks with SSBs.

Internal control system for Islamic micro financing

PurposeThis paper aims to contribute to literature on managing Islamic micro financing by formulating and evaluating the implementation of internal control system for Islamic micro financing. It also aims to investigate the implementation of an internal control system for financing activities practiced by Baitul Maal wat Tamwil (BMT), a special micro finance organization, in Indonesia.Design/methodology/approachFirst, the paper introduces the concept of internal control system. Second, an internal control system for Islamic financing is formulated. Primary data that relate to the implementation of an internal control system for financing activities are obtained through a direct survey using questionnaires. The data are then analyzed using descriptive statistic and qualitative analysis to find the implementations of the internal control system.FindingsBMTs in Indonesia have implemented an internal control system for their financing activities. The rank of the implementation is: information and communication; monitoring; control environment; risk assessment; and control activities. This study also indicates that the implementation of authorization and consultation to the Shariah Supervisory Board was low.Research limitations/implicationsThe respondents of this study are small in number. However, the findings are valid and reliable.Originality/valueTo the author's knowledge, there is a lack of scholars' attention on the implementation of internal control especially for Islamic micro financing. Therefore, this study will provide insight to the literature on how to manage Islamic micro financing efficiently and effectively.

Issues and Challenges of Shari?ah Audit in Islamic Financial Institutions: A Contemporary View

The Islamic Banking and Finance is said to be the alternative to the conventional finance and banking system. Although it has been around for slightly more than forty years, the tremendous growth in Islamic Finance has seen the assets under management by the Islamic Financial Institutions (IFIs) have exceeded one trillion US Dollars. Inevitably, a proper system of audit is envisaged for the IFIs to continue growing and providing assurance that they are strictly following the shari’ah in all aspect (of their products, rules and procedures and contracts). Hence, failure to give reasonable assurance will dampen the objectives of the IFIs and the achievement of maqasid al shari’ah. This paper is trying to provide a contemporary view on the issues and challenges of shari’ah audit in IFIs. It looks at the actors in Islamic finance especially the shari’ah auditors, the regulators and standard setters and the Shari’ah Supervisory Board (SSB). Furthermore, the paper highlighted four of the pressing issues and challenges as discussed in extant literature on auditing in IFIs. This paper is trying to promote the institutions of Hisbah as one the possible solutions to the issues of shari’ah auditor’s independence and accountability. This paper also touches on the issue of lack of competency among the shari’ah auditors. This paper concludes that the IFIs are in dire needs of independent and accountable shari’ah auditors with high level of competency. History tells us that the institution of Hisbah has played a major role in ensuring the market comply to the shari’ah requirements and it is possible to revive this institution and improvised on its structure and mechanism not just to give reasonable assurance but to be very sure that the IFIs are shari’ah based.

Corporate Governance and Islamic Social Responsibility Disclosure In Kuwaiti Shariah Compliant Financial Institutions

This study examines the relationship between corporate governance characteristics and the extent of Islamic social responsibility disclosure in Kuwait. The annual reports of 40 Shariah-compliant financial institutions listed on the Kuwait Stock Exchange in 2010 are examined. Four major corporate governance characteristics are investigated: 1) the existence of a Shariah supervisory board; 2) the number of board members; 3) the proportion of non-executive directors to the total number of directors on the board; and 4) role duality. The extent of Islamic social responsibility disclosure is measured using a self-constructed index. The index consists of 46 Islamic information items. Multivariate regression analyses are used to examine the relationships between these characteristics and the level of Islamic social responsibility disclosure. The results show that Shariah-compliant financial institutions disclosed 18% on average of the possible voluntary disclosure items. The findings report that Islamic social responsibility disclosure increases with the presence of a Shariah supervisory board, but decreases with role duality. Other corporate governance characteristics were found not to be significant in the study.

Introduction to corporate governance from Islamic perspective

PurposeThe purpose of this paper is to draw an analytical review on corporate governance from the Islamic perspective, addressing the importance of understanding governance for Islamic institutions.Design/methodology/approachThe study follows a browsing method that takes into consideration the difference between normal corporate governance in conventional banking and comparing that to Islamic banking.FindingsIt was found that it is very important to take into consideration the corporate governance in Islamic banks because it might help to draw the right image about the organization. In particular, how the Shariah Supervisory board functions and how it could be linked to the Islamic banking process.Originality/valueThis paper is one of few papers that highlight the importance of studying corporate governance for Islamic banks. The paper is of value in describing governance in Islamic institutions and how there are many issues under the investigation process, especially issues related to the Shariah Supervisory board and its functionality.

The impact of Shari’ah governance practices on Shari’ah compliance in contemporary Islamic finance

The objective of this article is to highlight the impact of regulatory issues of the Shari’ah Supervisory Board (SSB) on Shari’ah compliance in the contemporary Islamic finance industry. For institutions offering Islamic Financial Services (IIFS) to gain the trust of their Muslim clients, financial institutions normally incorporate a religious board in the form of an SSB. In theory, the function of the SSB is to ensure that IIFS operate within Shari’ah norms and teachings. However, given that SSBs in countries like Saudi Arabia, Egypt, Turkey and the United Kingdom are generally unregulated, concerns have been raised about the feasibility of a viable and functional Shari’ah governance culture in IIFS. Doubts relate mainly to the unclear functions and legal settings of SSBs; a lack of accountability and transparency; conflict of interests and the lack of independence of SSBs, as well as poor training and the inadequate qualifications of SSB members. The key argument in this article is that the prevalence of these critical governance issues largely reduces the level of Shari’ah compliance in the Islamic finance industry. Thus, the article argues that regulators in Islamic and secular countries need to intervene and regulate Shari’ah governance in IIFS so as to ensure a sound financial system and investor confidence.

Shari’ah Supervisory Board Composition Effects on Islamic Banks’ Risk-Taking Behavior

Islamic banks underlie the fundamental principles of the Shari’ah, which encompass all business activities, financial contracts, and transactions. The Shari’ah Supervisory Board (SSB) monitors and certifies compliancy and is unique to the governance structure of Islamic banks compared to their Western counterparts. This study addresses the question of how the compositional characteristics of the SSB influence the loan portfolio risk-taking of Islamic banks. As such, we analyze to which degree the legal supervisory functions of a SSB affect the banks’ risk-taking behavior. Over the period from 2000 to 2010, we regard cross-country bank-level data from the Middle East and Northern Africa as well as from Southeast Asia. Our results reveal evidence that the loan portfolio risk-taking of Islamic banks is positively influenced by increasing size of the SSB, as well as when top ranked Shari’ah scholars with multiple memberships have board mandates and when annual changes occur in the composition of a SSB, regarding particularly previous period variables with second lags. We find that supervisory effectiveness and disciplining power of individual bank SSBs towards the risk-taking in the loan portfolio of Islamic banks decreases in a decentralized Shari’ah-compliant governance structure. The reverse causality analysis shows strongly that SSB factors affect primarily loan portfolio risk-taking, not the other way around.

Shariah Compliance Process and Corporate Governance in Islamic Banking Institutions (IBIs): A Proposed Model

Banking, by its very nature, entails taking a wide array of risks. One such risk is reputational risk, which arises from operational failures, i.e. failures to comply with the relevant laws and regulations, or other sources. Reputational risk is particularly damaging for banks since the nature of their business requires them to maintain the confidence of the depositors, creditors, and the general marketplace. Thus, the compliance issue is one of the most crucial factors in determining smooth and successful banking operations. Shariah compliance is a distinct feature of the Islamic banking industry. The need to have comprehensive and rigorous mechanisms in place to ensure shariah compliance as well as an effective and reliable shariah review process are the two key contributing factors for the industry to further progress. Indeed, the shariah compliance process is one of the areas upon which Islamic Banking Institutions (IBIs) must focus as part of the overall corporate governance. The purpose of this paper is to propose a shariah compliance framework for IBIs drawing from the present requirements on corporate governance (CG) in Malaysia. The framework proposes that the compliance process for IBIs is done through the internal auditing framework by establishing an internal shariah audit team. The framework proposes the Internal Shariah Audit Team (ISAT) to be a special cell of the Internal Audit Committee (IAC), which will review operations and transactions relating to shariah matters on a regular basis. The team should have bilateral functional interactions with both the IAC and the Shariah Supervisory Board (SSB).

Corporate Governance Disclosure in the Annual Report: An Exploratory Study on Indonesian Islamic Banks

Due to their different characteristics, banks are expected to report the features of their corporate governance in the corporate report. This paper is aimed to explore disclosure on corporate governance mechanisms in annual reports of Islamic commercial banks in Indonesia. Corporate governance mechanisms addressed in this study include the Shariah Supervisory Board, the Board of Commissioners, the Board of Directors, board committees, internal control and external audit, and risk management. Employing a sample comprising seven Islamic commercial banks in Indonesia, the present study constructs the so-called Corporate Governance Disclosure Index (CGDI) to score the banks’ disclosure level. It is revealed that Bank Muamalat and Bank Syariah Mandiri, the county’s two largest and oldest Islamic commercial banks, score higher than their peers. Disclosure of the sample banks on some dimensions, such as board members and risk management, is found to be strong. On the other hand, disclosure on internal control and board committees tends to be weak. The result of this study may have some important implications for the enhancement of corporate governance disclosure of Islamic banks, thereby wider acceptance and enhanced reputation could be gained.

An Examination of the Principles of Corporate Governance from an Islamic Perspective: Evidence from Pakistan

AbstractThis article attempts and establishes a positive and direct link between Islamic law and the principles of corporate governance, using practical examples from the banking and finance industry. Several theoretical approaches are implemented to analyse the subject of corporate governance. Commentators have previously linked theories to explain the elements of corporate governance and its essential principles, ranging from board activities to internal control mechanisms such as auditing. Once proven that there is a link, this research attempts to analyse how well or how this Islamic approach to corporate governance is enriched within organisations based in Pakistan. However, at the same time, despite the Islamic element involving accountability to God and individual responsibilities under Islam as a religion, one finds immense similarities to the types of internal and external control mechanisms. There is a similarity in the way an Islamic organisation is counselled by the Shariah Supervisory Board just as a conventional Board would perform their actions. Similar problems are associated in organisations implementing Islamic principles of corporate governance. The main difference unearthed by this research is the element of religious beliefs. Pakistan as a country exemplifies how the development of corporate governance code is more inclined towards the Anglo-Saxon model than towards the Islamic perspective, despite a strong Islamic law background. However, this does not mean that one perspective is better than the other. It just illustrates the flexibility of the subject of corporate governance and its principles. The task to choose the type of principles to adhere to is entirely up to the region, culture, and the corporate structure.

Corporate Governance in Islamic Banking Institutions

Islamic Banking has come to a critical phase where it has to balance between performance and sanctity of the offerings. Keeping the investors happy and at the same time maintaining the reason for existence of Islamic Banking has not been an easy task. Since all the contracts and products in Islamic Banking need to be approved by Shariah board, there is a heavy reliance on Shariah. Shariah Supervisory Board is the main decision making body in the Islamic financial institutions. Their powers supersede the powers of the Board. Hence they play a crucial role in the Corporate Governance. The paper examines the critical role of Shariah Supervisory Board in Islamic Banks in relation to corporate governance. Shariah Supervision can make significant contribution to the strategic direction of the organization while adhering to corporate governance principles. It can also help in maintaining the sanctity of the Islamic offerings thus fulfilling the prime role. It is evident that there is a strong link between the principles of Islamic Finance and corporate governance. The fundamental principle of avoiding Gharar lays down the foundation of corporate governance in Islamic Banking. Avoiding uncertainty and deceit are the basic rules of Islamic Banking. Following the corporate governance is thus not a matter of choice but a fundamental requirement and thus channelling it for providing the strategic direction to the organisation is the responsibility of the Shariah Board. There are several factors affecting Corporate Governance in Islamic Banking. A Governance Committee as proposed on the lines of IFSB is a viable option as a first step for corporate governance in the Islamic Banks. It should be noted that the disclosure requirements are more stringent in case of Islamic Banks as compared to conventional banks due to the fundamental principle of complete disclosure in Islamic Banking. Thus, Shariah Supervisory Board can provide critical direction to the organization while adhering to the principles of corporate governance in the Islamic banks.

The importance of Shari’ah supervision in Islamic financial institutions

Islamic financing differs from conventional financing in that it prohibits the payment or receipt of interest. The concept of interest-free financing existed prior to the advent of Islam and was embraced in ancient Arabia. The concept was officially launched in the 1970’s by the Organization of Islamic Countries (OIC) and introduced in most Muslim nations and some Non-Muslim nations. But while it has experienced phenomenal growth rate, the Islamic financial system has been criticized for failing to incorporate the true spirit of Shari’ah in their actions. Islamic financial institutions are also divided over the interpretation of which products are considered halal (acceptable under Islamic law). In order to overcome some of these issues, financial institutions dealing with Islamic products are required to utilize the services of a Shari’ah adviser or a Shari’ah Supervisory Board (SSB). The paper recommends a more collaborative effort between the central banks of Muslim nations and regulatory organizations

Comparative Study of Insurance and Takafol (Islamic Insurance)

Ibn Abidin (1784-1836) was the first scholar in the Muslim world to discuss the meaning and legal character of insurance.1 Islamicity of insurance has been under discussion since then. Opinions regarding legitimacy, adoption, and adaptability of insurance are numerous. Recently, however, a consensus was emerging for adapting insurance in the name of takafol and solidarity. As a result, several Islamic takafols and solidarity companies have been established since 1979. During the last decade the Council of Islamic Ideology Pakistan (ClIP) reviewed the operations of the existing takafols in order to find a suitable model for Pakistan.2 While declaring all of them incompatible with the injunctions of Islam, the ClIP proposed its own model of takafol, instead. Its rejection of existing takafols is a little paradoxical since the operations of all the takafols are claimed to be compatible with the Shariah. Each takafol guarantees Shariah compatibility of its operations by sUbjecting itself to the dictates of a Shariah Supervisory Board, which are empowered to review the company's practices, contracts, transactions and operations. This paper attempts to delineate the points of contact and convergence between insurance and takafol, and to .make recommendations for possible improvement in the takafol concept. The study is organised as follows: Islamic debate on insurance, with special reference to its application to takafols, is reviewed in Section II. Pertinent operational features of takafols are compared with insurance in Section III. The ClIP model is examined in Section IV. The final section features proposals meant to augment the conformity of takafol with the principles of Shariah.

Agency Problems and Residual Claims

Social and economic activities, like religion, entertainment, education, research, and the production of other goods and services, are carried on by different types of organizations, for example, corporations, proprietorships, partnerships, mutuals and nonprofits. There is competition among organizational forms for survival. The form of organization that survives in an activity is the one that delivers the product demanded by customers at the lowest price while covering costs. The characteristics of residual claims are important both in distinguishing organizations from one another and in explaining the survival of organizational forms in specific activities. This paper develops a set of propositions that explaim the special features of the residual claims of different organizational forms as efficient approaches to controlling agency problems. © M. C. Jensen and E. F. Fama, 1983 Michael C. Jensen, Foundations of Organizational Strategy Chapter 6, Harvard University Press, 1998. Journal of Law & Economics, Vol XXVI (June 1983) This document is available on the Social Science Research Network (SSRN) Electronic Library at: http://papers.ssrn.com/sol3/paper.taf?ABSTRACT_ID=94032 AGENCY PROBLEMS AND RESIDUAL CLAIMS