THE ROLE OF SHARI AH SUPERVISORY BOARD IN ENSURING GOOD CORPORATE GOVERNANCE PRACTICE IN ISLAMIC BANKS. Dr.Bedj Bedj Toufik

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1 THE ROLE OF SHARI AH SUPERVISORY BOARD IN ENSURING GOOD CORPORATE GOVERNANCE PRACTICE IN ISLAMIC BANKS. Dr.Bedj Bedj Toufik Visiting Lecturer, Academic of Islamic Studies, University of Malaya, Malaysia Abstract Good Corporate Governance Practice (GCGP) is important to Islamic banks and clients. It stresses the three main areas of accountability, transparency and trustworthiness. The board of directors in commercial banks acts on behalf of shareholders (owners) to monitor and ensure that all activities ensure maximization of the value and sustainability of the company. In Islamic banks Shari ah Supervisory Board (SSB) plays crucial role in reviewing products, instruments and policies on whether transactions and operations are religiously acceptable. This study is going to explore the role played by SSB in ensuring good corporate governance practice. This study is an exploratory and explanatory study; both primary and secondary sources of data were gathered and used to understand the elements of corporate governance in Islamic banks and to discover the real role played by SSB. The study concludes that in one hand the Islamic banks are progressing in adapting corporate governance elements which are; accountability, transparency and trustworthiness. In the other hand the SSB are playing vital and effective advisory, auditing and compliance roles in Islamic banks. We can conclude that the add value of SSB to the corporate governance practice in Islamic banks is the moral commitment, which even banks with the best corporate governance may not be able to avoid crises caused by immoral practice. Keywords: Shari ah,supervisory Board, Corporate Governance, Islamic Banks 109

2 1. Introduction It is not overstated if I had to say that apparently there is no Islamic banking without Good Corporate Governance Practice (GCGP), and no GCGP without strong Shari ah Supervisory Board (SSB). However, as it was clearly figured in the title, the theme itself is apparently a composite topic, which implies a two-stage analysis. In the first stage I will examine in general, the corporate governance frame work in conventional and Islamic banks. The issues that will be discussed in this stage are the concept and principles of corporate governance, the agreement and differences between corporate governance in Islamic banks and conventional banks. As for the second stage, I shall eventually project the major challenges faced by Shari ah Supervisory Board (SSB) in ensuring good corporate governance practice in Islamic banks. The issues that will be discussed in this stage are related to SSB role played in ensuring GCGP in Islamic banks. 2. Corporate Governance Frame Work in Conventional and Islamic Banks 2.1 Definition of Corporate Governance There are different definitions of Corporate Governance (GC). However the most suitable definition which is related to the topic is that of The Organization for the Economic Cooperation and Development (OECD) [1] defines CG as; a set of relationships between a company s management, its boards, its shareholders, and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining these objectives and monitoring performance are determined. Good cooperate governance should provide incentives for the board and management to pursue objectives that are in the interest of the company and its shareholders and should facilitate 110

3 effective monitoring. In simple words, GC is the system by which companies are directed and controlled. Saidi [2] indicate that all of the complex factors that are involved in balancing the power between the chief executive officer, the board, and the shareholders are now considered to be a part of corporate governance framework. Including auditing, balance sheet and off-balanced disclosure and transparency. Yoshimori [3] mentioned that CG has normally three systems of governance: monist systems (focusing on the shareholder), dualist systems (targeting shareholders and a third) and pluralistic systems (balancing the interests of multiple stakeholders (stakeholders-parties) 2.2 Concept of the Corporate Governance in Conventional Banks Banks are vital institutions in any economy as they form an important source of providing finance to majority business. The liquidity services provided to depositors, variety of lending activities are the most role played by conventional banks. Therefore, conventional banks like other financial institutions are encountering several problems related to lack of decent and well structured governance. Meanwhile, the application of corporate governance is argued to lowers the cost of capital to firms, improve capital formation, and further encourage productivity growth. The managers must be aware of different forms of corporate governance to control and coordinate the actions of various parties to ensure the success of the company and create the trust in the company. Many laws have come to tighten controls and ratings of financial institutions. The Organization for the Economic Cooperation and Development (OECD) issued in 1999 the official draft on the principles of corporate governance and subsequently revised in 2004 The paper provides 8 principles of sound corporate governance and explains the role of supervisors 111

4 and the supportive environment needed to form a sound governance framework for a bank. OECD principles of Corporate Governance[4] include; (i) Board members should be qualified, have a clear understanding of their role in corporate governance and be able to exercise sound judgment about the affairs of the bank. (ii) The board of directors should approve and oversee the bank s strategic objectives and corporate values that are communicated throughout the banking organization. (iii) The board of directors should set and enforce clear lines of responsibility and accountability throughout the organization. (iv) The board should ensure that there is appropriate oversight by senior management consistent with board policy. (v) The board and senior management should effectively utilize the work conducted by the internal audit function, external auditors, and internal control functions.(vi)the board should ensure that compensation policies and practices are consistent with the bank s corporate culture, long-term objectives and strategy, and control environment.(vii)the bank should be governed in a transparent manner. (viii) The board and senior management should understand the bank s operational structure, including where the bank operates in jurisdictions. 2.3 Concept of the Corporate Governance in Islamic Banks A Profile of Islamic Banking Islamic banking refers to a system of banking or banking activity which is consistent with Islamic law (Shari ah). However, All Islamic financing modes in Islamic banks are strictly governed by the following principles; (i) The forbiddance of interest (Ribā).(ii) The forbiddance of Gharar (contractual ambiguity). (iii) Inviolability of the contracts. (iv) Equitable sharing of risk and gains. (v)morals and ethics are given a greater weight relative to profits. Islamic finance 112

5 aims to be an ethical and socially responsible finance. While conventional finance is mainly interested by the economic and financial aspect of the transactions. Greuning et Iqbal [5] ascertained that the Islamic system gives an equal importance to ethic, moral, social and religious dimensions and the well-being of the entire society. De Jonge [6] indicates that historically, the concept of Islamic financing was introduced as early as the seventh century, but its commercial implementation only commenced in the 20th century. The first Islamic bank began in Egypt in Within one decade fifty other Islamic banks would appear. Over the past few decades, the Islamic financial industry has rapidly expanded worldwide. El Qorchi [7] figured more than 300 institutions operating in 75 countries with total assets' amount around $250 billion and grow at a rate of grow of 15% per year Concept of the Corporate Governance in Islamic Banks It can be seen from previous profile that Islamic banks must ensure that all transactions comply with Shari ah principles. The fact that the corporate governance in conventional banks focused on the protection of shareholders, while depositors get only a little protection. In counterpart corporate governance in Islamic banks is supposed to provide protection in a balanced way for owners and depositors alike, but the interests of depositors must be the most prominent because depositors are the weaker party from among the parties in the banks. The corporate governance in Islamic banks gives depends on the criteria of social and religious norms. According to Zied et Puchart [8] Managers of Islamic banks are subject to a particular dualist system of partnership governance, based on the principles of Anglo-Saxon governance (imposed by the non-muslims shareholders and by the international banking regulation) and Islamic governance (desired by Muslims shareholders and customers, as well as by religious 113

6 authorities)". Meanwhile, the conceptual framework of corporate governance for Islamic bank is legitimate control body known as the Shari ah Supervisory Board (SSB). In nutshell, from discussion above we can set four guidelines for corporate governance in Islamic banks which are as follow; (i) Compliance with Shari ah principles. (ii) Human service. (iii) Economic development. (iv) Social integrity. 3. The Role of Shari ah Supervisory Board (SSB) in Ensuring Good Corporate Governance Practice in Islamic Banks. 3.1 What is Shari ah Supervisory Board (SSB)? According to the Accounting and Auditing Organization for Islamic Financial Institutions AAOIFI [9] The Shari ah Supervisory Board (SSB) should be an independent body of legal scholars specialized in Fiqh al-mua malāt (Islamic commercial jurisprudence). SSB shall consist of at least three members appointed by the shareholders in their annual general meeting upon the recommendation of the board of directors. However, the SSBs may include a member other than those specialized in Fiqh al-muamalat but who should be an expert in the field of Islamic Financial Institution (IFI). 3.2 The Purpose of SSB The most obvious and immediate purpose of Shari ah supervision is to certify Muslim consumers and clients that the financial products or services being offered to them are acceptable from an Islamic legal perspective and is therefore lawful to them. Such certification is generally documented in a formal fatwa (Shari ah position paper), may be thought of as a form of due diligence. The primary beneficiary of Shari ah supervision will be Muslim consumers or investors who may not have necessary skills or knowledge to evaluate the Islamic banking 114

7 products in the light of Shari ah teachings. It also supplies form of guarantee and advocacy that money being invested in the IFIs is duly used in compliance with Shari ah rulings and haram elements are eliminated. From the view point of corporate governance, IFIs embody a number of interesting features since equity participation, risk and profit loss sharing arrangements from the basis of Islamic finance. SSB functions as an extra layer of governance in IFIs in order to bring transactions under strict conformity with the Islamic law and expectations of Muslim community. 3.3 The Role of Shari ah Supervisory Board (SSB) The role of SSB is thus seen as being similar to that of company auditors from some Islamic Finance Institutions (IFI). In another hand, some IFI stated that the SSB has the duty to supervise the bank and confirm that its products and operations are in compliance with the precepts of the Shari ah.. However, It should be clear that the SSB has no direct influence on the decisions of the managing board. Furthermore, SSB has only to deal with conformity and nonconformity of financial products. In the case of non-shari ah compliant, SSB should highlight different ways to solve the problem so that the managing board can choose between different alternatives. There are two non-governmental-organizations that mainly contribute to a standardization of Islamic finance. Besides the Accounting and Auditing Organization for Islamic financial Institutions (AAOIFI), which was established in 1991 to set up Shari ah acceptable accounting and auditing standards that would be used by Islamic financial institutions worldwide, the Islamic Financial Services Board (IFSB) published standards including guidance on key elements in the supervisory review process of institutions offering Islamic financial services. In nutshell, the SSB Role can be broadly categorized in the following categories: 115

8 3.2.1 Advisory Role. The advisory role of SSB is to give opinions whether a specific action taken by the bank is in conformity with the Shari ah principles or not. In this stage SSB give only advice and assist all related parties on Shari ah matters concerning the banks activities Compliance Role. The SSB role played in ensuring Shari ah compliance of the Islamic banks start from issuing and dissemination of Shari ah resolutions and end with internal periodic and annual Shari ah reviews. In short, the SSB must ensure proper mechanisms are put in place in banks to comply with Shari ah principles. The working mechanism process must cover both pr-product approvals, which consist of product process, structuring and developing prior to the introduction to the market and post-product approval process, which consist the process after the product has been offered to the customers Audit Role Audit refers to all actions taken by auditors to ensure that the bank s financial statements are prepared in all material respects in conformity with the professionally accepted financial reporting standards. However, Banks got two kinds of audits, internal and external audits. Auditors in general follow certain procedures, including inspection, observation, inquiry and confirmation, computation and analysis to fulfil their responsibilities. The main target of Shari ah audit is to ensure that deposits, financing, investment and others services offered by the banks have been offered according to the Sharī ah requirements. 116

9 4. Conclusion Having examined the role Shari ah Supervisory Board (SSB) in ensuring Good Corporate Governance Practice (GCGP) in Islamic banks. I can concludes that; Corporate Governance Practice (CGP) has gained great promise by conventional banks last three decades. Islamic banks gave attentions to all crucial aspects of GCGP and SSB as additional elements in CGP plays vital role in ensuring good corporate governance practice in Islamic banks. The study has revealed that, in one hand the Islamic banks are progressing in adapting corporate governance elements which are; accountability, transparency and trustworthiness. In the other hand the SSB are playing vital and effective advisory, auditing and compliance roles in Islamic banks. We can conclude that the add value of SSB to the corporate governance practice in Islamic banks is the moral commitment, which even banks with the best corporate governance may not be able to avoid crises caused by immoral practices. References [1] OECD (2004) : OECD Principles of Corporate Governance, Paris,1-67; Mulbert Peter O (2010) Corporate Governance of Banks after the Financial Crisis- Theory, Evidence and Reforms, European Corporate Governance Institute (ECGI), 1,40. [2] Nasser Saidi (2009) Corporate Governance in Islamic Finance Islamic Wealth,,Chapter 33, 06:40, p [3] Yoshimori, M (1995) Whose Company is it? The Concept of the Corporation in Japan and the West. Long Range Planning 28, 4:

10 [4] OECD (2006) Enhancing Corporate Governance for Banking Organization Basel Committee on Banking Supervision. [5] Greuning H et Iqbal Z (2008) Risk Analysis for Islamic Banks The World Bank. [6] De Jonge,A.(1996) Islamic law and the Finance of International Trade. Melbourne: Monash University Working Paper. [7] El Qorchi, M (2005) Islamic Finance Gears Up Finance and Devlopment. IMF, 42:4 [8] [(2006) Zied C et J. Puchart JJ, Proposition de Communication, La gouvernance de la banque islamique, Universite de Picardie CRIISEA [9]AAOIFI (1999) Governance Standards for Islamic Financial Institutions No.1. Shari ah Supervisory Board: Appointment, Composition and Report., Accounting and Auditing Organization for Islamic Financial Institutions Bahrain. 118