Shariah Governance Framework

Islamic Finance: Structure and Instruments

Conference Hall, Central Bank of Turkey
27 September 2011

Rustam Mohd Idris

Deputy Director
Islamic Banking and Takaful Department
[email protected]
Contents
 Background

 Development of Shariah Governance

 The Shariah Governance Framework

 Issues & Challenges

 Well developed governance structure is important for safety
& soundness of IFIs…

Governance Legal
Framework Framework

Governing
Infrastructure

Regulatory Framework

Shariah governance.. an important component of governance framework

IFIs – Islamic financial institutions

…Shariah governance is instrumental in instilling & shaping sound
governance practices ….
Ensures compliance with
Shariah rules & principles

Importance of
Shariah governance

Ensure full Shariah-compliant

Fiduciary
Shariah duties in Normal
Corporate
Instill public confidence
Governance Islamic
banking Governance
transaction
Promote financial stability

Principles of Islamic finance place great emphasis on

strong corporate governance values & structure,
transparency, disclosure of information &
strict adherence to Shariah principles…
 Shariah governance structure… two dominant models

Model I Model II

Central Centralised Shariah advisory

None
Bank body

Shariah committee Shariah committee

IFIs at IFIs
at IFIs

Malaysia
Countries Bangladesh
Pakistan
Kuwait
Indonesia
UAE
Sudan

Different model will give rise to different implications & outcomes…

Sources: 1) Islamic Financial System: Principles and Operations (ISRA); 2) Islamic Finance Opportunities: Country & Business Guide 2011
 Malaysia has experienced five phases of evolution in Shariah
governance development…
Ph Ph Ph Ph
Phase 1 as as as as
e2 e3 e4 e5
Promoting Recognition of Positioning SAC as
Building
Expansion of uniformity & SAC as apex authority &
foundation of
Shariah advisory harmonisation of an authoritative codify Shariah
Shariah
role Shariah body & establish governance
governance
interpretations governance for SC framework

 Establishment of
 Allow  Instituting  Specific  SAC’s rulings are
SC at IFIs level
conventional dedicated SAC at provisions in CBA binding on IFIs,
under specific laws
banks with Islamic Central Bank to  Court & arbitrator to courts and
to provide check &
window to address Shariah refer to SAC’s arbitrators
balance, to ensure
appoint Shariah compliance issues rulings in any
Shariah
advisers to proceedings related  Enhancing the roles
compliance
ensure Shariah  Providing a to IF matters & functions of the
compliance platform for IFIs to board, SC &
 Legal provision in
seek Shariah  Incorporating duties management in
dedicated laws to
require  Guided by advise through of SC in the industry relation to Shariah
specific SAC  Enlarging pool of governance
establishment of SC
guidelines issued Shariah talent
at IBs
by BNM within the Islamic  Formation of
financial industry Shariah key
 Created a small functions within
pool of Shariah IFIs to ensure
advisers Shariah-complaint

SC – Shariah Committee, SAC – Shariah Advisory Council, CBA – Central Bank of Malaysia Act 2009, IBs – Islamic Banks
Current Shariah Governance Framework in Malaysia…

Guided by two important

legislation & guidelines

Central Bank of Shariah Governance

Malaysia Act 2009 Framework for IFIs

Key Features: Objectives:

 An apex authoritative body for the  Set out the expectations of the Bank on an
ascertainment of Islamic law for the IFI’s Shariah governance structures,
purposes of Islamic financial business processes & arrangements to ensure that
all its operations & business activities are in
 Advise the Bank (and also IFIs) on any
accordance with Shariah
Shariah issue relating to Islamic financial
business
 Provide comprehensive guidance to the
 Appointed by the King, on the advice of the board, Shariah Committee and
Minister of Finance after consultation with management of the IFI in discharging its
the Central Bank duties in matters relating to Shariah

 The court & arbitrator shall take into  Outline the functions relating to Shariah
consideration any published rulings of the review, Shariah audit, Shariah risk
SAC, prior to any proceedings on Shariah management and Shariah research
matters
 Rulings made by the SAC shall be binding
on IFIs, court or arbitrator
 Why there is a need for Shariah governance framework for IFIs…?

 Business objective of IFI - to conduct financial business in accordance with

Shariah principles of Shariah
compliance
as the MAIN  Responsibility of Shariah compliance not confined to SC but also board,
management and staff
OBJECTIVE of
an IFI  Even more critical to IFIs that leverage on resource-sharing or outsourcing
with conventional infrastructure

 IFI that possess strong corporate governance structure, but weak in Shariah
governance

Some  Lack of independence - Strong influence by management on SC

observations on  SC’s limited role as advisor, certifying the product approval & validation
IFIs Shariah documentation
governance…
 Lack of communication between SC and board

 Lack of resources to ensure Shariah compliance

 Lack of robust Shariah governance infrastructure – Lack of Shariah

compliance functions including depth of Shariah research capabilities
Framing the Shariah governance framework…

Oversight, Accountability &

Independence
Responsibility

 Clear demarcations on accountability Aims at safeguarding independence of

& responsibility Shariah Committee in ensuring sound
 Outlines level of accountability and Shariah decision-making, and
responsibility of board of directors, emphasis on role of board of directors
Shariah committee and management in recognizing independence of
of IFIs Shariah committee

Guiding
Principles

Competency Confidentiality & Consistency

Highlights requirements and Minimum set of rules that

expected competencies to emphasizes the importance of
ensure key functions are capable observing and preserving
of implementing Shariah confidentiality and improving level
governance of consistency in decision making
by Shariah committee
 Combining principle-based & rule-based features…
Oversight, accountability

Direct reporting & regular engagement

Board overall accountability
between Board & SC
& responsibility

SC accountability on decisions, views

Independence
& opinions Recognition by BOD on SC’s
independence
Management’s responsibility in
providing adequate support Full observance to SC’s decision
Minimum 5 SC members (at least 3 Access to necessary info by SC
must be Shariah qualified)
Prior written approval BNM & SAC for
May appoint SC as BOD
appointment & removal of SC

Comply to fit & proper requirement SAC’s ruling binding on IFIs

set by BNM SC should not undermine SAC’s

Confidentiality &
Competency

consistency
Board, mgmt & SC expected to have rulings
reasonable understanding on Shariah Whistle blowing by SC to BNM
& Islamic finance respectively
Duty to observe confidentiality on
Continuous training provided to key sensitive info obtained by SC
internal stakeholders
Restriction on SC membership in IFI
Succession planning program for SC within same industry
Clarity of responsibilities of key stakeholders on Shariah governance…

• Ultimately accountable & responsible on the overall SGF & Shariah compliance of
Board the IFI
• Approve all policies relating to Shariah matters
• Appoint & remunerate SC
• Ensure effective communication policy

• Responsible & accountable for all its decisions, views & opinions related to
Shariah
Shariah matters
Committee
• Advise the board & provide input to the IFI on Shariah matters
• Endorse Shariah policies & procedures
• Endorse and validate relevant documentations (e.g. forms, contracts,
agreements, legal documentations, product manual, marketing advertisements,
brochures, etc)

• Responsible for observing and implementing Shariah rulings & decisions made by
the SAC & SC respectively
• Provide complete & accurate information to SC
Management
• Allocate adequate resources & manpower to support the SGF
• Provide continuous learning & training programs to key internal stakeholders
• Develop & adopt holistic culture of Shariah compliance with the IFI
• Ensure Shariah policies & procedures are accessible at all times
• Report on Shariah non-compliance events & rectitfy
 …and supported by comprehensive Shariah compliance & research functions

Objectives Scope

• To ensure that activities and operations • Overall business operations, including

Shariah carried out by the IFI do not contravene end-to-end product development
Review with Shariah process (from product structuring to
product off
• To provide an independent assessment &
Shariah objective assurance • All aspects of the IFI’s business operations
Audit & activities, including:
• To ensure a sound and effective internal • compliance audit on organisational
control system for Shariah compliance structure, people & information
technology application systems; and
• review of adequacy of the Shariah
governance process.

• Identification & assessment of • Form part of IFIs integrated risk

Shariah Risk Shariah risk would be systematically management control function
Management controlled & monitored

• Ensure proper deliberation of Shariah • Perform in-depth research on Shariah

Shariah related matters including providing day-to-day Shariah
Research advice & consultancy

• Coordinating meetings, compiling papers,

Shariah • Provide necessary support to
disseminating Shariah decisions
Secretariat Shariah committee & IFI in
implementing Shariah governance • Engaging with relevant parties that need
assistance
A snapshot of Shariah governance framework model for IFIs…

SHARIAH
as overarching principle in Islamic finance

CENTRALIZED SHARIAH ADVISORY COUNCIL

BOARD RISK BOARD

Overall oversight on Shariah BOARD AUDIT
MANAGEMENT
governance structure & Shariah SHARIAH COMMITTEE COMMITTEE
COMMITTEE
compliance
Oversight accountability on
Shariah related matters

MANAGEMENT
• Ensure executions of business & operations are in accordance
with Shariah principles
• Provide necessary support to the Shariah Committee

Shariah Risk Shariah Review Shariah Research Shariah Audit Function

Management Control Function Function Provide independent
Function Review business operations on Conduct in-depth Shariah assessment & objective
regular basis to ensure Shariah research prior to submission to assurance designed to value
Identify, measure, monitor,
compliance the Shariah Committee add & improve IFI’s compliance
report & control Shariah non-
with Shariah
compliance risk

Shariah Compliance and Research Functions

Issues & challenges in Shariah governance…

1 Centralised Shariah body or decentralised at IFIs?

Competency of Shariah scholars to understand the complexity of

2
Islamic financial instruments and their professionalism

Availability of a pool of Shariah scholars in the required Islamic

3
finance knowledge

4 Regulatory policy that can accommodate all types of entity

Capability to establish Shariah compliance functions (Shariah

5
review, audit, risk management & research)

6 Can non-Muslims be Shariah scholars?

Various types of IFIs

Types of
entity 1 ‘Stand-alone’ – Domestic & Foreign-owned

2 Islamic Subsidiary

3 Islamic Window

Development Financial Institution / Specialized

4
Institutions
Q & A session