Question

Corporate governance is an essential ingredient for the development of a sound Islamic
finance industry. It abides Islamic financial institutions with a set of Sharia compliance rules
to govern their operations and transactions as well as to monitor and supervise the roles of all
players within the banking system.

To ensure that Islamic banks comply with the appropriate Sharia rulings, the services of
religious boards known are employed. The Sharia board plays a vital role of supervision and
consultation.

Critically evaluate the role of the Sharia Board in Islamic banks and provide examples of the
tasks they carry out.

(400 words)

Answer 1

Over the past years Islamic finance has experienced tremendous development, and this is due to the effort of many parties, including the Shari’ah scholars, market practitioners and regulators. It is hoped that such efforts will continue in the future, as the Islamic finance industry still has a long way to go before it matures and fully develops. The tradition and experiences of conventional finance have also been valuable to the establishment of Islamic finance, in that the Islamic finance stakeholders have been able to learn from and employ all of its positive and permissible ideas, tools and traditions. Having said that, Shari’ah is the backbone of the industry and the role of Shari’ah scholars is very pertinent to ensure that the credibility and integrity of the industry are maintained. This includes all the classic scholars who have provided a wealth of guidance and references for the current scholars to work on and further develop. Over the past 30 years the Islamic finance industry has proven to be relevant, resilient and rich with potential for further progress, and it is now recognized worldwide as an alternative to conventional finance. However, all components of Islamic finance still need further improvement, and many more new initiatives from various parties are welcome.

Shari’ah Governance

Shari’ah governance is a very critical area in Islamic finance and is no less important than is corporate governance to any institution. However, Shari’ah governance is particular to Islamic finance, as it is the mechanism which determines the ‘Islamicity” of any particular Islamic business or financial institution as well as the system as a whole. The significance of Shari’ah governance transpires via its role of ensuring the confidence of Islamic finance industry in the eyes of the public. More importantly, Shari’ah governance ensures that the industry is at all times in accord with the wishes and laws of the Almighty by ensuring the legitimacy of the products offered. Shari’ah governance affirms that Shari’ah is backbone of this industry as well as its main driver. In addition, history has shown that improvement in the aspect of Shari’ah governance can assist the speedy and better growth of the industry. Thus, this aspect of Islamic finance can never be taken lightly, and discussion of how it can be enhanced is very much welcomed at all times and by all means.

Effective Shari’ah governance requires the setting up of a clear and comprehensive framework to regulate the Islamic finance industry and guide its development. Fundamental to this process is definition of its main actors, namely the Shari’ah advisors, and their responsibilities as well as the roles that they need to undertake for the wellbeing of the whole Islamic finance sector. Other aspects of Shari’ah governance are supporting initiatives that can assist in enhancing a Shari’ah advisor’s performance, such as legitimate mandate, Shari’ah secretariat and others. However, first and foremost, it must be emphasized that the Islamic finance industry in toto is accountable to Allah for all its practices, thus, adherence to Shari’ah in all activities undertaken is the responsibility of all Islamic finance stakeholders.[1]

From the regulatory perspective, discussion of Shari’ah governance usually focuses on four elements that need to be ingrained for a comprehensive Shari’ah governance system to be established. They are the elements of competence, independence, confidentiality and consistency. The installation of these elements has been elaborated in the recent IFSB Exposure Draft on Guiding Principles for the Shari’ah Governance System. These elements are very significant to ensure the best practices and conduct of Shari’ah boards, but the process and procedures for installing them may differ in different markets and jurisdictions. At present, different models of Shari’ah boards are operating in various jurisdictions, and the processes and procedures adopted for Shari’ah governance vary as well from one jurisdiction to another. Variation is also found in the regulation of Shari’ah advisory services, for which different practices have been adopted. Certain jurisdictions have instituted central regulation, while some take a voluntary tack and others have adopted a hybrid approach. Nevertheless, guidelines for the best practices are greatly needed so that Shari’ah advisory services can be further enhanced and respected.

Shari’ah Advisory Board

As mentioned earlier, Shari’ah advisory boards comprised of Shari’ah experts are the main actors in Shari’ah governance. Their existence and decisions are very crucial as they serve to ensure public confidence of the legitimacy of Islamic finance operations and products as well as ensuring that Islamic finance is operating and developing based on Shari’ah guidelines. They are further considered as the stakeholders’ advocate regarding Shari’ah compliance and optimum service.[2] Thus, they shoulder a very heavy responsibility towards many parties, but, most importantly, they are responsible to the Almighty for all their actions and statements. Therefore, it is important to affirm that qualified and competent Shari’ah advisors are appointed and that they are given various forms of assistance, exposure, resources and training to further develop them.

The development of Islamic finance has been accompanied by transformations in the duties and responsibilities of Shari’ah advisors. Their roles were previously limited to advice and product endorsement. However, at present they are also involved in product development and innovation, in addition to supervision of Islamic finance operations as well as, on certain occasions, development of policies and regulations for Islamic finance. This development increases the challenges facing the Shari’ah advisors, for they need to interact more with various people and stakeholders in the industry to understand and perform their roles better. As a matter of fact, in certain instances, experts from other relevant fields, such as finance, risk management, economics or law, are invited to Shari’ah board meetings to provide better understanding to the Shari’ah boards on matters related to their fields related to the issue under discussion. Thus, some scholars have encouraged that dual expertise scholars be appointed as members of Shari’ah boards, as such persons have expertise and mastery in Shari’ah and another field relevant to Islamic finance, as mentioned above. Such competence and caliber will certainly enhance and speed up the process of Shari’ah advisory.

Shari’ah Advisory Board: Criteria

It is crucial that criteria of the members of Shari’ah boards be discussed here, even if not in detail. This is due to the fact that only qualified and competent members will be able to perform their role well. Shari`ah advisors are defined in the Governance Standards of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), as follows:

Shari`ah advisors are specialized jurists, particularly in fiqh mu’amalat and Islamic finance, entrusted with the duty of directing, reviewing and supervising the activities related to Islamic finance in order to ensure that they are in compliance with Shari`ah rules and principles. The views of the Shari`ah advisors shall be binding in the specific area of supervision.[3]

The definition above illustrates the extensive duties that need to be performed by Shari’ah advisors; as such, their competence is essential to forming a good Shari’ah board.

As mentioned earlier, different models of Shari’ah advisory are adopted worldwide, but a consistent preference has been shown for in-house Shari’ah advisory boards,[4] which are perceived to be better able to advise and monitor the operation of an Islamic finance institution than an external Shari’ah advisory firm. However, it must be remembered that in- house Shari’ah advisors still act as external consultants and not as permanent employees, although they are expected to contribute significantly to the Islamic financial institutions. In addition, the best practice in Shari’ah governance require that the boards be comprised of more than three experts, thus allowing for the practice of collective ijtihad and the adoption of consensus. This practice, if adopted, shall improve Shari’ah advisory services, and the decisions arrived at shall be more reliable and credible.

Various regulators and Islamic finance institutions have placed minimum guidelines for eligibility to serve on a Shari’ah board; for instance, a Shari’ah advisor should possess necessary knowledge, expertise or experience in fiqh mu’amalat or usul al-fiqh, have considerable knowledge of current practices in finance and Islamic finance, and be a person of reputable character. Certain authorities do not require ‘paper qualifications’ or formal education in Shari’ah studies, but some other authorities specifically state the necessary working experience in the Islamic finance industry and the minimum length of time for such experience. In order to ensure the standard of advisory services provided, a Shari’ah advisor should possess the following criteria:

1. Considerable knowledge or mastery in fiqh mu’amalat and usul al-fiqh;

2. Sufficient knowledge of the current Islamic and conventional finance practices;

3. Deep understanding of maqasid al-Shari’ah;

4. The capability to derive legal rulings;

5. Sufficient understanding of the issue and problem posed;

6. Bold, trustworthy and dynamic; and

7. A person with good reputation and of good Islamic character.

In addition to the above criteria, the members shall be practicing Muslims who preach what they believe, in order to maintain the credibility of the decisions made. This is important, as Islamic finance is not only related to the ‘legal’ aspects of Islam, but it is also part of Islam’s belief system.

Having discussed the above criteria, one of the critical issues faced by the industry nowadays is the lack of qualified Shari’ah scholars, as the current numbers of scholars does not match the numbers of growing institutions that require their services. Thus, initiatives to educate, train and produce new scholars are very much welcomed and should be intensified, and Islamic financial institutions need to realize that they should make significant investments to develop the necessary human resources. In addition, the new and young scholars need to be reminded that, in addition to technical competence, they have to be proactive and dynamic to fulfill their duties in the ever challenging industry in order to develop it. Close interaction with various Islamic finance stakeholders is required to further enhance their understanding, and they should aim and strive to contribute as much as possible to the industry and to the Shari’ah.

Apart from the above structure, certain quarters have suggested that the industry appoint a permanent Shari’ah advisor in each Islamic finance institution. This is to ensure comprehensive supervision as well as free access of the institution’s staff to the Shari’ah advisor. Such arrangement will be beneficial to the IFI; however, it might increase the operational cost. In fact, the current trend of one Shari’ah scholar sitting on many Shari’ah boards at the same time has raised the concern of the industry as to the focus and quality of the advisory services those scholars can provide, and there may be a need for guidelines to regulate this practice.

Another issue worth considering is the setting up of a monitoring mechanism to ensure that Shari’ah advisors are competent and provide quality service, for no such mechanism is available at present. Thus, it is proposed that a professional association of Shari’ah advisors be formed and that this body organize and ensure a continuous professional development (CPD) programme for Shari’ah advisors, establish an acceptable qualification for members and oversee the conduct of Shari’ah advisors. It may also be given a mandate to issue a professional certification to Shari’ah advisors, without which they will not be able to practice, and to determine its renewal by periodic review and screening to ensure that the Shari’ah advisor holds the necessary professional and educational qualifications and at all time exercises competent and ethical conduct. It may also become a good forum to increase discussion and exchange of opinion among scholars as well as a means to move towards uniformity of fatwas and practices. In fact, the existence of such bodies in other professions, such as the Bar Council, the Medical Association and others, has assisted in ensuring that the integrity of such professions is maintained. Therefore, it is timely to consider the establishment of such a dedicated and professional body for Shari’ah advisors.

Shari’ah Boards’ Duties and Responsibility

As some jurisdictions have provided a clear framework on Shari’ah governance or Shari’ah advisory, a clear outline of Shari’ah board’s duties and responsibility can be easily found. It also assists the Shari’ah board members to understand all their responsibilities and execute them accordingly. Some jurisdictions, such as Malaysia, have also listed the duties and responsibilities of Islamic finance institutions to support the Shari’ah board’s function.[5] A clear framework for proper Shari’ah governance and advisory is obviously needed for clarity and consistency in the performance and services of Shari’ah boards. However, apart from those guidelines, Shari’ah advisors may assist Islamic finance institutions and the industry in other matters consistent with their competence and capability that are relevant to the growth of the industry.

The range of roles and duties of Shari’ah advisors includes giving advice to Islamic finance institutions on matters pertaining to Shari’ah issues, involvement in designing the framework for the establishment of an Islamic finance institution, monitoring the activity and proceeds of the institution, developing products and underlying contracts, acting as a reference on Shari’ah matters to Islamic finance institutions specifically and the Islamic finance industry in general, providing training and awareness programs for Islamic finance institutions’ staff, supervising the Islamic finance industry, trying to harmonize it with global practices, representing Islamic finance institutions in forums to allow for the exchange of ideas and sharing of experiences and, lastly, conducting Shari’ah audit exercises for the Islamic financial institutions.

The abovementioned shows the wide scope of roles that Shari’ah advisors may play, and the tasks that lie ahead of them are not at all light or trivial, so they will need all the support that can be provided. This can be done via establishment of a Shari’ah department or secretariat to assist Shari’ah boards by providing resources, collecting fatawa and Islamic finance institution reports, conducting research, assisting in the product development process and in conducting internal reviews, audits or any other assistance that may be necessary to Shari’ah board.

In discharging their duties there are several considerations that particularly need to be observed:

Firstly, ensure that product development uses the acceptable principles of the Shari’ah and follows acceptable Shari’ah standards, whether those standards are developed locally or internationally. The rapid growth and advancement of Islamic finance has resulted in the development of Shari’ah standards and frameworks for product development by international bodies such as AAOIFI and the Islamic Financial Services Board (IFSB) or national bodies like the Shari’ah Advisory Council of central banks and other financial institutions. Thus, the task of Shari’ah scholars is to ensure that these standards are upheld and followed, whenever applicable to a local situation, in order to preserve the high level of integrity of their decisions.

Secondly, ensure that the decisions of the Shari’ah boards are understood by the practitioners so that they will be properly implemented, as they are the ones responsible for applying the decisions of the Shari’ah boards. Negligence and lack of understanding on the part of the practitioners may jeopardize the whole Islamic offering. Apart from that, Shari’ah boards have a duty to educate the practitioners on Shari’ah principles so that both sides can mutually work for better Shari’ah-compliant products, operations and conduct by the Islamic finance institutions. It is also highly desirable that Shari’ah scholars conduct training and engage in close interaction with officers in the institution to increase their understanding of Shari’ah and fiqh mu’amalat.

Thirdly, Shari’ah scholars need to be competent to scrutinize the documents related to products and transactions, as negligence will result in non-compliance and negative legal consequences. Therefore, Shari’ah scholars must have sufficient knowledge about the Shari’ah, legal and operational aspects of the products and transactions. It is highly desirable that Shari’ah scholars be involved in product development from the early stages up until the contract is concluded. This will definitely require them to have a good command of languages, as they need to read and examine all the terms, conditions, clauses and secondary contracts that are set out in the contract, as well as all the supporting documents. They shall need to ensure clarity in Shari’ah principles in the documents and that the contract is fair and just for both parties.

Next, Shari’ah advisors must have full knowledge of the purpose of the products and its technicalities. They have to ensure that the products have positive objectives and are not used as means to forbidden ends. It is also a major cause for concern if Islamic finance proceeds are not well managed or are channeled to non-compliant activities. If this is not checked, then efforts to build a Shari’ah-compliant system will be fruitless, as a permissible matter that leads to a prohibited matter is also prohibited. Shari’ah scholars must be firm and strict so as not to allow any forbidden or doubtful activity or one that involves legal trickery (hiyal).[6]

In addition, Shari’ah scholars must also assess the economic implications of the product to the Ummah. This will require them to take a maqasid approach. It must be remembered that Islamic finance products are supposed to provide facility to the people and not to burden them, as in Islam wealth is one of the essentials of human life. Therefore, Islamic finance has to be reviewed on a macro-scale, namely, ensuring that it is serving the Ummah effectively. For instance, retail products must not be neglected, although wholesale products may yield more profits. The Islamic financial system, which is commonly characterized as a moral and ethical system, must contribute effectively to overall wealth creation, growth and development, and greater shared prosperity.[7]

Another aspect that needs to be considered by Shari’ah scholars is their role in strengthening the governance of Islamic financial institutions as well as instilling Islamic values in the financial institutions’ business operations and governance.[8] This will include facilitating Shari’ah audits, ensuring Islamic and ethical management practices, protecting consumers’ rights and ensuring the accountability of the financial institutions. Islamic ethics and discipline should be incorporated in the policies and governance of the Islamic finance institution, and Shari’ah advisors should be role-models in ethics and work performance. This shall add to the Islamicity of the institution, and an Islamic standard of Corporate Social Responsibility (CSR) should be incorporated.

Duties and Responsibilities of Shari’ah Boards from Legal and Regulatory Perspectives

Shari’ah advisors have many roles to play, and their advice and expertise are sought after in many areas. Apart from their duties to the Islamic financial institutions that engage them, Shari’ah advisors should also play significant roles in the growth and betterment of the industry on the national level, at least, if not the global. Islamic finance as it exists today is the fruit of a collective effort of all its stakeholders and a combination of various disciplines and knowledge. These disciplines include banking and finance, accounting, law, economics, information technology and others. However, it is acknowledged that law and regulation comprise two of the most important elements that will be determining factors in the growth of Islamic finance. As they are essential to Islamic finance’s growth, Shari’ah advisors need to play a role in ensuring that these disciplines are not in contradiction with Shari’ah requirements.

Legal Status of Shari’ah Boards

In certain jurisdictions, such as Malaysia, the existence of Shari’ah boards has been made a prerequisite for the establishment of Islamic finance institutions or “Islamic windows” or the transformation of a conventional institution into an Islamic finance institution. For instance, Section 3 of the Malaysian Islamic Banking Act 1983 prescribes the following:

(1) Islamic banking business shall not be transacted in Malaysia except by a company which is in the possession of a licence in writing from the Minister authorizing it to do so.

(5) The Central Bank shall not recommend the grant of a licence, and the Minister shall not grant a licence, unless the Central Bank or the Minister, as the case may be, is satisfied—

(a) that the aims and operations of the banking business which it is desired to carry on will not involve any element which is not approved by the Religion of Islam; and

(b) that there is, in the articles of association of the bank concerned, provision for the establishment of a Syari’ah advisory body, as may be approved by the Central Bank, to advise the bank on the operations of its banking business in order to ensure that they do not involve any element which is not approved by the Religion of Islam.

(6) Any person who contravenes the provisions of this section shall be guilty of an offence and shall on conviction be liable to a fine not exceeding twenty thousand ringgit or to imprisonment for a term not exceeding three years or to both such fine and imprisonment.

Thus, without a Shari’ah board, their establishment and operation is null and void, according to the law. Existence of such provision is highly desirable. In other jurisdictions such a requirement is provided in the article of association or in the constitution of the institution. Thus, it is made an integral part of every Islamic finance institution, and its availability cannot be compromised, as it secures public confidence and subscription to the institution and its businesses. Shari’ah advisors need to ensure the source of their mandate to fully understand the extent of their responsibility. They should not treat their existence solely as fulfilling the requirement of the law but consider it a crucial necessity with multifold contributions to make for the progress of the institution and the industry.

In addition, Shari’ah scholars should be involved in laying the foundation stone of an institution and advise the institution on many aspects including the policies and rules of the institution in order to make them Shariah compliant and be of an Islamic mould. The institution’s article of association or the Shari’ah board’s appointment letter should explicitly state that all of its policies have to be Islamic and Shari’ah compliant and, thus, the Shari’ah scholar or Shari’ah board needs to be engaged to ensure that such objectives are achieved. Thus, the Shari’ah advisors’ duty is not restricted to monitoring the chain of Shari’ah compliance but, rather, extends to promoting the Islamicity of the institution.

All the duties of the Shari’ah board and its members should be stated clearly in their letter of appointment or term of reference for their appointment and, upon acceptance by the Shari’ah scholar, it shall constitute a binding contract of service between him or her and the institution. Negligence in the performance of their duties shall make them answerable to the respective authority in the institution that appointed them. Therefore, upon acceptance of the appointment, Shari’ah scholars must endeavor to perform their duties with due care and diligence and keep in mind that they are accountable to Allah and the other stakeholders involved. The institutions shall assess the work of the Shari’ah advisors and take necessary steps to ensure that they provide quality service.

The tremendous growth of the industry has seen rapid progress in product development as well as regulatory requirements. However, further development of legal aspects is still needed, as there are insufficient laws to cater to the needs of Islamic finance. The industry avidly welcomes and appreciates any new laws or policies friendly to the industry and the amendment or reform of existing laws to accommodate the practices and progress of Islamic finance. The neutrality of certain taxes for a certain period in certain jurisdictions to institutions offering Islamic finance services is one of the key elements to the further development of Islamic finance industries.

It is crucial for Shari’ah scholars to have adequate knowledge of the relevant laws and assess whether they form obstacles or provide opportunities to Islamic finance services. For instance, Shari’ah advisors need to be aware of the new Malaysian move of deregulation or liberalization of a certain fraction of the financial industry and evaluate its impact on the Islamic finance industry. This is especially needed in countries that adopt a dual system, as they have both Islamic and civil law and two financial systems, conventional and Islamic. Thus, Shari’ah advisors must always be up to date and alert to the development of laws, especially laws that are relevant to Islamic finance operations. They should also propose new laws that are beneficial and crucial for the industry’s wellbeing and growth and propose amendments to laws that are not Shari’ah-friendly for Islamic finance practices. This shall require Shari’ah advisors to participate in the national sphere and for the benefit of the overall industry and not merely provide services to individual institutions.

Other than that, Shari’ah advisors need to scrutinize legal documents related to Islamic finance operation and products. They must ensure that they satisfy all the relevant Shari’ah and contractual principles, ensure a fair and equitable deal is made between the parties and clearly outline all their rights and obligations. Thus, Shari’ah scholars need to learn and have sufficient understanding of legal jargon or, if they don’t, to seek assistance in reading those documents and only approve them after being satisfied that they are in line with Shari’ah requirements and clearly describe the transaction that ought to take place.

Recent developments in Islamic finance and laws have highlighted the need for clarity in Islamic finance legal documents, standard contracts and terminologies of Islamic finance. Clarity of Islamic finance legal documents is very important so as to ensure that no disputes arise between the parties and that the terms and conditions of the contract will be honoured. In addition, that will assist judges in understanding the transactions and providing just resolution to the parties. This is highly crucial if no dedicated Shari’ah or Islamic finance court is available in the jurisdiction or if Islamic finance cases are decided by a judge who is not well versed with Shari’ah. Standard contracts and terminologies are also observed as crucial in the industry as they will boost understanding and uniformity in Islamic finance practices and increase the speed of Islamic offerings as well as avoid disputes between parties. At present some parties such as the International Islamic Financial Market (IIFM) and the Association of Islamic Banking Institutions of Malaysia (AIBIM) are working towards producing standardized documents. In fact, some have been produced, such as the Murabahah Master documents by IIFM and AIBIM.[9]

Alternative Dispute Resolution (ADR) in Islamic Finance

The application of Alternative Dispute Resolutions (ADR) methods to Islamic finance is another aspect pertinent to addressing the ever-increasing disputes related to Islamic finance. ADR is seen as a better dispute resolution method for Islamic finance than litigation, as it is speedier, more flexible and preserves the parties’ desire for privacy. Thus, Shariah advisors may promote its application in the industry and advise as to the best method to be adopted by the institution in case of dispute and include it in the legal documents of the transaction. Apart from that, the Shari’ah advisor may participate as the arbitrator or mediator in ADR, thus allowing for better understanding and resolution of Shari’ah compliant transactions.

Notwithstanding that, the Shari’ah advisor may become an expert witness in case of litigation of Islamic finance disputes, so they must be well equipped and of a calibre to provide assistance to the court on the Shari’ah-compliant transactions. Moreover, they may even be called as witnesses in cases involving Islamic finance institutions they are servicing or be questioned by the court about their services. This eventuality is a reminder that they must perform their duty with full accountability and with due diligence at all time.

Legitimacy and Enforcement of Shari’ah Decisions

Shari’ah boards should have binding authority in their existence and function. This means that the decision made by a Shari’ah board needs to be binding on the management of the Islamic finance institution and, moreover, they are the highest authority on Shari’ah issues and transactions. Thus, the Shari’ah board has to be free from the influence or force of the management or executives, as this will ensure the board has the independence and freedom to execute its tasks. Other than that, the Shari’ah board’s decision should be binding upon the financial institution in order to ensure that its operation is Shari’ah compliant; therefore, no other Shari’ah board’s resolutions can be adopted unless with prior permission of its in-house board, as they are the experts on the operations of the respective institution. This matter can be facilitated if it is specified by law or regulation, or a policy is issued, or it is embedded in the institution’s constitution or policies.

Regulatory Perspectives

Certain regulators have issued guidelines on Shari’ah governance and clearly outlined the duties and responsibilities of Shari’ah advisors. For instance, the Central Bank of Malaysia has outlined for this purpose the following:

“All Shariah Committee members are expected to participate and engage themselves actively in deliberating Shariah issues put before them. The main duties and responsibilities of the Shariah Committee are as follows:

1. To advise Board of Directors on Shari’ah Matters in its business operation

2. To endorse Shari’ah Compliance Manual

3. To endorse and validate relevant documentation

4. To assist related parties on Shari’ahfor advice upon request

5. To advise on matters to be referred to the Shari’ah Advisory Council BNM (SAC)

6. To provide written Shari’ah opinion; and

7. To assist SAC on reference for advice.”[10]

They are listed clearly in the Guidelines on the Governance of Shari`ah Committee for Islamic Financial Institutions (GPS 1) and their details and elaboration are provided as well. Such guidelines ease the task of Shari’ah boards and allow them to know the extent of their responsibilities. However, in certain jurisdictions such guidelines are not available, and a clear framework on Shari’ah governance is nowhere to be found. This creates some uneasiness among industry players and leaves Shari’ah advisors without clear guidelines to be followed. Shari’ah advisors, with other industry players, should push forward this agenda and request for a Shari’ah governance framework.

Apart from the guidelines issued by the regulators, the Islamic Financial Services Board (IFSB) has also issued Exposure Draft on Guiding Principles for a Shari’ah Governance System which serves as a guideline to the best services and practices by Shari’ah boards. The aim of the draft is to provide guidelines for a general approach to Shari’ah governance and instill the elements of competence, independence, confidentiality and consistency in Shari’ah boards’ practices.

The draft recommends that Islamic finance institutions must ensure proper functioning Shari’ah governance is in place in the institution and that Shari’ah compliance is a shared responsibility and not solely placed on the Shari’ah board. It also emphasized that the Shari’ah board should have a clear mandate and responsibility and they should meet certain ‘fit and proper’ criteria. In relation to the Shari’ah board and their duties, the recommendations or guidelines can be summarized as in the following:

Principle 1.2 declares that the Islamic finance institution has to ensure that its Shari’ah board shall have clear terms of reference regarding its mandate and responsibility, well-defined operating procedures and lines of reporting, and good professional ethics and conduct.

Principle 2.1 declares that people overseeing Shari’ah governance system shall be at all time fit, qualified and competence, of good character and possessing sound knowledge to perform their respective roles. They shall include the dedicated officers or departments assigned to assist the Shari’ah board and its members in their functions.

Principle 2.2 directs Islamic financial institutions to facilitate continuous professional development for the Shari’ah board and its officers whilst Principle 2.3 mandates institutions to assess the performance of the Shari’ah board, its contributions and commitment. These principles touch on the element of competence of the Shari’ah board and its officers and how such matter can be attained and enhanced. Implementation of these recommendations is very important, and it is the responsibility of the Shari’ah board to ensure that they are competent and worthy of the trust and responsibility bestowed upon them.

Principle 3.1 of the Draft reminds the Shari’ah board to be free from conflict of interest issues and that they must at all time be capable of exercising independent and objective judgment.

Principle 3.2 requires the Islamic finance institution to provide complete, sufficient and timely information and resources to the Shari’ah board. That shall include access to legal, accounting, financial or other relevant advices to assist the execution of their duties. Para 51 asserts that the Shari’ah board shall have access to all relevant data on the institution, even if it is confidential.

Hence, Shari’ah boards have to be free from any suspicious action in their conduct and decisions. Apart from that, they need to interact closely with their officers or other executive staff in the institutions and to study relevant documents. In addition, they shall conduct research in order to enhance their understanding of issues forwarded to them that require their decisions. Islamic finance institutions have to facilitate their Shari’ah boards in achieving strong, clear and objective decisions via all means.

Principle 4.1 sets out the element of confidentiality that the Shari’ah board needs to observe and that this issue must be made clear in their letters of appointment. It also lists the types of data and documents considered confidential and those which are not and proposes certain disciplinary or administrative actions that may be taken against Shari’ah board members for breaching the non-disclosure agreement. The Shari’ah board needs to honour the trust vested in it by its clients and employer, but data or documents related to Shari’ah principles and rules should not be considered confidential. It is also recommended that Shari’ah resolutions of the Shari’ah board be shared with peers and the public, as is done by some institutions. Besides being a good idea for its own sake, it can also boost public confidence in and trust of the Islamic financial institution.

Finally, Principle 5.1 recommends some practices that if followed may assist in attaining consistency in Islamic finance practices. Among these practices are: observation of the legal and regulatory framework for the issuance of Shari’ah resolutions, adherence to appropriate procedure and process (ijtihad methodology) to develop and conclude a Shari’ah pronouncement, making available supporting evidence for the resolution issued, trying as much as possible to follow available resolutions issued by the central Shari’ah authority or other international fatwa bodies, participation in international Shari’ah dialogue to implant mutual respect and harmonization and adopting a specified process for revision of resolutions.

In addition to the above point, it is also important to note that while Shari’ah advisors deserve remuneration for the professional service they render and efforts invested, financial independence has to be achieved as well. It can be achieved by a clear decision of the Board of Directors on the quantum of the remuneration. The prevalent practice is to allocate a retainer fee for the Shari’ah advisors, and some allocate a meetings allowance as well. Apart from that, regulators may determine the range of reasonable remuneration for Shari’ah advisors so as not to allow disparities that would motivate a Shari’ah advisor to choose to service certain institutions only and create unrest in the industry. Some have suggested that the payment should be made by the shareholders of the Islamic financial institution by means of a decision in its annual general meeting, but others have said that the authority vested in the board of directors is sufficient, as they represent the stakeholders of the Islamic financial institution.

Challenges Facing Shari’ah Advisory Boards and Services

Apart from the various tasks that need to be undertaken by the Shari’ah board or Shari’ah advisor, there remain a few challenges that they must overcome for better service. Those challenges are as follows:

1. The lack of knowledge and comprehension among Shari’ah scholars about modern financial practices. It was observed that not many scholars have adequate knowledge about both aspects. It is vital to be well versed in both Shari’ah and finance, as it affects the integrity of the Islamic financial industry.

2. Shortage of Shari’ah scholars to serve Islamic financial institutions. This will require all the relevant authorities to invest in producing and training new Shari’ah scholars as well as providing them with the necessary exposures and experience to be fit and competent for the tasks that they have to undertake.

3. The challenge to synergize between the Shari’ah, regulatory, legal, finance and tax requirements in product development. More often, the products will face hurdles from any of those aspects. Therefore, it increases the tendency to replicate conventional products and modify them to be Shari’ah-compliant.

4. The challenge to move towards innovations and providing Islamic-based services and products.[11] This is to move away from the prevailing practice of imitation and replication of the conventional products or the sole focus on Shari’ah-compliant services. This will require Shari’ah advisors to be more bold and proactive in conducting research and product development.

5. The challenge to provide speedy and timely Shari’ah solutions to the Islamic financial institution’s issues. It is acknowledged that delays can translate into loss of opportunities. Competence of the Shari’ah board, transparency and the supply of resources and research works as well as human assistance to the board by the Islamic financial institution will assist in overcoming this challenge. However, the Shari’ah board should not rush in making ijtihad or giving Shari’ah rulings or prohibiting a subject matter without clear understanding or in-depth research. Sufficient contemplation of the issues is necessary.

6. The challenge to balance between monetary and Shari’ah objectives. The challenge is commonly known as achieving corporate social responsibility (CSR). Islam promotes comprehensive ethical values and emphasizes social justice, and this entails more responsibilities than CSR. Their observance will further lead to the continuous excellence of business performance and corporate accountability. However, this initiative will fail without continuous effort of Shari’ah scholars and continuous support from the Islamic finance institution.

7. The challenge of secrecy and confidentiality, whereby absence of full disclosure on the part of the financial institutions can prove to be detrimental to the legitimacy of products and affect the rights of customers. In addition to that, it is important to ensure clear and transparent procedures of decision-making as well as the independence of Shari’ah scholars.

8. The challenge of the knowledge gap in the industry whereby the unique features of Islamic finance and its products are not well understood and appreciated. Such gap is dangerous, as it will leave the Shari’ah board to work in isolation without the support of various parties, and the industry shall not have clear aim or direction.

As listed above, there are many challenges faced by Shari’ah scholars in fulfilling their real and noble task of serving Islam, the Ummah and the industry. They are required to be more proactive and need to be assisted by new, well-trained scholars and various parties in the industry.

Conclusion

Islamic finance is an industry with huge potential, and more achievements are anticipated from it with the collective efforts of its stakeholders who aim at its progress and development. As Shari’ah advisors are among the industry’s main actors and Shari’ah governance is an integral part of the industry, their roles need to be clearly set out and observed. This matter is also crucial in that the development of the industry has resulted in a transformation in Shari’ah advisory services. Overall, Shari’ah advisors need to undertake a variety of tasks and fulfill a variety of responsibilities to their respective Islamic finance institutions in particular and to the industry at the national and global level. It shows that effective contributions and commitment of Shari’ah advisors are highly sought after by the industry in line with their position as Shari’ah experts and Shari’ah guardians in the Islamic finance system. Assessment from the regulatory and legal perspectives alone signifies that Shari’ah advisors need to perform a multitude of duties and responsibilities. In fact, it is important that the legal and regulatory framework and requirements be given due attention; failure to do so shall give rise to serious and negative consequences. Shari’ah boards and advisors face a variety of other challenges, and many more are to be expected as the market grows. Thus, it is essential that Shari’ah advisors continuously enhance their competence, caliber and knowledge and prepare themselves to face all the responsibilities and challenges that lie ahead. Wallahu a’lam.

[1] AAOIFI Accounting, Auditing and Governance Standards for Islamic Financial Institutions, 2004-2005, Governance Standard (No. 2), Article 5 and 6.

[2] See Faris Mahmoud Abomouamer, An Analysis of the Role and Function of the Syariah Control in Islamic Banks, (Cardiff: University of Wales), 1989 at p. 366

[3] AAOIFI Accounting, Auditing and Governance Standards for Islamic Financial Institutions, 2004-2005, Governance Standard (No. 1), Article 2.

[4] Board that serves at a particular Islamic finance institution and engaged by them.

[5] See BNM’s Guidelines on the Governance of Shariah Committee for the Islamic Financial Institutions (GPS 1) at p. 11 – 13.

[6] See Abdul Sattar Abu Ghuddah, Al Ijtihad wa Al Ifta’ fi Al Masarif Al Islamiyyah at p. 10. A paper presented in the Conference of Ifta’ dan Ijtihad in the 21st Century at IIUM on 12th August 2008.

[7] See Zeti Akhtar Aziz, Islamic Banking and Finance Progress and Prospects Collected Speeches: 2000 – 2005, Bank Negara Malaysia: Kuala Lumpur, 2005 at p. 196.

[8] See Zeti Akhtar Aziz, Islamic Banking and Finance Progress and Prospects Collected Speeches: 2000 – 2005, Bank Negara Malaysia: Kuala Lumpur, 2005 at p. 205.

[9] Association of Islamic Banking Institutions Malaysia (AIBIM) has recently produced Interbank Murabahah Master Agreement (IMMA) whilst International Islamic Finance Market (IIFM) has produced Master Agreement for Treasury Placement (MATP) as a standard contract to be applied in the Islamic finance industry.