Shariah Governance Framework for IFIs: Raising Shariah Competency to the Next Level

International Conference on Islamic Business and Finance Islamabad, Pakistan

9 February 2011

Rustam Mohd Idris Deputy Director Islamic Banking and Takaful Department

Contents
Background Development of Shariah Governance Building competencies for Shariah Governance Malaysian experience

Well developed governance structure is instrumental for safety & soundness of IFIs

Shariah Governance Framework

Legal Framework

Governing Infrastructure

Regulatory Framework

Shariah governance framework is one of the key ingredients

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Shariah Governance plays an important role in instilling & shaping sound governance practices .
Ensures compliance with Shariah rules & principles

Importance of Shariah governance

Ensure strict Shariah-compliant

Fiduciary Normal duties in Corporate Islamic Governance banking transaction

Shariah Governance

Instill public confidence 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

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Development of Shariah Governance

Domestic initiatives
AAOIFI

International initiatives
Issuance of standards: i) Governance standards for IFIs ii) Auditing standards for IFIs iii) Ethics standards Issuance of standards: i) IFSB-3: Guiding Principles on Corporate Governance for IIFS ii) IFSB-10: Guiding Principles on Shariah Governance Systems For IIFS Published guidance for Shariah advisorys roles in Islamic finance activities

Establishment of Shariah Committee within each IFIs Ensure business operations are in adherence with Shariah principles

Intervention by Central Bank Promote stakeholders confidence & integrity of Islamic financial industry

IFSB

Set up of centralized Shariah advisory body

Ensure uniformity & harmonisation of Shariah interpretations

Legal provision / legislation & issuance of specific guidelines

Establishment of Shariah advisors at IFIs Guidance on roles & responsibilities of Shariah advisors in ensuring Shariah compliance

OIC Fiqh Academy

AAOIFI Accounting and Auditing Organizations for IFIs IFSB Islamic Financial Services Board OIC Organisation of the Islamic Conference IFIs Islamic Financial Institutions IIFS Institutions offering Islamic Financial Services

Source: www.aaoifi.com www.ifsb.org www.fiqhacademy.org.sa

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Building Competencies for Shariah GovernanceMalaysian experience

Phase 5
Elevating stature of SAC SAC as the highest authority in IF / Issuance of comprehensive SGF SACs rulings are binding on IFIs, courts and arbitrators Enhancing the roles & functions of the board, SC & management in relation to Shariah governance Formation of Shariah key functions within IFIs to ensure Shariah-complaint

Phase 4

Recognize SAC as an authoritative body in issuing Shariah rulings / Establish governance for SC

Specific provisions in CBA Court & arbitrator to refer to SACs rulings in any proceedings related to IF matters

Incorporating duties of SC in the industry Enlarging pool of Shariah talent within the Islamic financial industry

Phase 3

Instituting dedicated SAC at Central Bank to address Shariah compliance issues

Promoting uniformity & harmonisation of Shariah interpretations amongst IFIs

Phase 2

Providing a platform for IFIs to seek Shariah advise through SAC

Building foundation of legal, regulatory & Shariah framework

Phase 1

Establishment of SC at IFIs level under specific laws to provide check & balance, to ensure Shariah compliance

SAC Shariah Advisory Council of Central Bank of Malaysia; SC Shariah Committee of IFIs; IBIs Islamic Banking Institutions

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Shariah Governance Framework in Malaysia

Guided by two important legislation & guidelines

Central Bank of Malaysia Act 2009

Key Features:

Shariah Governance Framework for IFIs

Objectives:

An apex authoritative body for the ascertainment of Islamic law for the purposes of Islamic financial business Advise the Bank (and also IFIs) on any Shariah issue relating to Islamic financial business Appointed by the King, on the advice of the Minister of Finance after consultation with the Central Bank The court & arbitrator shall take into consideration any published rulings of the SAC, prior to any proceedings on Shariah matters Rulings made by the SAC shall be binding on IFIs, court or arbitrator

Set out the expectations of the Bank on an IFIs Shariah governance structures, processes & arrangements to ensure that all its operations & business activities are in accordance with Shariah Provide comprehensive guidance to the board, Shariah Committee and management of the IFI in discharging its duties in matters relating to Shariah Outline the functions relating to Shariah review, Shariah audit, Shariah risk management and Shariah research

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Framing the Shariah Governance Framework

Oversight, Accountability & Responsibility Clear demarcations on accountability & responsibility Outlines the level of accountability and responsibility of the board of directors, Shariah committee and management of the Islamic financial institutions Independence Aims at safeguarding the independence of the Shariah committee in ensuring sound Shariah decision-making, and emphasis on the role of the board of directors in recognizing the independence of the Shariah committee

Guiding Principles
Competency Highlights requirements and expected competencies to ensure key functions are capable of implementing Shariah governance Confidentiality & Consistency Minimum set of rules that emphasizes on the importance of observing and preserving confidentiality and improving the level of consistency in decision making by the Shariah committee

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Measures to Heighten Shariah Governance Structure

Ex-ante regulation
Minimum of 3 SC members

The new Framework

Minimum of 5 SC members
- Majority must possess Shariah qualifications

Oversight, accountability & responsibility

Minimal engagements between board & SC SCs roles limited to advisory role, product approval & endorsement Prior written approval by BNM on removal of SC member

Advocate regular engagements between board & SC May appoint SC member as board SC accountable on its decisions, views & opinions on Shariah matters Recognition by board on SCs independence SCs decisions to be observed at all times by IFIs Prior written approval by BNM & SAC for removal of SC Full disclosure & transparent information to SC

Independence

Competency

Appointment of SC by board, upon recommendation by Nomination Committee

Comprehensive fit & proper criteria for SC

- Apart from board, BNM & SAC approve the appointment of SC

Continuous learning & training programs to key stakeholders Develop succession planning program for SC Restriction on membership of SC to sit in IFIs within same industry Retain restrictions on membership of SC to sit in IFIs within the same industry Whistle blowing provision by SC to BNM Development of structured process in making Shariah decisions
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Confidentiality & consistency

Model of the New Shariah Governance Framework for IFIs

SHARIAH as overarching principle in Islamic finance
BOARD
Overall oversight on Shariah governance structure & Shariah compliance

BOARD RISK MANAGEMENT COMMITTEE

SHARIAH COMMITTEE
Oversight accountability on Shariah related matters

BOARD AUDIT COMMITTEE

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

Shariah Risk Management Control Function

Identify, measure, monitor, report & control Shariah noncompliance risk Form part of IFIs integrated risk management framew ork Perform by risk officers with suitable qualifications & experience

Shariah Review Function

Review business operations on regular basis to ensure Shariah compliance Cover overall business operations (end-to-end product development process) Perform by qualified Shariah officer(s)

Shariah Research Function

Conduct in-depth Shariah research prior to submission to Shariah Committee Assist & provide advice to relevant parties based on decision of SC Perform by qualified Shariah officer(s)

Shariah Audit Function

Provide independent assessment & objective assurance designed to value add & improve IFIs compliance w ith Shariah Scope of audit covers all aspects of IFIs business operations & activities Perform by internal auditors, w ho have acquired adequate Shariah-related trainings

Shariah Compliance and Research Functions

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Issues & challenges in Shariah governance

Competency of Shariah scholars to understand the complexity of Islamic financial instruments

Demand for talented Shariah experts outstrips its supply? Whether a robust Shariah governance framework is essential for each institutions regardless of their structural differences?

Absence of Shariah audit framework

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Thank you

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