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Shariah Governance – The real nexus for comprehensive Islamic financial regulatory and supervisory infrastructure

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By Suapi Shaffaii – 28 August 2008 (published and retitled “How Shariah Governance Empowers Islamic Finance” in Islamic Finance News Vol.5, Issue 36, 12 September 2008)

1. I always believe that a strong political determination will significantly set the motion of Islamic financial services in any country notwithstanding the complexities of its legal system or the size of its Muslim population. We see that this has catapulted the emergence of Malaysia, Singapore, London and Hong Kong as the newest Islamic financial centres. The same political trend has also mooted the Islamic finance interest in Japan and South Korea.

2. While political support is central to the survival of Islamic finance, we cannot discount the substantial elements which form the mechanics of Islamic finance, namely, an accommodative regulatory and supervisory framework, and an effective Shariah governance. In this age of transparency and good corporate governance, perhaps, it does not conform to the best practices to operate Islamic financial services by adopting one element and shunning the other. Unfortunately, this has always been at the prerogative of the financial policy makers and sometimes no amounts of politics may influence this.

3. The Shariah governance is the nexus for a comprehensive regulatory and supervisory infrastructure. It is the brain of the Islamic financial regulatory and supervisory infrastructure as the overall compliance of Islamic financial business will solely rest on the adequacy and efficiency of the Shariah governance. Ignore it, you will have a limping infrastructure. The policy makers need to zoom into the components of the Shariah governance to appreciate the complete link the Shariah governance provides to the oversight of the Islamic financial services in their country.

4. The Shariah governance comprises two vital components- (a) a Shariah apex body as appointed by regulators or supervisors and (b) a Shariah body as set up by a financial institution.

5. The Shariah apex body is intended to assist the Islamic financial industry in the interpretation of the Shariah issues. While the Shariah issues are never the expertise of the regulators or supervisors but this body will never intervene in the regulation and supervision of the industry as they will deal strictly on the mandated role of attending to the Shariah compliance issues. Regulators or supervisors may impose rules on how this body will operate and the appointment of the Shariah scholars is to be effected. The effectiveness of this apex body will be subject to these elements:

(i) It becomes a central reference on the Shariah issues where industry players and authorities alike may refer to it for its advice;

(ii) The opinions issued by the body will be binding upon the regulators/supervisors and financial institutions so as to accord respect to the body as the highest authority in Shariah issues. This will lend credibility to the Islamic financial system;

(iii) It provides guidance in interpreting Shariah issues related to the Islamic financial services transactions in a court of law; and

(iv) The court of law may not be bound to follow the opinions offered by the body in a court of law as in this sense it only acts as an expert witness. Furthermore, the judicial authorities, particularly from a common law country, would strictly apply the doctrine of binding precedent i.e inferior courts will only be bound by by their superior courts and not any other bodies.

6. The institutional Shariah body as the second component of the Shariah governance, is appointed by any individual financial institution. This rationale behind this set up is to ensure that Shariah governance is efficiently managed at the institutional level. Under this component, each financial institution is required to have its own Shariah unit. While this internal body will be responsible for the Shariah compliance issues at its own institution, it may seek the assistance of the apex Shariah body for its resolutions on more complex Shariah issues as they come. As explained before, the opinions issued by the apex body will be binding. You may have 20 Shariah bodies if you have 20 financial institutions in your country. Imagine all these bodies are accountable to the central Shariah body. Think about how systematic the Shariah compliance issues will be handled with these components of the Shariah governance.The regulators or supervisors may provide rules on the appointment and background vetting of proposed Shariah officers for this internal Shariah body.

7. You may notice by now that the components of the Shariah governance are merely facilitative in nature. They may co-exist with the regulators or supervisors but they will never disrupt the existing pattern of the regulatory and supervisory framework. In fact, they will greatly assist the regulators or supervisors to oversee an aspect of compliance that they are not familiar with ie. the Shariah requirement. This has worked well in Malaysia. Indonesia have also followed suit.

8. Notwithstanding the aforementioned, it may be an arduous task to convince regulators or supervisors to adopt the Shariah governance as their potent policy tool. But I think it’s all about awareness issue. They do not envision the significance of Shariah governance in setting the design of the Islamic financial regulatory and supervisory. The Shariah governance was never engaged as part of a comprehensive financial framework as the only immediate focus was the specific legislative amendments to empower regulators or supervisors to oversee Islamic financial services. They cannot fathom the regulatory and supervisory oversight over Islamic finance beyond licensing requirements and surveillance duties. As such, the Shariah governance in their countries is often at best decided by the industry players. Here, we have the Shariah people being accountable only to the institutions that hired them.

9. Shariah compliance is the utmost crucial requirement and this cannot be imposed upon leaving this freely at the hand of the industry players. Conflicts of interest may arise as it will be set up with a business priority in mind. In this regard, the Shariah compliance requirements, like other compliance requirements, must be standardised for an effective control mechanism. The Shariah governance components in the form of the Shariah apex body and the institutional Shariah body are intended to maintain the order of the Islamic financial services industry. All these, warrants the Shariah governance system which comes under the purview of the regulators or supervisors. But how could this be done?

10. Islamic finance needs a legitimate platform to operate for a greater efficiency and seamless integration with the existing financial system. Otherwise, the regulators or supervisors will find their vague authorities at overseeing Islamic financial services industry in their country. Likewise, the Shariah governance needs to be legitimized. In some countries, it will be a straight case of amending the existing financial legislation. In some other countries, that will attract some constitutional issues. The point is, as long as the Shariah governance employs a kind of legislative effect under the main financial legislation, it will play its mandated role effectively.

11. Malaysia is ahead in terms of the Shariah governance for the Islamic financial services industry. The Central Bank of Malaysia Act 1958 provides for the setting up of the Shariah Advisory Council which plays the role of a Shariah apex body. The Islamic Banking Act 1983 and the Takaful Act 1984 provide for the establishment of the institutional Shariah body at the Islamic banking and takaful industries. The body will refer to the Shariah Advisory Council for its resolutions on a Shariah issue. Indonesia has moulded its Shariah governance system after the Malaysian module in their recently legislated Shariah Banking Act.

12. Leaving the Shariah governance issue to run on its own chartered course will undermine the integrity of the Islamic financial system. The auto pilot mode will create a vacuum where the regulators or supervisors would be toothless to consider circumstances which necessitate their immediate remedial actions. The Shariah governance components will assist the regulators or supervisors to fill in the gap. Hence, more effective regulation and supervision of Islamic financial institutions.

13. As more and more countries have become interested to leverage on the potential growth of Islamic finance as a springboard to elevate their status as an international financial centre or at least to jump in the bandwagon so as not to be far deserted in the race, it is disappointing to see, while the splurge was obvious on the celebrated new pursuit, little has been done or seen to be carried out on creating a comprehensive Islamic finance framework. This includes the Shariah governance. Therefore, it calls for a vital role of the government agencies which are entrusted with the regulatory and supervisory duties. Ignore it, their credibility and the integrity of the Islamic financial services industry may be at stake.

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Written by Suapi Shaffaii

August 27, 2008 at 7:49 am

2 Responses

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  1. […] Shariah Governance – The real nexus for comprehensive Islamic financial regulatory and supervisory… […]

  2. Dear Suapi,

    I came across your article and found it interesting. I would like to have a telephonic interview with you as I am research a very similar topic.

    Thanks in anticipations.

    Best, Shakir

    Shakir Ullah

    March 23, 2010 at 5:19 pm


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