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Foundations of Shari'ah Governance of Islamic Banks

ISBN: 978-1-118-46077-1
408 pages
April 2015
Foundations of Shari


A practical guide for robust sharī'ah governance of the Islamic banking industry

Debate in the market on the extent of sharī'ah compliance of Islamic banks, their products, and activities has piqued stakeholders' interest. In Foundations of Sharī'ah Governance of Islamic Banks, Karim Ginena and Azhar Hamid explore the depths of sharī'ah governance to unravel its mysterious dimensions, and equip academics and practitioners with a solid understanding of the subject, which has become a serious challenge and thus deserves dedicated attention.

The authors make a strong case for the need to contain the sharī'ah risk that Islamic banks experience, and present a compelling argument for how this should be done. Ginena and Hamid propose a robust sharī'ah governance model that comprehensively tackles thisrisk, and helps improve the extent of sharī'ah compliance of market players. The authors detail the internal, external, and institutional arrangements needed to promote responsible sharī'ah governance, and critically analyze current laws, regulations, and industry practices on the topic. The chapters of the book do the following:

  • Examine the roots, characteristics and objectives of sharī'ah and its relation to financial dealings;
  • Probe the role of regulators in sharī'ah governance, explore the different approaches adopted by banking supervisors, and provide examples of relevant legal and regulatory measures;
  • Explain to bank directors and management the fiduciary duty they assume with respect to sharī'ah compliance, and detail how they could discharge this responsibility in line with best practices;
  • Elaborate on the purpose of the Sharī'ah Supervisory Board (SSB), its responsibilities, competence criteria, internal regulations, and key governance guidelines; additionally, they explore different SSB models;
  • Describe the internal sharī'ah control system including its six components, and examine the internal sharī'ah audit function as well as different stages of conducting a sharī'ah audit;
  • Clarify the role of a sharī'ah auditor, with guidance on reporting lines, scope of duties, authority, and practical ways on fulfilling tasks, such as a sample sharī'ah risk assessment grid and audit checklists;
  • Discuss the newly emerging external sharī'ah advisory firms that are expected to play a key role in the coming years and the services they provide.

Through an effective treatment of each of these elements, and the way that they interact with one another, the book offers a fresh take on how robust sharī'ah governance of Islamic banks can be successfully accomplished. It is a comprehensive resource for academics, regulators, directors, lawyers, auditors, consultants, employees, and customers of Islamic banks interested in learning more about these challenges. This essential reading persuasively extends the discourse on the subject and addresses critical sharī'ah issues that have policy implications for decision makers in jurisdictions aiming to attract the fast-growing Islamic finance industry or increase their market share.

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Table of Contents

Foreword xiii

Acknowledgements xv

Introduction xvii

Part I 1
Karim Ginena

Chapter 1 The Roots, Characteristics, and Objectives of SharÓ’ah and the Islamic Economic System 3

1.1 SharÓ’ah, the Qur’‚n, and Sunnah 3

1.2 What is Fiqh? 8

1.3 Performing Ijtih‚d and Differences in Juristic Opinions 11

1.4 SharÓ‘ah Rulings 16

1.4.1 Obligation-Creating SharÓ‘ah Rulings 16

1.4.2 Declaratory SharÓ‘ah Rulings 19

1.5 The Subject of a SharÓ‘ah Ruling 19

1.6 Characteristics of SharÓ‘ah 23

1.7 Objectives of SharÓ‘ah 30

1.8 The Islamic Economic System and its Characteristics 35

1.9 Objectives of SharÓ‘ah Relating to Property 50

Chapter 2 Corporate and SharÓ‘ah Governance of Islamic Banks 57

2.1 Corporate Governance Gains Prominence 57

2.2 Hisba System and an Islamic Perspective on Corporate Governance 60

2.3 OECD and Islamic Principles of Corporate Governance 65

2.4 Importance of Corporate Governance to Banking Sector 67

2.5 The Financial Crisis and Corporate Governance Challenges 69

2.6 Developing Countries and Corporate Governance Issues 70

2.7 Corporate Governance Concerns for Islamic Banks 71

2.8 IFSB and AAOIFI Issue Guidance 71

2.9 Adapted Corporate Governance Understanding 72

2.10 Stakeholders of Islamic Banks and their Governance Responsibilities 73

2.11 Connecting Risk Management, Corporate Governance, and SharÓ‘ah Compliance 76

2.12 SharÓ‘ah Governance Model 80

2.13 Importance of SharÓ‘ah Governance 83

2.14 SharÓ‘ah Supervision vs Governance 83

2.15 SharÓ‘ah Risk Definition 84

2.16 SharÓ‘ah Risk and Possible Implications 85

2.16.1 Credit Risk 85

2.16.2 Legal and Compliance Risk 85

2.16.3 Reputational Risk 86

2.16.4 Market Risk 86

2.17 SharÓ‘ah Risk – Causes and Events 88

2.17.1 Internal Causes 88

2.17.2 External Causes 94

2.18 SharÓ‘ah Risk Management 96

2.19 SharÓ‘ah Compliance Responsibility of BOD and Senior Management 97

Appendix 2.1: Operational Risk – Loss Event Types 102

Chapter 3 Legal and Regulatory Aspects of SharÓ’ah Governance 103

3.1 Institutional Arrangements 103

3.2 SharÓ‘ah and Common Law Encounters in English Courts 106

3.2.1 The Islamic Investment Company of the Gulf (Bahamas) Ltd v Symphony Gems N.V. & others 106

3.2.2 Shamil Bank of Bahrain E.C. v Beximco Pharmaceuticals Ltd & Others 109

3.2.3 Investment Dar Co KSCC v Blom Developments Bank Sal 111

3.3 Lessons Learned from Cases and the Desirability of a Secular Interpretation of SharÓ‘ah 112

3.4 Malaysia: A Common Law Jurisdiction of Choice? 113

3.5 Role of Banking Supervisors in SharÓ‘ah Governance 117

3.6 Regulatory Approaches to SharÓ‘ah Governance 119

3.6.1 Hands-off 120

3.6.2 Nominal 124

3.6.3 Engaged 125

3.6.4 Proactive 132

3.6.5 Committed 143

Appendix 3.1: Legal and Regulatory Framework for IFSI in Jurisdictions with Known IIFS presence 152

Chapter 4 The Internal SharÓ’ah Control System 181

4.1 Internal SharÓ‘ah Control – Definition and Objectives 181

4.2 SharÓ‘ah Control System Components 182

4.2.1 SharÓ‘ah Control Culture 182

4.2.2 SharÓ‘ah Risk Identification and Assessment 184

4.2.3 SharÓ‘ah Control Activities 185

4.2.4 SharÓ‘ah Associated Information and Communication 186

4.2.5 SharÓ‘ah Monitoring of Activities 188

4.2.6 Evaluation of Internal SharÓ‘ah Control System by Banking Supervisors 189

4.3 Internal SharÓ‘ah Audit Function 191

4.3.1 Purpose, Responsibility, and Authority 191

4.3.2 ISAF in Practice 191

4.3.3 Importance of Independence and Objectivity 192

4.3.4 Planning for SharÓ‘ah Audit 193

4.3.5 Engagement Program Execution 200

4.3.6 Communicating Findings 201

4.3.7 Following Up and Post-Engagement 202

4.3.8 SharÓ‘ah Audit Quality Assurance Program 203

4.4 Proficiency and Due Professional Care of ISAF Staff 204

4.5 Professional SharÓ‘ah Audit Body 205

4.6 SharÓ‘ah Governance Manual 205

Appendix 4.1: Sample SharÓ‘ah Governance Manual (Also available on the book companion website at www.wiley.com/go/shariahgovernance) 207

Appendix 4.2: Sample SharÓ‘ah Audit Checklists (Also available on the book companion website at www.wiley.com/go/shariahgovernance) 223

Part II
Azhar Hamid

Chapter 5 The SharÓ‘ah Supervisory Board 249

5.1 The SharÓ‘ah Supervisory Board Defined 249

5.2 Multiple Titles for the SSB 252

5.3 Importance and Purpose of the SharÓ‘ah Supervisory Board 254

5.4 History of SSBs in Modern Islamic Banking 256

5.4.1 Accounting and Auditing Organization for Islamic Financial Institutions 257

5.4.2 Islamic Financial Services Board 258

5.4.3 Organization of Islamic Conference Fiqh Academy 258

5.5 Key Governance Guidelines: Independence, Objectivity, Confidentiality, Consistency, Transparency, and Disclosure 260

5.5.1 Independence 260

5.5.2 Objectivity 263

5.5.3 Confidentiality 265

5.5.4 Consistency 267

5.5.5 Transparency and Disclosure 269

5.6 Regulating SSBs 270

5.6.1 GCC Jurisdictions 271

5.6.2 Non-GCC Jurisdictions 273

5.7 SSB Location Within the Organizational Chart 275

5.8 SSB Models 276

5.8.1 SSB at IB Model 277

5.8.2 SSB at Central Bank and IB Model 277

5.8.3 Central Authority and SSB at IB Model 279

5.8.4 Market-Driven SSB at IB Model 279

5.9 An SSB-Free Model? 280

5.9.1 Need to Understand SharÓ‘ah Requirements for the Industry 281

5.9.2 Securing the Support of Key Stakeholders 281

5.9.3 Commitment to a Unified SharÓ‘ah Reference 281

5.9.4 Being Highly Receptive to New Developments in Industry 282

Chapter 6 SharÓ’ah Supervisory Board Member Qualifications and Internal Regulations 283

6.1 Competence of SSB Members 283

6.1.1 Character, Professional Ethics, and Conduct 284

6.1.2 Academic Qualifications of SSB Members 289

6.1.3 Experience 294

6.1.4 Essential Skills for SSB Members 297

6.1.5 Professional SSBs 298

6.2 Establishing an SSB 299

6.2.1 Systemized SSB Application Process 299

6.3 SSB Charter 303

6.3.1 Number of SSB Members 303

6.3.2 Terms of Agreement 304

6.3.3 Reporting Line 304

6.3.4 Reappointment 304

6.3.5 Selection of SSB Chairman and Executive SSB Member 305

6.3.6 SSB Members’ Remuneration 306

6.3.7 Compensating SSB Members 308

6.3.8 Procedure for Dismissal and Resignation 308

6.3.9 Procedure for Replacing an SSB Member 310

6.3.10 SSB Meetings 311

6.3.11 Frequency of Meetings 311

6.3.12 Quorum for SSB Meetings 312

6.3.13 Decision-Making Process 312

6.3.14 Meeting Minutes 314

Chapter 7 Authority of the SharÓ’ah Supervisory Board and Conflict Management 315

7.1 SSB Authority 315

7.2 Nature of SSB Decisions 317

7.3 BOD and Management Responsibility Towards the SSB 319

7.3.1 Address SSB Matters in Company Bylaws and Establish SharÓ‘ah Governance Framework 320

7.3.2 Grant SSB Access to Information 320

7.3.3 Seek SSB Guidance and Abide by its Fatawa and Resolutions 320

7.3.4 Honor SSB Independence 321

7.3.5 Provide Administrative Support 321

7.3.6 Assess SSB Performance 321

7.4 Conflict between SSB Members 322

7.5 Conflict between the BOD and the SSB 323

7.6 Conflict between Management and the SSB 323

Appendix 7.1: Performance Evaluation Form for SSB Members (Also available on the book companion website at www.wiley.com/go/shariahgovernance) 325

Chapter 8 Stages of SharÓ’ah Supervision and Responsibilities of the Shar-i‘ah Supervisory Board 329

8.1 SharÓ‘ah Supervision 329

8.1.1 Ex-ante SharÓ‘ah Supervision 330

8.1.2 Intermediate SharÓ‘ah Supervision Stage 332

8.1.3 Ex-post SharÓ‘ah Supervision 333

8.2 Responsibilities of SSB Members 335

8.2.1 Collective Responsibilities 335

8.2.2 Individual Responsibilities 342

8.3 Chairman and Executive SSB Member(s) and their Responsibilities 344

8.3.1 Issuing Fatawa and Ijtih‚d in Islamic Finance 345

8.3.2 Differences in Juristic Opinion and Conflict Resolution 349

8.3.3 Different Approaches to Issuing Fatawa 351

8.3.4 Reversal of Fatawa and Implications 351

8.4 Annual SharÓ‘ah Compliance Report 352

8.4.1 AAOIFI’s Report 353

8.4.2 Possible Opinions in the Report 355

Appendix 8.1: Lease Ending with transfer of Ownership Financing Instrument (Also available on the book companion website at www.wiley.com/go/shariahgovernance) 357

Chapter 9 SharÓ’ah Advisory Firms 363

9.1 Introduction to SharÓ‘ah Advisory Firms 363

9.2 Services Offered by SharÓ‘ah Advisory Firms 364

9.2.1 SharÓ‘ah Supervision 365

9.2.2 Internal SharÓ‘ah Audit 365

9.2.3 External SharÓ‘ah Audit 366

9.2.4 Product Development and Transaction Structuring 367

9.2.5 Legal Document Preparation and Review 368

9.2.6 SharÓ‘ah Training 368

9.3 Outsourcing Internal SharÓ‘ah Functions 369

9.4 Regulation 369

9.4.1 Adherence to Directives and Guidance Issued 369

9.4.2 Competency 370

9.4.3 Monitoring 370

9.5 Liability 370

Appendix 9.1: Application Form for the Appointment of an External SharÓ‘ah Audit Office (Also available on the book companion website at www.wiley.com/go/shariahgovernance) 371

Index 373

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Author Information

KARIM GINENA has held both academic and industry positions in Islamic Banking. Most recently, he worked as a Senior Researcher with the Center for Islamic Economics and Finance at the Faculty of Islamic Studies, Hamad Bin Khalifa University (HBKU) in Doha, Qatar. Prior to that, he served as Head of sharī'ah Audit at Doha Bank. He is currently pursuing his PhD in Management at the University of Virginia's Darden Graduate School of Business and is a member of the Qatar Science Leadership Program. He holds an MSc. in Islamic Finance from HBKU and a Bachelors of Business Administration from Simon Fraser University in British Columbia, Canada. Karim is a 2013 Young Policy Professional of Harvard Law School's Institute for Global Law and Policy and is an AAOIFI Certified sharī'ah Advisor and Auditor. Karim has presented his research at international academic conferences and forums, such as at Harvard University, the American University of Sharjah and the British Academy of Management. His research has appeared in reputable journals, such as the Virginia Law & Business Review and Corporate Governance.

AZHAR HAMID is a seasoned Islamic banker and an academician. Presently, he serves Ahli Bank Oman as Head sharī'ah Audit and Compliance. Previously, he worked as Deputy Head of the sharī'ah Audit Department at Doha Bank and Manager of sharī'ah Compliance at Dubai Islamic Bank, Pakistan. Academically, Azhar held the positions of Lecturer, Islamic Bankingand Finance, and Research Assistant to the President of the International Islamic University Islamabad (IIUI) at IIUI. Azhar holds MSc. Economics and MPhil Economics degrees with specialization in Islamic banking and finance from IIUI. Azhar is a researcher of Islamic finance and writes regularly with special focus on sharī'ah governance, sharī'ah auditing and product development of Islamic financial institutions. Azhar lives in Muscat, Oman, with his wife Dr. Qurrat ul Ain Akram, a son Faateh Abdul Rahman and a daughter Falah Amayem.

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“..a timely and important book…….a treasure trove of information and guidance.” (Arab Banker, September 2015)
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