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Shari'ah Supervision in Modern Islamic Finance

Shari'ah Supervision in Modern Islamic Finance



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Shari'ah Supervision in Modern Islamic Finance
Shari'ah Supervision in Modern Islamic Finance

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Published by: lahem88 on Jul 05, 2008
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Shari’ah Supercision in Modern Islamic Finance Yusuf Talal DeLorenzo1
Shari`ah Supervisionin Modern Islamic Finance
by Yusuf Talal DeLorenzo
hari`ah supervision maybe thought of as the singlemost important distinctionbetween a conventional and atruly Islamic financial venture.For, while a business mayattempt to represent itself as“Islamic,” unless it has qualifiedShari`ah supervision, it has noway of certifying that itsservices,products, and operations areactually Shari`ah-compliant. Inthe emerging Islamic financialsector, therefore, Shari`ahsupervision is not a matter tobe taken lightly. Publicconfidence,in any sector, is alwaysan important consideration;and in the financial sector itsimportance is paramount.Shari`ah supervision signifies areal commitment on the part of management to the principlesof transparency andaccountabilityin the matter of Shari`ahcompliance.
What is Shari`ah Supervision?
While it may be convenientto explain Shari`ah supervisionas a religious audit (especiallyto Western observers andregulators),its scope is far morecomprehensive. In essence,Shari`ah supervision is theprocess of ensuring that afinancialproduct or service complieswith Islamic legal precepts andprinciples, either by itsconforming(to one degree oranother) to a recognized Islamiclegal norm or by its not violatingthe same. Ideally, Shari`ahsupervision will be a part of anIslamic product or service fromthe time of its development, toits launch, and throughout theperiod it is offered. At the stageof research and development,or of drafting contracts orofferingmemorandums, Shari`ahsupervision, in one form oranother, should be an activeparticipant. By includingShari`ah supervision and adviceat the earliest stages,managementmay save costly legal feesthat may be required at a laterstage if elements of the proposedbusiness/contracts needto be modified to comply withShari`ah principles and precepts.Generally speaking, if Shari`ah supervisors are tocertifya venture, they will insiston being a part of itsdevelopment;or at least to havingaccess to the details of whateverwent into the development orstructuring of the product,instrument, service, orenterprise.Moreover, once a productis launched, Shari`ah supervisionmay take the form of ongoing monitoring throughperiodic audits. Such auditsmay be undertaken by meansof site visits, document reviews,or consultation withmanagementat regular intervals.
The most obvious andimmediate purpose of Shari`ahsupervision is to certify forpracticing Muslim consumersand clients that the financialproduct or service being offeredto them is acceptable from anIslamic legal perspective and istherefore lawful to them.
Suchcertification, generallydocumentedin a formal fatwa(Shari`ah position paper), maybe thought of as a form of duediligence. In effect, the Shari`ahsupervisor, or supervisoryboard, performs this duediligenceon behalf of consumerswho are without access to thedetails of what is offered tothem and, likewise, without theexperience or qualifications toevaluate those details in light of Shari`ah teachings. By assumingresponsibility for theShari`ah compliance of anIslamic financial institution,including its policies andpractices,Shari`ah supervisionplaces itself in a position of directly representing thereligiousinterests of the Musliminvestor or consumer; and bymaking every possible effort toensure that an Islamic financialproduct is halal, the servicesperformed by Shari`ah supervi-sors are directed toward theinvestor, or the consumer.Undoubtedly, as a result of these efforts, Islamic financialinstitutions and theirmanagementwill also benefit. But certainlythe primary beneficiary isthe Muslim consumer who canrest assured that his/her moneyis being put to use in ways thataccord with the teachings of Islam. It is for this reason thatShari`ah supervision may alsobe characterized as consumeradvocacy.
Shari’ah Supercision in Modern Islamic Finance Yusuf Talal DeLorenzo2
Since many if not most of thedealings or operations of Islamicbanks may be considerednovel, in the sense that thesewere unknown in the times of the classical jurists, there is avery real need for reliableopinionson these dealings; legaland academic opinions derivedfrom authentic Shari`ah sourcesby the means and methodologiesestablished by generationsof Muslim jurists. Then, while itmay indeed be possible for anindividual to come up withauthoritative opinions on theseissues, it soon became clear tothe newly established Islamicbanks that it would be better tohave the collective opinions of agroup of scholars. Moreover,the banks soon learned that itwas best to appoint scholarswith specializations in the fieldof fiqh al mu`amalat, and whoalso had working knowledge of modern financial markets andpractices. Then, by means of qualified Shari`ah supervision,Islamic banks may assure theirclients and investors that theoperations they undertake arereviewed in all of their detailsfor compliance with theprinciplesand precepts of theShari`ah. By means of such areview, by such a group of experts, the banks and financialinstitutions may clearlydemonstratethat their transactionsand dealings conform to Islamiclegal norms.
 Elements of Shari`ahSupervision: Numbers
Shari`ah supervision may beperformed by an individualsupervisor/advisor, or by aboard of supervisors/advisors,commonly known as a Shari`ahSupervisory Board.
Whetheran institution has a board or asingle supervisor is its ownchoice. Generally speaking,however, such a choice isinformed by severalconsiderations.Chief among theseconsiderationsis the product oroperation itself. An Islamichome financing alternative, forexample, is a complex affairand will undoubtedly benefitfrom the collective opinions of a diversified Shari`ah Board.The same will be true of acommercialor investment bankingoperation. An Islamic mutualfund, on the other hand, mayrequire a single supervisor,especially if it has licensed itself to an index provider like theDow Jones Islamic MarketIndexes, and is set up to do nomore than track the index. Anactively managed fund, however,even if it is licensed to anindex, may require more thanone supervisor. These areconsiderationsthat have to do withthe nature and requirements of the supervision itself. At thesame time, marketingconsiderationsmay also be of importanceto management. If a productor service is to be marketedinternationally, for example, orin a market in which Muslimsfrom different parts of theworld are found (like the USand UK), then it may be in theinterest of management toengage several scholars, eachfrom a different part of theMuslim world. Whatever thecase, prudence dictates thatthere be at least three supervisorsfor any Islamic financialundertaking. Moreover,experiencehas shown that at leastone of the members needs toreside in the same country orregion as the operation, so as tobe readily available forconsultation,even on short notice. Insome cases, too, a Shari`ahsupervisor will maintain anoffice and keep regular hours atthe bank or financial institution.
 Elements of Shari`ahSupervision:Qualifications
Obviously, a Shari`ah supervisorwill be someone with abackground in the classicalShari`ah sciences. In particular,however, supervisors need tohave studied the fiqh almu`amalat or rules concerningtransactions developed by theclassical jurists and expandedupon by later generations of Shari`ah scholars. Most Shari`ahsupervisors have producedacademicwork or studies on oneaspect or another of these rules.In addition, such a backgroundpresupposes facility in theclassicalArabic language and theability to deal directly with legaltexts, glosses, and commen-taries in that language. Inadditionto all this, an understandingof modern finance, markets,and economics is also clearlyrequired. Finally, an effectiveShari`ah supervisor must befamiliar with internationalbusinesspractices (`urf) and havean appreciation for regulatoryenvironments. For these reasons,the English language isespecially important. One morepoint that should be kept inmind is the supervisor’s abilityto work with a team, oftentimesin a cross-disciplinary andcross-cultural environment.Generally speaking, today’sShari`ah supervisors possess thequalifications and characteristicsdiscussed above. In addition,many Shari`ah supervisorshave benefited from theexposureafforded by multiple boardmembership. Then, while at thepresent time there are nostandardqualifications for Shari`ahsupervisors, it is to be hopedthat, in the future, and as theIslamic financial sector grows,graduate level programs will bedeveloped for the specificpurposeof preparing new generationsof scholars with all of therequisite skills. At present,however, the number of people
Shari’ah Supercision in Modern Islamic Finance Yusuf Talal DeLorenzo3
qualified to serve as Shari`ahsupervisors is limited.My own suggestion in regardto preparing scholars for afuture in Shari`ah supervision istwofold.
Firstly, Islamicfinancialoperations may appoint, inaddition to its full Shari`ahBoard members, junior memberswho will participate indiscussions,prepare memos andbriefs, take notes, and performresearch and other tasks for theShari`ah Board, but who willnot have full status as votingShari`ah Board members.Secondly, junior members may beappointed on a rotating basis,such that each will serve, muchlike a law clerk for a serving judge in the United States, for aperiod of one year. By means of this rotating arrangement, manyscholars will have an opportunityto learn first hand aboutthe workings of Shari`ahsupervision.Moreover, as juniormembers become increasinglymore familiar with modernbusiness norms and practices, itwill become easier for them toanalyze situations and think through options, with the resultthat their contributions to thework of the Shari`ah SupervisoryBoards will become increasinglyvaluable. Obviously, such junior members will becompensatedfor their efforts,though not at the same level asthe full board members.
 Elements of Shari`ahSupervision: Independence
In order to be effective,Shari`ah supervision must beindependent. In addition, thedecisions of the supervisor/smust be binding on management.If these steps are nottaken, the credibility of thesupervision, and the company,will be in question. Therecommendationof AAOIFI is thatShari`ah supervision must serveat the pleasure of the company’sBoard of Directors, and not besubject to management. Undersuch an arrangement, the Boardwill be free to approve ordisapproveof what managementdoes, or proposes to do, solelyon the basis of Shari`ah/legalconsiderations. Of course, thisis not to say that a Shari`ahBoard will automaticallybecome a thorn in the side of management. On the contrary,most Shari`ah Boards operate inthe spirit of cooperation andaccommodation.
 Elements of Shari`ahSupervision:Communication
An essential element in thesuccess of any undertaking iscommunication. This is equallytrue in regard to Shari`ahsupervision.To begin with, theremust be clearly delineated linesof communication betweenmanagement and Shari`ahsupervision. Oftentimes, anIslamic financial institution willappoint one of its executives,whether from businessoperations,finance, or legal, to act asliaison with the supervision.This person will be responsiblefor coordinating anddocumentingregular meetings, arrangingfor the requirements of Shari`ahsupervision, following up ondecisions and suggestions, andprocessing and channelingcommunications to and fromsupervision. When boardmemberslive on different continentsand work in different timezones, the work of such acoordinatorcan be challenging.
 Elements of Shari`ahSupervision: Education
The correlate of consumeradvocacy is consumer education.In making this observationI mean to refer to the world of possibilities for enhancingMuslimconsumer awareness of, andappreciation for, Islamicfinancialservices and products. Forexample, the Dow Jones MarketIndexes developed andsupporteda course on the Principlesof Islamic Investing thatwas offered to students of theDow Jones University on theinternet. Unfortunately, thecourse is no longer available,though efforts are underway forits revival at another venue.Likewise, several Islamicfinancialinstitutions supported theeffort to produce the
Guide to Islamic Investing
in cooperationwith the Lightbulb Press; andothers are supporting the
Guideto Islamic Home Acquisition
. Inshort, every institution offeringIslamic financial services needsto concern itself, to one degreeor another, with issues of consumereducation. Obviously,the chief concern will be toprovide information about theirown products. But, generallyspeaking, Muslim consumersneed to know that Islamicfinancial alternatives exist. Theyneed to know that thesealternativesare viable, from both areligious viewpoint and apracticalone. And they need toknow that these are competitiveand worthy of their trust. Theseare the basics of such aneducation.Obviously, there is muchmore that can be done. In aservice-oriented market that isdriven by competition, thefirms with the better serviceswill have the most success.Shari`ah supervision thatengages in consumer educationenhances service, not to mentionconsumer confidence.
Shari`ah Supervision Then and  Now
As the sector goes, so goes itsShari`ah supervision. Perhaps

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