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JFRC
18,4 Sharia supervision of Islamic
financial institutions
Samy Nathan Garas
386 New York Institute of Technology, Manama, Bahrain, and
Chris Pierce
Global Governance Services Ltd, Orpington, UK

Abstract
Purpose The governance structure of Islamic financial institutions (IFIs) implements Islamic canon
law (Sharia) into business transactions through Sharia supervision processes. This paper aims to define
Sharia supervision and examine Sharia supervisory councils (both within and outside the Central Bank),
Sharia consulting firms, Sharia advisors, and Sharia Supervisory Boards (SSB). It also discusses the
importance of the hierarchical position of SSBs and evaluates their objectives and functions.
Design/methodology/approach The paper reviews a wide range of theoretical literatures
especially recent proceedings of relevant conferences in the Gulf Cooperation Council (GCC) countries
along with the standards of the Accounting and Auditing Organization of Islamic Financial
Institutions (AAOIFI). A framework for understanding the role of the SSB is developed suggesting a
set of objectives and functions for the SSB.
Findings The paper finds a lack of standardization among the IFIs concerning the position of the SSB
within the corporate hierarchy. Moreover, the SSB is found to control the IFIs activities more than the other
types of Sharia supervision such as Sharia consulting firms and Sharia advisors.
Research limitations/implications The research focuses exclusively on the GCC countries and
excludes the other Middle East and Far East countries where Sharia supervision might have different
forms.
Social implications The research provides guidelines for IFIs in defining the SSB role in their
governance structure and recommends the SSB among the other forms of Sharia supervision (Sharia
consulting firms and Sharia advisors) in controlling the IFIs activities.
Originality/value This study contributes to the literature gap about the governance of IFIs. It is one of
the first studies that provide a conceptual foundation for the SSB role in the governance structure of IFIs.
Keywords Islam, Financial institutions, Recruitment, Governance
Paper type Conceptual paper

1. Corporate governance in Islamic financial institutions


The Islamic financial institutions (IFIs) are those financial institutions that officially
and practically abide by Islamic Sharia in their activities. IFIs exist in many countries
but are well established in Muslim communities (Appendix 1) and include banks,
insurance companies, mutual funds, hedge funds, and issuers of Islamic bonds. They
are regulated by central banks, capital market authorities, and other regulators. IFIs
provide products that may appear similar to the products of the conventional financial
Journal of Financial Regulation and institutions but very different in concept and application.
Compliance In 1970, IFIs started in Egypt and spread through the middle East, the far East,
Vol. 18 No. 4, 2010
pp. 386-407 Europe, and USA in subsequent decades. In 2009, the number of IFIs reached 458
q Emerald Group Publishing Limited worldwide (Appendix 1). Over the last three decades, several international organizations
1358-1988
DOI 10.1108/13581981011093695 have been established with a mandate of standardizing and harmonizing the practices of
governance among the IFIs. The Accounting and Auditing Organization for Islamic Sharia
Financial Institutions (AAOIFI, 2008) in Bahrain prepares, promulgates and interprets supervision
the accounting, auditing and governance standards for IFIs. These standards are
supported by different studies in Arabic and English from Sharia and academic scholars
(Banaga et al., 1994; Baydoun and Willett, 1997; Deehani et al., 1999; Gambling et al., 1993).
The Islamic International Financial Market (IIFM, 2009) in Bahrain was founded with two
primary roles: market education and Sharia authentication, which contribute to greater 387
self-regulation and the promotion of Islamic money and capital markets. The Islamic
Financial Standard Board (IFSB, 2009) in Malaysia is primarily focused on the structured
regulatory convergence of supervisory standards.

2. Definition of Sharia supervision


The principles of governance for IFIs exist in Islamic canon law (Sharia) which provides
guidelines for economic transactions with moral conduct (Abu-Tapanjeh, 2009). The best
practices of governance are embodied in the daily transactions of Muslims who consider
their wealth a trust from God and a test for their faith (Saeed, 1996). Haque (1999)
emphasizes the virtue of Islamic business as being fair and honest, where exploitation is
prohibited. Chapra and Ahmed (2002) define governance in Islam as fairness to all
stakeholders, which can be achieved through greater transparency and accountability.
IFIs derive their principles from Islamic Sharia and their activities are controlled
by Sharia scholars. However, there is no standard definition for Sharia supervision
(Al Qattan, 2004). Different Sharia scholars view Sharia supervision from different
perspectives. For example, Shehata (1991) defines Sharia supervision as:
[. . .] a process of review, investigation and analysis of all works, actions and behaviors that
are conducted by individuals, groups, institutions and business units to ensure their
compliance with Sharia. To do so, the Sharia Supervisory Board (SSB) uses appropriate
tools and approaches to detect errors and correct them immediately and submit its reports to
the relevant parties including its opinion, recommendations and guidance for improvement.
This seminal definition has been quoted by many other scholars in the field (Al Qattan,
2004; Hammad, 2006; Hemaish, 2005; Zighaba, 2009). However, the scope of the definition is
very wide since it includes individuals, groups, institutions and business units rather than
IFIs only. Hence, Abu Ghudda (2001) has refined the definition of Sharia supervision as:
[. . .] a process of review, investigation and analysis of all works, actions and behaviors that are
conducted by the institution to ensure its compliance with Sharia. To do so, the SSB uses
appropriate tools and approaches to detect errors, provide legitimate solutions for these errors,
and submit its reports to the relevant parties including Sharia opinion, decisions,
recommendations and guidance for generating legitimate profits (Halal) and improvements
in the future.
This definition restricts Sharia supervision to institutions only. In addition, it highlights
that Sharia supervisions has a variety of objectives including the provision of legitimate
solutions for barriers and conflicts, and improvements for the future.
Atteya (1993) emphasizes another aspect of Sharia supervision which was missing
in the previous definitions. He enlarges the scope of Sharia supervision to include:
[. . .] the initial efforts of IFIs founders and stakeholders which are derived by their desire to
lead the IFI and control its activities according to their zeal towards the IFI and their ability in
detecting errors and correcting them with the assistance of qualified individuals.
JFRC This definition focuses on the initial work of Sharia supervision during the early stages of
18,4 development of the IFI but marginalizes the importance of the regular work undertaken by
Sharia supervisors. Sharia supervision is defined by other scholars (Abu Memer, 1994;
Abu Shadi, 1990; Al Kaffrawi, 1986; Al Rabeea, 1992; Daoud, 1996; Zoair, 1996), who focus
upon Sharia supervision during the early stages of development of the IFI.
This paper consolidates and builds upon the earlier definitions and defines, Sharia
388 supervision as:
[. . .] the preventive, remedial and complementary process of control, review and analysis of
all the IFIs activities, products, contracts and transactions starting from the incorporation of
the IFI onwards to ensure compliance with Islamic Sharia for the purposes of generating
legitimate profits (halal) and improving in the IFIs performance.
We believe that this definition is an improvement upon earlier definitions since it covers
the four key activities of Sharia supervision: revising the articles of association and all
internal policies; issuing of religious decisions ( fatwas) before the release of products to
public to ensure their compliance with Sharia; reviewing new products and contracts
during their execution to ensure their compliance with Sharia; and reporting Sharia
opinion to relevant parties.

3. Importance of Sharia supervision


Sharia supervision occupies an essential position in the governance structure of IFIs.
The importance of Sharia supervision is derived from five different resources namely:
religious, social, economic, legal, and governance.
First, the religious position is derived from the ability of Sharia scholars to
understand and interpret Sharia principles to others. This role had been in place since
the beginning of Islam, when traders were not permitted to close any transaction (e.g.
selling products and leasing assets) unless they knew Sharia principles concerning the
transaction (Al Katani, 2001). Hence, Sharia scholars used to educate the traders in
Islamic law (Abdullah, 1997; Al Qattan, 2004), so that they would refrain from
conducting any transaction that contradicted Sharia (Abdullah, 1997; Al Mawardi,
1988; Hemaish, 2005). Nowadays, due to the lack of understanding of Sharia principles
among the IFIs management, the existence of Sharia supervision is essential to assist
the IFIs in conducting Sharia-compliant business (Al Saratawi, 1999; Hammad, 2006).
Thus, Sharia supervision receives its importance from the religious position of Sharia
scholars, who issue fatwas and decisions to guide the IFIs management (Al Nashmi,
2002; El-Khelaifi, 2005).
Second, the existence of Sharia supervision eliminates the stakeholders doubts about
the IFIs activities (Zighaba, 2009) as it confirms the compliance of these activities with
Islamic Sharia (Zoair, 1996). Since Sharia scholars have a well-respected position within
the Muslim communities, their approval of IFIs activities provides confidence to
stakeholders about the legitimacy of the transactions. If clients do not receive the approval
of Sharia supervision on each contract, they decline the contract (Omar, 2002). Hence,
Sharia supervision is materially derived from the social power of Sharia scholars.
Third, Sharia supervision has an economic power. El-Khelaifi (2002) formulated a
relationship between Sharia supervision and IFI profitability. He argued that the
profitability of an IFI is dependent on the performance of Sharia scholars and concluded
that the assistance of Sharia supervision in creating Sharia-compliant products
enhances IFI profitability. Since the IFIs transactions are backed by fixed assets Sharia
(Hammad, 2006), their investments lead to economic stability and directly contribute to supervision
the gross domestic product. Furthermore, Sharia supervision confirms the absence of
injustice and exploitation in transactions and the non-occurrence of interest on
borrowing and lending (Zighaba, 2009).
Fourth, the legal power of Sharia supervision may be derived from a variety of
sources including regulators (Abdulla, 2001; Al Dareer, 2001); the general law 389
(i.e. the general laws of Jordan, 2000; Kuwait 2003; and Lebanon, 2003); the private law
(i.e. Faisal Banking Group in Egypt and Sudan); the constitution of the IFI (Investment
Dar Co., First Investment Company, Osoul for Leasing and Finance in Kuwait); and the
internal policy of the IFI (Abu Ghudda, 2001; El-Khelaifi, 2005). In the Gulf Cooperation
Council (GCC) countries, both central banks and AAOIFI governance standards require
the existence of an Sharia Supervisory Boards (SSB) in every Islamic bank to be licensed
as an Islamic bank[1]. This enforcement represents the backbone of SSB authority and
makes its fatwas mandatory to the executive management.
Fifth, the IFIs articles of association usually include the appointment of Sharia
scholar by the shareholders (Al Baali, 1991; Fayyad, 2004; Hammad, 2006) to reflect
their commitment in conducting a Sharia-compliant business (Abu Ghudda, 2001;
Hammad, 2002; Hassan, 2001). Hence, the hierarchical position of Sharia supervision
is usually allocated under the shareholders to emphasize its superiority above other
governance organs and confirm its authority in steering the IFIs activities (Al Baali,
1991). Hence, Sharia scholars set their internal policy including tasks, responsibilities,
and relations with other governance organs in the IFI.

4. Sharia supervision: benefits vs costs


The existence of Sharia supervision brings several benefits and costs to the IFIs.
The beneficial side of Sharia supervision includes control over the IFI, guidance to the
management, and better governance. Previous research (Al Baali, 2008; Al Sharif, 2008;
El-Khelaifi, 2005; Farah, 2008) discussed some of these benefits and costs individually,
but this research gathers all of them along side with all the costs.
The Sharia scholars control the IFI contracts by approving them at their inception
stage. At the year end, they audit the completed contracts and issue their Sharia
annual report to express their opinion in the IFIs activities. The report reveals the
results of evaluating the management performance and the distribution of the net
income between the shareholders and investment accounts holders. This type of
control assures the legitimacy of the generated profit and enhances the stakeholders
confidence in the IFIs activities by providing more transparency.
The Sharia scholars guide the executive management by conducting workshops and
lectures to educate the directors and answer their queries. Whenever a new fatwa is issued,
the Sharia scholars explain to the management, the proper way of implementation. They
also explain the way of calculating the annual Zakat and spending any illegitimate profit
for charitable purposes. This type of guidance improves the management performance.
Moreover, the Sharia scholars might be involved in resolving legal disputes between the
management and the clients due to their religious and social positions.
According to the requirements of AAOIFI governance standards and central banks,
Sharia supervision should be allocated between the shareholders and the Board of
Directors (BoD) in the organization hierarchy to ensure its independence from the
JFRC influence of other governance organs. Moreover, Sharia scholars are not permitted to
18,4 hold any executive position or acquire significant ownership in the institution. This
independence enhances the stakeholders confidence in the decisions of the Sharia
scholars as well as the IFIs transactions.
On the other hand, the costs of Sharia supervision include fixed remuneration,
reduction in the IFIs investments, and loss of stakeholders confidence. In the IFIs, the
390 BoD remuneration is usually related to the annual net income; whereas, the remuneration
of Sharia scholars is fixed amount independent from the net income, which affects the
IFIs negatively during the financial distress. In addition, the Sharia supervision has the
supreme authority to cancel any product or investment that does not comply with Sharia
principles, which sometimes deprives the IFI from potential investment and reduces its
market share. On the other hand, the issued fatwas might affect the IFIs performance
negatively and reduce the stakeholders confidence if they are issued by negligent or
unqualified Sharia scholars.

5. Forms of Sharia supervision


Sharia supervision operates at the macro level (country level) as well as the micro level
(institutional level). At the macro level, Sharia supervision is conducted by national or
regional Sharia Supreme Councils (SSCs). Some countries have formulated SSCs inside the
central banks to monitor the IFIs in conduct of Sharia supervision. Other organizations
such as AAOIFI, the General Council for Islamic Banks and Financial Institutions
(CIBAFI), and the Islamic International Rating Agency (IIRA) have formulated their SSCs
to assist IFIs in maintaining their Sharia supervision. At the micro level, Sharia
supervision can be conducted by an SSB or Sharia Consulting Firms (SCFs) or single
Sharia advisor. Figure 1 shows the different types of Sharia supervision at both levels.

5.1 At the macro level


In the last decade, there have been many calls to establish a SSC in each country or
region to oversee the local Sharia supervisors. Some scholars (Abdulla, 2001; Al Haiti,
2009; Al Qattan, 2004; Rabawi, 1993) have proposed that the establishment of SSC to
control the IFIs should be within the central bank. Other scholars (Abu Ghudda, 2002;
Al Haiti, 2009; Al Qattan, 2004; Barian, 2009; Farah, 1994; Hemaish, 2005) have
proposed that the establishment of regional SSCs to guide local Sharia supervisors
should be outside the central banks. In both cases, the SSC was expected to achieve
Sharia supervision Sharia supervision
at the macro level at the macro level

Within the Sharia


SSC of UAE Islamic banks
Monitor & Guide

central banks supervisory board

IIUB SSC Sharia Islamic insurance


Figure 1. Outside the AAOIFI SSC Islamic funds
consulting firm
The types of Sharia central banks IIRA SSC Islamic real estate
and
supervision at macro and CIBAFI SSC Islamic capital
Sharia advisor
micro levels market institutions
four objectives, namely: to purify IFIs transactions from interest, speculation, abuse, Sharia
monopoly, and other similar activities; to ensure IFIs comply with Sharia; to approve supervision
the recruitment of local Sharia supervisors by setting a maximum number of IFIs that
a Sharia scholar may oversee and excluding unqualified candidates (Al Qattan, 2007;
Al Salaheen, 2005); and to collaborate with local Sharia supervisors in offering
standardized products and harmonizing their fatwas (Al Salaheen, 2005).
To achieve these objectives, the SSCs are required to maintain specific functions: 391
review the IFIs policies, constitutions, and documents to ensure their compliance with
Sharia; issue fatwas and decisions for central banks as well as local IFIs whenever it is
required; collaborate with local SSBs in issuing standardized contracts and agreements
(Archer and Karim, 2002); conduct regular auditing on IFIs transactions to ensure their
compliance with Sharia (Al Mazini, 2009); and assist the IFIs in setting comprehensive
programs for training their management.
When local Sharia supervisors contradict each other in their fatwas concerning a new
product or contract, the different fatwas have to be presented to the SSC which meets with
the issuers of the fatwas and subsequently issues a final decree (Al Mazini, 2009). In
addition, the SSC is required to review the unusual/contradicted fatwas and issue a report
expressing its opinion on the issued fatwas. The SSC is also required to approve the new
products and protect the IFIs right in the new product. The SSC has a responsibility to
supervise the conversion of the conventional financial institutions into IFIs.
In the GCC countries: Bahrain, Qatar, Kuwait, Saudi Arabia, and United Arab
Emirates (UAE) SSCs operate both within and outside the central banks.
5.1.1 Supreme Sharia council outside the Central Bank. Most SSCs in the GCC
countries when overseeing the local Sharia supervisors operate outside the Central
Bank. In Kuwait, the IFIs are regulated by the Ministry of Awqaf and Islamic Affairs
which controls the SSBs activities.
In 1978, the SSC of the International Islamic Union Bank was established in Saudi
Arabia under the Organization of the Islamic Conference for the purpose of monitoring
the SSBs of International Islamic Union Bank members (Babli, 1985). In Saudi Arabia,
the Saudi Arabia Monetary Agency (SAMA (2009)) follows the principles of Sharia by
charging no interest on receipts and payments.
In Bahrain in 1991, SSC was established by AAOIFI with a mandate of issuing
Sharia and governance standards for the IFIs and to supervise the SSBs of AAOIFI
members on a voluntary basis (AAOIFI, 2008). In 2005, the SSC of IIRA-Bahrain was
formed to provide a governance and credit rating service to local Sharia supervisors at
any jurisdiction (IIRA, 2009). In 2008, CIBAFI in Bahrain formed a SSC to guide the
local Sharia supervisors of its members all over the world (CIBAFI, 2009). In Bahrain
and Qatar, the central banks have issued exceptional laws for IFIs to work alongside
with the conventional financial institutions without a SSC (Al Henaiti, 2009).
5.1.2 Supreme Sharia council inside the Central Bank. The UAE is the only country
in the GCC region that has a SSC within the central bank. The UAE Government issued
a Unified Law No. 6 in 1985 to establish a SSC to monitor the localized SSBs and ensure
that IFIs comply with Sharia (Al Salaheen, 2005; Bakr, 2001).

5.2 At the micro level


The appropriate type of Sharia supervision is decided by the shareholders according
to the IFI size and the number of products and contracts that will be issued on an
JFRC annual basis (INCEIF, 2006). There is little standardization of Sharia supervision
18,4 among the IFIs. In Islamic banks only, the shareholders are obliged to establish an SSB
to meet the central bank requirements. Hence, Islamic banks have SSBs, while other
types of IFIs choose among SSBs, SCFs, and Sharia advisors.
5.2.1 Sharia supervisory board. The AAOIFI governance standard (2008, No. 1,
Para 7) recommends three members at least in the SSB with one member at least residing
392 in the same IFIs country. The SSB is a panel of three Sharia scholars or more who serve
one IFI. Having three members in the SSB brings four benefits. First, it benefits the SSB
from the collective opinions of diversified members (DeLorenzo, 2004; Kuwait Finance
House, 1985; Al Qaradawi, 2001). Second, it eliminates any conflicts of interest that might
arise from having one Sharia advisor alone (Al Baali, 1991). Third, issuing fatwas and
taking decisions is approved by voting rather than by one Sharia advisor alone
(Al Baali, 1991). Fourth, it enhances the clients confidence in IFIs products and
contracts (Hammad, 2006).
Despite these advantages, there is no ideal number of SSB members. Nevertheless,
having three members might delay the SSB work because the absence of one member affect
the SSB quorum and might delay the issuance of fatwas, which affect the SSB performance
in meeting the IFIs needs. Hence, Abu Memer (1994) concludes that having more members
lead to more compliance with Sharia, while Zoair (1996) suggests ten members in the SSB
to check the IFIs transactions and meet the managements need for consultation.
The AAOIFI governance standard (2008, No. 1, Para 2) defines the SSB as:
[. . .] an independent body of [Sharia scholars] with a [possibility of including] a member
other than a Sharia scholar, who should be an expert in the field of IFIs. The SSB is entrusted
with the duty of directing, reviewing, and supervising the activities of the IFI in order to
ensure that they are in compliance with Islamic Sharia.
This definition explains the structure of the SSB and highlights the responsibilities of SSB
in directing, reviewing, and supervising the IFIs activities to ensure their compliance with
Sharia. In an earlier definition, Hemaish (2005) defines the SSB as:
[. . .] an independent body of Sharia scholars and specialized economists who are responsible
of directing, controlling and reviewing the Islamic bank activities to ensure its compliance
with Islamic Sharia. The SSB fatwas and decisions are mandatory to the bank.
Although this definition supports the AAOIFI definition by explaining precisely the
SSB roles, it focuses on Islamic banks (Zighaba, 2009). On the other hand, El-Khelaifi
(2005) defines the SSB as:
[. . .] a group of Sharia scholars, responsible for looking at the IFIs transactions to protect
them from Sharia offense.
This definition covers the different types of IFIs and emphasizes the SSB role in approving
the IFIs products, contracts and transactions prior to their release (Faris, 2009). This paper
consolidates and builds upon these earlier definitions and defines the SSB as:
[. . .] a panel of Sharia scholars and experts of Islamic finance industry that starts with the
IFIs inception and continues with the IFI to ensure that all the incorporation documents,
internal policy, and activities in compliance with Sharia.
5.2.2 Sharia consulting firm. Although there are 219 IFIs in the GCC countries
(Appendix 1), there are only 100 Sharia scholars in the region who are qualified to sit on
a SSB of a IFI (Appendix 2). This shortage in qualified Sharia scholars has resulted in Sharia
creating SCFs as an alternative to traditional SSBs to meet the IFIs requirements of
Sharia supervision (Mashal, 2008). The SCFs originated in Kuwait in 2003 and have
supervision
spread around the GCC countries in recent years (Mashal, 2008; Al Qattan, 2008). To date
all of the SCFs have been approved either by the central banks of Kuwait and Qatar, or
the Ministry of Commerce in Saudi Arabia according to their location.
The SCFs act as independent contractor such as external auditors. They include 393
full-time Sharia scholars, full-time Sharia internal auditors, and a secretarial team.
The SCFs are qualified to issue fatwas, improve the products, supervise the process of
conversion of any conventional financial institutions into IFIs, and conduct internal
and external Sharia audits (Mashal, 2008; Al Qattan, 2008).
The SCFs are still immature in the provision of their services for a number of reasons.
First, there is no standardized law to organize their relations with the IFIs. Second, there is
no standard framework for the Sharia auditing process (Mashal, 2008). Third, some of the
SCFs act as consultants by issuing fatwas without Sharia auditing to ensure the right
implementation and correct the management violations during the implementation.
Fourth, some of the SCFs use improper advertising to deliver their message such as
offering services that are not related to Sharia supervision, while others are involved in
activities that are not related to Sharia supervision such as underwriting initial public
offerings (Mashal, 2008). To conclude, the current practices of the SCFs need to be
reviewed by the central banks and AAOIFI by issuing new regulations and standards to
guide the SCFs.
5.2.3 Sharia advisor. Omar (2003) defines the role of the Sharia advisor as:
[. . .] issuing fatwas according to one Sharia scholars discretion with neither standardization
nor relation to other Sharia scholars.
A Sharia advisor expresses his religious opinion in the transactions without any
control to ensure the compliance with his opinion. The recruitment of a single Sharia
advisor is a common practice in Jordan, Malaysia, and in some Islamic windows and
branches of conventional financial institutions (Bakr, 2001). In Bahrain, Sakana Real
Estate Company, TAMEER Company, and several IFIs have Sharia advisors.
The recruitment of Sharia advisor is rejected by several scholars (Abdul Bari, 1996;
Al Bayrkdar, 2008; Al Qaradawi, 2001; Al Qattan, 2008; Fayyad, 2004), except for
emergencies or before the constitution of an SSB has been developed (Al Qattan, 2004;
Bakr, 2001). Many commentators have suggested that the work of a Sharia advisor is less
effective and efficient than the teamwork of SSB or SCF, especially in the case of approving
new products and contracts (Al Baali, 1991; Hassan, 2001). Al Baali (1991) emphasized that
having an SSB would eliminate conflicts of interest and doubts, as decisions are made by a
group. On the other hand, El-Khelaifi (2003) and Hammad (2006) have argued that the
fatwas and decisions of Sharia advisor are less authoritative to an IFI because of the lack
of Sharia auditing to ensure the right implementation. The UAE Government has
addressed this issue by passing the Unified Law No. 6 in 1985 requiring each IFI to have an
SSB of three members at least, which supports the concept of having an SSB rather than
one Sharia advisor (Hemaish, 2005).
6. Objectives of Sharia supervision
The AAOIFI governance standard (2008, No. 1, Para 2) dictates the main objective of
Sharia supervision as:
JFRC [. . .] ensuring that all the IFIs activities are in compliance with Islamic Sharia rules and
principles.
18,4
This main objective can be divided into four objectives. First, Sharia scholars oversee the
activities to ensure their utmost compliance with Sharia by matching the products and
contracts against Sharia principles (Al Raee, 2005; Hemaish, 2005). Nevertheless, the
improvement of the products falls under the management responsibility (Bakr, 2002).
394 Previous studies (Abu Ghudda, 2001; Al Dareer, 2001; Fayyad, 2004; Hemaish, 2005)
argued that Sharia scholars have the responsibility of improving products and contracts
to enrich the Islamic finance industry. Accordingly, Sharia supervision aims to review
and improve the IFIs products and contracts to ensure their compliance with Sharia.
Second, the existence of Sharia supervision represents the shareholders in reviewing
the generated income at the year end to ensure its legitimacy (Al Zarrqa, 2002; Hassan,
2001). Therefore, the Sharia scholars issue their annual report to express their opinion in
the transactions and be published with the financial statements.
Third, the Sharia scholars educate the human capital in Sharia rules and principles to
understand the IFIs vision and achieve its objectives (Abu Ghudda, 2001; Al Haiti, 2009).
This objective is achieved by answering the management questions, identifying the errors,
and taking corrective actions towards any violation (Al Dareer, 2001; Al Saad, 2004).
Fourth, the existence of Sharia supervision enhances the stakeholders confidence
in the IFIs products and activities. This goal is achieved by issuing fatwa for each
product and publishing the Sharia annual report at the year end to confirm the
compliance of IFI with Sharia rules and principles.

7. Functions of Sharia supervision


To achieve these objectives, Hassan (2001) proposed two functions: guiding and
controlling. The guiding function includes revision to policies, contracts, and agreement,
and training the management in applying Sharia rules. Also, it involves conducting
research to issues that encounter Sharia scholars in their course of business. On the other
side, the controlling function includes a complete review of transactions to ensure the
compliance by fatwas and decisions.
Al Nashmi (2002) classified the functions into essential functions that cover the
implementation of Sharia over the transactions and supplementary functions which
include all the relationships between Sharia scholars and other governance organs.
However, Al Zarrqa (2002) classified the functions into internal and external functions.
Internal functions include issuing fatwas; controlling IFIs activities to ensure the
appropriate implementations of issued fatwas; and assisting IFIs to achieve their goals.
External functions include assuring that all transactions are Sharia compliant.
Fayyad (2004) classified the functions into moral, practical, consulting,
administrative, and control. The moral function includes the enhancement of clients
confidence in IFIs activities, the practical function includes issuance of fatwas.
The consulting function covers the guidance of Sharia scholars to management and
employees. The administrative function includes the presence of Sharia scholars in the
BoD meetings to discuss Sharia issues and the presentation of Sharia annual report to
express its opinion. The control function includes Sharia audit over completed
transactions and correction of violations.
Hammad (2009) classifies the functions into academic functions and executive
functions. The academic functions cover the enrichment of Islamic jurisprudence
through research, which are accomplished internally via the review of IFIs activities Sharia
against Sharia rules and regulations. The function also involves educating the supervision
employees in Islamic jurisprudence and preparing them to answer the clients questions.
These functions are externally accomplished by publishing the issued fatwas to educate
the community and conducting seminars, conferences, and workshops to address the
problems of Islamic financing industry.
The executive function includes the processes of preventive, remedial, and 395
complementary control. Preventive control includes a comprehensive review of policies,
articles of association, products, and contracts before they are released to the public to
ensure their compliance with Sharia. Remedial control includes auditing during the
execution of contracts and investment projects to ensure the right implementation of
fatwas. Complementary control includes a comprehensive review of all transactions
along with Sharia internal auditors reports.
In addition to the aforementioned classifications, some Sharia scholars (Abdulla,
2001, 2002; Abu Ghudda, 2001; Ahmed, 2003; Al Bayrkdar, 2008; Al Haiti, 2009;
Al Qari, 2003; Al Qorradaghi, 2008; Hammad, 2002) mentioned a number of functions
without any classification, which are presented in Appendix 3. Although the scholars
mentioned different functions, most of them included the following six functions in
their classifications: Sharia approval for the official documents of IFIs establishment,
Sharia approval for IFIs transactions, Sharia auditing for completed transactions,
approving and contributing to creating new products, submitting the SSB annual
report, and answering the management inquiries.
The SSB functions can be classified into supervisory functions and consulting
functions. The supervisory functions include:
.
issuance of fatwas and decisions before executing the transactions;
.
approving new products, contracts, and services;
.
auditing the procedures of implementing new products in collaboration with
Sharia internal auditors;
.
auditing the financial statements at the year end; and
.
approving the distribution of net income between shareholders and investment
account holders.

The consulting functions include:


.
finding Sharia compliant solutions during the implementation of contracts;
.
explaining the way of calculating the due Zakat, which is 2.5 per cent of the
individuals annual wealth donated for charity as almsgiving;
.
guiding the management in allocating the non-Sharia income for charitable
purposes; and
.
conducting workshops and lectures for management and clients.

8. Research limitations
The concepts included in this paper can be used as a platform for identifying the role of
the SSB in the governance structure of IFIs. However, there are still a number of
limitations to this study. First, the research does not address the forms of Sharia
supervision in other geographies such as middle East and far East countries, which have
JFRC a significant number of IFIs. Second, the study emphasizes the role of the SSB and
18,4 excludes the role of the alternative forms (SCF and Sharia advisor), which might have
different impact on the governance of the IFIs. Third, the study excludes the impact of
the IFIs stakeholders on the SSB role.

9. Recommendations for improvement


396 To improve the performance of Sharia supervision, there are several recommendations
that need to be considered at the macro level as well as the micro level. At the macro level,
the AAOIFI governance standards need to be enforced on the IFIs rather than used on a
complementary basis to standardize the work among the IFIs. Moreover, the central
banks and the SSCs need to promulgate comprehensive regulations to organize the
recruitment of SSB members and protect the IFIs privacy. The regulations should
control the multiple memberships for each Sharia scholar and the privacy of keeping the
information in case of being a member in two different boards.
At the micro level, it is recommended to establish governance committee in each IFI,
and set the code of conduct along with internal policies. This will urge the governance
organs to review their current practices and change them accordingly to meet the new
requirements. Also, it will enhance the stakeholders confidence in the governance
practices of the IFIs.
It is recommended to set the Sharia scholars under the shareholders in the
organization chart to emphasize their independence from other governance organs. In
addition, it is recommended that shareholders be more involved in recruiting the Sharia
scholars, setting up their remuneration, and evaluating their performance. On the other
hand, Sharia scholars need to gain more experience in finance, economy, and commercial
law to apply Sharia principles within the context of current financial activities. This can
be achieved by diversifying their memberships in different types of IFIs rather than
focusing on one type (i.e. Islamic banks only). Also, the contribution in conferences,
workshops, further study, and recruitment of Sharia scholars from different countries.

10. Conclusion
Sharia supervision plays an essential role in the governance of IFIs. It has different
forms at macro and micro levels. At the macro level, Sharia supervision is conducted
by SSC within and outside the central banks. At the micro level, it is conducted by SSB,
SSC, and Sharia advisor. The SSB is the mostly common form of supervision. The SSB
derives its importance from five resources: religious, social, economic, legal, and
governance and aims to ensure that IFIs activities are Sharia compliant through
supervising management and providing them with guidance.

Note
1. The central banks requirements from the IFIs concerning the establishment of the SSB are
listed on their web sites: Central Bank of Bahrain, www.cbb.gov.bh (accessed 30 June
2009); Central Bank of Kuwait, www.cbk.gov.kw (accessed 25 June 2009); Central Bank of
Qatar, www.qcb.gov.qa (accessed 28 June 2009); Central Bank of UAE, www.centralbank.
ae (accessed 27 June 2009); Doha Securities Market, www.dsm.com.qa/dsmsite/ (accessed
28 June 2009); Dubai Financial Market, available at: www.dfm.co.ae (accessed 27 June
2009); and Dubai Financial Service Authorities, available at: www.dfsa.ae (accessed
27 June 2009).
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Mimeo, Ministry of Foreign Trade, Cairo.

(Appendices follow overleaf.)


18,4

402
JFRC

worldwide
Table AI.

financial institutions
The number of Islamic
No. Country Bank Insurance Investment bank Capital market Real estate Fund Total

1 Albania 1 1
2 Algeria 2 2
Appendix 1

3 Australia 1 1 1 3
4 Azerbaijan 1 1
5 Bahrain 7 9 18 3 3 40
6 Bangladesh 5 1 1 7
7 Bosnia/Herzegovina 1 1
8 Brunei 2 1 3
9 Egypt 2 1 3
10 Gambia 1 1
11 Germany 3 3
12 Guinea 1 1
13 India 1 1 2
14 Indonesia 3 2 5
15 Iran 12 1 2 1 16
16 Iraq 1 1 2
17 Jordan 2 3 2 7
18 Kenya 1 1
19 Kuwait 3 6 37 13 19 78
20 Lebanon 3 1 2 6
21 Malaysia 16 12 3 3 34
22 Mauritania 1 1 2
23 Niger 1 1
24 Nigeria 1 1
25 Pakistan 8 3 10 6 2 29
26 Palestine 4 4
27 Philippines 1 1
28 Qatar 6 2 5 2 4 1 20
29 Russia 1 1
30 Saudi Arabia 9 15 8 5 1 38
31 Senegal 1 1 1
32 Singapore 1 1 2
(continued)
No. Country Bank Insurance Investment bank Capital market Real estate Fund Total

33 South Africa 1 1 3 5
34 Sri Lanka 1 1
35 Sudan 10 5 7 1 5 2 30
36 Switzerland 2 1 3
37 Syria 3 3 6
38 Thailand 1 1
39 Tunisia 1 1 1 3
40 Turkey 2 1 3 5
41 UAE 10 7 7 11 3 5 43
42 UK 6 4 4 2 7 5 28
43 USA 4 3 5 12
44 Yemen 3 1 4
Total 130 83 120 40 55 30 458
Note: The countries highlighted in italics are the GCC countries
Sources: GCC central banks; GCC stock exchanges; Zawya Database (2009); Securities Database (2009); CIBAFI (2009); Arab Banking and Finance
Directory (2009/2010); McKinsey & Company (2008/2009); Kulathakal (2007) and Direct calls
supervision
Sharia

Table AI.
403
JFRC Appendix 2
18,4
No. Sharia scholar Bahrain Kuwait Qatar KSA UAE Total

1 Abd El-Hady Mohammed Zarie (PhD) 1 1


2 Abdel Aziz Al Gasim (Sheikh) 1 1
404 3 Abdellatif Derian (Sheikh) 1 1
4 Abdel-Rahman bin Saleh Al-Atram (PhD) 1 1 2
5 Abdul Aziz Al Khulaifi (Sheikh) 1 1
6 Abdul Aziz Al-Qassar (PhD) 11 11
7 Abdul Dayem Abu Al Maaali 1 1
8 Abdul Latif Ahmed Al Sheikh (PhD) 1 1
9 Abdul Latif El Mahmoud (PhD) 5 1 6
10 Abdul Mohsin Al Asfoor (Sheikh) 1 1
11 Abdul Qader Al Amarei (Sheikh) 3 3
12 Abdul Rahman ibn Abdullah ibn Aqeel (Sheikh) 1 1 2
13 Abdul Sattar Abu Ghuddah (PhD) 14 7 1 2 7 31
14 Abdulaziz bin Hamad Amishal (PhD) 1 1
15 Abdulbari Mishaal (PhD) 2 2
16 Abdul-Hamid Al-Bali (PhD) 2 2
17 Abdulla Mohammed Al Mutlaq (PhD) 4 4
18 Abdullah bin Abdulaziz Al Musleh (PhD) 3 1 4
19 Abdullah bin Bayyah (Sheikh) 1 1
20 Abdullah bin Khunain 1 1
21 Abdullah bin Musa Al-Ammar (PhD) 1 1
22 Abdullah Bin Sulaiman Al Manea (Sheikh) 5 11 1 17
23 Abdullrazaq Al Shayji (PhD) 1 1
24 Abdul Sattar A. Al-Kattan (Sheikh) 5 5
25 Abou Salman Aziz (Sheikh) 1 1
26 AddulAziz bin Fawzan Al Fawzan (PhD) 1 1
27 Adnan Al Qattan (Sheikh) 4 4
28 Adulaziz bin Abulrahman Al Mosnad (Sheikh) 1 1
29 Ahmed Al-Hajji Al-Kurdi (PhD) 1 1
30 Ahmad Bazie Al-Yaseen (Sheikh) 1 8 9
31 Ahmad bin Abdul Aziz bin Baz (Sheikh) 1 1
32 Ahmad bin Humaid 1 1
33 Ahmad Sair Mubaraki 1 1
34 Ahmed Abdul Aziz Al Haddad (PhD) 1 1
35 Ahmed Mohiadeen Ahmed (PhD) 1 1
36 Ajeel Jassim Al-Nashmi (PhD) 3 8 6 17
37 Ali Al Mohamady (PhD) 3 3
38 Ali Moehi El Din Al Qaradaghi (PhD) 3 2 3 5 13
39 Anwar Shuaib Abdulsalam (PhD) 1 5 6
40 Dato Sheikh Gazali bin Abdul Rahman (Sheikh) 1 1
41 Esam Khalaf Al-Enezi (PhD) 1 5 6
42 Essa Zaki Essa Abo-Shaqrah (PhD) 1 12 1 14
43 Essam Mohammed Ishaq (Sheikh) 3 1 4
44 Fareed Mohammed Hadi (PhD) 1 1
45 Fareed Yaqoub Al Miftah 1 1
46 Farees Mohammed Hadi (Sheikh) 1 1
47 Hamad Al Mahmoud (Sheikh) 2 2
Table AII. 48 Hammed Abdulrhman Al Janidal (Sheikh) 1 1
The number of SSBs for 49 Hamza bin Hussain Al Qamar (PhD) 1 1
Sharia scholars in GCC 50 Hany AbduShakur (Sheikh) 1 1
countries (continued)
No. Sharia scholar Bahrain Kuwait Qatar KSA UAE Total
Sharia
supervision
51 Hasan Al-Shathli (PhD) 2 2
52 Hassan Awad (Sheikh) 1 1
53 Hassan Filimban (Sheikh) 1 1
54 Hussain Hamid Hassan (PhD) 2 11 13
55 Ibraheem Al-Jarbou 1 1
56 Ibrahim Abdullah Al-Sibiie (PhD 1 1 405
57 Isa Abdulla Al Duwaishan (Sheikh) 1 1
58 Jassem Ali Shamsi (PhD) 1 1
59 Kahlad Al Safei (PhD) 1 1
60 Khaled Shuja Al-Otaibi (PhD) 2 2
61 Khalid Mathkour Al-Mathkour (PhD) 2 10 12
62 Khalid S. Al Otaibi (PhD) 1 1
63 Mishaal Al Enazi (PhD) 1 1
64 Mohammed Abdul Gaffar Al-Sharif (Sheikh) 1 1
65 Mohammed Abdul Hakim Zoeir (PhD) 1 4 5
66 Mohammed Abdul Razzaq Al Siddiq (Sheikh) 6 6
67 Mohammed Abdulrazaq Al-Tabtabae (PhD) 2 6 8
68 Mohammed Ali El Gari (PhD) 7 1 1 9 6 24
69 Mohammed Anas Zarka (PhD) 1 1
70 Mohammed Arbouna (PhD) 1 1
71 Mohammed bin Saud Al-Osaimi (PhD) 1 1
72 Mohammed Damas Al-Ghamdi (PhD) 1 1
73 Mohammed Daud Bakar (PhD) 3 3 6
74 Mohammed Fawzi Faidhalla (PhD) 7 7
75 Mohammed Imran Usmani (PhD) 1 1 2
76 Mohammed Jaffar Al Jiffari (Sheikh) 1 1
77 Mohammed Taqi Usmani (Judge) 1 1 1 3
78 Naif Mohammad Al-Ajami (PhD) 1 1
79 Nayef M. Al Ajmi (PhD) 1 1
80 Nazih Hammad (PhD) 1 1
81 Nizam Yaqubi (Sheikh) 18 5 7 30
82 Omar Abdul Aziz (PhD) 3 3
83 Osaid Mohammed Adeeb Kailani (Sheikh) 1 1
84 Osam Qyis Al-Deraiay 1 1
85 Osama Mohamed Bahar (Sheikh) 1 1 2
86 Riyad Al-Khulifi (PhD) 1 1
87 Saad bin Mohammed (Sheikh) 1 1
88 Saleh Al Meziad (PhD) 1 1
89 Saud Abdullah Al-Funaisan (PhD) 1 1
90 Saud Mohammed Al-Rabea (PhD) 1 1
91 Siddiq Mohammed Al-Amin Al Dareer (PhD) 2 2
92 Sultan Al Hashemy (PhD) 1 1
93 Waleed Al Mahmoud (Sheikh) 1 1
94 Walid Bin Hady (Sheikh) 2 2
95 Walid Hadi (Sheikh) 1 1 2
96 Yousef Hassan Al-Sharrah (Sheikh) 1 1
97 Yousif bin Abdullah Al-Shubaily (PhD) 1 1 2
98 Yousuf Al Qaradawi (Sheikh) 3 3
99 Yousuf Al Sharah (PhD) 1 1
100 Yusuf Talal DeLorenzo 2 2 4
Total 99 115 28 56 66 364

Sources: Zawya Database (2009); Securities Database (2009); CIBAFI (2009); IFIS (2009) and Arab
Banking and Finance Directory (2009/2010) Table AII.
18,4

406
JFRC

functions
Table AIII.
Classifications of the SSB
Appendix 3

Al
Functions Abu Ghudda Hammad Abdulla Ahmed Al Qari Al Haiti Al Qorra Daghi Beriquridar

Sharia approval for official documents X X X X X X


Sharia approval for IFIs transactions X X X X X X X X
Issuing fatwas for new products X X X X X
Sharia auditing for completed transactions X X X X X X X X
Finding solutions to non-compliant transactions X X X X X
Approving and contributing to creating new
products X X X X X X
Equipping the employees X X X X
Auditing the annual financial statements X X X X X
Excluding the non-Sharia income X X
Explaining the way of computing Zakat X X
Submitting the annual report X X X X X X
Providing Sharia legislation X X X X
Representing the IFI X X X X
Answering the inquiries X X X X X X X
Consulting the shareholders, BoD, and CEO X X X X
Conducting Research in Islamic banking X X
Total functions 14 11 10 8 5 12 9 9
Note: The italicized functions are the functions most used by the researchers
About the authors Sharia
Samy Nathan Garas has almost 19 years of experience in Accounting and Finance in both
academia and practice in Egypt and Bahrain; he held senior positions in multinational firms in supervision
Egypt. He moved to Bahrain ten years ago to be a Lecturer of Accounting in New York Institute of
Technology. In 2005, He was awarded the Professor of the Year award from NYIT. During the last
four years, all his researches and writings have been focused on corporate governance in Islamic
financial institutions (IFIs). Recently, he participated in the CIPA training program provided by
the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). He 407
received his MBA from University of Phoenix, Arizona in 2006, and is about to defend his doctoral
dissertation in University of St Gallen, Switzerland. His doctoral dissertation discusses the role of
the Sharia Supervisory Board in the governance of IFIs in the GCC countries. Samy Nathan Garas
is the corresponding author and can be contacted at: samynathan@nyit.edu.bh
Chris Pierce is the Chief Executive Officer of Global Governance Services Ltd in the United
Kingdom. He is a Director on a number of boards in the UK and overseas. He is internationally
renowned for his work with policy makers, directors and boards in Europe, Asia, Africa, the USA
and South America. Prior to becoming CEO, he was the Director of Professional Standards and
Professional Development at the Institute of Directors (IoD) in the United Kingdom. He has also
held senior management positions in the Overseas Development Administration, British Airways
and Leeds Business School. Chris Pierce has written extensively on director and board
development issues and regularly speaks at international conferences. His qualifications include
an Economics degree, a Post Graduate Certificate in Education, a Masters degree in Science, a
Masters degree in Philosophy and an MBA. He is a Chartered Company Secretary and
Administrator, an Executive Fellow of Henley Management College, a Visiting Fellow at Cranfield
Management School, a Fellow of the Caux Round Table and a Fellow of the Royal Society of Arts.

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