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ROLES AND RESPONSIBILITIES OF SHARIAH ADVISORS

IN ISLAMIC BANKING INSTITUTIONS

By: Omar Mustafa Ansari - FCA

Shariah compliance is the core and essence of Islamic banking. This


statement emerges from the fact that Islamic banking has taken grounds from
the need of Muslim Ummah to have opportunities to carry on their banking and
relevant commercial activities in line with the principles devised by Islamic
Shariah.
In the Islamic banking practices, the core responsibility of guiding and
supervising the operations of Islamic banks rests with respectable Shariah
Scholars duly appointed as the Shariah Advisors and members of Shariah
Boards of these institutions. Although, over the last decade, international
standard setting bodies and regulators have made numerous efforts to
standardize and homogenize the practices of Islamic banking amongst
institutions and even across borders, yet, it is the core responsibility of the
Shariah Advisors to determine the requirements of Shariah for different
transactions and contracts.
The Shariah Boards and the Shariah Advisors are the central point for
Shariah compliance, and they are the ones on whose reliance, people rely on
Islamic banking and financial institutions. In this article, we will try to
summarize the roles and responsibilities of the Shariah Advisors and the
members of the Shariah Boards in this respect.

Role of Shariah Scholars on Governance and Risk Management for Islamic


Banking
Islamic Financial Services Board (IFSB) standards state that Shariah
compliance is central in assuring the integrity and credibility of the Institutions
offering Islamic Financial Services (IIFS). They state that Shariah non-
compliance risk is the risk that arises from IIFSs’ failure to comply with the
Shariah rules and principles determined by the Shariah Board of the IIFS or the
relevant body in the jurisdiction in which the IIFS operate.
According to these standards, Shariah compliance is critical to IIFSs’
operations and such compliance requirements must permeate throughout the
organization and their products and activities. As a majority of the fund
providers uses Shariah-compliant banking services as a matter of principle,
their perception regarding IIFSs’ compliance with Shariah rules and principles
is of great importance to their sustainability. In this regard, Shariah compliance
falls within a higher priority category in relation to other identified risks. They
accordingly, require that IIFS shall have in place adequate systems and
controls, including Shariah Board / Advisor, to ensure compliance with Shariah
rules and principles.

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Roles and Responsibilities of Shariah Advisors of Islamic Banking Institutions
By: Omar Mustafa Ansari
IFSB standards also give Shariah compliance a significant place in the
overall governance framework of an IIFS. According to these standards, IIFS
shall establish a comprehensive governance policy framework, which will guide
them in cultivating a good governance culture. In its governance policy
framework, the IIFS should be able to set out the strategic roles and functions
of each organ of governance, including the Board of Directors (BOD), its
committees, the executive management, the Shariah Supervisory Board (SSB),
the internal and external auditors, etc.. It should also address the mechanisms
of balancing the accountabilities of each of the organs of governance to
various stakeholders.

Appointment of Shariah Advisors


In Pakistan, every Islamic Banking Institution (IBI) is required to appoint a
Shariah Advisor (SA). It is required that the appointment of SA together with its
terms and conditions should approved by the BOD in case of a local corporate
bank, and by the Management / Country Head in case of branches of foreign
banks.

The appointment of a SA is for a renewable period of three years. SA should


meet the “Fit and Proper Criteria” for SA issued by the State Bank of Pakistan
(SBP) and this appointment also requires a pre-approval by the SBP.

Legal Status of Shariah Boards in Pakistan


In Pakistan, SBP has given all the relevant authorities relating to Shariah
interpretations, review and supervision to the SA and the formation of a
Shariah Board (SB) is not mandatory. However, in certain banks, particularly
the full-fledged banks, there are certain SBs and committees comprising at
least two members.
An issue arises, as to whether these SBs have any legal authority in
Pakistan or these are functioning just as a “marketing symbol”? In case of full-
fledged banks, which have included the setting-up of a SB in their Articles of
Association, the SB has a legal standing and the bank is obliged to abide by its
rulings and decisions. In certain cases, particularly, the Articles define that
Shariah means interpretation of their SB. In such cases, these banks are
obliged to obtain Shariah rulings from their respective SB in all Shariah
matters.
Generally, in Pakistan, the BOD appoints the SB.
According to the standards issued by the Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI), the SSB is an
independent body of specialized jurists, which is entrusted with the duty of
directing, reviewing and supervising the activities of an Islamic Financial
Institution (IFI). Shareholders in Annual General Meeting (AGM) upon
recommendation of BOD appoint it, although they may authorize BOD to fix
the remuneration of SSB.
These standards define that SSB shall consist of at least three members.
The SSB may seek the services of consultants who have expertise in business,
economics, law, accounting or others fields.

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Roles and Responsibilities of Shariah Advisors of Islamic Banking Institutions
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It needs to be clarified that AAOIFI’s governance and auditing standards
have no legal standing in Pakistan, although these can be applied as
benchmark for global best practices.
In this regard, IFSB standards are comparatively liberal. They require that
the IIFS shall have in place an appropriate mechanism for obtaining rulings
from Shariah scholars, applying Fatawa and monitoring Shariah compliance in
all aspects of their products, operations and activities. However, they allow
that outside scholars may also provide these guidelines and rulings.

Core Responsibilities of SA as per SBP’s Instructions


SBP requires that SA should review operations of the IBIs on a periodic
basis for Shariah compliance to ensure that all the products and services
offered by the IBI conform to the injunctions of Shariah rules and principles.
However, there is a point crucial for understanding, that the role of review
encompasses “all the products and services.” There is a dire need for further
clarification in this area, as there are many functions, which at present, are
considered outside the ambit of SA e.g. Human Resource policies, Marketing
policies, Public Relations and so on.
SA is also required to vet all the related policies and agreements
regarding the products, and their respective manuals. Once again, there might
be some operational areas, which remain outside the ambit of the functions of
the SA. SA is, however, responsible for all locations of the IBI.
SA shall on an ongoing basis ensure that all products, services, related
policies, and agreements of IBIs comply with Shariah rules and principles.
Particularly, before launching any new products and services, SA shall duly vet
the related policies and agreements.
SA shall review operations of the IBI on periodic basis in coordination
with officials responsible for Shariah compliance to ensure that all the products
and services offered by the IBI conform to the injunctions of Shariah.

According to IFSB standards, the mechanism for obtaining rulings from


Shariah scholars, applying Fatawa and monitoring Shariah compliance shall
cover, both, ex ante and ex post aspects of all financial transactions carried
out by the IIFS. It means to ensure Shariah compliance of the contracts and,
later, the performance of obligations under the contracts, as well as, the
operations of the IIFS, including aspects such as Shariah compliance review,
investment policies, disposal of non-Shariah-compliant income, charitable
activities, etc.

SA’s Access to Records


SBP empowers SA to have access to all records, documents and
information from all sources including professional advisors and IBI employees
in discharge of his duties. The management shall be responsible to provide him
all information relating to the IBI’s compliance with Shariah.

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Roles and Responsibilities of Shariah Advisors of Islamic Banking Institutions
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SA’s Responsibility for Training
SBP makes SA responsible to conduct / arrange Shariah training
programs for the IBI’s staff in coordination with the management.
Whenever we talk about Islamic banking and finance, at any forum,
people including the SAs express the dire need of training for IBI staff.
However, still this is one of the weakest areas in Islamic banking. SA should
have access to the training records of each individual and should supervise
and arrange the setup of training courses, internally as well as, externally. SA
should also ascertain the suitability of the training programs and the budgets
available for training, as it is one of the key responsibilities of the SA.

Annual Report of Shariah Advisor


SBP requires that based on review conducted by the SA, he shall issue an
annual report, which shall be published in the IBI’s annual report.
In this respect, it would be worthwhile to refer to the IFSB’s standards,
which require that IIFS shall undertake a Shariah compliance review at least
annually, performed either by a separate Shariah control department or as part
of the existing internal and external audit function by persons having the
required knowledge and expertise for the purpose. The objective is to ensure
that the nature of the IIFS’s financing and equity investment and their
operations adhere to the applicable Shariah rules and principles as per the
Fatawa, policies and procedures approved by the IIFS’s SB.
Important aspects of the SA’s report include the following:
SA has to report, as to whether he has examined, on test check basis,
each class of transaction, the relevant documentation and procedures adopted
by IBI. It implies that he shall examine the documentation and procedures
(including application of procedures) for each class of transaction i.e. each
product and service.
It is also important to note that since it is an annual report, hence, this
examination shall not be confined to the new products only, and instead, he
should examine all the products in which the bank has entered into during the
current year, irrespective of approval of the said product, maybe, a few years
back.
SA also has to render his opinion, as to whether the affairs of IBI have
been carried out in accordance with rules and principles of Shariah, SBP
regulations and guidelines related to Shariah compliance and other rules, as
well as, with specific Fatawa and rulings issued by him from time to time. In
other words, it means that while he is responsible for determining compliance
with his own rulings, he also has to ensure compliance with the SBP regulation
for Shariah compliance.

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SA is also required to give opinion in respect of profit and loss computation and
distribution, as well as, the Haram income and charity.

Standards for Shariah Review


While SBP defines the contents of the annual report of SA, which includes
the broad scope of review, it is silent about the methodology and detailed
scope of such review. In this respect, it is advisable to refer to the relevant
AAOIFI’s standard.
According to the said standard, Shariah review is an examination of the
extent of an IFI’s compliance, in all its activities, with the Shariah. The
objective of the Shariah review is to ensure that the activities carried out by an
IFI do not contravene the Shariah.
While the SSB is responsible for forming and expressing an opinion on
the extent of an IFI’s compliance with the Shariah, the responsibility for
compliance therewith rests with the management of an IFI.
This standard also defines the broad scope and methodology for the
Shariah review that includes: planning review procedures; executing review
procedures; and preparation and review of working papers; and documenting
conclusions and report. It also requires that the SSB shall implement adequate
quality control policies and procedures to ensure the conduct of review in
accordance with this standard.
IFSB Standards broadly describe that for internal Shariah compliance
reviews, the SSB or Shariah scholars of IIFS shall work together with either a
separate Shariah control department or the designated internal auditors /
Shariah reviewers. This would enable the SSB or Shariah scholars to advise the
Shariah control department or designated internal auditor / Shariah reviewers
on the scope of audit / reviews required. As the Shariah control department or
designated internal auditors / Shariah reviewers shall be responsible for
producing the internal Shariah compliance reports, they shall acquire the
relevant and appropriate training to enhance their Shariah compliance review
skills.

SA’s Responsibility for Profit and Loss Distribution


SBP requires that IBIs shall have a policy statement in place, vetted by
the SA and approved by the BOD.
SBP further requires that in the annual report, SA shall report as to
whether or not in his opinion, the allocation of funds, weightages, profit sharing
ratios, profits and charging of losses (if any) relating to PLS accounts conform
to the bases vetted by him in accordance with Shariah rules and principles.

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In addition, SBP also requires that based on aforementioned policy, the
distribution of profit and loss by IBIs shall be subject to verification / audit
jointly by SA and the external auditor.

SA’s Responsibility for Charity Fund


SA has the authority to declare the income considered non-compliant
with Shariah that should be credited to the charity fund. These instances may
arise out of his normal Shariah compliance supervisory requirements or
because of internal or external Shariah audit. Except for the amounts of
purification from capital market operations in line with a set of rules, SA is the
only authority to decide which income has to be taken to charity.
SBP also empowers the SA to vet the policy in respect of the utilization of
the amount in charity fund for charitable and social welfare purposes. This is a
key area of weakness in Islamic banking because, in a number of IBIs, these
policies are not clear and the funds remain idle for long periods.
SA is also required to include his opinion in his annual report as to
whether any earnings realized from sources or by means prohibited by Shariah
rules and principles have been credited to charity account. This is a very
controversial matter and needs to be dealt with due care and prudence.
SA also has the authority, at his sole discretion, to approve deposit of
such funds in a Shariah compliant remunerative account.

Limitations of SA’s Authority for Interpretation of Shariah


According to SBP, SA has full authority for decisions and rulings subject
to anything contained in the Instructions and Guidelines for Shariah
Compliance in IBIs and the instructions, guidelines and directives issued by
SBP Shariah Board from time to time.

SA’s Powers to Adopt AAOIFI’s Shariah Standards


SBP authorizes the SA to adopt / use as a guideline, the AAOIFI’s Shariah
Standards for the Islamic financing modes for which the SBP has not prescribed
the essentials.

SBP’s Conflict Resolution Mechanism


SBP has also provided a dispute resolution mechanism. According to the
said mechanism, in case any difference of opinion between SA of the IBI and
SBP’s inspection staff or other SBP department regarding Islamic banking
practices, SBP may refer the case to SBP Shariah Board and the decision of
SBP Shariah Board, notified by SBP, shall be final.
IBIs may refer issues relating to Shariah compliance to SBP for
consideration of SBP Shariah Board. In case management of any IBI has a
difference of opinion on any ruling of their SA based on Shariah principles, the
management shall refer the case to the audit committee or BOD for decision.
In case the matter remains unresolved, the same shall be referred to SBP
Shariah Board for final decision. The management shall produce the ruling and
arguments of SA along with their views based on Shariah. The decision of the
SBP Shariah Board, notified by SBP, shall be final.

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SA of any IBI, with the concurrence of management, may also refer
issues relating to Shariah compliance to SBP for consideration of SBP Shariah
Board along with his arguments based on Shariah. The SBP Shariah Board shall
provide guidance in such cases at its earliest convenience.

Resignation and Termination of SA


Termination of SA or his removal before the expiry of his term shall be
with the approval of authority, which has approved his appointment i.e. BOD in
case of local IBIs and the management in case of branches of foreign banks.
IBIs shall be required to notify SBP of any resignation or termination of
the SA within 14 days of the date of resignation or termination. IBI shall also
state the reasons of such termination and alternate arrangements for interim
period.
It is worthwhile to note that according to AAOIFI standards, the dismissal
of member of the SSB shall require a recommendation by the BOD and
approval of the shareholders in a general meeting.

Responsibility for Shariah Compliance Mechanism


SBP’s guidelines require establishment of a strong and sound Shariah
compliance mechanism, within each IBI as a part of its control structure. SA
has to play a central and pivotal role in this function.
These guidelines suggest close coordination of compliance officials with
SA of the IBI, which may further help in streamlining the process with
necessary inputs by the SA. In addition, irregularities, if any, related to Shariah
compliance shall be properly recorded and rectified with the approval of SA.

To some extent, we may conclude that SA is responsible to have an oversight


on the overall Shariah compliance mechanism.

Limited Responsibility in Respect of Internal Shariah Audit


While Shariah compliance may be termed as amongst the responsibilities
of the SA, internal Shariah audit does not form a part of his responsibilities.
Unfortunately, in our culture, compliance and internal audit, which are different
phenomenon; are being used and applied interchangeably. It is pertinent to
note that in order to ensure the independence of SA, as well as, to avoid the
self review threat, it is better to avoid involvement of SA in the internal Shariah
audit process.
According to SBP’s guidelines for internal Shariah audit, which are
primarily in line with AAOIFI’s standard on internal Shariah review, the internal
Shariah auditors shall have direct and regular communications with
management and SA. Any disputes / difference of opinion between
management and Internal Shariah auditors on matters relating to Shariah
interpretation shall be referred to the SA for decision. Similarly, the final report
of the internal Shariah audit shall be placed before the SA for advising the
appropriate corrective action.

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Roles and Responsibilities of Shariah Advisors of Islamic Banking Institutions
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Accordingly, one may conclude that the internal Shariah audit function is
outside the ambit of the functions of the SA, except for giving the rulings on
differences of opinions and the corrective measures.

Difference between Advisory and Supervision


According to a definition taken from www.dictionary.com, an advisor is
“One that advises, such as a person or firm that offers official or professional
advice to clients.” On the contrary, a supervisor is “a person who supervises
workers or the work done by others; superintendent” or “one who is in charge
of a particular department or unit.”
SBP regulations, in Pakistan, use the term “Shariah Advisor” while AAOIFI
standards use the term “Shariah Supervisory Board.” IFSB standards are
comparatively open and do not standardize the term. However, while providing
best practices these standards state that Shariah compliance is central in
assuring the integrity and credibility of IIFS, and is one of the ultimate
responsibilities of the BOD. As a result, the BOD needs to establish a swift and
efficient mechanism, as and when required, to obtain rulings from Shariah
scholars and monitor Shariah compliance. The Shariah scholars may be
external or internal, depending on the requirements of the IIFS’s business
model.
In view of the above, a question arises as to whether the responsibilities
of these scholars are of advisory in nature, or that of the supervision. In our
humble view, since review, monitoring and oversight are amongst their
functions, hence, their responsibility is not of advisory, but of supervision in
nature. This is correct in light of all, i.e. SBP, AAOIFI and IFSB standards,
irrespective of the nomenclature and terms used.

SA’s Responsibilities to the Auditors and Advisors


SBP also requires that if the legal counsel, auditor or consultant of an IBI
seeks advice on the Shariah matters from the SA, he shall provide such advice
to them. However, it does not provide detailed mechanism in this respect.

Whom SA should Report?


SA reports functionally to the BOD, in case of IBIs incorporated in
Pakistan. In case of branches of foreign banks, SA reports to the Country Head.
Nevertheless, as per AAOIFI standards, SSB is an independent body and
is accountable to the shareholders only. This apparently provides better
support and increased level of “independence” to these scholars.

Auditors’ Testing for Shariah Compliance


According to AAOIFI’s relevant auditing standard, when testing for
Shariah compliance, the auditor shall obtain sufficient appropriate audit
evidence in this respect. For this purpose, the rulings and guidance issued by
SSB form the basis on which the auditor considers whether the IFI has
complied with Islamic Shariah rules and principles.

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Roles and Responsibilities of Shariah Advisors of Islamic Banking Institutions
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The auditor shall issue his report only after he has taken note of the
SSB’s draft report on the IFI’s compliance with Islamic Shariah rules and
principles. If the SSB’s draft report indicates that compliance with Islamic
Shariah rules and principles is lacking, and the auditor decides, based on the
SSB’s draft report, to modify his draft report, he shall provide an adequate
explanation of the nature of and reasons for the modification.
Even in Pakistan, in case of full-fledged Islamic banks, normally the
auditors require first obtain the SA’s / Shariah Auditors’ report to ascertain
compliance of Shariah because it is required by the objects of the banks.

Independence of SSB / SA
The importance of SSB emanates from its role in enhancing the public
confidence in IFIs, as well as, achieving the fundamental objective of an IFI.
Accordingly, AAOIFI has given due weightage to the independence of SSBs and
has issued a comprehensive standard on the same.
The said standard defines independence as an attitude of mind, which
does not allow the viewpoints and conclusion of its possessor to become reliant
on or subordinate to the influences and pressures of conflicting interests. It is
achieved through organizational status and objectivity.
These standards specifically require that the SSB should not include
directors or significant shareholders of IFI.

Conclusion
The objective of this article is to summarize and identify the roles and
responsibilities of Shariah Advisors and Shariah Boards according to the
Pakistan law, as well as, according to the international best practices. It is
expected, that the same shall be beneficial for both, the Shariah scholars and
the management of the IFIs enabling them to improve the overall Shariah
compliance mechanism and to comply with the legal requirements and the
global best practices.

Acronyms
AAOIFI – Accounting and Auditing Organization for Islamic Financial
Institutions
AGM- Annual General Meeting
IBI – Islamic Banking Institution
IFSB – Islamic Financial Services Board
IFI – Islamic Financial Institution
IIFS – Institutions offering Islamic Financial Services
SA – Shariah Advisor
SB- Shariah Board
SBP – State Bank of Pakistan
SSB – Shariah Supervisory Board

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Roles and Responsibilities of Shariah Advisors of Islamic Banking Institutions
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Sources and Acknowledgment
The primary source for compilation of this article is SBP’s Shariah
Compliance Instructions and Guidelines. In addition, considerable guidance has
been taken from AAOIFI’s relevant Auditing and Governance Standards and
IFSB’s Standards on Corporate Governance and Risk Management.
The author acknowledges with the thanks the contribution made by his
colleague Syed Saleem Haider in collection and summarization of the
requirements of relevant standards, and Br. Mahmood Shafqat (Sr. Joint
Director - State Bank of Pakistan) for taking his time in review of this
document. Jazak Allah.

Disclaimer
The author wrote this article in his personal capacity, and not as a
partner of the firm. Its contents are correct to the best of his knowledge as of
the date of writing and distributing the same. It is being presented in good
faith and it should be regarded neither as comprehensive nor sufficient for
making decisions, nor should it be used in place of professional advice. The
author and his firm do not accept any responsibility for any loss arising from
any action taken by anyone using this material. All the readers are advised to
refer to the original law, regulations and standards before taking any action or
to seek professional advice accordingly. (Dated: March 18, 2009).
About the Author
Omar is a fellow member of the Institute of Chartered Accountants of Pakistan.
Presently, he is working as Partner – Islamic Financial Services Group at Ford
Rhodes Sidat Hyder & Co. which is a member firm of Ernst & Young Global
Limited. Omar has considerable experience in providing services to Islamic
finance industry particularly including audits, Shariah audits, training, manual
development, risk management, product structuring and advisory. Omar has
time to time contributed articles on various topics, particularly on Islamic
finance. He is author of a book on Islamic finance, namely “Managing Finances
– A Shariah Compliant Way”.

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