CH 5

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni
Chapter 5
Corporate Governance for

Islamic Financial Institutions
Learning Objectives
Upon the completion of this chapter, the reader should be able to:
1.Describe the meaning of corporate governance within the

Sharī‘ah framework as practiced in modern Islamic financial
institutions
2.Explain the models and key principles of corporate governance,
including Sharī‘ah governance
3. Understand the mechanisms of corporate governance and
control, including the different organs in Islamic financial
institutions
4. Understand the different models of corporate governance and
Sharī‘ah governance, and the different approaches adopted by
Islamic different financial institutions
5. Understand the dynamics of corporate governance in Islamic
insurance entities.
Learning Objective 5.1
Describe the meaning of
Meaning of Corporate Governance corporate governance
within the Sharī‘ah
framework as practiced in
modern Islamic financial
institutions
• There is no generally accepted definition for corporate

governance that can be applied to all contexts
• Corporate governance has been defined in different contexts

and jurisdictions according to the goal it is designed to
achieve
institutions
Defining Corporate Governance
“A set of relationships between a company’s management, its

board, its shareholders and other stakeholders. Corporate
governance also provides the structure through which the
objectives of the company are set, and the means of
attaining those objectives and monitoring performance are
determined”
(Organization for Economic Corporation and Development [OECD])

institutions
Defining Corporate Governance
“Corporate governance is the relationship between corporate

managers, directors and the providers of equity, people and
institutions who save and invest their capital to earn a
return. It ensures that the board of directors (BoD) is
accountable for the pursuit of corporate objectives and that
the corporation itself conforms to the law and regulations”
(International Chamber of Commerce [ICC])

Meaning of Corporate Governance Describe the meaning of

corporate governance
Defining Corporate Governance modern Islamic financial
institutions
“Corporate governance is the system by which companies are

directed and controlled…”
(The Cadbury Report)
• The definition and description given in the Cadbury Report

explains the interrelationship among stakeholders in corporate
entities and their responsibilities in ensuring the transparent
and fair management of the company based on accountability
institutions
Common Features Shared by the Majority of Definitions
• A system of relationships defined by structures and

processes
• Relationships with different and in some cases contrasting

interests
• Stakeholders’ involvement in the direction and control of the

company
• Rights and responsibilities are properly distributed among

the stakeholders
Corporate Governance in Islam institutions
• Sharī‘ah supervisory board:

- lays down Sharī‘ah-compliant rules and procedures
- supervises/ensures Sharī’ah compliance of new products
• Sharī'ah scholars have both consultative and supervisory

functions
• Sharī‘ah corporate governance structure of IFIs ensures

strict compliance with the Sharī‘ah in all activities carried
out by other stakeholders
Models of Corporate Governance: Explain the models and key

principles of corporate
Stakeholder versus Stockholder governance, including
Sharī‘ah governance
Conventional Perspective: Two Basic Models
1. The Anglo-American model
• Emphasizes interests of the shareholders

• Aims at aligning manager’s interests with shareholders
interests
• Applies various ways to accomplish aims, including
shareholder representation on the BoD, management
compensation scheme, and external market discipline
• The Anglo-American model has a great relevance for Islamic
finance
Explain the models and key
Models of Corporate Governance: principles of corporate
governance, including
Stakeholder versus Stockholder Sharī‘ah governance
Conventional Perspective: Two Basic Models
2. The Franco-German model
• Emphasizes the stakeholder-value system
• Incorporates interests of shareholders and non-

shareholders with more emphasis on non-shareholders
considered to be stakeholders
The Islamic paradigm
Under the Islamic paradigm of corporate governance, all

stakeholders (including shareholders, employees and
executive management) should all serve on the board to
ensure transparency, accountability, fairness, and mutual
consultation
Role of Corporate Governance in Islamic Financial

Institutions
• The inclusion of Sharī‘ah governance to emphasize the

compliance with the requirements of the Sharī‘ah
• Accountability in business transactions to protect interests of

all stakeholders, particularly investors
• Issues of competitiveness and globalization of IFIs prompted

some standard-setting bodies (IFSB, AAOIFI) to issue
specific guidelines intended to help such institutions
The role of corporate governance in IFIs include:
• Establishing a harmonious relationship among concerned

parties
• Promoting prudent and transparent practices in the
management of IFIs
• Protecting the interest of all stakeholders
• Ensuring proper discharge of corporate social responsibility
role of the IFIs
• Promoting a sound, stable, and competitive Islamic financial
industry
Comprehend the
Mechanisms of Corporate Governance mechanisms of corporate
governance and control
and Control including the different
organs in Islamic financial
institutions
Principles of Corporate Governance in Islam
• Concept of tawhid (unity of God)
• Principle of shurah (mutual consultation)
• Islamic legal rules on harmonious relationship and mutual

benefits in commercial transactions
Comprehend the
institutions
Figure 5.1:
Functional
Roles of
Corporations
in Islam
Comprehend the
institutions
Sharī‘ah Governance
• Sharī‘ah governance and corporate governance are

inextricable in Islamic corporate entities
• Sharī‘ah governance is missing in corporate governance

frameworks of conventional financial institutions
• Sharī‘ah system of governance introduced to:

- complement adaptable standards of corporate
governance
- streamline non-compatible standards
Comprehend the
institutions
Guiding Principles
• Corporate Governance for Institutions Offering Only Islamic

Financial Services (Excluding Islamic Insurance (Takaful)
Institutions and Islamic Mutual Funds, 2006 (IFSB-3)
• Sharī'ah Governance Systems for Institutions Offering Islamic

Financial Services, 2009 (IFSB-10)
•Governance for Takâful (Islamic Insurance) Undertakings,

2009 (IFSB-8)
• Governance for Islamic Collective Investment Schemes, 2008

(IFSB-6)
Mechanisms of Corporate Governance Comprehend the
mechanisms of corporate
and Control governance and control
including the different
institutions
Functions of Sharī‘ah Governance System in

IFIs
• Advising the Board of Directors on Sharīàh-related matters
• Reviewing/endorsing Sharīàh-related policies and guidelines
•Endorsing/validating documentation for new products and

services
•Overseeing computation/distribution of zakat and funds for

charity
• Assisting and advising relevant parties that serve the IIFS

Comprehend the
institutions
Major areas of the Sharī‘ah Governance System in IFIs
• Issuance of relevant Sharīàh pronouncements/resolutions
•Dissemination of the
Sharī‘ah resolution to the
Sharī‘ah Review Unit
• The ISCU to record and

report its findings
• Preparation of an Annual
Sharī‘ah Compliance
Review Report
Comprehend the
institutions
Institutionalization of the Sharī‘ah

Governance System
•The first Sharī‘ah Board was established in 1976 by the Faisal

Islamic Bank of Egypt
•The institutionalisation carried out through:
- Pre-modern society model (hisbah model) - more
emphasis on Sharī‘ah-compliance
- Modern scholars model (collective ijtihad model) -
Sharī‘ah advisory and consultancy
•In modern IFIs, the Sharī‘ah Board is responsible for product
development, certification, and issuance of resolutions
Comprehend the
institutions
Fiqh
The whole corpus of Islamic jurisprudence. Fiqh may
also mean the jurists' understanding of Islamic Law
Fiqh al-mu‘malat
The jurisprudence concerning transactions regulated by
Islamic law
Hisbah (market ombudsman)

An Islamic institution that guards against infringement
of the law in economic, social, and political domains
Comprehend the
institutions
Organs of the Sharī‘ah Governance System
1. Sharī‘ah Supervisory Board at the micro level

2. Sharī‘ah Supervisory Council of the Central Bank at the
macro level
3. Internal Sharī‘ah Compliance Unit (ISCU)
Comprehend the
institutions
Sharī‘ah Supervisory Board at the Micro Level

•The Sharī‘ah Supervisory Board (“Sharī‘ah Board”)
- the highest organ of an Islamic financial institution
- the advisory and supervisory roles ensuring
Sharī‘ah compliance in all activities
- is based on the traditional concept of hisbah
•Hisbah - important organ of the Sharī‘ah governance system
•Institutionalization of hisbah led to introduction of the Sharī‘ah

Supervisory Board
•Utilization of collective ijtihad to establish the Sharī‘ah Board

Comprehend the
institutions
Sharī‘ah Supervisory Council of the Central Bank at the

Macro Level
• The establishment of Sharī‘ah Board at macro level:
- A national set up - Al Rajhi
- An international set up - HSBC Amanah
• Compliance of Sharī‘ah resolutions of the Sharī‘ah

Supervisory Boards of IFIs with general standards created by
the supreme Sharī‘ah Council of the Central Bank
•Resolution of Sharī‘ah Supervisory Council of the Central

Bank prevails if any conflict with the Sharī‘ah Board of an IFI
Comprehend the
institutions
Internal Sharī‘ah Compliance Unit (ISCU)
• ISCU responsible for verification of processes, services, and

transactions ensuring compliance with the resolutions and
pronouncements of the Sharī‘ah Board
• ISCU tasked to report on its Sharī‘ah compliance audit
• The report is presented to the Sharī‘ah Board or at the AGM

for the stakeholders in the IFI
Comprehend the
institutions
The Sharī‘ah Governance Process
The Sharī‘ah governance process in IFIs comprises of
•Appointment
•Composition
•Qualification
•Sharī‘ah Coordination
•Sharī‘ah Compliance Process
•The Sharī‘ah Resolution
Comprehend the
institutions
The Sharī‘ah Governance Process: Appointment

• The appointment of Sharī‘ah scholars is either done by:
- the shareholders at the Annual General Meeting (AGM)
- the Board of Directors on behalf of the shareholders and
subject to their approval at the AGM
•The Board of Directors appoint members of the Sharī‘ah

Board
•The members of the Sharī‘ah Advisory Council are appointed

by the relevant government authority

institutions
The Sharī‘ah Governance Process: Composition
•Sharī‘ah Boards of IFIs generally put together by scholars who are
well-versed in fiqh al-mu‘amalat and usul al-fiqh
• Composition of Sharī‘ah Boards of IFIs determined by individual

institutions
• Composition of Sharī‘ah Boards of international financial

institutions vs. national IFIs
• Usually between 3 and 6 members in a Sharī‘ah Board
• Max number of the Sharī‘ah Board of AAOIFI is twenty members

(appointed by the Board of Trustees for four years)
Comprehend the
institutions
The Sharī‘ah Governance Process: Qualification

• Practical knowledge and considerable expertise in the
application of fiqh al-mu‘amalat and usul al-fiqh in modern
financial transactions
• Non-experts in fiqh al-mu‘amalat and usul al-fiqh

- are experts in specific areas of banking and finance
operations
- may be appointed with the purpose of strengthening
the board in complex banking and finance operation
Comprehend the
institutions
The Sharī‘ah Governance Process: Sharī‘ah Coordination

•Coordinate the Sharī‘ah governance process, consisting of
corporate interaction between:
- The Sharī‘ah Board and the ISCU
- External Sharī‘ah audit review and other organs of the IFI
•In some IFIs, there is no clear distinction between the Sharī‘ah

compliance officer and the Sharī‘ah coordinator
• The secretary of the Sharī‘ah Board or the Sharī‘ah compliance

officer may perform the task of Sharī‘ah coordination
Comprehend the
institutions
The Sharī‘ah Governance Process: Compliance Process
1. Conducting a standard Sharī‘ah review that includes both

internal and external Sharī‘ah audits, to ensure total
compliance with the resolutions and specific instructions of the
Sharī‘ah Board
2. Carrying out the Sharī‘ah compliance process by an

independent division or part of an internal audit
3. Performing an internal Sharī‘ah audit to verify the extent of

compliance
Comprehend the
institutions
The Sharī‘ah Governance Process: Compliance Process
4. Undertaking an independent Sharī‘ah compliance process by

an external Sharī‘ah auditor or Sharī‘ah firm
5. Producing a report indicating whether the IFI has complied

with the Sharī‘ah requirements in the financial year under
review
While the internal audit department of IFIs reports to the Audit

Committee, the internal Sharī‘ah audit reports to the Sharī‘ah
Board
The Sharī‘ah Governance Process: organs in Islamic financial
institutions
The Sharī‘ah Resolution
•The Sharī‘ah Board is to produce a Sharī‘ah report periodically or

annually to explain its position on:
- The overall business and products of the IFI
- fatwa on matters brought before the board
•The Sharī‘ah report may be in any of the following forms:

1. a fact finding report
2. (an ex-ante) report in relation to product design and
development
3. (an ex-post) internal Sharīàh audit/review report
on the products offered to customers
4. an annual Sharīàh compliance report
Comprehend the
institutions
The Distribution of the Sharī‘ah Report
1. The fact-finding reports and product design and development

reports are submitted to the management of the IFI
2. The internal Sharī‘ah audit/review report on the products
offered to customers is submitted to the Audit Committee
3. The annual Sharī‘ah compliance report is submitted to:
- The BOD to be distributed to the shareholders at the AGM
- Members of the public including the investment account
holders (IAH)
4. The supervisory authority in the jurisdiction may also have
access to the report
Understand the different
A Different Approach for Islamic models of corporate
governance and Sharī‘ah
Financial Institutions governance and the
different approaches
adopted by Islamic
different financial
institutions
• As there is no universal standard for corporate governance

in IFIs, diverse approaches are adopted in different
jurisdictions
• The Governance Standards for IFIs by IFSB and AAOIFI are:

- similar in many aspects
- complementary to other prudential standards issued by
international standards of corporate governance
adopted by Islamic
different financial
institutions
International standard-setting bodies include:
• The Organization of Economic Co-operation and

Development (OECD)
• The International Organization of Securities Commission
(IOSCO)
• The Basel Committee on Banking Supervision (BCBS)
International standards did not address the specifics of the

Islamic finance industry. Therefore, IFSB and AAOIFI
Standards are specifically meant for the IFIs
A Different Approach for Islamic Understand the different

models of corporate
Financial Institutions
1
governance and the
Models of Sharī‘ah Governance from Selected adopted by Islamic
Islamic Countries different financial
institutions
• Malaysia
- Islamic capital markets are regulated by the Securities
Commission
- Legislation aims at harmonizing different Shari‘ah
interpretations on Islamic financial issues to strengthen
the regulatory and oversight framework
• Pakistan
- The State Bank of Pakistan (SPB) has established a Shari‘ah
board at the macro level
- At the micro level, all IFIs operating in Pakistan are
required to appoint a Shari‘ah advisor
A Different Approach for Islamic
1
Models of Sharī‘ah Governance from Selected

Islamic Countries
• Kuwait
- Provision for Shari‘ah boards in IFIs, but no Shari‘ah
board at the macro level at the Central Bank of Kuwait
- fatwa board in the Ministry of Awqaf and Islamic Affairs,
the final authority on Islamic banking business/financial
transactions
• Bahrain
- The National Shari‘ah Advisory Board has no authority over
IFIs but the Central Bank of Bahrain has a board
- At the micro level, all IFIs are required to establish a
Shari‘ah supervisory committee
A Different Approach for Islamic
1
Models of Sharī‘ah Governance from Selected

Islamic Countries
• UAE
- Establishment of a Higher Shari‘ah Authority to supervise
Islamic banks and financial institutions – except in Dubai
- At a micro level, all IFIs establish a Shari‘ah supervision
authority, or simply a Shari‘ah board
• Qatar
- No Shari‘ah advisory board at the Qatar Central Bank (QCB)
but there is a Supreme Shari‘ah Council
- Two major regulatory frameworks for Shari‘ah governance in
IFIs, namely those of the QCB and the Qatar Financial
Centre (QFC)
adopted by Islamic
different financial
Figure 5.2 Sharī‘ah Governance Framework institutions
under BNM
A Different Approach for Islamic Understand the different models

of corporate governance and
Financial Institutions Sharī‘ah governance and the

different approaches adopted by
Islamic different financial
institutions
Figure 5.3: A Model

of Sharī'ah
Governance
Framework for
IFIs
Understand the different models
A Different Approach for Islamic of corporate governance and
Sharī‘ah governance and the
Financial Institutions different approaches adopted by
Islamic different financial
institutions
Table 5.2: Summary of the

Sharī‘ah Governance System
in Selected Countries
Understand the dynamics
Corporate Governance for Islamic of corporate governance in
Islamic insurance entities
Insurance
Major requirements for good corporate governance
within the context of takāful
1. Set of organisational arrangements
2. Provision of proper incentives for the organs of

governance
3. Compliance with the Sharī‘ah rules and principle
• The compliance with the Sharī‘ah rules and principles is

ensured and sustained through an independent Sharī‘ah
Supervisory Board
Insurance
IFSB Guiding Principles on Governance for Takāful
(Islamic Insurance) Undertakings
• No single model of corporate governance that works well for

every country and all types of business
• Good governance in securing/preserving public confidence in

takaful undertakings necessitated the development of
separate guidelines for the takaful industry
Insurance
Objectives of the IFSB Guiding Principles on Governance
for Takāful (Islamic Insurance)
•To provide benchmarks for use by Takāful supervisors in

adapting/improving regulatory regimes or establishing new
ones
• To address regulatory issues, e.g. risk management and

financial stability for the Takāful industry
• To provide appropriate levels of consumer protection in terms

of risk and disclosure
• To support the orderly development of the Takāful industry

Insurance
The IFSB Guiding Principles
• Part I: Reinforcement of relevant good governance

practices for insurance companies, while addressing the
specificities of takāful undertakings
• Part II: A balanced approach that considers interests of all

stakeholders and calls for their fair treatment
• Part III: An impetus for a more comprehensive prudential

framework for takāful undertakings
Corporate Governance for Islamic Understand the dynamics

of corporate governance in
Insurance Islamic insurance entities
Figure 5.4: Summary of IFSB Guiding Principles for

Takāful Undertakings
Corporate Governance for Islamic Understand the dynamics

of corporate governance in
Insurance Islamic insurance entities

Part I: Reinforcement of relevant good governance practices
for insurance companies, while addressing the specificities of
takāful undertakings
- Principle 1.1: Having in place an inclusive governance
framework appropriate for takāful business model:
(i) clear identification and segregation of strategic and
operational roles and responsibilities for each organ
governance
(ii) mechanisms for observing and addressing the
rights and interests of all stakeholders
(iii) a compliance mechanism
- Principle 1.2: The adoption of an appropriate code of
ethics and conduct
Insurance

Part II: A balanced approach that considers the interests of all
stakeholders (shareholders and the participants) and calls
for their fair treatment
Principle 2.1: Takāful Operators shall have in place an

appropriate governance structure that represents the
rights and interests of takāful participants
Principle 2.2: Takāful Operators shall adopt and implement

procedures for appropriate disclosures that provide
takāful participants with fair access to material and
relevant information
Insurance
Part III: A more comprehensive prudential framework for

takāful undertakings
Principle 3.1: Takaful Operators shall ensure that they

have in place appropriate mechanisms properly to
sustain the solvency of takāful undertakings
Principle 3.2: Takaful Operators shall adopt and implement

a sound investment strategy and prudently manage the
assets and liabilities of takāful undertakings
Key Terms and Concepts
• Franco-German
• AAOIFI
• Hisbah
• Actuary
• IFIs
• Anglo-American
• IFSB
• Arbitral tribunals
• IFSB-10
• BNM
• Ijtihad
• Corporate governance
• Islamic Finance
• Fatwa
• Maslahah mursalah
• Fiqh
• Muhtasib
• FiqhFiqh al-mu‘amalat
• Sukuk
• Sharī’ah compliance
• Takaful
• Sharī’ah governance
• Zakat

CH 5

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CH 5

Uploaded by

Copyright:

Available Formats

Introduction to Islamic Banking and Finance:

Principles and Practice

M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Corporate Governance for

1.Describe the meaning of corporate governance within the

• There is no generally accepted definition for corporate

• Corporate governance has been defined in different contexts

Defining Corporate Governance

“A set of relationships between a company’s management, its

(Organization for Economic Corporation and Development [OECD])

Defining Corporate Governance

“Corporate governance is the relationship between corporate

(International Chamber of Commerce [ICC])

Meaning of Corporate Governance Describe the meaning of

“Corporate governance is the system by which companies are

(The Cadbury Report)

• The definition and description given in the Cadbury Report

Common Features Shared by the Majority of Definitions

• A system of relationships defined by structures and

• Relationships with different and in some cases contrasting

• Stakeholders’ involvement in the direction and control of the

• Rights and responsibilities are properly distributed among

• Sharī‘ah supervisory board:

- supervises/ensures Sharī’ah compliance of new products

• Sharī'ah scholars have both consultative and supervisory

• Sharī‘ah corporate governance structure of IFIs ensures

Models of Corporate Governance: Explain the models and key

Conventional Perspective: Two Basic Models

1. The Anglo-American model

• Emphasizes interests of the shareholders

Conventional Perspective: Two Basic Models

2. The Franco-German model

• Emphasizes the stakeholder-value system

• Incorporates interests of shareholders and non-

The Islamic paradigm

Under the Islamic paradigm of corporate governance, all

Role of Corporate Governance in Islamic Financial

• The inclusion of Sharī‘ah governance to emphasize the

• Accountability in business transactions to protect interests of

• Issues of competitiveness and globalization of IFIs prompted

The role of corporate governance in IFIs include:

• Establishing a harmonious relationship among concerned

Principles of Corporate Governance in Islam

• Concept of tawhid (unity of God)

• Principle of shurah (mutual consultation)

• Islamic legal rules on harmonious relationship and mutual

• Sharī‘ah governance and corporate governance are

• Sharī‘ah governance is missing in corporate governance

• Sharī‘ah system of governance introduced to:

• Corporate Governance for Institutions Offering Only Islamic

• Sharī'ah Governance Systems for Institutions Offering Islamic

•Governance for Takâful (Islamic Insurance) Undertakings,

• Governance for Islamic Collective Investment Schemes, 2008

Functions of Sharī‘ah Governance System in

• Reviewing/endorsing Sharī`ah-related policies and guidelines

•Endorsing/validating documentation for new products and

•Overseeing computation/distribution of zakat and funds for

• Assisting and advising relevant parties that serve the IIFS

Major areas of the Sharī‘ah Governance System in IFIs

• Issuance of relevant Sharī`ah pronouncements/resolutions

• The ISCU to record and

Institutionalization of the Sharī‘ah

•The first Sharī‘ah Board was established in 1976 by the Faisal