Accommodation of Islamic Banking in banking regulatory frameworks-Corporate Governance.

Board of Directors and Shariah Board

Regulatory frameworks typically do not prescribe distinct and separate corporate governance frameworks applicable only to Islamic banks. However, some regulatory frameworks deal with the additional responsibility and authority of the board of directors in relation to Shariah compliance, though, typically, the Shariah board has the ultimate responsibility and authority in advising on Shariah matters.

There is equal preference that the legal framework requires the setting up of a national/central Shariah board or setting up a Shariah board at the central bank (Afghanistan, Malaysia, Uganda, Pakistan, Palestine, Sudan, and Syria). Besides, a majority of jurisdictions require Islamic banks to have a Shariah board that has legal standing and its actions have legal implications (e.g., Iraq, Kuwait, Malaysia, and Sudan).

In most cases it seems that ultimate overall responsibility for an Islamic bank’s Shariah compliance lies with the Islamic bank’s board of directors, which typically delegates the responsibility for day-to-day Shariah compliance to senior management. Senior management is required to ensure Shariah compliance in line with Shariah board guidance, which implies that the relationship of an Islamic bank’s Shariah board vis-à-vis the Islamic bank is advisory.

Supervisory authorities should be aware of the risks when there is no requirement for an Islamic bank to have a Shariah board. In jurisdictions where there are no prescriptions relating to a Shariah board (e.g., Kenya, Tanzania, Tunisia, and Turkey), the supervisory authorities would consider it a possible case of mis-selling Islamic financial products if a purported Islamic bank did not have in place an appropriate function and internal controls to ensure Shariah compliance.

There appears to be heterogeneity regarding the bodies to which the Shariah board reports to. These may include: the board of directors of the bank , the general assembly of the bank, the top management of the Islamic bank and the executive committee of the Islamic bank. The best is to report to BOD or general assembly of the bank.

Shariah compliance function

The function and role of ensuring Shariah compliance within an Islamic bank is usually conducted by internal auditors or Shariah auditors. In specific jurisdictions where Shariah Law is the default source of all legislation (e.g., Iran, Pakistan, Saudi Arabia, and Sudan), including banking and financial legislation, an Islamic bank’s internal auditor has a statutory responsibility to ensure Shariah compliance by the Islamic bank. In other jurisdictions, an Islamic bank is required to have a dedicated Shariah auditor/Shariah compliance officer whose appointment is required to be approved by the bank supervisory authority.

The function and role of the external auditor in relation to Shariah compliance depends on legal frameworks. In jurisdictions where Shariah Law is the default source of all legislation, including banking and finance legislation, an Islamic bank’s external auditor has a statutory
responsibility to assess and verify Shariah compliance by the Islamic bank. However, in jurisdictions where Shariah Law is not the default source of banking legislation, the Islamic bank’s external auditor has no direct responsibility to assess and verify Shariah compliance by the Islamic bank. It is critical to have external auditor with statutory responsibility to assess shari'ah compliance even if after every three years to ensure robust Shari'ah controls are place and add wide range of experience on shari'ah compliance function.