The University of Adelaide Business School. Adelaide, Australia
© Islamic Finance Today
The commercialisation of the Islamic financial system in the 1970s was greeted with both hope and scepticism. More than three decades later the system is widely accepted and practiced worldwide. But the future of Islamic finance remains shrouded with uncertainty due to the lack of uniformity in the system’s application. One such area of uncertainty relates to Shari’ah (Islamic religious law) supervision and implementation by Islamic financial institutions.
Islamic financial institutions are guided by a legitimate control body known as the Shari’ah Supervisory Board (SSB), which consists of a number of Shari’ah advisors. The purpose of the SSB is to ensure that the financial institutions operate in conformity with Shari’ah and are usually made up of a number of jurists who provide clarification in regards to any Shari’ah related questions that the financial institutions may have. These SSBs are hired by the financial institutions and act as an internal control body in the organisation, therefore, enhancing the credibility of the bank in the eyes of its customers, and bolstering its Islamic credentials.
The role of the SSB is thus seen as being similar to that of company auditors. Even though, the financial institution compensates them, the SSB members are expected to retain their independence. And just like auditors, SSBs certify at the end of the year whether the financial institutions operations were in conformity with Shari’ah. This task includes reviewing products and policies of the financial institution, and deciding on whether a new financial instrument introduced by the organisation is religiously acceptable.
Theoretically if the SSB refuses to endorse a product, the financial institution should automatically remove that product from their portfolio. Also in theory, the SSB would perform a religious audit of all accounts. The reality however is more complicated. Surveys conducted by researchers in Islamic financial institutions has revealed that in many cases the review is treated as a routine matter, with boards approving decisions already made by the bank’s management.
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) has tried to regulate the role of the Shari’ah advisors by setting standards for appointment and composition of SSBs. According to the standards, the authority to appoint SSB members should be vested in the annual general meeting of all shareholders of the institution. The justification for such action is that SSBs members will be free from any undue pressure from the management board if they do not have the power to appoint or dismiss them. The AAOIFI standards also specify the presence of three Shari’ah advisors as the minimum number required in a SSB.
The AAOIFI regulatory framework and guidelines are yet to be applied by institutions worldwide and variations in Shari’ah governance still exist. A review of the Shari’ah governance and supervision models used by financial institutions reveals inconsistencies between national models of governance. There are five countries that follow their own Shari’ah governance regulations. These countries are Bahrain, Indonesia, Iran, Malaysia, and Pakistan. A review of these national models of governance reveals that contrary to AAOIFI regulations, not all Islamic financial institutions utilise the services of SSBs. In Malaysia and Pakistan financial institutions only require one Shari’ah advisor, while Iran does not require institutions to have their own SSBs or advisors.
Another concern expressed by consumers and critics relates to the Shari’ah advisors’ potential conflict of interest. The advisors are employees of the financial institution and perform their duties relating to Shari’ah implementation and supervision. But unlike other staff members, Shari’ah advisors in some countries are permitted to be employed by more than one financial institution. As these advisors are seen as internal Shari’ah auditors rather than external auditors, being employed by more than one institution is seen as a direct conflict of interest.
The variation in the number of advisors in financial institutions and the permission to act as Shari’ah advisor for more than one financial institution is related to the limited pool of qualified Shari’ah advisors available worldwide. A look at the global situation reveals the extent of this problem. In Britain, the most active European market in the Islamic banking sector, the Financial Services Authority watchdog in November 2007 highlighted possible “significant” conflicts of interest in that concentration of expertise. The agency reported that the shortage of appropriately qualified scholars raised concerns over the ability of SSBs to provide rigorous supervision.
One of the world’s most respected scholars, Sheikh Nizam Yaquby, in a recent interview described the challenge of having a very limited pool of Shari’ah advisors. According to Sheikh Yaquby there are about 60 scholars in the world qualified to advise banks involved in Islamic finance. This number is not even sufficient to fill the demand in the Middle East. Therefore, one way banks are overcoming this shortage is by hiring scholars and advisors who are already performing their duties in other organisations.
This shortage of qualified scholars leads to the obvious question of training of Shari’ah advisors. There are various opinions on what qualifications are required for an individual to be prepared for the duties of a Shari’ah advisor. In countries like Pakistan, the central bank (State Bank of Pakistan) requires financial institutions to only hire those individuals who meet the specified “Fit and Proper Criteria”. These requirements specify that the individual be trained in religious education (Dars-e-Nizami curriculum offered by Madrasas). Since this education requires schooling through Madrassas, one would expect that the training of Shari’ah advisors would take 11 years or more. Considering the fact that many of those educated in religious education, may not be too well-versed in banking and finance knowledge, the advisors may require additional training time for such education, and this would add to the overall training time. The amount of time required for training means that the shortage of Shari’ah advisors will continue to be an issue for the industry for some time.
Another issue faced by the industry is the lack of educational infrastructure. As stated earlier, the training of advisors in religious education is no longer sufficient in the commercial world. Therefore, understanding the application of Shari’ah rules in the banking and finance industry is an area that future Shari’ah advisors need to be trained in. Unfortunately, the industry has lagged behind in setting up appropriate institutions that would help bridge this educational and training gap.
In the past, any Shari’ah advisors were trained in a handful of institutions in countries like Pakistan, Malaysia and Bahrain. This lack of educational infrastructure has further added to the limited number of qualified Shari’ah advisors that are available worldwide. While some action has been taken to address this (like the opening of a dedicated university in Malaysia), the number of institutions operating are not enough to meet the growing demand of the industry. The Islamic finance sector needs to address these concerns to ensure that the system remains viable in the long run and does not compromise on issues related to transparency and quality of Shari’ah supervision. There are a number of steps that the industry and governments of Muslim countries can take to address the shortage of qualified advisors. The financial institutions and governments can jointly invest in the establishment of further training institutions. These institutions would not only help train the students in religious education, but with the involvement of financial institutions, the students would also get trained in the practice of Islamic banking and finance. The AAOIFI regulation of a minimum of three Shari’ah advisors serving on a SSB should also be implemented. The regulation though should require that at least one member of the SSB be a junior advisor. This requirement would give junior Shari’ah advisors the opportunity to work with experienced advisors and would act as a means of getting ‘on the job’ training for the junior staff. If implemented, this requirement would help overcome some of the issues related to the lack of trained and qualified Shari’ah advisors, and would help improve the quality of Shari’ah supervision.
As the world’s economy struggles through one of its more difficult periods, many businesses are looking at the Islamic financial sector as a legitimate alternative to the current financial system. To be able to take advantage of these emerging opportunities, the Islamic finance sector has to prepare for the associated growth. Through the combined efforts of governments and financial institutions in the Islamic finance sector, the training of more Shari’ah scholars can be further improved. This in turn would ensure that Islamic financing remains a viable option in the long run.
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