5.4.1 Accounting and Auditing Organization for Islamic Financial Institutions

AAOIFI was established in 1991 in the State of Bahrain as an autonomous, international, non-profit body that has the following main objectives:

1. to develop accounting, auditing, and banking ideas relevant to IBs;
2. to disseminate accounting and auditing thought relevant to IBs and their applications through training, seminars, publication of periodical newsletters, carrying out and commission of research, and other means;
3. to prepare, promulgate, and interpret accounting and auditing standards for IBs; and
4. to review and amend accounting and auditing standards for IBs.

At the time of its establishment in 1991, AAOIFI devised a sharī‘ah committee consisting of four members that was later to become its sharī‘ah board. The membership of this sharī‘ah board is composed of not more than 20 sharī‘ah jurists who serve on the SSBs of IBs, which are members of AAOIFI, as well as the SSBs of central banks. Such jurists are appointed by AAOIFI’s board of trustees to serve on its sharī‘ah board for a five-year term. Currently, AAOIFI’s sharī‘ah board comprises the members shown in Table 5.1.²⁸

Source: AAOIFI Shari’a Standards, 2010.

5.4.2 Islamic Financial Services Board

The IFSB describes itself as “an international standard setting organization that serves to promote and enhance the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles for the industry, broadly defined to include banking, capital markets and insurance sectors.” The IFSB issued its Guiding Principles on Sharī‘ah Governance Systems for Institutions offering Islamic Financial Services in 2009. The principles include details about the procedure for sharī‘ah governance, competencies of sharī‘ah governance organs as well as their code of ethics and professional conduct. The sharī‘ah governance system proposed by IFSB considers the SSB the most important element.²⁹ On the issuance of sharī‘ah resolutions by the SSB it says:

Sharī’ah pronouncements/resolutions refers to a juristic opinion on any matter pertaining to Sharī’ah issues in Islamic finance, given by the appropriately mandated Sharī’ah board. In jurisdictions where there is a central authority such as the national Sharī’ah board or Fatwa Council, that central authority has the power to issue such pronouncements/resolutions, resulting in the Sharī’ah board at the IIFS usually focusing only on ensuring that the IIFS is compliant with the pronouncements/resolutions issued by the central authority. Once it is decided that a Sharī’ah pronouncement/ resolution should actually be implemented, it becomes a “Sharī’ah ruling” (hukm al-Shar’ī) with full legal effect that binds the IIFS. A Sharī’ah pronouncement/resolution shall be issued only through appropriate due processes, which, amongst others, should involve rigorous deliberation among members of the Sharī’ah board over any proposed Sharī’ah-compliant products or transactions that require a Sharī’ah endorsement, as well as detailed scrutiny of the legal contracts and other documents relevant to the products or transactions.³⁰

5.4.3 Organization of Islamic Conference Fiqh Academy

The OIC Fiqh Academy was established during the Third Islamic Summit Conference held in Makkah, Saudi Arabia, in January 1981. The Fiqh Academy includes Muslim scholars from among various disciplines such as sharī‘ah, economics, and other sciences from across the world in order to analyze contemporary issues and provide solutions that are in congruence with sharī‘ah guidelines. Forty-seven countries participate in the Fiqh Academy. The first conference was held in 1983 and since then 19 other conferences have taken place. The Fiqh Academy plays a vital role in contemporary Islamic finance issues and has considerable impact. For example, it helped the Islamic Development Bank (IDB) by advising it on several issues at a time when the IDB did not have its own sharī‘ah supervisory board. On the basis of this advice, the IDB revised some of its policies to enhance its sharī‘ah compliance. More recently, in the conference held in Sharjah on April 30, 2009, the OIC Fiqh Academy declared organized tawarruq (monetization) impermissible.

5.5.1 Independence

Independence is defined as “an attitude of mind which does not allow the viewpoint and conclusions 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.”³³ Being objective is, thus, crucial to the independence of individuals when expressing their views. Sharī‘ah supports the independence of individuals, and their freedom to reveal truths, irrespective of whether such truths are to the liking of others. The Qur’ān says: “O you who have believed, be persistently standing firm for Allah, witnesses in justice, and do not let the hatred of a people prevent you from being just. Be just; that is nearer to righteousness. And fear Allah indeed, Allah is Acquainted with what you do.”³⁴ Having an independent opinion requires the individual to be mindful of factors that could influence the person’s judgment in order to protect against them. Personal desire is one such factor. The Qur’ān says: “O David, indeed We have made you a successor upon the earth, so judge between the people in truth and do not follow [your own] desire, as it will lead you astray from the way of Allah. Indeed, those who go astray from the way of Allah will have a severe punishment for having forgotten the Day of account.”³⁵

To form unbiased and just opinions, the SSB must, therefore, be independent of any internal or external influence that could affect its judgment. Any lack of independence would not only affect the final juristic opinion of the SSB, it would also shake stakeholder confidence in the sharī‘ah compliance of the institution and the industry. To be independent, SSB members must avoid any influence or pressure from any of the stakeholders in performing their role.³⁶ The independence of SSB members results in its verdicts not being affected by internal (for personal motives) or external powers (institutional pressure).³⁷ The IFSB states: “The Sharī‘ah board should play a strong and independent oversight role, with adequate capability to exercise objective judgment on Sharī‘ah related matters. No individual or group of individuals shall be allowed to dominate the Sharī‘ah board’s decision-making.”³⁸ The SSB must observe this independence at all times in exercising its duties, at the heart of which is making objective and informed judgments.³⁹

Several factors could affect the independence of SSB jurists, including business pressures and profit incentives, the political environment, social relationships, norms of society that do not align with Islamic teachings, etc. But in all these situations, SSB members must have the courage to stand up to any temptations and confidently base their judgment on guidance from the Qur’ān and sunnah of prophet Muhammad (pbuh). We will now explore the SSB’s intellectual, regulatory, and organizational independence.

5.5.2 Objectivity

Being objective means “not influenced by personal feelings or opinions in considering and representing facts.”⁴⁴ In an SSB context, objectivity entails that decisions be based on sharī‘ah precepts uninfluenced by emotions or other prejudices. AAOIFI states:

Objectivity is an independent mental attitude which SSB members should maintain in performing Shari‘a supervision. SSB members are not to subordinate their judgment on Shari‘a supervision matters to that of others. Objectivity requires SSB to perform Shari‘a supervision in such a manner that they have an honest belief in their work. SSBs should avoid potential and actual situations that impair their ability to make objective professional judgments.⁴⁵

Given that the SSB must not participate in managerial decisions and operational responsibilities, they cannot be employees of the organization. Otherwise, their objectivity would be questionable and this would impact their independence.⁴⁶ The need to be objective thus imposes an obligation on sharī‘ah jurists to be fair, academically honest, and free of conflicts of interest.

When conducting research on issues and deriving rulings from sharī‘ah sources, SSB members must be academically honest. To this end, different interpretations or opinions deserve understanding and contemplation before coming to a decision. One form of academic dishonesty is having double standards when issuing rulings. Instead, jurists need to be consistent and this requires them to have humility and acknowledge weak or wrong opinions or judgments that they may have adopted in the past, and replace them with stronger and more authentic opinions or judgments. To do so, SSB members need to be committed to critical thinking and be willing to invest ample time and effort in conducting the necessary research.

Lo and Field define conflict of interest as “a set of circumstances that creates a risk that professional judgment or actions regarding a primary interest will be unduly influenced by a secondary interest.”⁴⁷ Having a secondary interest is not necessarily considered wrong, but it becomes objectionable when it affects judgment, and results in sacrifices in the primary interest. Conflicts of interest may occur as a result of providing favours through questionable means, as evidenced in nepotism. The recipients of the favours may be internal to the organization, such as employees of other departments, or external to it, such as consultants. In some professions, employees are required to agree to a clause that if they leave their employer, they would not be entitled to compete in the same geographic region for a period of time. This is to ensure that the employee does not take away customers from the first employer. In the legal profession, clients may sometimes require attorneys not to represent other clients in the same market for the same kind of service in order to protect against the transmission of secrets from an organization to its competitor. In the context of SSBs, some regulatory authorities, such as Malaysia, have limited the participation of SSB members in the jurisdiction to one financial institution per industry. This is commendable as it limits possible avenues for conflicts of interest and the probability of a breach of confidentiality occurring. The IFSB advises:

A Sharī‘ah board can only be deemed “independent” when none of its members has a blood or intimate relationship with the IIFS, its related companies or its officers that could interfere, or be reasonably perceived to interfere, with the exercise of independent judgment in the best interests of the IIFS by the Sharī‘ah board. In the case of Sharī‘ah advisory firms, it can only be deemed independent from the IIFS if they are not related parties, such as in terms of having common shareholders or common directors.⁴⁸

5.5.3 Confidentiality

SSBs undertake to protect the confidentiality of information revealed to them. This encourages the BOD and management to share, with complete comfort with the SSB, important details that would provide the necessary background needed for issuing sharī‘ah rulings and guidance. Although the sharī‘ah encourages the sharing of general Islamic knowledge and prohibits its concealment, private knowledge does not fall in this domain. Moreover, jurists undertake to maintain the confidentiality of this information, and it is an obligation to fulfill this clause whether a promise has been given orally, or agreed to in writing, as part of a contract: “And fulfill the covenant of Allah when you have taken it, [O believers], and do not break oaths after their confirmation while you have made Allah, over you, a witness. Indeed, Allah knows what you do.”⁴⁹ In praising those who are entitled for the heavens, the Qur’ān describes them as, “those who respect their trusts and covenants.”⁵⁰

Most SSB members advise several IBs, in many cases within the same industry and jurisdiction.⁵¹ A study by Ünal reports the following statistics on the activity of sharī‘ah scholars in numerous jurisdictions:

1. UAE: 36 sharī‘ah scholars serve Islamic financial institutions headquartered in UAE. The top five scholars hold 48.47% of positions and the top 10 scholars represent 73.01% of the 163 positions available in the UAE.
2. Kuwait: 49 sharī‘ah scholars serve Islamic financial institutions headquartered in Kuwait. The top five scholars hold 41.78% of positions and the top 10 scholars represent 63% of the 246 positions available in Kuwait.
3. Bahrain: 40 sharī‘ah scholars serve Islamic financial institutions headquartered in Bahrain. The top five scholars hold 48.92% of positions and the top 10 scholars represent 64.75% of the 139 positions available in Bahrain.
4. Qatar: 26 sharī‘ah scholars serve Islamic financial institutions headquartered in Qatar. The top five scholars hold 46.67% of positions and the top 10 scholars represent 74.67% of the 75 positions available in Qatar.
5. Saudi Arabia: 44 sharī‘ah scholars serve Islamic financial institutions headquartered in Saudi Arabia. The top five scholars hold 56.58% of positions and the top 10 scholars represent 69.74% of the 152 positions available in Saudi Arabia.
6. Non-GCC Countries (25 of them): 177 sharī‘ah scholars serve Islamic financial institutions headquartered outside the GCC in 25 other countries. The top five scholars hold 27.87% of positions and the top 10 scholars represent 40.44 % of the 366 positions available in these countries.⁵²

The above statistics clearly indicate that there is a risk that proprietary information could be passed through SSB members to competitors, which could benefit from it without bearing or sharing the costs involved. SSB members who are associated with multiple IBs thereby increase this risk of the financial institution they serve, irrespective of how trustworthy these individuals may be. Hence, institutions have valid confidentiality concerns.⁵³ According to Alnachaar, there is “a potential case for conflict of interest, and a case of information leakage or perhaps competition impact.”⁵⁴ Thus, SSB members collectively and individually must be very careful not to breach this obligation as this would not only affect the jurist’s relationship with the IB, but would also affect the image and dignity of jurists, who are regarded with great respect.

It is also the responsibility of IB to ensure that policies and procedures are in place to maintain the confidentiality of information in order for it not to be leaked to unauthorized individuals. For instance, sharī‘ah decisions that address sensitive issues that the IB does not want to share, because it affects its strategic plans, etc., may be protected from the public eye for the benefit of the institution. Proper controls have to be in place to maintain the secrecy of such information. Additionally, the institution needs to have a sharī‘ah repository to keep track of the rulings issued. In general, the SSB has to be careful to maintain the confidentiality of:

1. Decisions of the BOD and management;
2. Discussions among SSB members or with the BOD and management;
3. Guidelines or opinions on products, policies, procedures, and transactions.

There should be a minimum set of rules developed by the IB that emphasize the importance of observing and preserving confidentiality.⁵⁵ The Malaysian experience of limiting SSB members from sitting on multiple boards within the same industry is the first attempt by a jurisdiction to regulate this practice. One benefit of such a regulation is that it provides an opportunity for new talent to emerge. However, there have also been concerns that until such a pool of talent becomes experienced, there may be a scarcity of Islamic transactional jurists to fulfill market demand.⁵⁶ The Central Bank of Oman (CBO), in its newly issued Islamic banking regulations, followed the Malaysian precedent. Its directives state:

No SSB member can be on the Shari’a Supervisory Board of more than one competing institution in Oman. However, a SSB member can be on the Shari’a Supervisory Board of more than one non-competing institutions (e.g. the SSB member of an Islamic Bank can also sit on the SSB of a Takaful company or an Islamic fund management company, etc.). Overall, no SSB member can be on the SSBs of more than four institutions in Oman.”⁵⁷

It further lists the following as grounds for disqualification of an SSB member: “If a SSB member assumes membership in the Shari’a Supervisory Boards of two or more competing financial institutions in Oman.”⁵⁸ Again, while this provides great benefits in the medium to long term, in the short term there may be some difficulties finding sufficient experienced jurists to sit on the SSBs of the numerous Islamic banks of Oman that have arisen since the recent Islamic banking regulations issued by CBO.

5.5.4 Consistency

It is important for SSBs to be coherent in the issuance and application of opinions and decisions for the sake of logic, accuracy, academic honesty, and fairness. Such consistency should be observed in judgments made across IBIs within the same jurisdiction and across jurisdictions. In exceptional cases, decisions made in other jurisdictions may be slightly different due to regulatory requirements. However, this should by no means be the norm. In reaching their decisions, SSB members should make use of the classical and contemporary references and resources, in addition to employing their faculties in order to reach what they see is the most authentic decision that would not include contradictions. In other words, decisions made by the SSB are expected to remain the same for similar issues, except when new information is revealed that requires additional consideration, or the SSB realizes that its previous decision is incomplete or incorrect.

To ensure consistency in sharī‘ah decisions, the SSB needs to develop a process for arriving at sharī‘ah decisions. This process must be documented, adopted, and maintained at all times to enhance the credibility of the decision-making process and minimize conflicts. Further, each member of the SSB has a role to play in formalizing a fatwa; hence, mistakes by any of the members would affect the final decision of the SSB, if not caught by other members. One issue that is of concern across different SSBs is the issuance of conflicting fatawa. This could not only shake stakeholders’ confidence in the Islamic finance industry, but also provide unequal opportunities to different institutions if such fatawa are not regulated by a central body. Grais and Pellegrini, however, cautiously downplay the issue. They observe:

In reality, however, the diversity of opinions is less widespread than might be expected. The CIBAFI [General Council for Islamic Banks and Financial Institutions] sampled about 6000 fatwas, and found that 90% were consistent across banks. The fact that over one hundred Shariah scholars around the world issued these fatwas would suggest an overall consistency in the interpretation of the sources. Further, this high degree of consistency between the fatwas would also point to a substantial independence of SSBs. Nevertheless, as the industry expands, the number of conflicting fatwas on the permissibility of an instrument is likely to increase. This could undermine customer confidence in the industry and have repercussions on the enforceability of contracts.⁵⁹

Bodies such as AAOIFI, the IFSB, and the International Islamic Financial Market (IIFM) are working to resolve the fatwa inconsistency issue. AAOIFI asserts that “the powers of [AAOIFI’s] Shari’a Board include, among others, the following: achieving harmonization and convergence in the concepts and application among the Shari’a supervisory boards of Islamic financial institutions to avoid contradiction or inconsistency between the fatwas and applications by these institutions, thereby providing a pro-active role for the Shari’a supervisory boards of Islamic financial institutions and central banks.”⁶⁰ The AAOIFI-issued shari‘ah standards have benefited from the various fatawa issued by jurists. In fact, they reflect the opinions of competent Muslim jurists in the field of Islamic finance from the different schools of jurisprudence.⁶¹ Likewise, the IFSB has issued its guiding principles on the sharī‘ah governance system. In contrast to the work done by AAOIFI, the IFSB does not work on standardizing fatawa on issues; instead, it focuses on the system that produces these fatawa. Hence, its guiding principles aim to:

1. complement other prudential standards issued by the IFSB by highlighting in more detail to the supervisory authorities in particular, and the industry’s other stakeholders in general, the components of a sound Sharī‘ah governance system, especially with regard to the competence, independence, confidentiality and consistency of Sharī‘ah boards;
2. facilitate better understanding of Sharī‘ah governance issues and how stakeholders should satisfy themselves that an appropriate and effective Sharī‘ah governance system is in place;
3. provide an enhanced degree of transparency in terms of issuance, and the audit/review process for compliance with Sharī‘ah rulings; and
4. provide greater harmonization of the Sharī‘ah governance structures and procedures across jurisdictions, especially since there are increasing numbers of IIFS with cross-border operations.⁶²

Similarly, IIFM states that it aims to “facilitate unification, Shari’ah harmonization and legal reforms in Islamic financial markets.”⁶³

The harmonization process is further enhanced and supported through the initiatives of regulatory authorities and central banks, such as the issuance of detailed directives in the form of regulations⁶⁴ on sharī‘ah-related matters and the establishment of an SSB at the regulatory level. These SSBs facilitate the sharī‘ah standardization process, and this decreases the risk of inconsistencies or contradictions arising in opinions, in addition to providing an equal sharī‘ah footing for the understanding and application of opinions by market participants.⁶⁵ The standardization discussed here must not undermine innovation or the engineering of new products; instead it should aim to establish a minimum common understanding that would serve as a starting point for institutions when they innovate. This contributes to the mitigation of sharī‘ah risks; moreover, it boosts the confidence of stakeholders in the industry as they value regulatory supervision of sharī‘ah dimensions.⁶⁶

5.5.5 Transparency and Disclosure

Transparency implies openness, accountability, and communication, and these three ideals are equally important and applicable to IBs. An IB develops its governance structures in a candid manner, making itself answerable to stakeholders and ensuring that pertinent information is readily accessible to them. In such a context, the IFSB defines transparency as “an environment where material and reliable information about the IIFS is made available in a timely and accessible manner to the market at large and to all stakeholders. Such transparency can reduce asymmetric information and uncertainty in financial markets.”⁶⁷ Disclosure is an inbuilt feature of transparency and it is furnished through communication. An IB cannot be seen to be transparent unless it discloses to the public reliable information in a timely manner. Iqbal and Mirakhor define disclosure as “[t]he process and methodology of providing information and making policy decisions known through timely dissemination and openness.”⁶⁸

Transparency is given great consideration in sharī‘ah, and any form of misrepresentation, concealment, or fraud is a violation of the principle of justice upheld by sharī‘ah. In highlighting the importance of documenting debt and collaterals, for instance, the Qur’ān instructs: “And if you are on a journey and cannot find a scribe, then a security deposit [should be] taken. And if one of you entrusts another, then let him who is entrusted discharge his trust [faithfully] and let him fear Allah, his Lord. And do not conceal testimony, for whoever conceals it – his heart is indeed sinful, and Allah is Knowing of what you do.”⁶⁹ In another verse, the Qur’ān states: “O you who have believed, be persistently standing firm in justice, witnesses for Allah, even if it be against yourselves or parents and relatives. Whether one is rich or poor, Allah is more worthy of both. So follow not [personal] inclination, lest you not be just. And if you distort [your testimony] or refuse [to give it], then indeed Allah is ever, with what you do, Acquainted.”⁷⁰ Through financial transparency sharī‘ah aims to:

1. Prevent the misuse of assets;
2. Promote lawful income and inhibit unlawful income;
3. Endorse honest transactions and dealings;
4. Prevent disputes;
5. Develop trust and confidence among people.⁷¹

Accordingly, in adhering to transparency, a sharī‘ah governance system needs to disclose the structure, processes, and functioning of such governance within an IB, and the measures devised to uphold sharī‘ah compliance. In doing so, consideration must be given to international standards, codes, and best practices of corporate governance, such as the Principles of Corporate Governance issued by the Organisation for Economic Co-operation and Development (OECD), the Enhancing Corporate Governance for Banking Organisations guidance issued by the Basel Committee on Banking Supervision, and the Disclosures to Promote Transparency and Market Discipline for Institutions Offering Islamic Financial Services and the Guiding Principles on Sharī‘ah Governance Systems for Institutions Offering Islamic Financial Services issued by the IFSB. Disclosures should thus include information about the competence, composition, role, and responsibilities of the SSB, BOD, and management, and decisions regarding sharī‘ah compliance of the IB. This level of transparency regarding sharī‘ah governance not only enhances the credibility of the IB and promotes accountability, but it also educates and empowers stakeholders by keeping them abreast of developments.

In a study conducted in 2004 and 2005, the IFSB observed a weakness in the level of transparency offered by IBs. It found, for example, IBs reluctant to disclose any information beyond the minimum disclosure requirements. Furthermore, specific disclosure pertaining to investment accounts (e.g. expense charges, profit allocation, allocation of assets) was generally unsatisfactory. In case of non-compliance with the sharī‘ah, despite supervisory authorities issuing warning letters to IBs, such action was generally not disclosed to the public.⁷²

Wafik and Pellegrini have also studied sharī‘ah governance disclosure and concluded the following:

Out of 13 banks reviewed, all declared the existence of an SSB within the organization and disclosed information on its composition. However, only 7 made the annual report of the SSB easily accessible, and 7 did not provide detailed information on the professional background of SSB members. Moreover, only two banks disclosed the fatwas authorizing the provision of financial services and products. Only one disclosed provisions for decision-making and interaction with other bodies of the firm. Finally, only one institution disclosed on its website the duties and obligations of the SSB.⁷³

Based on the observed deficiencies in the market with respect to sharī‘ah governance disclosure, the IFSB issued the quantitative and qualitative requirements shown in Table 5.2.⁷⁴

Source: IFSB, “Disclosures to Promote Transparency and Market Discipline for Institutions Offering Islamic Financial Services (Excluding Islamic Insurance (Takāful) Institutions and Islamic Mutual Funds)” (Kuala Lumpur, December 2007), 28.

5.6.1 GCC Jurisdictions

The GCC was established on May 25, 1981.⁷⁵ With the exception of Saudi Arabia, SSBs in GCC countries are similar in that they are mostly found at the bank level.⁷⁶ Below are some details on each of these countries.

United Arab Emirates (UAE): In the UAE, the Higher Sharia’h Authority is supposedly the entity that governs sharī‘ah-related matters of IBs under Federal Law No. 6 of 1985. In practice, this national entity has never existed, and it is the SSBs at the bank level that undertake this task. Article 6 requires IBs to stipulate the establishment of an SSB in the articles and memoranda of association.⁷⁷

Kuwait: Article 93 of the Central Bank Kuwait (CBK) Law, requires there to be an SSB to address sharī‘ah matters. In cases when the SSB of an IFI fails to resolve a sharī‘ah issue, the law stipulates that the Fatwa Board of Ministry of Endowments (Awqaf) and Islamic Affairs make the final decision.

Bahrain: The Central Bank of Bahrain requires all banks to establish an independent sharī‘ah supervision committee in compliance with AAOIFI’s governance standards for Islamic Financial Institutions Nos 1 and 2.⁷⁸ It further states:

All Islamic Bank Licensees must comply with all AAOIFI issued accounting standards as well as applicable Shari’a pronouncements issued by the Shari’a Board of AAOIFI. The Islamic Bank Licensee must have a separate function of Shari’a review to verify compliance with the above. The internal Shari’a review must be carried out in accordance with AAOIFI governance standard No.3. The Shari’a review function may be located in the Internal audit function of the Islamic Bank Licensee.⁷⁹

Qatar: Qatar Central Bank (QCB) and Qatar Financial Center Regulatory Authority (QFCRA) regulate IBs in the country. The prudential regulations issued by QCB in 2008 and 2012 provide guidelines for IBs. Similarly, QFCRA has also issued its own set of regulations.⁸⁰ Regulatory authorities require each IB to have an SSB. In addition, the regulations describe the roles and responsibilities of the SSB. However, no central sharī‘ah is found at the regulatory level.

Saudi Arabia: By virtue of Royal Decree No. 5 issued on 12 June 1966, the Banking Control Law governs banking activities in Saudi Arabia; however, this law is silent on the issue of interest.⁸¹ Saudi Arabia is different from other GCC jurisdictions with respect to sharī‘ah governance, in that there is no regulatory requirement to maintain an SSB at the IB level; however, all IBs operating in Saudi have SSBs, as this has become the norm in Islamic banking.⁸² For example, in 1999 Al-Rajhi Bank approved its sharī‘ah board charter. According to the charter, the sharī‘ah board verifies bank compliance with sharī‘ah precepts in all activities, in addition to providing counsel as well as guidance to the bank in line with the intent of Islamic legislation.⁸³

Oman: In pursuance to Royal Decree 69/2012, the Central Bank of Oman (CBO) issued the Islamic Banking Regulatory Framework (IBRF). The IBRF is a detailed and comprehensive document covering multiple aspects of Islamic banking. The IBRF considers the sharī‘ah supervisory board one of the key elements of the sharī‘ah governance framework of an Islamic bank. SSB members are given the authority to exercise appropriate discretion in decision-making by considering technical aspects of sharī‘ah and its objectives, while keeping in mind the ethical and legal dimensions.⁸⁴ IBRF recognizes the binding nature of SSB decisions. It says:

The SSB is entrusted with the duty of directing, reviewing and supervising the activities of the Licensee in order to ensure that they are in compliance with Shari’a principles. The Fatawa and rulings of the SSB shall be binding on the Licensee.⁸⁵

Although an SSB at the regulatory level does not yet exist, CBO is in the process of devising and regulating such an entity.⁸⁶

5.6.2 Non-GCC Jurisdictions

Malaysia: In Malaysia, Bank Islam Malaysia Berhad (BIMB) set up the first SSB in 1983.⁸⁷ After the Central Bank of Malaysia introduced the Interest Free Banking Scheme on March 4, 1993, several conventional banks opened Islamic banking windows and started offering Islamic banking products,⁸⁸ and they appointed expert sharī‘ah jurists as members of their sharī‘ah committees. The second full-fledged Islamic bank in Malaysia was developed in October 1999 and named Bank Muamalat Malaysia Behrad (BMMB).⁸⁹ In 1997, under the Banking and Financial Institutions Act (BAFIA) of 1984, the Sharī‘ah Advisory Council of the Central Bank of Malaysia was established as the highest sharī‘ah authority for IBs wishing to standardize sharī‘ah interpretations.⁹⁰ The directives and decisions of the SAC are binding for the SSBs of IBs. The Central Bank of Malaysia Act 2009 reinforced the role and functions of the SAC and deemed the entity the sole authoritative body on sharī‘ah matters pertaining to Islamic banking and takāful (Islamic insurance). The rulings of the SAC prevail over any contradictory ruling given by a sharī‘ah body or committee constituted in Malaysia. Moreover, courts and arbitrators are required to refer to the SAC rulings for any proceedings relating to Islamic financial business, and such rulings would be binding on institutions.

The authorities, duties, and responsibilities of SAC at the national level, as well as SSBs that will not be expanded upon here (called sharī‘ah committees in Malaysia) at the IB level, are different in several aspects. Members of the SAC have vast experience in banking, finance, economics, law, and the application of sharī‘ah to Islamic financial contexts. The list of SAC members for the period 2013–2016 is as follows:

1. Dr. Mohd Daud Bakar (Chairman)
2. Prof. Madya Dr Mohamad Akram Laldin (Deputy Chairman)
3. Yang Amat Arif Tun Abdul Hamid Mohamad
4. Tan Sri Sheikh Ghazali Abdul Rahman
5. Y.B. Sahibus Samahah Dato’ Haji Hassan Ahmad
6. Prof. Dr Engku Rabiah Adawiah Engku Ali
7. Prof. Dr Ashraf bin Md. Hashim
8. Prof. Madya Dr Rusni binti Hassan
9. Prof. Madya Dr Asmadi Mohamed Naim
10. Dr. Shamsiah Mohamad.

Pakistan: An initial attempt to “Islamize” the banking system in the nation in 1980 was not that successful.⁹¹ Mudārabah-based companies were developed in 1981, but there was no concept of an SSB for these companies back then. Nowadays, the State Bank of Pakistan (SBP) requires all IBs to establish an SSB “to advise the BOD [Board of Directors] and the executive management of the IBI [Islamic Banking Institution] on all Shari’ah related matters […] The SB shall ensure that all the IBI’s products and services and related agreements/contracts, structure, process flows, product manuals, marketing advertisements, sales illustrations and brochures etc are in conformity with the rules and principles of Shari’ah.”⁹² General directives on products and procedures are provided by the SBP in coordination with a regulatory-level SSB. A new requirement of a Resident Shari’ah Board Member (RSBM) has also been introduced. The individual, who would not be the chairperson of the SB, would be a resident of Pakistan and offer the following services:

1. Provide guidance on a day-to-day or routine Shari’ah related issues raised by the management and the staff of IBI.
2. Provide post product approval clarifications on various Shari’ah related issues and queries of management, staff, and approve routine documents, process flows etc.
3. Facilitate and provide guidance to the IBI’s product development function regarding the Shari’ah aspects of new products/ideas.
4. Guide, advise and lead the SCD [Shari’ah Compliance Department] in conducting Shari’ah compliance reviews of key business areas on sample and test check basis.
5. Respond to the Shari’ah related queries of IBI’s present/prospective clients regarding IBI’s products, services and Shari’ah practices received through SCD.
6. Supervise the preparation of Shari’ah training material and collaborate with SCD and Training Department in designing and delivery of Shari’ah related trainings.
7. Respond to all Shari’ah related queries made to him through SCD by different department of the IBI.
8. Submit a quarterly report to the SB of all the material clarifications, opinions etc given on routine/operational nature Shari’ah issues including guidance provided to the executive management to get all such opinions etc ratified by the SB.⁹³

North Sudan: The Sudanese Islamic banking experience is worthy of detailed study. Much of this journey is documented on the website of the Central Bank of Sudan (CBOS). Faisal Islamic Bank (Sudan) was incorporated in 1977 and started operations the following year. The SSB of the bank is reported to have participated in drafting the articles and memorandum of association of the bank, in addition to providing sharī‘ah guidance on other issues.⁹⁴ In 1984, Sudan introduced Islamic laws that altered the practices of CBOS and the operations of banks. The government, in 1993, established the Higher Sharia Supervisory Board to ensure compatibility of IBs with sharī‘ah principles.⁹⁵ At the bank level, each IB has its own SSB.

Indonesia: Islamic finance activities commenced in 1992 with the development of Bank Muamalat Indonesia, the first Islamic bank in the country. IBs are regulated under the government Law No. 7 of 1992 concerning banking which was subsequently amended by Law No. 10 of 1998.⁹⁶ Indonesia features a National Sharī‘ah Board (Dewan Syriah Nasional) at the central bank (Bank Indonesia) that was formed by the Indonesian Council of Ulemas in 1999 as an independent body responsible for issuing sharī‘ah rulings for IBs.⁹⁷ According to the regulations, Islamic banks are obliged to have an independent SSB.

United Kingdom: There are several IBs operating in the UK; however, there is no mandate from the regulators for these IBs to have an SSB. Additionally, sharī‘ah governance is managed by the institutions without regulatory involvement.⁹⁸

5.8.1 SSB at IB Model

In this model, regulatory authorities require IBs to have an SSB to supervise sharī‘ah matters. However, there is neither an SSB at the central bank level, nor a central authority of last resort. The difference between this model and the Market-Driven SSB at IB Model, discussed later, is that establishing an SSB is a legal requirement here, whereas in the other model it is not. This model is in effect in Qatar. It could also be argued that it is in effect in Oman, until the Central Bank of Oman chooses to establish its SSB, which it has mentioned in recently issued regulations. Variations of this model can be found in the market. Here are two examples:

Example 1: The model comprises one SSB for a group of entities within a jurisdiction or across jurisdictions, whereby this SSB supervises all entities of the group with regard to sharī‘ah compliance. Dallah Al-Baraka Group is an example of this.¹⁰⁶

Example 2: The model features a separate SSB for different entities of the same group located within a jurisdiction. Ahli United Bank is an example of this. The bank has entities in Bahrain, Kuwait, Oman, and the UK. However, each of these is supervised by a different SSB in the separate jurisdictions. This does not mean, however, that some individuals do not sit on multiple SSBs of Ahli United Bank in the different jurisdictions.

5.8.2 SSB at Central Bank and IB Model

This model features sharī‘ah supervision at both the central bank as well as at the IB level. The SSB at central bank provides sharī‘ah guidelines that assist the regulatory authority in preparing regulations for Islamic banking. In addition, it oversees and monitors the SSBs of individual IBs within the jurisdiction.¹⁰⁷ Accordingly, the SSB at the IB level is tasked with overseeing activities from a sharī‘ah perspective, and interpreting for the institution sharī‘ah guidance issued by the regulatory-level SSB so that it can be understood by practitioners. The IB-level SSB is required to consult the higher SSB on new sharī‘ah issues raised by the IB, in order to seek the latter’s guidance and directives. This is a highly structured model that helps safeguard IBs from falling into inconsistencies on sharī‘ah matters and contributes toward the standardization of practices. Furthermore, the model is dynamic in its approach and its proponents develop it on the basis of regulatory provisions that promote robust sharī‘ah governance systems. This model is in effect in Malaysia, Pakistan, Indonesia, and Sudan.

Bank Negara Malaysia (BNM) established its Sharī‘ah Advisory Council on May 1, 1997 as an authority that would advise BNM on IFI operations from a sharī‘ah perspective, and ascertain Islamic law for products and policies. Both the Malaysian judiciary and the Regional Center for Arbitration Kuala Lumpur use the SAC as a reference point for disputes on sharī‘ah issues relating to Islamic banking. As per the Central Bank of Malaysia Act 1958, which was later amended in 2003, the SAC was accorded the authority of final decision-making with regard to sharī‘ah matters of IBs. To tackle the issue of independence, SAC members of BNM are not allowed to participate in any SSB of any IFI within the jurisdiction. Additionally, BNM requires IBs to establish an SSB, referred to as a Shariah Committee (SC), that would advise the bank on sharī‘ah-related matters within the scope of the SAC- issued guidance.¹⁰⁸

Sudan is also an example of this model. It maintains an SSB both at the central bank as well as at the IB level. The High Shariah Supervisory Board at the central bank level was established on March 2, 1992 as an independent board comprising eleven members specialized in fiqh, economics, and Islamic banking and finance. Their major responsibilities include:

1. Issuing a charter highlighting the board’s responsibilities and activities;
2. Assisting supervisory authorities in carrying out their activities in line with sharī‘ah precepts, and helping the Central Bank of Sudan establish an economy guided by these precepts;
3. Supervising the activities of the Central Bank of Sudan and IBs with respect to sharī‘ah dimensions, researching sharī‘ah issues that arise, and providing their opinion on them;
4. Issuing fatawa and advising on numerous matters, such as proposed regulations and the sharī‘ah standardization of financial matters for IBs;
5. Assisting supervisory authorities draft sharī‘ah-compliant model contracts to be used as templates within the jurisdiction and develop government securities;
6. Preparing a yearly report addressed to the minister of finance concerning sharī‘ah compliance of IBs and the central bank.¹⁰⁹

Pakistan grants authority to the Federal Shariat Court, as a third party institution, to decide on sharī‘ah matters pertaining to Islamic banking. Furthermore, SBP has its own Shari’ah Board in addition to the SSBs found at individual banks. The Shari’ah Board at SBP issues sharī‘ah guidelines relating to financing, model agreements, etc.

The Central Bank Bahrain (CBB) requires all banks to establish an independent SSB complying with AAOIFI’s governance standards for IBs# 1 and 2. The CBB also has a National Sharī‘ah Advisory Board that assists the regulator with sharī‘ah matters.¹¹⁰

Indonesia also endorses this model featuring an SSB at the central bank (Bank Indonesia) – known as the National Sharī‘ah Board (Dewan Syriah Nasional) – as well as SSBs at the IB level to supervise the application of sharī‘ah principles. The Dewan Syriah Nasional was formed by the Indonesian Council of Scholars (Ulemas) in 1999 as an independent body recognized by Bank Indonesia for issuing sharī‘ah rulings.

5.8.3 Central Authority and SSB at IB Model

With this model there is no SSB at the central bank and IBs are required to devise their own SSB for sharī‘ah supervision. However, in the case of disputes on sharī‘ah issues between the IB and its SSB or between SSB members, the IB is advised to present the case to a higher authority for it to resolve the matter. The latter’s decision would be binding. Hence, the authority oversees issues that are brought to its attention on an as-needed basis and does not monitor the SSBs of IBs. The authority is independent from the central bank and plays a passive role. The following jurisdictions present examples of this model.

In Kuwait, there is no SSB at the central bank level; however, IBs are required to have their own individual SSB.¹¹¹ The Fatwa Board of the Ministry of Endowments (Awqaf) and Islamic Affairs is the external central authority that has the final say on resolving sharī‘ah disputes presented to it. Article 93 of the Central Bank Kuwait (CBK) Law states:

Each Islamic bank is required to develop an independent Shari’ah Supervisory Board, comprised of not less than three members appointed by the bank’s General Assembly […] In case of a conflict of opinions among members of the Shari’ah Supervisory Board concerning a Shari’ah rule, the board of directors of the designated bank may transfer the matter to the Fatwa Board in the Ministry of Awqaf and Islamic Affairs, that shall be the final authority on the matter.¹¹²

Similarly, the UAE’s regulatory framework requires IBs to have their own SSB, and assigns the “Higher Sharia’h Authority” binding authority to resolve disputes.¹¹³ There are no restrictions in this model regarding the number of SSB positions that jurists can serve on. One observation about the central authority, in both these cases, is that it has hardly ever played a meaningful role. In fact, in the case of the UAE, the Higher Sharia’h Authority was not even formed.

5.8.4 Market-Driven SSB at IB Model

In this model there is no legal requirement to establish an SSB on any level, yet IBs choose to regulate sharī‘ah dimensions by establishing an SSB at the IB level, due to industry practices, norms, and market demands. This model is found in countries such as Saudi Arabia, the United Kingdom, the United States, Canada, Australia, and France. In some cases, Islamic banking institutions can be found contracting the SSB work to a sharī‘ah advisory firm, rather than maintaining individual SSBs. As far as Saudi Arabia is concerned, the Saudi Arabian Monetary Agency – like the regulators of the countries previously mentioned – treats IBs as it treats their conventional counterparts, with no special arrangements.¹¹⁴

Table 5.3 summarizes the different SSB models discussed above.

^* Oman remains in this category until it establishes its SSB at the Central Bank.