Shariah Governance for Islamic Banking: Room For Reform

Abdulazeem Abozaid
Islamic Finance Program – Qatar Foundation


What is Shariah governance?

Shariah governance is a component of corporate governance, and it is peculiar to Islamic banking and finance.  Islamic banking and finance has the responsibility to ensure compliance with Shariah principles in its products, instruments, operations, practices, management etc.


The significance of Shariah governance

One of the unique characteristics of Islamic banking and finance is compliance with Shariah principles and rulings. Shariah compliance is what distinguishes an Islamic bank from a conventional bank as the former observes certain rules and prohibitions not observed by the latter. Failing to fulfill Shariah compliance requirements would generate a risk called ‘the Shariah non-compliance risk’. This risk is unique to the Islamic banking and finance industry, and it is particularly significant to it for the following reasons:


  1. It generally impacts the industry’s reputation as well as the reputation of the financial institution and thus, it may deteriorate reliance of the depositors, investors, customers and stakeholders in the long-term
  2. o

  3. Contracts containing Shariah-repugnant elements and already executed shall be deemed null and void, which would in turn render the profit derived thereof non-halal, and as a result the tainted income arising from such transactions must be channeled to charity and cannot be kept by bank
  4. o

  5. It may involve some legal costs as potential suits may lead to payment of damages.


Therefore, the existence of non-Shariah compliant element would not just affect the confidence of the public in Islamic banking and finance, but it might also expose Islamic banks to profitability, fiduciary and reputational risks.

Hence, Shariah compliance is the backbone of Islamic banking & finance. It gives legitimacy to the practices of Islamic banking and finance and thus validates the profits. It also boosts the confidence of all stakeholders in that all the practices and activities of the bank are in compliance with the Shariah. However, compliance with the Shariah will be confidently achieved only by having a proper Shariah governance framework. This is because Shariah governance is meant for nothing but to ensure compliance of Islamic banking and finance industry with the rules of the Islamic Shariah.


Anything wrong with the existing Shariah governance?

Islamic banking and finance has been left for self-regulation in terms of Shariah governance. Despite the importance of regulating this relatively-new industry and the critical risks resulting from feeble Shariah governance, there is no genuine or effective interference by the high authorities to regulate this industry. There is no one unified Sharia governance system, and in most jurisdictions supervisory authorities may permit the Islamic financial institutions to decide for themselves what kind of Shariah governance system to adopt. The market is left to determine freely which system lends sufficient credibility to the products and services that each Islamic financial institution offers. This self-regulation has in fact led to many cautions rendering Shariah control ineffective in most cases.

Even in the very few countries that have national Shariah governance framework, like Malaysia, Oman and Syria, this framework has not been effective enough to lift the Shariah concerns associated with lack of or improper Shariah governance. Therefore, the existing Shariah governance frameworks have failed to fulfill their perceived objective as a guarantee of Shariah compliance.

More importantly, the Islamic Shariah as a whole needs to be safeguarded and protected from being possibly manipulated or twisted by Islamic banks to serve their self-interests. This also requires setting robust Shariah governance for the Islamic finance industry to guarantee the preservation of Shariah rules and the protection of the Shariah image.

Now, to identify the problems with the existing Shariah governance we need to locate the existing Shariah concerns over the practices of the industry, because every Shariah concern in the current practices relates to some corresponding deficiency in the existing Shariah governance frameworks. Generally, the basic Shariah concerns over the practices of the industry are the following:


  • The invasion of highly controversial products, which are no different in essence from the conventional banking products that are believed to be unlawful

  • o

  • The non-independence of the Shariah controllers, including the Shariah supervisory board members, from the financial institution they are supposed to control and supervise. This would create conflict of interest and inevitably open the door for subjective and arbitrary endorsement of the banking products and services

  • o

  • The existence of unqualified Shariah controllers lacking the necessary expertise and knowledge; naturally, this would in turn lead to wrong evaluation and assessment of the financial products

These Shariah concerns are natural outcomes of weak Shariah governance, which fails to fulfill its purpose in safeguarding the Shariah aspects of the business. Obviously, the problem with the existing Shariah governance in Islamic finance relates to the legitimacy of some Islamic financial products and the efficiency of the Shariah control in Islamic finance. Noticeably, these two problems are interrelated since an inefficient Shariah control will lead to questionable products.


Some proposed governance rules:

To help solve the deficiencies in Shariah governance, the following are suggested:

Accreditation of Shariah board members

Shariah boards should have only accredited Shariah scholars, so that not any holder of some Shariah or Islamic studies degree can jump in and pose as a Shariah board member. As a prerequisite, a Shariah board member should have an MA or PhD in Islamic financial law, in addition to some basic knowledge in banking and finance. He must also be accredited by an institution set up for this purpose, through passing some exams and taking some intensive courses if necessary.

Similar to practicing Medicine or Law, a Shariah scholar who possesses the said basic qualifications must be licensed, before practicing, by taking some exams to ensure that he is really knowledgeable in these fields and that his academic studies have really made him a scholar. In fact, issuing Shariah pronouncements that would outline the Haram is a more serious and critical task than that of a medical doctor or a lawyer, and it is very unfortunate that people do not regard it as such.


Independence of the Shariah control

To ensure independence and avoid conflict of interest, Shariah board members must be selected, appointed and possibly dismissed by an independent third party, like the central bank or by an international institution like the Council for Islamic Banking and Financial Institutions.

As per the existing policies in Islamic banks, the BOD (Board of Directors) is supposed to select and appoint the Sharia board members, and then the appointment receives approval from the shareholders in a General Meeting. However, in practice it is the bank’s executive managers who select the Shariah board members, and then BOD handles the official appointment. Besides, neither the executive managers nor the BOD are truly independent. This is because independence here is meant to ensure absence of conflict of interest, and both parties are actually hired to serve the best interest of the bank, which in most cases falls in contrast with Shariah compliance. The same can also be said with respect to the shareholders when they are given the authority to appoint Shariah board members, since they are the owners of the bank, so giving them the authority to appoint Shariah board members, as stated by AAOIFI, never achieves or serves the cause of independence.


Adding to Shariah boards financial and legal experts 

Shariah boards should also include financial and legal experts with no voting right to advise the Shariah scholars and brief them on any relevant financial or legal concerns in addition to the possible implications of any Shariah resolution. This step is particularly important when the Shariah board members do not have adequate legal, finance or market experience, so they need to consult trustworthy and independent experts before they can make a decision. In point of fact, a wrong fatwa in many cases could be a result of a misrepresentation by the bankers or a misunderstanding by the Shariah board members.


Limiting the number of Shariah boards a person can join

It is noticeable that a few Shariah scholars dominate Shariah boards. This unhealthy phenomenon can be attributed to multiple reasons, all relating to the absence of proper and effective Shariah governance. Undoubtedly, the proven convenience of the fatwas of particular Shariah person would grant him a privileged pass to other Shariah boards. Besides, newly-opened institutions usually ask some existing and known Shariah board members to recommend scholars for their own Shariah boards – a practice that ends up with the same scholars working for a number of institutions. This phenomenon is far from professional, as it carries the seeds of many negative implications, such as the subjection of the whole industry to the limited views of a small group of people, in addition to the incapability of those people to efficiently discharge their responsibilities. Therefore, the number of boards one person may join must be limited to a reasonable number, such as three, and this would also give the chance to other brains to join and benefit the industry.


Setting an international Shariah supervisory board

To help solve the above-mentioned problems and to remove the conflicts related to Islamic banking products on a universal level, an international Shariah supervisory board needs to be established. Its responsibility shall mainly involve endorsing products and main contracts only, since it would not be feasible for it to look into the daily customized transactions of the operating Islamic banks. It should have a specific number of the most credible, experienced and qualified Shariah scholars from various jurisdictions and schools of thought. They must be fully independent by not sitting on any individual Shariah board. Such a committee could also be made affiliated to the Organization of Islamic Cooperation (OIC) and also paid by the OIC after receiving funds from the member banks. Its resolution shall be binding on the individual Islamic banks, and in case of a proven infringement by one of these banks it should have authority to declare the violating bank as non-operating according to Shariah rules. Individual Shariah boards should also be empowered to report to this international board any infringement by their respective banks. Even if this international board is not given the legal power to withdraw the license of the non-compliant bank or cause it to be withdrawn, it will still have a great influence over the banks and their Shariah boards since it can blacklist or declare a particular bank as one not complying with Shariah. This is because both the bank and its Shariah board will fear losing credibility in the eyes of the public. To ensure compliance with its regulations, this board should have its audit arm to carry out unannounced inspecting visits to the banks to scrutinize their products and report any infringement.


Finally, it is worth noting that the intervention of central banks to rectify Shariah governance may not be the optimum solution, because the core problem resulting from the existing ineffective and deficit Shariah governance ultimately relates to the credibility of the products and their resemblance to the conventional banking counterparts. Naturally, central banks will not be pleased with Islamic banks offering genuinely Islamic products because these products will then inherently carry various business risks. Therefore, balanced Shariah governance with minimum interference by central banks is imperative, and the full independence of any potential Shariah regulatory authority from the Islamic financial institutions remains a prerequisite.



One Comment

  • Azhar Hamid

    Asssalamo Alikum wr wb

    I just went through your website details and found it good informative. We have a publication on Foundations of Sharia Governance of Islamic Banks and find it good to share with you. You may please refe to the following link to read the book:


Leave a comment

Your email address will not be published. Required fields are marked *

Interested in investing with Wahed?

Open your account in minutes

Get Started