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Published by odllab, 2019-12-20 06:05:56

BBF314/03 Islamic Finance

Islamic Finance
Course code:BBF314/03
Course adapter by: Ms. Tenku Nur Shahrul Hizam Binti Tenku Izhan School of Business and Administration (SBA)

Professor Dr Zoraini Wati Abas
Content Adapter: Tenku Nur Shahrul Hizam Tenku Izhan
Lead Instructional and Visual Designer: Fauziyah Md Aris Instructional and Visual Designers: Norliza Mhd Rodzi and Nurain Mohd Hassan Language Editor: Meilina Puteh
Margin Setting: Norliza Mhd Rodzi
Cover Page and Content Design: Norliza Mhd Rodzi
Tenku Nur Shahrul Hizam Tenku Izhan
Online Digital Learning Lab (ODL Lab)
Instructional Design for Engaging Experiences (IDeX) Wawasan Open University
First edition, December 2019
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Part 1 | About the Course
Part 2 | Course Overview
Course Synopsis
Course Contents
Course Learning Outcomes Study Schedule Assessment Methods
Part 3 | Study Guide
Unit 1: Introduction to Islamic Finance Unit 2: Islamic Corporate Governance Unit 3: Islamic Economics
Unit 4: Islamic Capital Market
Unit 5: Islamic Wealth Management
04 05
Part 4 | References
Part 5 | Feedback Form

Part 1
(Course Details & Allocation of Student Learning Time)
Course Type
Credit Hours
Learning Hours : 120 hours Pre-Requisites
: School of Business Administration (SBA) : Core Course
: BBF201/03N Introduction to Financial Management
: 3 hours
Course Title Course Code
: Islamic Finance : BBF314/03
Course Coordinator Email
Contact No
: Ms Tenku Nur Shahrul Hizam Tenku Izhan : [email protected]
: 04-2180 438
No. of Hours
42 10 30
12 2
1 Study Learning Materials, Learning Activities and Self- Tests
2 Attending 5 Tutorial Classes (2 Hours per class)
3 Participation in Online Forum Discussions
4 Completing the Course Assignments (CA1 & CA2)
5 Exam Revision
6 Examination
BBF314/03 Islamic Finance

Part 2
(Course Synopsis, Course Content, Course Learning Outcomes, Study Schedule & Assessment Methods)
Course Synopsis
BBF314/03 Islamic Finance emphasizes on five (5) major subtopics such as Introduction to Islamic Finance, Corporate Governance, Islamic Economics, Islamic Capital Market and Islamic Wealth Management related to Islamic Financial Institution (IFI) such as Islamic Commercial Banks, Islamic Capital Market, Islamic Insurance companies and Islamic Investment Funds.
Various contracts applied to Financial Instrments will be discussed in this subject. Mudarabah, Musyarakah, Murabaha, Ijara, Salam, Istina’, Wakala, Katalah and Ju’ala are the few example of Islamic Financial Contracts offered in Malaysia.
Islamic finance has started to grow in international finance across the globe, with some concentration in few countries such as Malaysia, Indonesia and Pakistan. Malaysia’s adopt an integrated Islamic Finance Regulations and its Islamic financial system is governed by legal Shariah structures. The basic principles that govern Islamic Financial Services Act 2013 (IFSA) are Principle of Equity, Principles of Participation and Principles of Ownership. IFSA falls under the purview of Bank Negara Malaysia which covers the regulation and supervision of the Islamic banking and Takaful sectors. Besides, it is also subject to many regulations similar to those of the conventional system with which it exists side by side. While the Islamic Capital Market in Malaysia is facilitated by the Securities Commission. SC has responsible for issuing licenses to market intermediaries and guidelines on the offering of Islamic securities.
BBF314/03 Islamic Finance 2

COURSE LEARNING OUTCOMES (CLOS) By the end of this course, you will be able to:
1. Describe the basic concepts ad characteristics of the contracts that govern the work of Islamic Financial Institutions in Malaysia
2. Apply auditing, governance and ethical standards issued by Shariah Advisory Council (SAC).
3. Evaluate the Islamic financing tools in various applications in Islamic Economics, Islamic Capital Market and Islamic Wealth Management.
BBF314/03 Islamic Finance 3

Course Content
Course is divided into five (5) units and topics are as below: Unit 1: Introduction to Islamic Finance
Unit 2: Islamic Corporate Governance Unit 3: Islamic Economics
Unit 4: Islamic Capital market
Unit 5: Islamic Wealth Management
BBF314/03 Islamic Finance 4

(Weekly topic and study activity for each unit)
Unit Week Topic Focus
Learning Self- Activities Assessment
Introduction to Islamic Finance
Corporate Governance for Islamic Financial Institutions
Islamic Economics
1.2 The Framework of Islamic Finance
1.3 The Three Principles Govern Islamic Finance
1.4 Key Instruments of Islamic Finance
2.2 Corporate Governance in
2.3 Models of
Corporate Governance: Stakeholders vs Stockholder
2.4 The Role of Corporate
Governance in Islamic Financial Institutions
2.5 Mechanism of Corporate
Governance and
2.6 Functions of Shariah
Governance System in Islamic Financial Institutions
3.2 Methodology of Islamic Economics
3.3 The Islamic Economics System
3.4 Characteristics and Principles of
Islamic Economics
3.5 Allocation of
Resources in an Islamic Economics System
Web Based Learning Concept Illustration
Problem Based Learning & Cases Based Learning
Lecture & Tutorials
Assessment: Essay, Short Answer questions, Concept mapping, Case Based Articles
Assessment: Essay Question, Report, Problem Based Learning (PBL)
Assessment: Essay, Report, Critical Evaluation of the literature, Critique on an Issue
BBF314/03 Islamic Finance 5

COURSE STUDY SCHEDULE (Weekly topic and study activity for each unit) ... continued
Unit Week Topic Focus
Learning Self- Activities Assessment
Islamic Capital Market
Islamic Wealth Management
4.2 The roles and functions of
financial markets
4.3 Structures of
Financial Markets
4.4 Types of Financial
5.3 Islamic Wealth Management
5.4 Review and Fundamental of
Islamic Investing
5.5 Selection of
Islamic Stocks for
5.6 Structure,
Marketing and Distribution of Islamic Investment Funds
5.7 Shariah Governance of
Islamic Funds
5.8 Composition of
Shariah Supervisory Board
Lecture & Tutorials Web Based Learning
Lecture & Tutorials Trading simulation
Assessment: Essay, Report, Critical Evaluation of the literature, Critique on an Issue
Assessment: Essay, Report, Critical Evaluation of the literature, Critique on an Issue
BBF314/03 Islamic Finance 6

BBF314/03 Islamic Finance 7
TOTAL 100%
Problem Based Learning,
Case Based Learning and Trading Simulation Based on Shariah Counters
Web Based Learning
The student will be assessed through the following methods:
Note: The grade for a course is assigned based on the overall score, which combines both the contiuous assessment and the final examination compoents (please refer to the Student Handbook for details).

1.1 The Framework of Islamic Finance
1.2 Three Principles Govern Islamic Finance
1.3 Key Instruments of Islamic Finance
1.4 Growth Drivers of Islamic Finance
1.5 Comparison of Islamic and Conventional Finance
1.6 Conclusion
2.1 The Meaning of Corporate Governance
2.2 Corporate Governance in Islam
2.3 Models of Corporate Governance: Stakeholder Versus Stockholder
2.4 The Role of Corporate Governance in Islamic Financial Institutions
2.5 Mechanisms of Corporate Governance and Control
2.6 Functions of Shariah Governance System in Islamic Financial
2.7 A different Approach for Islamic Financial Institutions
2.8 Models of Shariah Governance from Selected Islamic Countries
2.9 Corporate Governance for Islamic Insurance
3.1 Islam, its Worldview and Islamic Economics
3.2 Methodology of Islamic Economics
3.3 The Islamic Economic System
3.4 Characteristics and Principles of Islamic Economic System
3.5 Allocation of resources in an Islam Economic System
3.6 Why Islamic Economics and Finance?
3.7 Conclusion
BBF314/03 Islamic Finance 8

4.1 Key Highlights of The Islamic Capital Market in Malaysia
4.2 The Roles and Functions of Financial Markets
4.3 Structures of Financial Markets
4.4 Types of Financial Intermediaries
4.5 Development o of Islamic Capital and Money Markets in Malaysia
4.6 Conclusion
5.1 Conventional Wealth Management
5.2 Islamic Wealth Management
5.3 Review and Fundamentals of Islamic Investing
5.4 Selection of Islamic Stocks for Investment
5.5 Structure, Marketing, and Distribution of Islamic Investment Funds 5.6 Shariah Governance of Islamic Funds
5.7 Composition of the Shariah Supervisory Board
5.8 Risk Management for Islamic Investment Funds
5.9 Conclusion
BBF314/03 Islamic Finance 9


1.6 1.7
The Framework of Islamic Finance
Learning Activity 1.1 Self-Check 1.1
Three Principles Govern Islamic Finance
Learning Activity 1.2 Self-Check 1.2
Key Instruments of Islamic Finance
Learning Activity 1.3 Self-Check 1.3
Growth Drivers of Islamic Finance
Learning Activity 1.4 Self-Check 1.4
Comparison of Islamic and Conventional Finance
Learning Activity 1.5 Self-Check 1.5
Summary References
BBF314/03 Islamic Finance 11

U1 Introduction to Islamic Finance INTRODUCTION
Islamic Finance is growing within international finance. Modern Islamic banking started with pioneering experiments in the early 1960’s in Egypt, while in Malaysia, it started with the establishment of Lembaga Tabung Haji.
Even though several banks were already operating, the Muslims were reluctant to use conventional banking for their hajj savings because they wanted to ensure that their hajj savings were free from riba (usury) in order to attain a Mabrur Hajj. There was no Islamic financial institution that provided services to the Muslim community in this country to save for hajj expenses.
The idea to set up the Prospective Hajj Pilgrims Savings Corporation (Perbadanan Wang Simpanan Bakal-bakal Haji (PWSBH)) was triggered by a proposal made by the renowned Malay economist, the Royal Professor YM Ungku Abdul Aziz bin Ungku Abdul Hamid in December 1959 to the Federal Government of Malaya.
y the end of this course, you should be able to:
1. To provide an introduction to the concepts of Islamic Finance applied locally and globally
2. To explain the theories and concepts of the Islamic Financial Instruments and Islamic Financing Models used in the Islamic Finance Industry.
BBF314/03 Islamic Finance 12

Key Principles of Islamic Finance
Islamic economics, banking and finance derive from the rulings of the Shari’ah legal code. Shari’ah jurisprudence does not distinguish between religious and other aspects of life. Shari’ah Law includes the transactions falling under either the political, economic, or social sphere (muamalat). In Islamic economics, productive human activity is mandatory.
Islam does not endorse every human wish, and it prohibits on moral grounds activities related to tobacco and other drugs, alcohol, pork products, gambling involving money and non-money assets (maysir), speculation, pornography, and armaments and destructive weapons.
Muslim Beliefs
Islam is the name of the religion transmitted by the Prophet Mohammed as revealed to him by God (Allah).
Al- Quran
The Quran is the book containing the speech of God revealed to the Prophet Mohammed in Arabic and transmitted to us by continuous testimony. Al Quran is the central focus point to Islamic beliefs. The Quran is deemed to be a proof of the prophecy of Mohammed, is the most authoritative guide for Muslims and is the first source of the Shariah.
BBF314/03 Islamic Finance 13

It was revealed exclusively to the Prophet Mohammed
It is recited in salah (ritual prayer)
It was put into writing
It is the inimitable speech of God
It is all
(universally accurately reported)
BBF314/03 Islamic Finance
Figure 1.1. The salient attributes of the Quran

Five pillars of faith (Rukun Islam)
The structure of Islam is founded on pillars. These are the essential religious duties required of every mentally able, adult Muslim. The five pillars are each described in some part of the Quran and were already being practised during Nabi Mohammed’s lifetime.
The profession of faith
Five pillars of Islamic Faith
Daily prayer (Salat)
Almsgiving (zakat)
Fasting (sawm)
BBF314/03 Islamic Finance
Pilgrimage (hajj)
Figure 1.2. The five pillars of Islamic Faith Click on each pillar for more details

Six islamic creeds (Rukun Iman)
The structure of Islam is founded on pillars. These are the essential religious duties required of every mentally able, adult Muslim. The five pillars are each described in some part of the Quran and were already being practised during Nabi Mohammed’s lifetime.
Destiny (Qadha & Qadar)
Existence and Attributes of Allah
The Hereafter (Hari Qiamat)
Angels (Malaikat)
BBF314/03 Islamic Finance
Prophets (Rasul-Rasul)
Revealed Books (Kitab-kitab)
Figure 1.3. The six Islamic Creeds (Rukun Iman) Click on each creed for more details

Learning Activity 1.1
Watch "Basic Beliefs of Islam" on YouTube
Title : Basic Belief of Islam Duration : 6.39 minutes
Watch "01- The Creed of Imam At-Tahawi - Belief of Muslims" on YouTube
Title : 01- The Creed of Imam At-Tahawi - Belief of Muslims Duration : 52.42 minutes
Based on the two videos, contrast between the pillar of Iman (Faith) and Creed of Islam.
BBF314/03 Islamic Finance 17

Principle of equity
Scholars generally invoke this principle as the rationale for the prohibition of predetermined payments (riba), with a view to protecting the weaker contracting party in a financial transaction. The term riba, which means “hump” or “elevation” in Arabic, is an increase in wealth that is not related to engaging in a productive activity.
The principle of equity is also the basis for prohibiting excessive uncertainty (gharar) as manifested by contract ambiguity or elusiveness of payoff. Transacting parties have a moral duty to disclose information before engaging in a contract, thereby reducing information asymmetry; otherwise the presence of gharar would nullify the contract.
The principle of equity and wealth distribution is also the basis of a 2.5 percent levy on cash or in-kind wealth (zakat), imposed by Shari’ah on all Muslims who meet specific minimum levels of income and wealth to assist the less fortunate and foster social solidarity.
Principle of participation
Although commonly known as interest-free financing, the prohibition of riba does not imply that capital is not to be rewarded. According to a key Shari’ah ruling that “reward (that is, profit) comes with risk taking,” investment return has to be earned in tandem with risk-taking and not with the mere passage of time, which is also the basis of prohibiting riba. Thus, return on capital is legitimised by risk-taking and determined ex post based on asset performance or project productivity, thereby ensuring a link between financing activities and real activities.
The principle of participation lies at the heart of Islamic finance, ensuring that increases in wealth accrue from productive activities.
Principle of ownership
The rulings of “do not sell what you do not own” (for example, short-selling) and “you cannot be dispossessed of a property except on the basis of right” mandate asset ownership before transacting. Islamic finance has, thus, come to be known as asset-based financing, forging a robust link between finance and the real economy. It also requires preservation and respect for property rights, as well as upholding contractual obligations by underscoring the sanctity of contracts.
BBF314/03 Islamic Finance 18

In Islamic finance, the term “loan” refers only to a benevolent loan (qard al hasan), a form of financial assistance to the needy to be repaid free of charge. Other instruments of Islamic Finance are not referred to as “loans’ but rather as financing modes falling under one of the three categories.
Profit and Loss Sharing (PLS)
Musharakah Mudarabah
Non Profit and Loss Sharing
Murabahah Ijarah Salam Istisna
Fees based Products
Wakalah Kafalah Ju’ala
Figure 1.4. Islamic Financing Modes Profit Loss Sharing (PLS) Financing Products
PLS financing is closest to the spirit of Islamic finance. Compared with non-PLS financing, its core principles of equity and participation, as well as its strong link to real economic activities, help promote a more equitable distribution of income, leading to a more efficient allocation of resources. There are two types of PLS financing: musharakah and mudarabah.
Musharakah is a profit-and-loss sharing partnership and the most authentic form of Islamic financing.It is a contract of joint partnership where two or more partners provide capital to finance a project or own real estate or movable assets, either on a permanent or diminishing basis. Partners in musharakah have a right to take part in management; they seem to bear the greatest risk among all Islamic financing modes with the potential for earning the highest reward. However, whereas profits are distributed according to pre-agreed ratios, losses are shared in proportion to capital contribution.
BBF314/03 Islamic Finance 19

Mudarabah is a profit-sharing and loss-bearing contract where one party supplies funding (financier as principal) and the other provides effort and management expertise (mudarib or entrepreneur as agent) with a view to generating a profit. The share in profits is determined by mutual agreement but losses, if any, are borne entirely by the financier, unless they result from the mudarib’s negligence, misconduct, or breach of contract terms. Mudarabah is sometimes referred to as a sleeping partnership because the mudarib runs the business and the financier cannot interfere in the management, though conditions may be specified to ensure better management of capital. Islamic banks mainly make use of mudarabah financing to raise funds; mudarabah contracts are also used for the management of mutual funds.
Non-PLS Financing Products
Non-PLS contracts are most common in practice. They are generally used to finance consumer and corporate credit, as well as asset rental and manufacturing. Non-PLS financing instruments include murabahah, ijarah, salam, and istisna’.
Murabahah is a popular Shariah-compliant sale transaction mostly used in trade and asset financing. The bank purchases the goods and delivers them to the customer, deferring payment to a date agreed by the two parties. The expected return on murabahah is usually aligned with interest payments on conventional loans, creating a similarity between murabahah sales and asset-backed loans. However, murabahah is a deferred payment sale transaction where the intention is to facilitate the acquisition of goods and not to exchange money for more money (or monetary equivalents) over a period of time. Unlike conventional loans, after the murabahah contract is signed, the amount being financed cannot be increased in case of late payment or default, nor can a penalty be imposed, unless the buyer has deliberately refused to make a payment. Also, the seller has to assume any liability from delivering defective goods. Murabahah transactions are widely used to finance international trade, as well as for interbank financing and liquidity management through a multistep transaction known as tawarruq, often using commodities traded on the London Metal Exchange (LME). However, in some jurisdictions, tawarruq transactions are not considered compliant with Shari’ah principles.
BBF314/03 Islamic Finance 20

Ijarah is a contract of sale of the right to use an asset for a period of time. It is essentially a lease contract, whereby the leaser must own the leased asset for the entire lease period. Since ownership remains with the leaser, the asset can be repossessed in case of nonpayment by the lessee. However, the leaser is also responsible for asset maintenance, unless damage to the leased asset results from lessee negligence. This element of risk is required for making ijarah payments permissible. A variety of ijarah takes a hire-purchase form, whereby there is a promise by the leaser to sell the asset to the lessee at the end of the lease agreement, with the price of the residual asset being predetermined. A second independent contract gives the lessee the option to buy the leased asset at the conclusion of the contract or simply return it to the owner.
Salam is a form of forward agreement where delivery occurs at a future date in exchange for spot payment. Such transactions were originally allowed to meet the financing needs of small farmers as they were unable to yield adequate returns until several periods after the initial investment. A vital condition for the validity of a salam is payment of the price in full at the time of initiating the contract, or else the outcome is a debt-against-debt sale, which is strictly prohibited under Shariah. The subject matter, price, quantity, and date and place of delivery should be precisely specified in the contract. In the event that the seller can neither produce the goods nor obtain them elsewhere, the buyer can either take back the paid prices with no increase, or wait until the goods become available. Should one of the parties fail to fulfill their contract, the bank will get back its initial investment, but will have to accept the lost profit. To reduce exposure to credit risk, the bank may ask for a financial guarantee, mortgage, advance payment or third-party guarantee.
Istisna’ is a contract in which a commodity can be transacted before it comes into existence. The unique feature of istisna’ (or manufacturing) is that nothing is exchanged on the spot or at the time of contracting. It is perhaps the only forward contract where the obligations of both parties are in the future. In theory, the istisna’ contract could be directly between the end user and the manufacturer, but it is typically a three-party contract, with the bank acting as intermediary. Under the first istisna’ contract, the bank agrees to receive payments from the client on a longer-term schedule, whereas under the second contract, the bank (as a buyer) makes progress installment payments to the producer over a shorter period of time.
BBF314/03 Islamic Finance 21

Fee-Based Products
Islamic banks offer a wide spectrum of fee-based services using three types of contracts, wakalah, kafalah, or ju’ala. They are usually auxiliary to the main murâbaah and mudârabah transactions, though they generate various types of fees and commissions. The fee-based services provided by Islamic banks include bank transfers, issuing letters of credit and guarantees, credit cards, and offering collection and safe-custody services, mostly used in trade financing.
Wakalah results from the bank acting as the agent of a customer in a trade transaction or issuing a letter of credit facility.
Kafalah is a financial guarantee whereby the bank gives a pledge to a creditor on behalf of the debtor to cover fines or any other personal liability. It is widely used in conjunction with other financing modes or documentary credits.
Juala is essentially an istisna’ contract that is applicable for rendering a specified service as opposed to the manufacturing of a product.
Learning Activity 1.2
Please read:
Differentiate between the concept of mudarabah and musharakah.
BBF314/03 Islamic Finance 22

The growing need of Muslims for a Shari’ah-compliant financial system seems to drive the growth of Islamic finance. The concept of a bank as a modern institution is new to societies. Muslims realised that interest payments from conventional banking were at odds with the prohibited riba, hence they naturally looked for alternative modes of financing. Early initiatives in the 1960s led to the establishment of Islamic financial institutions in Egypt, India, Malaysia, Pakistan, Saudi Arabia, and later in Iran and Sudan, where Islamic finance was adopted as the only financial system countrywide.
It is therefore not surprising to see that Muslims continue to look for Shariah-compliant financial institutions around the world, as these become more mature and integrated in conventional financial systems, whilst offering a wider range of services. Part of the industry growth is driven, naturally, by economic growth in the Middle East and North African (MENA) region.
Efficiency and Profitability
The efficiency of Islamic banks tends to be comparable with that of conventional banks.
Many argue that despite differences between the business models of conventional banks and Islamic institutions, at least for the period before the recent global recession, the efficiency of both banking systems was not significantly different (di Mauro et al., 2013). Since the financial crisis, recent studies show that the profitability of Islamic banks decreased more than conventional banks during the crisis. This is mainly because of weaker risk management practices and financial crisis spillovers to the real economy (for example, Rashwan, 2012 and Hasan and Dridi, 2011).
Although international evidence suggests that both cost and profit efficiency of Islamic banks are on the rise, Islamic banks in advanced countries seem to be more efficient than those in other countries. This could be partly explained by well-established regulatory frameworks, more advanced human capital, and better risk management practices in these countries (Tahir and Haron, 2010).
BBF314/03 Islamic Finance 23

Risk Management
Shariah Compliant Risk
In addition to facing common risks with conventional financial institutions, Islamic banks also face their own unique risks. The Shari’ah-compliant nature of assets and liabilities distinguishes them from conventional banks while at the same time exposing them to similar market, credit, liquidity, operational and legal risks. Notably, differences in opinion among religious scholars regarding the Shari’ah compliance of specific financial arrangements can expose Islamic banks to the risk of noncompliance with Shari’ah principles.
Further, operational differences across countries result in different permissible financial products, thereby raising legal uncertainty in the area of cross-border Islamic financial activities (Jobst, 2007). Islamic financing is also subject to high judicial risk, as clients may turn to Shari’ah courts that rule on a case-by-case basis, as well as seek redress in regular courts.
Additionally, Islamic financial institutions may confront commercial pressure to pay competitive rates of return that exceed returns on the assets that are actually being financed, with the result being that shareholders may have to forego part, or all of their share in profits to minimise the risk of funds withdrawal. Such exposure to rate of return risk (resulting from unexpected changes in rates of return) engenders a risk that is unique to Islamic banks known as displaced commercial risk.
Finally, equity risk arises when Islamic banks enter into musharakah and mudarabah partnerships as providers of funds and they share in the business risk of the activity being financed. Mark-up risk tends to rank highly for Islamic banks. The 2001 Islamic Development Bank (IsDB) report contends that Islamic banks face more severe mark-up (interest rate) risk in fixed-income instruments like istisna’ and murahabah. The report argues that operational risk, liquidity risk, credit risk, and market risk are next to mark-up risk for these institutions.
All in all, profit-sharing investment accounts (PSIA), diminishing musharakah, mudarabah, salam, and istisna’ tend to be considered riskier than murahabah and ijārah.
To mitigate risks, Islamic banks use a variety of prudential reserves. Islamic banks use conventional risk management measures, but there is a need for additional risk mitigating tools to address their unique risk exposures. Conventional tools in use by Islamic banks that do not conflict with Shari’ah include internal rating systems, risk reports, internal control systems, external audits, maturity matching, and GAP analysis. However, the unique nature of Islamic financing, with a diverse set of instruments used as sources and uses of funds, calls for the development of new techniques, processes, institutional setup, and procedures to further enhance risk management practices and
tackle Islamic finance–specific risks.
BBF314/03 Islamic Finance 24

Corporate governance concerns are associated with these prudential reserves. While IFSB standards set rules on disclosure requirements on displaced commercial risks and smoothing practices, investment account holders generally have no control over the PER and IRR usage
and, in some cases, are not informed of the Islamic bank’s practices of maintaining these reserves. Also, an investment account holder with a short-term horizon may be negatively affected by the constitution of reserves that will most likely benefit someone else in the future. In addition, IRR may give rise to moral hazard akin to that arising from deposit insurance, as bank management may be encouraged to engage in excessive risk taking.
Further standardisation for Shari’ah compliance would benefit Islamic financial institutions. Unlike conventional banking where a unified set of international standards help agents to identify risks associated with the bank’s activities, Islamic financial institutions often face difficulties presenting internationally accepted Islamic instruments to their customers.
It is challenging to standardise different interpretations of certain religious matters across jurisdictions and Shari’ah scholars. Harmonising differences in the Shari’ah compliance of different instruments would reduce uncertainty and foster industry growth. In this vein, the AAOIFI and IFSB have provided some Shari’ah standards and governance guidelines.
Three key principles govern Islamic finance: equity, participation, and ownership. These principles imply that in an Islamic financial system, financing can only be extended to productive activities, trade, and real assets—thus it is often considered an asset-based financial system. If fully complied with, these principles ensure appropriate leverage and help limit speculation and moral hazards.
BBF314/03 Islamic Finance 25

1. The resolution of Islamic Fiqh Academy is considered one of the main sources of Al Sharī‘ah (Islamic law) that constitute the basis of Islamic banking and finance
2. Any form of banking and financial institution that is consistent with the principles of the Sharī‘ah can be referred to as Islamic bank or financial institution.
3. Within the modern context, the interest element in banking and finance is replaced with profit-sharing through certain Islamic financial products such as mudarabah and musharakah.
4. Any form of interest-free banking based on ethical ideals of financial transactions will be recognised as Sharī‘ah - compliant.
5. The enormous development of Islamic banking and finance industry means that there no room for improvement to meet modern challenges facing the industry.
Unit 1 Exercise
Conceptual Question
Explain the key concepts and Financial Instruments in Islamic Finance.
Bay mu’ajal
Qard Hassan
Analytical Question:
Explain how experts envisage the future of the Islamic Finance Industry.
BBF314/03 Islamic Finance 26

Asian Development Bank and Islamic Financial Services Board. (2015). Islamic Finance for Asia: Development, Prospects, and Inclusive Growth.
Di Mauro, F., Caristi, P., Couderc, S., Di Maria, A., Ho, L., Grewal, B.,Masciantonio, S., Ongena, S., & Zaher, S. (2013). "Islamic Finance In Europe", Occasional Paper Series. Frankfurt am Main, Germany: European Central Bank.
Hasan, M., & Dridi, J. (2011). The Effects of the Global Crisis on Islamic and Conventional Banks: A Comparative Study. Journal of International Commerce, Economics and Policy, 2(2).
Jobst , A. (2007). The Economics of Islamic Finance and Securitization. Retrieved from
Muslim Community Radio. (2015, Mar 10). 01- The Creed of Imam At-Tahawi - Belief of
Muslims [Video file]. Retrieved from Rashwan, M. (2012). How did listed Islamic and Traditional Banks Performed: pre and post the
2008 financial crisis? Journal of Applied Finance & Banking, 2(2).
Tahir, I., & Haron, S. (2010). Cost and profit efficiency of Islamic banks: International Evidence
using the Stochastic Frontier Approach. Banks and Banks Systems, 5(4), 78–83. University of Nottingham. (2016, Jan 26). Basic beliefs of Islam [Video file]. Retrieved from
BBF314/03 Islamic Finance 27


2.2 2.3 2.4 2.5 2.6
2.8 2.9
The Meaning of Corporate Governance
Corporate Governance in Islam
Models of Corporate Governance: Stakeholder vs Stockholder
The Role of Corporate Governance in Islamic Financial
Mechanisms of Corporate Governance and Control
Functions of Shariah Governance System in Islamic Financial Institutions
A different Approach for Islamic Financial Institutions
Models of Shariah Governance from Selected Islamic Countries Corporate Governance for Islamic Insurance
BBF314/03 Islamic Finance 29

Corporate Governance for Islamic Financial Institution
Sound corporate governance is crucial to the proper running of a corporate entity, such as an Islamic bank or financial institution. Corporate governance within the context of Islamic financial institutions (IFIs) includes Sharī‘ah governance, which builds and maintains a high-level of confidence with shareholders.
Though independent from its stakeholders, the company’s management must ensure the accountability and transparency in all their financial dealings. To ensure sustainable practices that protect stakeholders’ rights, corporate governance has a vital role to play in the Islamic finance industry.
The corporate governance for IFIs, including Sharī‘ah governance begins with the meaning of corporate governance. The models and mechanisms of corporate governance are then reviewed.
y the end of this course, you should be able to:
1. Describe the meaning of corporate governance within the Sharī‘ah framework as practised in modern Islamic financial institutions
2. Explain the models and key principles of corporate governance, including Sharī‘ah governance
3. Distinguish between the mechanisms of corporate governance and control, including the different organs in Islamic financial institutions
4. Differentiate the models of corporate governance and Sharī‘ah governance, and the different approaches adopted by Islamic different financial institutions
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In order to develop a proper understanding of the corporate governance framework in IFIs, it is important to begin with the meaning of corporate governance as given by major codes and best practices. This section examines the definitions of corporate governance as defined by the Organisation for Economic Cooperation and Development (OECD), International Chamber of Commerce (ICC), and the Cadbury Report of the United Kingdom. Additionally, a brief overview of the definition of corporate governance is given from the Islamic perspective. This focuses mainly on the meaning of corporate governance within the Sharī‘ah framework as defined in the Guiding Principles on Corporate Governance for Institutions Offering Only Islamic Financial Services issued by the IFSB.
Defining Corporate Governance
There is no generally accepted definition of corporate governance. It has been defined in different contexts and jurisdictions according to the goal it is designed to achieve; this is due to the fact that no single definition can be applied to all contexts. There is also a slight difference between the conceptual understanding of the meaning of corporate governance in Islamic law and the conventional conception.
There are several widely circulated definitions of corporate governance.
One comprehensive definition of corporate governance is given by the Organisation for Economic Cooperation and Development which states that “Corporate governance is 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.”
The ICC’s defined corporate governance as 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 conforms to the law and regulations.
It explains the mechanisms and dynamics of the stakeholders and how they work together to ensure the three- pronged objectives of transparency, fairness, and accountability in the management of the company.
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Another widely recognised definition of corporate governance is contained in the report of the committee chaired by Sir Adrian Cadbury-
Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. The responsibilities of the directors include setting the company’s strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board’s actions are subject to laws, regulations and the shareholders in a general meetin
This explains the interrelationship among the stakeholders in a corporate entity and their respective responsibilities in ensuring the transparent and fair management of the company based on accountability.
Although there are many definitions of corporate governance, they all have certain features in common. They include:
1) 2)
3) 4)
A system of relationships defined by structures and processes .
Relationships with different and, in some cases, conflicting interests of all the stakeholders, who in one way or the other, are involved in the direction and control of the company .
Stakeholders’ involvement in the direction and control of the company. Rights and responsibilities are properly distributed among the stakeholders.
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The definitions of corporate governance in conventional terms and in Islam have few differences. The inclusion of Sharī‘ah governance in the corporate governance structure of IFIs is the only difference between the two definitions.
The Sharī‘ah governance organ ensures strict compliance with the Sharī‘ah in all the activities carried out by all other stakeholders in the management of the company (usually represented by the Sharī‘ah supervisory board in the governance structure of an IFI).
Corporate governance has been defined by the IFSB, a leading standard-setting body, as:
Corporate governance in Islam is defined as a set of organisational arrangements whereby the actions of the management of institutions offering Islamic financial services (IIFS) are aligned, as far as possible, with the interests of its stakeholders; provision of proper incentives for the organs of governance such as the board of directors, Shariah supervisory board and management, to pursue objectives that are in the interests of stakeholders and facilitate effective monitoring, thereby encouraging IIFS to use resources more efficiently; compliance with Islamic Shariah rules and principles.
The Sharī‘ah supervisory board, which lays downSharī‘ah -compliant rules and procedures for the smooth running of the company, is the key organ in the business and continued existence of the corporate entity (added to the shareholders). The board supervises and ensures the Sharī‘ah compliance of new products, is composed of Shariah scholars who are well-versed and competent in Sharī‘ah matters, particularly in aspects of economics and finance.
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Learning Activity 2.1
Watch "Principles of Good Governance in Islam | MILE Webinar" on YouTube
Briefly discuss the role of corporate governance in Islamic financial institutions.
Title : Principles of Good Governance in Islam Duration : 1.13.20 minutes
There are two basic models of corporate governance from the conventional perspective
Due to the fact that the Anglo-American model aims to align management’s interests with shareholder’s interest, it is particularly relevant to the Islamic finance industry. In Islamic finance, shareholders are considered to be important stakeholders akin to partners in a joint-venture company. The Anglo-American model accomplishes its aims through a number of mechanisms, including shareholder representation on the board of directors, management compensation
schemes, and external market discipline.
The first based on the Anglo-American model, which emphasises the interests of the shareholders
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a) b) c) d) e)
to establish a harmonious relationship among the shareholders, board of directors, management, stakeholders, and, above all, God .
to promote prudent and transparent practices in the management of Islamic financial institutions.
to protect the interest of all stakeholders including the investors, depositors, staff, and the general public .
to ensure the proper discharge of the corporate social responsibility role of Islamic financial institutions.
to promote a sound and stable Islamic financial industry that can compete globally with conventional financial institutions in ensuring standard practices.
The second is based on the Franco-German model, which tends to emphasise the stakeholder value system.
Conversely, the Franco-German model, which is a form of a stakeholder-value system, emphasises cooperative relations between stakeholders, and employee protection and welfare. Although the Anglo-American model is closer to the Islamic theory of corporate governance, stakeholders’ interests are important in corporate policies. As such, some have recommended integrating the two models.
The main aspect of corporate governance in Islamic financial institutions is the inclusion of Sharī‘ah governance to emphasise compliance with the mandatory requirements of the Sharī‘ah . The accountability in business transactions includes true and fair disclosure and transparency so that the interests of all stakeholders, particularly investors, are protected.
The need for IFIs to have sound corporate governance and to compete globally with conventional institutions has led to the guidelines issued by some standard-setting bodies, such as the Islamic Financial Services Board (IFSB) and the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), specifically to guide the increasing number of IFIs around the world.
Corporate governance in Islamic finance has a vital role to play in strengthening the confidence of all stakeholders. The roles of corporate governance in Islamic financial institutions include:
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Principles of Corporate Governance in Islam
The underlying premise of corporate governance from the Islamic perspective is the concept of:
Tawhid (unity of God)
It is the basis of many Shariah rules concerning the functional roles of corporate entities. The tawhid framework emphasizes the need for stakeholders to cooperatively embrace transactions that are compliant with the will of God.
Shura (mutual consultation)
Shura, as a concept (in Islamic banking, usually in the form of consultation by members of Sharī‘ah boards), places the highest degree of value on mutual consultation based on the common goal of the oneness of God; essentially it entrenches the stakeholder-oriented value system.
Mechanisms of Corporate Governance and Control
a) 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.
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Tawhid as the Episteme
Shari’ah Board as the apex governance
Shura or consultation
General participation: shareholders
Social wellbeing
Community participation: Minimal regulation needed
Determination of the interactive, integrative and evolutionary process complementing corporate and social goals
Testing unity of knowledge according to Shari’ah rules
Figure 2.1. Functional Roles of Corporations in Islam
Source: Choudury, M.A. and Hoque, M.Z. (2004). An Advanced exposition
of Islamic Economics and Fiannce (p.86). New York: Edward Mellen Press. b) Sharī‘ah Governance
The Sharī‘ah system of governance, which can be described simply as an additional layer in the pyramidal structure of the governance structure, was introduced to complement the adaptable standards of corporate governance and streamline non-compatible standards according to the philosophical foundation of corporate governance in Islam (see “Islamic Finance in Practice- The Corporate Governance Structure of Meezan Bank” for an outline of the corporate governance structure of an Islamic bank).
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The Islamic Finance in Practice box provides a practical description of the relationship between an IFI’s general corporate governance framework and the Sharī‘ah governance system. As you can see from the box, Meezan Bank has a separate Sharī‘ah governance system (on the left side of the diagram), which includes the Sharī‘ah supervisory board, the Sharī‘ah executive committee and Sharī‘ah auditors.
The scope of the Sharī‘ah governance system in a jurisdiction may vary depending on the corporate governance system established by the regulatory bodies in a specific country (also, in some cases the Sharī‘ah board may not be able to ensure compliance with its resolutions).
According to IFSB-10, the Sharī‘ah governance system “refers to the set of institutional and organisational arrangements through which an institution offering Islamic financial services (IIFS) ensures that there is effective independent oversight of Sharī‘ah compliance.” This oversight is specifically meant to regulate the process of issuing Sharī‘ah rulings or resolutions, and their dissemination to the bank personnel for implementation. An internal Sharī‘ah compliance unit may also help in ensuring compliance by conducting periodic reviews to ascertain that the Sharī‘ah resolutions have been complied with.
Though contingent upon the duties conferred on the Sharī‘ah board and the jurisdiction within which an IFI carries out its business, IFSB-10- states the following duties as being those of primary importance for the Sharī‘ah board in an IFI.
They include, among other items, advising the board of directors on Sharī‘ah-related matters, reviewing and endorsing Sharī‘ah-related policies and guidelines, and endorsing and validating relevant documentation for new products and services.
Issuance of Relevant Sharī‘ah Pronouncements/Resolutons
The Sharī‘ah board’s main function, as the main arm of the Sharī‘ah governance system, is to review the policies or issues of executive management (which may be controversial) to assess whether or not they are in line with the methodology of collective ijtihad (independent legal reasoning by a competent jurist/jurists based upon deductions made from examining all relevant information sources) and issue a resolution to that effect. This forms the basis of a Sharī‘ah resolutions and rulings.
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Dissemination of the Sharī‘ah Resolution to the Sharī‘ah Review Unit
The Sharī‘ahboard disseminates any information on a new Sharī‘ah pronouncement to : The relevant department or personnel in the IFI; typically IFI’s have internal compliance units (and in some cases, a Sharī‘ah compliance officer is appointed to monitor such processes).
The ISCU to Record and Report its Findings
The Sharī‘ah compliance review/audit unit must verify that compliance has been satisfied, and in the event of non-compliance, the unit must record and report the issue as well as rectify the issue to the fullest extent possible.
Preparation of an Annual Sharī‘ah Compliance Review Report
The ISCU in conjunction with the Sharī‘ahboard should prepare an annual Sharī‘ah compliance
review/audit report to be presented to the IFI’s annual general meeting (AGM).
Institutionalisation of the Sharī‘ah Governance System
Until recently, most advisory roles were filled by the promoters of corporate firms and, in some cases, were outsourced to Sharī‘ah consultancy firms. The first Sharī‘ah board was established in 1976 by the Faisal Islamic Bank of Egypt and this ushered in a new regime in the embedding of Sharī‘ah governance in IFIs. The pre-modern society model on which the Sharī‘ah governance system is premised is hisbah (the Sharī‘ah board is based on this model), while the modern model is collective ijtihad (this model focuses more on Sharī‘ah advice and consultancy).
The prominent Sharī‘ah board for the Organisation of Islamic Cooperation (OIC) is the International Islamic Fiqh Academy, which issues resolutions on all Islamic matters (including those related to Islamic banking). The Academy has resolutions, which have been cited in many IFI Sharī‘ah board resolutions around the world, on the jurisprudence of transactions regulated by Islamic law, known as fiqh al-mu‘amalat.
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Organs of the Sharī‘ah Governance System
The Sharī‘ah governance system of an IFI comprises the Sharī‘ah Supervisory Board, the Sharī‘ah
Supervisory Council, and the Internal Sharī‘ah Compliance Unit. Sharī‘ah Supervisory Board at the Micro Level
The Sharī‘ah supervisory board is essentially the highest and most visible organ of an IFI. As mentioned above, hisbah (market supervisor), is the premise by which the initial modelling of the Sharī‘ah governance system was created. Accordingly, an official appointed to investigate complaints made by individuals against maladministration (by either a public authority or in a private relationship is known as the muhtasib, or ombudsman). A business cannot certify itself as ‘Islamic’ if it does not have a proper Sharī‘ah governance system, which is also crucial to public confidence. More recently, the concept of the collective itjihad has been explored in Islamic finance issues to establish the Sharī‘ah board as the main arm of the Sharī‘ah governance system.
Sharī‘ah Supervisory Council at the Macro and Central Bank Level
At the macro level, it is widespread practice to have a Supreme Sharī‘ah Supervisory Council, which may be in the form of a national or international set-up. In order to standardise the process of certifying and reviewing products, services, and operations of Sharī‘ah boards in a country, the central bank often establishes its own Sharī‘ah Supervisory Council. In the event of any conflict between the decisions of the Sharī‘ah board of an IFI and the Sharī‘ah Supervisory Council of the central bank, the resolution of the Sharī‘ah Supervisory Council prevails.
Internal Sharī‘ah Compliance Unit
The internal Sharī‘ah compliance unit/department (ISCU), which can be considered an independent body, is responsible for verifying processes, services, and transactions to ensure that the relevant departments have complied with the resolutions/pronouncements of the Sharī‘ah board.
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Islamic Finance in the News: Islamic banking seeks global standards (Source: Roula Khalaf, “Islamic banking seeks global standards”, Financial Times, November 18, 2007.)
Over time, the Islamic banking industry has moved from a niche sector to the mainstream. However, a lack of standard opinions has emerged as well as a dearth of religious scholars with proper experience. It is agreed upon by many experts that a few dozen scholars essentially control the industry, sitting on many Sharī‘ah boards. “There are 50 top Sharia scholars and hundreds of billions of dollars are decided by them,” says another industry expert who asked to remain anonymous. “It’s like having a whole industry with one regulator that has a staff of 50.” Coupled with the fact that the some of these scholars differ in opinions on certain Islamic products, the Islamic banking industry may need to develop a centralised Sharī‘ah board, an entity that some experts agree may be essential in moving forward.
The Sharī‘ah Governance Process
The process outlined here begins with the appointment of the members of the Sharī‘ah board up to the point of making the Sharī’ah resolution. This process includes a brief appraisal of the appointment, composition, qualification, Sharī‘ah coordination, Sharī‘ah compliance process, external Sharī‘ah review, and finally the Sharī‘ah resolution.
Sharī‘ah Compliance Process
Sharī‘ah Governance Process
Sharī‘ah Coordination
Click on each process for more details
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The Sharī‘ah Resolution

Despite attempts by AAOIFI to introduce a universal standard for corporate governance in IFIs, different approaches are adopted in different jurisdictions; however, as more IFIs adopt AAOIFI’s governance standards and IFSB 10, there will be a gradual drift towards unification of standards, though some countries may require their own governance standards.
Those of the IFSB and AAOIFI are similar in many aspects and complement other prudential standards (these standards do not address the specific of the Islamic finance industry) issued by standard-setting bodies and international standards of corporate governance (the Organisation for Economic Cooperation and Development (OECD), the International Organisation of Securities Commissions (IOSCO) and the Basel Committee on Banking Supervision (BCBS). As most IFIs operate under the regulatory regimes and banking laws of their respective jurisdictions, the corporate standards of other countries are applicable to them provided they do not contradict the Sharī‘ah.
Global Islamic Finance (Figure source: Haniffa, R. (2010). Islamic Finance: Instruments and Markets. London: Bloomsbury Information Ltd: pp. 45–48).
In order to strengthen the corporate governance of IFIs, Sharī‘ah governance was introduced to ensure the proper supervision and monitoring of Sharī‘ah compliance of IFI products. Managing and resolving differences in opinion among Sharī‘ah scholars has been difficult, creating problems for new jurisdiction that seek to join the global Islamic finance industry. AAOIFI, as a leading international standard-setting body, should at least for now be regarded as a unifying body whose standards represent best practices in the industry. The complementary role of the Islamic Financial Services Board (IFSB) has further strengthened the global Sharī‘ah governance framework of IFIs.
It should be noted that the key players in Sharī‘ahgovernance and audit roles in IFIs do not pose any problem regarding the juristic differences occasionally experienced in substantial matters that relate to specific Islamic financial products. The diagram (pg. 191) within the “Global Islamic Finance” box provides a good illustration of the corporate governance structure of IFIs and the respective roles of key players within the corporate governance framework.
The continued and necessary harmonisation among various jurisdictions regarding Sharī‘ah corporate governance may begin with the codification of universally acceptable principles, which may be compiled during a major stakeholders’ meeting where leading Sharī‘ah scholars from countries around the world will have the opportunity to present their views on salient governance and commercial issues for IFIs.
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Models of Sharī‘ah from Malaysia
The regulatory framework for Sharī‘ah governance in Malaysia has two major aspects. IFIs are under the Central bank, while the Islamic capital markets are regulated by the Securities Commission (each of these bodies has its own guidelines for Sharī‘ah governance). The main Sharī‘ah governance framework in Malaysia is contained in sections 51-58 of the Central Bank of Malaysia Act 2009 and the Sharī‘ah Governance Framework for Islamic Financial Institutions issued in 2010.
At the macro level is the Sharī‘ah Advisory Council (SAC) of the Central bank. The SAC is the final authority in matters relating to Islamic banking business dealings, Islamic development financial business, and all other business based on Sharī‘ah principles (supervised and regulated by the Central Bank of Malaysia).
Arbitration tribunals, courts or special dispute resolution panels, are the means by which disputes involving Sharī‘ah issues in Islamic banking and finance and takaful are usually handled; however, some issues may be referred to the SAC in disputes involving Sharī‘ah issues.
Duties, Responsibilities and Accountability of the Sharī‘ah Committee According to the Sharī‘ah Governance Framework for Islamic Financial Institutions
(Source: Shar ‘ah Governance Framework for Islamic Financial Institutions, 2010, pp. 34-35. Available at Framework_20101026.pdf.)
1) Responsibility and Accountability.
2) Advise the board and IF.I
3) Endorse Sharī‘ah policies and procedures.
4) Endorse and validate relevant documentations.
5) Assess work carried out by Sharī‘ah reviews and audits.
6) Assist related parties on Sharī‘ah matters.
7) Advise on matters to be referred to the SAC.
8) Provide written Sharī‘ah opinions.
To ensure the transparency, accountability, and maximum independence of the members of the SAC and Sharī‘ah committees of IFIs, certain legal restrictions have been imposed which includes:
(1) no IFI is allowed to appoint a member of the SAC to serve on its Sharī‘ah committee.
(2) a Sharī‘ah advisor can serve as a member of the Sharī‘ah committee of only one IFI in the same
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In the event that there is a conflict between the ruling given at the micro level by an IFI’s Sharī‘ah committee and the ruling given at the macro level by the SAC, the ruling of SAC prevails. The model structure for the key bodies in the Sharī‘ah governance framework for IFIs proposed by BNM is a comprehensive model worth emulating in the global Islamic finance industry (a depiction of this model is given in Figure 2.8).
As mentioned above, the Islamic capital markets are regulated by the Securities Commission. The functions of the SAC of SC are to:
1) To ascertain the application of Sharī‘ah principles on any matter pertaining to Islamic capital
market business or transactions and issue a ruling upon reference made to it in accordance with
this division (Islamic Capital Market Division).
2) To advise the commission on any Sharī‘ah issue relating to Islamic capital market business or
3) To provide advice to any person on any Sharī‘ah issue relating to Islamic capital market business
or transactions.
4) Such other functions as may be prescribed by the Minister.
Advice or a ruling may be sought from SAC of SC by any licensed person, stock exchange, futures exchange, clearing house, central depository, listed corporation, or any other person on any matter relating to ICM business or transactions (similarly, a court or arbitral tribunal may also refer a Sharī‘ah matter pertaining to ICM to the SAC of SC).
At the micro level, an individual or a corporation can register as a Sharī‘ah advisor (an applicant that is a corporation must employ at least one full-time officer to be responsible for Sharī‘ah matters) for the purpose of transactions in the ICM (The qualification for individuals seeking to become Sharī‘ah advisors is a minimum of a degree in Sharī‘ah or have at least one year of relevant experience and/or exposure in Islamic finance and have attended at least 5 Islamic finance courses/workshops).
Shari’ah advisory counsil of BNM
Shari’ah committee of IFIs
Figure 2.2. Sharī‘ah Governance Framework under BNM
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Court or tribunal

Figure 2.3. A Model of Sharī'ah Governance Framework Source: Bank Negara Malaysia (2010)
The Sharī‘ah governance model in Pakistan, similar to the Malaysian model, also has two tiers, but with some variations. The State Bank of Pakistan (SPB) has established a Sharī‘ah board, the sole and highest authority in matters pertaining to Islamic finance, at the macro level for advisory purposes in matters relating to Islamic banking and financial transactions. The board has a minimum of five members and is composed of experts drawn from several relevant fields. The roles and responsibilities of the Sharī‘ah board include reviewing and approving for Sharī‘ah compliance the products/instruments developed by the SPB, advising the SPB on prudential regulations developed for the Islamic banking sector, approving the fit and proper criteria for the appointment of Sharī‘ah advisors of institutions conducting Islamic banking activities, and several other tasks. The decisions or resolutions of the Sharī‘ah board of SPB are binding on all IFIs in the country.
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However, there is no specific legal cover through statutory provisions for the powers conferred on the Sharī‘ah board.
At the micro level, all IFIs operating in Pakistan are required to appoint a Sharī‘ah advisor (the BoD is the body vested with the power to appoint the Sharī‘ah advisor for domestic IFIs, while for foreign banks with branches in Pakistan, the management may appoint the advisor). The duties and responsibilities of the Sharī‘ah advisor (SA) are as follows:
1) Ensure that all products, services, related policies, and agreements of IFIs are in compliance with Sharī‘ah rules and principles.
2) Have access to all records, documents, and information from all sources including professional advisors and IFI employees.
3) Review operations of the IFI periodically in coordination with officials responsible for Sharī‘ah compliance.
4) Provide advice to the legal counsel, auditor, or consultant of an IFI seeking guidance on Sharī‘ah matters.
The SPB’s Sharī‘ah board resolves differences of opinion on Sharī‘ah issues involving Islamic banking practices between an IFI’s Sharī‘ah advisor and the inspection staff of the SPB or any of its departments. In situations where there is a difference of opinion on a Sharī‘ah principle between an IFI and its Sharī‘ah advisor, this is often resolved by referring such issues to the BoD’s audit committee. If not, it may be referred to the Sharī‘ah board of the SPB for a final decision. Unlike in Malaysia, any member of the SPB’s Sharī‘ah board can serve as a Sharī‘ah advisor to an IFI, but can only serve one IFI at any one time.
Unlike in Malaysia and Pakistan, there is provision for Sharī‘ah boards in IFIs, but no Sharī‘ah board at the macro level at the Central Bank of Kuwait (CBK). There is however, a fatwa board in the Ministry of Awqaf and Islamic Affairs, which is considered as the final authority on matters relating to Islamic banking business and financial transactions.
The Sharī‘ah governance framework is regulated by Article 93 of the CBK Law, which requires all IFIs to establish an independent Sharī‘ah board appointed by the general assembly of the IFI. Supervisory board appointment can only be done at the AGM, with all stakeholders involved. When there is a conflict of opinion among the members of the Sharī‘ah board concerning a ruling, the BoD may refer the matter to the fatwa board although this is not compulsory for all issues (note: the board is considered as the final authority but it is independent of the CBK, which makes this Sharī‘ah governance framework different from the models in Malaysia and Pakistan).
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The CBK Law does not cover the fatwa board rulings and whether they are binding or merely persuasive. There is no restriction on the number of members on the fatwa board, no legal restriction on those members serving on the Sharī‘ah board of any IFI, and no limitation on a member of the Sharī‘ahboard serving on more than one IFI. The Sharī‘ah board submits its report annually to the AGM as part of the IFI’s annual report.
Similar to the models in Malaysia and Pakistan, the Bahraini Sharī‘ah governance framework is a two-tiered hierarchical system, but with some element of variation at the macro level. The Central Bank of Bahrain (CBB) established a national Sharī‘ah advisory board to serve and verify the Sharī‘ah compliance of its own products only. The board, called the National Sharī‘ah Advisory Board, has no authority over IFIs operating in the country.
At the micro level, all IFIs are required to establish a Sharī‘ah supervisory committee, which must comply with AAOIFI’s governance standards for IFIs No. 1 and No. 2.28. Principle 9 of The Corporate Governance Code of the Kingdom of Bahrain emphasises that companies are guided by Islamic principles and have additional responsibilities to their stakeholders to assure them that the company is in compliance with the Sharī‘ah.
Every company should establish an advisory committee composed of at least three scholars (extended to IFIs through paragraph HC-9.2.1 of the CBB Rule Book, volume 2, Part A, High-level Control on Islamic Banks). IFIs are also required to have separate Sharī‘ah reviews (which are expected to be carried out in accordance with AAOIFI governance standard No. 3) for the purpose of ensuring compliance.
United Arab Emirates
The Sharī‘ah governance system of the UAE, with the exception of Dubai, is governed by Federal Law No. 6 of 1985, where Article 5 provides for the establishment of a Higher Sharī‘ah Authority (made up of a minimum of three members, who are appointed by the BoD or the AGM) to supervise Islamic banks. The authority is considered to be the final authority on matters pertaining to Islamic banking and finance.
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