SHARIAH NON-COMPLIANCE TREATMENT IN MALAYSIAN ISLAMIC BANKS
BY
HANI NABILA BINTI OMAR
A research paper submitted in fulfilment of the requirement for the degree of Master of Science (Islamic Banking and
Finance)
IIUM Institute of Islamic Banking and Finance International Islamic University Malaysia
AUGUST 2019
ii
ABSTRACT
Islamic finance in Malaysia has been growing rapidly in the past 30 years and continues to thrive in many countries. In 2019, a total of 16 Islamic banks (IBs) is listed and supervised by Bank Negara Malaysia (BNM) with 5 banks being foreign entities. In view of the rivalry with the conventional banking sector, Islamic banks (IBs) offer new innovative Islamic products and financial projects which may lead to greater risk of Shariah non-compliance (SNC) exposure to the Islamic Financial Institutions (IFIs) in its effort to stay competitive. This study attempts to explore IBs current practice of treating the SNC and the extent of compliance with BNM rules and guidelines focusing on the BNM Operational Risk Integrated Online Network (ORION) requirement on SNC reporting event. This study also intends to review the challenges faced by IBs and propose recommendations for the existing policy to enhance the treatment of SNC. This study adopts qualitative research method by conducting semi-structured in-depth interviews with Islamic banking professionals targeting five IBs. Both the primary and secondary sources are used for data collection. The finding shows that IBs adhere to the BNM rules and requirements, with some minor differences in the implementation process. The finding of this study would contribute positively in terms of establishing the level of compliance of the banks as well as facilitating policy makers and regulators on enhancing the regulations and practices in ensuring zero SNC events. Simultaneously, the existing literature on the SNC practices by IBs will be expanded so that more researchers can have larger resource of reference to diversify the topics related to this study.
Key words: Shariah non-compliance, risk, Shariah non-compliance event, Shariah non-compliance reporting, Islamic banks, BNM guidelines
iii
ثحبلا صخلم
ديدعلا يف راهدزلاا يف رمتسي هنأ امك ،يملاسلإا ليومتلا يف ًاعيرس ًاومن ةيضاملا ًاماع نيثلاثلا ذنم ايزيلام تدهش ماع يف .نادلبلا نم ٩١٠٢
يزيلاملا يزكرملا كنبلا ةبقارمو فارشإ تحت فراصم ةدع جاردإ مت ، (BNM)
، ٠١
و ًايملاسإ ًافرصم ٥
ا عم سفانتلا لظ يف .ةيبنجأ فراصم ( ةيملاسلإا فراصملا موقت ،يديلقتلا يفرصملا عاطقل
IBs )
مدع رطخل ةضرع رثكأ اهلعجي امم ،سفانتلا ىلع ةرداق ىقبتل ةيلام عيراشمو ةديدج ةركتبم ةيملاسإ تاجتنم حرطب ( ةيملاسلإا ةعيرشلا ماكحأ عم ةقباطملا SNC
فراصملا لماعت ةيفيك نع باقنلا فشك ةساردلا هذه لواحت .)
لاسلإا كنبلا تاهيجوتو حئاولب اهلاثتما ىدم ةفرعم ىلإ ةفاضلإاب ،ةيملاسلإا ةعيرشلا ماكحأ عم ةقباطملا ةيضق عم ةيم
يزيلاملا يزكرملا (BNM)
ةيليغشتلا رطاخملا صخي اميف يزيلاملا يزكرملا كنبلا بلطب قلعتي ام ىلع زيكرتلا عم ،
( ةيتوبكنعلا ةكبشلل ORION
يف غلابلإا ىلع صني يذلاو ) .ةيملاسلإا ةعيرشلا ماكحأ عم ةقباطملا مدع لاح
حرط ىلإ ةفاضلإاب ،ةيملاسلإا فراصملا اههجاوت يتلا تابوعصلاو تايدحتلا ضرع ىلإ ةساردلا هذه فدهت امك ةيملاسلاا ةعيرشلا ماكحلأ ةقباطملا مدع ةلكشم لح نم زيزعتلا فدهب ةيلاحلا ةسايسلا صخت يتلا تاحارتقلاا ضعب ( SNC دقو .) ةمظتنم هبش ةفثكم تلاباقم ءارجإ للاخ نم ةساردلا هذه يف يليلحتلا يفصولا جهنملا مادختسا مت
عمجل ةيوناثلاو ةيلولأا رداصملا نم لك مادختسا ًاضيأ متو .ةفلتخم ةيملاسإ فراصم ةسمخ يف نيصصختم عم يلإ تلصوت يتلا جئاتنلا مهأ نم .ةساردلا هذه ءارجإ يف مهاست يتلا تانايبلا فراصملا نأ يه ةساردلا هذه اه
( يزيلاملا يزكرملا كنبلا حئاولب مزتلت ةيملاسلإا BNM
.ذيفنتلا ةيلمع يف ةطيسب تافلاتخا دوجو عم اهتابلطتمو )
ةفاضلإاب ،ةيملاسلإا ةعيرشلا ماكحأ عم فراصملا ةقباطمل دح ءاشنإ قيرط نع يباجيإ لكشب جاتنتسلاا اذه مهسيو لاا اذه لهسيس كلذ ىلإ تاسرامملاو حئاوللا ريوطتو زيزعت ةيميظنتلا تاهجلاو تاسايسلا يعضاو ىلع جاتنتس
( ةيملاسلاا ةعيرشلا ماكحأ عم ةقباطم ريغ ةسرامم ةيأ دوجو مدع نامضل SNC
هذه مهستس ،هتاذ تقولا يفو .)
رشلا ماكحأ عم ةيفرصملا تاسرامملا ةقباطم لوح ةدوجوملا تاساردلا ددع ةدايز ىلإ ةساردلا ةعسوتلاو ةيملاسلإا ةعي
.ةساردلا هذهب ةقلعتملا تاعوضوملا عيونتل ربكأ ةيعجرم دراوم ىلع لوصحلا نم نيثحابلا نكمتس يلاتلابو اهيف
iv
APPROVAL PAGE
I certify that I have supervised and read this study and that in my opinion, it confirms to acceptable standards of scholarly presentation and is fully adequate, in scope and quality, as a research paper for the degree of Master of Science (Islamic Banking and Finance)
………..
Rusni Hassan Supervisor
This research paper was submitted to the IIUM Institute of Islamic Banking Finance and is accepted as a fulfilment of the requirement for the degree of Master of Science (Islamic Banking and Finance)
………..
Syed Musa Alhabshi
Dean, IIUM Institute of Islamic Banking and Finance
v
DECLARATION
I hereby declare that this research paper is the result of my own investigations, except where otherwise stated. I also declare that it has not been previously or concurrently submitted as a whole for any other degrees at IIUM or other institutions.
Hani Nabila Binti Omar
Signature ... Date ...
vi
INTERNATIONAL ISLAMIC UNIVERSITY MALAYSIA
DECLARATION OF COPYRIGHT AND AFFIRMATION OF FAIR USE OF UNPUBLISHED RESEARCH
SHARIAH NON-COMPLIANCE TREATMENT IN MALAYSIAN ISLAMIC BANKS
I declare that the copyright holders of this research paper are jointly owned by the student and IIUM.
Copyright © 2019 Hani Nabila and International Islamic University Malaysia. All rights reserved.
No part of this unpublished research may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without prior written permission of the copyright holder except as provided below
1. Any material contained in or derived from this unpublished research may be used by others in their writing with due acknowledgement.
2. IIUM or its library will have the right to make and transmit copies (print or electronic) for institutional and academic purposes.
3. The IIUM library will have the right to make, store in a retrieved system and supply copies of this unpublished research if requested by other universities and research libraries.
By signing this form, I acknowledged that I have read and understand the IIUM Intellectual Property Right and Commercialization policy.
Affirmed by Hani Nabila
……..……….. ………..
Signature Date
vii
This research paper is dedicated to my lovely husband and my family, especially my beloved parents and parents in-law,
Omar Tahar and Faridah Said & Hj Azlan and Siti Hawa
For their endless support, pray, and encouragement.
viii
ACKNOWLEDGEMENTS
ميحرلا نمحرلا هللا مسب
In the name of Allah, I would like to express my gratitude for His blessings and favours that He has bestowed on me throughout my life. He is the One and Only who helps me in my hardship. Peace be upon to our beloved Prophet Muhammad, his family and all his companions.
First and foremost, it is my utmost pleasure to dedicate this work to my dearest husband, Muhammad Syukri, for being understanding, considerate and patience and render the support I needed. And I would also like to dedicate this work for my dear parents, Omar Tahar and Faridah Said, for being the biggest supporters, emotionally and the financial throughout my life.
I would like to express my deepest gratitude to my academic supervisor, Prof Dr.
Rusni Hassan for being patient in guiding and helping me to complete this research.
She gave great valuable suggestions related to the research and kept supporting me so that I have the motivation to write a good research paper. I have learned many lessons in my journey to finish this study. I am also indebted to all lecturers and staffs at the IIUM Institute of Islamic Banking and Finance (IIiBF) for their guidance, and moral support
A special acknowledgement the respondents of the five Islamic banks who were willing to invest their precious time for interview, helping me in gathering relevant data to complete my research paper.
Finally, a lot of gratitude to my fellow study-mates that always provided their words of encouragement and supports throughout the completion of my Master study. Thank you for your support and patience.
ix
TABLE OF CONTENTS
Abstract ... ii
Abstract in Arabic ... iii
Approval Page ... iv
Declaration ... v
Copyright Page ... vi
Dedication ... vii
Acknowledgements ... viii
List of Figures ... xi
List of Tables ... xii
CHAPTER ONE: INTRODUCTION ... 1
1.1 Background of Study ... 1
1.2 Problem Statement ... 2
1.3 Research Questions ... 3
1.4 Research Objectives ... 4
1.5 Significance of Study ... 4
1.6 Scope of the Study ... 5
1.7 Research Methodology ... 5
1.8 Organization of the Study ... 6
CHAPTER TWO: LITERATURE REVIEW ... 7
2.1 Introduction ... 7
2.2 Overview of the Islamic Banks in Malaysia ... 8
2.3 Shariah Governance and Requirement for Islamic Financial Institutions .... 10
2.3.1 Shariah Governance Models ... 11
2.3.2 Shariah Governance Framework ... 14
2.4 Shariah Compliance Requirement ... 17
2.5 Shariah non-compliance Risk ... 19
2.5.1 Elements of Shariah non-compliance ... 20
2.5.2 Statutory Requirement on Shariah non-compliance ... 22
2.6 Conclusion ... 27
CHAPTER THREE: RESEARCH METHODOLOGY ... 28
3.1 Introduction ... 28
3.2 Research Method ... 28
3.3 Research Design ... 29
3.3.1 Primary Data ... 30
3.3.2 Secondary Data ... 30
3.3.3 Sample ... 31
3.4 Research Framework ... 34
3.5 Conclusion ... 36
x
CHAPTER FOUR: ANALYSIS AND FINDINGS ... 37
4.1 Introduction ... 37
4.2 Research Analysis and Findings for Research Objective 1 ... 37
4.2.1 Shariah Governance and Key Organs Involved ... 37
4.2.2 The Process Involved in Shariah non-compliance Treatment ... 39
4.2.3 Identification of Shariah non-compliance Event ... 41
4.2.4 Confirmation by Qualified Shariah Officer on Shariah non-compliance Event ... 42
4.2.5 Decision of Shariah Committee on Shariah non-compliance Event... 43
4.2.6 Rectification Plan ... 45
4.2.7 Summary of Shariah non-compliance Treatment ... 47
4.3 Research Analysis and Findings for Research Objective 2 ... 48
4.4 Research Analysis and Findings for Research Objective 3 ... 51
4.5 Summary Comparison of Findings between the 5 Islamic Banks ... 52
4.6 Conclusion ... 56
CHAPTER FIVE: CONCLUSION AND RECOMMENDATION ... 57
5.1 Conclusions ... 57
5.2 Policy Recommendations ... 59
5.3 Limitation and Extension for Future Research ... 61
REFERENCES ... 62
APPENDIX I: PERMISSION LETTER FOR INTERVIEW ... 65
APPENDIX II: INTERVIEW QUESTIONS ... 66
xi
LIST OF FIGURES
Figure No. Page No.
2.1 Model of Shariah Governance Framework for Islamic Financial Institutions
16
2.2 The Illustration of Process Flow for Shariah non- compliance Reporting
24
4.1
4.2
4.3 4.4
The Process of Shariah non-compliance Event Treatment
The Process of Qualified Shariah Officer Confirmation
The Process of Shariah Committee Decision The Process of Rectification Plan
40
42
44 46
xii
LIST OF TABLES
Table No. Page No.
2.1 List of Islamic Banks in Malaysia 9
3.1 3.2 3.3
The Participating Islamic Banks
List of Respondents for Semi-structured Interviews Summary of Research Objectives, Research
Questions and Method used
33 33 34
4.1 Internal Shariah Governance Framework of Islamic Banks
39
4.2
4.3
Summary of Findings Comparison between the Islamic Banks
Shariah non-compliance Events in the Latest Financial Year
53
54
1
CHAPTER ONE INTRODUCTION
1.1 BACKGROUND OF STUDY
The emergence of Islamic Finance industry in Malaysia started more than three decades ago with the inception of the first Islamic bank in 1983. According to Bank Negara Malaysia (BNM), currently there are sixteen (16) Islamic Banks (IBs) in Malaysia in which eleven (11) are local ownership. Malaysia has been known as an Islamic financial hub of the world and has been rapidly developing and continuing to expand in the challenging conventional environment. The factors contributing to the robust growth of Islamic finance are the policy requirement, laws, and legal regulations by the government.
The push for innovation to fulfil commercial purposes has led the Islamic financial institutions (IFIs) to adopt conventional principles and instruments.
However, this may expose the IFIs towards the risk of Shariah non-compliance (SNC), as all the financial transaction, projects and activities must comply with the law of Shariah. BNM has issued a Shariah Governance Framework (SGF) in 2011 to be complied by all IFIs that include established core functions that would guide the Islamic banks in achieving effective operational excellence and adhering to the Shariah principles.
Despite the BNM framework, Shariah non-compliance risks (SNCR) can potentially arise when there is a mistake made in the documentation or execution process in dealing with certain contracts. Apart from that, conflicts appear when the Islamic products are improperly managed although the terms and conditions in place have already been stipulated to be in line with Shariah. According to Islamic Financial
2
Services Board (IFSB), Shariah non-compliance risk (SNCR) is defined as “The risk that arises from the bank’s failure to comply with rules and principles determines by the relevant Shariah regulatory councils”.
Therefore, this study intends to explore the practices of Islamic banks in managing SNC and identifying the gap of the actual practice of several Islamic banks.
Management of SNC is crucial to ensure customers’ faith and confidence in the Islamic banking and finance. Hence, the monitoring of SNC events has to be on continuous basis and transparent in establishing credibility of the banks in their transactions. This study will also review the concerns and challenges of SNC issues faced by Islamic banks. Subsequently, this study will take the current practices into consideration to propose recommendations on how to improve and enhance the treatment of Malaysian Islamic Banks towards SNC events.
Any breach of contract with regard to the Shariah requirement or misalignment against any standards of BNM guidelines could potentially lead to the risk of SNC.
The rectification processes have to be done with the purpose of damage control and purification. Failure to rectify the non-compliance issue will result in the banks to be subject to punishment.
1.2 PROBLEM STATEMENT
The first important feature of Islamic banking system is the compliance with Shariah and the BNM guidelines. All the business operations, transactions and projects should be free from the prohibited elements such as riba, gharar and maysir. The core element that distinguishes Islamic banking system from its conventional counterparts is the aforementioned prohibition. However, the SNC issues will arise under the condition when the bank fails to comply with the principles of Shariah or become
3
contradictory with the rules determined by relevant Shariah regulatory councils and the prevailing law applied in Malaysia. The question whether Islamic banks are free from SNC has to be investigated thoroughly based on the guidelines issued by BNM.
Unfortunately, despite the existing supporting rules and regulations, the annual reports on the Islamic banks state that there are still SNC events occurred in the operations or activities of the banks.
BNM provides specific procedures of reporting the SNC event for IFIs. Thus, this study will explore on how Islamic bank implement the procedures with respect to the details of the current practices and adherence to the procedures and guidelines.
Although considerable research and past studies have been conducted in the area of SNC, the studies were not focusing on the SNC treatment by Malaysian Islamic banks. Due to this void, the researcher will deliberate on the current practices of Islamic banks in Malaysia with the attempt to specifically explore the implementation for potential industrial improvement.
1.3 RESEARCH QUESTIONS
The research questions are listed as follows: -
1 How do the Islamic banks in Malaysia treat Shariah non-compliance (SNC) events?
2 What are the issues and challenges faced by the Islamic bank with Shariah non-compliance (SNC) treatment and reporting?
3 How to improve the existing practices of Islamic bank on Shariah non- compliance (SNC) treatment and reporting?
4 1.4 RESEARCH OBJECTIVES
The objectives of this research are listed as the followings: -
1 To explore the processes taken by the Islamic bank in Malaysia in the case of Shariah non-compliance (SNC) events
2 To review the concerns and challenges faced by the Islamic bank with Shariah non-compliance (SNC) treatment
3 To provide recommendations for enhancing the Islamic bank treatment of Shariah non-compliance (SNC) events
1.5 SIGNIFICANCE OF STUDY
From the Islamic banking perspective, the banks and customers must obey and follow the terms and conditions of certain contract provided with the scope of Shariah principles. Islamic Financial Services Act 2013 (IFSA), which was enacted in June 2013, provides the regulations and supervision of Islamic Financial Institutions to ensure full enforcement of Shariah compliant products and services. Section 28(1) IFSA 2013 states that all operations, businesses, affairs and activities of the Islamic Financial Institutions must comply with Shariah at all times (Kunhibava, 2015).
Failure to comply may lead to SNC events that have to be rectified by IFIs.
This study will contribute to the existing literature related to SNC by further enriching the existing pool of information for future reference by researchers. This study will also support in enriching literature in the area of the implementation of BNM regulations and guidelines and the practices of Islamic banks in Malaysia.
Academicians will also benefit from this study by helping them to further analysis and enhance their understanding on the implementation of the BNM regulations and guidelines on the reporting of SNC event. The result of this study can
5
also increase the awareness among the beneficiaries and the regulators to better improve the policy and guidelines on SNC event in Malaysia.
1.6 SCOPE OF THE STUDY
The scope of this study is limited to Malaysian Islamic banks practices on SNC treatment which is regulated by BNM. The study focuses on the steps taken from the identifying process, the investigation and reporting processes and rectification plan. In addition, this study intends to examine the rules and guidelines by BNM and IFSA on SNC events and the actual practices of the Islamic banks to ascertain the level of conformity with the regulations. By analyzing the existing practices and regulations provided, the recommendation will be put forward to provide the best way in dealing with SNC event and further enhance the existing guidelines and treatment for SNC by Islamic bank in Malaysia.
1.7 METHODOLOGY
This study employs qualitative research considered it is the most suitable approach based on the nature of the topic. The researcher will use primary sources for data collection and conduct semi-structured interviews with banking professionals of five (5) selected Islamic Banks in Malaysia in order to achieve the research objectives. The interview questions are designed purposely to obtain the specific answer from the respondents on the processes taken by the banks in the event of SNC issue. The researcher will also attempt to find out any concerns and challenges faced by the banks, and acquire the practitioners’ recommendations on how to improve the Islamic banks treatment of SNC. This study is also based on document analysis and literature reviews. References are made to refereed journal, articles, and textbooks including related past studies as secondary data.
6 1.8 ORGANISATION OF THE STUDY
This study is divided into five chapters as follows:
Chapter One: The first chapter provides the background of the study, problem statements, research objective and research questions, significance and scope of study, and research methodology.
Chapter Two: The second chapter consists of literature reviews that explain the overview of Islamic banking industry, Shariah governance and requirement, Shariah compliance requirements, Shariah non-compliance risk, the element of Shariah non- compliance risk, regulations on Shariah Committee and statutory requirement on Shariah non-compliance events
Chapter Three: The third chapter elaborates on the research methodology and research design adopted for this study
Chapter Four: The fourth chapter deliberates on the findings obtained from various
data collection to achieve the research objectives.
Chapter Five: This study is concluded by expressing further thoughts and recommendations to improve the policy on the treatment of Shariah Non-compliance in Islamic banking industry in Malaysia.
7
CHAPTER TWO LITERATURE REVIEW
2.1 INTRODUCTION
Islamic banking and finance is an alternative channel that is significant for Muslims to perform banking and financial transactions that is free from all the prohibited elements mentioned in the Quran and Sunnah. What distinguishes the Islamic banking and finance with the conventional counterparts is the foundation that is based on Islamic laws known as Shariah principles. IFIs must ensure compliance with Shariah principles of all aspects for their products, services, operations and instruments of their entire businesses activities.
Shariah compliance is the core element and the most predominant factor in operations of the Islamic banking and finance business. Failure to adhere to Shariah principles and values in carrying out the financial activities, business and operations may lead the Islamic bank to be exposed to the risk of non-compliance. SNC risk is considered as the unique risk of Islamic banks and IFIs compared to the conventional counterparts. Thus, Islamic banks need to ensure that the risks are being reviewed, audited and managed properly, otherwise it will blur the difference between Islamic finance and conventional finance (Salman, 2018).
IFIs’ business and operations are largely driven by the Shariah principles and rules. Comprehensive compliance with Shariah principles would gain public confidence and the faith in participation of Islamic financial market. Furthermore, it would strengthen the image of the Islamic bank and IFIs in the market. Any contradiction with the Shariah rulings and guidelines may render the contracts as void or invalid from the Shariah perspective. It will not only diminish the faith and reduce
8
the expectations of the participants, but will also negatively affect the credibility of Islamic bank and indirectly damage the reputation of Islamic financial industry.
2.2 OVERVIEW OF ISLAMIC BANKS IN MALAYSIA
Islamic banking and finance industry in Malaysia have been rapidly growing and increasing remarkably since more than 30 years ago. Malaysian model of Islamic banking today is one of the most advanced Islamic banking systems in the world (Marimuthu, Jing, Gie, Mun, & Ping, 2010).
In order to differentiate Islamic from conventional banking, we should begin by defining Islamic banking. According to Bank Negara Malaysia (BNM), Islamic banking is a banking system that complies with Shariah law. The fundamental principles of Islamic banking are profit and loss sharing between parties involved, the assurance of fairness and the transactions are based on an underlying business activity or asset ownership. The general secretariat of Organisations of Islamic Cooperation (OIC) defines Islamic Bank as an Islamic institutions that explicitly state its adherences to the Islamic law in the whole operations, statutes, rules, and procedures that completely banned interest in any form of receipt or payment. Islamic banks offer facilities with a various financing arrangement with the contractual terms used between the bank and the customers as partners, buyer and seller, wakil (agent), fund provider and entrepreneur. Meanwhile conventional banks offer facilities based on loan arrangement and interest with the contractual term used between the bank and the customers are as borrower and lender.
The first Islamic commercial bank in Malaysia, Bank Islam Malaysia Berhad (BIMB) was established and started its operations in July 1st 1983. BIMB operated as the only Islamic bank in Malaysia for 10 years before the government allowed Islamic
9
Windows Operation, also known as ‘Window’ to be offered by other conventional banks. Islamic Financial Board Services (IFSB) defines Islamic Window Operation as
“A part of a conventional financial institution (which may be a branch or dedicated unit of that institution) that provides both fund management (investment accounts) financing, and investment that are Shariah compliance but with a separate fund”
(IFSB, 2017). Window operation has contributed to the growth of Islamic banking and finance industry in Malaysia as the conventional banks started accepting deposits based on Islamic contract and offering Islamic financing product to the customers.
With the establishment of BIMB, Islamic banks in Malaysia continuously grow in numbers. Currently, there are sixteen (16) Islamic banks including several foreign owned entities that are supervised by BNM. Table 2.1 below shows the latest list of all Islamic banks in Malaysia retrieved from BNM website.
Table 2.1 List of Islamic Banks in Malaysia
No Name Ownership
1 Affin Islamic Bank Berhad Local
2 Al Rajhi Banking & Investment Corporation (Malaysia) Berhad
Foreign
3 Alliance Islamic Bank Berhad Local
4 AmBank Islamic Berhad Local
5 Bank Islam Malaysia Berhad Local
6 Bank Muamalat Malaysia Berhad Local
7 CIMB Islamic Bank Berhad Local
8 HSBC Amanah Malaysia Berhad Foreign
9 Hong Leong Islamic Bank Berhad Local
10
10 Kuwait Finance House (Malaysia) Berhad Foreign
11 MBSB Bank Berhad Local
12 Maybank Islamic Berhad Local
13 OCBC Al-Amin Bank Berhad Foreign
14 Public Islamic Bank Berhad Local
15 RHB Islamic Bank Berhad Local
16 Standard Chartered Saadiq Berhad Foreign
Source: Bank Negara Malaysia (BNM) 2018.
2.3 SHARIAH GOVERNANCE REQUIREMENT FOR ISLAMIC FINANCIAL INSTITUTIONS
Shariah governance is a governance framework and arrangement to safeguard and ensure that all Islamic institutions complies with Shariah and free from the risk of SNC. IFSB defines Shariah as the practical divine law derived from its legitimate sources mainly the holy Quran and Sunnah, and other approved sources of Shariah such as consensus (ijmaʻ), analogy (qiyas)”. Meanwhile SNC risk is an operational risk resulting from non-compliance of the Islamic institution with the principles of Shariah in its operations or products and services offered (IFSB, 2017).
IFSB-10 (2009) Guiding Principles on Shariah Governance Systems for Institutions Offering Islamic Financial Services defines Shariah governance as "A set of institutional and organizational arrangements through which Islamic financial institutions ensure an effective and independent oversight and supervision of the state of compliance with Shariah over any issuance of relevant pronouncements, dissemination and circulation of information and an internal Shariah compliance review”.
11
Shariah governance aims to ensure the compliance with Shariah principles in actuality either in the overall operations and activities, or any Shariah legitimacy of products. Shariah governance also aims to enhance the confidence and trust in the stakeholders. Hence, it will improve the perception of the customers and gain more reputation and public confidence.
2.3.1 Shariah Governance Models
Each legislation or country has a distinguishable and different Shariah governance practices from each other. Hazizi and Kassim (2016) categorized the Shariah governance practices into three major different models and structures. The models are centralized model, laissez faire model and lastly the hybrid model.
1 Centralized Model: This centralized Shariah governance model is constructed by the central regulatory authority and regulated by the government with the establishment of Shariah Advisory Council (SAC). SAC will ascertain the relevant Islamic laws to all Islamic financial matters at the central level.
Decisions by SAC is binding to all IFIs internal Shariah Committees and they shall follow the guidelines and instruction by the authority. The centralized model is more reliable and systematic in terms of Shariah governance efficiency and public and customer confidence. Malaysia, Brunei, Sudan, Iran, and Indonesia are the countries that have been practicing the centralized model.
2 Laissez-faire Model: The laissez faire governance model is a self-regulated structure with no intervention and involvement in Shariah advisory matters by the government and central authority. IFIs shall establish their own Shariah governance structure to ensure all the financial matters comply with Shariah laws. This model is more flexible without standardization at the central level and it can bring more creativity and possibility for different approaches of Shariah
12
governance depending on the nature of the country. United Kingdom, Qatar, Singapore, Jordan, Thailand, Japan, Hong Kong, Germany, France and Turkey are the countries that adopt the laissez-faire model.
3 Hybrid Model: The Shariah governance hybrid model has a Shariah Advisory Council (SAC) or Shariah Supervisory Board (SSB) established at the central level with the internal SSB within the Islamic institutions. IFIs that adopt this model must ensure a full compliance with Shariah in their operations and report their efforts to the central regulatory authority. UAE and Pakistan are the countries that use the hybrid model.
Malaysia is one of the countries that adopt centralized model for Shariah governance structure. There are two layers of Shariah advisory board in Shariah governance structure which aim to ensure Shariah compliance and harmonization of Shariah decision taken by IFIs. The first layer is Shariah Advisory Council or also known as SAC of BNM at the central level. SAC is the highest authority to decide on Shariah matters in Islamic banking and finance in Malaysia. The establishment of SAC is under section 51 (1) of Central Bank Malaysia Act (CBMA 2009). It states that “The Bank (BNM) may establish a Shariah Advisory Council (SAC) which shall be the central authority of Islamic finance for the ascertainment of Islamic laws for the purpose of Islamic financial business”.
Section 52 (1) of CBMA 2009, mentions the functions of Shariah Advisory Council as follows:
(i) To ascertain the relevant Islamic law on any financial matter and issue a ruling/decision upon reference made to it
(ii) To advise the Bank on any Shariah matter relating to Islamic financial business, the operations or transactions
