Foundations of Shari'ah Governance of Islamic Banks

Name: Foundations of Shari'ah Governance of Islamic Banks
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Karim Ginena Azhar Hamid(Autor*in)

Wiley (Verlag)

Erschienen am 9. März 2015

408 Seiten

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A practical guide for robust shari'ah governance ofthe Islamic banking industry
Debate in the market on the extent of shari'ahcompliance of Islamic banks, their products, and activities haspiqued stakeholders' interest. In Foundations of Shari'ahGovernance of Islamic Banks, Karim Ginena and Azhar Hamidexplore the depths of shari'ah governance to unravelits mysterious dimensions, and equip academics and practitionerswith a solid understanding of the subject, which has become aserious challenge and thus deserves dedicated attention.
The authors make a strong case for the need to contain theshari'ah risk that Islamic banks experience, andpresent a compelling argument for how this should be done. Ginenaand Hamid propose a robust shari'ah governance modelthat comprehensively tackles thisrisk, and helps improve the extentof shari'ah compliance of market players. The authorsdetail the internal, external, and institutional arrangementsneeded to promote responsible shari'ah governance, andcritically analyze current laws, regulations, and industrypractices on the topic. The chapters of the book do thefollowing:
* Examine the roots, characteristics and objectives ofshari'ah and its relation to financial dealings;
* Probe the role of regulators in shari'ahgovernance, explore the different approaches adopted by bankingsupervisors, and provide examples of relevant legal and regulatorymeasures;
* Explain to bank directors and management the fiduciary dutythey assume with respect to shari'ah compliance, anddetail how they could discharge this responsibility in line withbest practices;
* Elaborate on the purpose of the Shari'ahSupervisory Board (SSB), its responsibilities, competence criteria,internal regulations, and key governance guidelines; additionally,they explore different SSB models;
* Describe the internal shari'ah control systemincluding its six components, and examine the internalshari'ah audit function as well as different stages ofconducting a shari'ah audit;
* Clarify the role of a shari'ah auditor, withguidance on reporting lines, scope of duties, authority, andpractical ways on fulfilling tasks, such as a sampleshari'ah risk assessment grid and auditchecklists;
* Discuss the newly emerging external shari'ahadvisory firms that are expected to play a key role in the comingyears and the services they provide.
Through an effective treatment of each of these elements, andthe way that they interact with one another, the book offers afresh take on how robust shari'ah governance of Islamicbanks can be successfully accomplished. It is a comprehensiveresource for academics, regulators, directors, lawyers, auditors,consultants, employees, and customers of Islamic banks interestedin learning more about these challenges. This essential readingpersuasively extends the discourse on the subject and addressescritical shari'ah issues that have policy implicationsfor decision makers in jurisdictions aiming to attract thefast-growing Islamic finance industry or increase their marketshare.

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KARIM GINENA has held both academic and industry positions in Islamic Banking. Most recently, he worked as a Senior Researcher with the Center for Islamic Economics and Finance at the Faculty of Islamic Studies, Hamad Bin Khalifa University (HBKU) in Doha, Qatar. Prior to that, he served as Head of shari'ah Audit at Doha Bank. He is currently pursuing his PhD in Management at the University of Virginia's Darden Graduate School of Business and is a member of the Qatar Science Leadership Program. He holds an MSc. in Islamic Finance from HBKU and a Bachelors of Business Administration from Simon Fraser University in British Columbia, Canada. Karim is a 2013 Young Policy Professional of Harvard Law School's Institute for Global Law and Policy and is an AAOIFI Certified shari'ah Advisor and Auditor. Karim has presented his research at international academic conferences and forums, such as at Harvard University, the American University of Sharjah and the British Academy of Management. His research has appeared in reputable journals, such as the Virginia Law & Business Review and Corporate Governance.
AZHAR HAMID is a seasoned Islamic banker and an academician. Presently, he serves Ahli Bank Oman as Head shari'ah Audit and Compliance. Previously, he worked as Deputy Head of the shari'ah Audit Department at Doha Bank and Manager of shari'ah Compliance at Dubai Islamic Bank, Pakistan. Academically, Azhar held the positions of Lecturer, Islamic Bankingand Finance, and Research Assistant to the President of the International Islamic University Islamabad (IIUI) at IIUI. Azhar holds MSc. Economics and MPhil Economics degrees with specialization in Islamic banking and finance from IIUI. Azhar is a researcher of Islamic finance and writes regularly with special focus on shari'ah governance, shari'ah auditing and product development of Islamic financial institutions. Azhar lives in Muscat, Oman, with his wife Dr. Qurrat ul Ain Akram, a son Faateh Abdul Rahman and a daughter Falah Amayem.

Inhalt

Foreword xiii

Acknowledgements xv

Introduction xvii

Part I 1 Karim Ginena

Chapter 1 The Roots, Characteristics, and Objectives of Shari'ah and the Islamic Economic System 3

1.1 Shari'ah, the Qur'an, and Sunnah 3

1.2 What is Fiqh? 8

1.3 Performing Ijtihad and Differences in Juristic Opinions 11

1.4 Shari'ah Rulings 16

1.4.1 Obligation-Creating Shari'ah Rulings 16

1.4.2 Declaratory Shari'ah Rulings 19

1.5 The Subject of a Shari'ah Ruling 19

1.6 Characteristics of Shari'ah 23

1.7 Objectives of Shari'ah 30

1.8 The Islamic Economic System and its Characteristics 35

1.9 Objectives of Shari'ah Relating to Property 50

Chapter 2 Corporate and Shari'ah Governance of Islamic Banks 57

2.1 Corporate Governance Gains Prominence 57

2.2 Hisba System and an Islamic Perspective on Corporate Governance 60

2.3 OECD and Islamic Principles of Corporate Governance 65

2.4 Importance of Corporate Governance to Banking Sector 67

2.5 The Financial Crisis and Corporate Governance Challenges 69

2.6 Developing Countries and Corporate Governance Issues 70

2.7 Corporate Governance Concerns for Islamic Banks 71

2.8 IFSB and AAOIFI Issue Guidance 71

2.9 Adapted Corporate Governance Understanding 72

2.10 Stakeholders of Islamic Banks and their Governance Responsibilities 73

2.11 Connecting Risk Management, Corporate Governance, and Shari'ah Compliance 76

2.12 Shari'ah Governance Model 80

2.13 Importance of Shari'ah Governance 83

2.14 Shari'ah Supervision vs Governance 83

2.15 Shari'ah Risk Definition 84

2.16 Shari'ah Risk and Possible Implications 85

2.16.1 Credit Risk 85

2.16.2 Legal and Compliance Risk 85

2.16.3 Reputational Risk 86

2.16.4 Market Risk 86

2.17 Shari'ah Risk - Causes and Events 88

2.17.1 Internal Causes 88

2.17.2 External Causes 94

2.18 Shari'ah Risk Management 96

2.19 Shari'ah Compliance Responsibility of BOD and Senior Management 97

Appendix 2.1: Operational Risk - Loss Event Types 102

Chapter 3 Legal and Regulatory Aspects of Shari'ah Governance 103

3.1 Institutional Arrangements 103

3.2 Shari'ah and Common Law Encounters in English Courts 106

3.2.1 The Islamic Investment Company of the Gulf (Bahamas) Ltd v Symphony Gems N.V. & others 106

3.2.2 Shamil Bank of Bahrain E.C. v Beximco Pharmaceuticals Ltd & Others 109

3.2.3 Investment Dar Co KSCC v Blom Developments Bank Sal 111

3.3 Lessons Learned from Cases and the Desirability of a Secular Interpretation of Shari'ah 112

3.4 Malaysia: A Common Law Jurisdiction of Choice? 113

3.5 Role of Banking Supervisors in Shari'ah Governance 117

3.6 Regulatory Approaches to Shari'ah Governance 119

3.6.1 Hands-off 120

3.6.2 Nominal 124

3.6.3 Engaged 125

3.6.4 Proactive 132

3.6.5 Committed 143

Appendix 3.1: Legal and Regulatory Framework for IFSI in Jurisdictions with Known IIFS presence 152

Chapter 4 The Internal Shari'ah Control System 181

4.1 Internal Shari'ah Control - Definition and Objectives 181

4.2 Shari'ah Control System Components 182

4.2.1 Shari'ah Control Culture 182

4.2.2 Shari'ah Risk Identification and Assessment 184

4.2.3 Shari'ah Control Activities 185

4.2.4 Shari'ah Associated Information and Communication 186

4.2.5 Shari'ah Monitoring of Activities 188

4.2.6 Evaluation of Internal Shari'ah Control System by Banking Supervisors 189

4.3 Internal Shari'ah Audit Function 191

4.3.1 Purpose, Responsibility, and Authority 191

4.3.2 ISAF in Practice 191

4.3.3 Importance of Independence and Objectivity 192

4.3.4 Planning for Shari'ah Audit 193

4.3.5 Engagement Program Execution 200

4.3.6 Communicating Findings 201

4.3.7 Following Up and Post-Engagement 202

4.3.8 Shari'ah Audit Quality Assurance Program 203

4.4 Proficiency and Due Professional Care of ISAF Staff 204

4.5 Professional Shari'ah Audit Body 205

4.6 Shari'ah Governance Manual 205

Appendix 4.1: Sample Shari'ah Governance Manual (Also available on the book companion website at www.wiley.com/go/shariahgovernance) 207

Appendix 4.2: Sample Shari'ah Audit Checklists (Also available on the book companion website at www.wiley.com/go/shariahgovernance) 223

Part II Azhar Hamid

Chapter 5 The Shari'ah Supervisory Board 249

5.1 The Shari'ah Supervisory Board Defined 249

5.2 Multiple Titles for the SSB 252

5.3 Importance and Purpose of the Shari'ah Supervisory Board 254

5.4 History of SSBs in Modern Islamic Banking 256

5.4.1 Accounting and Auditing Organization for Islamic Financial Institutions 257

5.4.2 Islamic Financial Services Board 258

5.4.3 Organization of Islamic Conference Fiqh Academy 258

5.5 Key Governance Guidelines: Independence, Objectivity, Confidentiality, Consistency, Transparency, and Disclosure 260

5.5.1 Independence 260

5.5.2 Objectivity 263

5.5.3 Confidentiality 265

5.5.4 Consistency 267

5.5.5 Transparency and Disclosure 269

5.6 Regulating SSBs 270

5.6.1 GCC Jurisdictions 271

5.6.2 Non-GCC Jurisdictions 273

5.7 SSB Location Within the Organizational Chart 275

5.8 SSB Models 276

5.8.1 SSB at IB Model 277

5.8.2 SSB at Central Bank and IB Model 277

5.8.3 Central Authority and SSB at IB Model 279

5.8.4 Market-Driven SSB at IB Model 279

5.9 An SSB-Free Model? 280

5.9.1 Need to Understand Shari'ah Requirements for the Industry 281

5.9.2 Securing the Support of Key Stakeholders 281

5.9.3 Commitment to a Unified Shari'ah Reference 281

5.9.4 Being Highly Receptive to New Developments in Industry 282

Chapter 6 Shari'ah Supervisory Board Member Qualifications and Internal Regulations 283

6.1 Competence of SSB Members 283

6.1.1 Character, Professional Ethics, and Conduct 284

6.1.2 Academic Qualifications of SSB Members 289

6.1.3 Experience 294

6.1.4 Essential Skills for SSB Members 297

6.1.5 Professional SSBs 298

6.2 Establishing an SSB 299

6.2.1 Systemized SSB Application Process 299

6.3 SSB Charter 303

6.3.1 Number of SSB Members 303

6.3.2 Terms of Agreement 304

6.3.3 Reporting Line 304

6.3.4 Reappointment 304

6.3.5 Selection of SSB Chairman and Executive SSB Member 305

6.3.6 SSB Members' Remuneration 306

6.3.7 Compensating SSB Members 308

6.3.8 Procedure for Dismissal and Resignation 308

6.3.9 Procedure for Replacing an SSB Member 310

6.3.10 SSB Meetings 311

6.3.11 Frequency of Meetings 311

6.3.12 Quorum for SSB Meetings 312

6.3.13 Decision-Making Process 312

6.3.14 Meeting Minutes 314

Chapter 7 Authority of the Shari'ah Supervisory Board and Conflict Management 315

7.1 SSB Authority 315

7.2 Nature of SSB Decisions 317

7.3 BOD and Management Responsibility Towards the SSB 319

7.3.1 Address SSB Matters in Company Bylaws and Establish Shari'ah Governance Framework 320

7.3.2 Grant SSB Access to Information 320

7.3.3 Seek SSB Guidance and Abide by its Fatawa and Resolutions 320

7.3.4 Honor SSB Independence 321

7.3.5 Provide Administrative Support 321

7.3.6 Assess SSB Performance 321

7.4 Conflict between SSB Members 322

7.5 Conflict between the BOD and the SSB 323

7.6 Conflict between Management and the SSB 323

Appendix 7.1: Performance Evaluation Form for SSB Members (Also available on the book companion website at www.wiley.com/go/shariahgovernance) 325

Chapter 8 Stages of Shari'ah Supervision and Responsibilities of the Shar-i'ah Supervisory Board 329

8.1 Shari'ah Supervision 329

8.1.1 Ex-ante Shari'ah Supervision 330

8.1.2 Intermediate Shari'ah Supervision Stage 332

8.1.3 Ex-post Shari'ah Supervision 333

8.2 Responsibilities of SSB Members 335

8.2.1 Collective Responsibilities 335

8.2.2 Individual Responsibilities 342

8.3 Chairman and Executive SSB Member(s) and their Responsibilities 344

8.3.1 Issuing Fatawa and Ijtihad in Islamic Finance 345

8.3.2 Differences in Juristic Opinion and Conflict Resolution 349

8.3.3 Different Approaches to Issuing Fatawa 351

8.3.4 Reversal of Fatawa and Implications 351

8.4 Annual Shari'ah Compliance Report 352

8.4.1 AAOIFI's Report 353

8.4.2 Possible Opinions in the Report 355

Appendix 8.1: Lease Ending with transfer of Ownership Financing Instrument (Also available on the book companion website at www.wiley.com/go/shariahgovernance) 357

Chapter 9 Shari'ah Advisory Firms 363

9.1 Introduction to Shari'ah Advisory Firms 363

9.2 Services Offered by Shari'ah Advisory Firms 364

9.2.1 Shari'ah Supervision 365

9.2.2 Internal Shari'ah Audit 365

9.2.3 External Shari'ah Audit 366

9.2.4 Product Development and Transaction Structuring 367

9.2.5 Legal Document Preparation and Review 368

9.2.6 Shari'ah Training 368

9.3 Outsourcing Internal Shari'ah Functions 369

9.4 Regulation 369

9.4.1 Adherence to Directives and Guidance Issued 369

9.4.2 Competency 370

9.4.3 Monitoring 370

9.5 Liability 370

Appendix 9.1: Application Form for the Appointment of an External Shari'ah Audit Office (Also available on the book companion website at www.wiley.com/go/shariahgovernance) 371

Index 373

Chapter 1
The Roots, Characteristics, and Objectives of Shari'ah and the Islamic Economic System

Chapter Summary

This chapter examines the roots of shari'ah in order to provide a solid theoretical foundation that is needed for understanding Islamic jurisprudence in general and Islamic transactional law in particular. Without this minimum understanding of shari'ah, it would be rather difficult to discuss shari'ah governance. The chapter begins by defining key terms, such as shari'ah, the Qur'an, sunnah, and fiqh. Next, it discusses ijtihad and the differences in juristic opinions that could result from undertaking such an activity. Thereafter, the chapter explores obligation-creating and declaratory shari'ah rulings and the subject of these rulings. The characteristics and objectives of shari'ah are investigated in order to provide a context for these rulings. Subsequently, the chapter explores the Islamic economic system and its characteristics, in addition to identifying the objectives of shari'ah relating to property.

1.1 Shari'ah, the Qur'an, and Sunnah

Shari'ah1 etymologically means the source of drinking water,2 and shar' means to ordain.3 Muslims believe that shari'ah is an ethical way of life revealed by God to secure the success (falah) of creation in this world and the next.4 It does so by promoting what will benefit beings and protecting against that which will harm them.5 God, the Divine, uses several derivatives of the word shari'ah when addressing His final messenger to creation, prophet Muhammad (pbuh),6 in the Qur'an.7

Qur'an etymologically means the recited one.8 Terminologically speaking, Qur'an is defined as "the communication of God the Exalted, revealed to prophet Muhammad (pbuh), whose recital is considered worship to God."9 Muslims believe that the Qur'an is the word of God, and that its words and meanings were revealed to prophet Muhammad (pbuh) over a 23-year period.10 They therefore take it to be a holy book of guidance and legislation,11 and see an obligation to ponder over it, deduce from it, and act upon it.12

Imam Al-Shaibi observes that Shari'ah was revealed not only to illuminate a way for creation to glorify and worship their Creator, but also to stop people from aimlessly following their whims.13 In commenting on the concept of "worship," Ibn Taimiyah (d. 728 ah14/1327 CE) states that it encompasses two aspects: first, abiding by shari'ah with humility towards the Divine; second, doing so with a loving heart.15 Ibn Taimiyah identifies the realm of worship as encompassing everything, whether said or performed, that pleases the Divine.16 This entails carrying out prescribed duties and staying clear of outlined prohibitions. He gives examples of acts of worship that extend beyond the main rituals. These include truthfulness, trustworthiness, being dutiful to one's parents, honoring covenants, being kind to neighbors, orphans, destitute people, wayfarers, and animals, as well as patience, gratitude, being content with God's decree, and dependence on the Divine.17 He adds that pursuing the means necessary for achieving God's obligations is an act of worship in itself. In essence, every act can be considered an act of worship as long as the individual's intention is to please the Divine and the act is in line with the teachings of prophet Muhammad (pbuh). For example, the brain can contemplate, the tongue can call to good and prevent evil, the heart can love and fear God, etc. Such a holistic understanding of worship is meant to develop a strong personal relationship between the individual and the Divine that holistically covers the different avenues of life.18

While shari'ah offers guidance to creation to steer them in the direction of that which is beneficial and to protect them from what is detrimental, it is not meant to be burdensome.19 Ibn Kathir (d. 674 AH/1372 CE) comments in his exegesis on the verse which reads, "He has chosen you and has not placed upon you in the religion any difficulty" (22:78), by saying:

He has not given you more than you can bear and He has not obliged you to do anything that will cause you difficulty except that He has created for you a way out. So, the salah [prayer], which is the most important pillar of Islam after the two testimonies of faith, is obligatory, four rak'as [units] when one is settled, which are shortened to two rak'as when one is traveling . And he [prophet Muhammad (pbuh)] said to Mu'adh and Abu Musa, when he sent them as governors to Yemen: Give good news and do not repel them. Make things easy for the people and do not make things difficult for them.20

This clement approach of the Divine is embraced by prophet Muhammad (pbuh), as evident in his sayings. For example, "He who is deprived of gentleness is, in fact, deprived of all good."21 Attesting to this, the Divine says: "And We have not sent you, [O Muhammad], except as mercy to the worlds" (21:107). This mercy is embodied in the prophet relieving people from their burdens through his teachings. 'Aishah (d. 58 AH/678 CE), the wife of the prophet (pbuh), reported: "Whenever the prophet was given a choice between two matters, he would [always] choose the easier as long as it was not sinful to do so; but if it was sinful he was most strict in avoiding it."22 After reflecting on shari'ah, Ibn Qayyim (d. 751 AH/1350 CE) observes:

Shari'ah is built and founded on wisdom and people's welfare in this life [on earth] and the afterlife [hereafter]. It is all justice, mercy, benefits, and wisdom. So, any ruling that results in an outcome that replaces justice with injustice, mercy with its opposite, welfare with mischief, and wisdom with futility is not from shari'ah, even if it is interpreted in a way that tries to make it a part of it.23

Moving from the wider meaning of shari'ah to a more specific definition, the Islamic shari'ah has been defined as the laws that God revealed to prophet Muhammad (pbuh) in the Qur'an and sunnah.24 Sunnah etymologically means a way.25 Terminologically, it refers to the teachings of prophet Muhammad (pbuh), apart from the Qur'an, communicated through his sayings, actions, and tacit approvals.26 While the Qur'an is the exact meanings and words of God, adith is the meanings of God but in prophet Muhammad's words.27 Some jurists believe that the term shari'ah comprehensively includes revelation relating to all topics such as creed, morals, etc., while others disagree and restrict the term to practical rulings28 of conduct (al-akam al-'amaliyah).29 Approximately 500 out of 6235 verses of the Qur'an relate to these practical rulings. The majority of the Qur'an speaks about parables of past nations, the reality of life on earth and the hereafter, creed, morals, and other aspects.30 Ibn 'Abbas (d. 68 AH/687 CE) limits shari'ah to the Qur'an and minhaj to sunnah.31

Even though the Islamic shari'ah came with new rulings, it was not all new, as it approved some of the rulings of society at the time, so long as they did not contradict the principles of shari'ah. The Arabs, like any other people, had their own mores of social, economic, and political dealings. Their reference in these dealings included established customs, inherited traditions, principles from previous religions, and norms from nearby nations such as the Persians and the Romans. They did not have a court system, but voluntarily resorted to venerated leaders of tribes or to fortune tellers. These judicators ruled based on the known customs of the people. Furthermore, if a party was convicted yet chose not to abide by the judgment, then matters would escalate beyond retaliation against the culprit to include the individual's tribe. In other words the counterparty would summon their tribe and wage war against the offender's tribe. Inevitably, conflicts and wars arose. Injustice was imminent in an environment in which each tribe did what was best for its interests. Amidst this discord the prophet was sent to reform society. Thus, he confirmed some customs that were in place at the time, prohibited certain beliefs and practices, and initiated new ideas and obligations. For example, he affirmed the Arab's prohibition of marrying one's mother, approved bequests, lease, partnership,...

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