Shariah governance and regulations in Islamic finance remain a diverse topic despite countless initiatives to set a common international framework of rules to standardise or at least harmonise governance for all jurisdictions where Islamic finance plays a major role.
The sector is growing fast and on the way to become an important pillar of the global financial industry and, as such, needs cross-border regulations to allow banking and financial services to flourish. It is also a matter of competition towards the conventional industry which is much more streamlined and globally interconnected. And, furthermore, Shariah governance plays a key role in ensuring the effective functioning of the Islamic financial market and promoting its integrity.
There are different approaches towards establishing unified standards, mainly by Islamic finance-related organisations in Malaysia and the Middle East, such as the Islamic Financial Services Board of Malaysia’s central bank; the Association of Shariah Advisors In Islamic Finance, also in Malaysia; Bahrain’s Accounting and Auditing Organisation for Islamic Financial Institutions and the Islamic Finance Market Advisory Group in London, just to name a few of the more influential standard-setting organisations.
However, it is still the case that a variety of different Shariah governance models exist in different jurisdictions, often even varying from bank to bank in the same country.
A key element of the Shariah governance of an Islamic finance institution is the supervisory board constituting scholars or Islamic jurists who oversee and validate the Shariah compliance of products and operations. Even in the absence of regulatory requirements, they would establish the legitimacy and credibility of the institution’s operations, i.e. giving it their own governance structure. This has happened many times in the past and is one of the root causes why it is so difficult to reach unified regulations.
Another issue is that Islamic scholars are not uncommonly of different opinion on a subject, owing to different interpretations of Islamic laws and might issue fatwas which would declare the same Islamic finance product either haram or halal. Or, in countries with more “liberal” interpretations of Shariah rules such as Malaysia or Turkey, economic factors will be given more weight at the cost of Shariah principles, which may result in opting for controversial products and – in the absence of common guiding principles for Islamic finance – can lead to a conflict of interest.
Thus, to reduce Shariah compliance risks and reputational issues for a bank, as well as to protect stakeholders, investors and consumers, regulatory bodies are needed to introduce Shariah governance framework and guidelines.
Countries with comprehensive guidelines on Shariah banking are, for example, Sudan, which in 2003 created the Shariah Control Higher Commission. Indonesia’s Islamic Banking Act 2008 mandates Islamic financial institutions to focus on Shariah issues in banking, while Malaysia set up a Shariah Governance Framework for Islamic Financial Institutions in 2010 and in the Islamic Financial Services Act 2013 emphasises the strengthening of the Shariah governance framework to promote compliance in the Islamic financial sector.
Oman added Shariah compliance to its Banking Law of 2012 and the country’s central bank then delivered an Islamic Banking Regulatory
Framework, while Pakistan’s central bank introduced a comprehensive Shariah Governance Framework in 2015. The central bank of Bangladesh issued guidelines for Islamic Banking as early as 2009, and Nigeria’s central bank did the same with guidelines on Shariah governance for what it calls non-interest financial institutions.
But there are still jurisdictions without such regulatory bodies or common guidelines. For example, the UAE mandates in Federal Law No 6 of 1985 that Islamic financial institutions must establish a Shariah committee, but there are no details on the Shariah governance framework required by licensed Islamic banks in the law.
Kuwait is practising self-regulation of Islamic financial institutions, as does Qatar, even though the central bank is considering setting up a central Shariah committee for Islamic banks to create consistency in Islamic finance.
All this makes a common regulatory structure on Shariah compliance for all market participants an extremely tricky issue.