EMPIRICAL STUDY ON THE UNDERSTANDING OF SHARIAH REVIEW BY ISLAMIC BANKS IN MALAYSIA

Transcription

1 EMPIRICAL STUDY ON THE UNDERSTANDING OF SHARIAH REVIEW BY ISLAMIC BANKS IN MALAYSIA Zariah Abu Samah&Rusni Hassan Abstract The key value proposition offered by Islamic banking and finance is an end-to-end Shariah compliant business environment. In supporting the above proposition, Bank Negara Malaysia (BNM) had on October 2010 issued the Shariah Governance Framework for Islamic Financial Institutions (the Framework) with the aims to strengthen the Shariah Governance process, accountability, decision making and independence of Shariah Committee. One of the important expectations of BNM via the Framework is for the Islamic Financial Institutions (IFIs) to outline and perform the function of Shariah Review for a comprehensive Shariah compliant environment in their operation and business activities. Its introduction received several comments from the Islamic banking players, which stated that its function is more or less similar to Shariah Audit function that would entail duplication of function. This paper examines on the understanding of Shariah Review function performed by the Islamic banks via (1) analyzing the existing practices of Shariah Review function by the Islamic banks and (2) identifying gaps in the Shariah review function performed by Islamic banks in comparison to those stipulated in the Framework. This study would provide an environment to evaluate the understanding of Shariah Review by the Islamic banks. Keywords: The Framework, Shariah Compliance, Shariah Review, Islamic banks 1.1 INTRODUCTION A dynamic and comprehensive Shariah Governance is important as it performs an exclusive role in ensuring that the activities & operations of Islamic banks do not contravene with the Shariah followed by effective and independent oversight on Shariah compliance within the internal management and the organization of Islamic banks. The Central Bank of Malaysia had undertaken an important task in 2010 for the issuance of the Shariah Governance Framework with the enforcement date on 1 January 201. The frameworks main objective was to enforce and strengthen the Islamic Financial Institutions (IFIs) Shariah governance structures, processes and arrangements to ensure that all IFIs operations and business activities in accordance with Shariah principles. Simultaneously, the framework enforced the requirement to institute a structured and comprehensive internal control and processes to handle and address Shariah non-compliance in a holistic manner. Shariah Review is considered a new mechanism for Shariah compliance under the Framework and it is conducted in a collaborative manner with Shariah Audit and Shariah Risk Management with its crucial enforcement being to conduct regular assessments on a continuous basis, to review that the activities and operation carried out by IFIs do not contravene with the Shariah, including to strengthen the Second Line of Defense for the banking industry in safeguarding internal risk control framework. Hence, thispaper focuses on Shariah Review as defined in the Shariah Governance Framework (SGF) 2011 and its operationalization by the Islamic Banks.Also, this paper will evaluate the level of understanding on Shariah Review by the Islamic Banks in Malaysia, through their performance in delivering the ShariahReview functions, scope, processes and independency of deliverables in comparison to those stipulated in the Framework. This study is in the light of the issues arising currently from the practice of shariah review function in the Islamic banks such as duplication of function of shariah review with that of shariah audit, adoption of shariah audit framework, processes and documentation for shariah review as well as

2 the Shariah Review function being performed by Shariah Audit or Compliance Division of the Islamic Banks parent bank. The present study has employed qualitative methodology with interview and questionnaire methods for data collection.. The questions for the questionnaires methodwere designed to cover the topics as per stipulated in the Framework (Section VI (i) - Shariah Compliance & Research Function) which are Shariah Review functions, scope of work, process flow function, reporting structure and the qualification and competencies of Shariah Review officers in performing Shariah Review function. 1.5 RESULTS AND FINDINGS Nine localislamic banks and one foreign Islamic bank were selected based on their commitment to support this study. The ten interview sessions were conducted between mid of March to mid of April The overall results collected during the interview sessions with respect to the four questions are as tabulated. Table 1.0 Summary of Results/Findings No Questions YES NO 1 Has your bank fully understood on the requirement to perform Shariah Review as stipulated in the Shariah Governance Framework of BNM? 100% - 2 Are product development and product implementation the major portfolio of Shariah Review? 100% - 3 Do your Shariah Review Officers have adequate Shariah knowledge to perform Shariah Review? 40% 60% 4 Has your bank emplaced the Shariah Review work flow process? 100% - For question one, all the ten selected Islamic banks confirmed that their management and Shariah Reviewers fully understood the requirement to perform Shariah Review with respect to its definition, objective, function, scope of work, review process, competency of Shariah Reviewers and independency of Shariah Review reporting structure. The Framework s function of Shariah Review and the result and finding are as tabulated in Table 1.1 below. Table 1.1 the Function of Shariah Review No Functions Feedbacks Response Rate 1 Do you agree that your bank s Shariah Review performs, but not limited to the following functions: a) Assess and evaluate Shariah compliance in all activities and operation of the Bank. b) Undertake remedial rectification measures to resolve Shariah non-compliances and control mechanism to avoid recurrences.

3 No Functions Feedbacks Response Rate c) Examine the compliance of documentation which includes contract, agreements, policies, products & services, transactions, report and other related documents. The finding for this questionnaire is that all the respondents agreed and performed all the functions under shariah review. The scope of work of Shariah Review and the result and finding is summarized as per table 1.2 below. Table 1.2 Scope of Work of the Shariah Review Scopes of Work Feedbacks Response Do you agree that your bank s current scope of work of the Shariah Review cover, but not limited to the following: (a) The bank s overall business operation including end-toend product development process from pre-product approval to post product offering processes. (b) The scope of work of Shariah Review cover, but not limited to, the following areas: i) Product Development & Implementation Review ii) Business Activities Implementation and Operational Review The findings reveal that all respondents agree to the scope of work under items (a) and (b) part (i) and (ii), and are currently performed by them. Based on the model structure of roles, functions and reporting relationship of the key organs in the Framework, Shariah Review Dept. is to directly report to Shariah Committee, and under the administrative structure report to the Management of Islamic banks. The required reporting structure for Shariah Review, instituted to safeguard independence of Shariah Review for effective review performance & sound Shariah decision by Shariah committee, is as per Figure 1.0 below:- Figure 1.0 Reporting Structure of Shariah Review of the Framework The summary of result and finding shows that 10% of the Islamic banks adopted the reporting structure of the Framework where theshariah Review department reported directly to Shariah Committee. The Shariah Review departments of the remaining 90% of the Islamic banks are not reporting directly to the Shariah Committee resulting in their reporting structure inconsistent with the Framework. With regard to the second question, all banks concur on the processes and transactions covered under shariah review to involve pre-product approval process (comprised of product concept paper, Shariah

4 endorsement, product sign-off, Islamic banks management endorsement and final product approval), with the participation many level of stakeholders including BNM; product implementation review and post product approval process. The product implementation review platform could be presented as per Figure 1.4 below. Figure 1.4 Shariah Review Platforms for Product Implementation Review Platform (1) Review Platform (2) Product SOP Branches Business Units Manpower & Training Legal/Documentation Source: Author s own Product Implementation Credit Administration IT/System Funding Accounting Remedial Management The main focus for Shariah Review dept. are the areasdirectly related to products, which are represented by (a) Pre-product approval process, (b) Post-product approval process and (c) Branch & business unit review. The said three areas cover more than 70% of the Islamic banks activities and operation as presented in figure 1.5 below Figure 1.5 The Overall Focus Area of the Islamic Banks in Performing Shariah Review Branch & Business Unit Review Non-Product Related Segment Review Post-Product Approval Process Review Pre-Product Approval Process Review The 4. 5%non-product related areas are represented but not limited to (a) credit processing process, (b) credit approval process, (c) remedial management, (d) bank s investment portfolio and (e) financial statement. These areas would require a different set of competency, other than Shariah knowledge to beacquired by the Shariah Officers specifically in credit and finance. However, as generally informed by the Islamicbanks these areas would gradually be added to the scope of work of Shariah Review from time to time. As for the qualification of the officer conducting Shariah Review covered under the question 3, 85% of Shariah review members hold a bachelor s degree in Shariah, 7.5% having experience in auditing, and 2.5% in banking operation as shown in Figure 1.6 below.

5 Figure 1.6 Qualification & Knowledge of Shariah Review Officers Bachelor s Degree in Shariah Bachelor s Degree in Law Knowledge & Experience in Banking Operation Knowledge & Experience in Auditing Almost all the Shariah Review Officers at the Islamic banks hold a bachelor s degree in Shariah. However, a mixture of knowledge, experiences and competencies in related areas such as banking operation, banking products & services, with an expansion to finance, credit operation, remedial management including IT/System, would be a great advantage in delivering Shariah Review deliverables as those would speed-up the review task and smoothing the documentation and reporting transaction of Shariah Review. It is also agreed by all the respondents that the knowledge and training requirement to be treated as an urgent call agenda for future ongoing forward planning for Shariah Review. Question four checks on the placement of the review work flow process, which was extracted from the Framework and were shared with the ten Islamic banks during the interview sessions as per table 1.3 below. Table 1.3 Major Steps for Shariah Review Work Flow Process Step Major Steps for Shariah Review Work-Flow Process 1 Plan and design Shariah Review planning and the procedures, including the objectives, scope, reporting, rectification and follow-up actions. 2 Document the processes, findings, identified gaps and conclusions in the review. 3 4 Prepare Shariah Review report for presentation and communication the findings, outcomes and conclusions to Shariah Committee and the bank s management. Follow-up on rectification of identified gaps and non-compliances within an agreed stipulated period. All the ten Islamic banks confirmed that they duly understood the abovementioned work flow processes and have accordingly adopted for their Shariah Review. The review process has also been expanded and enhanced for a more comprehensive work flow process to be easily understood and performed accordingly by their Shariah Review officers. Hence, all the ten Islamic banks confirmed that they have emplaced comprehensive Shariah Review work flow process, as stipulated by the Framework. The final summarization of the research analysis to evaluate the understanding of Shariah Review function by the Islamic banks is presented under Table 1.4 below. Table 1.4 Percentages of the Selected Islamic banks Performing Shariah Review according to the Framework

6 No Requirement of the Framework % of compliance 1 Mode of assessment (Sect VI Para 7.3) 100% 2 Function of Shariah Review (Sect VI Para 7.4) 100% 3 Scope of Shariah Review (Sect VI Para 7.5) 70% 4 Qualification of Shariah Review Officer (Sect VI Para 7.3) 100% 5 Shariah Review process (Sect VI Para 7.6) 100% 6 Independency of Shariah Review (Section I Para 1.7) 80% 7 Understanding Shariah Review in comparison to Shariah audit 100% The overall findings on the requirement of Framework are as follows:- (1) The mode of assessment for Shariah Review is on regular and continuous basis, of which all the Islamic banks have put them in practice in performing their Shariah Review function. (2) Both Shariah Review function and Shariah Review process were performed by the Islamic banks according the requirement of the Framework. (3) The qualification of Shariah Review officers has been fully met, as majority of the Shariah Review officers in the Islamic banks hold a bachelor degree in Shariah as required by the Framework. (4) The Islamic banks have only covered about 70% of the required scope of Shariah Review, which represents the end-to-end product pre and post development process.the remaining 30% which are related to non-related product segment such as credit process and approval, financial management, treasury and remedial management would be performed gradually in thefuture. Only one of the ten selected Islamic banks adopted the Framework s Shariah Review reporting structure, with its Shariah Review reporting directly to the Shariah Committee whilst two of the Islamic banks are not consistent to the requirement of the Framework. The remaining seven Islamic banks allowed direct reporting of their Shariah Review to Shariah Committee with simultaneous reporting to either Shariah department or Group Compliance department. (5) All the Islamic banks confirmed on their fully understanding on the difference between Shariah Review function to those of the Shariah Audit. 1.6 CONCLUSION& RECOMMENDATIONS Based on the research analysis, the Islamic banks have fully understood the requirement of Shariah Review specifically on the requirement to perform Shariah Review on a continuous basis to maintain regular assessment on the status and level of Shariah compliance. Their responses and feedbacks during the interview sessions and to the research questionnaires can be concluded as that the Islamic banks have duly performed their Shariah Review according to function, scope of work and review process as stipulated in the Framework. Also, all the ten Islamic banks have duly understood the Shariah Review and its function as stipulated in the Framework. However, two gaps have been identified with regard to comprehensive shariah review:- (1) Inappropriate reporting structure of Shariah Review where the Shariah Review unit/section does not report directly to Shariah Committee, for the independence of deliverables by Shariah Review function. The practice of Shariah Review of not reporting directly to Shariah Committee would restrict the independence of Shariah Review deliverables which would lead to an issue on how a review in Shariah department or Group compliance department would be conducted by the Shariah Review unit/section. The Shariah Review reports would need to have the clearance of other departments prior to submission to Shariah Committee. (2) Scope of work of Shariah Review performed by the Islamic banks is yet to reach the requirement of the Framework of which the review scope shall cover the Islamic bank s overall business

7 operation, including the end-to-end product development process which start from product structuring to product offering. Currently the review scope for majority of the Islamic banks comprise of product development and product implementation which represent about 70% of the bank s activities and operation. The remaining 30% is for credit operation and approval, remedial management, financial management, treasury and trade finance. The ability of the Islamic banks to review their overall activities and operation would increase the degree of Shariah compliance and simultaneously reduce the level of Shariah non-compliance risk. Expansion of the review scope would need the support of adequate manpower with the right knowledge, experiences and competencies. The overall study analysis has provided positive findings on the understanding of Shariah Review function by the Islamic banks with their awareness on the identified gaps and commitment to manage the gaps gradually for achieving effective Shariah Review function in their banks. A recommendation for adequate and knowledgeable manpower to perform Shariah Review would lead to possible expansion of review scope and simultaneously increase the credibility of Shariah Review function. Successful effort to increase the awareness on the importance of Shariah Review throughout the Islamic banks supported by strong and reliable collaboration between Shariah Review, Shariah Audit, Shariah Risk Management and Shariah Research would speed up the delivering of Shariah Review deliverables in compliance with the expectation of the Framework. This paper has been presented at the Islamic Business Management Conference on 19 th August 2014