ENHANCING SHARIAH COMPLIANCE OF ISLAMIC FINANCIAL INSTITUTIONS THROUGH SHARIAH GOVERNANCE Prof. Dr. Rusni Hassan IIUM Institute of Islamic Banking and Finance International Islamic University Malaysia hrusni@iium.edu.my ISLAMIC FINANCE INTELLECTUAL DiSCOURSE 2018 Organised by: IRICIEF KUIS Bangi, Selangor (20-21 February 2018)
2 The Outline Islamic Finance: A Recap Regulatory Approach on Shariah Compliance Shariah Governance of IFIs Shariah Governance Framework: The Malaysian Model SGF & Shariah Compliance Conslusion & The Way Forward
3 Islamic Finance: A Recap Shariah principles are the foundation for the practice of Islamic finance through the observance of the tenets, conditions and principles espoused by Shariah
4 Shariah Framework of IBF The Shariah Features Practice and operations of Islamic Banking & Finance based on principles of Shari`ah, fiqh and ijtihad Islamic Banking & Finance products that reflect islamicity of its terms & conditions Distinguished features from conventional practice in terms of products, legal requirement, tax, accounting etc
Sharuiah Framework of IBF The Underlying Shariah Principles 5 Islamic Finance is to adopt Shariah principles Islamic Finance is to reflect Shariah components or aspects in all its activities Akhlaqiyyah (Morality) Iqtidadiyyah (Belief) Islamic Finance is commercial transactions based on prescribed principles of Fiqh al- Muamalat Muamalah (Dealings) Amaliyyah (Dealings Islamic Finance is to uphold the objectives of Shariah (Maqasid al-syariah) Ibadah (Worship)
6 Shariah Framework of IBF The Operating Challenges Debt-based, Collateral Based & Risk Averse Dual Banking System Leveraging on Conventional Banking/Financial Business Model Fiat Monetary System Conventional Banking/ Financial System Framework Fractional Reserve Banking
7 Shariah Framework of IBF Balancing with Conventional Framework Application of Shariah compliant contracts eg: Murabahah, Musharakah, Ijarah etc What IBF have to do Offer Shariah compliant products & services which satisfy form & legal technicalities Finance & invest in Shariah compliant business portfolio Apply/use majority of conventional banking rules & products which are consistent with Shariah
8 Shariah Framework of IBF The Effect of Conventional Framework Fitting-in Conventional banking/finance features has resulted the following: THUS Expose IFIs to Shariah Non-Compliance Risk & THE NEED for Shariah Compliance and Governance Framework
9 Regulatory Approach on Shariah Compliance The growth and development of Islamic finance industry are supported through good governance and its comprehensive legal frameworks
10 Regulatory Approach on IBF The Legal Guidance on Shariah Compliance In addition of the Shariah framework, the legal & regulatory requirements also mandated IBF to comply with Shariah principles
Regulatory Approach on IBF Ensuring End-to-End Shariah Compliance 4 Sec 6 IFSA : The principal regulatory objectives of this Act are to promote financial stability and compliance with Shariah Sec 28(1) IFSA: An institution shall at all times ensure that its aims and operations, business, affairs and activities are in compliance with Shariah
Regulatory Approach on IBF Roles of Key Functionaries on Shariah Compliance 12 Oversight role in ensuring Shariah compliance & due regards to SC s decision BOD Oversight role to assist BOD & senior management for prudent management of TO by ensuring/safeguarding interest of takaful participants Actuary SC Oversight & advisory role on Shariah matters to ensure Shariah compliance Enhanced statutory reporting obligations (Audit & Shariah Audit) Auditors CEO Ensure business operations meet Shariah requirements & Reporting obligations to BNM & SC
Regulatory Approach on IBF Procedure for Shariah Compliant Events 13 Where the IFI is aware that any of its business, affair or activity is not incompliance with Shariah or the advice of SC or the ruling of the SAC, the IFI shall (a) notified to BNM & SC (b) cease the activities (c) Rectify within 30 days
Regulatory Approach on IBF Penalty of Non-Compliance 14 IFIs shall at all times ensure Shariah compliance Contravention of Shariah Compliance requirements will subject to imprisonment not exceeding 8 yrs or fine not exceeding RM25 million or both
15 Shariah Governance of the IFIs Dynamic and good shariah governance is the very essence in the development of Islamic banking and finance sector. Good shariah governance guarantees the Islamic financial growth. The ultimate purpose of Shariah governance is to ensure shariah compliance to its operations and products
Shariah Governance for IFIs The Models Centralized Laissez Faire Government regulates Shari ah advisory on a central level Internal assurance on Shari ah compliance through Shariah advisor Countries: Malaysia, Brunei, Indonesia, Iran, Sudan No government intervention in the provision of Shari ah advisory Self-regulated Countries: UK, Singapore, Qatar, Turkey, Jordan, Thailand, Japan, Hong Kong, Germany, France
Shariah Governance for IFIs Understanding Shariah Governance Shariah Governance system is a set of institutional and organisational arrangements through which Islamic financial institutions ensure that there is an effective independent oversight of Shariah compliance over the issuance of relevant Shariah pronouncements, dissemination of information and an internal Shariah compliance review. Key Features of Shariah Governance IFSB-10 Guiding Principles on Shariah Governance Systems for Institutions Offering Islamic Financial Services
TRULY SYARIAH COMPLIANT INSTRUMENTS & PRACTICES 18 Shariah Governance for IFIs Aims & Objectives of Shariah Governance SG aims to ensure Shariah compliance in actuality i.e. Shariah legitimacy of products and/or Shariah compliant operations of IFIs SG is essential to gain confidence and trust of stakeholders i.e. perception of the outsiders and reputation/ public confidence PROCESS CONCEPT STRUCTURE OPERATION PURPOSE FUNCTIONS SHARIAH ADVISORY SHARIAH SUPERVISION SHARIAH REVIEW/AUDIT Shariah Compliance aspects are to be observed throughout the process in developing/constructing the products/framework and to be supported by proper Shariah governance functions
Shariah Governance for IFIs Key Components of Shariah Governance 19 Who is/are responsible on SG? BODs Shariah Committees Management Employees Qualification & Competency Fit and proper criteria Continuous development & enhancement Robustness of the structure Rigorous & efficient process Effective communication Reporting & Disclosure
20 Shariah Governance for IFIs Principles of Shariah Governance Professionalism Shariah Compliant Functions Sound and Robust Shariah Governance Structure Oversight, Accountability & Responsibility Confidentiality & Consistency Independence Competency
21 Shariah Governance Framework: The Malaysian Model BNM places great importance in ensuring that the overall Islamic financial system operates in accordance with Shariah principles. This is to be achieved through the two-tier Shariah governance infrastructure comprising two vital components, which are a centralised Shariah advisory body at the BNM and an internal Shariah Committee formed in each respective IFI.
22 SGF in Malaysia The Centralised Approach Two layer of Shariah Advisory Board to ensure Shariah Compliance and harmonisation of Shariah decision Shariah Advisory Council at the Central level (BNM) established under Sec 51 of CBMA 2009 Highest authority to decide Shariah matters in Islamic Finance in Malaysia Shariah Committee at the respective IFIs Appointed by Board of Director Upon recommendation/approval of BNM
SGF in Malaysia The Shariah Advisory Council Establishment of Shariah Advisory Council Sec 51 (1) of CBMA The Bank may establish a Shariah Advisory Council on Islamic Finance which shall be the authority for the ascertainment of Islamic law for the purposes of Islamic financial business. To ascertain the Islamic law on any financial matter & issue a ruling upon reference made to it BNM shall consult SAC on any matter relating to Islamic financial business for the purpose of carrying out its functions or conducting its business or affairs in accordance with Shariah Any ruling made by SAC shall be binding on IFI, Court and/or arbitrator
SGF in Malaysia Reference or Consultation to SAC BNM Sec 55 (1) CBMA 2009 BNM shall consult the SAC on any matter relating to Islamic financial business for the purpose of carrying out its functions or conducting its business or affairs in accordance with Shariah IFIs Sec 55 (2) CBMA 2009 Any IFI may refer to SAC in respect of its Islamic financial business for the purpose of seeking advice or to get a decision/ruling on Shariah matters
SGF in Malaysia SAC in Judicial Proceeding Reference to SAC Effect of SAC Decision In judicial proceedings (in court or arbitration), where any question relating to Shariah matter arises Court or arbitrator shall (a) take into consideration of rulings of SAC (b) refer such question to SAC Any ruling made by SAC shall be binding on IFI, Court and/or arbitrator Mohd Alias bin Ibrahim v RHB Bank Berhad & Anor [2011] 3 MLJ 26 1. For questions concerning a Shariah matter, the civil court is bound to take into consideration any published rulings of the SAC or refer such questions to the SAC for its ruling and any such ruling made shall be binding on the court. 2. Sec 51 of CBMA 2009 refers to SAC s role to make an ascertainment, and not determination, of Islamic laws relating to IBF 3. The issue of whether the facility is Shariah compliant or not is to be decided by the court. 4. The rulings as passed by the SAC constitute a form of expert opinion in the matter of Islamic finance. 5. SAC as the amicus curiae Note: See also Tan Sri Khalid Ibrahim s case
SGF in Malaysia Shariah Committee Establishment of Shariah Committee (Sec 30 IFSA) A licensed person shall establish a Shariah committee for purposes of advising the licensed person in ensuring its business, affairs and activities comply with Shariah. Accountable & responsible for Shariah decisions Ensure Shariah compliant operations of IFIs BoD shall give due regards to SC decision
SGF in Malaysia Shariah Governance Framework 2011 Shariah Governance at the IFIs is regulated under the Shariah Governance Framework of IFIs issued by BNM Objectives: 1. Sets out the guidelines on the IFI s Shariah governance structures, processes and arrangements to ensure that all its operations and business activities are in accordance with Shariah 2. Provides a comprehensive guidance to the board, Shariah Committee and management of the IFI in discharging its duties in matters relating to Shariah 3. Outlines the functions relating to Shariah review, Shariah audit, Shariah risk management and Shariah research Applicability: The SGF is applicable to all IFIs under supervision of BNM: Licensed Islamic banks Takaful company Financial institutions offering Islamic finance services Development financial institutions which carries Islamic Banking Scheme (DFI banks)
28 SGF in Malaysia Shariah Governance Structure The Shariah governance structure shall be robust & supportive to the IFIs internal infrastructure to ensure effective overall Shariah compliant process
29 SGF in Malaysia Accountability of Key Functionaries Functions Governance Authorities in Normal Financial Institutions Additional Elements in IFIs Governance Board of Directors Shariah Committee Risk Management & Internal Control Compliance Internal & External Auditors Risk Management Unit or Department Regulatory & Financial Compliance Officers, Unit or Department Shariah Auditors Shariah Risk Management Officers Shariah Review Functions or Unit Explanation on Functions Provide independent view and decisions on Shariah related matters Report directly to BOD Conduct audit on Shariah related matters Conducted by internal Shariah trained personnel Report to Shariah Committee Identify all possible Shariah non-compliance risk Provide mitigating measures Continuos assessment on Shariah compliance Take prompt rectification measures Report to Shariah Committee & Management
SGF in Malaysia Independence of Shariah Committee 30 SGF Principles Independence of Shariah Committee BOD to recognise & ensure SC s independence SC shall have access to all information SC report directly to BOD BOD must ensure SC s decisions are implemented
31 SGF in Malaysia Continuous Knowledge Enhancement BOD & Management shall have sufficient Islamic Finance knowledge Ensure competency of SC through Fit & Proper Criteria Establish adequate continuous education programme Rusni Hassan 2018. All rights reserved.
SGF in Malaysia Professional Ethics, Judgment & Consistency of Decision 32 Establish a structured Shariah decision making process SC not to undermine their decisions & SAC s References to SAC in case of dispute (internal dispute/ arbitration/court
33 SGF & Shariah Compliance Shariah principles are the foundation for the practice of Islamic finance through the observance of the tenets, conditions and principles espoused by Shariah. Comprehensive compliance with Shariah principles would bring confidence to the general public and the financial markets on the credibility of Islamic finance operations.
SGF & Shariah Compliance Rigorous Shariah Compliance Process 34 Shariah Review & Audit Shariah Risk Management Control Shariah Research & Secretariate Regular exercise of Shariah Review Independent Shariah audit exercise conducted by trained Shariah auditors Identify possible Shariah risk Measures for mitigation & control Formulate Shariah compliance risk management policy & guidelines Qualified Shariah officers to perform in-depth Shariah research Establishing Shariah secretariate SGF requires rigorous Shariah Compliance process to ensure end-to-end Shariah compliance Operations of IFIs This enhanced process ensures no SNCs occurrence, protect the sanctity of Islamic Finance and achieving the objectives of Shariah (maqasid al-shariah)
SGF & Shariah Compliance Shariah Compliance Towards Financial Stability SG ensure end-to end Shariah compliant aspects which is the essence of IF SG ensure consistent market practices in view of differences of views of scholars SG supports Corporate Governance principles SG enhance accountability of stakeholders SG ensure the public expectations are met
36 SGF & Shariah Compliance The Regulations on Reporting of SNCs SGF Principle 1.1 An IFI carrying out Islamic financial business shall ensure that the aims and operations of its business are in compliance with Shariah principles at all times. An end-to-end Shariah compliant control mechanism shall be established in all aspects of its business operations to ensure that all activities are Shariah compliant. IFSA Section 28 IFIs shall ensure that its overall operations are Shariah compliance Any SNC shall be reported immediately to Shariah Committee and to BNM within 14 days Rectification must be made within 30 days Guidelines on Reporting of Islamic Banks Section 10.1 10.5 Shariah Committee must disclose overall Shariah compliance aspects of IFIs including SNC, remedial action for such SNC & uses of SNC income ORION The IFIs must report the actual SNC event to BNM upon confirmation by the SCs The IFIs must submit to the rectification plan as approved by the Board and the SC within 30 days. SGF requirements on Shariah compliance is fully supported by other regulations & guidelines and thus ensure industry s commitment towards Shariah compliance & no tolerance towards SNCs
37 SGF & Shariah Compliance Some Issues & Challenges Corporate Governance vis-a-vis Shariah Governance Conflict of laws vs harmonization of laws Optimal Shariah Governance practice Human resource issues Shariah Governance & Maqasid al-syariah Cross border practices of Shariah Governance
38 Conclusion and The Way Forward The Islamic financial system is in its evolutionary phase.. provided that the basic supportive infrastructure is established, the inherent features of the Islamic financial industry can themselves contribute to strengthening the global financial architecture.
Conclusion & The Way Forward Shariah Governance for Development & Progress of Islamic Finance Introduction and infrastructure development Growth and market expansion by entering into global market Enhanced regulatory requirements and financial stability Development of IF markets, players, products & instruments Pilot projects DIB; IDB; First Takaful; BIMB Broader & deeper market on IF Global expansion especially sukuk market Strengthening of the regulations on IF Governance & financial stability
Conclusion THE WAY FORWARD 40
41 Wasaalamualaikum warahmatullahi wabarakatuh & THANK YOU