role of islamic banking on economic growth of pakistan

7/24/2019 role of islamic banking on economic growth of pakistan

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RESEARCH ON

Comparative Study of Shariah Compliance Governance Frame Work

The case of Pakistan, Malaysia, and Indonesia

Supervised by

Mr. Haroon Khan

Submitted by

Muhammad Arif

Amna Afridi

Zeeshan Ahmad

State bank of akistan !SC

esha"ar

Session #$%&'#$%(

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Contents)ntrodu*tion+................................................................................................................. 2

History and Evo,ution of )s,ami* !ankin-+..........................................................................2

ifferen*e bet"een Conventiona, !ankin- and )s,ami* !ankin-..............................................3

Conventiona, !ankin-+.................................................................................................3

/hat is )s,ami* bankin-0.................................................................................................4

/hy separate sharia *omp,ian*e frame "ork+......................................................................6

Shariah 1rame /ork of akistan+.....................................................................................7

An )ntrodu*tion to Shariah 2overnan*e 1rame /ork+.......................................................7

Ro,e of !O in Cir*u,ar #$%&+.......................................................................................8

Ro,e of E3e*utive Mana-ement+.....................................................................................9

Sharia !oard+............................................................................................................. 9

Constitution of the S! and Appointment of S! Members.................................................9

Ro,e of Shari4ah !oard+...........................................................................................10

Shari4ah !oard Meetin-s5 6uorum5 Minutes et*...........................................................10

)ndependen*e of Shari4ah !oard 7S!8+.......................................................................10

Resident Shari4ah !oard Member 7RS!M8+................................................................10

Sharia Comp,ian*e epartment+..................................................................................11

)nterna, and E3terna, Sharia Audit+..............................................................................11

1it and roper Criteria+.............................................................................................12

Conf,i*t Reso,ution+................................................................................................... 12

)ntrodu*tion to Ma,aysian Shariah 1rame /ork+...............................................................12

2enera, Re9uirement for Shariah 2overnan*e 1rame /ork+............................................13

Oversi-ht5 A**ountabi,ity5 and Responsibi,ities+..............................................................13

Shariah Committee+...................................................................................................14

Mana-ement+........................................................................................................... 14

)ndependen*e of the shariah Committee+.......................................................................14

Competen*y+............................................................................................................ 15Confidentia,ity and Consisten*y+..................................................................................15

rofessiona, Ethi*s and :ud-ment for Ensurin- Sharia Comp,ian*e+...................................15

Shariah Comp,ian*e and Resear*h 1un*tion+..................................................................15

1it and roper Criteria of the Shariah Committee+..........................................................16

uties5 Responsibi,ities5 and A**ountabi,ity of Shariah Committee+....................................17

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Operation ro*edure of Shariah Committee+..................................................................17

rodu*t eve,opment ro*ess+.....................................................................................17

Shariah Comp,ian*e 1rame/ork of )ndonesia+..................................................................18

Mana-ement E3e*utive Offi*er and Shariah supervisory board+........................................18

ro*edures and Re9uirements+.................................................................................18

Mana-ement+........................................................................................................... 18

E3e*utive Offi*ers+....................................................................................................19

Sharia Supervisory !oard+..........................................................................................19

E3penditure+............................................................................................................ 20

Comparative ;ab,e of Stru*ture+.....................................................................................21

1it and roper Criteria Comparison+...............................................................................21

Attra*tive 1eatures+...................................................................................................... 22

akistani 1rame /ork+..............................................................................................22Ma,aysian frame "ork+.............................................................................................. 23

)ndonesian 1rame /ork+............................................................................................23

Repe,,ent 1eatures of A,, 1rame /orks+............................................................................23

1uture Re*ommendations+.............................................................................................24

Con*,usion+................................................................................................................. 25

Referen*es+................................................................................................................. 28

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Comparative Study of Shariah Compliance Governance Frame Work

Case of Pakistan, Malaysia, and Indonesia

)ntrodu*tion+The term Islamic banking refers to a banking activity or a system of banking that is in

consonance with the basic principles of Islamic Shraiah(rules and values set by Islam). Islamic

banking is also known as interest free banking system as the Shariah disallows the acceptance of

Riba or interest rate for the accepting and lending of money. Islamic banking offers the same

facilities as conventional banking system e!cept that it strictly follows the rules of Shariah or

"i#h al$ %uamlat.

History and Evo,ution of )s,ami* !ankin-+The origin of Islamic banking system can be traced back to the advent of Islam when the &rophet

himself carried out trading operations for his wife. The %udarbah or Islamic partnerships has

been widely appreciated by the %uslim business community for centuries but the concept of

Riba or interest has gained very little diligence in regular or day$to$day transactions.

The first model of Islamic banking system came into picture in '* in +gypt. ,hmad ,l -aar

was the chief founder of this bank and the key features are profit sharing on the non interest

based philosophy of the Islamic Shariah. These banks were actually more than financial

institutions rather than commercial banks as they pay or charge interest on transactions. In '/01

the 2rgani3ation of Islamic 4ountries (2I4) had established the first Islamic bank called the

Islamic 5evelopment 6ank or I56. The basic business model of this bank was to provide

financial assistance and support on profit sharing.

6y the end of '/71 several Islamic banking systems have been established through out the

%uslim world1 including the first private commercial bank in 5ubai('/8)1 the 6ahrain Islamic

bank('/) and the "aisal Islamic bank of Sudan ('//).

%aor %odels of Islamic 6anking and "inance System

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ifferen*e bet"een Conventiona, !ankin- and )s,ami* !ankin-

Conventiona, !ankin-+ %oney is a commodity besides medium of e!change and store ofvalue. Therefore1 it can

be sold at a price higher than its face value and it can also be rented out.

Time value is the basis for charging interest on capital.

Interest is charged even in case the organi3ation suffers losses by using bank9s funds.

Therefore1 it is not based on profit and loss sharing.

:hile disbursing cash finance1 running finance or working capital finance1 no agreement

for e!change of goods ; services is made.

4onventional banks use money as a commodity which leads to inflation.


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Islamic banks are based upon profit and loss sharing like they accept deposits from clients on the

bases of mudarba. Sometimes they receive money as ammanah in the form of current account if

the right of use is obtained then on the bases of :adiah is accepted. Islamic banks mostly do

musharakah same like partnership in the conventional system.

Islam is a religion which clearly portray the guideline to eliminate gharar1 uncertinity and avoide

gambling types of activities to safeguard the interst of the depositor holders. Riba is generally a

term used for the interest which refers to the increase on cash or any e!cess charge on the money

while riba is of two type one is the riba$an$nisiyah which means e!cess amount charge upon the

money and the other is riba$al$fadal which refers to the e!cess amount charge on the e!change of

good like in borter system.

Islamic banks are mainly involve in a trade activities through different modes of financing orproducts which are given below

Mudarabah

Musharakah

These two modes are the participatory mode in which provide or receive funds and take part in

the profits on the bases of pre agreed ratios on the bases of mutual concern while the rest are

non$participatory modes given below

Murabah

Musa"amah

Sa,ma

)stisna

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%udaraba is mode of financing where bank raise funds from the client by investing them and act

as a mudarib by sharing certain portion of profit in the return of their skills. The fund provider is

a rabulmal while the bank act as mudarib.

Salam is a sale transaction in which full payment for the naturally made products are made fullyin advance while the delivery is made in future. &arallel salam is done here as a risk mitigation

tool to sell out the commodity obtained through salam contract. It9s mostly done for the

facilitation of small formers to fulfill their need of funds.

Istisna is same like a salam agreement done in the human made products here full payment in

advance is not necessary funds are made available with the progress of work and delivery is

made in future. =ere parallel istisna can be done for the sake of risk mitigation.

Iarah refers to the transfer of usufruct of an assets or service for a specified time of period for

specified rental. In some iaraha like iarah muntahi bitamlik ownership gradually transfer with

the passage of time.

%ainly the above mentioned transactions are very much comple! in nature and need to be

observed carefully to follow the sharia limits in both form and substance. The sharia rules should

be taken into consideration to avoid sharia compliance risk for which sharia compliance frame

work is necessary which would be further discussed.

/hy separate sharia *omp,ian*e frame "ork+,s Islamic banking is fully based upon the golden principals of Islam prescribed by >uran1

,hades and other sources of knowledge of Islam is completely different from that of already

established conventional system. Islamic bank is free of Riba while conventional system is fully

based upon interest. The Islamic banks is fully based upon trade transactions which encourage a

real increase in the wealth while conventional is against of the trade and encourage a bubble

increase which have witnessed in the past in many of the crises like


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contracts in I6I9s like Salam1 %usharakah1 Istisna1 Iara and other contracts of more risky nature

re#uired standard rules from S6& to be followed by I6I9s. 6eside this the sharia compliance

limitation should be clearly specified by S6& to provide the sharia boundaries for each contract

to avoid operational risk of Islamic banks otherwise income earned will be penali3ed and would

be transfer to charity account which can be considered as unust with deposit account holders.

"rom the above mentioned problems and issues related to Islamic banks can be removed or

eliminated with the help of proper guideline recommended by an authoritative body and

enforceable that is what raise the need of shariah compliance frame work for I6I9s to specify

boundaries of every contract under the umbrella shariah. Islamic banks have some e!tra accounts

that they have to deal with like 3akat account which is considered to be the right of other people

should be verified from Sharia advisor to check the sharia violation of any contract1 the contract

is compared with frame work of sharia and on that bases halal or haram can be ustified.

,fter all the discussion it can be argued that Sharia frame work is working as an instructor for

the I6I9s operations and activity and is considered to be the back bone of I6I9s. ,s Islamic banks

differ from conventional in both form and substance so the already established rules of

conventional system can9t be applied upon Islamic system. That is why Sharia governance frame

work is introduce by S6& to support the development of Islamic banks.

Shariah 1rame /ork of akistan+An )ntrodu*tion to Shariah 2overnan*e 1rame /ork+Sharia governance frame work is an essential part of Islamic banking industry to specify the

limits of transactions of Islamic banks and to provide a valuable source of trust to general public

for believing in Islamic banking practices. S6& is playing a role of an authority who keep check

and balance on the Islamic banks to ensure weather they are following sharia rules and principles

or not. %ostly accounting standards are designed according to the need of the country

commercial banking sectors known as guide lines.

"or the improvement of Islamic banks governance structure and tight control S6& have issued

revised rules in


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commercial banks. In &akistan Islamic banking is developed as a parallel system beside the

conventional system. "or the sake of insuring sharia compliance environment in banks limits are

identified for each and every transactions that Islamic banks are involved in1 in a form of

guideline. If any of the bank fail to comply with these guide lines will provoke the banking

companies9 ordinance '< and accordingly bank will be penali3ed for such act. If in some area

guide lines are not followed written reason should be recorded by Islamic bank.

Such guide lines help in defining the roles and responsibilities of different people and organs or

department with in the Islamic bank including 6oard of directors1 Sharia board1 +!ecutive

committee1 internal and e!ternal audit etc.

Sharia governance frame work includes the following attributes which must be followed

6oard of directors should ensure the sharia compliance environment by introducing

effective mechanism and &roper check and balance of management for implementation of

sharia compliance frame work

,n independent board should be appointed by S6& according to fit and proper criteria

consisting of * members including resident sharia board member. ,mong the three of the

board member one will be the chairman1 beside this supporting members can be taken

like lawyer1 banker or economist Resident sharia board member will help bank in day to day operations activity and will be

available to bank every time The decision taken by him up to his best knowledge and past e!perience should be

accepted by other board members1 if in some cases he make mistake would not be

considered a negligence. If RS6% make a wrong decision and the same case was previously disused in annual

general meeting then RS6% would be responsible Sharia compliance department should e!ist between the sharia board and management to

clearly portray the sharia compliance in every transaction

Review mechanism of sharia compliance is necessary to access the effectivenessgovernance structure and sharia compliance frame work introduce by S6& and 625

Independent internal sharia unit should e!ist if bank is small or separate sharia unit if

bank is large to ensure the sharia rules in every transaction or agreement +!ternal audit should be conducted to check the authenticity and integrity of internal

audit unit

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Ro,e of !O in Cir*u,ar #$%&+ To ensure the Islamic banking institutions operations as a sharia compliance1 and

eliminate sharia noncompliance risks associated to I6I9s for the sake of eliminating

reputational risk faced by Islamic banks. ,n effective mechanism should be implied for

the assessment of operations to check their validity and sharia compliance as refer by

S6& 625 should perform its fiduciary responsibility towards the funds of restricted and

unrestricted investment account holders because these account holders share the same

risk as shareholders without any voting right or any concern in investment types. Islamic

banks should safeguard the interest of account holders and their funds under the sharia

compliance limits. ,ny issue related to sharia compliance in dealings should be reported by 625 to sharia

board and accordingly sharia frame work would be developed1 beside this S6 will assist

625 for the development of sharia compliance culture Salaries of the S6 should be fi!ed by 625 and also the nomination of S6 member

would be done by 6259s. In case of foreign bank country head or 4+2 will nominate the

S6 members and approval should be taken from S6&.

625 shall meet twice a year to discuss the sharia related issues and assess the

performance of a bank and ensure the timely and effective enforcement of S6 decisions

and recommendations

Ro,e of E3e*utive Mana-ement+ The +% should ensure the implacability of sharia compliance framework in every

department and make the e!isting workforce knowledgeable about it by proper training

while every group head should be responsible for the implementation of his department

decision in the light of sharia authority if any one fail shall be accountable. In case of any

sharia related issue full information should be conveyed to S61 while the decision taken

by them shall be binding upon every one. If there is any disagreement shall be resolve

through conflict resolution.

Sharia !oard+

Constitution of the S! and Appointment of S! Members

+very I6I shall have a Sharia 6oard consist of three members all sharia scholars

appointed by fit and proper criteria. ,mong these one should be chair person with the 8

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years of e!perience and others should be having * years of e!perience as a sharia advisor.

,ny appointment of the board member should be done by prior written approval of S6&.

%embers appointed by S6& for S6 are for * years term. In case of the removal of sharia

advisor or the renewal of sharia advisor S6& should be informed by bank * months

before the completion of period with the reason. ,ny decision taken by S6& would be

binding upon both bank and sharia advisor. If any S6 member want to resign before the

end of his tenure should inform 625 in case of local bank while to country manager in

case of foreign bank. The vacancy of sharia advisor should be full fill with in three

months after the end of term of sharia advisor.

Ro,e of Shari4ah !oard+

The S6 should make clear all the department and committees related to sharia issues

while any decision made by them should be binding and they would be responsible for it.

on all Shari9ah related matters. , comprehensive sharia framework should be introduce

for all types of opreations and products. S6 should be given every type of information

they are in need of1 while their fatwas or decisions upon the halal or haram of transaction

should be recorded. The internal sharia department and audit unit report should be

submitted to S6 for their enforcement.

Shari4ah !oard Meetin-s5 6uorum5 Minutes et*

Shari9ah 6oard shall meet at least on #uarterly basis and each member of S6 shall

attend at least three fourth of the meetings during a calendar year. ,ll meetings shall be

chaired by the S6 4hairperson and in his absence one of the Shari9ah Scholar

members shall chair the meeting. The S6 decisions should be based upon sharia

scholar9s decision. S6 should be informed from the agenda of the meeting. The

minutes of meeting shall be made part of the ne!t meeting with the full detail of sharia

issues signed by all the members of meeting and to be conveyed to S6& within 08

days.

)ndependen*e of Shari4ah !oard 7S!8+

The S6 should be an independent authority reporting to 625 without any influence from the

upper management to insure the integrity of I6I9s and its financial dealings. The appointment

letter of each S6 member shall clearly state the role and responsibilities of the S6 and shall be

duly accepted by him. The member of this board will not be responsible for any operational

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activity while their decision will be binding upon management. If management have any issue

they can only send comments to S6&. The report made by S6 is based on the work of sharia

audit department and sharia compliance report which is signed by all the members of S6.

Resident Shari4ah !oard Member 7RS!M8+RS6% is available to banks for their daily bases sharia issues arise in different contracts. =e is

nominated amongst the * member of the board and is given the level of 4+2 because his

reporting line is to S6. =e is actually the employee of S6&. +very type of sharia issue in various

operational activities and contracts are approved from him. -ew ideas about the development of

products are recommended through this channel. RS6% take opinion of the sharia research

department on different issues. The decision made by him would be accepted by board if he

utili3e best of his knowledge and past ,@% issues1 in such case if decision made is wrong would

not be considered the negligence of RS6% otherwise he will be responsible. >uarterly report is

submitted to S6 upon the different issues.

Sharia Comp,ian*e epartment+, separate S45 should work in the I6I9s headed by RS6% or any other e!pert recommended by

S6 to ensure the sharia compliance frame work in bank and report to the S6 on the different

issues arising from operations. It perform the role of a secretariat to inform S6 about the agenda

and working papers etc. ,ll the proposal and documents of different contract are submitted to

them after their review they are submitted to RS6% or S6. They also facilitate management by

resolving many issues related to operational activities. Sharia compliance review is made by

S45 to ensure the sharia governance frame work in each transaction by conducting internal

sharia review at department level and branch level to ensure sharia compliance culture. Report is

submitted to S6 by RS6% on #uarterly bases. ,fter the submission of report sharia compliance

enforcement is recommended by S6 which is then the responsibility of S45 to enforce those

actions. Sharia related training should be given to employees for the enhancement of

performance through =R department of the bank recommended by S6 through S45. 6eside this

S2&9s and detail about the products or S6 members are issued by them through websites.

)nterna, and E3terna, Sharia Audit++very I6I9s should have its own internal sharia audit unit. If bank is small it will have internal

sharia unit and if large will have separate department1 the reporting line would be to internal unit

head for small banks and in large banks reporting line is to internal sharia department head.

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These audit units or department should have #ualified staff and check list methods approved by

S6 report made should be submitted to S6 for the corrective comments and enforcement of the

corrections. ,n e!ternal sharia audit report is made in accordance to the I4,& rules for ensuring

the integrity of the internal audit of I6I9s. such audit compare the transactions and contract

se#uence of the I6I9s with the guidelines prescribed by S6& and ,,2I"I9S to check the sharia

compliance. ,ll the sharia accounting procedures are checked and after that a report is made by

them to be submitted to 625 on the overall sharia compliance fulfillment and rules of S6&. This

report mainly shows the level of risk that bank is associated with due to non$sharia compliance

risk.

1it and roper Criteria+%embers of shariah board should be #ualified of shahadat$ul$almia degree1 should have

knowledge about modern sciences1 and #ualified from recogni3ed maddrasa with minimum of

/7A marks. =ave done post graduate degree in Islamic urisprudence1 BB% with minimum of *

4@&,1 and have e!poser of Islamic banking and finance. ,t least 0 years of shariah should be in

the shariah roling and should have sufficient knowledge about ,rabic1 and +nglish. =is track

record should be clear of criminal offense1 have never taken loan from any conventional

institution. =e must be financially sound1 honest and show integrity in his work while he cannot

be the shareholder of a bank where he is acting as a shariah advisor or RS6%. ,t the same time

RS6% cannot be the shariah advisor of two banks at a same time while in one bank and takaful

company is allowed.

Conf,i*t Reso,ution+If there e!ist any disagreement on the fatwas or shariah decision of the RS6% or board of the

bank1 the matter should be refer to the shariah board of the S6&. If in some cases there is the

difference of opinion between the bank shariah board and S6& shariah board then matter will be

refer to the board and on the bases of proper research and verification recommendation and

guidelines are issued which are bound to be followed by I"I9s.

)ntrodu*tion to Ma,aysian Shariah 1rame /ork+Shariah compliance frame work is introduce for Islamic banks to provide boundaries for I6I9s

operations. These comprehensive guidelines increase the trust e!posure of general public over

the Islamic banks. State bank of %alaysia -igara had introduced a two$tire governance

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structure for I6I9s to operate the system of Islamic banking with in the sharia culture consisting

of a centrali3ed shariah board at the bank level and also internal sharia unit to tackle the shariah

issues in each Islamic financial institutions. The shariah advisory council of bank -igara

%alaysia is a central body for the determination of Islamic laws related to all types of Islamic

transactions and made rules in accordance with the Islamic references to be followed by Islamic

financial institutions. The guide lines issued in


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Shariah research department should be established if institute operating is large in si3e otherwise

they may outsource this activity to the already established institute research department with the

approval of I"I board. If there is any financial group in the market carrying out Islamic business

are allowed to make a separate shariah committee which will carry out all the sharia related

issues of the group only if they are capable to satisfy the shariah regarding problem of the I"I

group.

Oversi-ht5 A**ountabi,ity5 and Responsibi,ities+"or every functional area of the I"I9s accountability and responsibilities are important factors for

the implementation of Shariah governance frame work. The key role in insuring sharia frame

work is of 625 of I"I9s by oversight of all the functional areas and to ensure that frame work is

applied appropriately with respect to the si3e and comple!ity of the I"I9s. ,ll polices made by

the Shariah committee should be approved by 625 with the concern of S4. There should be at

least 8 members of the Shariah committee nominated by 625 on the bases of nomination

recommended by nomination committee. ,ll the members should have relevant knowledge about

the shariah and must be aware of performing their fiduciary responsibilities. 625 appoint one

member of the shariah committee as a member of board to make a bridge between shariah

committee and board which will help in the understanding of board on the sharia committee

issues. ,n effective communication system is involved to communicate the issue to board from

time to time. The sharia committee member9s salaries should be recommended by remuneration

committee.

Shariah Committee+The main function of the committee is to oversight over the shariah related issue of the business

through shariah audit and shariah review. The decision or recommendation made by this

committee should be enforced by the board on the management to carry out in the operational

activities. :hile the disclosure should be made by the committee regarding the I"I9s in their

annual reports to portray clear image of the business.

Mana-ement+Shariah rulings and decisions recommended by shariah audit committee and shariah committee

should be implemented by the management and also to inform these committees regarding the

different shariah issues for solutions. To check the implacability of shriah rules by management a

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report must be submitted to the respective committees in a transparent manners. The

development of these committees is the responsibility of management by providing them

sufficient resources and funds. ,ll the staff of the I"I9s who are involved in dealings should be

given shariah related training on timely bases when neded. Shariah compliance culture should be

introduce to make aware all the staff related to shariah issues and rules about every product. If

any operational activity is found to be nonshariah compliance the matter should be refer to

shariah committee and within *7 days that activity should be furnished with the help of shariah

committee.

)ndependen*e of the shariah Committee+The independence is must to bring clarity and integrity in the operations of the I"I9s. it9s the

responsibility of the board to ensure independence of the shariah committee to keep them save

from any managerial influence of the management to make sound and independent decision

related to shariah matters. The reporting line of this committee should be directly to board to

inform them about different issues1 while any changes made would be done by the committee not

the management. 4ommittee should be given the full and timely access to information that they

are in need of. If information is not provided on timely bases board must inform shariah

committee with the valid reason. In some situation where the frame work is not followed by the

management committee have to inform the board. The appointment and removal of the shariah

committee members made by board with the approval of shariah audit committee and bank.

Competen*y+,n individual who are performing or carrying out responsibilities at the I"I9s must update

themselves with latest development in Islamic finance. %anagement and shariah committee

members are responsible to update themselves regarding the development of finance and Islamic

finance whereas shariah committee members should have some knowledge about the general

finance to make appropriate decision in the development of new products. ,ll the members of

S4 should be nominated on the bases of fit and proper criteria that an image is portray in thesocity and as well in the market such that people have trust on the I"I9s. 6eside this supporting

members can be add up in the S4 like lawyers1 economist etc and their evaluation should be

done on timely bases to enhance their skills in the areas where they are lacking.

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Confidentia,ity and Consisten*y+Information obtained by the shariah committee in the form of documents or in meeting should be

kept secret and not be disclosed to anyone. 4onfidential information consist of the new product

development or services1 management decision regarding any issue1 internal memorandum1 the

progress status of business1 and other management related confidential information.

rofessiona, Ethi*s and :ud-ment for Ensurin- Sharia Comp,ian*e+Shariah committee have to ensure the practice of shariah rules and guidelines by properly

documenting the shariah related decisions made by the committee. The decision made by sharia

committee should not be in a manner which contradict with S,4. In case of any dispute and

court proceedings related to any transaction or Islamic bank products1 both the court and the

arbitrator should follow the S,4 published rules and their decision or rules will be prevailing on

all the parties including court and shariah committee.

Shariah Comp,ian*e and Resear*h 1un*tion+Sharia compliance function of the I"I9s should be insured through review mechanism discussed

earlier in the study should be applicable if in some cases the activity is outsourced to some

institute or research department1 the accountability should remain with I"I9s. Sharia review

function start from the product design to product offering and follow up options. Shariah audit

confirm the enforcement of sharia rules to be followed in every transaction by observing

activities through control mechanism. &eople with in audit committee should have sufficient

knowledge regarding Islamic banking while for group audit members should have augmented

knowledge regarding different business that group is involved in. shariah related audit is applied

on management and as well money laundering activities to check the risk of bank raise from

shariah noncompliance. They mostly do audit of financial reports1 structural process and people

of the I"I9s. The finding of audit is submitted to board audit committee and shariah committee

while e!ternal audit can be also done.

The role of sharia risk management is necessary in addressing the sharia noncompliance risk in

all the agreement and contracts of the I"I9s. Risk is identified assess and mitigate through

different techni#ues. It enables the I"I9s to be on the safe side and e!pose to risk up to the limit

mentioned by the regulatory authority. Integrated risk approach should be used by I"I9s through

trained officers. ,ny shariah noncompliance risk report should be submitted to board1 shariah

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committee and management periodically. This department have to keep the record of risks

associated with operation their solutions and strategies adopt for the mitigation for the sake of

future help.

+very Islamic bank should have its own research department to find the issues and their solutionsfor daily bases problems1 pre and after product development problems and should consist of the

e!pertise of relevant field. In short word this department should play the role of advisory and

consultancy to the S,6 and sharia committee regarding sharia issues either on bank level or

product level. Shariah secretariat play a role of facilitator of shariah committee by coordinating

meetings1 combining proposals related to research work and disseminate shariah related

decisions to stakeholders.

1it and roper Criteria of the Shariah Committee+The member of the S4 is appointed by board on the bases of nomination recommended by

nomination committee. In case of reappointment of the committee members the written approval

of bank and S,4 is re#uired. The appointment of the members should be in accordance with the

rules otherwise appointment would be revoked. "or the sake of appointment detail verification is

done1 while at the renewal of the term S4 member will not perform his duty in a regular course

of action until and unless his reappointment verification is not completed. ,ny changes made by

the committee should be announced after the approval of bank. Reappointment of the S4

members should be submitted to bank before 7 days of the appointment while I"I shall inform

the bank within '0 days about the resignation of S4 members.

%ember of S4 should be a %uslim having a degree of bachelor in shariah and also have a valid

knowledge about Dsul$e$fi#ah or fi#hi mamilat. Should understand ,rabic and speak %alaysian

as well +nglish language. 6eside this they should also have some knowledge about financial

matters and dealings and have sound and clear background. If in any case member fail to attain

the re#uirement or do not attend /8A of the meeting1 declared as bank corrupt1 found guilty in

any criminal offense. In such case I"I have the right to terminate S4 members. The member of

shariah committee can9t be the member or employee of any other I"I at the same time.

uties5 Responsibi,ities5 and A**ountabi,ity of Shariah Committee+They are mainly responsible for all shariah related decisions. &rovide information to board over

the shariah related issues by checking the policies and products validity with shariah rules. ,ll

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the documents and manual of advertisement should be approved by the committee. Shariah

compliance review of audit committee is review by them which is then disclosed in the annual

reports. If there is dispute upon any shariah issue1 issue is refer to S,4 in written.

Operation ro*edure of Shariah Committee+%ostly their meetings are done confirm the level of engagement of shariah committee in the

shariah related issues of I"I. Their meeting shall be conducted at least once after every two

months1 while in a year every member is re#uired to attend /8A of the meeting may be

physicalyy or through video conference call and telephone. The record of these meetings are

disclosed in the financial reports. Two third of the #uorum shall attend the meeting with the

maority of sharia committee members while decision made should be also on two third voting

bases. The chairman should be of high skills and knowledge about shariah. In absence of the

chair person member should be selected by the S4 from the shariah committee members. ,ny

issue related to shariah will be communicated to board in written.

rodu*t eve,opment ro*ess+It9s one of the most sensitive area of the I"I where the procedures and techni#ues should be

comprehensively defined to avoid shariah violations. Such risk mainly arise due to week research

or any issue in launching the product at the initial stage. ,y difficulties raise in these stages

should be effectively referrer to S4 to provide proper solutions and guideline in the

documentations and product design. +very product design should be backed by the relevant

fatwa and ustification backed by Islamic law and legal law with the help of shariah committee.

In the development process the preapproval process involve the literature background of the

product introduced1 fatwas1 and legal documentation within the boundaries of shariah. ,ny

shariah related decision taken on the back of product shall be documented and send to 625.

:hile post approval involve the issues araising after the product is launch where appropriate

actions are recommended to management. Shariah review and follow up are necessary to

overcome product related shariah risk.

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Shariah Comp,ian*e 1rame/ork of )ndonesia+

Mana-ement E3e*utive Offi*er and Shariah supervisory board+

ro*edures and Re9uirements+

The management1 e!ecutive officers and Sharia Supervisory 6oard of a bank play a very vital

role in order to compliance with the regulatory re#uirements and the Shariah principles in day to

day operations of the bank. "or this purpose we must need to ensure the integrity and

competence of management1 e!ecutive officers and also the shariah supervisory board. In order

to fulfill this need1 the bank Indonesia has formulated procedures and re#uirements for the

person intending to become managers1 e!ecutive officers and also the members of Shariah

supervisory board at the banks.

Mana-ement+

The 6ank management consists of board of directors and also the board of

commissioners and other organs which are e#uivalent to them. The candidates of board of directors and board of commissioners must be approved by

the bank of Indonesia before to appointment by the general meeting of shareholders and

taking up their position.

The following re#uirements are necessary for members of board of directors and board of

commissionersE'. -ot listed in the list of persons banned from becoming shareholders andFor managers

in banks.


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?. %embers of the 6oard of 5irectors and 6oard of 4ommissioners involved in a

conflict of interest with the bank are prohibited from making decisions.. The conflict of interest shall be disclosed in the decision.

E3e*utive Offi*ers+

+!ecutive officers are those officers who e!erts influences on the policy of the

bank and operations and they are directly responsible for the board of directors1

but it does not include branch office managers.

6anks are re#uired to report the appointment or replacement of any +!ecutive

2fficer to 6ank Indonesia not later than '7 days after the effective date.

+!ecutive officers who are involved in a conflict of interest with the bank are

prohibited from making decisions.

The conflict of interest shall be disclosed in the decision.

Sharia Supervisory !oard+The Shariah Supervisory board is a board responsible for oversight of compliance with

the principles of Shariah in banking business. %embers of the Sharia Supervisory 6oard

are categori3ed as affiliated parties.

The Sharia Supervisory 6oard shall have a membership of at least < persons and

not more than 8 persons. The members of the Sharia Supervisory board might not hold the concurrent

positions as Sharia supervisory board members at not more than < other banks and

< non$bank sharia financial institutions. The bank should submit an application for the Sharia Supervisory 6oard

candidates in order to obtainE

'. ,pproval from 6ank Indonesia.


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0. assessment of new products and services not covered by e!isting fatwas in order to

re#uest a fatwa from the -ational Sharia 6oard8. Submission of at least semi$annual reports on sharia oversight to the 6oard of

5irectors1 6oard of 4ommissioners1 the -ational Sharia 6oard and 6ank Indonesia.

Those members of the sharia board who are involved in conflict of interest with the bankare prohibited from making decisions.

So the conflict of interest shall be disclosed in the decision.

E3penditure+6anks may e!patriates in the course of their business. The regulations and re#uirements for

employment of e!patriates at a bank are as followsE

The bank is re#uired to submit an +!patriate &ersonnel +mployment &lan (R&TG,) to

6ank Indonesia1 and this plan shall be disclosed in the bank 6usiness &lan.

"or positions in bank management1 an approval is re#uired from bank Indonesia. "or positions as +!ecutive 2fficer and +!pertF,dvisorF4onsultant or e#uivalent1 the

employment must be reported to 6ank Indonesia. +!patriates are not permitted to take up bank management positions in personnel and

compliance. The term of employment for e!patriates shall be not more than * years1 e!tendable once

by not more than ' year. 6anks with foreign ownership of at least


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Comparative ;ab,e of Stru*ture+4ountry S

4

Independenc

e of S4

RS6

%

S,

4

Research

department

&roduct

development

Shariah

compliance

department

4onflict

resolution

Intern

l,udi

dept

&akistan = = =

%alaysia = =

Indonesi

a

= = =

1it and roper Criteria Comparison+

4ountry +ducation +!perience Track record %arks&akistan Shahadatul

almia1 BB%

0 years =onest1 no

criminal record

/7A or * 4@&,

%alaysia Dsule fi#ah1

fi#hi mamilat

from madrassa

* years -ot bank corrupt

-o criminal

record

"irst division

Indonesia 6achelor degree1

BB% in shariah1

and shariah

related issues

< years not involved in

interest

honest1 and

integrity

"irst division

Attra*tive 1eatures+

akistani 1rame /ork+:ith the new amendment made by the circular


24/30

of the time the amount earned would have been transferred to the charity amount1 while

introducing resident shariah board member for the banks day to day issues related to the

transaction help out the management in #uick decision about the legality of transaction with the

concern of RS6%. 6eside this RS6% is given the place of ust like 4+2 which refers to the

independence of the shariah board to ensure their integrity. The shariah compliance department

play its vital role in ensuring the fulfillment of shariah re#uirement to inform the shariah board

related to the shariah issues. The main attractive feature of &akistani frame work is the

independence of the resident shariah board member that his decision should be free of any type

of influence from the management. The frame work of &akistan is not that much comprehensive

as in other countries is ust because of the emerging stage of Islamic banks and lack of

standardi3ed procedures due to different schools of thoughts provide rela!ation in many aspect of

transactions. %ost of the products are not yet offered in the market due to different legal

conditions. The governance frame work of &akistan is only applicable to Islamic banking

industry which would be developed with the future developments.

Ma,aysian frame "ork+

The governance frame work in %alaysia is much comprehensive in its nature

because it cover all the Islamic financial institutions operating in %alaysia

including Islamic banks1 Takaful companies1 and micro financial institutions. They

have introduce an effective channel of communication from lower level to upper

management for the sake of #uick decision process on daily bases. Institutions are

allowed to outsource or make a separate full fledge institute for their group of

Islamic business rather than making such department in each business line.

Training is recommended by the frame work at different point of time for the

improvement of e!isting work force. 4ommunication between shariah committee

and board members are to be done after every two months which contributes much

in the development and resolutions of the issues. Total of meetings of sharia

committee in a year insure the check and balance upon different issues. 5ue to

continuous development and more numbers of the product offered in that market

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governance frame work have e!tensively provide guide lines for the product

development issues.

)ndonesian 1rame /ork+

They have introduce board of commissioners at the board level which enhance the

check and balance at the board level. 6eside this their frame work is not much

comprehensive like the %alaysian ones. The rest of the frame work re#uirements

are simple as &akistani frame work.

Repe,,ent 1eatures of A,, 1rame /orks+Starting from the &akistani governance frame work which still need to be improved

the future upcoming needs. The first thing is governance frame work have not

clearly mentioned about the effective communication mechanism to faster the

decision making process. There is no such instruction about the training of

employees on time to time bases to bring awareness about the coming changes and

to bring re#uired skills. &ost of RS6% is perceived to be given a level of 4+2 but

still their decisions have a great pressure from the management. The overall

responsibility of decision is upon RS6% which sometimes cause a reputational and

ob loss for the shariah advisor.

-ow coming towards the %alaysian frame work the first repellent factor is that it

allows some of the groups to make a one research department for overall business

group that are involve in may sometime cause insufficient flow of information

from the business group which may sometimes cause wrong solutions on the bases

of insufficient information. In case of the disagreement on any shariah related issue

conflict resolution should be used like in &akistan. If the matter is referred to the

court in most of the cases it would incurred a reputational loss of Islamic banks

which may sometimes cause li#uidity run to banks.

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2ne of the most repellent factor of Indonesian frame work is that they have

allowed their shariah board members to act as a shariah board member at the same

time for two banks which would ultimately give raise to conflict of interest and can

harm the Islamic banks reputation.

1uture Re*ommendations+%alaysian governance frame work is much comprehensive in nature as compare to

the &akistani frame work so according to this study &akistani frame work is need to

be improved from different aspects. "irst of all the division of work prescribed by


27/30

decision making process or any recommendation related to shariah issues. It may

sometime cause biased solutions for a single institute with in a group. To ensure

the integrity of such separate department someone from outside like third party

should be assign to have a check and balance upon them. Indonesia strongly need

to work upon their check and balance positions at different points while reduce

fle!ibility in shariah related issues. @uide line should be prepared for the conflict

resolution if there e!ist any disagreement on the shariah issue because if there is no

such resolution every bank will do interpret their problem in their own favor and

will provide biased solutions which can ultimately lead to scarify the utmost good

faith.

Con*,usion+

:ith The emergence of every corporate entity specified set of rules and regulation

are re#uired to govern those entities through different types of frame works which

vary from country to country and law to law. Islamic financial institutions which

emerge from the last two decades also re#uired a legal shariah frame work to

specify boundaries for each transaction. ,s Islamic financial institutions are facing

a lot of challenges from it9s really start1 strongly re#uired a comprehensive and

well define governance frame work to ensure the integrity of operations and

safeguard the interest of shareholders. +very Islamic financial institution have

some e!tra governance structure and levels which are changed from that of the

conventional system. These e!tra governance factors includes Shariah board which

is responsible for the shariah related issues in &akistan while in %alaysia such

activity is perform by shariah committee. 6eside this RS6% is available for day to

day shariah related issues in &akistani school of thoughts Islamic banks. &akistan

and Indonesia have made separate governance frame work for Takaful and Islamic

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banks while %alaysia have made a comprehensive frame work which is followed

by all of the Islamic financial institutions. Shariah compliance department and

research department are necessary to provide solutions for different issues. 2nly in

%alaysia a group of business can make a separate research department for their

group of business which is not practicable in &akistan and in Indonesia. There are

different needs of customers which vary from country to country and accordingly

bank have to operate. 5ue to these geographical1 laws1 and school of thought

differences regulatory authorities have made different shariah governance frame

work which are mentioned previously in the study. These frame works have their

attractive as well repellent features which needs to be taken into consideration by

these regulatory authorities to overcome deficiencies and be ready for the

adaptation of future changes and growth in the industry. The focal point of the

discussion is to find out the best point for the &akistani shariah compliance

governance frame work which would help in the future development and as well in

the current practices of Islamic banks. &akistani frame work is lacing because of

the lack of standardi3ation problems in their governance frame work because they

have not fully adopted ,,2I"I9s as a standard rather they have adopted it as a

guideline. In short words key to success is standardi3ation which will ultimately

come with the development of Islamic culture in &akistan.

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Referen*es+

SBP. (2008, 2015). shariah compilance governance frame work.Karachi: state an!

o" #a!istan.

state an! o" $n%onesia. (2008). shariah compilance governance frame work.state

an! o" $n%onesia.

the an! o" &i'ara aa*sia. (2011). shariah compliance governance frame work.+he an! o" &i'ara.

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Documents

role of islamic banking on economic growth of pakistan