28th Jan, 2016

With the uptake of Islamic financial services surging by the day, governments and financial institutions are increasingly tightening the operational environments to seal loopholes and guarantee seamless products and services. Focus has been on structuring the operational architecture, by setting up several gate-keeping organs and systems. Islamic banking operates on the basis of the Shari’ah principles that promote the sharing of risks and rewards between parties, prohibition of interest, abhors financing activities that contradicts the Shari’ah rules and regulations and also forbids transactions that are clouded with uncertainties.

One of the distinctive features in the provision of Islamic financial services is the existence of a Shari’ah Supervisory board that consists of independent religious scholars and other experts in Islamic jurisprudence or Islamic commercial law. The directors or the shareholders of the Islamic financial institutions cannot be members of the Shari’ah supervisory boards as dictated by Shari’ah governance standards. Providers of Islamic banking solutions have been keen to develop an operational infrastructure to meet regulatory procedures set by the Central Bank of Kenya. In October for example, KCB Group picked three Islamic banking experts to run the Bank’s Sharia Advisory Committee, ahead of the lender’s official launch of Islamic banking services in Kenya on Thursday next week. The development of new financial products and other related innovations continues to generate challenges that have no direct references in the primary sources of the Islamic Shari’ah.

For instance, the practice of charging penalties on late payments by the Islamic financial institutions was a ruling arrived at by the Scholars for the purpose of instilling discipline in customers who are negligent and fail to honour their financial commitments as expected. However, the penalties cannot be factored into the books of the financial institutions but should be diverted to charitable causes under the guidance of the Shari’ah Supervisory boards.

There are two broad categories of corporate governance roles that are exclusive to the Islamic financial institutions. Firstly, there is need to re-assure stakeholders that their activities are fully compliant with Shari’ah standards and principles .Secondly, the stakeholders have a strong need to be assured that the institution maintains and improves sustainable growth. The corporate governance in Islamic financial institutions hence includes harmonizing these two functions to promote Shari’ah compliance and the objectives of business growth and the realization of profit.

The philosophical foundation of corporate governance in Islam requires an additional layer of governance for the purpose of Shari’ah compliance and that justifies the existence of the Shari’ah Supervisory Boards to oversee the Shari’ah compliance aspect of business and operations of the financial institutions offering Islamic finance.

The Shari’ah Supervisory Board focuses on the Shari’ah compliance of financial structures that includes documentations, contracts, product development and the transactional processes. The board is entrusted with the duty of directing, reviewing, supervising, advising and guiding the activities of the Islamic financial institutions in a manner that enhances the compliance with the Islamic Shari’ah rules and principles.

The existence of the Shari’ah board helps to boost the integrity of the Islamic financial institutions by promoting the compliance to Shari’ah principles and standards in the provision of financial services. No financial institution can introduce a new product without the prior approval of their Shari’ah scholars who can determine the success or failure of the product with its target customers. The board offers satisfaction to the stakeholders by way of monitoring the institution’s compliance with the Shari’ah principles.

The financial reports of the   financial institutions offering Islamic finance should reflect the Shari’ah supervisory boards ’ clear statement that confirms that the earnings realized from sources that are non- Shari’ah compliant have been allocated to charitable causes .The report should also capture any violations of the Shari’ah rules and standards as examined by the board.

The Islamic financial institutions have to develop a robust culture that reflects the desired Islamic identity quite distinguished from their conventional counterparts. The Shari’ah supervisory boards play a pivotal role in defining the appropriate culture for the Islamic financial institutions.

Owing to the existence of different schools of thoughts in Islam, there are bound to be inconsistencies in the interpretation of Shari’ah by different scholars without conflicting with the board guidelines contained in the Holy Quran and the teachings of Prophet Mohamed. For the purpose of harmonizing Shari’ah interpretations and avoiding inconsistencies at the global level, stakeholders in the Islamic finance industry should collaborate and share insights and invest adequately in research and development and set benchmarks and standards.

There is need for jurisdictions to formulate a responsive and accountable standards in regulating their appointment, composition and reporting approaches in line with best global practices and guidelines outlined in the Accounting and Auditing Organisation of Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB).

A widely adopted approach by the players in the Islamic finance industry is to have an internal and independent Shari’ah entities that certify their compliance with the Shari’ah tenets. Some jurisdictions like Malaysia, Indonesia, Pakistan and Sudan have central Shari’ah supervisory boards at the financial regulator’s level to play the significant role in the harmonization and standardisation of Shari’ah scholars’ rulings and edicts (fatwas) and exercising oversight over the internal SSB of the industry players.

One of the challenges facing the Islamic finance industry is the shortage of skilled manpower that includes the Shari’ah scholars who have a good grasp of both the Islamic jurisprudence and the dynamics of financial and commercial activities. Investment in continuous trainings and capacity-building of the Shari’ah scholars, policy makers, Islamic bankers and other stakeholders shall help to bridge the skills gap in the market and facilitate the growth of the industry.

The Kenya Bankers Association, the Central Bank of Kenya and the Capital Markets Authority are some of the key stakeholders in the financial sector that have so far undertaken some commendable initiatives to promote the understanding of the strategic importance of Islamic finance to the Kenyan economy.

The institutions of higher learning and other relevant agencies need to develop appropriate curriculum to address the capacity gaps in the provision of Islamic finance in a bid to make Kenya the Islamic financial hub in East and Central Africa.

By: Jaafar Sheikh Abdulkadir

The writer is the head Islamic Banking at KCB Group