Tuesday 9 December 2008
Wednesday 12 November 2008
ISLAMIC BANKING: CONFIDENCE IN COMPLIANCE
Islamic Banking
Confidence in Compliance
Caribbean Regional Compliance Association Conference
Tuesday November 11th, 2008 at 3.00 – 3.45 p.m.
Dr. Waffie Mohammed
Chairman – Shariah Supervisory Board
Islamic Banking Service
Clico Investment Bank Limited
Thank you Mr. Chairman.
Distinguished Members of the Head Table, Specially Invited Guests, Members of the Media, Ladies and Gentlemen all,
I greet you with salutations of peace and guidance of Almighty Allah on each and every one of us.
Our focus this afternoon is on the Islamic financial model of governance and compliance, and I must say that we were very pleased to accept the invitation to participate in this event, more so, given the recent financial turmoil and relatively stable position of Islamic financial intermediaries in this harrowing environment.
But before we delve into the meat of the matter, it is necessary to firstly examine the underlying philosophy of governance within the religion of Islam, since this underpins all activities across financial and other dimensions in the life of every Muslim.
Within Islam, human beings are responsible for their every thought, word and deed in this world, and they would have to account for these on the Day of Judgment – a day on which each individual alone would shoulder responsibility for his/her life on this earth.
As such, Islamic frameworks and guidelines that emanate from this philosophy recognize, and indeed strike a finely-tuned balance between individual human rights and social justice – between freedom and equality – to offer a system based on Justice.
But being a universal message to mankind, Islam also recognises the diversity of individual perspectives which can lead to ethical and even legislative dilemmas, and mitigates this through the imposition of divinely-revealed rules and regulations that serve to guide human behaviour and conduct.
Islamic Economic Principles
What are those divinely revealed regulations that guide any attempt at an Islamic Economic System?
Halaal vs. Haraam
As the Code of Guidance, Islam allows all that is morally and ethically permissible and beneficial to man. These are called in the Qur'an (halaalan taiyibah). It prohibits what is deemed detrimental, physically as well as spiritually, Called haraam, in pursuing economic gain (e.g. alcohol, gambling, pork, pornography are all haraam
Obligation to spend wealth judiciously – cannot be hoarded, kept idle or squandered. Allah says:
Woe to those who deal in fraud. (83:1)
Islam discourages hoarding. Allah says:
Woe be unto those who pileth up wealth and keep counting it. (104:2)
A Muslim has to go out and seek from the bounties of Allah. He says:
Do not neglect your portion of this world. (28:77)
Let there be among you, traffic and trade, by mutual goodwill. (4:29)
Give of surplus margins to alleviate poverty (Zakaat). Understand that wealth is a gift from Allah, and must be used for ones benefit, and for the benefit of others.
Prevention of monopolistic tendencies: Islam seeks to prevent the circulation of wealth in the hands of a few. Allah says:
Wealth should not only circulate among the wealthy. (59:7)
Aim is social justice without inhibiting individual enterprise. Allah says to the believers:
O you who believe, Stand out firmly for Allah, as witnesses to fair dealing, and let not the hatred of others to you make you swerve to wrong and depart from Justice. (5:8)
Islamic Banking
Some of these principles serve to set the stage for the Islamic banking framework, and these include
Prohibition of Riba (accepted as meaning rate of interest). Allah says:
Allah has permitted trade and forbidden usury, (i.e. the taking and giving of interest. (2:275)
No participation in Haraam (unlawful) businesses or industries. Allah warns believers about this. He says:
And you will see many of them (human beings) hastening toward sin and transgression and their devouring of ill-gotten wealth. (5:62)
Avoidance of Gharaar, (excessive uncertainty or speculation). Allah says:
O you who believe, intoxicants, gambling, (dedication of) stones and divination by arrows are an abomination of Satan's handiwork, avoid them in order that you may prosper. (5:90)
Agreements in writing. Allah says:
O you who believe, when you deal with each other, in transactions involving future obligations in a fixed period of time, reduce them to writing. Let a scribe write down faithfully as between the parties. (2:282)
Avoid committing fraud: Allah says:
Woe to those who deal in fraud, those who, when they have to receive by measure from men, exact full measure, but when they have to give by measure or weight to men, give less than is due. (83:1-3)
Mutual goodwill. Allah says:
Let there be among you traffic and trade, by mutual goodwill. (4:29)
Shariah Standards
Given these differences that underpin the Islamic financial model, the industry determined that the existing international standards did not fully accommodate its needs, and following from this recognition there first emerged the Accounting and Auditing Standards for Islamic Financial Organisations, adhered to and accepted globally in countries such as Bahrain, Sudan, Jordan, Malaysia, Qatar and Saudi Arabia, and more recently the United Arab Emirates. These standards which number well over 50 in all, benchmark conventionally recognised best practices in financial reporting, and cover such areas as accounting, auditing, governance, ethical and Shariah (Islamic Law).
The foremost emphasis on quality standards of reporting has resulted in the World Bank singling out this effort as an example of successful self-regulation by an industry.
Further, as the industry developed, there was the recognition of the need for prudential standards and guiding principles that promoted and enhanced the soundness and stability of Islamic financial services – broadly defined to include banking, capital markets and insurance sectors.
These standards include such areas as Corporate Governance, Risk Management, Capital Adequacy as well as Supervisory Review Processes, amongst others. In a similar spirit to the approach adopted for development of the financial reporting standards, development of these standards included consideration of accepted international best practices, and working with all related stakeholders within the global financial industry.
Supervisory Board
We also recognise that for standards to be effective, they need to be adhered to, and as such a second key ingredient in ensuring compliance within Islamic finance is the institution of the Shariah Supervisory Board.
The Shariah Board member is typically a scholar of Islam in particular and typically with an emphasis on Fiqh Mu’amalaat, (Islamic rules on transactions). They are charged with the dual role of guiding / supporting the development of the Islamic financial institution – helping to shape its processes and products as required by Shariah, and reviewing the operations to ensure that all documentation, practices and transactions comply with Islamic Law.
The synergy that is realised from this is one that hopefully is preserved as the Islamic finance model matures, and is also an approach that conventional finance practitioners and regulators can consider as they continue to ensure that the end-users of financial intermediaries continue to benefit, while confidence in the system is preserved.
Some Islamic banks have in fact appointed internal Shariah personnel to fully develop and oversee the internal operations, and retain the external Shariah board to audit the operations and ensure compliance with Islamic principles.
Shariah Review
Key elements in the supervisory review process:
Regulatory capital requirements / capital adequacy
Risk management & corporate governance
Transparency and Market Discipline
Disclosure
The Practitioner’s Perspective
Compliance with both financial / sovereign laws, and a second layer of Shariah compliance
Need for legislative recommendation for Islamic finance, until that time the key success factor for progression within governance rests with the synergy of compliance personnel and teams – from both a legislative as well as a religious perspective, so as to ensure the perpetuation of justice – for as the Qur’an says, “be just, for that is closest to piety”
Management:
In order to have the investments properly managed the person selected for doing so must be competent. The Qur'an advises Muslims as follows:
To those weak of understanding, do not hand over your property (to manage) which Allah has made as a means of support for you. (9:5)
One of the easiest ways to invest surplus wealth is through the Islamic Banks, as in this way one is sure that the monies invested:
• will maintain the religious prescription as well as the ideological orientation of an Islamic Society.
• It will assist in achieving the Islamic socioeconomic objectives, i.e. promotion of a pattern of growth best suited for eradication of poverty, equitable distribution of income and wealth and sufficient opportunities for gainful employment.
Some people believe that because Islamic Banking is different from conventional banking there can be the following misgivings, viz.
• As the Islamic banks are committed to share in losses, (since it is based on profit/loss sharing) it can be exposed to huge losses.
• There can be frequent loss and defaults if the clients conceal their correct income.
• Islamic banks cannot perform all the banking functions on non-interest basis.
While it is a fact that Islamic Banks are committed to share in losses recognition of this is translated to a greater emphasis on risk management, and because the banks invest in diversified portfolios the losses in some isolated cases will be outweighed by the profits in others, thereby resulting in an overall profitability. Losses in Islamic Banks may not necessarily be as great as in other banks due to the fact that:
• through screening of the party to whom fund is made available
• the purpose for which the fund is provided
• supervision exercised by the banks to the fund users
• supervision exercised by the SSB to the IBS
Because both parties work together to ensure success the losses are minimised in Islamic Banks as compared to that of other banks.
Islamic banking is based on moral and religious principles, and while it is possible to cheat regarding the declaration of profits, the risk potential should not be exaggerated. There are some measures that the banks can put in place to minimise such instances. These are:
• evidence of under-reporting of profits can be challenged in court.
• Users of funds guilty of such breach of confidence can be black listed.
• Contracts can be developed to elicit optimal behaviour even in the presence of moral hazards
• Tax laws can be adjusted to avoid attempts to conceal profits.
Regulatory Issues:
From its nature, a bank conducting Islamic finance is subject to those forms of regulation which apply to conventional banks, with due regards to the characteristics of Islamic banks, and also to the review of its compliance with Islamic principles and rules by its own Sharia supervisory board. This constitutes a key organ of governance in an Islamic bank.
Further structures used to deal with investors' funds, normally a profit-sharing mudaraba contract imply a high degree of fiduciary duty on the part of an Islamic bank, which should be reflected on its corporate governance.
All these regulations work for the benefit of the bank's investment account holders, and all others who may have some form of benefit from the assets deposited with the banks. The regulations help to minimise or avoid systematic risk which can lead to the bank collapse.
The regulation of Islamic banks also faces issues relating to liquidity management. Obligations are placed on banks by some regulators to maintain a certain percentage of their assets in securities or deposits in other banks with high credit ratings. To solve this problem some of the Islamic banks issue non-tradable, three-month salam bonds (sukuk) and tradable five year ijara sukuk; some issued tradable mudaraba certificates and the Bank Negara Malaysia issued tradable Islamic bonds.
Each Islamic bank will have a Sharia board (SSB) which reviews both proposed new products of that bank, and the types of transactions into which that bank has entered, to ensure that they are Sharia-compliant. New products will not be introduced until they are in a form acceptable to the SSB.
Ethics
Accounting is one of the professions that is required by Sharia as fard e kifaayah (a collective religious duty which, if performed by some, would exempt others from performing it. However, if it is not performed by any, the entire community is sinful). In addition to its technical definition, accounting is a means to fulfil a Sharia requirement, namely to record, measure and allocate rights fairly among claimants.
The concept of fairness is mentioned in the Qur'an. Allah says:
Allah doth command you to render back your trusts to those to whom they are due; and when you judge between people that you judge with justice. (4:58)
The concept of fairness has a counterpart in accounting thought known as "freedom from bias". As fairness has ethical values there is need for a code of ethics that guides professional accountants in the performance of their professional duties and services.
From an Islamic perspective, the ethics of accountants depend primarily on the principles and rules of Islamic faith and Sharia. Furthermore, Sharia principles and rules confer on these ethics potential enforceability which stems from the permanent and constant religious incentives that surpass in their purposes all other incentives. Even the accountants are supposed to be people conforming to certain standards recognised by Sharia. Some of these are: integrity, sincerity, piety, trustworthiness, etc.
Conclusion
Working for Islamic financial institutions is one of the professions which, according to Islamic Sharia should be established and given due consideration. Furthermore, it imposes the duty of implementing the rules and principles of Islamic Sharia in managing the funds and investing them in a lawful manner.
Compliance by employees of the institutions will lead to the fulfilment of the objectives of Islamic banking and will contribute to establishment of a saying of Prophet Muhammad (pboh) that: Allah loves it when a person carries out a deed and seeks to perfect it.
Confidence in Compliance
Caribbean Regional Compliance Association Conference
Tuesday November 11th, 2008 at 3.00 – 3.45 p.m.
Dr. Waffie Mohammed
Chairman – Shariah Supervisory Board
Islamic Banking Service
Clico Investment Bank Limited
Thank you Mr. Chairman.
Distinguished Members of the Head Table, Specially Invited Guests, Members of the Media, Ladies and Gentlemen all,
I greet you with salutations of peace and guidance of Almighty Allah on each and every one of us.
Our focus this afternoon is on the Islamic financial model of governance and compliance, and I must say that we were very pleased to accept the invitation to participate in this event, more so, given the recent financial turmoil and relatively stable position of Islamic financial intermediaries in this harrowing environment.
But before we delve into the meat of the matter, it is necessary to firstly examine the underlying philosophy of governance within the religion of Islam, since this underpins all activities across financial and other dimensions in the life of every Muslim.
Within Islam, human beings are responsible for their every thought, word and deed in this world, and they would have to account for these on the Day of Judgment – a day on which each individual alone would shoulder responsibility for his/her life on this earth.
As such, Islamic frameworks and guidelines that emanate from this philosophy recognize, and indeed strike a finely-tuned balance between individual human rights and social justice – between freedom and equality – to offer a system based on Justice.
But being a universal message to mankind, Islam also recognises the diversity of individual perspectives which can lead to ethical and even legislative dilemmas, and mitigates this through the imposition of divinely-revealed rules and regulations that serve to guide human behaviour and conduct.
Islamic Economic Principles
What are those divinely revealed regulations that guide any attempt at an Islamic Economic System?
Halaal vs. Haraam
As the Code of Guidance, Islam allows all that is morally and ethically permissible and beneficial to man. These are called in the Qur'an (halaalan taiyibah). It prohibits what is deemed detrimental, physically as well as spiritually, Called haraam, in pursuing economic gain (e.g. alcohol, gambling, pork, pornography are all haraam
Obligation to spend wealth judiciously – cannot be hoarded, kept idle or squandered. Allah says:
Woe to those who deal in fraud. (83:1)
Islam discourages hoarding. Allah says:
Woe be unto those who pileth up wealth and keep counting it. (104:2)
A Muslim has to go out and seek from the bounties of Allah. He says:
Do not neglect your portion of this world. (28:77)
Let there be among you, traffic and trade, by mutual goodwill. (4:29)
Give of surplus margins to alleviate poverty (Zakaat). Understand that wealth is a gift from Allah, and must be used for ones benefit, and for the benefit of others.
Prevention of monopolistic tendencies: Islam seeks to prevent the circulation of wealth in the hands of a few. Allah says:
Wealth should not only circulate among the wealthy. (59:7)
Aim is social justice without inhibiting individual enterprise. Allah says to the believers:
O you who believe, Stand out firmly for Allah, as witnesses to fair dealing, and let not the hatred of others to you make you swerve to wrong and depart from Justice. (5:8)
Islamic Banking
Some of these principles serve to set the stage for the Islamic banking framework, and these include
Prohibition of Riba (accepted as meaning rate of interest). Allah says:
Allah has permitted trade and forbidden usury, (i.e. the taking and giving of interest. (2:275)
No participation in Haraam (unlawful) businesses or industries. Allah warns believers about this. He says:
And you will see many of them (human beings) hastening toward sin and transgression and their devouring of ill-gotten wealth. (5:62)
Avoidance of Gharaar, (excessive uncertainty or speculation). Allah says:
O you who believe, intoxicants, gambling, (dedication of) stones and divination by arrows are an abomination of Satan's handiwork, avoid them in order that you may prosper. (5:90)
Agreements in writing. Allah says:
O you who believe, when you deal with each other, in transactions involving future obligations in a fixed period of time, reduce them to writing. Let a scribe write down faithfully as between the parties. (2:282)
Avoid committing fraud: Allah says:
Woe to those who deal in fraud, those who, when they have to receive by measure from men, exact full measure, but when they have to give by measure or weight to men, give less than is due. (83:1-3)
Mutual goodwill. Allah says:
Let there be among you traffic and trade, by mutual goodwill. (4:29)
Shariah Standards
Given these differences that underpin the Islamic financial model, the industry determined that the existing international standards did not fully accommodate its needs, and following from this recognition there first emerged the Accounting and Auditing Standards for Islamic Financial Organisations, adhered to and accepted globally in countries such as Bahrain, Sudan, Jordan, Malaysia, Qatar and Saudi Arabia, and more recently the United Arab Emirates. These standards which number well over 50 in all, benchmark conventionally recognised best practices in financial reporting, and cover such areas as accounting, auditing, governance, ethical and Shariah (Islamic Law).
The foremost emphasis on quality standards of reporting has resulted in the World Bank singling out this effort as an example of successful self-regulation by an industry.
Further, as the industry developed, there was the recognition of the need for prudential standards and guiding principles that promoted and enhanced the soundness and stability of Islamic financial services – broadly defined to include banking, capital markets and insurance sectors.
These standards include such areas as Corporate Governance, Risk Management, Capital Adequacy as well as Supervisory Review Processes, amongst others. In a similar spirit to the approach adopted for development of the financial reporting standards, development of these standards included consideration of accepted international best practices, and working with all related stakeholders within the global financial industry.
Supervisory Board
We also recognise that for standards to be effective, they need to be adhered to, and as such a second key ingredient in ensuring compliance within Islamic finance is the institution of the Shariah Supervisory Board.
The Shariah Board member is typically a scholar of Islam in particular and typically with an emphasis on Fiqh Mu’amalaat, (Islamic rules on transactions). They are charged with the dual role of guiding / supporting the development of the Islamic financial institution – helping to shape its processes and products as required by Shariah, and reviewing the operations to ensure that all documentation, practices and transactions comply with Islamic Law.
The synergy that is realised from this is one that hopefully is preserved as the Islamic finance model matures, and is also an approach that conventional finance practitioners and regulators can consider as they continue to ensure that the end-users of financial intermediaries continue to benefit, while confidence in the system is preserved.
Some Islamic banks have in fact appointed internal Shariah personnel to fully develop and oversee the internal operations, and retain the external Shariah board to audit the operations and ensure compliance with Islamic principles.
Shariah Review
Key elements in the supervisory review process:
Regulatory capital requirements / capital adequacy
Risk management & corporate governance
Transparency and Market Discipline
Disclosure
The Practitioner’s Perspective
Compliance with both financial / sovereign laws, and a second layer of Shariah compliance
Need for legislative recommendation for Islamic finance, until that time the key success factor for progression within governance rests with the synergy of compliance personnel and teams – from both a legislative as well as a religious perspective, so as to ensure the perpetuation of justice – for as the Qur’an says, “be just, for that is closest to piety”
Management:
In order to have the investments properly managed the person selected for doing so must be competent. The Qur'an advises Muslims as follows:
To those weak of understanding, do not hand over your property (to manage) which Allah has made as a means of support for you. (9:5)
One of the easiest ways to invest surplus wealth is through the Islamic Banks, as in this way one is sure that the monies invested:
• will maintain the religious prescription as well as the ideological orientation of an Islamic Society.
• It will assist in achieving the Islamic socioeconomic objectives, i.e. promotion of a pattern of growth best suited for eradication of poverty, equitable distribution of income and wealth and sufficient opportunities for gainful employment.
Some people believe that because Islamic Banking is different from conventional banking there can be the following misgivings, viz.
• As the Islamic banks are committed to share in losses, (since it is based on profit/loss sharing) it can be exposed to huge losses.
• There can be frequent loss and defaults if the clients conceal their correct income.
• Islamic banks cannot perform all the banking functions on non-interest basis.
While it is a fact that Islamic Banks are committed to share in losses recognition of this is translated to a greater emphasis on risk management, and because the banks invest in diversified portfolios the losses in some isolated cases will be outweighed by the profits in others, thereby resulting in an overall profitability. Losses in Islamic Banks may not necessarily be as great as in other banks due to the fact that:
• through screening of the party to whom fund is made available
• the purpose for which the fund is provided
• supervision exercised by the banks to the fund users
• supervision exercised by the SSB to the IBS
Because both parties work together to ensure success the losses are minimised in Islamic Banks as compared to that of other banks.
Islamic banking is based on moral and religious principles, and while it is possible to cheat regarding the declaration of profits, the risk potential should not be exaggerated. There are some measures that the banks can put in place to minimise such instances. These are:
• evidence of under-reporting of profits can be challenged in court.
• Users of funds guilty of such breach of confidence can be black listed.
• Contracts can be developed to elicit optimal behaviour even in the presence of moral hazards
• Tax laws can be adjusted to avoid attempts to conceal profits.
Regulatory Issues:
From its nature, a bank conducting Islamic finance is subject to those forms of regulation which apply to conventional banks, with due regards to the characteristics of Islamic banks, and also to the review of its compliance with Islamic principles and rules by its own Sharia supervisory board. This constitutes a key organ of governance in an Islamic bank.
Further structures used to deal with investors' funds, normally a profit-sharing mudaraba contract imply a high degree of fiduciary duty on the part of an Islamic bank, which should be reflected on its corporate governance.
All these regulations work for the benefit of the bank's investment account holders, and all others who may have some form of benefit from the assets deposited with the banks. The regulations help to minimise or avoid systematic risk which can lead to the bank collapse.
The regulation of Islamic banks also faces issues relating to liquidity management. Obligations are placed on banks by some regulators to maintain a certain percentage of their assets in securities or deposits in other banks with high credit ratings. To solve this problem some of the Islamic banks issue non-tradable, three-month salam bonds (sukuk) and tradable five year ijara sukuk; some issued tradable mudaraba certificates and the Bank Negara Malaysia issued tradable Islamic bonds.
Each Islamic bank will have a Sharia board (SSB) which reviews both proposed new products of that bank, and the types of transactions into which that bank has entered, to ensure that they are Sharia-compliant. New products will not be introduced until they are in a form acceptable to the SSB.
Ethics
Accounting is one of the professions that is required by Sharia as fard e kifaayah (a collective religious duty which, if performed by some, would exempt others from performing it. However, if it is not performed by any, the entire community is sinful). In addition to its technical definition, accounting is a means to fulfil a Sharia requirement, namely to record, measure and allocate rights fairly among claimants.
The concept of fairness is mentioned in the Qur'an. Allah says:
Allah doth command you to render back your trusts to those to whom they are due; and when you judge between people that you judge with justice. (4:58)
The concept of fairness has a counterpart in accounting thought known as "freedom from bias". As fairness has ethical values there is need for a code of ethics that guides professional accountants in the performance of their professional duties and services.
From an Islamic perspective, the ethics of accountants depend primarily on the principles and rules of Islamic faith and Sharia. Furthermore, Sharia principles and rules confer on these ethics potential enforceability which stems from the permanent and constant religious incentives that surpass in their purposes all other incentives. Even the accountants are supposed to be people conforming to certain standards recognised by Sharia. Some of these are: integrity, sincerity, piety, trustworthiness, etc.
Conclusion
Working for Islamic financial institutions is one of the professions which, according to Islamic Sharia should be established and given due consideration. Furthermore, it imposes the duty of implementing the rules and principles of Islamic Sharia in managing the funds and investing them in a lawful manner.
Compliance by employees of the institutions will lead to the fulfilment of the objectives of Islamic banking and will contribute to establishment of a saying of Prophet Muhammad (pboh) that: Allah loves it when a person carries out a deed and seeks to perfect it.
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