Regulating Ethics
in Islamic Finance –
The Way Forward
By
Syed Abdul Hamid Aljunid
5-7th July 2010
Sheraton Imperial Hotel
Kuala Lumpur
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Shariah,
Ethics.
Shariah
Governance
and
Role of worldviews, shariah and fiqh in
Islamic economic system.
Fiqh rulings and purpose of shariah in nexus
of contracts.
Problems with moral hazards, Shariah
governance, ethical awareness and integrity of
financial system.
Way forward – regulating ethics, governance
and integrity system.
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Islamic worldview and Islamic
economics.
Dynamic worshipping relationship.
Divine guidance and the framework of human
conduct e.g. Prohibition of zulm or injustice in
Al Quran.
Jurisprudence and laws of transactions
based on deductive and analogical reasonings
Khalifah, vicegerance and amanah.
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Shariah and human behavior.
Shariah is network of injunctions and rules of
behavior.
Compliance is rewarded in this world and Hereafter
e.g. Barakah.
Basic division of obligatory, forbidden and those in
between.
Interest (riba), gambling, uncertainty lead to injustice
and are prohibited.
To be ‘ethical’ is to stay clear from the prohibited and
do the obligatory and recommended.
Akhlaq or character is the disposition to act in 4
accordance with the dictates of the rational soul.
Fiqh and the role of commerce.
In Islamic history, fiqh muamalat or the law of
transactions determine validity and effectiveness of
contracts.
Business is nexus of contracts based on property.
Financing business is legal as long as there is no
riba involved.
Business transactions underpinned by the
important conditions of trust, promise keeping and
integrity as qualities of a Muslim.
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Ethics and integrity in business.
Intentions and purpose to do right and avoid
wrongdoing are important starting points i.e. substance
over form.
Understanding roles, responsibilities and respecting
obligations and rights are important for the ethical mind
e.g. social responsibility and due diligence.
Code of conduct and framework of governance protects
the company stakeholders from harm.
The problem is how to legislate or regulate ethical
behaviour e.g. Moral hazards in Islamic finance.
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What makes Islamic finance ethical?
When rules and institutions are properly formulated
explained and transparently enforced.
Compliance to rules, laws and regulations and
expectations of society for the type of practice
undertaken.
Avoiding harmful effects or consequences of the act on
shareholders (including living things and environment)
as well as oneself e.g. reputations.
Contributions it make to society through the usefulness
of its practice to society.
Managing significant risks and maintaining effective
internal controls or otherwise.
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Factors leading to questionable actions in
Islamic finance.
Lack of knowledge of the business and due diligence in arriving at a
decision. Also failure to understand or apply duty of good faith.
Good character or good intentions not relevant in evaluating the
failure to perform duties.
Over confidence or mindlessness in arriving at decisions or
solutions arising from complex problems e.g. failure to see different
perspectives or contexts of the problem.
Lack of integrity accountability and transparency in decision making
– no controls, check and balance. Agency problem and conflict of
values – Rewards versus duty of good faith.
Poor leadership and governance.
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Complexities and ethical challenge for Islamic finance
industry.
Shortage of competent and experienced shariah advisors and
managers who can complement these advisors.
General lack of proficiency in finance and economics among
shariah scholars. This is a constraining factor since contextual
analysis is not well applied.
No mechanism to exact accountability from shariah committees
since Board of Directors are accountable. However, they are not
proficient in shariah rules.
Limited codification of shariah rules for different categories of
instruments and products.
Although risk management rest with Board of Directors, managing
shariah risk has not been included among the duties of shariah
committees.
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Non-availability of mechanism to distinguish between
legal tricks (hilah) and legal way-out (makhraj) for
proper shariah compliance.
Lack of active interaction between shariah scholars
and non shariah professionals due to different
disciplines and styles of thinking. Mindlessness due to
inability to view problem from different perspectives.
Where standardization is lacking or where governance
structure is lacking, banks, got the fatwa they wanted.
In the case of sukuk, clients sought the least restrictive
fatwas, especially when syndications were arranged
by established conventional banks.
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The status of shariah advisors as providers of
remunerated services while at the same time
performing the assessment of Islamic financing
operation is potentially problematic
Poor disclosure about effectiveness of Board of
Directors and shariah committees in terms of their role
in shariah governance responsibilities. Also in some
jusrisdictions, there are no centralised regulations or
guidelines in these areas.
In some countries, even the quality of institutional
environment, judicial system, law and order, and
property rights are not well aligned even where they
exist.
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Governance framework of Islamic Financial
Institutions in Malaysia – Bank Negara Malaysia
Two tier shariah governance infrastructure comprising
National Shariah Advisory Council at the Centre and
Internal Shariah Advisory Committees at bank’s level
(Section 51 of Central Bank of Malaysia Act 2009 for
SAC).
The establishment of Shariah Advisory Committees
were required by Section 3(5)(b) of Islamic Banking Act
1983 and Section 8(5)(b) of Takaful Act 1984 and the
Guidelines on governance of Shariah Committee for
Islamic Financial Institutions, 2004.
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Currently a concept paper of revised
guideline for Shariah Governance is
available. The objective of this guideline:
To enhance the role and accountability of the Board of
Directors, shariah committees and management of Islamic
Financial Institutions in Shariah Governance.
To attain shariah based operating environment or culture.
Relates to improvement in processes, structures are in
accordance with shariah.
To strengthen the function of shariah review and shariah
audit, and to establish shariah research and shariah risk
management functions.
Professional ethics to be maintained in exercising duties
and responsibilities of shariah governance.
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The Way Forward.
Sound governance framework of equal standing to
corporate governance to enhance transparency, controls
and necessary check and balance e.g. Malaysia,
Bahrain.
Codification of Islamic Financial transactions for
different categories of instruments can ensure greater
confidence in the use of such products e.g. BNM’s
Shariah Parameter.
To overcome the apparent lack of support by some
jurisdictions in adopting standardised framework for the
application of shariah compliance and operations such
as AAOIFI.
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Developing research on fatwas and related shariah
issues of Islamic finance e.g. ISRA
Where no national shariah council is operative,
Shariah advisors to refer to collective fatwa of OIC
fiqh and reputable fiqh Academies. Where there is
non conformance, there should be publications of
such incidents.
Establish an International Association of Shariah
Advisors with clear rules of engagement and code of
ethics.
Making shariah advisory a professional practice
prescribed by law.
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Shariah advisory profession and its attributes.
The qualification reflects a body of knowledge or expertise and
ability to apply them in different context.
They adhere to updated collective knowledge of their
associations based on research and on policy requirements.
They conduct their own examinations and set entry requirements
into the profession.
They set standards on quality and best practice.
Self regulation in terms of best practices, membership and
continuing education and training.
They ensure members act in good faith and exercise duty of skill
and care where a breach is legally liable. They engage
regulators in developing and assist laws and guidelines.
Potential conflicts of interest are defined in the code of conduct
for guidance of members.
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Thank you
Q&A
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