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Shari’ah Governance, a Challenge to Islamic Finance

By Mushtak Parker. Available at

A number of statements, resolutions and judgments relating to Islamic banking that have been issued and passed during the last two years have rekindled the debate over the very nature of the Shariah governance process in the global Islamic finance industry.

These included Resolution 179 (19/5) on Tawarruq issued by the International Council of Fiqh Academy in April 2009; the statement issued by the Shariah Committee of the Accounting and Auditing Organization of Islamic Financial Institutions (AAOIFI) in Bahrain in February 2008 relating to musharaka and mudaraba sukuk; and the judgment of the Malaysian Appeal Court in April 2009 that the Al-Bai Bithaman Ajil (BBA) deferred payment contract as practiced in Malaysia is a valid Islamic sale contract.

It is true that no Islamic financial transaction can be closed without the sign-off of the Shariah Advisory Board as to whether the transaction or structure satisfies the tenets of Fiqh Al-Muamalat (Islamic law relating to financial transactions). In many markets, the reputation of the so-called top tier of international Shariah advisories do not mean much as retail customers in particular prefer to have the input of their local imam or Shariah scholar.

This is a potentially a major problem for the development of the sector because not every local imam or Shariah scholar is conversant with the rubrics of Fiqh Al-Muamalat, which is a highly complex yet under-developed area of Islamic jurisprudence. The Islamic finance sector not only has a human capital development challenge but, perhaps equally importantly, also a Shariah advisory development challenge. While the universities and specialized academies are now starting to offer academic and training courses in this respect, they are still few and far between and their curricula are at best mixed and not quality controlled.

The failure to develop educational best practice and independent governance at universities in most Muslim countries has stunted the institutional development of these institutions, which has resulted in an unfortunate inertia that has failed to recognize the main and unique chance that Islamic finance brings to Muslim countries and societies. Malaysia is a notable exception, for which other country has set up three trusts with a combined volume of funds totaling 700 million ringgits dedicated to education in Islamic finance, the training of Shariah scholars for the sector and conducting research in Fiqh Al-Muamalat.

The International Centre for Education in Islamic Finance (INCEIF), armed with a trust fund of 500 million ringgits, has ambitions of becoming the INSEAD and Harvard Business School for Islamic Finance. Bank Negara Malaysia, the central bank’s 100 million ringgits Shariah Development Fund aims to offer scholarships to aspiring qualified Shariah advisories both from Malaysia and abroad. The International Shariah Research Academy for Islamic Finance (ISRA), also with a trust fund of 100 million ringgits, specializes in conducting research in Fiqh Al-Muamalat and in compiling a database of fatwas (Islamic legal opinions).

Organizations such as the International Council of Fiqh Academy in Makkah, the Shariah Committee of Rabitah (World Muslim Congress) in Makkah, and the Shariah Committee of the AAOIFI in Bahrain are frontline organizations dealing with the issuing of fatwas and perhaps increasingly also debating the consequences of their opinions.

They are not training institutions nor do they have the capacity and independent governance structures to teach Fiqh Al-Muamalat. Although there is a clamor for standardization or uniformity of Shariah interpretations, this is unrealistic given the various Madhabs (schools of Islamic law). In any case, even in conventional finance there is no uniformity of rules and laws, and can differ even within one country as in the US where the state laws on banking differ from each other.

The late Azharite Shariah scholar, Zaki Badawi, used to stress that it would be wise to remember that in Islam there is no Vatican. Diversity of Shariah opinions is a strength and not a weakness. Only that way the Islamic finance sector will thrive. On the upside, there are signs that the Shariah governance process in Islamic finance is steadily evolving and gaining maturity with the latest call by prominent Saudi Shariah scholar and economist, Mohamed Elgari, for a scientific approach to Shariah compliance. This follows the recent call by another prominent Shariah scholar, Sheikh Esam Ishaq of Bahrain, that Shariah advisories serving the Islamic finance industry should be regulated.

Elgari has called on fellow Shariah advisories to adopt a scientific methodology in reaching their deliberations on Islamic finance. “To be respected,” said Elgari, “Shariah scholars should follow scientific methods to reach their conclusions. We have seen many mistakes where declarations have been issued. Only the correct resolutions will prevail. Shariah is not a group of infallible people. It is a science. It requires methodology, and resolutions require peer review and market consultation.”

Elgari is also a big supporter of the codification of Fiqh Al-Muamalat, which could contribute immensely to clarifying the rubrics and the contentious issues relating to products and services in the nascent Islamic finance industry. Similarly, he believes that greater transparency in the Shariah governance process, more professional articulation of the resolutions and statements, and prior debate and consultation between scholars and other stakeholders in the industry, could go a long way in mitigating the misconceptions and confusion that has arisen as a result of some of the recent Shariah rulings.

The market impact of these developments is real. Some bankers such as Mohammed Tariq, head of treasury at the Islamic Development Bank, agree that the AAOIFI Shariah Committee ruling is a marginal issue, but has contributed to the slowdown in the sukuk market.

Others such as Badlisyah Abdul Ghani, CEO of CIMB Islamic Bank, are less impressed: “The AAOIFI Resolution on musharaka sukuk,” he wrote in the May/June 2009 issue of Islamic Banker, “is rightly based on the provisions of a particular School of Islamic Law. However, the resolution cannot invalidate musharaka sukuk transactions based on other schools of Islamic law. To generalize that musharaka sukuk as currently structured are not Shariah-compliant is unjustifiable from a Shariah perspective. In the Shariah governance process in Islamic finance it must be appreciated that all schools of Islamic law are valid and enforceable in their own right.”

Another major development in August 2009 was the issuance by Bank Negara Malaysia of the first in a series of Shariah references. The first one, Shariah Parameter Reference 1 or murabaha Parameter (SPR1), will be followed by Shariah Parameters on ijarah (leasing), mudaraba (trust financing), musharaka (partnerships), istisna (construction financing) and wadiah (current accounts). Bank Negara Malaysia stressed that “SPR1 outlines the main Shariah requirements in the contracts and provides examples, methods and models for practical application of the contract, and is issued as guidance and reference to all IFIs. It also marks a key advancement in the bank’s efforts to promote greater harmonization in the development of the Islamic finance industry.”

Some scholars stress that the Shariah governance process has also got to be pragmatic. The Islamic Fiqh Academy, for instance, recommends that “to ensure that Islamic banking and financial institutions adopt investment and financing techniques that are Shariah-compliant in all its activities, they should avoid all dubious and prohibited financial techniques. All transactions must conform to Shariah rules in order to ensure it meets the objectives of Shariah (Maqasid Shariah). In addition, such a move will ensure the progress and actualization of the socio-economic objectives of the Muslim world. If the current situation is not rectified, the Muslim world would continue to face serious challenges and economic imbalances that will never end. The council encourages the application of Qard Al-Hasan and establishment of Qard Al-Hasan funds by financial institutions to shift people who are in need of fund from products such as Tawarruq.”

The concern raised by some of the Shariah scholars, who questioned this ruling, explains Mohammed Akram Laldin, executive director of ISRA (International Shariah Research Academy for Islamic Finance), the publisher of this e-newsletter, is based on the fact that most of the existing portfolios and products of IFIs globally are based on the mechanism of commodity murabahah based on the tawarruq mode. “If such transactions are deemed to be nonpermissible, then an alternative must be in place to facilitate such transactions which are worth billions of dollars,” he added.

The suggested use of Qard Al-Hasan, adds Laldin, has yet to be tested in the market. “The very nature of the Qard Al-Hasan that specifically disallows the taking of any additional profit or increase over and above the principal given would impose a major restriction on the Islamic finance industry. In addition, the fee that can be charged on the implementation of the Qard Al-Hasan must be the actual fee incurred in administering the transaction,” he explains.

Some Shariah scholars maintain that the imposition of such restrictions as the above might affect the rapid development of the industry going forward. Until Islamic finance achieves a reasonable level of total financial services market share, surely there has to be some room for “exceptional need” or necessity in the absence of viable alternatives. As long of course this need remains within the parameters allowed by the Shariah.

Scholars such as Sheikh Esam Ishaq of Bahrain would like greater inter-action with regulators. He stresses that scholars do engage with them in advising and counseling over matters relating to Fiqh Al-Muamalat. “If they are Muslim regulators, we do remind them that they cannot be ambivalent of the religious dimension of Islamic finance, which is faith-based,” he says.

The Islamic finance market is growing in tandem with the increasing awareness of the general public of Islamic finance per se and of the Shariah supervision process over the last decade or so. People are now more demanding and want proper regulation of Shariah boards. Sheikh Esam stresses that he is “definitely in favor of regulating Shariah advisories by some peer group or organization. But this process should be pragmatic. I agree that having the right education and skills sets to give Shariah advice relating to Fiqh Al-Muamalat are important aspects to this process. There should also be a limit to the number of Shariah boards any single advisory can sit on.”

Best Regards

Notes: With the failure of several IFIs such as Ihlas Finance House in Turkey, financial scandal like in the case of Dubai Islamic Bank and Bank Islam Malaysia Berhad and huge potential implication of Shari’ah non-compliance risk, the need for good and efficient Shari’ah governance system is considered as part of the crucial portion of corporate governance in IFIs. The demand to have effective Shari’ah Governance is really crucial which would then strengthen the credibility of IFIs failing with would inevitably lead to serious disruptions in the market which would have dire consequences for Islamic finance industry. Realizing this, the existing Shari’ah governance framework needs for further enhancement and improvement in order to reinforce the extent of Shari’ah compliance in IFIs. In this regard, it calls for a further research to study and examine the existing Shari’ah governance practices with purpose to identify a proper and high standard of Shari’ah governance framework for IFIs.

  • SDC16803
  • Burj Al Arab, Jumeirah, Dubai, UAE


    1. ezzman says:

      Salam Dr Zulkifli,
      I would agree with your views and from the article I can see the rapid development of islamic finance in the global arena despite the hiccups so to speak as mentioned. However, speaking for myself as a devouted muslim, i would be more comfortable if there were a streamline process in the application of Shariah principles and its methodology to all the Islamic products. And hopefully this could be undertaking by the highest level of authority internatinally (eg AAOFI etc) instead at the national level of each country.

      This is my first time visiting your blog and i am happy that i did. Look forward for more of your articles in the future.

      • ZULKIFLI HASAN says:


        Many thanks for your comment and I am more than happy that someone has benefited something from my weblog.

        Best Regards

    2. niken says:

      Nice article. Thanks for share.

    3. Richard says:

      Nice Post, I have bookmarked your site and will return again.
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