Corporate Governance in Islamic Financial Institutions Professor Dr Rashidah Abdul Rahman Deputy Director, Accounting Research Institute (ARI) Universiti Teknologi MARA, Malaysia [email protected] MOHE Centre of Excellence
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Corporate Governance in Islamic Financial Institutions
Professor Dr Rashidah Abdul Rahman Deputy Director,
Accounting Research Institute (ARI)Universiti Teknologi MARA, Malaysia
MOHE Centre of Excellence
Global Development of Islamic Finance
Development of Islamic Finance in Malaysia
Corporate Governance Framework in Islamic Financial Institutions
Risk Profile in Islamic Banks Empirical Findings
Outline
Myt Ghamr Bank,Egypt (1963)
Pilgrimage FundsManagement Board (Tabung Haji), Malaysia (1962)
Islamic finance was first introduced into the mainstream global banking system in the early 1960s
History & Development of Islamic Finance
And witnessed a period of accelerating growth between 1970s-1990s…. The millenium
Islamic Dev. Bank,Jeddah (1973)
Dubai Islamic Bank,UAE (1975)
Faysal Islamic Bank, Sudan (1977)
Kuwait Finance House (1977)
Bahrain Islamic Bank (1979)
Islamic Bank of Brunei (1992)
Bank Islam M’sia Berhad (1983)
Bank Muamalat, Indonesia (1992)
Islamic Bank of Thailand (2002)
Islamic Bank of Britain (2004)
History & Development of Islamic Finance
Today, Islamic finance with operations in more than 300 financial institutions and more than 80 takaful operates globally
Estimated size of Islamic banking assets – more than USD$1.0 trillion;
Global market capitalization of DJMI>USD 10 trillion;
350 Shariah-compliant funds established globally;
Islamic finance growth is 15%-35% globally;
…………enormous potential business opportunities
History & Development of Islamic Finance
Global development of Islamic Finance
Source: Creating & promoting the value propositions of Islamic Finance: Enter the next Phaseby Dr. Mohamad Nedal Alchaar, Secretary General Accounting & Auditing Organization for Islamic Financial
Institutions (AAOIFI)
COMMITMENT LEVEL
BUSINESS INNOVATION
MARKET INNOVATION
COMPETITOR MATCHING
MINIMUM PRECENSE
MONITOR DEVELOPMENT
WAIT & SEEEXPLORE MARKET POTENTIAL
SPORDIC DEVELOPMENT
MARKET DEVELOPMENT ACTIVITIES
MARKET EXPANSION ACTIVITIES
MARKET REACH
MALAYSIA, KUWAIT, SAUDI ARABIA, DUBAI, BAHRAIN
BRUNEI, INDONESIA, SOUTH AFRICA, MOROCCO, TURKEY, QATAR, UNITED KINGDOM
SYRIA, LEBANON. GERMANY, USA, SINGAPORE
CHINA, INDIA, HONG KONG, FRANCE
CLUSTER 1
CLUSTER 2
CLUSTER 3
CLUSTER 4
EVOLUTION OF ISLAMIC
FINANCIAL SYSTEM IN MALAYSIA
8
• IBFIM• SIDC• INCEIF• ISRA• BNM Act 2009• IIIBF, IIUM 2005
1983 1993 2001 2010 & beyond
• Islamic Banking Act 1983• Takaful Act 1984• Government Funding Act 1983• 1st full fledge Islamic bank• 1st full fledge takaful company• IIUM was established in
1983
Malaysian Islamic Banking & Finance Journey…
• FSMP – 10 year roadmap
• Foreign Islamic banks• Islamic subsidiaries• New takaful & retakaful
licences• Tax neutrality policy
• Islamic windows• 2nd Islamic bank• 2nd takaful company • Islamic money market • Shariah Advisory Council at
BNM
Inception stage Instituting foundations of Islamic finance & financial inclusion
Intermediate stage Institutional building,
stimulate competition, activity generation &
market vibrancy
Advanced stage Visioning,
comprehensive & international integration
Building foundation of legal, regulatory
& Shariah framework
Increase number of players, develop
financial markets & enhance Shariah
governance
Market liberalisation, upgrading
infrastructures, strengthen overall
Islamic finance landscape
FSMP – Financial Sector Masterplan, IBFIM - Islamic Banking and Finance Institute of Malaysia, SIDC – Securities Industry Development Corporation, INCEIF - International Centre for Education in Islamic Finance, ISRA – International Shariah Research Academy for Islamic Finance
9
Over the years…• Proven to be a
viable financial intermediation channel
• Fulfill needs of Muslims & non-Muslim
• Success enable expansion into new areas and products
Build solid foundation of legal, regulatory and Shariah framework
Thrusts• Fulfill Muslim’s
needs• Mobilize funds
for productive purposes
Takaful Act 1984
Islamic BankingAct1983
Government Investment Act 1983
Facilitate Islamic money market
Facilitate establishment of takaful operators
Facilitate establishment of Islamic banks
Instituting Foundations for Islamic FinanceInception Stage (1983 – 1993)
Comprehensive
Financial Landscape
Comprehensive
Financial Landscape
Islamic Financial System in Malaysia
Financial markets
Diversified PlayersGovernance
Malaysian Financial
System
Islamic
Bank &
Takaful
Companies
Islamic Capital MarketCapita
l Market
Conventional Banks
& Insurance
Companies
Money Marke
t
Labuan
IBFC Islamic Money Market
•Legal & Regulatory-Islamic Banking Act-Takaful Act-Government Funding Act-Capital Market Services Act-New foreign legal firm
•Shariah Advisory Council-Central Banking Act
•Dispute Resolution-Judicial system:dedicated high court-KL Regional Centre for Arbitration-Financial Mediation Bureau
•Money Market-Islamic interbank money market-Diverse shot-term Islamic money market instruments
•Capital Market-58% of outstanding bonds are sukuk-88% Shariah counters-143 Islamic unit trust fund
•Banking-17 Islamic banks-16 Islamic windows-3 International Islamic Banks-14 International Currency Business Units
•Takaful-8 takaful operators-4 retakaful operators-1 International Takaful Operator-7 International Currency Business Units
•Fund Management-9 licensed Islamic fund management companies-35 fund management companies with Islamic mandates
CORPORATE GOVERNANCE
FRAMEWORK IN ISLAMIC BANKS
“is a set of organisational arrangements whereby the actions of the management of institutions offering Islamic financial services are aligned, as far as possible, with the interest of its stakeholders; provision of proper incentives for the organs of governance such as the BOD, Shari’ah Supervisory Board and management to pursue objectives that are in interests of stakeholders and facilitate effective monitoring, thereby encouraging IIFS to use resources more efficiently; and comply with Islamic Shari’ah rules and principles‟ (IFSB, 2006, pp.33)
Concept of corporate governance in IFIs
A central feature of Governance in Islamic Banks is ensuring Shariah
Compliance
Conduct financial business in
accordance with prohibition of Riba & Gharar Enhance Islam’s
social objectives in particular the promotion of
social behaviour
Development and promotion of
integrated Islamic Financial System
Internal Arrangement External Arrangement
Functional role of Islamic banks Legal & Regulatory arrangement
Financial Information Infrastructure
Depositor
Agency Solution provider
Trustee/ guarantor
Fund Manager/ Agent/Mydarib
Mudaraba facilitator
Shareholder Current accounts (CA)
Restricted Investment Account (RIA)
Unrestricted Investment Account (UIA)
Stake Holder
Allah the Almighty
Ethical Values
Islamic Banks
Shariah Board
Corporate Governance
Islamic banks shall establish: a comprehensive governance policy framework reporting of their financial and non financial
information acknowledge the right of investment account
holders adopt a sound investment strategy mechanism for Shariah scholars applying fatawa
and monitoring make adequate and timely disclosure
IFSB Principles of Corporate Governance for Islamic Banks
Shariah Governance Framework Model for Islamic Financial Institutions by
Bank Negara (Central Bank) Malaysia
Roles of Shariah Board
the issuance of fatwa via
collective ijtihad
supervision (raqabah)
review (mutabaah)
RISK PROFILE IN ISLAMIC BANKS
19
RISK PROFILE OF ISLAMIC BANK
Strategic
Legal Fiduciary
Reputation
Transparency
Regulatory compliance
RATE OF RETURN
RISK
DISPLACED
COMMERCIAL
RISKEQUITY
INVESTMENT
RISK
OPERATIONAL
RISK
LIQUIDITY RISKMARKET
RISK
CREDIT
RISK
SHARIAH
NON-COMPLIANCE
RISK
UN
IQU
EG
ENER
IC
ISLAMIC BANK
Reference: IFSB Guiding Principles On Risk Management (December 2004)
Credit Risk
Market Risk
Operational
Equity Investment
Risk
Rate of Return Risk
Liquidity Risk
SIX CATEGORIES OF RISK
SHARIAH COMPLIANCE RISK
Based on IFSB
Shariah Compliance cuts across the six categories of risk
OPERATIONAL RISK
“Risk of losses resulting from inadequate of failed internal process, people and systems or from external events, which includes legal risk and Shariah compliance risk, but excludes strategic and operational risk.”
SHARIAH COMPLIANCE RISK
“The risk that arises from the Bank’s failure to comply with the Shariah rules and principles determined by the relevant Shariah regulatory councils.”
IFSB CLASSIFIED SHARIAH COMPLIANCE RISK AS PART OF OPERATIONAL RISK…
20
Policy/
procedures
Documentation
Marketing/
Selling
Control
framework
Employee
negligent
Communication
Knowledge/ skill
Unauthorized
activities
o System support
o System
monitoring
o System design
Regulation
Political
Outsourcing
Fraud (External
fraud)
INTERNAL PROCESS
PEOPLE SYSTEM EXTERNAL EVENT
SHARIAH NON-COMPLIANCE RISK MAY OCCURS IN OPERATIONAL RISK FIELDS…
21
IFSB’S GUIDING PRINCIPLES OF RISK MANAGEMENT
15 guiding principles which cover:
1. General requirement for an effective risk management process
(1)
2. Credit risk (4)
3. Equity Investment Risk (3)
4. Market Risk (1)
5. Liquidity Risk (2)
6. Rate of Return Risk (2)
7. Operational risk (2)22
EVIDENCE FROM RESEARCH FINDINGS
Assessing the RM Practices: Malaysia Vs Pakistan
Risk management practicesMalaysia
Mean
Pakistan
MeanMean of
Both
T- Test Sig-
LevelRisk Management Practices 5.83 5.77 5.80 0.5
Understanding Risk Management
6.09 5.88 5.97 0.00
Risk Identification 5.64 5.43 5.52 0.01
Risk Mitigation (Assessment and Analysis) 5.93 5.85 5.89 0.27
Risk Monitoring 6.02 5.93 5.97 0.15
Regression Results on Risk Management Practices
VARIABLES MALAYSIA PAKISTAN OVERALL
Coefficient Prob. Coefficient Prob. Coefficien
t
Prob.
CONSTANT 3.33 0.050* 3.29 0.034** 3.65 0.011**
URM 0.713 0.113 0.708 0.122 0.670 0.150
RI 0.317 0.002** 0.247 0.010** 0.342 0.031**
RAA 0.421 0.031** 0.352 0.051* 0.671 0.045**
RM 0.446 0.201 0.448 0.315 0.446 0.543
Adjusted
R2
0.357 0.356 0.357
F-statistic 3.163** 3.139** 3.165**
Prob. (F-
statistic)
0.000 0.000 0.000
N 119 165 284 Abdul Rahman , Syed and Dean (2013), J of Islamic Economics, Banking & Finance, forthcoming
Governance & Risk Management: Malaysia and Egypt Mean
T-test Sig.
Level
Skewness
Kurtosis
Variables Malaysi
a
Egypt Total Sample
Boards’ involvement in risk management
5.39 4.83 5.32 0.03 -0.163 -0.072
Process of risk management
5.92 5.02 5.81 0.00 -1.508 2.378
Risk management practices
5.85 5.00 5.74 0.00 -1.200 1.371
Abdul Rahman , Syed and Ismail, submitted to Spanish J of Finance and Accounting
Governance & Risk Management: Malaysia and Egypt
ME: Process of Risk Management
DV: Risk Management
Practices
IV: Boards’ involvement in risk
management
SignificantStep 1, Path a
Step 3, Path c
Step 4, Path c’
Significant
Significant, but lower effect than Path c
Significant
Step
2, P
ath
b
Figure 1:The Expected Results from Four Hierarchical Regressions(Where, ME= mediator variable, IV=independent variable, DV=dependent variable)
Thank you
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