Shari’ah Supervision in Islamic Banks and Financial Institutions;
An Overall Review

Ash-Shaikh H. Abdul Nazar
President, Centre for Spiritual Solidarity
General Secretary, All Ceylon Jamiyyathul Ulama

Abstract

This paper endeavours to give hints to design a firm framework for Shari’ah supervision in Islamic banks and financial institutions within the parameters of contemporary developments. It also offers instructive understanding of basis for Shari’ah supervision in such establishments from an Islamic perspective.

This article investigates the importance of Shari’ah supervision in institutions of Islamic banking and finance, qualifications of Shari’ah supervisors and their role. The definition of Shari’ah supervision, selection of Shari’ah supervisors, method of decision making, role of In-house Shari’ah supervisors, obstructions facing Shari’ah supervisory boards, etc. are explored in this article.

Shari’ah compliance in Islamic banks and financial institutions is, really, very crucial and depend anything and everything on it. It should be necessarily maintained in all their bearings with no excuse since the whole show is based on laws laid down by Almighty Allah.

The growing trend is that the general public particularly investors and clients irrespective of faith look for spotlessness of the operation in these establishments. Islam is clean and pure and things happening in its name must, also, be clean and pure. Otherwise, ultimately the name of this very great and noble divine religion will get tarnished and its infallible teachings will be misconstrued.

Therefore, being true to its word and committed to applying the regulations and ethics in terms of Islamic banking and finance, each and every institution of this nature has to prove that it falls into line with Shari’ah.

Significance of Shari’ah Supervision

The fundamental reason for emergence of Islamic banks and financial institutions is to provide a Shari’ah alternative to interest-based banks and financial institutions. That is why each institution of Islamic banking and finance has a Shari’ah supervisory board as an intrinsic part of its organizational structure. It is now embedded in everybody’s mind that any establishment claiming to be an Islamic bank or an Islamic financial institution is incomplete without a proper Shari’ah supervisory board to ensure its purity and accuracy in the eyes of Shari’ah.

In this background, supervising the entire operation in such institutions offering Islamic banking and financial services and their adherence to the tenets of Shari’ah in all activities is, of course, indispensable.

That most of the workers in these institutions lack knowledge of Islamic banking and finance is another element that demands Shari’ah supervision. However magnificent the infrastructure in such an institution is, it is extremely illogical for it to assert Shari’ah compliance when its workers are not conversant with Islamic banking and finance.

The present modern world has seen a number of new forms of trade which in some cases do not have reference in the old treatises of Islamic Jurisprudence (Fiqh). Even if the reference is available, the bankers are incapable of reading, understanding and interpreting them. This is another factor that contributes to the fact that Islamic banks and financial institutions need to be kept under the supervision of Shari’ah scholars.

Running an Islamic bank or financial institution, indeed, entails people, money, property, etc. with a large number of dealings, transactions and investments. So the day-to-day operation possibly encounters problems and cases which should be addressed in the light of Shari’ah. Here comes the key role of Shari’ah scholars who can solve them by applying the Shari’ah principles. For this reason too, the constant Shari’ah supervision is of paramount importance.

It is public knowledge that with ulterior motive of money making, some unscrupulous people have established institutions in the name of Islamic banking and finance. Though their memorandum and articles and / or rules spell out that the whole operation and conduct of business should conform to the doctrines of Shari’ah, it is not so in practice. They do not want to commit to applying of Shari’ah principles either. This saddening phenomenon, which sometimes makes the whole thing absurd, compels other institutions with real commitment to adhering to Islamic principles both in word and deed to be under the Shari’ah supervision.

By and large, all these establishments ought to have full-time Shari’ah supervision as expected by investors, clients and general public at large and forced by nature as things have developed.

What is Shari’ah Supervision?

The Shari’ah supervision has been defined by various institutions and scholars in different ways. The all-embracing one is ‘Shari’ah supervision in essence is to ensure that Islamic banks and financial institutions conduct their business in accordance with the Islamic principles, rules and etiquette as guided, advised and instructed by the Shari’ah supervisory boards’.1

It is crystal clear from the above definition that two areas receive the focus of the Shari’ah supervision; viz application of principles and application of etiquette. Islam in general does not lay down the rules alone; but it formulates a framework for their application. This framework requires inter alia application of rules and ethics both side by side. Islamic Banking and Finance is not an exemption.

Basis for Shari’ah Supervision

Supervising the market place for Shari’ah compliance is not new or alien. If one looks at the history of Islam, he / she could easily find that this was practiced by Prophet Muhammad (Sallallahu alaihi wasallam). It is recorded by Imam Muslim (Rahimahullah) on the authority of Aboo Hurairah (Radhiyallahu anh) that Allah’s Messenger (Sallallahu alaihi wasallam) passed by a heap of a foodstuff. He inserted his hand into the heap. His fingers sensed dampness. ‘What is this? O owner of the foodstuff!’ asked Allah’s Messenger (Sallallahu alaihi wasallam). The owner said: ‘It got wet in rain. O Allah’s Messenger!’. Then said Allah’s Messenger (Sallallahu alaihi wasallam): ‘Why had you not kept it over in order that people would notice it? The one, who deceives, is not from me.’2

The practice adopted by Allah’s Messenger (Sallallahu alaihi wasallam) in supervising the market activities did not end with his demise, but continued throughout the caliphate of four caliphs (Radhiyallahu anhum). The Islamic caliphate had a separate department called ‘Al-Hisbah’. The chief task assigned to Al-Hisbah was to enjoin what is right if it is abandoned and forbid what is wrong if it is perpetrated. This embodied among other things monitoring the business activities in the market.3

Selection of Shari’ah Supervisors

To perform the heavy task of supervising the show in the Islamic banks and financial institutions, a handful of Islamic scholars are selected by the institutions. In some establishments, board of directors handles the selection, and in some, stakeholders do it. The way of selection and appointment may vary, yet the job entrusted to the Shari’ah scholars thus selected and appointed is same.

A minimum three (03) members are needed to constitute a full Shari’ah supervisory board.

Duties Involved in Shari’ah Supervision

The job of supervising includes amongst other things the following responsible duties:

1. to examine the Shari’ah aspects in the institution’s memorandum and articles, rules, etc.
2. to vet for Shari’ah compliance manuals, agreements, contracts, rules and regulations, bonds, promissory notes and all other documentation.
3. to introduce more and more Shari’ah compatible products.
4. to study proposals of new investment ventures.
5. to lay down necessary rules to regulate the relationship with un-Islamic banks and financial institutions.
6. to expound the Shari’ah position on transactions referred to the Shari’ah supervisory board for Shari’ah clearance.
7. to audit for Shari’ah compliance all dealings, transactions and operations of the institution, to make observations and to follow up rectification of shortcomings before anything else.
8. to stipulate that any new product, investment or service should have the approval of the Shari’ah supervisory board before embarking on it.
9. to provide Shari’ah advices with regard to dealings, transactions and operations of the institution.
10. to act on complaints from the standpoint of Shari’ah.
11. to audit for Shari’ah compliance all investment, facility and transaction related files and documents.
12. to analyze the budgets, auditors’ reports, etc.
13. to present periodical reports in which the Shari’ah supervisory board airs its opinions in respect of dealings and transactions carried out and the institution’s upholding of and complying with Fatwas (Islamic rulings), decisions, guidance, etc. of the Shari’ah supervisory board.
14. to adjudicate transactions that have run into dispute.
15. to stipulate that manuals, agreements, contracts, rules and regulations, bonds, promissory notes and all other documentation should have the approval of the Shari’ah supervisory board before bringing them into effect.
    
    

The advisory and supervisory role of Shari’ah supervisory boards nowadays includes Shari’ah audit too. The Shari’ah supervisory boards perform audits either annually, biannually or monthly, as the case may be. However, it is difficult for the Shari’ah supervisory boards with a limited number of members to review all the transactions that have taken place in different branches of the institutions. It would, therefore, be ideal and practical to form independent Shari’ah audit firms in the private sector or that the existing chartered audit firms acquire necessary expertise to undertake the Shari’ah audit. In both cases, the firms need to hire and train adequate staff to conduct the Shari’ah audit effectively and impeccably. Nevertheless, if the existing chartered audit firms can come forward to undertake this job, it will be most welcomed with open arms by Islamic banks and financial establishments as this would be more convenient for them to have the Shari’ah audit and accounts audit at a same time. The renowned scholars and researchers M. Umer Chapra and Habib Ahmed also have suggested same.4

Qualifications of Shari’ah Supervisors

Even by cursory reading of the duties mentioned above, one can appreciate the grave and serous responsibility shouldered by Islamic scholars engaged in the Herculean job of supervising the institutions of Islamic banking and finance. Therefore, picking out Ulama for this assignment has to be handled with utmost care and due prudence. We have an age-old adage in Arabic that:

‘أعـط الـقـوس بـاريـهـا’

‘Give the bow to the one who knows how to shape it’.

Generally the following qualifications should be essentially found in such scholars as suggested by some eminent Ulama like Shaikh Hamzah Abdul Kareem Muhammad Hammad:5

1. They should be well-versed in the Holy Qur’an and its Sciences.
   
2. They should have thorough knowledge of Sunnah and its Sciences.
3. They should know well the cases of Ijma’ (Consensus of Ulama on a matter).
4. They should be proficient in Arabic.
5. They should have cognizance of individual reasoning (Ijtihaad) of Islamic Jurists, evidences in support of their opinions, bases of their views, reasons for their differing in views, etc.
6. They should be conversant with Principles of Jurisprudence (Usool Al-Fiqh).
7. They should be knowledgeable about Intents of Shari’ah (Maqaasid Al-Shari’ah).
8. They should be familiar with general banking practices.
9. They should bear good character both in personal and public life.
10. They should be able to act impartially in delivering Fatwas (Islamic Rulings) and adjudicating of disputes.
    

The entire operation of the establishments in the field of Islamic banking and finance must conform to Shari’ah. Showing Shari’ah in front and face and ignoring it behind the curtain is violation of Shari’ah and taking people especially the investors for a ride. It should, also, be noted that Shari’ah compliance is not complete by mere paperwork only. It needs physical application to be completed. Here a question automatically arises ‘Who is responsible for this?’

The answer is simple. Boards of directors are responsible for running the institutions according to Shari’ah principles and values and Shari’ah supervisory boards are responsible for ensuring that the operation is in harmony with Shari’ah. This necessitates complete transparency in all stages and aspects.

Procedure for Decision Making

There ought to be a clear-cut system adopted by each Shari’ah supervisory board in making decisions and delivering Fatwas (Islamic Verdicts). All decisions must be taken in conformity with Al-Qur’an and Al-Sunnah, and the Fiqh Schools of Thought (Math-habs) have to be taken into consideration for such decisions. In the event of difference of opinions on any matter or issue, the opinion of the majority of the members most supported by the evidences shall be final.

Before concluding on anything, the members of Shari’ah supervisory boards must study it in depth. If necessary, experts could be consulted. In any case, they shall not rush to issue any Fatwa before close analysis of the matter or issue in the light of Shari’ah.

Libraries are pregnant with treatises containing marvelous studies of Islamic jurists especially in areas of economy, trade and commerce. These books should be referred to at times of attempting to deliver Fatwas.

It is imperative, while making efforts to issue a Fatwa, to closely look at the context and intent of a text in the Holy Qur’an or Sunnah.

This is a general rule accepted by great Islamic jurists throughout the ages. Shari’ah supervisory boards must take this also into account in the event of delivering Fatwas.

There are some other general rules agreed upon by all Islamic jurists;

‘Hardship brings simplification’ (المشقة تجلب التيسير),

‘Worse evil is removed by lesser evil’ (الضرر الأشد يزال بالضرر الأخف),

‘Public welfare is given preference over personal welfare’
(المصلحة العامة مقدمة على المصلحة الخاصة),

‘Warding off evils is given preference over procurement of virtues’
(درأ المفاسد مقدم على جلب المصالح),

‘Necessities permit forbidden things’ (الضرورات تبيح المحظورات), etc.

Scholars benefit from one another, exchange views and share knowledge and experience. No scholar is perfect. No Shari’ah supervisory board should think that they are self-sufficient and therefore, need not consult other Ulama nor benefit from their knowledge and experience. Each Shari’ah supervisory board has to consider the decisions and Fatwas of Fiqh academies and other institutions that organize conferences and assemble Ulama of eminence to make collective studies and deliver Fatwas on important matters and issues. In most cases, as proven practically, collective efforts outweigh individual efforts.

All this naturally requires that the members of Shari’ah supervisory boards should keep them updated by intensive reading and reference and keep abreast of current affairs and new developments that take place in Islamic banking and finance.

In-house Shari’ah Supervisors

As discussed earlier, the advisory and supervisory role of the Shari’ah supervisory boards is a tremendous responsibility and a challenging job and it certainly entails a great degree of fastidious perusal, consultation, reference and meticulous research. Are the scholars who serve on Shari’ah supervisory boards in a position to spare time to act their part duly and effectively? This is a pragmatic question. In reply to this, the scholars have suggested having in-house Shari’ah supervisors full-time inside the institutions.6

In-house Shari’ah supervisors primarily ease the burden of the members of Shari’ah supervisory Boards by carrying out most of the duties technically entrusted to them. In the meantime, in-house Shari’ah supervisors may act as secretaries to their respective Shari’ah supervisory boards. So, in this way, convening of Shari’ah supervisory board meetings, minuting the proceedings of meetings, maintaining such minutes and other Shari’ah related documents, etc. may rest with them as agreed between the managements and Shari’ah supervisory boards.

As in-house Shari’ah supervisors are expected to perform the duties of Shari’ah supervisory boards, the institutions should necessarily look for Shari’ah scholars with the qualifications stipulated for members of Shari’ah supervisory boards and appoint them. Only those, who fit the bill, should be appointed formally. Such appointees have to work in the establishments on a full-time basis and they are technically their employees. However, the regulators of Islamic banks and financial institutions very precisely say that even though they are employees in such establishments, they are fully independent in the assessment of Shari’ah compliance and should not be influenced at all by managements or any others. They also enjoy complete freedom to report to Shari’ah supervisory boards on any matter or issue.7

Obstacles Confronting Shari’ah Supervisory Boards

Circumstances warrant analyzing the barriers before Shari’ah supervisory boards. Of course, Shari’ah supervisory boards face numerous obstructions that could be outlined as follows:

1. Shortage of Ulama fulfilling the conditions set out for members of Shari’ah supervisory boards.
2. Rapid and tremendous developments and sudden changes in trade and economy and difficulty in expounding the Shari’ah position then and there, keeping pace with the latest developments and unexpected changes.
3. Lethargy of managements in implementing the decisions of Shari’ah supervisory boards.
4. Carelessness of managements about following the guidance of Shari’ah supervisory boards to the letter.
5. Non-implementation by managements of guidelines issued by Shari’ah supervisory boards.
6. Pressurizing by managements of Shari’ah supervisory boards to approve some of their dealings or transactions which are not in harmony with Shari’ah.
7. Poor performance of Shari’ah supervisory boards in their duty.
   
   

In order to overcome theses obstacles, it is proposed as follows:

1. to pick out and appoint only the scholars who meet the qualifications stated earlier.
2. to support Shari’ah supervisory boards with banking experts.
3. to establish institutes to train Ulama in Islamic banking and finance.
4. to establish independent Shari’ah audit firms and to motivate existing chartered audit firms to prepare them to undertake Shari’ah audits.
5. to let Shari’ah supervisory boards examine and review closely every activity of the institutions; major or minor with complete transparency and without let or hindrance or pressure form anyone.
6. to make it compulsory that the establishments should adhere to the guidance of Shari’ah supervisory boards, put their decisions into practice and rectify the shortcomings as directed by them.
7. Scholars shall equip themselves well with English knowledge since it is the working language in most of these establishments.
   
   

The Shari’ah supervision shall be meaningful, efficient and effective in its full sense. Ulama especially young ones must arm themselves with necessary knowledge in this sphere and good command of English. Institutions of Islamic banking and finance should operate in line with Shari’ah with honesty, integrity and complete transparency to Shari’ah supervisory boards. They must always remember that they all deal with divine laws not man-made laws.

People everywhere at all times like to deal and bank with credible establishments in the market.

Endnotes

1. Hamzah Abdul Kareem Muhammad Hammad, Al-Raqaabah Al-Shar’iyyah Fee Al-Masaarif Al-Islamiyyah (Amman: Daar Al-Nafaais, 2006) 30 - 32
2. Aboo Al-Husain Muslim Ibn Al-Hajjaj, Saheeh Muslim, Book of Iman, Chapter: Saying of Prophet (Sallallahu alaihi wasallam): ‘The one, who deceives us, is not from us’
3. Abdul Azim Islahi, Economic Concepts of Ibn Taimiyah (United Kingdom: The Islamic Foundation, 1996) 42, 186 – 191
   Al-Khulafa’ Al-Raashidoon Wa Al-Dawlah Al-Umawiyyah for Intermediate Second Year (Kingdom of Saudi Arabia: Ministry of Higher Education, Fifth Edition) 182
4. M. Umer Chapra and Habib Ahmed, Corporate Governance in Islamic Financial Institutions (Jeddah: Islamic Development Bank, 2002) 68 - 69
5. Hamzah Abdul Kareem Muhammad Hammad, Al-Raqaabah Al-Shar’iyyah Fee Al-Masaarif Al-Islamiyyah, 43 - 51
6. Banking Advisory Committee of All Ceylon Jamiyyathul Ulama, Standards for Islamic Financial Institutions Seeking Accreditation by All Ceylon Jamiyyathul Ulama, 10
7. Banking Advisory Committee of All Ceylon Jamiyyathul Ulama, Standards for Islamic Financial Institutions Seeking Accreditation by All Ceylon Jamiyyathul Ulama, 10 - 11
   
   

02.08.2008