Islamic Finance Offers Good Governance To Conventional Banking

Islamic finance, which borrowed features such as products from conventional banks, can now return the favor by lending its set of principles for good governance and responsibility, the Raja Muda of Perak, Raja Dr Nazrin Shah said on Tuesday.

"To date, Islamic banks have borrowed from conventional finance in terms of products.But, I think, the time has come where the flow of information and knowledge can and should flow the other way as well," he said in his keynote address at the second day of the World Capital Markets Symposium, here.

He said Islamic finance could also help the global finance industry to be more aware of following the rules and curtailing excess as well as create an infrastructure of honesty, fairness and integrity.

"But, I also believe Islamic finance can offer much more than this," Raja Nazrin, who is also the financial ambassador for the Malaysia International Islamic Financial Centre, said.

"At its heart, Islamic finance is an ispiration towards good finance.As we have seen, good finance is about trust, and trust is a cornerstone of stability.

"Therefore, I believe that Islamic finance can help break the vicious cycle of boom and bust that has come to characterise global finance," he said.

Islamic finance is now a truly global market, participating across borders with a vast range of investment alternatives including sukuk, mutual funds, commodity funds, equity traded funds, real estate investment trusts, shariah compliant derivatives and hedge funds.

Recent developments also included the possibility of an Islamic bank in France, the publishing of a book on Islamic finance in Italian and shariah compliant real estate funds in Australia.

There is also news of expected sukuk issuances from the United Kingdom, Australia and Korea.

There have also been a diverse range of issuers of shariah compliant products including the World Bank, the Islamic Financial Centre, the German state of Anhalt-Saxony, Aston-Martin and Shell, which pioneered the sukuk.

"The world is interested and I believe Islamic finance to be up to the challenge," Raja Nazrin said, adding that the industry is growing with more demand seen from non-Muslim investors, not only in Malaysia but also abroad.

He stressed that one of the most important goals of the Islamic finance industry should be to integrate into the global financial system.

Link: http://www.bernama.com/bernama/v5/newsbusiness.php?id=431825

Corporate Governance and Islamic Finance

by Hany Abou-El-Fotouh

Good corporate governance is essential for the development of a vibrant and sound Islamic finance industry. Corporate governance has mainly to do with transparency, accountability and fairness. The concept of corporate governance was proposed as a result of increasing awareness about the importance of the need to protect the rights of all stakeholders, including minority shareholders. Whilst the term corporate governance has gained importance only in the last two decades, the concept is not essentially strange to Islam.

Good Corporate Governance

Good corporate governance is more than a good idea. It encourages flow of investments, lowers the cost of capital and supports strong capital markets. Corporate governance represents structures and processes that entail individuals carrying out business whilst exercising professional discretion in a way that exhibits integrity, judgment and transparency. These principles are essential to Shari'ah and Islamic finance.

The Organisation for Economic Cooperation and Development (OECD) Principles of Corporate Governance focus on:

Accountability:

Ensuring that management is accountable to the Board and the Board is accountable to shareholders.

Fairness:

Protecting shareholders rights; treating all shareholders - including minorities - equitably and providing for effective redress for violations.

Transparency:

Ensuring timely and accurate disclosure on all material matters, i.e., financial situation, performance and ownership.

Responsibility:

Recognising the legal rights of stakeholders.

The teachings of Shari'ah bind fairness and honesty to the main principles of any conduct, including transactions. We may strongly argue that good corporate governance is consistent with Shari'ahcompliant financial conduct which prohibits fraud, embezzlement, misstatement and other patterns of dealings that cause abuse, injustice and gharar (risk, uncertainty, and hazard).

Is the Islamic Corporate Governance Model Different?

The question remains: How is the corporate governance of an Islamic financial institution different from that of a conventional counterpart? The Islamic model of corporate governance would first look at the transactional structure to see whether the transaction involves elements that invalidate the gains or profits. Conventional governance practices do not perform a similar function (except for transactions with related parties, self-dealing, etc.) On the other hand, it ensures that the transactions do not contravene the corporate code of business ethics and cross the line that the law has drawn. Since Shari'ah represents a major source of legislation in most of the Muslim countries, it plays an important role in the legislative and regulatory development in such countries. It is not unlikely that some Muslim countries would rely on Shari'ah for possible future implementation of corporate governance, whether in the form of code or regulations.

For example, Shari'ah provides the proper platform for codifying fiduciary duties and related ethical practices. These practices are the foundation of good corporate governance as outlined in the OECD Principles of Corporate Governance. Therefore, we believe that modern corporate governance practices are consistent with Shari'ah.

The OECD Corporate Governance Principles emphasise more disclosure and rights to shareholders. Protection of minority interest is considered crucial for stronger capital markets. For that reason, legal protections for minority shareholders and their strong enforcement encourage local and international investors to invest in emerging markets.

Shari'ah has mandated similar or higher importance to such issues for doing business. Like modern governance practices, the Islamic corporate governance model requires application of modern and higher standards of minority protection against expropriation, more disclosures and transparency and effective accountability.

With this outlook, and as Shari'ah does not indicate any upper limit for better regulation, the contemporary drive for achieving higher standards in corporate governance does not appear to conflict with Shari'ah. Consequently, Islamic financial institutions would have no problem in meeting modern corporate governance practices.

Who Are the Major Stakeholders in Islamic Financial Institutions?

There are a number of key players and stakeholders in Islamic financial

Institutions:

Shareholderswould be interested in protecting the value of their equity in the financial institution and obtaining a good rate of return

Demand Depositors would be interested in guaranteeing the value of their deposits and having ready access to their funds.

Investment Depositors are murabaha contract holders with Islamic banks who supply funds to banks to invest properly. They would be interested in protection of principal and obtaining a good rate of return.

Regulators have legal power to monitor the daily activities of Islamic financial institutions. They would be interested in preventing systemic problems and crises, protection of the quality of financial products and efficiency of the financial system.

Financial Market Authorities set minimum standards for transparency and disclosure and would be interested in an efficient financial market.

The Islamic Finance Community would benefit from standardising Islamic financial products, contracts and practices.

The Public would be interested in obtaining quality financial services at competitive prices. In order to have good corporate governance, the board of directors, management and the auditors of an Islamic financial institution should perform their professional duties with the objectives of satisfying the needs of the shareholders and Allah as well. Corporate governance aims to enhance accountability, transparency and trustworthiness. These values are crucial in Islam.

The Shari'ah Supervisory Boards Role in Corporate Governance

The Shari'ah supervisory board is part of the internal governance structure of the Islamic financial institutions and appointed by shareholders of the institution. Its main function is to review and ensure that all transactions, contracts, products and applications relating to Islamic financial institutions comply with Shari'ah rules and principles according to the specific fatwa, rulings and guidelines that have been issued.

In order to establish a good corporate governance framework, the Shari'ah supervisory board may have to extend its jurisdiction to cover governance issues of this nature.

Actions Louder Than Words

According to The Islamic Financial Services Board (IFSB), there is no single model of corporate governance that will work in every country; each country or even each organisation needs to develop its own model.

From the standpoint of Islam, deeds are more significant than rhetoric, as highlighted in one verse of the Quran: "Why do you say that which you do not do? Corporate governance should be practiced in the form of deeds. Only when actions speak louder than words can a good corporate culture come forward and protect the welfare of all.

Link: http://www.islamica-me.com/article.asp?cntnt=342

IFSB invites comments for three Exposure Drafts

The Islamic Financial Services Board is working on a consultation paper which examines areas like corporate governance, Takaful and the role of Shari’ah boards and has issued three drafts for the public to comment on.

The Technical Committee of the Islamic Financial Services Board (IFSB) has recently issued three exposure drafts for public comment. They are:

ED-8: Guiding Principles on Governance for Islamic Insurance (Takaful) Operations

Part I recommends the adoption of good governance practices as prescribed by other international standards for insurance companies, while also addressing the specific needs of Takaful undertakings, while part II explains the appropriate governance structure and processes, including the relevant transparency and disclosure practices that adequately address the needs and interests of all stakeholders, with particular reference to Takaful participants. Part III relates to the general approach to sustaining a Takaful undertaking's solvency and promoting sound investment management of its assets.

ED-9: Conduct of Business for Institutions offering Islamic Financial Services (IIFS)

The IFSB said that ED-9 aims to promote a climate of confidence and a supportive environment in the business of the Islamic financial services industry by upholding and strengthening the relevant moral, social and religious values in business practices.

“These principles,” it says, “are desired from institutions that offer Islamic financial services (IIFS) not only because of Shari`ah obligations and requirements, but also because they serve to manage operational risks of the IIFS, particularly reputational risk.”

Apart from complementing the IFSB standards and guidelines, the document addresses the specificities of the IFSI. It thereby aims to ‘add value’ to other existing internationally recognised frameworks that set out sound principles and best practices pertaining to the conduct of business of participants and institutions in the conventional banking, insurance and capital market industry segments.

ED-10: Guiding Principles on Shari`ah Governance System

ED-10 aims to highlight to the supervisory authorities in particular, and the industry's other stakeholders in general, the components of a sound Shari`ah governance system, especially with regard to the competence, independence, confidentiality and consistency of Shari`ah boards. The ED has five parts:

·         Part I explains the general approach to a Shari`ah governance system, whereby various globally accepted ex-ante and ex-post governance processes are adapted in order to strengthen the Shari`ah governance system. These processes include, among others, terms of reference for Shari`ah boards, appropriate alignment of incentives, proper record-keeping, and adoption of a professional code of ethics;

·         Part II addresses the issue of competence by proposing various measures and criteria to ensure a reasonable level of expertise and skill-sets for members of Shari`ah boards. The proposed measures and criteria are intended to act as the basis for evaluating the performance of Shari`ah boards and determining their professional development;

·         Part III focuses on safeguarding the independence of Shari`ah boards, particularly from the management of IIFS, by highlighting various issues arising from potential conflicts of interest and recommending approaches for managing them;

·         Part IV highlights the importance of observing and preserving confidentiality by the organs of Shari`ah governance;

·         Part V emphasises a set of best practices that aim to maintain the appropriate level of professionalism among the members of the Shari`ah board.

The IFSB Secretariat said it would like to invite all IFSB members to share their input and comments on the drafts for the respective working group review and further action. All three exposure drafts are downloadable from the IFSB website (www.ifsb.org), and those who are interested may email their comments to ifsb_sec@ifsb.org. The Public Consultation period for the drafts end on 15 May 2009 and they are scheduled for adoption by the end of the year.

The IFSB is holding a Public Hearing on the Exposure Drafts on 5 May 2009 in Singapore, prior to the 6^th IFSB Summit. All members of the IFSB are invited to attend the session. Details of the Public Hearing and the Summit can be seen at www.ifsbsingapore2009.com

Link: http://www.cpifinancial.net/v2/fa.aspx?v=0&aid=205&sec=Islamic%20Finance