LECTURE 14 �Monitoring and corporate governance in Islamic bank

Islamic Banking Management

FEB UI

Wahyu JATMIKO, PhD

wahyujatmiko@ui.ac.id | w.jatmiko09@gmail.com

May 2022

Objectives

• Islamic bank stakeholders
• Regulation and monitoring in Islamic bank
• Monitoring and regulation in financial sector
• Corporate governance in Islamic bank
• Critical issue related to corporate governance of Islamic bank

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Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Reading Materials

HAL Ch. 9

VAN Ch 3, 4, 11, 12, 14

WAH Ch 3

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Islamic Bank Stakeholders

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Islamic Bank Stakeholders

(Beekun and Badawi, 2005; Greuning and Iqbal, 2008)

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Regulation and monitoring in Islamic bank

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Full-fledged Islamic Banking System Vs Dual Banking System

• Most Muslim countries have adopted some variant of Western legal systems either due to colonisation or imitation.
• Islamic Law: Iran, Saudi Arabia and Sudan
• Western legal systems with supporting Islamic banking law
• English Common law: Malaysia and Pakistan
• French Civil Law: Indonesia, Bahrain
• Western legal systems without supporting Islamic banking law
• UK, USA, Canada
• Potential Legal paradox in IB business 🡪 legal risk
• Banking law: following country
• Tax law: following country
• Contract law: Shari’ah

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Legal regimes and laws

Two broad criteria can be used to classify Shari‘ah governance regimes.

• The first is the existence of a national framework for Shari‘ah governance in the form of law/regulations supported by a complementary national Shari‘ah supervision mechanism at the regulatory level.
• A second aspect of the Shari‘ah regulatory framework would set up requirements to strengthen the organisational Shari‘ah governance structures and processes.

Given the two-criteria framework above, the Shari‘ah regulatory regimes can be identified as the following four types.

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Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Additional Monitioring

Legally constructed

• The Shari‘ah framework is determined by law with no supporting Shari‘ah bodies at the national or organisational levels.
• An example of this system is the governance regime in Iran where the products that can be offered by banks are identified by the Usury Free Banking Act 1983.
• While the central bank is responsible for implementing the law, there is neither any Shari‘ah body at the national level nor any requirement to have an SSB at the organisational level.
• If a new product is introduced, the central bank seeks advice and endorsement on the Shari‘ah-related issues from well-respected Shari‘ah scholars

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Additional Monitioring

Robust Shari‘ah governance

• This regime has an active Shari‘ah governance system both at national and organisational levels.
• Examples of robust Shari‘ah governance regimes include Indonesia, Pakistan and Malaysia.

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Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Additional Monitioring

Passive Shari‘ah governance

• Countries have a passive Shari‘ah governance at national level and active Shari‘ah governance at organisational level.
• Countries in this category may have a National Shari‘ah Authority (NSA), but its role is limited and does not include approval of new products.
• Examples of countries falling under passive Shari‘ah governance regimes are the UAE and Kuwait.

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Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Additional Monitioring

Market driven

• Shari‘ah compliance is left to the banks and there is no central NSA to oversee the products being marketed.
• There is no regulatory oversight or guidelines for the SSB at the organisational level.
• A market-driven practice of Islamic banking is found in Bangladesh, the Kingdom of Saudi Arabia, and the UK.

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Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Additional Monitioring

Corporate Governance in Islamic Bank

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Corporate Governance

• Corporate Governance is the process by which organizations are directed and controlled.
• Using a series of board and committees, corporate governance is designed to oversee the running of a company by its managers and to ensure that interests of all the stakeholders (customers, employees, vendor partners, state and local entities, and the communities in which the company operates) are fairly represented and treated
• However, when we examine who is controlling the corporation, and for whom, the situation gets a little more complicated.

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Corporate Governance

• Corporate governance is about the way in which boards oversee the running of a company by its managers, and how board members are, in turn, accountable to shareholders and the company.
• This has implications for company behavior toward employees, shareholders, customers, and banks.
• Good corporate governance plays a vital role in underpinning the integrity and efficiency of financial markets.
• Poor corporate governance weakens a company’s potential and at worst can pave the way for financial difficulties and even fraud.
• If companies are well governed, they will usually outperform other companies and will be able to attract investors whose support can finance further growth.

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Governance in Modern Corporation

Fred R. Kaen, A Blueprint for Corporate Governance (New York: AMACOM, 2003).

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Two Approaches of Corporate Governance

Comply or Explain

• Guidelines that require companies to abide by a set of operating standards or explain why they choose not to.

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Comply or Else

• Guidelines that require companies to abide by a set of operating standards or face stiff financial penalties.

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Risk Governance in Islamic Banks

• The approach and principles of risk governance in Islamic banks will be similar to conventional banks
• Specific issues arising from Shari’ah
• Risk capacity and modes of financing
• Are partnership contracts within the risk capacity of banks?
• Risk Appetite
• Risks vs. Shari’ah compliance/ethics
• Shari’ah compliance and reputational risks
• Shari’ah governance framework
• Shari’ah audit framework

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Critical issue related to corporate governance of Islamic bank

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Shareholders’ versus Stakeholders’ Value

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Grais and Pellegrini (2006, WB WP)

Different Regulations on Internal Shariah Advisory

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Grais and Pellegrini (2006, WB WP)

Different Regimes on External Shariah CG

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Grais and Pellegrini (2006, WB WP)

Variations in the Accounting Standards

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Grais and Pellegrini (2006, WB WP)

Issues in Shari’ah Governance?

Wahyu Jatmiko | Monitoring and corporate governance in Islamic bank

Thank you

Wahyu JATMIKO, PhD

wahyujatmiko@ui.ac.id

w.jatmiko09@gmail.com