Sharia Supervision in modern islamic finance

8/9/2019 Sharia Supervision in modern islamic finance

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Shariah Supercision in Modern Islamic Finance Yusuf Talal DeLorenzo

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Shariàh Supervisionin Modern Islamic Finance

by Yusuf Talal DeLorenzo

S hariàh supervision maybe thought of as the singlemost important distinctionbetween a conventional and atruly Islamic financial venture.For, while a business mayattempt to represent itself asIslamic, unless it has qualifiedShariàh supervision, it has no

way of certifying that itsservices,products, and operations areactually Shariàh-compliant. Inthe emerging Islamic financialsector, therefore, Shariàhsupervision is not a matter tobe taken lightly. Publicconfidence,in any sector, is alwaysan important consideration;and in the financial sector itsimportance is paramount.Shariàh supervision signifies areal commitment on the part of management to the principlesof transparency andaccountabilityin the matter of Shariàhcompliance.

What is Shariàh Supervision?While it may be convenientto explain Shariàh supervisionas a religious audit (especiallyto Western observers andregulators),its scope is far morecomprehensive. In essence,Shariàh supervision is theprocess of ensuring that afinancialproduct or service complieswith Islamic legal precepts andprinciples, either by itsconforming(to one degree oranother) to a recognized Islamiclegal norm or by its not violatingthe same. Ideally, Shariàh

supervision will be a part of anIslamic product or service fromthe time of its development, toits launch, and throughout theperiod it is offered. At the stageof research and development,or of drafting contracts orofferingmemorandums, Shariàhsupervision, in one form oranother, should be an activeparticipant. By including

Shariàh supervision and adviceat the earliest stages,managementmay save costly legal feesthat may be required at a laterstage if elements of the proposedbusiness/contracts needto be modified to comply withShariàh principles and precepts.Generally speaking, if Shariàh supervisors are tocertifya venture, they will insiston being a part of itsdevelopment;

or at least to havingaccess to the details of whateverwent into the development orstructuring of the product,instrument, service, orenterprise.Moreover, once a productis launched, Shariàh supervisionmay take the form of ongoing monitoring throughperiodic audits. Such auditsmay be undertaken by meansof site visits, document reviews,or consultation withmanagementat regular intervals.

PurposeThe most obvious andimmediate purpose of Shariàhsupervision is to certify forpracticing Muslim consumersand clients that the financialproduct or service being offeredto them is acceptable from an

Islamic legal perspective and istherefore lawful to them. 1 Suchcertification, generallydocumentedin a formal fatwa(Shariàh position paper), maybe thought of as a form of duediligence. In effect, the Shariàhsupervisor, or supervisoryboard, performs this duediligenceon behalf of consumers

who are without access to thedetails of what is offered tothem and, likewise, without theexperience or qualifications toevaluate those details in light of Shariàh teachings. By assumingresponsibility for theShariàh compliance of anIslamic financial institution,including its policies andpractices,Shariàh supervisionplaces itself in a position of directly representing thereligious

interests of the Musliminvestor or consumer; and bymaking every possible effort toensure that an Islamic financialproduct is halal, the servicesperformed by Shariàh supervi-sors are directed toward theinvestor, or the consumer.Undoubtedly, as a result of these efforts, Islamic financialinstitutions and theirmanagementwill also benefit. But certainlythe primary beneficiary isthe Muslim consumer who canrest assured that his/her moneyis being put to use in ways thataccord with the teachings of Islam. It is for this reason thatShariàh supervision may alsobe characterized as consumeradvocacy.


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Background Since many if not most of thedealings or operations of Islamicbanks may be considerednovel, in the sense that thesewere unknown in the times of the classical jurists, there is a

very real need for reliableopinionson these dealings; legaland academic opinions derivedfrom authentic Shariàh sourcesby the means and methodologiesestablished by generationsof Muslim jurists. Then, while itmay indeed be possible for anindividual to come up withauthoritative opinions on theseissues, it soon became clear tothe newly established Islamicbanks that it would be better tohave the collective opinions of a

group of scholars. Moreover,the banks soon learned that itwas best to appoint scholarswith specializations in the fieldof fiqh al muàmalat, and whoalso had working knowledge of modern financial markets andpractices. Then, by means of qualified Shariàh supervision,Islamic banks may assure theirclients and investors that theoperations they undertake arereviewed in all of their detailsfor compliance with theprinciples

and precepts of theShariàh. By means of such areview, by such a group of experts, the banks and financialinstitutions may clearlydemonstratethat their transactionsand dealings conform to Islamiclegal norms.

Elements of ShariàhSupervision:

NumbersShariàh supervision may beperformed by an individualsupervisor/advisor, or by aboard of supervisors/advisors,commonly known as a ShariàhSupervisory Board. 2 Whetheran institution has a board or asingle supervisor is its ownchoice. Generally speaking,however, such a choice isinformed by severalconsiderations.

Chief among theseconsiderationsis the product oroperation itself. An Islamichome financing alternative, forexample, is a complex affairand will undoubtedly benefit

from the collective opinions of a diversified Shariàh Board.The same will be true of acommercialor investment bankingoperation. An Islamic mutualfund, on the other hand, mayrequire a single supervisor,especially if it has licensed itself to an index provider like theDow Jones Islamic MarketIndexes, and is set up to do nomore than track the index. Anactively managed fund, however,even if it is licensed to an

index, may require more thanone supervisor. These areconsiderationsthat have to do withthe nature and requirements of the supervision itself. At thesame time, marketingconsiderationsmay also be of importanceto management. If a productor service is to be marketedinternationally, for example, orin a market in which Muslimsfrom different parts of theworld are found (like the US

and UK), then it may be in theinterest of management toengage several scholars, eachfrom a different part of theMuslim world. Whatever thecase, prudence dictates thatthere be at least three supervisorsfor any Islamic financialundertaking. Moreover,experiencehas shown that at leastone of the members needs toreside in the same country orregion as the operation, so as tobe readily available forconsultation,even on short notice. Insome cases, too, a Shariàhsupervisor will maintain anoffice and keep regular hours atthe bank or financial institution.

Elements of ShariàhSupervision:Qualifications

Obviously, a Shariàh supervisorwill be someone with abackground in the classicalShariàh sciences. In particular,however, supervisors need tohave studied the fiqh almuàmalat or rules concerning

transactions developed by theclassical jurists and expandedupon by later generations of Shariàh scholars. Most Shariàhsupervisors have producedacademicwork or studies on oneaspect or another of these rules.In addition, such a backgroundpresupposes facility in theclassicalArabic language and theability to deal directly with legaltexts, glosses, and commen-taries in that language. In

additionto all this, an understandingof modern finance, markets,and economics is also clearlyrequired. Finally, an effectiveShariàh supervisor must befamiliar with internationalbusinesspractices (ùrf) and havean appreciation for regulatoryenvironments. For these reasons,the English language isespecially important. One morepoint that should be kept inmind is the supervisors ability

to work with a team, oftentimesin a cross-disciplinary andcross-cultural environment.Generally speaking, todaysShariàh supervisors possess thequalifications and characteristicsdiscussed above. In addition,many Shariàh supervisorshave benefited from theexposureafforded by multiple boardmembership. Then, while at thepresent time there are nostandardqualifications for Shariàhsupervisors, it is to be hopedthat, in the future, and as theIslamic financial sector grows,graduate level programs will bedeveloped for the specificpurposeof preparing new generationsof scholars with all of therequisite skills. At present,however, the number of people


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qualified to serve as Shariàhsupervisors is limited.My own suggestion in regardto preparing scholars for afuture in Shariàh supervision istwofold. 3 Firstly, Islamicfinancial

operations may appoint, inaddition to its full ShariàhBoard members, junior memberswho will participate indiscussions,prepare memos andbriefs, take notes, and performresearch and other tasks for theShariàh Board, but who willnot have full status as votingShariàh Board members.Secondly,

junior members may beappointed on a rotating basis,such that each will serve, much

like a law clerk for a serving judge in the United States, for aperiod of one year. By means of this rotating arrangement, manyscholars will have an opportunityto learn first hand aboutthe workings of Shariàhsupervision.Moreover, as juniormembers become increasinglymore familiar with modernbusiness norms and practices, itwill become easier for them toanalyze situations and think through options, with the result

that their contributions to thework of the Shariàh SupervisoryBoards will become increasinglyvaluable. Obviously, such

junior members will becompensatedfor their efforts,though not at the same level asthe full board members.


IndependenceIn order to be effective,Shariàh supervision must beindependent. In addition, thedecisions of the supervisor/smust be binding on management.If these steps are nottaken, the credibility of thesupervision, and the company,will be in question. Therecommendationof AAOIFI is thatShariàh supervision must serve

at the pleasure of the companysBoard of Directors, and not besubject to management. Undersuch an arrangement, the Boardwill be free to approve ordisapproveof what management

does, or proposes to do, solelyon the basis of Shariàh/legalconsiderations. Of course, thisis not to say that a ShariàhBoard will automaticallybecome a thorn in the side of management. On the contrary,most Shariàh Boards operate inthe spirit of cooperation andaccommodation.

Elements of ShariàhSupervision:CommunicationAn essential element in the

success of any undertaking iscommunication. This is equallytrue in regard to Shariàhsupervision.To begin with, theremust be clearly delineated linesof communication betweenmanagement and Shariàhsupervision. Oftentimes, anIslamic financial institution willappoint one of its executives,whether from businessoperations,finance, or legal, to act asliaison with the supervision.

This person will be responsiblefor coordinating anddocumentingregular meetings, arrangingfor the requirements of Shariàhsupervision, following up ondecisions and suggestions, andprocessing and channelingcommunications to and fromsupervision. When boardmemberslive on different continentsand work in different timezones, the work of such acoordinatorcan be challenging.


EducationThe correlate of consumeradvocacy is consumer education.In making this observationI mean to refer to the world of

possibilities for enhancingMuslimconsumer awareness of, andappreciation for, Islamicfinancialservices and products. Forexample, the Dow Jones Market

Indexes developed andsupporteda course on the Principlesof Islamic Investing thatwas offered to students of theDow Jones University on theinternet. Unfortunately, thecourse is no longer available,though efforts are underway forits revival at another venue.Likewise, several Islamicfinancialinstitutions supported theeffort to produce the Guide to

Islamic Investing in cooperation

with the Lightbulb Press; andothers are supporting the Guideto Islamic Home Acquisition . Inshort, every institution offeringIslamic financial services needsto concern itself, to one degreeor another, with issues of consumereducation. Obviously,the chief concern will be toprovide information about theirown products. But, generallyspeaking, Muslim consumersneed to know that Islamicfinancial alternatives exist. They

need to know that thesealternativesare viable, from both areligious viewpoint and apracticalone. And they need toknow that these are competitiveand worthy of their trust. Theseare the basics of such aneducation.Obviously, there is muchmore that can be done. In aservice-oriented market that isdriven by competition, thefirms with the better serviceswill have the most success.Shariàh supervision thatengages in consumer educationenhances service, not to mentionconsumer confidence.

Shariàh Supervision Then and NowAs the sector goes, so goes itsShariàh supervision. Perhaps


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nothing could be more obvious.In the days when Islamicbankingwas in its infancy, Shariàhsupervision, too, was feeling itsway. With little or no exposureto modern finance, Shariàh

supervisors faced a very steeplearning curve. To begin with,in the fifties and sixties, therewas very little in terms of literatureon the subject. The StateBanks of a handful of Muslimcountries sponsored conferenceson Islamic Economicsand Shariàh scholars wereinvited to contribute. Theseearly papers and presentationsled to more concerted effortsand scholarship. With theadvent of Islamic banking in

the seventies, and a realdemand for Shariàh supervision,there was more incentivefor such academic efforts.Indeed, the development of thesector, and the development of the various sets of expertiserequired to give it momentumwent hand in hand. Today, afterthe passing of over thirty yearssince the first Islamic banksopened their doors for business,Shariàh supervision continuesto improve and evolve.Globally, a number of different

efforts to increase ourunderstanding of Islamicfinance are underway.Universitiesoffer courses on varioussubjects in Islamic Financetoday, not only Economics; andseveral important graduatedissertationshave been publishedin English and Arabic. Journalson the subject of Islamicfinance are published regularly.Websites devoted to the subjectare available on the internet.Learned academic bodies likethe OIC Fiqh Academy inJedda, AAOIFI in Bahrain, theIIBI in London, the IIIT inCairo, and the Fiqh Academy inIndia have produced volumesof literature on the subject; andeverywhere scholars are atwork. Recently, at a conferenceon Islamic Finance in Dubai, a

welcome step was taken topromotethe efforts of individualscholars. This was the NewVoices competition, sponsoredby the US-based GuidanceFinancial Group, in which

scholars were invited to submittheir original work to a jury of experts; and the best paper wasawarded a substantial dollarprize.My own experience has ledme to a view of the future of Shariàh supervision thatincludes increasingly informeddiscourse by enlightenedShariàh scholarship. It may bedifficult to achieve consensuson every issue, but the importantthing is that our Shariàhscholars are now able to speak

with authority on these issues.Moreover, cross-disciplinarycollaboration on projects inwhich there is activeparticipationby lawyers, Shariàh scholars,and business professionalswill bring more innovation tothe industry and further enrichthe emerging academicdiscourse.Innovation and creativethinking have always been apart of development; and it isclear that the Islamic financial

industry is developing in ways,and on a scale, that wereunimaginable only a fewdecades ago.

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Footnotes1 The operative religious/legalprinciple in this matter is oneregarding collective andindividualresponsibility. In cases whereexpertise is required for thegood of the community, such asexpertise in medical, or political,or military affairs, the principleis that as long as the communityproduces individuals capable of dealing with such matters, thecommunity will have performedits duty, or fard kifayah.2 The First Annual Conferenceon Shariàh Supervisionheld last year by the Accounting

and Auditing Organization of Islamic Financial Institutions(AAOIFI) in Bahrain held that itwas sufficient to call such a bodya Shariah Board. In order to bemore readily understandable toregulators in Muslim-minority

countries, such as the US andEurope, there is nothing wrongin using another name, likeEthicalAdvisory Board.3 I am pleased to report thatone of these suggestions hasbeen implemented by one of thegroups with which I work; andthat the other will beimplementedin the coming year byanother.

Sharia Supervision in modern islamic finance

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