Islamic Finance

Central Shariah boards: The shift away from self-regulation

| 20 April, 2017 | General
 Yazad Darasha, White Paper Media
Central Shariah boards: The shift away from self-regulation

As a multitude of countries with burgeoning Islamic finance sectors establish centralised Shariah boards to harmonise principles and structures at the national level, analysts say this would reduce the costs of executing transactions, improve market depth and increase product innovation.

The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) announced late last year that it was working on developing a standard for central Shariah boards, or CSBs, which would provide guidance for strengthening corporate governance. The initiative intends to shift the Islamic finance industry away from self-regulation.

“[The initiative] is about understanding the requirements of the overall industry rather than allowing one bank to do whatever they want to in the name of Shariah compliance. Regulators are now more aware of the need for standardisation in the Shariah principles and structures related to Islamic financial products,” Omar Mustafa Ansari, AAOIFI’s Deputy Secretary General for Accounting and Governance, told Salaam Gateway.

AAOIFI’s standards for CSBs are likely to be finalised this year. The industry body is currently holding public hearings in different parts of the world on the draft standard it released in February. The draft provides detailed guidance on the definition, scope, responsibilities, appointment, composition, independence and terms of reference of a CSB, among other relevant issues.


A long-held industry argument is that the lack of standardisation has created an additional layer of complexity for Islamic financial market instruments, particularly sukuk, and has deterred some potential issuers from tapping the market. Differences in interpretation across jurisdictions continues to prevent Shariah-sensitive investors from using some instruments due to questions about adherence to Shariah rules.

“The most important goal is to harmonise Shariah principles for the benefit of the financial sector and capital markets in a particular country as well as to provide strong governance around the fatwa process to prevent conflicts of interest or at least manage them transparently,” Khalid Howladar, Founder and Managing Director of Acreditus, a consultancy providing risk, rating and Islamic finance advisory, and former Global Head of Islamic Finance with credit ratings agency Moody’s, told Salaam Gateway.

“Standardised financial contracts and structures should be consistent within the country, thus improving transparency and market liquidity,” he said.

Mohamed Damak, S&P’s Global Head of Islamic Finance, further reminds the industry of the need for external audits, “The presence of CSBs could enhance the quality of national supervision of the Islamic finance industry. This could help achieve greater market discipline, coupled with the move toward external Shariah auditing that some core Islamic finance markets are implementing. External Shariah audits could, in our opinion, help increase the transparency of the industry when it comes to Shariah compliance,” Damak wrote in a research note.

Shariah audits are currently conducted by internal auditors for Islamic banks, and pose the risk of conflict of interest and do not involve public disclosure. Addressing this risk, Bahrain’s central bank proposed external Shariah audits for Islamic banks under its jurisdiction in September last year.

Damak also underlined the industry’s argument that standardisation could increase its attractiveness for corporate and retail customers because it would reduce doubts about Shariah compliance as well as the possibility of Shariah arbitrage by issuers and banks.

"By documenting their decisions, central Shariah boards could help push the industry toward greater innovation." - Mohamed Damak, S&P


Expanding on the role, composition and priorities of a CSB, Howladar believes that good corporate governance is critical and would drive strength in all other aspects. “The processes, policies and decisions [of a CSB] should be documented with audits by third parties and published for improved transparency and liquidity,” he said.

Damak agrees. “By documenting their decisions, CSBs could help push the industry toward greater innovation. Boards would need to spend less time on recurring issues related to Shariah compliance, allowing scholars to spend more time on innovation,” he wrote.

Further, Howladar calls for a clear mission statement, saying, “At the moment, there exists a clear tension between the Shariah financing principles of the unsecured debt-based market and the asset- or equity-backed instruments.”

The analysts also agree with AAOIFI’s recommendation to include expert members such as accountants, lawyers and economists. To this, Damak reiterates a long-held industry concern, “The shortage of Shariah scholars and the presence of some prominent scholars on a significant number of Shariah boards are generally viewed by the market as a major impediment to the development of the Islamic finance industry.”

Given its role related to financial and market supervision, Howladar stresses the need for a CSB to be set up and managed by the central bank and/or the relevant securities commission of the country.

“Regulations should be passed to encourage adoption of market standards. Other non-compliant structures can still be implemented, but these would not be endorsed by the CSB. Hopefully, market forces will then take care of the rest,” said Howladar.


The UAE last year announced the creation of a national-level Shariah Authority by the central bank to oversee the country’s Islamic financial sector, approve financial products and set rules and principles for banking transactions in accordance with Islamic jurisprudence. The central bank will oversee and select members of the authority, which will not replace the Shariah boards of individual banks.

The UAE is by no means an early mover. Bank Negara Malaysia, the Malaysian central bank, set up its Shariah Advisory Council in 1997 and another oversees the capital market that is regulated by the Securities Commission. Pakistan has a similar setup.
Oman’s central bank established its central Shariah board in 2012 when the sultanate finally gave Islamic finance the nod, while Bahrain is currently in the process of forming its own CSB and Morocco is setting one up as a precursor to establishing fully fledged Islamic banks and issuing its first sovereign sukuk.

"The central Shariah boards could one day (in sha Allah) cooperate for a global Shariah board." - Khalid Howladar, Acreditus


While the AAOIFI’s standards for CSBs would be a first step in helping to harmonise the various facets of Islamic finance at the national level, the next impetus would come from an international body that does the same at a wider level, much like the Basel Accords that create a global, voluntary regulatory framework for conventional banking principles.

In the current situation, individual Shariah boards have significant leeway in making decisions regarding compliance, resulting in variations across the industry. Malaysia is perceived by market participants as the least conservative jurisdiction and Saudi Arabia as the most conservative.

According to S&P’s Damak, “AAOIFI’s proposal could benefit from recommendations on the ways national boards could interact on regional and global levels to push forward standardisation. Such an approach will lend greater consistency across countries where Islamic finance is developing and could spur greater integration within the industry.”

Acreditus’s Howladar added, “The CSBs could one day (in sha Allah) cooperate for a global Shariah board. This would truly bring depth and advantages to all Islamic markets.”

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