Governance and Islamic Finance

Islamic Finance has been emerging as an alternative finance segment of the global financial system, for the past few years. The principles used are based on Shariah principles that are consistent with the good governance frameworks that countries have been asking the financial systems and banks to follow. Islamic principles, such as preventing risk, uncertainty, and hazard and avoiding business transactions that cause injustice to any of the parties are ingrained in the Islamic finance model. Of course, if this can be achieved then there is no need to talk about governance and systems because people should be acting in good faith to meet the objectives of these principles?

However, I was fortunate to learn about a set of challenges that the Islamic finance industry faces on a day to day basis. I’ve tried to list only 4 of them.

The products/services coming under the IF banner require an approval by Shariah scholars called a Fatwa [seal of approval, confirming the product is Shariah compliant]. One of the foremost challenges faced by the Islamic finance industry is the shortage of qualified Shariah scholars and the high concentration of a few top scholars serving the industry. These scholars who have to guard the principles behind Islamic finance don’t come under any specific body and therefore are not ‘guarded’ to operate within any governance framework.

Secondly, since there is no universal framework that the Scholars must follow, they can even issue public opinions (Fatwa) contrary to previous opinions established by themselves or other scholars. This effectively places the industry hostage to the change of attitude by scholars who gain prominence through their years of serving the industry. Such fatwas can vary from country to country and from scholar to scholar as well. This gives rise to a third challenge.

The third challenge is that it would not create a level playing field, as the process for obtaining these fatwas allows institutions to search for a religious opinion that is suitable to its business proposition. Which may raise the issue of “fatwa shopping.” Due to this, banks can create the same type of products that are used in the conventional markets and then phone up a Shariah scholar for a Fatwa. If this is not forthcoming from a particular scholar, they can go shopping for a Fatwa!

The above three challenges compound to a fourth one of potential conflict of interest of scholars. The challenge of scholars being appointed by the management of Islamic banks or funds and thereby being paid by them represents a conflict of interest. Others may argue that it’s similar to lawyers, accounting advisors or auditors being used by banks. May be its a challenge due to the absence of a particular standard or framework for IF. Some countries have resolved this issue to a certain extent with the announcement of a Central Shariah Committee which has to approve all products in the jurisdiction, in addition to institution specific boards, which may be a way forward.

Whilst, appreciating the good nature of this type of alternate finance, I was confused as to how customers can get the confidence that their money is used to uphold the Islamic principles of preventing risk, uncertainty, and hazard and avoiding business transactions that cause injustice to any of the parties. May be for that reason IF institutions should have good governance structures to abide by the Islamic principles?

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About surenraj

“Views expressed are my own”
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2 Responses to Governance and Islamic Finance

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