a critique of shariah reports in selected islamic banks

A Critique of Shariah Reports in Selected Islamic Banks

Ezry Fahmy Bin Eddy Yusof

Abstract

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) as well

as Bank Negara Malaysia (BNM) have provided guidelines for Shariah reports of Islamic

financial institutions (IFIs). In this paper we will try to show the differences of AAOIFI and

BNM guidelines for Shariah reports of Islamic institutions, and then we compare Shariah

Supervisory Board (SSB) reports in 10 different selected banks inside and outside of Malaysia.

Then the last part of the paper we will try to analyze some possible suggestion made by some

literatures in the betterment of the Shariah Committee Report in the aspect of its disclosure and

transparency by making a holistic view from Shariah perspective on the current method of

Shariah Committee Report.

Field of Research: Shariah Committee Report, Roles and Responsibilities of Shariah Advisory Board

P a g e | 2 A Critique of Shariah Reports in Selected Islamic Banks

Quran 02:42

1.0 Introduction

Islamic banking pre-supposes an Islamic society and an Islamic polity. A society bereft of

faith in Allah and in Islamic values can hardly be able to establish an Islamic banking and

finance order. And that is why the Holy Quran has emphasized faith as the first pre-requisite in

setting up an Islamic economic order. Muslims should come forward to help their brothers in

society to do their business, to do their trade, to carry on their industrialization, to carry on their

cultivation, to carry on all that is required to get the wheels of the society and continuing to move

more easily.

The Islamic banking and finance industry has grown enormously over the last decade. To

build the public’s confidence, and make the industry prosper. It become very crucial to have a

governance mechanism (Shariah Supervisory Board) ensuring its compliance with Shariah by

auditing their operations and report their findings to the Board of Directors (BOD). This is the

distinctive characteristic of the Islamic finance industry as compared to the conventional one.

2.0 Differences of Existing Guidelines: AAOIFI & BNM Guidelines

AAOIFI and BNM are provided guidelines of Shariah reports of Islamic institution. AAOIFI

guidelines are much more detailed and compliance-focused. On the other hand BNM guidelines

(GP8-i) are just a requirement of the opinion of Shariah board members on institution’s

operation conformity with Shariah principles.

We will disclose further why there are some literatures deemed that Shariah reports

based on BNM guidelines (GP8-i) are lacking more information as compared to the information

provided in AAOIFI based Shariah reports, which are meant to be the minimum Shariah


Committee Report. But before explaining the main problem, we need to understand the

differences between these two guidelines.

2.1 AAOIFI Guidelines

AAOIFI Shariah standard had emphasized that the Shariah committee, “is entrusted with

the duty of directing, reviewing and supervising the activities of the Islamic financial institution

in order to ensure that they are in compliance with Islamic Shariah rules and principles”(Mohd

Hairul et al, 2005 ).

On the other hand, The Islamic Banking Act 1983 had state that “the establishment of a

Shariah advisory body to advise the bank on the operations of its banking business in order to

ensure that they do not involve any element which is not approved by the Religion of Islam.”

Thus the function of the Shariah committee is more on an advisory role on the bank’s operation.

In order to effectively execute the advisory role, the Shariah Committee still needs to have

Shariah review as an indicator of the bank compliance with Shariah before dispensing an advice.

In addition to the above, the roles of the Shariah committee as outlined in the GPS-1 is

generally more on the Shariah compliance of the bank products aside from giving consultation

and advise on any Shariah issues faced by the Bank. The minimum content of the Shariah report

provided by GP8-i had included that the operation of the bank is in compliance with

Shariah.”.(Mohd Hairul et al, 2005)

2.1.1 AAOIFI outlines the basic elements which must be contained in the Shariah

report.

Shahul (2009) explains thoroughly regarding the template or sample of AAOIFI’s

Shariah Report whereby the Shariah supervisory board’s report should contain the following

basic elements

(i) Title;

The Shariah supervisory board’s report should have an appropriate title.

(ii) Addressee;


The Shariah Supervisory Board’s report should be appropriately addressed as required by

the circumstances of the engagement and local laws and regulations.

(iii)Opening or Introductory paragraph;

The Shariah supervisory board’s report should identify the purpose of the engagement.

Illustrative wording for an (introductory) paragraph is shown below;

“In compliance with the letter of appointment, we are required to submit the

following report:”

(iv) Scope paragraph describing the nature of the work performed;

Illustrative wording for a scope paragraph is shown below;

“We have reviewed the principles and the contracts relating to the transactions and

applications introduced by the Example Islamic Financial Institution during the

period ended. We have also conducted our review to form an opinion as to whether

the Example Islamic Financial Institution has complied with Shariah rules and

principles and also with the specific fatwas, rulings and guidelines issued by us.”

(v) Management’s responsibility

A clear statement that the management of the Islamic financial institution is responsible

for proper complying with Islamic Shariah rules and principles can be illustrative

wording for Shariah statement as shown below.

“The Example Islamic Financial Institution’s management is responsible for

ensuring that the financial institution conducts its business in accordance with

Islamic Shariah Rules and Principles. It is our responsibility to form an independent

opinion, based on our review of the operations of the Example Islamic Financial

Institution, and to report to you.”

(vi) Scope Paragraph

There is also a need of confirmation that the Shariah Supervisory Board has performed

appropriate tests, procedures and review work as appropriate. Where appropriate,

examining, on a test basis of each type of transaction, evidence to support that the

transaction and dealings entered into by the respective Islamic financial institution are in

compliance with the Islamic Shariah rules and principles. Illustrative wording to explain

the review process is shown below;


“We conducted our review which included examining, on a test basis of each type of

transaction, the relevant documentation and procedures adopted by the Example

Islamic Financial Institution.

We planned and performed our review so as to obtain all the information and

explanations which we considered necessary in order to provide us with sufficient

evidence to give reasonable assurance that the Example Islamic Financial Institution

has not violated Islamic Shariah Rules and Principles.”

Where appropriate, the report of the Shariah supervisory board should include a clear

statement that the financial statements have been examined for the appropriateness of the

Shariah basis of allocation of profit between the equity holders and the investment account

holders. Where appropriate, the report of the Shariah supervisory board should include a clear

statement that all earnings that have been realized from sources or by means prohibited by

Islamic Shariah rules and principles have been disposed of to charitable causes. Where an

Islamic financial institution prepares a statement of sources and uses of Zakah and charity funds,

the Shariah supervisory board’s report should state whether the calculation of the Zakah is in

compliance with Islamic Shariah rules and principles.

(vii) Opinion paragraph containing an expression of opinion on the compliance of

the Islamic financial institution with Islamic Shariah rules and principles;

The Shariah supervisory board’s report should state whether the Example Islamic

financial institution’s contracts and related documentation are in compliance with Islamic

Shariah rules and principles. An illustration of these matters in the opinion paragraph is

shown below:

“In our opinion;

a. The contracts, transactions and dealings entered into by the Example Islamic

financial institution during the year ended…that we have reviewed are in

compliance with the Islamic Shariah rules and guidelines;


b. The allocation of the profit and charging of losses relating to investment accounts

conform to the basis that had been approved by us in accordance with Islamic

Shariah rules and principles

c. All earnings that have been realized from sources or by means prohibited by

Islamic Shariah rules and principles have been disposed of to charitable causes;

and

d. The calculation of Zakah is in compliance with Islamic Shariah rules and

principles.”

If the Shariah supervisory board has ascertained that the management of Islamic

financial institution has violated Islamic Shariah rules and principles or the fatwas, ruling

and guidelines issued by its Shariah supervisory board then the Shariah supervisory board

has to report the violations in the opinion paragraph of its report.

(viii) Date of report; and

The Shariah supervisory board should state the period covered by its report and

date the report as of the completion date of the review. Shariah supervisory board should

not date the report earlier than the date on which the financial statements are signed or

approved by management.

(ix) Signature of the members of Shariah supervisory board.

The Shariah supervisory board’s report should be signed by all members of the

board. Publication of the report of the Shariah supervisory board The report of the

Shariah supervisory board shall be published in the annual report of the Islamic financial

institution. Publication of fatwas, rulings and guidelines of the Shariah supervisory board

It is recommended that the Islamic financial institution publishes the fatwas, rulings and

guidelines issued by its Shariah supervisory board during the year. (AAOIFI: Shariah

Supervisory Board: appointment, composition and report, 2008)


2.2 BNM Guidelines

The objective of the ‘Guidelines on Financial Reporting for Licensed Islamic Bank’s

(GP8-i) is to provide the basis for presentation and disclosure of reports and financial statements

of Islamic banks in carrying out its banking and finance activities. The GP8-i set out the

minimum disclosure requirement that should be observed by the reporting institutions. The

reporting institutions are encouraged to disclose additional information on the accounting

policies, new financial instruments and other material activities of the reporting institutions.

This is to ensure that all the above activities are reported and well understood by readers

of the financial statements. The disclosure illustrated in the GP8-i (e.g. Auditors’ Report and

Shariah Committee Report) are not meant to be templates that must be adopted by the reporting

institutions. Further specific information and depending on each reporting institution’s

circumstances may be required in order to ensure fair presentation. (Ng Boon Ka et al, 2009)

Shariah Committee Report is like the auditor’s report in which it serves as an executive

summary of the Sharī`ah compliance aspect of an IFE. Hence, not everything is needed as long

as it fulfills the basic disclosure and transparency requirement. Nevertheless, audit processes i.e.

how the audit is conducted is not clearly lay out. It is understood that some banks processes are

perhaps too simplistic which raises transparency and proper governance issue. (Ng Boon Ka et

al, 2009)

3.0 Selected Shariah Committee Reports in Islamic Banks: Local and Foreign banks in

Malaysia (Shariah Report of 2006-2008)

Affin Islamic Bank Berhad

Reference to Sample

Report

All the report is based on BNM GP8-i.

Distinctive Feature No.


Al Rajhi Banking & Investment Corporation (Malaysia) Berhad

Reference to Sample

Report

The 2006 and 2007 report was based on BNM GP8-i and has no

much difference. But the 2008 report is more extensive than its

previous years.

Distinctive Feature The 2008 report is added with basmalah, salawat and salam (Islamic

salutation). But the content of reporting is still using the same

method (BNM GP8-i). No major development in terms of its

content.

Asian Finance Bank Berhad

Reference to Sample

Report

The 2006 and 2007 report is based on BNM GP8-i and has no much

difference. But there is a change in the 2008 report where it is

wholly based on AAOIFI sample.


Bank Islam Malaysia Berhad

Reference to Sample

Report

The 2006 and 2007 report was based on BNM GP8-i. However, the

2008 report is more extensive than the previous years since its

combine both BNM GP8-i and AAOIFI sample with some

distinctive feature.

Distinctive Feature (i) Number of meetings to review products, transactions and

processes in line with the Shariah requirements and approved the

following products.


(ii) Reviewed, adopted and approved several initiatives of the Bank

in strengthening the Shariah governance of the Bank.

(iii)The Bank carried out Shariah compliance review performed by

Internal Audit Division and Shariah Department throughout the

organization and the report was deliberated in the Council

meeting. The Council confirms that necessary efforts have been

taken to rectify the Shariah breaches, and the Bank has also

implemented several mechanism(s) to prevent similar Shariah

breaches from recurring.

(iv) Disclosure of more than 25 Shariah training sessions and courses

were organized which mainly aimed at enhancing the level of

understanding of Shariah application in the banking business

among the staff.

Kuwait Finance House (Malaysia) Berhad

Reference to Sample

Report

All the report from 2006 up to 2008 is wholly based on the AAOIFI

sample.


RHB Islamic Bank

Reference to Sample

Report

The 2006, 2007 and 2008 reports were based on BNM GP8-i and

have no much difference.


Distinctive Feature (i) There is no mentioned of Zakah payment except some

improvement in the 2008 report where they mention it.

(ii) Same goes as non-halal earnings that are set aside for

charitable purposes

Maybank Islamic Berhad

Reference to Sample

Report

The 2008 report is a modified version of BNM GP8-i and AAOIFI

sample.

Distinctive Feature

(i) It is been stated that the Shariah committee members have

provided the Shariah advisory services on various aspects to the

Bank in order to ensure compliance with applicable Shariah

principles as well as the relevant resolutions and rulings made

by the Shariah Advisory Councils of the regulatory bodies.

(ii) All the Shariah committee members signed the report.

4.0 Selected Shariah Committee Reports in Islamic Banks from outside Malaysia (Shariah

Report of 2006-2008)

Islamic Bank of Britain

Reference to Sample

Report

The 2006, 2007 and 2008 reports were based on BNM GP8-i and

have no much difference.

Distinctive Feature

(i) All report did not mentioned about the Zakah even most of the

template are following AAOIFI sample of Shariah Committee

report.


(ii) No mentioned of harm earnings in any of the report.

(iii) All reports are added with basmalah, salawat and salam

(Islamic salutation).

Albaraka Islamic Bank

Reference to Sample

Report

The 2006, 2007 and 2008 reports were based on simplified version

of AAOIFI and have no much difference.

Distinctive Feature

(i) The 2006 report did not mentioned about the Zakah.

However the report later have improved but disclose the

Zakah payment in the 2007 and 2008 report.

(ii) Same goes as non-halal earnings that are set aside for

charitable purposes

Shamil Bank

Reference to Sample

Report

The 2006, 2007 and 2008 reports were based on simplified version

of AAOIFI and have no much difference.

Distinctive Feature

(i) Zakah is not mentioned in the annual report even most of the

template are following AAOIFI sample of Shariah

Committee report.

(ii) There is also a disclosure of ensuring that the non-halal

earnings are set aside for charitable purposes


5.0 Shariah Committee Report: A Holistic View from Shariah Perspective

The influence of Islam on the corporate reporting practices of Islamic banks is such a

fundamental. Therefore, the existence of Shariah Supervisory Board (SSB) is one of the most

important governance mechanisms of an Islamic Financial Institution (IFI) to ensure the Islamic

Financial Institutions (IFIs) are compliance with Shariah. It is important for the SSB to

understand their roles and responsibilities as well as the process of how an SSB should reviews

the performance of a given IFIs.

It is understandable that financial statement or the annual report represent a business

language that allows management to communicate the financial condition of their organizations.

The Shariah Committee Report could also been seen as a vital role as a means of communicating

information about the Islamic banks operations for to be used by decision makers both inside and

outside the reporting corporation as well as potentially delivering a more adequate reflection of

the non-market affects of corporate behaviour.

The existence word of ‘Shariah’ in every aspect of Islamic banks operational,

transactions, up to financial reporting reflects a vital role that need to be noted. The word

Shariah is very broad and includes all aspects in a Muslim daily life. Thus Mohd Rizal et al.

(2006) believes that the disclosure of the financial reporting should be included the aspect of

ethics, worship and law of business transactions in it scope, as what they translated as tawhidic

approach. Tawhidic approach according to them need to be expressed in the financial reporting

of Islamic banks operation since it covers all relationship, mainly Man-Allah, Man-Human

Beings and Man-Environment that they see it as Islamic banking operation (IBOs) and Allah,

IBOs and Human Beings, and IBOs and Environment.

Hence the only sentence such “The operations of the bank for the year ended dd/mm/yy

have been conducted in comformity with the Shariah principle” to reflect the bank’s operational

throughout the year in the Shariah Committee Report can be considered as an act of narrowing

the view of Shariah as to only what is permissible and what is wrong. Thus according to Ng


Boon Ka et. al. (2009) the whole array part of business policies, processes and procedures,

contracts and agreements, financial system of reporting, human resource management, social

activities and contributions, marketing and advertising, reports and circulars, zakat calculation

and payment as well as the IT systems should be taken into a consideration to a holistic view of

Shariah.

The above mentioned examples may be wide in range, but it is an urge to the SSB of IFIs

to accept the challenge and enhance their roles and responsibilities as it is in line with public

accountability in a large institutions.

5.1 Review of GP8-i’s Shariah Comittee Report

Bank Negara Malaysia through its “Guideline on Financial Reporting for Licensed Islamic

Banks” (GP8-i) had required the Shariah committee to produce a Shariah committee report

expressing their opinion on the Islamic Bank’s compliance with Shariah (GP8-i, p.27). The

requirement of the report can be seen at Appendix I. The GP8-i sets out as a minimum disclosure

requirement, the objective of GP8-i is as follows:

"..to provide the basis for presentation and disclosure of reports and financial

statements of Islamic banks in carrying out its banking and finance activities. This is

to ensure consistency and comparability of these statements among the Islamic banks

in complying with the provisions of the Companies Act 1965, applicable approved

accounting standards and Shariah requirements, and to facilitate users in their

evaluation and assessment of the financial position and performance of an Islamic

bank." (GP8-i, p.1).

However, it is interesting to note that most of the Islamic banks in Malaysia as shown in

above findings only compliance with the minimum requirement as been outlined by Bank

Negara Malaysia through the GP8-i. This is evidence has been observed in their respective

annual report. In fact, the example shown in the guideline is not meant to be a template that must

be adopted solely.


The fundamental of Shariah Committee Report made by the SSB can be explained for the

purpose of reflecting executive summary of the Shariah compliance aspect of the Islamic bank.

Thus what exactly important is to fulfill the basic requirement of disclosure and transparency.

When the issue of disclosure and transparency rises, the basic requirement as required by the

GP8-i should be added additional and any necessary information that could provide strong

assurance to the shareholders as well as the stakeholders from the annual report of respective

Islamic bank.

If fulfilling the basic requirement as according to the GP8-i alone will be insufficient, this

is because most of the Shariah Committee Reports by Islamic banks in Malaysia only stated that

the Islamic banks operational is conform to the Shariah. The stakeholders may keen to know

how the review has been carried out to come out with such general statement besides other

relevant information that may needed in assisting them in their decision making (Mohd Hairul et

al. 2005, p.7).

Besides that, without a standardization of audit framework lead to differ coverage

included in Shariah Committee Reports. We can see that some banks may have comprehensive

reports than the others. Therefore there may be issues in comparing the Islamic banks overall

aims and operations whether it is purely being compliance with Shariah. Among the questiona

that may arise are do the audit and report made by the SSB have any set of religious statement to

be audited by them? Are the SSB having a necessary expertise and qualification to perform the

auditing task? Even if there is an external auditors, is they really qualified in the field of

Shariah? (Ng Boon Ka et al. 2008, p.7)

Hence the Shariah Committee Reports that following minimal requirement of the GP8-i

are questionable and could be put to ascertain whether the examination of SSB’s report by

auditors are merely a procedural requirement, an endorsement or a robust scrutiny. The Islamic

banks must bear in mind that both the Shariah committee report and execution of Shariah review

is important in exercising governance especially in ensuring the Banks compliance with Shariah.

Any lope hole in the presenting the report reveal it lacks the depth of providing such assurance.


5.2 AAOIFI’s Standard on Shariah Committee Report

It is been explained in the earliest discovery of this paper where some of the SSB may

adopted different method of presenting their Shariah Committee Reports, some of the banks

adopted the GP8-i, some follows AAOIFI standard while some other may follow partially or

even a simplified version. The issue is not which guidelines is the best that should be follow or

make it standardize, but what is being addressed is the matter of disclosure and transparency of

the SSB in executing their roles and responsibilities via the Shariah Committee Report.

AAOIFI that basically an international body that responsible for the formulation and

issuance of standards for the Islamic finance sector has issued a Governance Standard 1for IFIs

with sample of the recommended report that can be seen in the Appendix II. They regard the

report to be produced by the SSB as part of their annual report of the IFIs. It is obviously seen in

the recommended report as shown in the Appendixes (I and II) that what currently prepared by

the SBB in Malaysia are lacking compared to what has been recommended by AAOIFI.

In the earlier of this paper, we’ve shown the differences of the guidelines (mainly

AAOIFI and the GP8-i), what obvious features that can be seen from these two is the

requirement or the standard required whereby we could say that the GP8-i of BNM guidelines is

more towards principle based with its minimum requirement, in contrast with AAOIFI standards

of we believe to be more prescriptive approach. In general, the comparison made shows that the

GP8-i of BNM guidelines is merely an endorsement of the bank’s Shariah compliance in general

without any emphasize on the actual operational or conduct of the respective banks.

Contrast to that, according to Mohd Hairul et. al. (2005), the roles and responsibilities of

the SSB of IFIs as define by the AAOIFI connotes a greater duty of not only endorsing and

approving the Bank’s products but ensuring its compliance through directing, supervising and

importantly reviewing its operations. This actually has no difference than what define by IBA

1983 whereby the function of the Shariah committee is more than just an advisory role on the

bank’s operation.


5.3 Shariah Comittee Report: The Way Forward

As mentioned earlier, the comparison of AAOIFI and the GP8-i is addressed on the subject of

disclosure and the transparency of presenting the bank’s operation. Shahul (2009) draw an

attention with his substantive comments to the relevance of minimal requirement standard and

improvement in way of presenting the Shariah Comittee Report. Among the thing that has been

highlighted are:

(i) The title part of the report, the basmallah is added as symbolic of Islamic salutation.

This may seems a small matter but one of the most important differences in the

philosophy of the Islamic bank.

(ii) The addressee part that usually addressed to the shareholder of the IFI (as what practised

by the conventional audit report), but some report even do not have any addressee. This is

important to portray a good image to the stakeholders.

(iii) Introductory/opening part of the paragraph is vital in identifying the purpose of the

engagement as well as describing the nature of work performed. It is also suggested that

the name given to the engagement such as “Shariah review” perhaps to start with a

standard requiring a “review engagement” rather than an “assurance engagement” to

avoid misunderstanding in indicating that the assignment as merely an ‘agreed upon

procedure’.

(iv) It is suggested to the AAOIFI to omit the financial statement from the orbit of the

Shariah review. If not, the report should give their opinion and conclusion about the

review of the financial statement.

(v) The date used may best suit using Islamic date in addition to the Christian date.

(vi) All the SSB members must signs the report to motivate to share the responsibility and to

avoid free riders

Besides these matters, Shahul (2009) further commented that these are not the only things that

should be addressed since there are still wide ranges of aspects that need to be taken into

consideration. As what mentioned in the SFA 1’s objective, like environmental, social, and

employee matters are equally important and should be subject to the Shariah review, even

perhaps on voluntary basis. Thus the SSB are responsible in most aspects of the bank’s


operational rather than just act as an advisor and treat the Shariah Comittee Report as merely a

procedure.

6.0 Conclusion

Accounting and corporate reporting need to respond to their environment, this is because

the operational circumstances of Islamic banks are different from those of conventional banks,

due to that people are not expecting the Islamic banks to produce financial reports similar to

those of non-Islamic banks. Therefore it is recommended and advisable that the Islamic banks to

not adopt the accounting standards of non-Islamic banks in way of the presenting their financial

reports or especially regarding Shariah compliance and non-compliance that needed a greater

detail on it.

This connotes a greater duty of not only endorsing and approving the Bank’s products but

ensuring its compliance through directing, supervising and importantly reviewing its operations.

Agreed with what mentioned by Mohd Hairul et. al. (2005) in describing the importance of

Shariah review as:

Without a strong and proper Shariah review, the Shariah committee would not be

able to support their opinion thus failure to discharge their entrusted duties as

expected by the stakeholders. An effective Shariah review will be able to assist the

Shariah committee in forming their opinion with the appropriate evidence on Shariah

compliance or noncompliance (p.10).

Shariah Comittee Report is differ from one bank to the others, thus it is in need to

draft with a proper standardization that will suit the Shariah with its broad range of

coverage. Moving towards a more transparent disclosure would require more proactive

involvement especially it is an urged to the BNM and all the industry players to work in

glove in reviewing the existing guideline and to develop a more comprehensive guideline

that could help fulfilling the spiritual and economical needs of Muslim users of annual

report.


Appendix I

Shariah Review Report as Outlined in GP8-i


Appendix II

Sample of the report issued by AAOIFI as provided in the governance standard


References

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a critique of shariah reports in selected islamic banks

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