Governance and Corporate Disclosure:

A Study in Bank Muamalat Indonesia and Bank Syariah Mandiri

Irma Aulia R. Kasri Department of Accounting, Andalas University

Kampus Unand Limau Manis Padang, West Sumatra, Indonesia Email: irma.kasri@gmail.com

Niki Lukviarman Department of Accounting, Andalas University

Kampus Unand Limau Manis Padang, West Sumatra, Indonesia Email: niki.lukviarman@yahoo.com

ABSTRACT This study analysis the governance implementation and disclosure practices in Bank Muamalat Indonesia and Bank Syariah Mandiri. The Bank Indonesia Regulation PBI No.8/4/PBI/2006 concerning the implementation of corporate governance for commercial bank and Islamic Financial Services Board (IFSB) Exposure Draft No. 4/2006 concerning the implementation of corporate governance in Institution Offering Financial Services are used as the indicators for compliance of regulation and practice in both bank. The result indicate that both bank already implement the corporate governance practice and have good tendency to disclose information regarding the corporate governance implementation.

Keywords: Governance, Disclosure, Islamic Bank

1. INTRODUCTION

Islamic banking is a worldwide phenomenon involving a variety of

instutitions and instrument, not one “project” or institution. Its all part of a trend

in which the financial products comply with the set of Qur’anic laws that govern

daily life, or Sharī`ah, are evolving from novelty to normal part in doing business

in much of developing world. Islamic banks were set up as an alternative to

conventional banks. Muslim depositors who believe that interest (riba) is

incongruent to their religious tenets have no choice but to resolve this conundrum

by depositing their funds into Islamic banks or banks which have services that

comply with Islamic law (Satkunasingam and Shanugam, 2004).

Islamic bank is defined as banking in consonance with the ethos and value

system of Islam and governed, in addition to the conventional good corporate

governance and risk management rules, by the principles laid down by Islamic

laws (Sharī`ah). Islamic banking, the more general term is expected not only to

avoid interest-based transaction which are prohibited in Sharī`ah, but also to

avoid unethical business practices and participate effectively in achieving the

goals and objectives of the Islamic economy.

Good governance is crucial to the ability of a business to protect the

interests of its stakeholders. In the case of an institution offering financial

products and services such as Islamic banks, the stakeholders expect that its

operation be carried out in compliance with the principles of Sharī`ah. A

corporate structure that enables such as institution to implement good governance

through Sharī`ah-compliant operations is therefore essential (Grais and Pellegrini

2006).

It is also recognized that good corporate governance reinforces sound

regulation and supervision. It contributes towards maintaining market confidence,

and strengthening transparency and accountability. Its emphasis is to be value

oriented and promote fairness and justice with respect to all stakeholders of the

banking institution. For corporate governance to work, good corporate practices

need to be instilled and embedded in all aspects of the operation and at all levels

within the organization.

Indeed, Islam strongly advocates all form of positive governance. These

values and ethical conducts have already been inbuilt and have become inherent in

the Islamic community. Islamic corporate governance serves through the

underlying principle of economic well-being of the Ummah, universal

brotherhood, justices, accountabilities and equitable distribution of income.

Therefore, while the virtues of Islam have always advocates good corporate

governance, the challenge to us lies in its application.

Closely linked to the corporate governance issue is the role of market

discipline. Transparency and disclosure are essential particularly in a rapidly

changing environment. While comprehensive and timely availability of financial

information will increase market discipline, the disclosure of information needs to

be complemented with the ability of the market players to analyze and

appropriately interpret the information. Transparency and disclosure are even

more relevant in multi-facet role played by the Islamic Financial Institutions in

dealing with Islamic banking customers. This is relevant as the Islamic financial

transactions are not merely based on lender and borrower relationship as is in the

case of conventional banking (Aziz, 2004).

With reference to principles of corporate governance and the greater need

for disclosure, the study will look broadly to the Good Corporate Governance

implementation in Islamic Bank. The study also examines the corporate disclosure

whether the Islamic Bank in Indonesia has have a good standard for general

governance and Sharī`ah governance disclosure.

The rest of the study is structured as follow. Section 2 reviews literature on

corporate governance in Islamic bank and governance disclosure. Section 3

discusses the research design of the study. Section 4 presents and discusses the

findings of the study and section 5 concludes.

2. LITERATURE REVIEW

2.1 Corporate Governance in Banking Institution

In between 1980 to 1997, over 130 countries, comprising almost three

fourths of the member countries of the International Monitory Fund (IMF) have

experienced important problems with their bank (Ciancanelli & Gonzales, 2000;

Lindgren & Garcia, 1996; Saal, 1996). The facts that this crises occurred after

implementation of far reaching reforms of the financial system revived long

standing debates in Economic and Finance on role of bank regulation (Ciancanelli

& Gonzales 2000; Mishkin 1992; McKinnon, 1993). Notably absent in the debate

is the consideration of the corporate governance of banks who recently growing

faster than before (Macey and O’hara, 2003; Caprio and Levine. 2002; Levine,

2003; Charkam, 2003).

Banks are in the unique position of effectively collecting and allowing the

use of fund in given manner or enterprises as well as engaged in the business of

financial intermediation between savers and investors. Bank is not similar with

other financial institutions, and indeed from all sectors, due to the possibility of

bank system instability leading to credit contraction for all other sectors.

Charkham (2005) wrote that “Banks are different from the generality of

companies in that their collapse affects a far wider circle of people and moreover

may undermine the financial system itself, with dire effect for the whole

economy.”

According to Levin (2003), the need for a separate analysis of the

corporate governance of bank is not self evident and requires justification. Caprio

and Levine (2002) and Levin (2003) identify three characteristic of bank. They

argue that banks are generally more opaque than other financial institution, which

fundamentally intensifies the agency problem. Although information asymmetries

plague all sectors, evidence suggests that these informational asymmetries are

larger with banks (Furfine, 2001). Second, banks are exposed to heavy regulation.

Because of the importance of banks in the economy, because of the opacity of

bank assets and activities, and because banks are a ready source of fiscal revenue,

government impose an elaborate array of regulations in banks. Third, the

widespread government ownership of banks raises specific governance issue.

Corporate governance of banks is of fundamental importance for those

who are concerned with or have the responsibility for financial regulation and for

developing market and economies. Banking supervisors have long recognized the

importance of good governance; supervision can not function properly if sound

corporate governance is not in place. The focus of it is mainly of those elements

that relate to the manner in which the business and affairs of an organization are

governed by its board and managers. This means the decision making process

within the bank, the respective responsibilities and accountabilities of the board

and managers, the control functions that provide assurance to the monitoring

processes and the structures that support all these function (Caruana, 2005).

The control function is also done through their monitoring function of

their client: evaluating the creditworthiness of new projects; monitoring of

ongoing performance of the project and the company; and assisting in

restructuring of client firm in distress. Effective monitoring requires that the bank

be independent of the borrower, and also of government pressures, so as to make

objective lending decisions. It must have sufficient access to information about

the borrower’s capabilities and performance; collateral alone is not enough. The

bank itself must also engage in good corporate governance practices, including

disclosure rules and transparency.

2.2 Corporate Governance in Islamic Bank

The Corporate Governance (CG) for Islamic Financial Institutions (IFIs) is

assuming growing significance with the steep growth in Islamic Finance system

both regionally and now globally. This industry has become a major source of

wealth creation and financing of investment projects world wide and cumulative

worth of its transactions are reaching a trillion dollar. IFIs provide a viable option

to savers and investors who are inclined to deal with exclusively Islamic financial

system given their religious and ideological stance (Aziz, 2006)

In the context of an Islamic bank, good corporate governance should

encompass:

• A set of organizational arrangements whereby the actions of the

management of Islamic bank are aligned, as far as possible, with the

interest of its stakeholders

• The provision of proper incentives for the organs of governance such as

board of directors, the Sharī`ah board and management, to pursue

objectives that are in the interests of the stakeholders and facilitate

effective monitoring, thereby encouraging Islamic banks to use resources

more efficiently

• Compliance with Islamic Sharī`ah rules and principles.

In place of interest-bearing deposit, Islamic bank mobilize funds through

profit-sharing and loss-bearing investment accounts whose return are, as a matter

of Sharī`ah jurisprudence (that is, that of the mudaraba concept), based on

performance of the assets portfolios in which their funds are invested. In the

majority of Islamic banks, such investment accounts contribute the preponderant

amount of funds available to the bank for investment. However, investment

account holders (IAHs) lack rights of governance such as shareholders enjoy,

although like shareholders they are (legally speaking) a type of equity holder with

residual claims to their share of the bank’s assets (Archer et al., 1998). While debt

holders, with fixed contractual claims to the firm’s cash flows and are met,

residual claimants by definition have no such contractual rights and thus require a

governance structure to protect their interest (Williamson, 1996). As Williamson

points out, the law typically provides a governance structure for debt holders in

case of default. In case of IAHs, neither the Sharī`ah nor secular law make any

such provision (Archer, 2007).

The absence of any governance structure in the case of IAHs is thus an

anomaly, and raises fundamental corporate governance issues – for example,

possible conflicts of interest between the two classes of equity holders, disclosure

of adequate information to enable IAHs to protect their interest, and so on. It also

draws attention to market discipline, which is emphasized for the first time by the

Basel Committee on Banking Supervision (BCBS) in its new capital adequacy

framework (2004), and raises the issue of the extent to which IAHs have the

necessary mechanism to exercise effective discipline on the management of the

bank, given their lack of governance rights. Furthermore, the mobilization of

funds through IAHs highlights the need to examine the approach adopted by

central banks to regulate Islamic banks in order to help sustain the soundness and

stability of the financial systems in the countries in which these banks operates.

2.3 Transparency and Governance Disclosure

Transparency as well as corporate governance became a highlight issue in

Asian market following the Asian Financial crisis in 1997. Since that time, foreign

investors and regulators have become wary of corporate financial reporting in

these countries, and the OECD (2004) has obliged increased transparency, a better

framework for financial market integrity and greater accountability in the region

(Aksu & Kosedag, 2005).

A good standard of transparency and market discipline are closely

interlinked with good standards of corporate governance (Vicary, 2007).

Bushman, Piotroski and Smith (2004) define corporate transparency as the

availability of firm-specific information to outside investors and stakeholders.

Transparency is an intuitively appealing idea. It should assist investors in making

better decisions regarding their investments and therefore, result in better resource

and capital allocation. Transparency also regarded as a corporate governance

mechanisms and therefore essential for the development of emerging economies

(Leung and Morris 2005).

The expected benefits of transparency and disclosure are more important

in emerging market because they are dire need of external capital as their

economies are growing faster than that of more developed nations. Transparency

of financial information is vital components of the corporate governance

framework (OECD, 1999) and is regarded as an important indicator of corporate

governance quality (Aksu & Kosedag 2005).

Beeks and Brown (2005) find that firm with higher corporate governance

quality make more informative disclosures. Advantages of good transparency and

disclosure practices are:

1. Minimize information asymmetry in the firm and probability of fraud

2. Increase investor awareness which will reduce the uncertainty of the

returns to the capital suppliers, which again is expected to reduce the

firm’s cost of external capital and hence increase its value.

Mitigates the political cost of non-compliance and hence reduce the risk of

litigations.

In Basel Core Principle 21 also asks for better disclosure by banks and to

allow the counterparties of the banks to price and deal appropriately. More

disclosure should reduce information asymmetry between those with privileged

information and outside small investors, and facilitate more efficient monitoring,

because sufficient information is necessary for market participants to exert

effective disciplinary roles (Huang, 2007).

2.3.1 General Governance Disclosure

The implementation of corporate governance in Indonesia is supervised by

central bank (Bank Indonesia). Bank Indonesia has issued some policies to

support the regulations related to bank operational and corporate governance.

Bank Indonesia has its own division for Islamic Banking that supports the

implementation of Sharī`ah governance in Islamic bank in Indonesia should

follow the regulations and policies that set by Islamic Financial Service Board

(IFSB).

As a banking regulator and banking supervisor in Indonesia, Bank

Indonesia found that there is increasing risk complexity faced by banks demands

an increased need for good corporate governance practice by banks. Whereas in

order to improve Bank performance, protect stakeholders’ interests and increase

compliance to prevailing regulations and general code of conduct in the banking

industry, good corporate governance implementation is considered necessary.

Improvement in the quality of good corporate governance implementation is

among the efforts to strengthen the internal condition of national banks pursuant

to the Indonesian Banking Architecture (IBA). Based on considerations above,

Bank Indonesia has issued Bank Indonesia Regulation (PBI) Number

8/4/PBI/2006 concerning good corporate governance implementation by

Commercial Bank, include Sharī`ah based Bank.

This regulation should be followed by Commercial Bank as referred to in

Act Number 7 Year 1992 concerning Banking as amended by Act Number 10

Year 1998, including branch offices of foreign banks. It’s stated that Good

Corporate Governance shall be Bank governing procedures through the

application of transparency, accountability, responsibility, Independency, and

fairness principles. And its focus to give information for the stakeholders includes

all parties having direct or indirect interests in Bank business activities. This

implementation of corporate governance in this study will refer to this regulation.

2.3.2 Sharī`ah Governance Disclosure

The Islamic Financial Services Board (IFSB) was launched in 2002 by a

consortium of central banks and the Islamic Development Bank (with the support

of IMF) with the mandate including the provision of prudential standards and

guideline for international application by banking supervisors in the supervision

of Islamic banks.

In December 2006 the IFSB issued two prudential standards for Islamic

banks that are designed to help supervisors of such banks meet the challenge of

implementing Basel II, one on guiding principles on corporate governance for

institution offering only Islamic financial services and an Exposure draft for

disclosures to promote transparency and market discipline for institution offering

Islamic financial services.

Guiding principles on corporate governance designed to facilitate IIFS in

identifying areas where appropriate governance structures and processes are

required, and to recommend best practices in addressing these issues. The Guiding

Principles are divided into four parts: (i) general governance approach of IIFS; (ii)

rights of investment account holders (IAH); (iii) compliance with Sharī`ah rules

and principles; and (iv) transparency of financial reporting in respect of

investment accounts.

General Governance Approach of IIFS shall establish a comprehensive

governance policy framework which sets out the strategic roles and functions of

each organ of governance and mechanisms for balancing the IIFS’s

accountabilities to various stakeholders. IIFS shall ensure that the reporting of

their financial and non-financial information meets the requirements of

internationally recognized accounting standards which are in compliance with

Sharī`ah rules and principles and are applicable to the Islamic financial services

industry as recognized by the supervisory authorities of the country.

There are two principles related to IAH in this guide. First, IIFS shall

acknowledge IAHs’ right to monitor the performance of their investments and the

associated risks, and put into place adequate means to ensure that these rights are

observed and exercised. Second, IIFS shall adopt a sound investment strategy

which is appropriately aligned to the risk and return expectations of IAH (bearing

in mind the distinction between restricted and unrestricted IAH), and be

transparent in smoothing any returns.

IIFS shall have in place an appropriate mechanism for obtaining rulings

from Sharī`ah scholars, applying fatāwā and monitoring Sharī`ah compliance in

all aspects of their products, operations and activities. IIFS shall comply with the

Sharī`ah rules and principles as expressed in the rulings of the IIFS’s Sharī`ah

scholars. The IIFS shall make these rulings available to the public. It’s a part of

the compliance of corporate governance with Islamic Sharī`ah rules and

principles. Transparency of financial reporting in respect of investment accounts

for IIFS shall make adequate and timely disclosure to IAH and the public of

material and relevant information on the investment accounts that they manage.

The exposure draft states that disclosure of general and Sharī`ah

governance are designed to provide information on the structure, processes and

functioning of such governance in an IIFS to ensure transparency regarding

Sharī`ah compliance by IIFS (Appendix 4.B). Such disclosure shall include the

rights of IAH compliance with Sharī`ah rules and principles, and transparency of

financial reporting in respect of investment account.

3. RESEARCH DESIGN

This study is qualitative in its form. It is a descriptive study which

emphasized more on estimating rather that testing. There are two general reasons

why the writer chooses the descriptive study, namely (1) to provide information

regarding this issue and (2) to identify areas for further research since the

application of the regulation will start being implemented on 2007.

In this study, the writer investigates Islamic Commercial Banks that have

already published their annual report to the public. The banks chosen for this

study are required to have a published annual report where the implementation of

corporate governance is being mentioned. The population of the research is the

Islamic Commercial Banks in Indonesia that have already implemented the

corporate governance principles since 2002. To answer research questions of this

study, the writer takes two banks as sample: Bank Muamalat Indonesia (BMI) and

Bank Syariah Mandiri (BSM). The principles of this study are Bank Indonesia

Regulation No. 8/4/2006 concerning Good Corporate Governance Implementation

by Commercial Bank and IFSB Standard concerning General Governance and

Sharī`ah Governance Disclosure.

3.1 Variable Identification and Measurement

This study analyzes the implementation of corporate governance in two

Islamic banks in Indonesia i.e. BMI and BSM and the banks’ governance

disclosure practices. The analysis of the implementation is based on the corporate

governance implementation list in Bank Indonesia Regulation Number

8/4/PBI/2006 concerning Corporate Governance Implementation by Commercial

Bank. Independent variable in this study is governance disclosure practices. It is

analyzed by using the disclosure indicators from Bank Indonesia regulation and

the indicators used by the Islamic Financial Services Board for Sharī`ah

governance disclosure.

Based on appendix 4.A disclosure of the issues above are examine:

A. Share ownership

1. Whether Board of Commissioners and Board of Directors have share

ownership at the bank and other banks and companies domiciled

domestically and abroad

2. Whether Board of Commissioners and Board of Directors have financial

relationship and family relationship with other members of the Board of

Commissioners, members of the Board of Directors and /or Bank

Shareholders.

B. Remuneration Package

3. Procedure of remuneration package/policy and other facilities for the Board

of Commissioners and the Board of Directors

C. Share Option

4. The share option owned by Commissioners, the Board of Directors, and

Executive Officers

D. Ratio of Highest Salary to the Lowest Salary

5. The ratio of highest salary to the lowest salary

E. Frequency of Board of Commissioners Meeting

6. Whether the Board of Commissioner have held meeting at least 4 (four)

times a year

7. Whether Board of Commissioners physical meeting attended by all

members of the Board of Commissioners no less than 2 (two) times a year.

F. Internal Fraud

8. Number of internal fraud and Bank’s efforts to handle them

G. Legal Problem

9. Number of legal problems and Bank’s settlement efforts

H. Conflict of Interest

10. Transactions containing conflict of interest

I. Buy Back Share/Bond

11. Buy back of Bank shares and /or bonds

J. Provision of Fund for Social Activities

12. Provision of funds for social activities and political activities, stating both

the nominal value and the recipients

This study also examines disclosure of Sharī`ah compliance in Islamic

Bank (Appendix 4.B):

A. Qualitative Disclosure

1. Governance Arrangements, System and Control Employed to Ensure

Sharī`ah Compliance

2. Non- Sharī`ah Compliance Earning and Expenditure Occur

B. Quantitative Disclosure

3. The Nature, Size and Number of Violations of Sharī`ah Compliance

4. Annual Zakat Contribution

5. Remuneration of Sharī`ah Board Members

4. RESEARCH AND ANALYSIS

4.1 Bank Overview

4.1.1 Bank Muamalat Indonesia

PT Bank Muamalat Indonesia Tbk (BMI) was established in 1991,

endorsed by the Indonesian Council of Ulamas (MUI) and the Government of

Indonesia, and commenced operations in May 1992. On October 27, 1994, barely

two years from its founding date, Bank Muamalat Indonesia received its license to

operate as a Foreign Exchange Bank. This recognition strengthened the Bank’s

position as the first and leading Sharī`ah (Islamic) bank in Indonesia with a

growing array of products and services. The vision of BMI is to become the

premier Sharī`ah bank in Indonesia, dominant in the spiritual market, admired in

the rational market. Moreover, the mission is to become a role model among the

world’s Sharī`ah financial institutions, emphasizing in entrepreneurial spirit,

managerial excellence, and innovative investment orientation to maximize value

to stakeholders (BMI, 2007)

4.1.2 Bank Syariah Mandiri

PT Bank Syariah Mandiri (BSM) was established as PT Bank Susila Bakti

on August 10th 1973. Due to the changes of Government regulation No. 1 year

1995 concerning the limited company (PT), the basic regulation of the bank has

reviewed. In 1999, the bank agreed to change their operational from conventional

bank into Sharī`ah based and followed with the change of the bank name into PT

Bank Syariah Mandiri. The vision of BSM is to be a reliable Sharī`ah bank

chosen by the partners.

In 2002, BSM established Bangun Sejahtera Mitra Ummat foundation

(BSM Ummat) which controlling the Lembaga Amil Zakat (LAZ). BSM Ummat

is established as the bank’s commitment to have good zakat, infaq and shadaqah

management. It is also a part of the bank’s corporate responsibilities. The bank

has given the collectable zakat to the LAZ division, so bank is do managing zakat,

infaq and shadaqah and qardhul hasan function indirectly.

4.2 Governance Standard in Islamic Bank

Understanding of governance standard is important in implementing the

good corporate governance in an institution. Islamic bank as part of Islamic

financial institution has separated governance standard to ensure the compliance

of corporate governance implementation with the Sharī`ah rules and principles.

The Accounting and Auditing Organization for Islamic Financial Institution

(AAOIFI) has been stated the Governance Standard for Islamic Financial

Institution (GSIFI) in 1999. The standard classified into 3 (three); first, GSIFI

No.1 concerning Sharī`ah Supervisory Board: Appointment, Composition and

Report. Second, GSIFI No. 2 concerning the Sharī`ah Review; and third, GSIFI

No. 3 concerning Internal Sharī`ah Review.

A Sharī`ah Supervisory Board (SSB) as stated in GSIFI No. 1 is the organ

of governance for ensuring compliance of the Islamic Financial institution in all

its dealings and transaction with Islamic Sharī`ah Rules and Principles. It is an

independent body that specialised jurist in fiqh almua’amalat (Islamic commercial

jurisprudence) who entrusted with the duty of directing, reviewing, and

supervising the activities of the Islamic Financial institution. Every Islamic

financial institution, including Islamic Bank, shall have a Sharī`ah Supervisory

Board to be appointed by shareholders in their annual general meeting upon the

recommendation of the board of directors taking into consideration the local

legislation and regulation. Shareholders also may authorise the board of directors

to fix the remuneration of the SSB.

The Sharī`ah Supervisory Board shall consist of at least three members

who expertise in business, economics, law, accounting and/or other. The SSB

should not include directors or significant shareholders of the Islamic financial

institution. The SSB should give a report to explain the confirmation that Sharī`ah

Supervisory Board has performed appropriate test, procedures and review work as

appropriate. The SSB should also state whether the example Islamic Financial

Institution’s contracts and related documentation are in compliance with the

Islamic Sharī`ah Rules and Principles. This report shall be published in the annual

report of Islamic Financial Institution.

Governance Standard for Islamic Financial Institution (GSIFI) No. 2 is

the standard and guideline that purpose to assist SSB of Islamic Financial

Institution (IFI) in performing the Sharī`ah review to ensure compliance with

Islamic Sharī`ah Rules and Principles as reflected in the fatwas, ruling and

guideline issued by IFI. Sharī`ah review is an examination of the extent of an

IFI’s compliance, in all its activities, with the Sharī`ah. This examination includes

contracts, agreements, policies, products, transactions, memorandum and articles

of association, financial statement, report (especially internal audit and central

bank inspection), circulars, etc. The SSB shall have complete and unhindered

access to all records, transactions, and information from all sources including

professional advisers and the IFI employees.

The procedure of Sharī`ah review are planning review procedures;

executing review procedures and preparation and review of working papers; and

documenting conclusion and report. The SSB shall implement adequate quality

control policies and procedures to ensure that the review is conducted in

accordance with this standard. The report to shareholder shall be based on GSIFI

No. 1.

The purpose of GSIFI No. 3 is to establish standard and provide guideline

on the internal Sharī`ah review in institutions which conduct business in

conformity with Islamic Sharī`ah rules and principles. The standard covers the

objectives, internal Sharī`ah review, independence and objectivity, professional

proficiency, scope of work, performance of the internal Sharī`ah review work,

management of the internal Sharī`ah review, quality assurance and elements of an

effective internal Sharī`ah review control system. The standard also covers

responsibility for its implementation.

The internal Sharī`ah reviewers shall plan each internal Sharī`ah reviews

assignment. They shall collect, analyse, interpret and document information to

support their internal Sharī`ah review result. The head of internal Sharī`ah review

shall discuss conclusions and recommendations with appropriate levels of

management before issuing final written report. On completion of internal

Sharī`ah review, at least a quarterly written report addressed to the board of

directors and copied to the SSB and management.

The internal Sharī`ah reviewers shall follow up to ascertain that

appropriate action is taken on their reported internal Sharī`ah review findings. In

addition any other recommendations relating to Sharī`ah shall also be followed

up. The management is responsible for rectification of non-compliance,

prevention of non-recurrence of no-compliance and ensuring that the agreed upon

action were carried out including their timing and extent follow up

These governance standard should applied in all Islamic financial

institution including Islamic bank to ensure the compliance with the Sharī`ah

rules and principles. The implementation of corporate governance itself is depend

on the country regulation, in this study the implementation is based on the Bank

Indonesia regulation which will discuss in next section. Also by knowing the

governance standard of Islamic financial institution, the study will examine the

importance of disclosure in Islamic bank.

4.3 Identification of Corporate Governance Implementation in Islamic Bank

A bank with Sharī`ah basis has an obligation to follow the Bank Indonesia

regulation as the regulator including the regulation Number 8/4/PBI/2006

concerning the Good Corporate Governance Implementation by Commercial

Bank. Both Bank Muamalat Indonesia (BMI) and Bank Syariah Mandiri (BSM)

have been implemented the corporate governance since 2002.

BSM has started the commitment to implement the good corporate

governance to their majority shareholder based on the guideline issued by the

Forum for Corporate Governance in Indonesia (FCGI). Following the industry

regulation, on March 2004 BSM adopted the guideline issued by Komite Nasional

Corporate Governance concerning the guideline of Corporate Governance for

Indonesian Banking Industry (Indonesia Banking Sector Code). With the new

regulation from Bank Indonesia, Number 8/4/PBI/2004, BSM has to complete the

entire requirement needed before the end of year 2007.

BMI started the implementation of Good Corporate Governance in 2002.

In 2003, the bank implemented some policies for risk management as a part of

corporate governance in BMI. The risk management practices followed include

financing risk, market risk, liquidity risk, operational risk, legal risk, reputation,

strategic and compliance management. To support the implementation process,

Management Risk division of BMI created the Code of Conduct to serve as

guidance for all the bank’s personnel on how to interact with consumer, business

partner and vendors. The code of conduct clearly states that all of its employees

are not allowed to receive gifts from customers or other parties since that would

be considered as conflict of interest. The code of conduct also includes guidance

on the prevention of misuse of authority and information.

Furthermore, the BMI established the Corporate Governance Principles

which represent regulations, principles and policies that should be complied with

by all the bank’s employees, to maintain responsibility and un-deviated work, and

at the same time motivate the employees to perform effectively and efficiently, to

produce continuous economic value for the stockholders and stakeholders using

the guidelines of justice, principles, transparency, accountability and

responsibility. To strengthen the implementation of corporate governance, BMI

also follow the Bank Indonesia Regulation Number 8/4/PBI/2006 concerning the

implementation of corporate governance for commercial bank.

4.4 Analysis of Corporate Governance Implementation in Islamic Bank in

Indonesia

According to article 2 of Bank Indonesia Regulation PBI No.

8/4/PBI/2006, the implementation corporate governance principles must at least

be realized in seven items. The items are:

a. Implementation of tasks and responsibilities by the Board of Commissioners

and the Board of Directors;

b. Completeness and implementation of the tasks of committees and the work

unit performing bank internal audit function;

c. Performance of compliance, internal auditor and external auditor functions;

d. Risk management implementation, including the internal control system;

e. Provision of funds to related parties and provision of funds in large amount

(large exposures);

f. Strategic plan of the Bank;

g. Transparency in Bank financial and non financial conditions.

Table 4.1 Governance implementation of both banks

Bank

BMI BSM Note

Board of Commissioner and

Board of Director V V

Internal Audit Committee V V

External Audit V V

Risk Management

Implementation V V

Large Exposure V V

Bank Strategic Plan V V

Bank Financial Transparency V V

Report and Self Assessment

X V

Report

obligation is

for the end

of 2007

4.5 Governance Disclosure in Islamic Bank in Indonesia

4.5.1 General Governance Disclosure

The disclosure of corporate governance implementation is a main issue in

corporate governance report. As mentioned earlier in previous section regarding to

report and self assessment of corporate governance implementation in bank, the

governance disclosure could be the right measurement. The measurement for this

study is the completeness of bank disclosure practices with the requirements

obligated by the Bank Indonesia Regulation No. 8/4/PBI/2006. This study

classifies it as general governance disclosure.

Table 4.2 General Governance Disclosure

Disclosure of

General Governance

BMI BSM

Board of Commissioners V V Share

Ownership Board of Directors V V

Board of Commissioners V V Remuneration

Package Board of Directors V V

Board of Commissioners X V

Board of Directors X V

Share Option

Executives Officers X V

Ratio of Salary Ratio of Highest to Lowest Salary X V

Periodically Meeting X X Board of

Commissioner

Meeting

Physical Meeting attended by all

members

X X

Internal Fraud Number of Internal Fraud X V

Legal Problem Number of Legal Problem X X

Conflict of

Interest

Transaction Containing Conflict of

Interest

X V

Buy Back

Share/Bond

Buy back of Bank shares and /or

bonds

V V

Provision of funds for social

activities

V V Provision of

Fund for Social

Activities Provision of funds for political

activities

V V

4.5.2 Sharī`ah Governance Disclosures in Islamic Bank

Disclosures of Sharī`ah governance are designed to provide information

on the structure, processes and functioning of such governance in an Islamic bank.

An important objective of these disclosures is to ensure transparency regarding

Sharī`ah compliance by IIFS.

Table 4.3 Sharī`ah Governance Disclosure

Disclosure of

Sharī`ah Governance

BMI BSM

Governance Arrangements, System

and Controls Employed to Ensure

Sharī`ah Compliance

X X Qualitative

Disclosure

Non- Sharī`ah Compliance Earning

and Expenditure Occur

X X

The Nature, Size and Number of

Violations of Sharī`ah Compliance

X X

Annual Zakat Contribution V V

Quantitative

Disclosure

Remuneration of Sharī`ah Board

Members

V V

Based on data in table 4.1, the BSM has implemented all of the principles

stated in Bank Indonesia regulation No. 8/4/PBI/2006. The table also shows that

the BMI has no report and self assessment yet. It might be because when the time

this study is taken, the BMI still on progress in making it since according to

regulation all bank should implement it for 2007 year report.

General governance disclosure of both banks, in table 4.2, shows the BMI

only disclose 43.75 % where the BSM has disclose 81.25 % of all the item need to

be disclosed based on Bank Indonesia regulation No.8/4/PBI/2006. For Sharī`ah

governance disclosure, either BMI or BSM only disclose 40 % from the total item.

So, this study find that the BSM has better implementation and disclosure

practices of their corporate governance and its compliance with Sharī`ah principle

rather than the BMI.

5. CONCLUSION

5.1 Conclusion

This study comes with the purposes to identify the governance standard in

Islamic bank, to analyze the corporate governance implementation, to identify the

role of disclosure and the governance disclosure in Islamic bank. The governance

disclosure is stress to the indicator provided by the Bank Indonesia regulation No.

8/4/PBI/2006 concerning the implementation of corporate governance in

commercial bank and Islamic Financial Service Board (IFSB) Exposure Draft No.

4 concerning the disclosure to promote transparency and market discipline for

institution offering financial services

The result indicates both banks in this study, Bank Muamalat Indonesia

and Bank Syariah Mandiri, have already implemented the corporate governance

practices. The implementation process is mainly stated in their annual report. Both

banks have shown a good tendency to disclose information regarding the

corporate governance implementation. It shows in governance disclosure check

box. As the bank operates based on Sharī`ah, the result shows that bank has fulfil

the Sharī`ah principle requires in this research.

5.2 Recommendation

Further studies can be conducted by increase the number of samples and

add the disclosure indicators such as from the financial aspect. The in-depth

analysis, from the first report of corporate governance implementation based on

Bank Indonesia Regulation No. 8/4/PBI/2006 to recent regulations will complete

the research of this study. Thus, further research findings are expected to support

current research findings and can contribute to the governance practices in

Indonesia.

5.3 Limitation of Study

This study found some limitation. They are:

1. Data limitation because this study examines the new regulation that started

to be implemented in 2007 and not all Islamic banks have already had the

report for the focus problem of this study

2. This study uses only two commercial Islamic banks, therefore it can not

stand as the generalization of the Islamic banking condition in Indonesia

3. This study has found limited reference regarding to Islamic banking

research in Indonesia and the governance disclosure literature.

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Appendix 4.A

Bank Indonesia Regulation No. 8/4/PBI/2006

Concerning Good Corporate Governance Implementation by Commercial

Bank

Article 2

(1) Each bank must implement Good Corporate Governance principles in any of

its business activity on all organizational levels or hierarchy of the. (2) Implementation of Good Corporate Governance principles as referred to in

Paragraph (1) must at least be realized in:

a. Implementation of tasks and responsibilities by the Board of Commissioners

and the Board of Directors;

b. Completeness and implementation of the tasks of committees and the work

unit performing bank internal audit function;

c. Performance of compliance, internal auditor and external auditor functions;

d. Risk management implementation, including the internal control system;

e. Provision of funds to related parties and provision of funds in large amount

(large exposures);

f. Strategic plan of the Bank;

g. Transparency in Bank financial and non financial conditions.

Every end of book year, starting for year 2007, each bank should prepare the

implementation report and result of self assessment on Bank Corporate

Governance Implementation.

Exclude the contents stated in article 2, PBI No. 8/4/PBI/2006 also arrange

bank to disclose all the following corporate governance aspects:

1. Share ownership by members of the Board of Commissioners and financial

relationship and family relationship among members of the Board of

Commissioners with other members of the Board of Commissioners, members

of the Board of Directors and /or Bank’s Shareholders. Members of the Board

of Commissioners must disclose:

a. Share ownership at the bank and other banks and companies domiciled

domestically and abroad;

b. Financial relationship and family relationship with other members of the

Board of Commissioners, members of the Board of Directors and /or

Bank Shareholders.

2. Share ownership by members of the Board of Directors and financial

relationship and family relationship among members of the Board of Directors

and members of the Board of Commissioners, other members of the Board of

Directors, and /or Bank Shareholders. Members of the Board of Directors

must disclose:

a. Share ownership at the bank and other banks and companies domiciled

domestically and abroad;

b. Financial relationship and family relationship with members of the

Board of Commissioners, other members of the Board of Directors and

/or Bank Shareholders, in the Good Corporate Governance

implementation report

3. Remuneration package/policy and other facilities for the Board of

Commissioners and the Board of Directors;

4. Share options owned by Commissioners, the Board of Directors, and Executive

Officers;

5. Ratio of the highest salary to the lowest salary;

6. Frequency of Board of Commissioners meetings as referred to in

a. Board of Commissioners meeting must be held periodically at least 4

(four) times a year.

b. Board of Commissioners meeting must be physically attended by all

members of the Board of Commissioners no less than 2 (two) times a

year.

7. Number of internal fraud and Bank’s efforts to handle them;

8. Number of legal problems and Bank’s settlement efforts;

9. Transactions containing conflict of interest;

10. Buy back of Bank shares and /or bonds; and

11. Provision of funds for social activities and political activities, stating both the

nominal value and the recipients.

Appendix 4.B

Exposure Draft No. 4

Disclosures to Promote Transparency and Market Discipline for Institution

Offering Islamic Financial Services (Excluding Islamic Insurance Institution

and Islamic Mutual Funds)

Section 6 General Governance and Sharī`ah Governance Disclosure

67. Disclosures of general and Sharī`ah governance are designed to provide

information on the structure, processes and functioning of such governance in

an IIFS. An important objective of these disclosures is to ensure transparency

regarding Sharī`ah compliance by IIFS.

68. International standards, codes and best practices of corporate governance, such

as Principles of Corporate Governance by the OECD, Enhancing Corporate

Governance for Banking Organisations by the Basel Committee on Banking

Supervision, and the AAOIFI’s governance standards, are congruent with

these aims and, where relevant, are complementary in terms of guidance for

appropriate disclosures.

69. The IFSB’s Corporate Governance Standard deals with four areas: general

governance; rights of IAH; compliance with Islamic Sharī`ah rules and

principles; and transparency of financial reporting in respect of investment

accounts.

70. Various corporate and Sharī`ah governance practices are adopted by different

IIFS in different countries. In particular, some countries have a national

Sharī`ah authority that issues or approves the applicable fatawa, while in other

countries, each IIFS has a Sharī`ah board which issues the applicable fatawa

for that IIFS.

71. An IIFS shall make disclosures of the structure, processes and functioning of

its general and Sharī`ah governance. Such disclosures shall include the rights

of IAH, compliance with Islamic Sharī`ah rules and principles, and

transparency of financial reporting in respect of investment accounts.

Table 16: General Governance Disclosure

1 Disclosure of any departure from complying with the

applicable financial reporting standard

2 Disclosure of the IIF’s corporate governance

arrangements and practices, including whether the IIFS

complies in full with the IFSB’s Corporate Governance

Standard, and if it does not so comply, an explanation of

any non-compliance.

3 Disclosure of any related party transaction and treatment

of material evens by the IIFS.

4 Disclosure of any investors/consumer education programs

for information on new products and services.

5 Information on mediation and advice bureaus for

investors and customers set up by the IIDS, including

clearly written procedures for lodging of complaints.

Qualitative

Disclosure

6 Disclosure of social functions and charitable contributions

of the IIFS, such as sadaqah, qard, etc.

Table 17 Sharī`ah Governance Disclosures Qualitative

Disclosure

1 A statement on the governance arrangements, systems

and controls employed by the IIFS to ensure Sharī`ah

compliance and on how these meet applicable national or

international standards, an explanation of the reasons for

non-compliance. In countries where national guideline

Sharī`ah governance in IIFS exist, and the related

governance requirements of the IIFSB’s Corporate

Governance Standard are followed, a statement of

compliance with these standard (and reasons for any non-

compliance) shall be provided.

2 Disclosure of how non-Sharī`ah-compliant earnings and

expenditure occur and the manner in which they are

disposed of.

3 Disclosure of the nature, size and number of violations of

Sharī`ah compliance during the year.

4 Disclosure of annual zakat contributions of the IIFS,

where relevant, according to constitution, general

assembly or national requirements

Quantitative

Disclosure

5 Remuneration of Sharī`ah board members, if applicable.