Shari'ah Governance and Audit Assurance in Islamic Banks

Shari'ah Governance and Audit Assurance in Islamic Banks

Nor Faezah Ghazi Ahmad, Aisyah Abdul-Rahman
Copyright: © 2020 |Pages: 20
DOI: 10.4018/978-1-7998-1611-9.ch015
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This chapter is about two major components namely Shari'ah audit (SA) and Shari'ah compliance (SC). The chapter evaluates the role and function of Shari'ah audit and Shari'ah committee and observes to what extent the Shari'ah audit helps in reducing Islamic banks' risk exposure. Five banks were chosen to answer the research questions; and five Shari'ah officers from different groups of respondents, who are involved directly in the process of Shari'ah compliance/auditing in Malaysian Islamic Financial Institutions (IFIs), were interviewed. Findings of the in-depth interviews revealed that the Shari'ah Governance Framework (SGF) positively impacts SA. The research shows that the functions of Shari'ah audit are more specific and covers all aspects. It should possess good knowledge, both of Shari'ah and accounting/auditing. The majority of the respondents agreed that Shari'ah non-compliance risk in IFIs is minimal.
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1. Introduction

The strength and stability of the Islamic financial system has gained worldwide attention especially during the global financial crisis that took place in 2008. After the crisis, the growth of Islamic financial institutions (IFI) was boosted and the total assets of Islamic financial institutions (IFIs) rose 19% in 2011 and 21% in 2012 as compared to less than 10% in the conventional banking system around the world .Contributions to corporate social responsibility (Abdelsalam, Duygun, Matallín-Sáez, & Tortosa-Ausina, 2014; Platonova, Asutay, Dixon, & Mohammad, 2018) and the improvement of financial development can be seen as the achievement and development of IFIs (Gheeraert, 2014; Gheeraert & Weill, 2015). With the improvement and rapid growth in the finance industry, Malaysia is documented as the third largest country in the world after Iran and Saudi Arabia to contribute to the overall assets of domestic banks at approximately 21.9%, while there was a 9.6% contribution to global Islamic banking in the year ending 2014. The outstanding achievement shown by Malaysia has placed the country within the world as having developed an Islamic banking system. This progress is due to the comprehensive and efficient governance framework embodied in the Shari’ah governance framework (SGF) which was enforced in 2011 (IMF, 2017). Shari’ah principles, which are the backbone of Islamic finance, are crucial for the confidence of stakeholders in IFIs. Therefore, the strength of governance practiced by IFIs is seen as promoting stakeholder confidence and enhancing the credit rating of IFIs (Ginena, 2014; Grassa, 2016; Ullah, Harwood, & Jamali, 2018).

In order to safeguard the interests of stakeholders, Shari’ah audit is compulsory for every IFI in Malaysia (Ghani & Rahman, 2015) and it is performed as an internal audit function. This function is responsible to provide assurance of risk management (Zakaria, Nurazalia, & Noraini Mohd Ariffin, 2016). Organisations that have an effective audit function are better and more stable in terms of risk exposure to fraud and mismanagement (Omar & Bakar, 2012). Shari’ah audit has become the main aspect of research interest in recent years. However, little is known about the roles and responsibilities of Shari’ah audit practice especially in mitigating Shari’ah Non-Compliance Risk (SNCR) in IFIs (Ghani & Rahman, 2015). The lack of knowledge and proper training regarding Shari’ah audits has led to the occurrence of Shari’ah SNCR in IFIs (Endaya & Hanefah, 2013, 2016). In addition, mistakes in understanding the terms, and wrong interpretation of fatwa by the Shari’ah audit staff is the cause of the occurrence of SNCR. Previous studies have focused on Shari’ah audit issues such as the aspect of separation between conventional and Shari’ah audit (Karim, 1990), human capital in implementing Shari’ah audit (Shafii, Abidin, Salleh, Jusoff, & Kasim, 2013) and the gap between the actual and the desired outcomes in implementing Shari’ah audit (Kasim, Mohamad Ibrahim, & Sulaiman, 2009) and research into Shari’ah audit effectiveness (Endaya & Hanefah, 2016). Even though many studies have been implemented, it is indeed difficult to find field studies concerning a review of Shari’ah audit after implementation of SGF 2011. Therefore, this area of study is worth exploring and to narrow the gap between theoretical and field study research.

Key Terms in this Chapter

Shari’ah Audit: Refers to the periodical assessment conducted from time to time, to provide an independent assessment and objective assurance designed to add value and improve the degree of compliance in relation to the IFI’s business operations, with the main objective of ensuring a sound and effective internal control system for Shari’ah compliance ( SGF-Section IV, Principle 7 (ii); 7.7).

Shari’ah Review: Refers to regular assessment on Shari’ah compliance in the activities and operations of the IFI by qualified Shari’ah officer(s)12, with the objective of ensuring that the activities and operations carried out by the IFI do not contravene with the Shari’ah (SGF-Section IV, Principle 7 (i); 7.3).

Shari’ah Risk Management: Refers to systematically identify, measure, monitor and control of Shari’ah non-compliance risks to mitigate any possible of non-compliance events. The systematic approach of managing Shari’ah non-compliance risks will enable the IFI to continue its operations and activities effectively without exposing the IFI to unacceptable levels of risk ( SGF-Section IV, Principle 7 (iii); 7.15 ).

Shari’ah: The code of law derived from the Qur’an and from the teachings and example of Prophet Mohammad (May peace be upon him); “ Shari’ah is only applicable to Muslims”.

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