Islamic finance sets sights on centralised sharia boards

A global body for Islamic finance is developing a standard for centralised sharia boards to provide guidance for strengthening corporate governance and increasing the consumer appeal of sharia-compliant financial products.

The move is the clearest indication yet that the industry is shifting away from self-regulation, an approach whichS proved flexible in its early years but which is now regarded as an obstacle to further growth.

A standard on centralised sharia boards is one of the main themes covered at the annual conference of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), being held in Manama this week.

AAOIFI is conducting a preliminary study drawing on the experience of countries that have already implemented centralised sharia boards, the Bahrain-based body said in a statement ahead of the event.

The new standard could be ready by early next year, according to Farrukh Raza, a board member of AAOIFI’s board of governance and ethics and managing director of Islamic finance consultancy IFAAS.

Central sharia boards could improve the take-up of Islamic financial products and address differing approaches across institutions, some of which have been regarded as liberal, Raza said on the sidelines of the conference.

Islamic banks have traditionally established their own internal sharia boards, employing scholars to rule on whether their products are religiously permissible.

This has spawned divergent practices among Islamic banks, making it difficult to develop homogeneous transactions that are cheap and quick to structure.

The approach is also prone to criticism of conflicts of interest, something the industry can ill-afford at a time when it wants to tap a wider audience beyond its core base of religiously-sensitive customers.

In a centralised model, a national body such as a central bank or capital market regulator establishes a sharia board that is independent from financial institutions.

This body can provide both guidance and oversight, and serve as an arbitrator providing final rulings in the event of disputes among sharia boards of Islamic banks.

The centralised model is increasingly being adopted across the industry, with Oman and Bahrain having established national sharia boards in the past year. The United Arab Emirates and newcomer Kenya have also proposed setting up similar bodies.

Malaysia, Indonesia and Pakistan have centralised sharia boards, but the way in which they operate can vary.

The new standard aims to help define those roles and responsibilities, addressing issues such as optimal board composition, fit and proper criteria of scholars, as well as enforceability of rulings.

The work comes a year after AAOIFI revamped its internal structure by appointing 50 members across three technical boards, which included the creation of the board on governance and ethics.