Tursina Yaacob 0800974

Short Essay

Tursina Yaacob 0800974

This project paper is a partial fulfilment of Module IE2001 of Part II of Chartered Islamic Finance Professional (CIFP) INCEIF

September 2010

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1) Describe the role of ethics in business from the Islamic perspective. Based on this perspective indicate how and when Islamic ethics can contribute to corporate governance of profit and non-profit organisations.

Ethics in the corporate landscape can be defined as the critical and structured assessment of how people and companies should behave in the business world. It involves examining appropriate constraints on the pursuit of self-interest, or to a company, in pursuit of profits, when the actions of individuals or firms can affect others. Therefore, ethical behaviour aims to improve and maintain the integrity of a system which covers the areas of corporate governance, management, etc. as it sets limits on individual and corporate behaviour to achieve long-term goals of well-being and development. Ethics aims to maintain the integrity of the system of corporate governance, which in turn maintains organizational integrity. Among values that will drive corporate governance are responsibility, accountability, check and balance, fairness, independence, transparency and personal and corporate integrity. These values will lead to the development and sustenance of trust within the organisation.

According to Iqbal and Lewis (2009), the closest concept to governance is through an Arabic word al-hakimiya, which it refers from Bahlul (2000)1 goes beyond the procedural view of governance to identify the blueprint of a higher moral social order to which all decision making structures or authority ought to submit, if they believe that peace in its outer and inner manifestations could be achieved only by surrendering ones will to the Will of God

Corporate governance refers to the method by which a corporation is directed, administered or controlled. It includes the laws and customs affecting that direction, as well as the goals for which it
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Bahlul, Raja (2000), People vs. God: the logic of divine sovereignity, in Islamic democratic discourse, Islam and Christians Muslim Relations, 11(3), 287-97 Page 2 of 8

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is governed. Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection. Corporate governance is also viewed as a process of monitoring performance by applying appropriate counter-measures and dealing with concepts such as transparency, integrity and accountability.

Within the Islamic context, ethics, be it in business or personal level, is an expected element in a Muslim. Ahmad (2004)2 reminded that man requires property in order to fulfil his function as the khalfah, Gods vicegerent on earth, as said in the Quran. Behold thy Lord said to the angels: I will create a vicegerent on earth. They said, Wilt thou place therein one who will make mischief therein and shed blood? Whilst we do celebrate Thy praises and glorify Thy holy (name)? He said: I know what ye know not (Quran 2:30, trans. Ali).

Therefore, it is essential that Muslims, as a khalifah, adheres to Gods [perintah], which includes conducting his life in an ethical manner. As God is perfect and omniscient, Muslims have a code that is neither timebound nor biased by human whims. The Islamic code of ethics is enforceable at all times because God is closer to man than his jugular vein, and has perfect, eternal knowledge. With this as basic guidance to life, the Shariah law provides a holistic and complete way of undertaking all aspects of business dealings from speaking to a customer, writing a contract to awarding tenders/ projects. Among the concepts or doings that should be undertaken according to Shariah requirements and its impact on corporate governance are as follows: Code of Ethics. The setting up of a code of ethics within an organisation is in line with good corporate governance practice. Such codes should enhance ethical behaviour among organizational employees and management. Personal values. An individuals values and morals will also influence his or her ethical
Ahmad, Imad-ad-Dean. Islam, Commerce, and Business Ethics. Plenary address at the Loyola Institute for Ethics and Spirituality in Business International Ecumenical Conference. 10-12 June 2004. IE2001 Assignment Page 3 of 8
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standards. A person who stresses honesty will behave very differently from another who does not respect other peoples property.

In commerce, an organisations aim is to maximise profit. This is allowed within the Shariah context, depending on some criterias such as: 1) operations must not be business not permissible by Shariah standards; 2) no element of gharar and discrimination in all business dealings/ transactions; and 3) transparent operations (e.g. guidelines and expectations are clearly defined and profit/risk sharing arrangements are pre-determined). Here, not only Shariah views are required (e.g. banks need to have a Shariah Advisory Committee to ensure products and transactions adheres to the requirement of Shariah) but the people running the business are also required to conduct the transaction in a responsible, fair, just and transparent manner. The impact of this is obvious in the real world where it will win customers trust and contribute to repeat business thus enhancing profits and zakat contribution. In hereafter, the rewards from God would be greater.

In summary, the teaching of Islam and corporate governance practices goes hand-in-hand and cannot be separated. People that adhere to Shariah obligations of doing business will automatically conduct himself in an ethical way, which will translate into his dealings in commerce, communications in the society as well as within his family.

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2) Discuss the recent guidelines on governance of financial institutions formulated by International Islamic Financial and Accounting Standard organizations. Explain why despite these standards, some Muslim countries are still adopting their own standards. Use the country example familiar to you.

Good corporate governance is considered vital as it promotes morality, honesty, integrity, trust, openness, performance orientation, responsibility and accountability, as well as mutual respect and commitment to the organisation from all parties in an organisation. Corporate governance does not only does apply to directors and executives, but to all players in the organisation.

To this end, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Service Board (IFSB) have outlined a set of guideline on governance. A common trait is that all banks have to take account of risks and within it, the role and importance of good corporate governance and risk management are highlighted.

In December 2006, the IFSB released a set of guiding principles on corporate governance for institutions offering only Islamic financial services. The document has four guiding principles, as follows: 1. General governance approach of Islamic financial services institutes 2. Rights of Investment Account Holders (IAH) 3. Compliance with Shariah rules and principles 4. Transparency of financial reporting in respect of investment accounts

In ensuring a general governance approach, the IFSB proposed an establishment of a comprehensive governance policy framework which will cultivate a good governance culture with specific strategic roles and functions of each organ of governance. In addition, the IFSB also

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recommends that Islamic financial institutions abide by globally recognized reporting standards. This should include the setting up of an Audit Committee and its management and supervisory role. In dealing with IAHs, Islamic financial institutions should ensure that the investment accounts are managed within the mandated parameters. IAHs should be adequately advised of their contractual rights and risks with regard to investment account products, including primary investment and asset allocation strategies and the method of calculating the profit/loss made from their investments. The investment strategy should be aligned to the risk and return expectations of IAH and be transparent in smoothing any returns. Furthermore, it is also important to make adequate and timely disclosure to IAHs and the public of material and relevant information on the investment accounts managed. Compliance with Shariah requirement is a given task in Islamic financial institutions. What is key is an appropriate system for obtaining rulings from Shariah scholars, applying fatwa and the monitoring Shariah compliance in aspects of products, operations and activities.

While these are the industry standards as proposed by the IFSB, some countries and jurisdictions have their own governance standards. The rationale for this is to be aligned with their own set of regulations as outlined by the relevant authorities. In Malaysia for instance, Bank Negara Malaysia (BNM) as the central bank as the banking sector regulator has introduced in October 2005, its own Guidelines on Corporate Governance for Licensed Islamic Banks. It was introduced as a general guideline following the introduction of these guides, which was established earlier, as depicted in the table below. Guidelines Date Introduced Guidelines on the Governance of Shariah Committee for the Islamic 15 December 2004 Financial Institutions Guidelines on Financial Reporting for Islamic Banks 24 June 2005 Guidelines on Minimum Audit Standards for Internal Auditors 27 January 1997 Source: Guidelines on Corporate Governance for Licensed Islamic Banks, BNM

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BNM has also introduced a Concept Paper on Shariah Governance Framework for Islamic Financial Institutions, aimed to provide a comprehensive guidance to the board, Shariah committee and management of the IFI in discharging its duties in matters relating to Shariah.

Nevertheless, BNMs Guidelines on Corporate Governance for Licensed Islamic Banks are aligned to several governance guidelines including the IFSB Guiding Principles on Corporate Governance for Institutions Offering Only Islamic Financial Services (Excluding Islamic Insurance (Takaful) Institutions and Islamic Mutual Funds)3. Similar to IFSB, BNMs governance guidelines were formulated based on the fundamental concepts of responsibility, accountability and transparency, with greater emphasis on the role of the board and management. The guidelines also contain broad principles dealing with 1) board matters; 2) management oversight; 3) accountability and audit; and 4) transparency. These principles are similar to that outlined by IFSB.

Therefore, while certain countries have their own governance standards, it is still based on the same principles and values that have been proposed by IFSB and other international authority. It should be viewed positively by industry observers as these additional guidelines are tailored to the domestic industry. At the end of the day, it serves the same purpose of promoting governance with the aim to further grow the Islamic banking and finance industry. In times of promoting transparency, these additional guidelines offer a positive perception towards the Islamic banking and finance industry as it shows that this is a proper and structured industry, especially when comparison is made with conventional banking and finance. It will help in attracting new stakeholders4 into the industry and further promote Islamic banking and finance.

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Clause 1.05 of Guidelines on Corporate Governance for Licensed Islamic Banks, BNM, 1 October 2005 Stakeholders may include investors and other conventional and Shariah-compliant financial institutions including banks, asset management companies, takaful and private equities entities. Page 7 of 8

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References

Iqbal, Zafar & Lewis, Mervyn. An Islamic Perspective on Corporate Governance. Elgar Publishing, 2009 Ahmad, Imad-ad-Dean. Islam, Commerce, and Business Ethics. Plenary address at the Loyola Institute for Ethics and Spirituality in Business International Ecumenical Conference. 10-12 June 2004. Islamic Financial Services Board. Guiding Principles on Corporate Governance for Institutions Offering Only Islamic Financial Services (Excluding Islamic Insurance (Takaful) Institutions and Islamic Mutual Funds). December 2006. Bank Negara Malaysia. Guidelines on Corporate Governance for Licensed Islamic (Revised). January 2007. Bank Negara Malaysia. Concept Paper on Shariah Governance Framework for Islamic Financial Institutions.

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