Shari`ah Non-Compliance Risk Management and Legal Documentations in Islamic Finance

“This book is a welcome addition to the growing literature on the rapid evolution of the Islamic financial system. The elimination of riba is not the only criterion for compliance with Sharia law. There are many other factors to consider. A holistic approach must be taken and the risks of non-compliance are serious as the validity of the transaction and the legality of the income are questioned. All this is clearly explained in the book, which also discusses Malaysia`s IFSA 2013 and documentation requirements. It should find a place on the desks of all Islamic banking practitioners, from directors and risk managers to accountants, Sharia Committee members and lawyers. Science and students will find this enlightening. Mohamed Ismail Shariff, Lawyer and Lawyer Assistant Professor, INCEIF The first Islamic commercial bank in Malaysia, Bank Islam Malaysia Berhad (BIMB), was established and became operational on 1 July 1983. BIMB was the only Islamic bank in Malaysia for 10 years before the government offered Operation Islamic Windows, also known as the “window”, by other conventional banks. Islamic Financial Board Services (IFSB) has defined the Islamic window operation as “part of a conventional financial institution (which may be a branch or dedicated unit of that institution) that provides both fund administration funding (investment accounts) and Shariah-compliant investments with a segregated fund” (IFSB, 2017, p.

61). The window operation has contributed to the growth of Islamic banking and finance in Malaysia as conventional banks have started offering Islamic financing products to customers. The number of Islamic banks in Malaysia continues to grow and there are currently 16 Islamic banks overseen by Bank Negara Malaysia, including several foreign companies. As in Hanefah et al. (2020), significant risks of Sharia non-compliance can result in nullity of contracts and non-recognition of benefits. Moderate events that are not Sharia compliant include inaccurate/incomplete contractual conditions that have not been met. Minor risks of Sharia non-compliance include inadequate explanation of product information or incorrect marketing materials on IFI websites. Sharia risk management in international financial institutions should systematically identify, measure, monitor and control the risks of Sharia non-compliance in order to mitigate possible non-compliant events. Management should identify and understand the risks inherent in Sharia non-compliance that impact the reputation of the IFI. Management is responsible for ensuring that adequate internal controls are in place and their effectiveness in mitigating risks (including reputational risks). The potential impact of risks on the bank, based on historical and actual derecognition of proceeds from non-Sharia compliant activities, should be measured.

IFIs should monitor the risks of Sharia non-compliance and report on risk indicators to the operating system, SC and management. There should be adequate internal control to avoid repetition. The objective is to track unaccounted income from non-Sharia activities and assess the likelihood of occurring in the future. Shariah non-compliance risk management policies, procedures and guidelines should be formulated and implemented (Shafii et al., 2017; Hanefah et al., 2020). Mr. Lahsasna presents a research-based approach ranging from a discussion of the overall concept of the risk of Sharia non-compliance, to actual studies of this risk as presented in Islamic banking and finance, to specific tools and instruments to identify and mitigate areas of non-compliance. His methods help readers fully understand Sharia non-compliance, especially when it comes to legal documents and contracts. They can then use this knowledge in their own financial and banking institutions to avoid common problems.

Shariah Non-Compliance Risk Management and Legal Documentation in Islamic Finance provide an in-depth explanation of how the risk of Shariah non-compliance should be understood and carefully managed within the Islamic financial institution to ensure appropriate compliance in theory, practice and operations. The book provides assistance in understanding the legal documentation, risk areas, and some important Sharia and legal aspects that are considered when creating legal documentation for products and services. In addition, the book provides useful advice and understanding to the legal departments of Islamic financial institutions, as well as lawyers, Sharia advisors, Sharia officers, and students studying Islamic finance. The book will be a significant contribution to the market and a useful reference for the Islamic finance industry in the field of Sharia non-compliance risk management and legal documentation. Daud Vicary Abdullah, President and CEO, International Centre for Islamic Finance Education The core functions of the Sharia governance framework, such as Sharia risk management, Sharia audit, and Shariah audit, must be exercised on an ongoing basis to ensure effective management within the Bank. Some important provisions of IFSA regarding the Shariah requirement for Islamic banks and IFIs are Article 28(1) and (2) of IFSA 2013. It states that IFIs must ensure that their objectives and all their operations, undertakings and activities comply with Sharia rules at all times. Compliance with all decisions and decisions of the Shariah Advisory Council (SAC) relating to a particular purpose and operation, enterprise, business or activity is considered Shari`a compliant. The risk management team must follow up monthly and provide the monthly update to the Sharia department, and the update on the status of the correction plan is submitted to the Sharia Committee of the bank concerned. Recent measures taken by Islamic banks as control measures to correct the current CNS need to be updated in the ORION system.

CNS risks can arise from a variety of areas, such as product structure. These must be observed accordingly, as any violation of Sharia rules for contract features may lead to SNC. Documentation should not conflict with Sharia principles, as the nature of Islamic finance differs from that of traditional counterparties, with additional requirements in the terms of products and services. SNC may also result from poor performance of the product, even if the underlying contract complies with Sharia rules and principles. The weakness of the system`s technology will worsen the effectiveness of SNC`s risk management, while inappropriate advertising or questionable and inappropriate marketing can misrepresent the Islamic Bank and the product offered, and damage the IFI`s reputation in the eyes of the public. Hanefah, M.M., Kamaruddin, M.I.H., Salleh, S., Shafii, Z. und Zakaria, N. (2020), “Internal control, risk and Sharīʿah non-compliant income in Islamic financial institutions”, ISRA International Journal of Islamic Finance, Vol.

12 No. 3, pp. 401-417. doi.org/10.1108/IJIF-02-2019-0025 An important contribution of this study is the new Internal Control System Assessment Matrix for Shariah Compliance. This matrix can be used and adopted by Sharia auditors in Sharia audit programs for SNCI. It is strongly recommended that this matrix be adopted in other Sharia audit programs to mitigate Sharia risks in IFIs. Recognition is investigated through Sharia verification and risk management and is confirmed by the Qualified Sharia Officer (QSO) as a potential NSC before the matter is referred to the Sharia Committee for decision. BNM defines potential CNS as “any CNS event that is detected and confirmed by a QSO but not yet decided by the Sharia Committee.” Figure 1 shows the summary of the QSO confirmation process: According to SGF 2011, Sharia risk management is accountable to management and the Board`s Risk Management Committee on Sharia risk issues. In the meantime, the Sharia review must report simultaneously with the SC and the Directorate on the conformity of Sharia law with ongoing business activities. Sharīʿah research is then responsible for presenting new products and services to SC and management before they receive BSB approval. The Sharia review shall report to the Accounts Committee and the SC on the results of the review.

Findings on non-Sharia events are documented by the IFIs for review by auditors during the audit period.