LONDON, 30 May 2005 — Corporate governance and safeguarding the interests of all stakeholders, no matter how big or small, is not only an emerging phenomenon for the global conventional financial services market, but also for the growing Islamic financial services industry.
The Kuala Lumpur-based Islamic Financial Services Board (IFSB), whose mandate is to develop prudential and supervisory standards for the global Islamic finance industry, for instance, started preparing a standard on corporate governance in May 2004, and is expected to issue an exposure draft by early 2006, and if necessary hold a public hearing on the proposed standard.
In fact, the hallmark of the Islamic financial system, stressed Dr. Zeti Akhtar Aziz, governor of Bank Negara, the Malaysian central bank, at an IFSB conference on corporate governance held in Doha last week, “lies in the high ethical values that underpins the governance and business operations of Islamic finance...The challenge is essentially to evolve strategies that will promote the adoption of strong and effective corporate governance practices that also facilitate innovation and that support business operations. Strengthening the robustness of the corporate governance framework and practices has become even more important in today’s environment of greater uncertainty and heightened risks.” For Governor Zeti, full disclosure and transparency, is perhaps, equally important and complementary to corporate governance.
Failures in corporate governance in recent years, however, have not been confined to such high profile cases as Enron and WorldCom. Islamic finance has had its share of such failings, perhaps not on the same scale and certainly not as spectacular.
In Turkey, the collapse of Ihlas Finance House in 2000, then the largest of the six Islamic banks in the country, was as much a failure of corporate governance and management, as it was of regulation.
The institution, a subsidiary of Ihlas Holdings, was effectively financing other companies within the group with over 60 percent exposure to them — contrary to both Turkish banking law and Islamic business ethics.
To its credit, the parent, Ihlas Holdings, according to Turkish banking sources, has repaid most of the depositors, with the last tranche due to be settled during this year. This in contrast to BCCI, Barings, Daiwa and a host of other failures in the conventional sector in which depositors lost millions. The Ihlas collapse should also be seen in the context of the then Turkish banking crisis, which saw the collapse of some 20 conventional financial institutions.
In Dubai, the oldest Islamic commercial bank, Dubai Islamic Bank, suffered an AED400 million fraud involving several senior managers, who were subsequently charged and convicted. Thanks to prompt action by the UAE central bank and the Dubai government, the bank was saved and the management and internal controls completely overhauled.
Even in Malaysia, the embarrassing fraud at Tabung Haji (the Pilgrims’ Management Fund), albeit a non-bank savings institution, in July 2001, involving the withdrawal in cash of millions of dollars from two accounts in 14 transactions using forged identity cards, exposed a disturbing lack of oversight and governance inertia especially in institutions where the government has a golden share, and is directly responsible for the management of the institution.
Kuala Lumpur did immediately tighten withdrawal procedures stipulating that any amount over RM1,000 can only be made bank-to-bank.
Corporate governance, simply is the exercise of power over and responsibility for a corporate entity. Good corporate governance entails corporations to fullfil their obligations to shareholders, employees, counterparties, customers, suppliers, regulators and the community in which they operate.
While it applies primarily to privately-owned institutions, it also applies to mixed corporations, and in state-owned institutions. After all, in the latter, although the state is the technical shareholder, the real stakeholders are the taxpayers or the citizens of that particular country.
Islamic laws on partnerships and business conduct are specific and clear. It is a religious duty for shareholders, for instance, to monitor their businesses and the top management to take part in the decisions concerning their strategies; and to insist on total transparency to ensure the proper participation in the running of the institutions.
The modern corporation, a relatively new concept of business organization, is considered as a new development by contemporary Muslim jurists that requires incorporation within the Shariah rules. The jurists are more familiar with the traditional models of Islamic business organizations such as Musharaka (equity partnerships or joint ventures) and Mudaraba (trusts), which must operate within the limits set through consultation and agreement by the parties to the contract.
The governance of the corporate has to rest with the shareholders, who must meet at reasonable intervals, for instance annually, to debate the corporation policy.
Bank Negara Governor Dr. Zeti has suggested five key considerations in developing a corporate governance strategy and framework for the global Islamic finance industry.
1. The task is to ensure the design and implementation of the corporate governance strategy should not impose a regulatory burden to the business objectives and the growth potential.
2. There must be robust corporate governance framework at the institutional level with the shareholders and the board as key players.
3. Existing mechanisms must be strengthened to translate Islamic values into business operations and governance.
4. The role of the regulator in strengthening the standards and best practices in inculcating good governance.
5. And the role of other standard setting bodies such as the auditing and accounting organization for Islamic financial institutions must be amplified.
