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KembaraXtra – Islamic Finance – Regulators: Shari’ah Advisory and Supervisory Boards

Introduction

A cornerstone of Islamic financial regulation is the requirement for institutions to establish their own Shari’ah boards before being granted a license. These boards serve as the primary guardians of Shari’ah compliance, ensuring that all products, services, and operations align with Islamic principles.


Two common types of Shari’ah boards exist, though their actual authority depends on the terms of reference given to them:


  1. Shari’ah Advisory Board – Primarily responsible for issuing fatwas (religious rulings) or opinions on specific products, schemes, or funds. Advisory boards are often appointed in Islamic windows of conventional financial institutions, where their role is limited to ensuring that particular products meet Shari’ah requirements.
  2. Shari’ah Supervisory Board (SSB) – A broader and more comprehensive body entrusted not only with issuing fatwas but also with reviewing and supervising day-to-day operations. Their scope covers the full range of an institution’s activities, including legal documentation, accounting practices, IT systems, and risk management methods. SSBs are typically mandatory for full-fledged Islamic financial institutions, takaful companies, or Islamic asset management firms.




The distinction between these boards lies not so much in their names but in their mandated powers. An advisory board with supervisory authority written into its terms of reference is functionally equivalent to an SSB. Conversely, an SSB without defined supervisory powers would be reduced to an advisory role.


An SSB is usually composed of jurists specializing in Fiqh al-Muamalat (Islamic commercial law), though it may also include experts in finance who have knowledge of Islamic law. According to AAOIFI Governance Standards (2004–2005), the rulings of the Shari’ah Supervisory Board are binding on the financial institution.


From a regulator’s perspective, this system provides a robust mechanism to maintain Shari’ah compliance. Bank management may not have the scholarly expertise to ensure full compliance on their own, making the guidance of Shari’ah boards essential. Failure to establish or properly observe the rulings of such boards can lead to regulatory action, including revocation of licenses under laws such as the Malaysian Islamic Banking Act 1983.


In short, Shari’ah boards function as the ethical compass and compliance enforcers of Islamic finance, balancing between religious rulings and practical business operations.


20 Case Scenarios with Solutions

  1. Case: An Islamic bank operates without appointing a Shari’ah board.
    Solution: License should be revoked; regulators require a Shari’ah board before licensing.
  2. Case: A Shari’ah advisory board approves a murabahah product but does not monitor its execution.
    Solution: Breach of continuous compliance; a supervisory role must ensure day-to-day review.
  3. Case: A takaful company has an advisory board that only meets annually.
    Solution: Insufficient oversight; requires supervisory-level monitoring with regular reporting.
  4. Case: A conventional bank offering an Islamic window appoints a supervisory board.
    Solution: Not necessary; an advisory board is sufficient for limited product oversight.
  5. Case: A supervisory board identifies non-compliance in IT systems but management ignores advice.
    Solution: Regulator intervention required; rulings of SSB are binding.
  6. Case: A Shari’ah advisory board approves sukuk issuance but does not review proceeds allocation.
    Solution: Non-compliance risk; SSB should ensure funds are used only for halal purposes.
  7. Case: A bank claims to have an SSB but the terms of reference exclude supervisory functions.
    Solution: Misleading; regulator must enforce proper terms of reference.
  8. Case: Advisory board approves an ijarah product but fails to check accounting treatment.
    Solution: Supervisory oversight needed; compliance must cover accounting as well.
  9. Case: A Shari’ah scholar without expertise in Islamic law but with financial knowledge sits on the board.
    Solution: Permissible if balanced by qualified jurists in Fiqh al-Muamalat.
  10. Case: A Shari’ah board approves “guaranteed returns” in a mudarabah product.
    Solution: Invalid ruling; regulators may require product withdrawal and board restructuring.
  11. Case: A Shari’ah board member has shares in the bank whose products he approves.
    Solution: Conflict of interest; board composition must ensure independence.
  12. Case: The SSB fails to detect that the bank invested in conventional derivatives.
    Solution: Strengthen review function; continuous supervision is mandatory.
  13. Case: Advisory board rulings differ across two jurisdictions for the same product.
    Solution: Shows need for harmonization through international standards (AAOIFI, IFSB).
  14. Case: Customers question a Shari’ah ruling but the bank refuses to disclose fatwas.
    Solution: Non-transparent; fatwas must be published for accountability.
  15. Case: A supervisory board only reviews legal documents but ignores operational practices.
    Solution: Breach of duty; full review of activities is mandatory.
  16. Case: An IFI fails to implement SSB’s recommendation due to cost concerns.
    Solution: Regulators may enforce compliance; financial reasons do not justify breach.
  17. Case: A Shari’ah advisory board member lacks training in modern financial instruments.
    Solution: Ongoing professional development and cross-disciplinary expertise required.
  18. Case: An Islamic window sells a Shari’ah-approved fund but later uses proceeds in interest-bearing deposits.
    Solution: Advisory board must review regularly; regulator should enforce corrective action.
  19. Case: A supervisory board approves risk management tools linked to interest rates.
    Solution: Non-compliant; must adopt Shari’ah-compliant alternatives like profit-rate swaps.
  20. Case: A bank ignores advisory board fatwas, claiming they are not binding.
    Solution: Advisory boards may have limited scope, but regulators can enforce rulings if tied to licensing conditions.


25 Questions and Answers

  1. Q: What is the role of a Shari’ah advisory board?
    A: To issue fatwas on specific products and ensure their compliance.
  2. Q: How does a supervisory board differ from an advisory board?
    A: It not only issues fatwas but also supervises daily operations of the IFI.
  3. Q: Which type of board is appropriate for full-fledged Islamic banks?
    A: Shari’ah Supervisory Board (SSB).
  4. Q: Which board is suitable for Islamic windows within conventional banks?
    A: Shari’ah Advisory Board.
  5. Q: Can the title of a board determine its powers?
    A: No, actual terms of reference define the scope.
  6. Q: Who usually composes an SSB?
    A: Jurists in Fiqh al-Muamalat and sometimes experts in finance with Islamic knowledge.
  7. Q: Are SSB rulings binding on the bank?
    A: Yes, according to AAOIFI Governance Standards.
  8. Q: What happens if a bank fails to establish a Shari’ah board?
    A: Its license may be revoked.
  9. Q: What law in Malaysia enforces this requirement?
    A: The Islamic Banking Act 1983.
  10. Q: Can advisory boards supervise daily operations?
    A: Only if terms of reference explicitly grant that power.
  11. Q: Why is continuous supervision important?
    A: To prevent breaches that may occur after initial approval.
  12. Q: Can scholars without Fiqh al-Muamalat expertise sit on the board?
    A: Yes, if they bring relevant financial expertise and are balanced by jurists.
  13. Q: How do Shari’ah boards affect customer confidence?
    A: They provide assurance that products are genuinely compliant.
  14. Q: Why is independence important in board composition?
    A: To avoid conflicts of interest and ensure unbiased rulings.
  15. Q: What if rulings differ across jurisdictions?
    A: International harmonization through AAOIFI and IFSB is needed.
  16. Q: Should fatwas be disclosed publicly?
    A: Yes, for transparency and accountability.
  17. Q: What aspects beyond product design must an SSB review?
    A: Legal documents, IT, accounting, risk management, and marketing.
  18. Q: What happens if management ignores SSB rulings?
    A: Regulators can intervene and enforce compliance.
  19. Q: Can SSB approve risk tools based on interest?
    A: No, only Shari’ah-compliant alternatives are acceptable.
  20. Q: What ensures board rulings are enforceable?
    A: Regulatory backing and licensing conditions.
  21. Q: How do SSBs contribute to governance?
    A: By directing, reviewing, and supervising all IFI activities.
  22. Q: Why is professional training necessary for board members?
    A: To keep up with evolving financial products and practices.
  23. Q: Can financial cost justify ignoring Shari’ah rulings?
    A: No, compliance is mandatory regardless of expense.
  24. Q: What ensures consistency between advisory and supervisory roles?
    A: Clearly defined terms of reference.
  25. Q: Why are Shari’ah boards seen as essential by regulators?
    A: Because management alone lacks the scholarly expertise to ensure compliance.


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