Why Islamic banks are in need of sound

corporate governance?
By Dr Hanudin Amin
April 17, 2017 | Updated at March 07, 2018

Corporate governance is composed of two terms, viz., corporate and

governance. Corporate emanates from the term, Latin “corporare”,
which means “to embody”. The term “governance” stemmed from the
Latin word “gubernare,” or originally from the Greek word
“kubernaein,” that means “to steer”. I define the term “corporate
government” as the system of rules, practices and processes by which
an Islamic bank is directed and controlled where tawheed and
governance of contract matter.

In this article, I draw your attention on the four issues related to

sound corporate governance for Islamic banks. In essence, the banks
have developed a cogent approach to inculcate sound corporate
governance for enhanced reputation at a reduced conflict of interest.
Four questions explained.

Q#1 – Does a sound corporate governance promote in Islam?

Q#2 – Does an Islamic corporate governance concept different from

its peer?

Q#3 – Why a sound corporate governance is important for a

successful Islamic banking operation.

Q#4 – What are key elements that enhance corporate governance in

Islamic banking?

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Corporate governance has been prescribed in the Quranic verses. For
instance, Surah al-Maidah (5:8) explicates that “O you who believe
stand up as a witness for Allah in all fairness, and do not let the hatred
of people deviate you from justice (‘adl). Be just, this is closest to
piety”. There are five moral stories sprung from this Surah. (1) The
importance of God-fearing (2) The importance of justice (3) Al-amr bil
maruf wan ahi an al-munkar (4) Equity (5) Golden rule or mutual
respect. With respect to a Hadith, the need for corporate governance is
best explained by a Hadith reported by Abdullah ibn Umar: The
Prophet Muhammad (p.b.u.h) says “Every one of you is a shepherd
and is responsible for his flock. The leader of people is a guardian and
is responsible for his subjects. A man is the guardian of his family and
he is responsible for them. A woman is the guardian of her husband’s
home and his children and she is responsible for them. The servant of
a man is a guardian of the property of his master and he is responsible
for it. No doubt, every one of you is a shepherd and is responsible for
his flock.”(Sahih al-Bukhari 6719, Sahih Muslim 1829).
This Hadith provides two key lessons: (1) The importance of leading
by example (2) The relationship between responsibility and one’s
position. All these explicitly expound that the Quran and
the Hadith are a key source of knowledge for better corporate
governance practice.

Of course, Islamic banks have different corporate governance concept

than their peers, out of the expectations for them to balance the need
for profit and social obligations. Four discrepancies are explained:
(1) Shariah compliancy – Islamic banks must follow rulings and
guidelines of Shariah in all aspects and manners in their financial
transactions with their clients. Conventional banks, however, are

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merely secular in nature. (2) Social implication – Ummah’s interest is
much more vital in Islamic banking operations that makes it different
compared with its conventional peer, which stresses on self-interest.
(3) Equity-based businesses – Interest-based activities are forbidden
in Islamic banking in which only profit-based transactions are
tolerable. Equity based on musharakah enables both parties to involve
actively in a business venture at reduced asymmetric information
problem. (4) Wealth ownership – Islamic banks view wealth is totally
owned by Allah (SWT). Shareholder is the trustee for the wealth he
generated while in the conventional banking, the shareholder is the
sole owner.

Sound corporate governance is typically essential for Islamic banks to

resolve conflict of interest among management, board of director,
shareholder and other stakeholders. Particularly, sound corporate
governance offers four (4) distinct benefits: (1) Protection – an Islamic
bank can protect its shareholder by adopting new levels
of accountability and transparency. Good corporate governance
ensures directors and managers are more accountable to shareholders,
enhanced investor confidence and protect the shareholders from fraud
and egregious conduct, assuring their wealth creation. (2)
Performance – goal congruence between the manager and the bank
will result greater profits and faster growth, which will benefit the
bank and all stakeholders. Good corporate governance helps to
improve operating performance, an improved ROE and share price
performance (3) Benefit – an Islamic bank that practices good
corporate governance allows it to gain the trust of the investor, the
customer and the community at large. Good board oversight, extensive
full disclosure, Shariah compliancy and improved stakeholder’s

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confidence lead to better public image, enhanced investor acceptance
and improved access to capital. (4) Cost – a bank with good corporate
governance is consistently associated with both lower cost of equity
and cost of debt capital attributed by extensive disclosure practices,
good management quality and strong regulatory framework.

Moreover, four (4) key elements are essential to ensure a sound

corporate governance is effectively upheld. First, Islamic banks must
ensure employees’ contribution is given priority. Their success and
contribution must be gauged equitably to promote justice at the
expense of favouritism. Second, the communication of responsibilities
must be disseminated with cautious to ensure employees have an
avenue to raise question and to be advised accordingly. Third, there
exists a strong internal control system to mitigate immoral issues. In
Islamic banks, board of directors, top management and others are of
responsible for the internal control system. Bank Islam, for instance
has seven members who provide leadership to achieve the overall
performance in meeting the corporate goals and objectives of the
bank. The control system means a mechanism by which a bank
maintains an environment that encourages incorruptibility and deter
fraudulent activities by management and employees. Fourth, the
importance of adequate corporate value. For instance, Bank Islam‘s
core values – to be an organisation that is trustworthy, constantly
strives for the highest level of integrity, honesty and responsibility,
which are the foundation of Islamic principles, applying in every facet
of the bank’s operations.

To sum up, a sound corporate governance is a key defence to ensure

Islamic banks are sheltered from egregious conducts that hamper the
reputation and public image of the banks. It is an enhanced protection
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to both shareholders and stakeholders, who are essentially need fully
consideration by the bank to protect their profit and social obligations,
respectively. To be successful, thus, it requires the banks to extend an
enhanced ethical decision making to their routine operations where
commitment and attentiveness are conveyed into play at reduced
errors and frauds, at least.

*The author is an Associate Professor/Dean at the Labuan

Faculty of International Finance, Universiti Malaysia
Sabah, Labuan International Campus. He has a PhD from
the International Islamic University Malaysia (IIUM) in
Islamic Banking and Finance (PG310163). He can be
contacted at hanudin@ums.edu.my