SHARIAH AUDIT COMMITTEE

Dr. Abdullah Mohd Ayedh

(abdullah.mohammed@usim.edu.my)
 Lesson Outcome

Describe the main purpose and content of Shariah Committee

Report.

Discuss the changes that BNM have made to the format and
content of the Shariah Committee Report.

Compare and contrast between the requirements of Bank

Negara Malaysia and AAOIFI on Shariah Committee Report
 Background
Shariah Committee is one of the important CG organs in IFIs.

One of the statutory requirement is to establish Shariah

Committee in all IFIs.

SGF superseded (replaced) the BNM/GPS1 that was issued in

2004.

To meet high expectation of the key stakeholders of the IFI in

relation to Shariah compliance process.
 IFIs Shariah Governance Structure

Shariah
BOARD RISK
BOARD OF BOARD AUDIT
MANAGEMENT
COMMITTEE DIRECTORS COMMITTEE
SHARIAH COMMITTEE

MANAGEMENT

Shariah Risk
Shariah Review Shariah Research Shariah Audit
Management Control
Function Function Function Function
 Shariah Governance Framework
The Framework provides guidelines for all IFIs to properly structure, develop and
practice Shariah compliance activities.

The Framework emphasized that the Board of Directors is responsible to provide

overall oversight of Shariah governance structure and Shariah compliance.

The Framework also reiterated that the Management is responsible to ensure the
executions of business and operations must be in accordance with the Shariah
principles; and provide necessary support to the Shariah Committee.

Part of Shariah Governance of IFIs is the role of

Shariah Committee to provide oversight and
accountability on Shariah related matters.
 Main Organs of Shariah Governance

Shariah Committee
Board of Directors Management Oversight
Overall oversight on Ensure executions of
Shariah governance accountability on
business and
structure & Shariah operations are in
Shariah related matters
compliance accordance with The Board is expected
Ensure effective Shariah principles
communication
to rely on Shariah
Provide necessary Committee on all
policy among the support to the
key functions of the Shariah Committee Shariah decisions,
IFIs views and opinions
 Shariah Committee

SHARIAH COMMITTEE
Oversee Shariah related matters

Management
Shariah Shariah Shariah
Review Research Audit

Shariah Committee (SC) position in the SGF can be seen as higher than
management and nearly at par with the Board of Directors (BOD).
 Responsibilities & accountabilities of SC

Responsible and accountable for all its decisions, views and

opinions related to Shariah matters.

Perform an oversight role on Shariah matters related to the IFIs

business operations and activities.

Provide sufficient disclosure in the IFIs annual financial report

on the state of compliance of the IFI Shariah Committee
Report.
Additional guidelines on duties, responsibilities
& accountability

Responsibility & accountability

Advise the Board & IFI
Endorse Shariah policies & procedures
Endorse and validate relevant documentations
Assess work carried out by Shariah review & audit
Assist related parties on Shariah matters
Advise on matters to referred to the SAC
Provide written Shariah opinions
 Independence of Shariah Committee
Independence = being free from any influence;
exercise objective judgment.

Their position or rank the same level of the Board of

Directors (BOD) or in other words any decision made
by the SC could not be overruled by the BOD.

BOD need to ensure that the decisions made by the SC

are implemented by the IFI and ensure that decisions
made by the SC are not modified without their
consent.
 Independence of SC

Access to accurate, timely and complete information from the

management to effectively perform their duties.

Shariah non-compliant activities are not effectively or

adequately addressed or no rectification were made by the IFI
SC to report such matter to the BNM
 Independence of SC
Reappointment, resignation and removal of the SC are made by
the BOD.

This decision is subjected to the approval by the BNM and

National Shariah Advisory Council of BNM.

There is the regulation that allows SC member to hold only one

post within the same industry so as to maintain the level of
independence and confidentiality of information amongst the
IFIs.
 Independence of SC

NEGATIVE LIST:
SC member should not have any relationship with the following persons that could
interfere with the exercise of independent judgment:
spouse, children or siblings who were employed by the IFIs or any related
companies as chief executive officer or non-independent board members.
substantial shareholder of or a partner or an executive officer or a director
of any for-profit business organization that the IFI or any of its subsidiaries
have received significant payments from the organization

SC member also should not be:

an employee of the IFI or any of its related companies
a SC member of another IFI within the same industry
 Competency of SC
Qualification
Degree in Shariah which includes the study in Usul Fiqh
(i.e. the origin of Islamic law) or Fiqh Muamalat (i.e. Islamic
transaction/commercial law).
Relevant backgrounds such as finance and law - support
Shariah deliberations
Assessment of the performance of the SC members.

Succession planning program for the SC member by

identifying, hiring and nurturing new members
 Confidentiality of SC
Supplied by management necessary access to files, records,
draft materials and conversations that is related to the work
undertaken by the SC.

Each SC member is required to observe the principle of

confidentiality at all times.

Refer to list of confidential information in module.

SC is allowed to disclose sensitive information to BNM in good

faith, meaning that it must be disclosed because the IFI do not
comply with Shariah principles
 Shariah Committee Report (SCR)

Shariah committee in IFIs required to disclose in the annual financial report on

the state of shariah compaliance of the IFIs.

BNM had issued in 2005, GP8-i (Guidelines on Financial Reporting for Licensed
Islamic Banks which Contain a sample format of SCR. (see figure 5.1 page 102)

The format is simple in terms:

Only state the confirmation by ShC members that in their opinion the IFIs operations for the
financial year is conformity with Shriah principles.
There is a lacks of important information:
No elaboration made concerning the roles and responsibilities of ShC members.
No explanation on the process undertaken by ShC members before forming their opinion.

The BNM had issued Shariah Governance Framework (SGF) for IFIs in 2011.
(see figure 5.2 page 104)
 Functional Gap on the role of the Board

According to SGF the SCR should contain:

1. Introductory paragraph on the responsibilities of the SC members.

2. Distinguishing the management responsibility from the ShCs responsibilities.

3. Scope paragraph outlining the scope of work for the ShC members.

4. Opinion paragraph stating whether the items that have been reviewed are in
compliance with Shariah principles.

5. Closing paragraph stating the confirmation by ShC members that the IFIs operations for
the financial year is in confirmatory with Shariah principles.

It shows that BNM has made great improvement to the content of the
SCR.
Adopted from the AAOIFI and
external auditor opinion
content
 Pitfall No. 3:
Reasonable vs. Complete Assurance
Report of the Auditors of
IslamicBank XYZ:
We conducted our audit in
accordance with approved
Standards on Auditing in Malaysia.
These standards require that we
plan and perform the audit to
obtain all information and
explanations which we consider
necessary to provide us with
evidence to give reasonable
assurance that the financial
statements are free from material
misstatements.
Report of the Shariah
Committee of Islamic Bank XYZ:
The duties and responsibilities of
Shariah Supervisory Council (SSC) are
to review, appraise and advise the
Directors on the operations of the
Group and of the companys business
in order to ensure that they do not
involve any element which is not
approved by Islam. () We,..and..,
being two members of the SSC, do
hereby confirm on behalf of the
Council, that in our opinion, the
operations of the Group and of the
company for the year endedhave
been conducted in conformity with
Shariah principles.
 AAOIFIs Guidelines on the Shariah Committee Report

In 1999 AAOIFI issued standard on the format of the Shariah committee

report (SCR) or Shariah supervisory board report (SSBR).
The standard of AAOIFI Governance Standard for Islamic Financial
Institutions (GSIFI No. 1) on Shariah Supervisory Board covers aspects such
as appointment, Composition and report.
By comparing GSIFI No.1 and SGF report criteria, both are quit similar.

The main differences in the content and wording for scope paragraph for
BNMs SGF and AAOIFIs GSIFI No.1:
BNMs SGF AAOIFIs GSIFI No.1

Scope
We have assessed the work carried out by
Shariah review and Shariah audit which
included examining, on test basis, each type
of transactions, the relevant documentation
and procedures adopted by the ABC IFIs.
Scope
We conducted our review which included
examining, on a test basis of each type of
transactions, the relevant documentation and
procedures adopted by the Example IFIs
 Why do IFIs need Shariah Audit?

Responsibilities of SAC or SSB Context

Evaluating and approving Islamic financial products, Shariah Committee of the IFIs normally expressed
prepare draft of Shariah opinions, prepare contracts their opinions on the Shariah compliance of the
in collaboration with legal advisor of the bank etc. products and services offered (ex-ante compliance).

So far Shariah advisors are not carrying out thorough However, a comprehensive and well-guided audit of
and comprehensive internal Shariah review or audit the Shariah legal contracts, documentations and
on the operations of IFIs due to their restricted scope operations so far has not been properly conducted
of work. (ex-post compliance).

As required by the Companies Act, IFIs are

also subjected to financial audit conducted Without such auditing function, there is
by external auditors which are normally a functional gap of Shariah compliance
carried out by professional accounting firms. in the Islamic financial system.