Download - SHARIAH FRAMEWORK & GOVERNANCE IN BANK ISLAM

Visitation by International Center for Development in Islamic Finance – Indonesian Banking Development Institute (ICDIF-LPPI),

Indonesia

SHARIAH FRAMEWORK & GOVERNANCE IN BANK ISLAM

Mohd Nazri Bin ChikAssistant General Manager, Shariah Division

24th June 2013/ 15th Syaaban 1434

Strictly Private & Confidential

Introduction to Shariah Governance

TOPIC 1TOPIC 1

IFSB-10 Guiding Principles on Shariah Governance Systems for Institutions Offering Islamic Financial Services defines:

“A set of institutional and organisational arrangements through which Islamic financial institutions ensure that there is an effective independent oversight of Shariah compliance over the issuance of relevant Shariahpronouncements, dissemination of information and an internal Shariahcompliance review.”

This requires:1.A set of institutional and organisational arrangement – Board of Directors, Shariah committee, Shariah division, internal audit function.

2.An effective independent oversight on Shariah compliance

3.Shariah pronouncements, disseminations of info and an internal Shariah review – ex-ante and ex-post aspects of the Shariah compliance framework.

WHAT IS SHARIAH GOVERNANCE?

DISSEMINATIONOF SHARI’AHRESOLUTIONS

ISSUANCE OFSHARI’AH

RESOLUTIONS

ANNUALSHARI’AHREVIEW

PERIODICINTERNALSHARI’AHREVIEWS

EX‐ANTE

EX‐POST

IMPLICATIONS OF SHARIAH NON‐COMPLIANCES?

IMPACT OF SNC

• Shariah non-compliant income due to invalidation of contract (‘aqad)

• Capital adequacy ratio (CAR) impact

• Against the commands of Allah SWT

• Impediment of Allah’s SWT blessing or barakah

• Jeopardize business reputation

Contravention of the Islamic Financial Services Act 2013:

Section 28(5) of the Act providesImprisonment for a term not exceeding eight years; or

Fine not exceeding twenty-five million ringgit; or both.

FINANCIAL NON-FINANCIAL

REGULATORY

MODELS OF SHARIAH GOVERNANCE

Shariah‐CompliantProcess

Regulatory Framework of Shariah Governance

TOPIC 2TOPIC 2

Effective date 1 January 2011 and Islamic banks are given 6 (six) months to comply with all requirements.

IFI to confirm status of compliance with SGF at the end of the six months. Full enforcement 1 July 2011.

Objectives:Set out the expectation of BNM on Shariah governance structures, processes and arrangements to ensure that all its operations andbusiness activities are in accordance with Shariah.Provides a comprehensive guidance to the Board, ShariahSupervisory Council and management of the Bank in discharging its duties in matters relating to Shariah; andOutlines the functions relating to Shariah review, Shariah audit, Shariah risk management and Shariah research.

BNM’S SHARIAH GOVERNANCE FRAMEWORK

GuidingPrinciples

Oversight, accountability & ResponsibilityClear demarcations on accountability &responsibility

Board overall accountabilitySC accountability on decisions, views & opinionsManagement’s responsibility in providing adequate support

IndependenceRecognition by board on SC’s independenceAppropriate reporting structureSC decision shall not be set asideAccess to necessary info by SCAppointment & removal of SC

CompetencyComply to fit & proper requirementContinuous training provided to key internal stakeholdersPerformance assessment for SCSuccession planning program for SC

Confidentiality & consistency

Duty to observe confidentiality on sensitive info obtained by SCRestriction on SC membership in IFI within same industryStructured decision making processSC should not undermine SAC rulings

Source: Bank Negara Malaysia

FRAMING SHARIAH GOVERNANCE FRAMEWORK

Shariah Principle in Islamic finance

MANAGEMENTEnsure executions of business & operations

are in accordance with Shariah rules & principles

Provide necessary support to the Shariah committee

BOARDOverall oversight on

Shariah compliance & review

BOARD AUDIT COMMITTEE

BOARD RISK MANAGEMENT

COMMITTEE

Shariah Review FunctionReview business operations on a regular basis to ensure

Shariah compliance

Shariah Risk Management Control Function

Identify, measure, monitor, report & control Shariah

non-compliance risk

SHARIAH COMMITTEEOversight accountability on

Shariah related matters

Shariah Audit FunctionProvide independent

assessment & objective assurance designed to value

add & improve IFI’s compliance with Shariah

Shariah Research Function

Conduct comprehensive Shariah research prior to submission to the Shariah

committee

Shariah compliance and Research Functions


SHARIAH GOVERNANCE FRAMEWORK’S MODEL

Shariah Review Shariah Audit

ScopeScope

ObjectiveObjective

ProcessProcess

To ensure that the activities and operations carried out by the IFI do not contravene with the Shariah

To provide an independent assessment & objective assurance to ensure a sound and effective internal control system for Shariah compliance

Overall business operations, including the end‐to‐end product development process (from product structuring to product offering)

Planning the review program (including objectives, scope, reporting, rectification and follow‐up actions followed by the execution of the program);

Documentation of the processes involved;

Communicating the outcome & highlighting any non‐compliances to the Shariah Committee & the management; and

Rectifying any instances of Shariah non‐compliance to prevent such events from recurring.

All aspects of the IFI’s business operations & activities, including:

audit of financial statements;

compliance audit on organisational structure, people & IT application systems; and

review of adequacy of the Shariah governance process.

Understanding the business activities of the IFI – to allow for better scoping of an audit exercise;

Developing a comprehensive internal audit program;

Obtaining and making reference to relevant sources (e.g. SAC’s published rulings, the SC’S decisions, etc)

Communicating results or findings to the Board Audit Committee and the Shariah Committee; and

Providing recommendations on rectification measures taken as well as following‐up on the implementation by the IFI.


SHARIAH REVIEW AND SHARIAH AUDIT FUNCTIONS

Shariah risk management control

Shariah risk management control

Shariah research function

Shariah research function

Shariah secretariat function

Shariah secretariat function

Apart from Shariah review & audit IFIs are also expected to establish other functions that complement and provide necessary support to Shariah compliance functions within the organisation

Objectives Scope & Functions

Form part of IFIs integrated risk mgmt control function

Identification & assessment of Shariah risk would be systematically controlled & monitored

Perform in-depth research on Shariah including providing day-to-day Shariah advice & consultancy

Perform by qualified Shariah officers

May seek input from experts on technical matters

Coordinating meetings, compiling papers, disseminating Shariah decisions

Engaging with relevant parties that need assistance

Ensure proper deliberation of Shariah related matters

Provide necessary support to Shariah committee & IFI in implementing Shariah governance


OTHER KEY INTERNAL FUNCTIONS

Shariah Supervisory Council

Board of Directors

Board Risk Committee

MRCC

ORCC*

Shariah Division

Audit & Examination Committee

Internal Audit Division (Shariah

audit)

ZakatCommittee

Managing Director

Note:SCRM – Shariah Compliance Risk ManagementMRCC – Management Risk Control CommitteeORCC – Operational Risk Control Committee

– Administratively– Functionally

* w.e.f July 2012. Previously Shariah non compliance risk was over sighted by Shariah Compliance Risk Control Committee.

Shariah Review

Committee

BANK ISLAM'S INTERNAL SHARIAH GOVERNANCE

TOPIC 3TOPIC 3

Shariah Non‐Compliance Risk Management

Guiding Principles:

Principle 7.1: IIFS shall have in place adequate systems and controls, including Shariah Board/ Advisor, to ensure compliance with Shariah rules and principles.

comply at all times with the Shariah rules and principles.

contract documentation complies with the Shariah – with regard to formation, termination and elements possibly affecting contract performance.

Shariah compliance review at least annually.

keep track of income not recognised arising out of Shariahnon‐compliance and assess the probability of similar cases arising in the future.

Principle 7.2: IIFS shall have in place appropriate mechanisms to safeguard the interests of all fund providers. Where IAH funds are commingled with the IIFS’’s own funds, the IIFS shall ensure that the bases for asset, revenue, expense and profit allocations are established, applied and reported in a manner consistent with the IIFS’’s fiduciary responsibilities.

DEFINITION OF SHARIAH NON‐COMPLIANCE RISK

OPERATIONAL RISK

“Risk of losses resulting from inadequate of failed internal process, people and systems or from external events, which includes legal risk and Shariah non compliance risk, but excludes strategic and reputational risk.”

SHARIAH NON‐COMPLIANCE RISK

“The risk that arises from the Bank’s failure to comply with the Shariah rules and principles determined by the relevant Shariah regulatory councils.”

IFSB -2 (Capital Adequacy Standard) -IFIs are required to set aside 15% of average annual gross income over preceding three (3) years gross for OR.

Regulator has discretion to impose a higher capital charge as they deem fit to cater for SCR of a particular IBI. The percentage is not specified in the IFSB-2 because the extent of losses arising from non-compliance with Shariah rules and principles cannot be ascertained owing to lack of data.

Annual Average Gross Income (previous three years) X 15%

Gross income is defined as:Net income from financing activities (e.g. selling

price less purchase price) which is gross of any provisions and operating expenses; plus

Net income from investment activities; plusFee income (e.g. commission and agency fee)*

Less:Investment account holders’ share of income

Operational Risk Capital Requirement (ORCR)

ORW = 12.5 * ORCR

* BNM’s CAFIB – may include income from Shariah non‐compliant sources, if any.

Malaysia – BNM’s Capital Adequacy Framework for Islamic Banks.Islamic banks may adopt Standardized

Approach (SA) subject to BNM approval.Islamic banks that have adopted SA are not

allowed to revert to BIA without the approval of BNM.

SCR AND CAPITAL ADEQUACY REQUIREMENT

18

BASEL SOUND PRACTICES ON OPERATIONAL RISK

Bank Islam adopted definition of OR as per BNM’s Capital Adequacy Framework of Islamic Banks (CAFIB).

Risk Management Framework of the Bank communicates the Bank’s vision and strategies in managing credit, market, operational, Shariah non compliance and other risks of the Bank.

The RMF is supported by various polices and guidelines.

BANK ISLAM’S RISK MANAGEMENT FRAMEWORK

Bank Islam’s Risk Management Framework is built upon the solah (prayer), the main pillar of Islam.

Risk Management Framework

Operational Risk Management Framework and GuidelineStandard of Control of Operational Risk (SCOR)Risk Loss Event Management and Reporting Guideline

Business Continuity Management PolicyBusiness Continuity Management Guideline

Shariah Compliance PolicyShariah Compliance Risk Management Guideline

Shariah contracts guidelines

RISK POLICIES AND GUIDELINES

RMF is supported by Risk Appetite Framework i.e. the guiding document for any strategic, business and/or risk decision making process. The document reflects the current macro‐economic environment and in line with Internal Capital Adequacy Assessment Process (ICAAP).

RAS 1Responsibility of Senior

Management via MANCO & subject to oversight by Board

RAS 3Periodic review on

comprehensiveness of the Bank’s risks and resources/ processes applied to manage

the risk

RAS 6All employees are

responsible for risk and held accountable

RAS 8Adherence to laws, Shariah principles and tenets. Zero-tolerance to Shariah non-

compliance

RAS 9Adherence to minimum control standards (Standard for the

Control of OR “SCOR)

RAS 10Only undertake well understood activities

RAS 11No compromise on

reputational risk

RAS 14Perform annual ICAAP as part of business & budget

planning. Establish a comprehensive capital plan

RAS 15Strong PIDM rating, minimum

of category 2

RISK APPETITE FRAMEWORK OF BANK ISLAM

BNM’S SHARIAH GOVERNANCE FRAMEWORK REQUIREMENTS ON SCRM

PRINCIPLE 7: There shall be a robust Shariah compliance function, comprising review and audit functions, supported by risk management control process and internal

research capacity.

Para 7.15Shariah risk management is a function to systematically identify, measure, monitor and control of Shariah non-compliance risks to mitigate any possible of non-compliance events.

Para 7.16The Shariah risk management control function shall form as part of the bank’s integrated risk management framework.

Para 7.17Due to technicality and complexity in managing the risk of non-compliance to the Shariah, the function shall be performed by risk officers that have suitable qualifications and/or experience in the subject matter.

Shariah Division – Shariah Compliance Risk

BNM’S SHARIAH GOVERNANCE FRAMEWORK REQUIREMENTS ON SCRM (cont.)

Para 7.18Shariah risk management function involves:

1) Facilitating the process of identifying, measuring, controlling and monitoring Shariah non-compliance risks inherent in the bank’s operations and activities.

2) Formulating and recommending appropriate Shariah non-compliance risk management policies and guidelines.

3) Developing and implementing processes for Shariah non-compliance risk awareness in the bank.


REPORTING LINE OF SCRM

Head of Shariah

Shariah Compliance Risk

Management

Shariah Supervisory

Council

Operational Risk

Management Department

Managing Director

Chief Risk Officer

Board Risk Committee

Double bold lines – SCRM reports to Head of Shariah and Head of ORM Department

>>


1ST LINE OF DEFENCE

3RD LINE OF DEFENCE

2ND LINE OF DEFENCE

Line Management (including Business and Support Heads, Branch Managers, BRO, SRO, DORC and all staff)

RESPONSIBLE for ongoing oversight of risk and control at day to day work level.

Operational Risk Mgmt Dept, Compliance &

Control Dept, Operational Risk Control Committee

and SCR Control Committee

ESTABLISH and maintain ORM and SCRM Framework, assessing monitoring, reporting & controlling risk on a bank wide level

Internal Audit (Including Shariah Audit)

PROVIDE INDEPENDENT ASSURANCE to Board of Directors and Senior Management that Risk Management processes and tools are effectively implemented.

ORM AND SCRM STRATEGY

26

SCRM Tools & Processes

Risk Profiling MASA-Shariah MASA-Shariah & SNCTR

MASA-Shariah & SNCTR

• Identify and document SCR to develop risk profile:1. Risk description2. Causal factors3. Controls

• Assess and measure SCR on half-yearly basis (role of BRO and DORC)

MASA-Shariah•Document actions taken/ required to mitigate SCR•Ensure resolution

SNC Tracking •SNC Tracking Report (SNCTR) mostly driven CCD

• Report risk (SNCTR)

• Compliance and Control Department actively drive identification of SCR and document SCR control & residual risk (SCR Profile)

• Monitor submission.• Validate residual

risk

MASA-Shariah•Monitor resolution of actions taken

SNC Tracking •Analyze and monitor

•Develop ShariahPolicy, Guidelines

• Report risk:1. SNCTR2. Shariah Non-

Compliant Income

• Report to Board/ BRC, SRC, MRCC, SCRCC

1ST LOD

2ND LOD

SCRM PROCESSES AND TOOLS

MASA‐Shariah (self assessment) – medium and highRisk Task OIC Comply

(Y/N) Shariah Requirement Additional Control

S1 –Customer is not eligible to transact.

• Financing application creation.

• Handle offer acceptance

PFE • Customer must have capacity to enter into transaction.

• Granting financing to customers who are clearly known not to have the capacity to pay it is prohibited (haram).

S2 –Appointment of Agent Form is not completed and signed.

Financing application creation.

PFE • Shariah Compliance Policy - All documents relating to the products and services must be approved by the SSC.

• To perform as an agent, the Bank must be appointed by the principal.

IDENTIFICATION OF SCR (RISK MAPPING)

REPORTING REQUIREMENTS UNDER BNM’S SGF

29SHARIAH DIVISION

No Section Principle Reporting Frequency

1. Section 1: General Requirements of the SGF

Principle I 1.6 IFI shall establish formal reporting channels among the key functions to ensure that the reporting of Shariah matters is carried out effectively & on timely manner.

• All Shariah non‐compliance events are to be reported to the board of the IFI and Bank Negara Malaysia.

Monthly

2. Section II: Oversight, Accountability & Responsibility

Principle 2 Shariah committee (SC) 2.9 In discharging its duties, the SC is expected to disclose sufficient information in the IFIs annual financial report.

Management 2.17 In the event the management becomes aware that certain operations are found to be carrying out businesses which are not in compliance with Shariah, or against the advice of the SC or the rulings of SAC, the management shall:

• Immediately notify the board and SC as well as Bank Negara Malaysia

Annually

‘As and when’

3. Section III: Independence

Principle 3 3.7 In cases where Shariah non‐compliant activities are not effectively or adequately addressed or no rectification measures are made by the IFI, the SC shall inform the Bank of the fact

‘As and when’

ACTUAL SHARIAH NON-COMPLIANCE REPORTING PROCESS

Shariah Division

POTENTIAL SHARIAH NON-COMPLIANCE REPORTING PROCESS

Shariah Division

32

SCR Policy & Guidelines

SHARIAH RELATED POLICY & GUIDELINES

No. Guideline Purpose Outline

1. Shariah Compliance Policy

To ensure that the Bank’s products, services and activities comply with the Shariah requirements as determined by relevant Shariah regulatory councils.

To establish the appropriate functional structures as well as their roles and responsibilities in managing Shariah compliance risk within the Bank.

To define general as well as specific Shariah requirements in deposit, financings, investments and other services offered by the Bank.

Application of Shariah in Islamic Banking Shariah Compliance Risk Management Definition of Shariah Compliance RiskSCRM Methodology SCRM Mission and Objectives SCRM Functional Structure “3 Lines of Defense” ConceptSCRM Policy and Guidelines SCRM Processes SCRM Enablers The Shariah Department SCRM Roadmap General Shariah ComplianceSpecific Shariah Compliance Specific Shariah Compliance on Deposits Specific Shariah Compliance on Services Specific Shariah Compliance on Financing Specific Shariah Compliance on Investment

Shariah Division



2. Shariah Compliance Risk Management (SCRM) Guideline

Provides guidance and reference to all staff in understanding the idea of SCRM.

Elaborates the process of managing Shariah compliance risk.

Details out the application of SCRM tools.

SCRM ProcessesRisk IdentificationAssessment and MeasurementControl and MonitoringRisk Reporting

3. Shariah Review Guideline

Provides guidance and/or reference to all staff in understanding Shariah review.

Standardizes and streamlines the methodology and procedures in undertaking Shariah review by relevant staff.

Definition and Objective of Shariah ReviewShariah Review and Shariah AuditShariah Review PolicyShariah Review ReferenceShariah Review CoverageShariah Review PlanNotification of Shariah Review ExerciseIndependent Review ProcessRecord KeepingShariah Review Process

Shariah Division



4. Business ZakatPayment Guidelines

Provides a standard guide to be followed by Bank’s staff in managing the payment of Bank’s business zakat;

Sets out the requirements for the Bank’s business zakat payment to ensure compliance with Shariah requirements as determined by the Shariah regulatory councils.

Legality of ZakatEligible Recipients of Zakat (Asnaf) General Requirements Approving Authorities Eligibility Criteria for Fuqara’, Masakin, Fi Sabilillah and MuallafatAl-qulub Recipient Fuqara’ and MasakinFi SabilillahMuallafat Al-qulubRoles and Responsibilities of Related Parties

5. Shariah Division Operational Manual

Acts as a guide for Shariah Division staff in discharging their roles and responsibilities.

Standardises and streamline Bank Islam procedures and practices for Shariah functions.

Shariah Division – Organisation Chart and Job DescriptionStandard Operating Procedure

Shariah Division



6.7.

8.

9.10.11.12.13.

Shariah Contract Guidelines

Wadiah Contract GuidelineIjarah and Ijarah Muntahiah bit Tamlik (IMB) GuidelineMusharakah & Mudharabah(Financing) Contracts GuidelineIstisna’ Contract GuidelineMudharabah (Deposit) GuidelineKafalah GuidelineWakalah Contract GuidelineTawarruq (Financing) Concept Guideline

All the Guidelines are to serve:

As a standard guide for the Bank’s personnel in dealing with the Bank’s products based on the respective Shariah contracts.

To set out the requirements for the Bank’s products which are based on the respective Shariahcontracts, to ensure that the planning, development, and implementation of the Bank’s products are in accordance with the Shariah rules and principles.

Definition and BasisModus Operandi Primary Shariah Requirements Specific Shariah Requirements

Shariah Division

37

SCR Awareness

SHARIAH COMPLIANCE TRAINING ‘HIJRAH TO EXCEL’ PROGRAMME

OBJECTIVE OF THE PROGRAMME COVERAGE OF THE PROGRAMME

1. To facilitate the process of ensuring compliance with Shariah requirements in the Bank’s products, services and activities.

2. To instill Shariah compliance risk aware culture within the Bank.

1. Islamic Banking: A Revisit

2. Shariah is Our Foundation

3. Shariah Contracts (sale, deposit, partnership & other supporting contracts)

4. Islamic Ethics

Shariah Division

OTHER INITIATIVES

No. Programme

1. Shariah Compliance Risk Masterclass for Senior Management

2. Workshop Sharing Session on Operational Issues for Clerical, Officers, Branch Service Managers and Branch Managers organized by Branch Supervision

3. Refresher course on Shariah compliance risk for high exposure functional areas on SCR. E.g.:1.Credit Administration Department2.Central Financing Processing Centre3.Vehicle Financing Department4.Bank Islam Card Centre5.Trade Finance Department

4. Issuance of Shariah Compliance Risk reminders to staffs

Shariah session during Orientation Programme for newly recruited staff.

The following programmes were and will be organized to instill Shariah compliance risk awareness culture among Bank Islam staff:The following programmes were and will be organized to instill Shariah compliance risk awareness culture among Bank Islam staff:

Shariah Division

40

Shariah Non‐Compliant Income

SHARIAH NON-COMPLIANT INCOME

Shariah Division

SourcesSources

Disposal policyDisposal policy

RecipientsRecipients

Approval authority for disposal

Approval authority for disposal

1) Pre-identified e.g. Interest from nostro accounts (conventional bank), Bank Islam Card

2) Income derived from SNC with regard to invalid contract between Bank and customer due to operational breach of Shariah rules and principles

1) Pre-identified e.g. Interest from nostro accounts (conventional bank), Bank Islam Card

2) Income derived from SNC with regard to invalid contract between Bank and customer due to operational breach of Shariah rules and principles

The Bank is obliged to dispose the Shariah non-compliant income by way of charity as soon as possibleShariah non-compliant income must be placed in a special accountThe account is under supervision of related departments i.e Finance and Shariah

The Bank is obliged to dispose the Shariah non-compliant income by way of charity as soon as possibleShariah non-compliant income must be placed in a special accountThe account is under supervision of related departments i.e Finance and Shariah

Among recipients of Shariah non-compliant income from Bank Islam are:a) PDK Seri Murni, Sg Siput, Perak. (passenger van)b) Yayasan Amal Malaysia (purchase of land for development of Regional

Dakwah Centre)c) Masjid an-Nur and Surau ar-Rayyan, Wilayah Persekutuan Labuan

(construction and refurbishment of toilet and ablution area)d) Jabatan Hal Ehwal Agama Islam Kelantan (purchase of hearse for rural area)

Among recipients of Shariah non-compliant income from Bank Islam are:a) PDK Seri Murni, Sg Siput, Perak. (passenger van)b) Yayasan Amal Malaysia (purchase of land for development of Regional

Dakwah Centre)c) Masjid an-Nur and Surau ar-Rayyan, Wilayah Persekutuan Labuan

(construction and refurbishment of toilet and ablution area)d) Jabatan Hal Ehwal Agama Islam Kelantan (purchase of hearse for rural area)

All decisions on disposal of Shariah non-compliant income must be approved by Shariah Supervisory Council

All decisions on disposal of Shariah non-compliant income must be approved by Shariah Supervisory Council

Disclaimer: This presentation material has been prepared by Bank Islam Malaysia Berhad (the Bank”) for information purposes only and does not purport to contain all the information that may be required to evaluate the Bank or its financial position. No representation or warranty, express r implied, is given by or on behalf of the Bank as to the accuracy of the information or opinions contained in this presentation. The presentation does not constitute or form part of an offer, solicitation or invitation of any offer, to buy or subscribe for any securities , nor should it or any part of it form the basis of, or be relied in any connection with, any contract, investment decision or commitment whatsoever. The Bank does not accept any liability whatsoever for any loss howsoever arising from any use of this presentation or their contents or otherwise arising in connection therewith.

BANK ISLAM MALAYSIA BERHAD27th Floor, Menara Bank Islam,No. 22, Jalan Perak, 50450 Kuala Lumpur.Tel: 603 2088 8222

www.bankislam.com.my

Mohd Nazri ChikAssistant General Manager, ShariahContact: 603 2088 8052Email: [email protected]

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