Saturday, November 27, 2010

Shari’ah Supervision: Can The Industry Incorporate More Scholars?

Shari’ah scholars are probably the most important—and often viewed as the most scarce—resource in the Islamic finance industry.  There are fewer than 20 scholars with the widest recognition who are used by the majority of Islamic financial institutions and conventional institutions with Islamic ‘windows’.  The conflicts of interest (actual or perceived) that Shari’ah scholars face with their duties to maintain confidentiality and their receiving of payment directly by the institutions they regulate have come under greater scrutiny over the past several months.

One of the most stringent regulations of Shari’ah boards was recently implemented in the United Arab Emirates for takaful companies, which prevented Shari’ah scholars from being on multiple boards simultaneously and prohibited them from having a financial interest in the company except for their pay for serving as members of the Shari’ah board. 

In addition to the UAE regulation, the Islamic Financial Services Board (IFSB) released a new standard (IFSB-10) covering the “Guiding Principles On Shariah Governance Systems For Institutions Offering Islamic Financial Services”.  The IFSB standard is not as rigid as the UAE regulation and it does not set a maximum number of boards that a scholar can sit on, so long as he is able to devote enough attention to each board of which he is a member. 

The central bank of Malaysia, Bank Negara, has adopted standards in line with the IFSB standard for Islamic financial institutions in that country.  Clearly, the question of Shari’ah scholar independence and potential conflicts of interest are being addressed.  However, with more stringent regulations, it will be a challenge if the top 20 scholars are included on nearly every board.  The latest report from Funds@Work and Zawya (pdf) found that the Top 20 scholars held 624 positions while the remaining 300 held only 520 positions (the report only looked at scholars who are on a Shari’ah board).

With a cluster of the top 20 scholars holding such a disproportionately large share of Shari’ah board memberships, it raises the question about how the industry will be able to sustain its growth as the number of institutions multiplies across the world.  However, the ability of such a small number of scholars to represent such a large number of institutions suggests that, if their time is managed well and the less represented scholars are incorporated into Shari’ah boards, the industry is not facing as much of a shortage of scholars as is commonly stated. 

However, the fact remains that despite significant attention being paid to the ‘scarcity’ of top scholars, there has not been much movement towards incorporating less experienced scholars into the boards at Islamic financial institutions.  What can be done to change this?  Are there ways that the traditional role of older Shari’ah scholars as teachers and mentors for younger scholars can be used as a way to spread the responsibilities for Shari’ah review and supervision more effectively across the industry?

I think there is a solution that can maintain the requirement of having experienced Shari’ah scholars on each board, while also broadening the pool of scholars who sit on multiple boards.  However, this will require a change in attitude by many Islamic financial institutions which may face resistance from some (particular international financial institutions), who rely on prominent scholars as a way to demonstrate their Shari'ah-compliance to potential clients. 

One of the areas where the Zawya Shariah Scholars database[1] can contribute is by showing the linkages between different scholars (who has worked with whom in the past) as well as the relative areas where each scholar has the most experience.  However, the availability of that information may be necessary, but is not sufficient.  There needs to be a change in the way that Shari’ah boards are put together, which may require more stringent regulation by standards setting bodies and national regulators.  It is not evident that Islamic financial institutions will voluntarily move away from hiring the most recognized scholars.

However, that being said, a regulation that specifies the maximum number of boards on which any one scholar can serve, is not the best way to regulate Shari’ah boards.  There is no hard and fast number of positions where a Shari’ah scholar becomes too busy to effectively serve each institution and each scholar will have his own limit.  The peripheral issues raised by the UAE, BNM and IFSB regulations relating to perceived conflicts of interest can be more widely applied without too much difficulty. 

There are two different tracks that I could see being an effective way of leveraging the relationships that already exist between Shari’ah-scholars are 1) Shari’ah advisory firms; and, 2) retaining the institution-by-institution system with some form of limitation that limits the most well recognized scholars from serving together on boards.  I think the limitations of regulation make the latter idea not practicable. It would more likely represent a status quo approach reliant on the voluntary decision by institutions to find a way to reduce their own reliance on the most in-demand scholars.  The former, by contrast, would create a way to manage conflicts of interest as well as use the existing relationships between scholars.

As I have mentioned before, the Shari’ah advisory firm model reshapes the Shari’ah advisory function into something that more closely resembles law firms and accounting firms.  Instead of hiring individual Shari’ah scholars, the institution would hire an advisory firm, who would be responsible for assigning the individual scholars to different firms based on their experience in that firm’s type of business, as well as the time constraints facing their scholars. 

There remain unsolved questions associated with this method.  For example, how would the potential for large firms with higher budgets to hire the top scholars while the smaller, local firms be forced to have less experienced scholars assigned to their boards be mitigated?  Would there be overlap allowed between Shari’ah advisory firms (for example, would one scholar be allowed to work at more than one Shari’ah advisory firm?).  How would the firms avoid becoming entrenched in one way of thinking.  For example would Shari’ah advisory firm A be known for being more lax on interpretations, while firm B would be known as having scholars who provide more conservative interpretations? 

Despite these unresolved questions, the Shari’ah advisory firm model is more realistic in my opinion, because it avoids the question of how to determine the maximum number of board positions each Shari’ah scholar is allowed.  It also makes a step forward in ‘professionalizing’ the Shari’ah review business that can over time limit the cost to Islamic financial institutions by spreading administrative and workflow management costs across a larger number of scholars.  This should ease the strain on the existing scholars who hold the most positions, reduce costs for the industry and also help to bring less prominent Shari’ah scholars onto more boards where they can learn from the top scholars and ensure the industry has the resources it needs to continue growing and pass Shari’ah supervisory duties from one generation of scholars to another.

[1] The Zawya Shariah Scholars database provides information on over 300 scholars with information about their affiliations, statistics on the other scholars with whom they have worked and the sukuk for which they have provided fatawa.  Thanks to Zawya for providing me with a tour of the features of the database.

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