Governance, Religious Assurance and Islamic Banks: Do Shariah Boards Effectively Serve?

J Manag Gov
https://doi.org/10.1007/s10997-018-9418-8
Governance, religious assurance and Islamic banks: Do

Shariah boards effectively serve?
Nurfarahin M. Haridan1 · Ahmad F. S. Hassan2 · Yusuf Karbhari3
© The Author(s) 2018
Abstract This study examines the quality of governance and religious assurance
provided by Shariah boards (SBs) when undertaking the crucial compliance review
required in fulfilling the expected ethical and social legitimacy of Islamic banks.
To better understand the complex behavioural processes, we explore the governance
role of SBs and assess issues related to competence, effectiveness and independence
in the light of the newly adopted 2011 Malaysian Shariah Governance Framework
(SGF). A series of semi-structured interviews were undertaken with key individuals
in two well-established fully-fledged Malaysian Islamic banks. Our findings reveal
that the newly implemented SGF has generally brought about some of the benefits
hoped for by its regulatory architects. We find the quality of religious assurance to
have been enhanced due to the emphasis placed on religious audit giving rise to
improved credibility. However, we report the compliance review process to be inad-
equately undertaken with SBs still excessively reliant on internal officers implying
possible independence compromise. We highlight concerns relating to (1) the gen-
eral level of competency of individual SB members; (2) lack of technical banking
and finance knowledge; and (3) SB members generally fulfilling a ceremonial role
rather than undertaking vigilant monitoring. Our findings lead us to question the
full impact of the new 2011 SGF and query the value and effectiveness of SBs. We
make the call for the establishment of external religious auditors to render compli-
ance assurance which could provide the much-needed impetus to improve govern-
ance and increase market and stakeholder confidence.
* Yusuf Karbhari
Karbhari@cardiff.ac.uk
1
Putra Business School, Universiti Putra, Malaysia, 43400 Serdang, Malaysia
2
Faculty of Economics and Management, Universiti Putra, Malaysia, 43400 Serdang, Malaysia
3
Cardiff Business School, Cardiff University, Colum Drive, Cardiff CF10 3EU, UK
13
N. M. Haridan et al.
Keywords Religious assurance · Religious audit · Governance · Shariah boards ·

Islamic banks · Malaysia
1 Introduction
In the last few decades, the Islamic finance industry has made rapid progress with
total global financial assets currently estimated to be around USD2trillion with a
compounded annual growth rate (CAGR) of 17.3% (MIFC 2014, p. 2). The suc-
cess of Islamic finance is also evident through its contribution to corporate social
responsibility (Farag et al. 2014; Abdelsalam et al. 2014; Platonova et al. 2016) and
economic development (Gheeraert 2014; Gheeraert and Weill 2015). In relation
to the growth of the industry, Malaysia was reported to be the third largest in the
world after Iran and Saudi Arabia and contributed approximately 21.9% of the total
domestic banking assets while also accounting for 9.6% of global Islamic banking
at the end of 2014 (IFSB 2015, p. 9). In particular, the Malaysian Islamic banking
industry is acknowledged to be the most developed globally with a comprehensive
governance framework in existence for its Islamic banks (Aziz 2012; MGCC 2015;
IMF 2017). As such, establishing sound governance practices in Islamic banks
would instil confidence in stakeholders (Chapra and Ahmed 2002; Grais and Pel-
legrini 2006a; IFSB 2006; Ginena 2014; Ullah et al. 2016), improve credit ratings
(Grassa 2015) and enhance stock exchange performance of this alternative banking
industry (Polato et al. 2016).
Despite their virtuous character, Shariah Boards (SBs) carry a heavy burden of
responsibility for providing religious assurance which contributes to the robustness
of the Islamic banking governance system as well as endorsing the religio-ethical
legitimacy required by stakeholders (Bougatef 2015; Ullah et al. 2016). In addition,
SBs are responsible for issuing an annual report on the religious compliance of the
banks operations (Tomkins and Karim 1987; Karim 1990a, b; Maali et al. 2006;
Ullah et al. 2016). It is, therefore, paramount that SBs demonstrate competence,
independence and effectiveness as they play a key role in confirming to stakeholders
of Islamic banks that an ethical system is in place allowing consumers to bank in
accordance with their faith. However, previous studies have reported several con-
cerns on the inherent deficiencies of SB role in relation to providing religious assur-
ance (see for example Alhabshi and Bakar 2008; Rammal and Parker 2010; Hasan
2011; Hassan 2012; Ullah et al. 2016). Additionally, Hassan (2012) and Ullah et al.
(2016) rightly allude to the lack of independence of SBs in delivering the crucial
religious assurance since top management of Islamic banks were found to use sev-
eral ‘overt’ and ‘covert’ practices to exert influence over decisions of SBs.
In this study, we investigate the quality of religious assurance provided by
SBs when performing the religious compliance review process in the light of the
newly implemented 2011 Malaysian Shariah Governance Framework (SGF). We
use the interview method and focus on two large well established fully-fledged
Islamic banks to gather valuable insight, allowing us to explore in greater depth
the role of SBs in fulfilling the central obligation of ethical and societal legiti-
macy. In this context, Cooper and Morgan (2008) note that case study approaches
13
Governance, religious assurance and Islamic banks: Do Shariah…
are especially useful in examining complex behavioral processes and address-

ing questions of how and why, whilst, Ahrens and Chapman (2006) highlight the
potential for qualitative research to contribute to theory. By undertaking inter-
views with SB members and other key actors in the two selected Islamic banks,
our study also directly contributes by responding to calls for qualitative research
(see for example Spira 2002; Gendron and Bédard 2006; Turley and Zaman
2007; Beasley et al. 2009; Zaman and Sarens 2013; Everett et al. 2016) and pre-
sents the advantage of gathering more detailed information than typically is col-
lected in quantitative research as mainly is the case for Islamic banking studies
(see for example Alhabshi and Bakar 2008; Hasan 2011; Grassa 2015; Kanaga-
retnam et al. 2015; Mollah and Zaman 2015). To the best of our knowledge, a
study focussing on the post 2011 implementation has not been previously under-
taken and since Malaysia is a global leading player in Islamic finance, such a
study would shed important light to prior literature and provide lessons for other
Islamic jurisdictions.
Our study also provides a theoretical contribution in relation to SBs role in
ensuring religious compliance since there are several competing theories regard-
ing corporate governance and the various organs of governance (see for example,
Kalbers and Fogarty 1998; Cohen et al. 2002, 2007b). We examine the religious
compliance role of SBs using three main governance theoretical foundations, i.e.
agency theory, stakeholder theory and legitimacy theory. However, some stud-
ies propose that the agency structure is ill-suited to the operations of Islamic
banks as its application can potentially result in a trade-off between compliance
to the Shariah and the protection of investor’s rights (see for example Hasan
2009; Safieddine 2009). In particular, due to the wide spectrum of Islamic bank
accountability, the Shariah broadens the concept of stakeholder interest and busi-
ness legitimacy to include socio-religious compliance and ethics in the govern-
ance system of this alternative banking industry. In this research, we find that SB
members, whose ultimate responsibility is to serve as agents to both shareholders
and other stakeholders, were found not to be diligently performing their fiduciary
duty of religious compliance as they remained heavily dependent on the outcome
and results presented to them by internal officers thus compromising independ-
ence. Therefore, due to the conflict between current practice and theoretical expo-
sition on the role of SBs, we suggest Islamic banks establish a clear line of sepa-
ration in the responsibility of SBs by delegating the religious compliance role to
an external auditor competent to undertake religious auditing whilst the SBs are
to focus on their advisory role.
In the next section, we present our literature review along with a discussion
on the concept of Shariah, issues surrounding the supervisory role of SBs and
the current framework for Shariah governance of Islamic banks in Malaysia and
presents the study’s theoretical framework. In Sect. 3, we describe our research
methodology and in Sect. 4, we provide analysis into the key features and func-
tions of SB members and the extent of diligence applied when undertaking the
all-important religious compliance review prior to providing their annual assur-
ance report. Finally, Sect. 5 concludes the study by highlighting the salient issues
surrounding this study.
13
2 Related literature, Islamic banking in Malaysia and theoretical

framework
2.1 Related literature
Islamic banks are established as ethical financial institutions with the fundamental
requirement for their product and services to be wholly Shariah compliant. The con-
cept of Islamic banking first emerged in the late 1940s but the pioneering effort in
bringing Islamic banking principles into practice only became reality in 1963 with
the development of the Mit Ghamer Savings Bank and the Nasser Social Bank in
Egypt. However, the activities of these two banks were only attuned to collecting
small savings and making direct investments in agricultural and industrial activities
or to small local businesses and hence, were more akin to a social bank. In 1975,
the Organisation of Islamic Cooperation (OIC) inaugurated an inter-governmental
Islamic bank, known as the Islamic Development Bank (IDB), which was estab-
lished with the sole purpose of fostering economic development and social progress
among member countries and their Muslim communities in accordance with the
Shariah laws. Now, there are over 300 Islamic banks offered across 75 countries and
this market industry has grown 50 per cent faster than their conventional counter-
parts (The Banker 2015).
According to the Islamic faith, the Shariah is regarded as a divine law that is
derived from two main sources—i.e., the Quran and Prophetic traditions and sayings
(otherwise known as Hadith). In the absence of clear guidance from these two main
sources, the Shariah is also derived from secondary sources which include: ijtihad
(legal reasoning), qiyas (analogical reasoning), istihsan (juristic preference), masla-
hah mursalah (unrestricted public interest), and ‘urf’ (customary practice). This pro-
vides justification for scholars to utilise the ijtihad facility to provide Shariah rulings
(i.e., otherwise known as a Fatwa). The interpretation of a Fatwa or ‘religious rul-
ing’ is provided only by religious scholars based on Islamic doctrine, the four main
schools of thought are the Shafii, Hambali, Hanafi and Maliki Schools of Jurispru-
dence)1 with the ultimate aim of meeting the “objectives of Shariah”.
The objectives of the Shariah were clarified by Islamic jurists such as Imam al-
Ghazali amongst others as: faith; life; intellect; lineage; and, property (Kamali 2008)
and was then applied in various contexts of a Muslims’ life including issues relating
to human relations (mu’amalat). Other studies have concluded that the operations of
Islamic banks promote the realisation of an Islamic financial system that is drawn
from Islamic law (see for example Iqbal 1997; Zaher and Hassan 2001). Among oth-
ers, Shariah law permits Islamic banks to operate business based on four principles:
(1) risk-sharing or concept of equality; (2) materiality or economic value; (3) no
exploitation whereby neither party nor the transaction should be exploited and (4),
no financing of activities that are banned by the Quran (e.g., alcohol, pork products,
1
It is worth noting that Malaysia follows the Shafii School of Jurisprudence whilst other Islamic coun-
tries in the Middle East and North Africa (MENA) and in South East Asia follow the remaining three
Jurisprudential schools.
13
etc.). Additionally, Shariah law forbids Islamic banks in business dealing with ele-
ments of riba (interest), gharar (speculative trading) and maysir (gambling) as such
activities lead to the conditions that may facilitate economic exploitation and unlaw-
ful profit (Naughton and Naughton 2000; Lewis 2007; Hassan and Lewis 2007; Hos-
sain 2009).
When attention is turned to governance, there are various mechanisms in place
to ensure that the integrity of the Islamic banking industry is upheld, including the
appointment of competent SBs who are entrusted with the highest responsibility on
aspects of religious compliance. Unlike their counterparts, assurance on religious
compliance is unique to Islamic banks as it builds stakeholders confidence on reli-
gious legality of the products and services that banks provide. Several studies have,
indeed, highlighted the key governance role of SBs in overseeing and monitor-
ing the religious compliance aspect of Islamic banks (see for example Briston and
El-Ashker 1986; Tomkins and Karim 1987; Karim 1990a, b; Banaga et al. 1994;
Najeeb and Ibrahim 2014; Ginena 2014; Bougatef 2015; Almutairi and Quttainah
2017). These studies outline the duties of SBs in assuring that Islamic banking oper-
ations along with their products, contracts and management of Zakat comply with
Islamic principles. Therefore, the issue of competency and independence of each
SB are key governance features which demonstrate the reliability and soundness
of SBs’ role in assuring ethical legitimacy.2 For this reason, members of SBs com-
prise of individuals who are experienced and qualified in various disciplines such as
Islamic law, accounting, auditing and finance (see for example Gambling et al. 1993;
AAOIFI 1997, para 7; Grais and Pellegrini 2006b; BNM 2011, p. 17; Ginena 2014)
enabling them to competently manage and evaluate Islamic banking issues (Malik
et al. 2011).
Moreover, given that the requirement of SB independence is consistent with the
current practice of external auditors, several studies have documented that auditor
independence is associated positively with the effectiveness of audit committees
in issuing quality audit reports (Bédard and Gendron 2010; Kueppers and Sullivan
2010; Jamal and Sunder 2011; Dobija 2015). After all, issuing a quality audit report
also requires the external auditor to be competent and transparent in providing com-
plete and truthful information to enhance understandability and reduce information
asymmetry among investors (Graham et al. 2005; Barth and Schipper 2007; Billings
and Capie 2009). However, since Islamic finance broadens the governance function
of SBs into a wider spectrum of religious compliance, SBs are not only accountable
to provide an independent and transparent religious report to stakeholders but also
to ensure religious compliance of banking operations. By religious compliance we
argue that SBs has the single most important authority to conduct regular reviews
and monitor assessment to ensure that Islamic banks do not contravene religious
2
In our view, Levitt’s (2000, p. 5) proposition that Audit Committees should be competent, committed,
independent, and tough-minded and should be “one of the most reliable guardians of public interest” also
apply to SBs in Islamic Banks. Without SBs, there is no existing mechanism available in Islamic finance
that can endorse the ethical, institutional and religious legitimacy expected by stakeholders. Thus, SBs
are a powerful mechanism that serves as the conscience of Islamic society.
13
principles governing its operations. When focussing on the issue of independence

of SBs, several studies have claimed that the minimum supervision and monitoring
role of SBs is due to lack of standardization in the governance of religious audit as
well as a shortage of qualified and independent religious auditors in Islamic banks
(see for example Garas and Pierce 2010; Najeeb and Ibrahim 2014; Othman and
Ameer 2015). For instance, Rahman (2008) highlight that only a few Islamic banks
undertake the crucial responsibility of reviewing and checking the transaction after
the accomplishment of contracts and products noting that these could be due to a
lack of regulation of the religious audit framework and the required expertise to per-
form this task.
Other empirical studies have also been undertaken on matters surrounding the
role of SBs. For instance, Ullah et al. (2016) applied grounded theory to key stake-
holders of three Islamic banks in two different countries (i.e., Pakistan and the
United Arab Emirates). The authors report that individual religious scholars as well
as SBs tend to play only a limited role in safeguarding and promoting religious prin-
ciples as management of Islamic banks attempt to avoid the supervision and audit
role of SBs. In doing so, managers do not truly uphold religious principles, but
merely aim to seek religious certification for their banking products. In fact, Ullah
et al. (2016) highlighted that some Islamic banks engage in recruiting liberal schol-
ars to attain permissibility of action especially when dealing with Islamic transac-
tions or financial contracts. The concern was raised because managers may attempt
to dictate to SBs’ decisions and opinions to tie up to their goal and objectives which
is referred to by the authors as “Fatwa Shopping”. This could well amount to ‘man-
agerial opportunism’. In an earlier study conducted by Garas (2012) on the key
Islamic financial institutions (IFI) in the GCC countries, the researchers identified
conflicts of interest in SBs and six specific independent variables: the SB executive
position, SB remuneration, the relation between the SB members and board of direc-
tors (BOD) and the multiple memberships in Islamic funds, issuers of bonds and
companies trading in capital markets. Garas (2012) asserts that a significant conflict
of interest exists between executives and SB members, the membership in Islamic
funds and the relation between the SB and the BOD. Furthermore, the study pro-
vides key evidence that the independence of SB should not be compromised if SB
members do not hold any managerial position in the IFI and fixes SB remuneration.
Discussion on the governance of SBs was also highlighted recently by research-
ers such as Mollah and Zaman (2015) who examined the effect of SBs and cor-
porate governance on the performance of Islamic banks from 25 countries for the
period 2005–2011. They claim that SBs provide a positive impact on performance
of Islamic banks but there is still much need for further improvement in the effective
oversight and monitoring role of SBs. In an earlier study, Alhabshi and Bakar (2008)
conducted a survey to examine the prevalence of SBs of institutions offering Islamic
financial services across several jurisdictions. The study highlighted that SBs have
inherent deficiencies when fulfilling the religious compliance review role in relation
to the development of Islamic financial products. Similar findings were further high-
lighted in a survey conducted by Hasan (2011) to examine the current governance
practices of IFIs in Malaysia, UK and the GCC countries. The study revealed that
SBs have minimum participation in conducting their review task as 58% of the SBs
13
delegated their religious compliance review function to be carried out by the inter-
nal religious compliance unit.
Additionally, Rammal and Parker (2010) conducted interviews to investigate
the role of SBs in IFIs in Pakistan and their study highlighted grave concern on the
credibility of SBs deliberating on Islamic banking issues and the limited pool of
religious knowledge amongst the participants of Islamic banks that would then cre-
ate a conflict of interest between SBs and management. Interestingly, Hassan (2012)
conducted in-depth interviews with 46 key leaders in the Malaysian Islamic bank-
ing industry to identify the role, independence and the effectiveness of the religious
compliance review of SBs. The study revealed that under the GPS-1 regime (dis-
cussed in the next section), Islamic banking operations in Malaysia experienced
weaknesses in the quality of religious assurance provided by SBs as the religious
compliance review function of SB was found to be mainly undertaken by internal
officers and results presented to SB for approval. Hassan (2012) reported that SBs
issued their religious assurance without proper due diligence as SBs were found to
rely heavily on the result performed by internal officers with top management found
to be over-ruling decisions of SB. Therefore, the arguments brought forward indi-
cate that the quality of religious assurance could be improved with the adoption of
the new 2011 Malaysian SGF framework which places substantial emphasis on the
religious audit function to enhance the governance process and ultimately the cred-
ibility of SB, this is the subject of the next section.
2.2 Islamic banking in Malaysia
Malaysia is regarded as a leading country for promoting Islamic banking and finance
and operates a dual-layer Shariah governance and regulatory framework. At the
individual Islamic bank level, the governance of bank operations is supervised by an
independent SB whereas supervision at the macro level is undertaken by the Shariah
Advisory Council (SAC) of the Central Bank of Malaysia or Bank Negara Malaysia
(BNM). It was discussed earlier in Sect. 1 that the governance system of Malay-
sian Islamic banking has experienced several stages of improvement. In 2005, the
BNM, introduced the ‘Guidelines on the Governance of Shariah’ otherwise known
as GPS-1. Following GPS-1, central requirements were imposed by the BNM which
required Islamic banks to have SBs with a minimum of three members responsible
to ensure that the business transactions are religious-compliant. GPS-1 also set the
limit on membership of SBs to be not more than one bank with appointment of its
members being subject to approval of BNM. To determine the extent of the author-
ity of the central religious body, the SAC was authorised with mandated power on its
governance role in the recent amendment to the Central Bank of Malaysia Act 2009
in which the resolutions issued by the SAC are binding on all Malaysian IFIs (BNM
2009). This Act repealed the earlier Central Bank of Malaysia Act 1958 which pro-
vided regulations for the licensing of the banking sector.
In 2011, the BNM introduced its SGF aimed to enhance the role of the BODs,
SBs and management alike in relation to the governance of Islamic banking
operations. Since the implementation of SGF in 2011, the quality of religious
13
assurance provided to the stakeholders by Islamic banks is expected to have been

enhanced. This proposition is made on the basis that the new SGF places empha-
sis on the accountability of key organs of an Islamic bank in undertaking their
governance function. The SGF further stipulates the minimum requirement for
SB membership to be at least five with most members to have a religious edu-
cational background. The SB members are also required to be accountable and
responsible for their decisions, views and opinions related to religious matters. In
strengthening religious compliance and disclosure, the SGF also recommends for
Islamic banks to establish Shariah audit and to develop an effective Shariah audit
plan according to their particular business objectives, scope, personnel assign-
ment, sampling, control, policies and procedures. Meanwhile, the management
of Islamic banks are expected to provide accurate information about the business
transactions and operations to the SBs. The SGF has also outlined the importance
of religious compliance and religious research functions aimed at the attainment
of a religious compliance-based operation environment in Islamic banks.
Meanwhile, in June 2013, the Islamic Financial Services Act (IFSA) was intro-
duced as an empowering mechanism to support the implementation of religious
principles and an operational standard for IFI’s, including penalties in the case of
non-compliance. Amongst issues highlighted relate to the appointment and quali-
fications of SB members and accountability of respected parties on the religious
assurance of Islamic banking operations. For example, Section 30 of IFSA high-
lights the appointment and qualifications of SB members in IFIs. In this regard,
under the new Act, banks may apply directly to the BNM on the establishment
of their SBs to advise and oversee all operations, activities and affairs of the
banks and to ensure that activities comply with Islamic law (BNM 2013, para
30). In relation to qualification of SB members, there is a provision for members
to meet all standards and requirements that are specified by BNM and other inter-
national regulatory body that has significantly influenced the financial reporting
of Malaysian Islamic banks including Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFIs) and Islamic Financial Services Board
(IFSB). For example, AAOIFI clearly spell out the role of SB’s as “the govern-
ance authority who are entrusted with the duty of directing, reviewing and super-
vising the activities of the IFIs in order to ensure that they are in compliance with
Islamic Shariah rules and principles” (AAOIFI 1997, para 2). In a similar context,
the IFSB recommended for the Islamic bank to establish an effective governance
mechanism for obtaining and applying rulings from SB as well as on monitoring
religious compliance aspects including the ex-ante and ex-post of financial trans-
actions and the operations of Islamic Financial Services (IFSB 2006, para 47). To
ensure the effective religious compliance procedure, SBs are required to have suf-
ficient knowledge in Shariah as well as knowledge in law, accounting, economics,
finance and audit (AAOIFI 1997, para 7; IFSB 2009, para 30; BNM 2011, p. 10).
The mixed knowledge and background of SB members provides an effective SB
composition on its commitment to ensure operations of Islamic banks are fully
Shariah-compliant. As stated in the IFSA 2013, Islamic banks shall, at all times,
ensure that business activities and transactions are religiously compliant. In the
event of failure of Islamic banks to comply with the above provisions this shall
13
make SB members liable to imprisonment for a term not exceeding 8 years or to a

fine not exceeding twenty-five million ringgits or both (BNM 2013, para 29).
More recently, the Guideline on Financial Reporting for Islamic Banking Institu-
tions have been revised and became effective on 1 January 2014 to better facilitate
users of financial statements to evaluate and assess the financial position and perfor-
mance of Islamic banks. This new guideline, referred to as GP8-i, provide recom-
mendations for the financial statement (i.e., statement of financial position, state-
ment of comprehensive income) of Islamic banks to have separate disclosure and
to be prepared in accordance with Malaysian financial reporting standards (MFRS).
In meeting the provision of religious compliance stated in the SGF, this GP8-i also
requires Islamic banks to disclose the SB report as part of the annual report and
signed by not less than two SB members.
2.3 Theoretical framework
As discussed in the introduction, corporate governance for financial institutions such

as banks exhibit different features due to the opacity and regulatory nature of the
industry (Ciancanelli and Gonzalez 2001; Andres and Vallelado 2008; Wilson et al.
2010; Mollah and Zaman 2015; Mollah et al. 2016). It is therefore important for
financial institutions to be well regulated and for effective corporate governance to
be implemented as such mechanisms are instrumental in promoting stability of the
financial system as well as enhancing social welfare (Grais and Pellegrini 2006b).
Similar arguments are deemed relevant when discussing Shariah governance in
Islamic banks. Nevertheless, the distinguishing feature and portfolios of Islamic
banks requires additional corporate governance mechanisms that ensure adher-
ence to religious principles in their business operations and transactions. Hence,
we examine the quality of religious assurance in Islamic banks using agency, stake-
holder and legitimacy theoretical foundations.3 The agency theory is generally
defined as the contractual relationship between the shareholder as the principal and
the managers as the agent who are given authority to perform services on behalf of
the principal (e.g., Jensen and Meckling 1976; Fama and Jensen 1983). However,
the agency problem arises due to information asymmetry between shareholders and
management (Agrawal and Knoeber 1996; Heath and Norman 2004). In such cases,
it would provide management with scope to engage in self-dealing opportunistic
behavior at the expense of shareholders (see for example Culpan and Trussel 2005;
Djankov et al. 2008; Cline and Williamson 2016).
Conversely, both the stakeholder and legitimacy theories postulate a much
broader concept of corporate governance to be applied in organizations. The
3
Besides the theories mentioned above, the institutional theory also considers changes in organisational
processes over time (Cohen et al. 2002, 2007b) and how governance structures “fulfil ritualistic roles
that help legitimise the interactions among the various actors within the corporate governance mosaic”
(Cohen et al. 2007b, p. 11). Furthermore, Kalbers and Fogarty (1998, p. 131) argue that “organizational
structures…become symbolic displays of conformity and social accountability”. In other words, some
governance activities and structures may be driven by a desire to foster legitimacy as in the case of
Islamic banks and the intricate workings of SBs.
13
stakeholder theory provides greater latitude in widening the corporate governance

concept as management not only acts in the interest of shareholders but also pursues
interests of other stakeholders (Freeman 1994; Berry and Rondinelli 1998; DesJar-
dins and McCall 2004; Letza et al. 2004; Solomon 2007; Collier 2008; Garcia-Torea
et al. 2016). Meanwhile, the legitimacy theory can be translated into the way an
organization commits itself to adopting corporate social behavior in its govern-
ance system to ensure compliance of values and norms of respective societies in
which organizations operate (Suchman 1995; O’Donovan 2002; Deegan and Uner-
man 2006; Golant and Sillince 2007). The above arguments provide a claim that the
integrity of the organization would be undermined if business operations are found
to have less legitimate social behavior (Dowling and Pfeffer 1975). Interestingly,
Deephouse and Carter (2005) elucidate that organizational legitimacy and organi-
sational reputation are two concepts representing assessments of an organisation
by a social system. Legitimacy also has influence on organisational theories such
as institutional theory (see Meyer and Rowan 1977), resource dependence theory
(Pfeffer and Salancik 1978) and organisational ecology (Carrol and Hannan 1989).
However, it was the frequent appearance of this concept which prompted scholars
such as Suchman (1995, p. 571) to observe that legitimacy is “an anchor-point of a
vastly expanded theoretical apparatus addressing the normative and cognitive forces
that constrain, construct, and empower organisational actors”. Thus, management
has gained reputation in formulating various strategies to maintain the legitimacy
of business operations leading to an enhancement of confidence in organisational
stakeholders (Ashforth and Gibbs 1990; Patten 1992; Suchman 1995; Deegan et al.
2000; Phillips et al. 2004; Khan et al. 2013).
In this paper, we maintain that from an Islamic banking perspective, legitimacy
and reputation can be viewed as a concept that is complex and multi-dimensional
and is linked to a variety of stakeholders having significance of being the ‘be all and
end all’ of an Islamic bank’s survival. This is because without religious or ethical
legitimacy, Islamic banks become meaningless as they require societal legitimacy to
attract constituent support. Several studies have also highlighted that agency theory
when applied in a conventional setting tends to limit the accountability of a bank’s
operations to that of investors alone whereas the Islamic perspective broadens this
to include moral integrity, an appropriate socio-political environment and religious
compliance (Archer et al. 1998; Chapra and Ahmed 2002; Beekun and Badawi
2005; Safieddine 2009; Belal et al. 2015; Ullah et al. 2016; Almutairi and Quttainah
2017). The next section outlines the research methodology used.
3 Research methods
The aim of this study is to examine the effectiveness of the religious compliance
review and the quality of the religious assurance process post 2011 Malaysian Sha-
riah Governance Framework. We investigate issues related to competency, experi-
ence and independence of SBs and employ a qualitative approach using in-depth
interviews to gather evidence. The use of in-depth interviews allowed us to discover
interviewee ideas and perceptions and to ascertain specific factors that underpin
13
their responses such as reason, feeling, opinion and beliefs (see for example; Lewis
and Ritchie 2003, p. 143; Turner 2010). At the time of the study, there were 16 fully-
fledged Islamic banks and 7 conventional banks offering Islamic windows in Malay-
sia. For this study, we selected two fully-fledged Islamic banks to meet our research
design. We use a dual case study approach to expand the knowledge and experience
in providing valuable insight of the phenomenon rather than averaging the effect
across a number of cases (see for example; Kennedy 1979). Yin (2009) asserts that
case studies allow researchers to find the characteristics of real life events such as
individual life cycles, small group behaviour, organizational and managerial pro-
cesses. Following Saeed and Izzeldin (2016) and My Phan et al. (2016), our sample
selection of the case study is based on the level of profit efficiency determined by
the reported net profit. Saeed and Izzeldin (2016) provided evidence that there is
no trade-off between risk and efficiency in Islamic banks as their investment and
financial products are based on a profit sharing paradigm unlike the interest based
paradigm of conventional banks. In terms of bank efficiency, the two Islamic banks
in our sample show relatively similar net profits for the financial year end 2015 indi-
cating similar commitment of both Islamic banks in preserving the quality of their
Shariah portfolio thus portraying robust governance mechanisms for assurance of
religious compliance. Our use of in-depth interviews in the case study also has the
benefit of providing a deeper consideration and not just surface understanding on the
quality of religious assurance provided.
Fortunately, our interview participants are the key actors with experience of both
‘pre’ and ‘post’ implementation of the new SGF in their institutions. This provided
the opportunity of eliciting views directly from the people who had immense knowl-
edge, experience and familiarity of the subject matter. We used several sources of
information to frame our questions, including (a) our prior knowledge of role and
function of SB members (b) previous academic literature (c) the professional litera-
ture (e.g. Central Bank regulations along with AAOIFI and IFSB guidelines on Gov-
ernance). We pre-tested our research instrument on several academics and bankers
to ensure that our questions were appropriate and there was no room for ambiguity.
We modified several of our questions in the light of their feedback which was found
to be invaluable.
We undertook 14 interviews using semi-structured interview questions and details
of our participants are shown in Table 1 below.4 Our participants are senior offi-
cials who are highly knowledgeable, have vast experience and who play a dominant
role in their respective Islamic banks. To maintain anonymity, we identify the two
Islamic banks participating in our study as Bank A and Bank B with interviewees
comprising of SB members, Chief Executive Officers (CEOs), Heads of Religious
Departments and Internal Auditors. Our interviews lasted approximately 90 min on
4
In a conventional setting, several qualitative studies focussing on corporate governance issues opted
for case study approach. For instance, Turley and Zaman (2007) used a single case study and interviewed
nine individuals. Gendron and Bédard (2006) interviewed three Audit Committee Chairs whilst Spira
(1999, 2002) interviewed 21 individuals. In this present study, we believe that the 14 interviews under-
taken in the two major institutions are sufficient to provide us with in-depth understanding on how SBs
undertook their crucial religious governance roles.
13

13
Table 1 Background information of interviewees
No. Gender Position No. of years in current Shariah qualification Other qualification
position
BANK A
1. Male CEO 3 months – Banking knowledge
2. Female RB member (1) 5 years Shariah qualified –
3. Male RB member (2) 2½ years Shariah qualified Legal expert
4. Male RB member (3) 5 years Shariah qualified Legal expert
5. Male Head of religious review 5 years Shariah qualified Islamic finance
6. Male Religious review officer 2 years Shariah qualified Islamic finance
7. Male Religious audit officer 15 years Shariah qualified Accounting and audit expert
BANK B
8. Male CEO 6 years – Banking and finance
9. Male Chairman of RB (1) 11 years Shariah qualified IT expert
10. Male RB member (2) 6 years Shariah qualified –
11. Male RB member (3) 12 years Shariah qualified Legal expert
12. Male Head of religious department 7 years Shariah qualified Islamic finance
13. Female Deputy manager of religious department 7 years Shariah qualified Islamic finance
14. Female Chief of internal audit 6 years – Accounting, finance and audit expert
average. We used a standardised checklist to guide our interviews and each inter-
viewee was assured of confidentiality and anonymity. Given the specificity of many
of the responses we received, we believe that our participants were truthful in their
responses. Our interviews were undertaken between June and August 2015, almost
4 years after the implementation of the new SGF to allow us to obtain perceptions
of its impact. We also observed how our participants responded to the questions
raised. After obtaining the data from the interview sessions, we transcribed the data
to attain general ideas of what the interviewees were responding to and to further
reflect on its meaning before the data was encoded. Coding of the data is the pro-
cess of managing the data into segments of text before being generated into infor-
mation and serves as the formal representation of analytic thinking (Rossman and
Rallis 1998, p. 171). Also, data coding is not just an analysis of data and data inter-
pretation but allows researchers to axial code by identifying the link between the
data to the idea and from the idea to all the data relating to that research (Richards
and Morse 2007, p. 137). As in the work of earlier qualitative studies (see example
Anderson-Gough et al. 2005; Jørgensen and Messner 2010), the codes in our study
were derived from our research questions, theoretical framework and related litera-
ture. We then categorized the data and generated the themes based on the data cod-
ing. When analysing the data, we adopted thematic analysis suggested by Boyatzis
(1998) which proved to have increased the traceability and assisted verification of
the analysis. Hence, the process of developing codes, generating themes and analy-
sis of the data were undertaken using Atlas.ti, which is a computer assisted qualita-
tive data analysis software documented to have been widely used in accounting and
management qualitative studies (see for example; Kend and Katselas 2013; Schäffer
et al. 2015; Teixeira et al. 2016).
4 Findings and discussion
This section presents the findings from our interview data on the effectiveness of the
SB in providing religious assurance thereby endorsing the ethical legitimacy post
implementation of the 2011 Malaysian SGF framework. It was highlighted earlier
in Sect. 1 that both the stakeholder and legitimacy theories imply that SBs should
be accountable in providing transparent and independent assurance to stakehold-
ers in relation to religious compliance of Islamic banks. Therefore, the competency
and capability of SB in issuing quality religious assurance should ensure a strong
dynamic in the governance system of an Islamic bank and add value for stakehold-
ers. Also, this study highlights some evidence on the current practice of SBs in per-
forming their all-important religious advisory and compliance review role.
4.1 Knowledge and competency of SB members
The competency of SB members is important in ensuring an effective governance

mechanism in Islamic banks in achieving legitimacy of their operations. It is the
13
inclusion of both religious and non-religious scholars5 in the composition of the SB

which could enhance the competency and capabilities of SBs in providing quality
religious assurance. For instance, if SB members have the benefit of being well-
versed in both Shariah and non-Shariah knowledge this would then enable them
to deliberate on religious matters and other issues pertinent to Islamic banking and
operations, such as finance. However, the feeling generated was that greater empha-
sis on both religious knowledge and banking knowledge was required because even
a CEO highlighted that the provision of religious assurance should be made by SB
members who have strong religious background and good banking experience. This
CEO, of Bank A, remarked:
Previously, our SB members only comprised of people from religious and
legal backgrounds. Now, we (the bank) also search for SB members who have
expertise in banking operations which is ideal. However, I am still satisfied if
all SB members have strong knowledge in Islamic law to enable them to delib-
erate on religious matters.
A similar sentiment was also expressed by the CEO of Bank B that the combina-
tion and consolidation of various backgrounds in the governance structure of SBs
would enhance the governance role of the SB on their commitment to provide qual-
ity religious assurance of the Islamic bank operations. This CEO highlighted:
When appointing a SB, we try to maintain a balance and require a combina-
tion of experience and qualifications in the field of law, fiqh (jurisprudence),
finance and accounting. The nomination of SBs would not only be selected
by the BOD as the appointment is also subject to the approval of Bank Negara
Malaysia (BNM).
However, discussions held with interview participants of both banks revealed
several major concerns relating to some weaknesses of SB members when perform-
ing their governance and oversight function, i.e., the religious compliance review.
SB members of both banks reported lack of knowledge in banking operations and
not having a financial background. This was stated to result in difficulties for SB
members when fulfilling their responsibilities of reporting religious compliance to
stakeholders. The Chair of the SB of Bank B remarked:
It is difficult for me to attest to the financial report because we (SB members)
have a lack of understanding on the discussion of subject matters. We have
to ask for assistance from bank officers to explain the issues pertaining to the
operations of the Islamic bank.
A similar argument was communicated by the SB members of Bank A relat-
ing to concerns on the need of non-religious experts as they can contribute to the
5
By non-religious scholars, we mean those SB members who are not qualified religious scholars per se,
but instead, serve on the SB due to their proficiency in law, business, finance or accounting. In Malaysia,
unlike elsewhere in the Islamic world, there is a stipulation that in every SB, there must be a member that
has a non-religious background (BNM 2011, p. 10).
13
governance role of the SB in numerous ways. In providing quality religious assur-

ance, the non-religious experts may provide consultancy to other SB members on
matters related to Islamic banking issues. The SB member of Bank A with expertise
in both religion and legal matters remarked:
In a case when the bank deals with legal documentation, our SB members
who possess strong knowledge in Islamic law along with our legal expert will
actively provide advice on particular issues.
Meanwhile, to improve the governance role of SBs, the BNM organised several
mandatory training workshops for all SB members of the Islamic banks aiming to
strengthen competency levels of individual members of the SB. In addition, both
the Islamic banks under this study are reported to have taken further initiative to
enhance the governance role of the SB by providing extra specialist training to their
respective SB members. Such investment of knowledge and intensive training for the
SB will improve the religious advisory role of SB who acts as a proxy for the stake-
holders in ensuring the ethical and legitimate operations of Islamic banks. Our find-
ing highlights the significance of investment in human capital as earlier studies elu-
cidate that organizations with greater human capital stocks are likely to yield better
business performance and sustain industry growth trends (see Becker and Huselid
2006; Subramony et al. 2008; Wang et al. 2009; Morris et al. 2017; Nawaz 2017).
Notably, the competency and capabilities of the SB is expected to be enhanced with
the Islamic banking workshops organized by BNM and individual Islamic banks. A
SB member of Bank A highlighted this point and remarked:
The Bank had given their support and has full respect to the SB by allocating
part of their financial budget for training and workshop of SB members.
This was also confirmed to be the case in Bank B where SBs were provided with
special training courses. In fact, Bank B went further and collaborated with several
educational institutions in expanding knowledge of SBs. The Chairman of SB of
Bank B remarked:
I think most Islamic banks including my Bank (i.e., Bank B) have initiatives
with academic institutes to provide training courses for SB members. In the
practice of Bank B, the respective management organised a familiarization
session to provide specialist training.
On a different scale the discussions with Bank B officials highlighted that stake-
holder of Bank B was struggling to uphold the governance role of the SB with
regards to adhering to the principles of Islamic law. In enhancing the understand-
ing and awareness of the religious governance framework, the SB will educate their
management and customers directly by exposing them to the knowledge of Maqasid
al-Shariah. The CEO of Bank B highlighted this point and remarked:
This is the only Islamic bank that provides knowledge for their management
and customers directly by inviting the SB as a speaker in a conference.
13
It can therefore be observed from the above discussion that the diversity in SB
membership enhances integrity on the governance role of SBs in assuring the ethi-
cal-religious operations and identity of an Islamic bank. These findings are consist-
ent with other empirical studies which highlighted that the shortage of qualified SB
members lacking appropriate knowledge in Islamic and banking law could poten-
tially have a negative effect on the governance system of Islamic banks and hinder
stakeholder trust (see for example; Garas and Pierce 2010; Malik et al. 2011; Garas
2012; Grassa 2013; Ginena 2014). However, the responsibility of giving construc-
tive advice and opinions on religious matters should be given only to the religious
scholars who are qualified with religious background. Indeed, issuing a Fatwa is a
heavy responsibility and only religious scholars are permitted to deliberate on reli-
gious issues. This religious qualification of SB members for these two Islamic banks
was highlighted in Table 1 above.
4.2 Effectiveness of Shariah boards
Previous research conjectures that the SB is equated to serve as a religious auditor

(Briston and El-Ashker 1986; Karim 1990a; Grais and Pellegrini 2006a; Garas and
Pierce 2010; Grassa 2013) and a religious scholar (Archer et al. 1998; Safieddine
2009; Hasan 2009; Ullah et al. 2016) in IFIs and its prominent role serves as an
additional governance mechanism intended to ensure the prudence of Islamic bank-
ing thereby increasing the level of confidence among stakeholders. In fact, the SB
plays an essential role in performing the ex-ante religious compliance and ex-post
religious compliance task. In the ex-ante religious compliance task, the Islamic bank
may seek advice from SBs on religious compliance matters. Meanwhile, in the ex-
post religious compliance task, SBs are required to perform their governance func-
tions in directing, monitoring and reviewing the works carried out by management
to ensure that all activities comply with the tenets codified in Islamic law.
In relation to a discussion of an ex-ante religious compliance task, the interview
participants of Bank A revealed that the responsibility of providing a religious rul-
ing must be given to those who are well-versed in Islamic law. For example, when
developing a new product, the SB should consider many aspects and issues relating
to religious compliance before any judgment and justification can be made. In this
regard, religious assurance should only be made in accordance to Islamic principles
laid down in religious texts. It is important to note that SB resolutions may influ-
ence the governance system in the industry and development of Islamic banks as
Islamic banks are held accountable for implementing SB decisions. The SB member
of Bank A, whose expertise and background is in religious affairs remarked:
SBs act like a National Fatwa Committee and their functions are to issue Fat-
was (i.e., Islamic legal rulings). As such, the membership of SB members is
compulsory to comprise of people from Islamic law backgrounds.
Participants from Bank B also highlighted that the SB plays a crucial role in
participating discussions relating to religious issues. Also, as SB members, they
13
are accountable to ensure competency in issuing Islamic rulings to the bank.

Thus, it is important for SB members to have knowledge, appropriate qualifica-
tions, and expertise in Islamic jurisprudence. A SB member of Bank B, an expert
in Islamic law, highlighted this point and remarked:
As members of the SB, we have complete authority to issue a Fatwa and
provide religious assurance on the activities of the Islamic bank. The abil-
ity to assess the religious issues is instrumental for SBs in performing their
roles.
Indeed, the philosophy underlying the stakeholder perspective entails that the
SB acts as an independent appraisal function in ensuring religious compliance
from the initial process of developing a new product until the product is ready to
be offered to customers. Hence, the capability of SBs in governing their advisory
role will contribute to the innovation of Islamic banking product development
and increase Islamic banking market share. At this point, the approval of Islamic
banking products and services should be obtained from the SB. Before the SB
issues the resolutions and endorses the product, a review of the product cycle
should be undertaken by the SB. In this regard, the SB has been given access to
review the operations of the Islamic bank including documentation, transactions
and operations. From the above discussion, it is apparent that the SB understand-
ing on the knowledge of Islamic banking product development is crucial. The SB
member of Bank A highlighted this point and remarked:
Before the bank offers the product to customers, the SB will deliberately
discuss and advise on product development pertaining to Islamic principles.
Then, they will identify whether the product is highly recommended and
permitted by religion or not….
Interestingly, the Chief Internal Auditor of Bank B made an argument that the
appointment of the SB should comprise of people from religious experts only as
their primary role is to provide advice on religious issues. The officer indicated
that only the religious scholar has the ability to provide deliberation and discus-
sion on a matters relating to religious issues. Indeed, the function of the SB has
been stipulated in the SGF for SB to be responsible in overseeing all the business
and operations of Islamic bank. The officer provides a suggestion for the SB to
focus on their advisory role while the religious auditing and religious compliance
review functions should be given to the Internal and External Auditor. The Chief
Internal Auditor highlighted this point and remarked:
If we look from the SGF guidelines, there are two main responsibilities of
SB which include ‘managing’ Zakat and providing advice on issues relat-
ing to religious events. The involvement of External Auditors will provide a
quality judgment on a true and fair presentation of the financial statements.
As such, the above remark gives rise for religious assurance to be issued by
only religious scholars. In relation to the development and innovation of Islamic
banking product and services, the Islamic banks are required to have the approval
13
Table 2 Religious compliance review role of religious boards

Interview participants Religious compliance review
Policy and Product Documentation System Advertisement
procedures develop- and transactions and soft- and promotion
ment ware
Bank A
CEO √ √ √ √ √
RB member (1) √ √ √ √ √
RB member (2) √ √ √ √ √
RB member (3) √ √ √ √ √
Religious audit officer X X X X X
Religious review officer √ √ √ √ √
Bank B
CEO √ √ √ √ √
RB chairman (1) √ √ √ √ √
RB member (2) √ √ √ √ √
RB member (3) √ √ √ √ √
Chief internal audit X X X X X
Religious department officers X X X X X
and endorsement from the SB before the product is offered to the customer.
Hence, the capabilities of the SB in providing good religious advice and opinions
could result in improving the soundness of the SB’s governance roles and provid-
ing an excellent image of the development of Islamic banking.
Another important governance role of SB in providing the religious assurance is
religious compliance review functions. The discussion held with the interview par-
ticipants of both Islamic banks under this study made apparent that the SBs play a
pivotal role in directing, monitoring and reviewing all documentation and activities
of Islamic banks before the religious assurance is made. As the SB, they are given
the ultimate authority to provide a quality religious assurance to the stakeholder
that all operations of the respective Islamic bank are in compliance with religious
law. Therefore, Islamic banks emphasise competency of SB members in performing
these religious compliance review tasks. The religious compliance review roles of
the boards—as reported by the interview participants of these two Islamic banks are
summarised in Table 2.
The discussion held with the CEO of Bank A indicated that the SBs play a crucial
role in determining and highlighting the religious non-compliance events (RNC) that
occurred in Bank A. Even though Bank A experienced minimal RNC, the SB pro-
vided critical concern on the matter. The internal officers will assist the SB members
in performing the religious compliance review task. The CEO of Bank A remarked:
In identifying the religious non-compliance events (RNC), the SB will dele-
gate their religious compliance review functions to the internal officers. RNC
of bank A is just a small fraction; probably around 20%.
13
Essentially, it is up to the SB to directly review and analyse the department with

risk of potential religious issues. At this point, SBs already have the right to request
further explanation on matters and may ask the department to re-submit their report.
That department will then be responsible for making corrections according to what
the SBs have suggested. A SB member of Bank B remarked:
We review their product manual from time to time after the product has been
launched. We will look at their standard operating procedures (SOP), docu-
mentations and so on. We hope that the products offered not only follow the
common law but also comply with the Islamic principles….
In fact, the CEO, SB members along with the Religious Audit Officer all
expressed similar sentiments that the SB plays a crucial role in evaluating and
assessing the report provided by internal officers. Nevertheless, in providing the reli-
gious assurance, the daily operations of the Islamic bank are subject to review and
monitoring by the internal officer. The result will be reported to the SB for their
approval. Then, the bank submits the SB decisions and resolutions to the BNM for
their approval. The CEO of Bank A highlighted this point and remarked:
In the stage of product development, the Religious Reviewer and Religious
Audit Officers would evaluate and rectify any religious issues on the product
manual, the contracts and transactions and the results would then be submitted
to the SB for approval.
Meanwhile, the Religious Review Officers shared their experience by stating
that the SB will directly review the departments of the Islamic bank as well as the
Treasury Department. For instance, the SB will examine how the Treasury Depart-
ment defines and excludes the income from RNC and channels it to a fund named
“Tabung Mawaddah” and the management of Zakat. Indeed, any income from for-
bidden activities (i.e.: riba, usury, gambling and all activities which are not permis-
sible by Islamic law) cannot be recognised as profit in the financial statement and
the income should be ‘cleansed’ by channeling these monies to other non-Islamic
and charitable funds. The Religious Review Officer of Bank A remarked:
In some cases, the SB will come and review directly the particular department
for further investigation. For instance, all the SB members came and reviewed
directly the process and transactions carried out by Treasury Department….
In providing religious assurance, the SBs were given rights and access to all
information, complete documentation, transactions, product manuals and operations
of the Islamic bank. On this, the SB member of Bank A remarked:
We, as a SB, should oversee the overall operations of the Islamic bank. In the
product development stage, we are given access to look at the entire process of
the product manual. In fact, our SB was very strict because we want to be truly
Islamic….
Generally, the discussion above suggests that it was crucial for the SB to play
a supervisory role in monitoring the religious compliance of the Islamic bank.
13
Considering this, the management of the Islamic bank bears responsibility to

provide accurate information and complete documentation to its SB. Thus, it is
important for SB members to effectively communicate and engage with vari-
ous parties within the bank to ensure that all operations are in accordance with
Islamic law. In fact, the governing role of the SB can be refined even more with
the assistance of internal officers as the daily operations of the Islamic banks are
subjected to review and these reviews are undertaken by internal officers. How-
ever, several interview participants of both banks highlighted the inadequacy of
religious compliance review roles undertaken by their SB. Therefore, our study
provides direct evidence that SB members have less exposure in understanding
technical business issues and financial matters to evaluate business activities con-
ducted by management. Often, the practice is for SBs to delegate their religious
compliance review function to internal officers. In such circumstances, SB mem-
bers were observed to be heavily reliant on the work performed by internal offic-
ers when providing religious assurance. The Religious Review Officer of Bank A
remarked:
At all times, the SB will not go through the entire process of the operations
of the bank. Basically, the internal officer will table the results to the SB. In
cases involving religious issues, the SB will request for further clarification
and check the documentation….
Similar discussions were held with the Chief Internal Auditor and Head of
the Religious Department in Bank B who questioned the competency of their
SB when performing the religious compliance review task. The arguments made
were that SBs are less credible in assessing and evaluating certain issues relat-
ing to Islamic banking operations due to the lack of Islamic banking knowl-
edge among their SB members. Because of this, SBs appeared to be delegating
their religious compliance review function to internal officers and subsequently,
the results presented to the SB for approval. The Chief Internal Auditor also
expressed grave concern about the work performed by the internal officers as they
are responsible for reporting their findings to the CEO of the bank. In this regard,
top management seems to have room for opportunistic behavior in influencing the
results presented by the internal officer. It is worth noting that the SGF required
Islamic banks to establish a religious audit as this will help in verifying the find-
ings reported by internal officers to the SB. Therefore, this implementation of a
religious compliance review and audit would effectively enhance the quality of
religious assurance provided by the SB. The Head of the Religious Department of
Bank B stressed this point and remarked:
The SB should oversee the operations of the Islamic bank as a whole. This
includes effectively monitoring the implementation of the religious compli-
ance audit and review functions.
Based on the above, it appears that often, the religious compliance review
function had not been effectively undertaken by SB members of these two Islamic
banks as they were overwhelmingly reliant on the findings presented to them by
13
internal officers. This argument is made on the basis that SBs have limited time
in assessing the day to day operations of Islamic banks as SB members only work
in a part-time capacity. Nevertheless, some of the interview participants were
critical about the shortcomings in the role of SB’s when performing the religious
compliance review task. This is discussed in the following section.
4.3 Quality of religious assurance post SGF implementation
Overall, our interview participants revealed that the implementation of the new
guidelines of the SGF in the Malaysian Islamic banking industry could enhance the
quality of religious assurance issued by SBs. This proposition is made on the basis
that the recent 2011 SGF guideline was perceived to better than the earlier GPS-1 in
terms of governance because of the inclusion of issues such as religious assurance,
scope and responsibility, accountability and on other matters relating to bank opera-
tions. It was well understood that greater understanding and commitment of every
party within the bank to uphold the holistic value of religious principles will ensure
the religious compliance and thus fulfill the required religio-social legitimacy of its
operations. The Religious Audit Officer of Bank A remarked:
Yes, the SGF covers almost all of the requirements. If we look at the guide-
lines of GPS-1, it only focused on the functions of the SB. However, the new
requirement of SGF clearly spells out the function as well as the role of every
single party to ensure religious compliance.
A similar argument was provided by a SB member of Bank B that the new struc-
ture and requirements in SGF promotes better governance practices. This SB mem-
ber, who is a religious expert, remarked:
The SGF has enhanced the ability of Islamic banks to guarantee religious com-
pliance on the operations and business dealings of particular Islamic banks. In
our case, we have become pioneers among other banks in practicing the guide-
lines laid down in the SGF.
When referring to the proficiency and background of SBs as shown in Table 1,
both of the banks participating in this research were found to have appointed com-
petent SB members for the purpose of issuing religious assurance. Generally, SBs
are supported in discharging their governance role from the various parties within
the bank when undertaking the religious compliance process. Often, the tendency
is for BODs to supervise and monitor the work performed by management so that
all activities are undertaken according to the objective of various stakeholders and
comply with Islamic principles. The discussion with the interview participants of
the two different banks made apparent that the internal officers contribute to the
governance role of SB as they are responsible in assisting the SB in ex-post religious
compliance tasks. In avoiding and mitigating the occurrence of any religious non-
compliance event, these two functions of audit and review highlighted in the SGF
13
will contribute in enhancing the monitoring and supervision role of SBs. A Reli-
gious Review Officer of Bank A highlighted this point by stating:
The new SGF clearly spells out the requirement for our Islamic bank to recruit
new personnel and to establish religious audit and risk functions. Before this,
in the GPS-1, the scope of internal officers was only to assist the SB in provid-
ing the religious assurance.
A discussion with our interview participants also highlighted that the enactment
of the IFSA 2013 had expanded the recommendations outlined in the guidelines of
the SGF. In ensuring religious compliance, IFSA required Islamic banks to appoint
a capable religious auditor to carry out the audit functions relating to religious com-
pliance. The SB member of Bank A remarked:
In a case where Islamic banks were not complying with the requirements
stated in the SGF, we also discovered that they were not complying with the
IFSA 2013. For our Bank, it is the SGF which would be the framework that
enforces us to seriously develop religious audit in ensuring religious compli-
ance.
Our interview findings present evidence that SB decisions were made without
proper diligence as they were heavily dependent on the recommendations provided
by internal officers. In such circumstances, it appears that SB members are observed
to be rubber stamping. Such limitation of the SB role would lead to negative impact
on the perception of stakeholders and jeopardize the reputation of this alternative
banking industry. The reality is that current practice of providing assurance will not
be deemed acceptable in the governance framework applied by External Auditors in
a conventional setting. Hence, we maintain that SBs should primarily focus on their
religious advisory role whilst the religious compliance task and the provision of the
religious report are left to external religious auditors. By doing so, the process of
religious audit as emphasised in the 2011 SGF could then ensure SB legitimacy in
providing attestation for religious compliance (see Najeeb and Ibrahim 2014), since
religious audit by its virtue would ensure that Islamic banking operations are con-
ducted according to its objectives, social benefit and religious prudence.
5 Conclusion
This study provides evidence on the governance role of SBs when undertaking
the crucial religious compliance review prior to providing assurance that Islamic
banking operations are religiously and ethically compatible. In doing so, SBs are
responsible to effectively and independently manage their religious compliance task
to fulfill the societal legitimacy expected of Islamic banks stakeholders. We, there-
fore, investigated the current role of SBs using stakeholder and legitimacy theories
which imply that Islamic banks shall always uphold ethical and religious compliance
as a key operational characteristic to operate business and to demonstrate ultimate
accountability to stakeholders. In such instances, this study reveals grave concern
13
about the inherent deficiencies of SB members in performing their task which is

attributed to a lack of banking and financial knowledge. More than necessary, the
SBs in the two Islamic banks under study were delegating the religious compli-
ance review function to internal officers who then presented their findings to them
for approval. Clearly, this practice goes against the grain of both the stakeholder
and legitimacy theories as SBs from both the banks participating in our study were
found not to have performed their religious governance role diligently. As a result,
our view is that there should be clear lines of separation in responsibility of SB’s,
with the task of religious compliance be transferred to external religious auditors
with the role of the SB to serve purely in an internal religious advisory capacity.
Our study also draws some recommendations for the Malaysian regulatory bodies to
take a more comprehensive approach to standardising the religious audit process and
develop further specific effective religious audit tools as the existing framework only
provides general recommendations allowing SBs with flexibility to operate ceremo-
nially rather than fulfill their task diligently.
This study also provides insights into the processes of the religious compliance
review and the provision of the subsequent religious assurance considering the
newly adopted Malaysian 2011 SGF. Previous studies have not investigated this
and from that perspective this study adds to existing literature by allowing a greater
understanding of the current role and function of SBs and the dynamics of gener-
ating the all-important religious assurance designed to convey the expected insti-
tutional legitimacy to stakeholders and communicated in the religious compliance
report published in banks annual reports. By focusing on the 2011 Malaysian SGF
framework, this study allows identification of the current strengths and weaknesses
of the Malaysian Islamic banking industry. Our findings suggest that because of the
newly implemented SGF, the quality of religious assurance has improved due to the
importance placed on religious audit which had contributed to enhancing SB cred-
ibility. From this perspective, it appears that the SGF did bring about some of the
benefits hoped for by its central bank regulatory architects.
Finally, the results presented in this research have implications for other Islamic
jurisdictions around the world especially those that are considering emulating a
dual-governance central regulatory and governance system like that in Malaysia.
This over-arching form of governance practice has its advantages in that a robust
and sound governance system can be implemented which would standardize Islamic
banking practice. As with other empirical studies, this study also has its caveats.
First, not all the key figures in Islamic banks were willing to share their experi-
ence with us as they lacked time to entertain requests for interview. Second, this
study focused only on the quality of religious assurance from the religious compli-
ance review undertaken by SBs whereas there are other governance mechanisms in
Islamic banks like religious audit and religious risk management that may also influ-
ence decisions of SBs. Therefore, future studies should be designed to investigate
such areas to enable a fuller understanding of the governance process currently prac-
ticed not only in Islamic banks in Malaysia but also in other Islamic jurisdictions. In
addition, since our study is based on two case studies of full-fledged Islamic banks
in Malaysia, we believe that future research should be conducted which could exam-
ine important cultural and institutional variables. This should be undertaken either
13
by a comparative or multi-country examination utilising the rich and diverse cul-

tural, religious and institutional differences in the Islamic world as this would pro-
vide fertile ground for a future research agenda.
For the time being at least, our findings suggest that although our interview par-
ticipants were generally positive about the impact of the new governance frame-
work, we report some genuine concerns and implications that would merit further
regulatory attention. For instance, we recommend that Malaysian regulators need
to address urgently some of the key issues identified in this study such as compe-
tence, independence and issues on the overall operational effectiveness of SBs to
enhance governance practice and to close any expectation gap arising between SBs
and Islamic bank constituents. This clearly is an important responsibility for regula-
tors, especially if they desire stakeholders to believe that SBs are working to achieve
the expected religious and governance legitimacy. After all, it is now well accepted
that the ‘raison d’etre’ and ‘modus operandi’ of SBs is to effectively serve as the
conscience of Islamic society.
Compliance with ethical standards
Conflict of interest The authors declare that they have no conflict of interest.
Ethical approval All procedures performed in studies involving human participants were in accordance
with the ethical standards of the institutional and/or national research committee and with the 1964 Hel-
sinki declaration and its later amendments or comparable ethical standards.
Informed consent Informed consent was obtained from all individual participants included in the study.
Open Access This article is distributed under the terms of the Creative Commons Attribution 4.0 Inter-
national License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribu-
tion, and reproduction in any medium, provided you give appropriate credit to the original author(s) and
the source, provide a link to the Creative Commons license, and indicate if changes were made.
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Nurfarahin M. Haridan is currently pursuing PhD research at the Putra Business School, Malay-
sia. Nurfarahin obtained her MSc from the Universiti Putra Malaysia and her main area of interest is in
Islamic Banking and finance with emphasis on accounting and financial reporting.
Ahmad F. S. Hassan is a senior lecturer in accounting at the Universiti Putra Malaysia (UPM). UPM
is a leading research university in Malaysia and was the first Malaysian university to be awarded the
AACSB accreditation. He holds a PhD in Accounting from Cardiff University, UK. Dr Fahmi’s area of
research and teaching is Islamic Banking and finance, corporate governance, business ethics and financial
reporting.
Yusuf Karbhari is a Reader in Accounting at Cardiff Business School, Cardiff University, UK. His
main areas of research are in Public Sector accounting, accounting and Auditing in emerging econo-
mies, corporate governance in emerging economies and Islamic banking and finance. He has held visiting
positions at King Fahd University, Saudi Arabia and at the Said Business School, Oxford University,
UK. He is also the recipient of the prestigious visiting Maybank Chair in Accounting at the Universiti
Putra Malaysia and has, previously, served as advisor to several international public and private sector
organisations.
13

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Governance, religious assurance and Islamic banks: Do

Nurfarahin M. Haridan1 · Ahmad F. S. Hassan2 · Yusuf Karbhari3

© The Author(s) 2018

Keywords Religious assurance · Religious audit · Governance · Shariah boards ·

are especially useful in examining complex behavioral processes and address-

2 Related literature, Islamic banking in Malaysia and theoretical

principles governing its operations. When focussing on the issue of independence

2.2 Islamic banking in Malaysia

assurance provided to the stakeholders by Islamic banks is expected to have been

make SB members liable to imprisonment for a term not exceeding 8 years or to a

As discussed in the introduction, corporate governance for financial institutions such

stakeholder theory provides greater latitude in widening the corporate governance

4.1 Knowledge and competency of SB members

The competency of SB members is important in ensuring an effective governance

inclusion of both religious and non-religious scholars5 in the composition of the SB

governance role of the SB in numerous ways. In providing quality religious assur-

4.2 Effectiveness of Shariah boards

Previous research conjectures that the SB is equated to serve as a religious auditor

are accountable to ensure competency in issuing Islamic rulings to the bank.

Table 2 Religious compliance review role of religious boards

Essentially, it is up to the SB to directly review and analyse the department with

Considering this, the management of the Islamic bank bears responsibility to

4.3 Quality of religious assurance post SGF implementation

about the inherent deficiencies of SB members in performing their task which is

by a comparative or multi-country examination utilising the rich and diverse cul-

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2 Related literature, Islamic banking in Malaysia and theoretical

2.2 Islamic banking in Malaysia

4.1 Knowledge and competency of SB members

4.2 Effectiveness of Shariah boards

Table 2 Religious compliance review role of religious boards

4.3 Quality of religious assurance post SGF implementation