Absence of Shariah audit a ‘serious loophole’

By Habhajan Singh
Shariah audit, one of the key missing links in the current operations of Islamic financial institutions (IFIs), is expected to gain prominence in a few years time.
A local academic, who has been studying the matter from the Islamic perspective, has said that the absence of Shariah audit is a "serious loophole" in the Islamic finance system that is now fast expanding, with Malaysia alone having 17 stand-alone Islamic banks.
A cursory examination of the Islamic financial services industry, especially in Malaysia, shows an apparent gap in the Shariah supervisory practices, said International Islamic University Malaysia's (IIUM) Dr Abdul Rahim Abdul Rahman.
He noted that even though the Shariah Supervisory Committee (SSC) — an Islamic bank's inhouse Shariah body that ensures compliance on the Shariah front — express their opinions on Shariah compliance, the thorough audit or review processes of the Shariah legal contracts, documentations and operations were rarely conducted properly.
"Without such an audit and review process will result in a functional gap of Shariah compliance processes. This gap is a serious loophole in the Islamic financial system that is founded on Shariah precepts," said Abdul Rahim who is an associate professor at IIUM's Kulliyah of Economics and Management Sciences and also a former director of IIUM's Institute of Islamic Banking and Finance (IIiBF).
Menwhile, Daud Vicary Abdullah, who has held key positions in several Islamic banks in Malaysia and is now with Delloitte Consulting Malaysia, said that Shariah audit is still at the design stage.
"There is a growing awareness of it. I sense that in the future, at some point in time, the professional services firms will be expected to conduct a review from the outside, to validate what's happening (at Islamic banks)," he said.
In a paper presented at a local Islamic finance conference late last year, Abdul Rahim highlighted Section 5(b) of the Islamic Banking Act 1983 which specifies the need for the establishment of a Shariah Advisory Council (SAC).
"That there is, in the articles of association of the bank concerned, provision for the establishment of a Shariah advisory body to advise the bank on the operation of its banking business," he said.
Here, he noted, there are two types of Shariah compliance — ex-ante compliance and ex-post compliance. The ex-ante Shariah compliance is basically the Shariah Advisory Council's (SAC) supervision, monitoring and control tasks that take place upon and during implementation of the bank's dealings.
These activities include making sure that banks and financial institutions comply with the Shariah rules and guidelines during the designing of the contracts and agreements, during the process of transactions, during the conclusion of the contract, and the execution of the contract up to the implementation of the terms of contract until liquidation, he wrote.
"So far, very few institutions undertake ex-post Shariah compliance process. Ex-post Shariah compliance process requires a thorough and comprehensive Shariah audit to review and check the transactions that took place after the execution of the contracts.
"The ex-post Shariah compliance is basically to perform the random samples of completed transactions to ensure that these transactions conform to Shariah rules and guidelines.
"An internal audit or external audit may be required to perform this where the result of the audit needs to be reported to the management," he said.
On the processes, Vicary agreed that the Shariah audit is a lot wider than just accounting as it includes areas like procesess, people and governance. Abdul Rahim noted that Shariah advisors are rarely carrying out thorough internal Shariah review or audit on the operations of Islamic banks due to their restricted scope of work.

(This story appeared in The Malaysian Reserve on June 29, 2009. The Malaysian Reserve is a daily business/finance newspaper published out of Kuala Lumpur, with a sectoral page on Islamic finance on Mondays, edited by Habhajan Singh)