The issue of good corporate governance has received a lot of attention in last several years within both conventional and Islamic financial system – more so after the global financial crisis of 2007-2009. In general, corporate governance refers to the way in which the business of banks is governed. Among the subject matters of the corporate governance are: setting corporate objectives, aligning corporate activities with the expectations of the managements, operating daily activities within an established risk profile, protecting the interests of depositors and stakeholders – just to name a few.

When it comes to Islamic financial institutions (IFIs), on top of the corporate governance, Shari’ah governance plays an important role (if not the most important). In general, there are three models of Shari’ah governance: centralized Shari’ah governance whereby there is a central Shari’ah body – usually within a central bank – such is the case of Malaysia, Sudan, Pakistan and Indonesia; laissez-faire or market driven Shari’ah governance whereby each institution relies on its own Shari’ah advisory board; and hybrid system that consists of the mixture of the above two models.

An overview of Qatar’s ban on Islamic windows

Recent circular of the Central Bank of Qatar (CBQ) regarding operations of Islamic windows within conventional banks is a good example of what happens when proper corporate governance is not in place.

Namely, on February 6, 2011, the CBQ ordered conventional banks operating in Qatar to shut down their Islamic finance operations. In an unprecedented and unanticipated move, the CBQ gave banks until December 31 2011 to shut down their Islamic windows.

Among affected banks are Qatar National Bank (which is the largest lender by market capitalization in Qatar), HSBC, Doha Bank, Commercial Bank of Qatar, Al Ahli Commercial Bank and International Bank of Qatar. As a result of this decision by the CBQ, shares of Qatar National Bank suffered a decline of 4.8 per cent.

Whether this decision will bear the fruits is yet to be seen, but critics are already raising their concerns for both short- and long-term negative consequences that the decision will have on the Islamic finance industry in general and Qatar as a financial center in particular.

Several reasons are given. First, it is believed that the CBQ’s ban may hurt Shari’ah-compliance industry by reducing the market share of Islamic finance and discoursing further development of the industry. Second, some reports also indicated that a number of Shari’ah scholars expressed their concern over the decision as well. Third, some put forward political reasons for the decision arguing that the CBQ is in fact trying to help its Islamic banks whose market share is deteriorating due to competition from conventional counterparts.

The above criticisms, in general, are valid ones if, and only if, the above stated criticisms are correct and if the banks’ operations are in line with Shari’ah. However, if – as some reports indicate – a breach of Shari’ah by commingling of Shari’ah-compliant and non-Shari’ah-compliant funds within conventional banks is the reason behind the ban then the CBQ’s decision gets a completely different tone.

The QCB justified the move under the transparency initiative. Many in the Islamic finance industry have identified the need to increase transparency and improve the governance of Islamic finance industry. The need for transparency and improved governance is a result of criticisms that Islamic finance too closely resembles conventional finance and that the industry’s products are a mirror image of their conventional counterparts. Furthermore, as pointed out above, the move by the QCB was prompted by the suspicion (shubha) that there was no clear separation of funds between conventional and Islamic financial operations. In other words there was commingling of funds; i.e. funds from non halal sources were used for providing Islamic financial services.

Be that as it may, as pointed out by Ashar Nazim, director of Islamic financial services at Ernst&Young, “Right now the biggest threat to Islamic banking is the credibility of the existing system. Therefore, the move by QCB is seen as the beginning of “housecleaning” period in which the Central Bank will revise Shari’ah governance framework and appropriately audit the operations of Islamic financial institutions. In case of Qatar, as pointed out, scholars were concerned about commingling of funds between conventional banks and their Islamic windows whereby funds from non-Shari’ah compliant sources were used for Islamic operations and vice versa.

Need for good governance (Shari’ah governance)

In the light of the above discussion, it is evident that proper governance is an essential prerequisite for further development of Islamic finance industry. Otherwise, as Qatar example shows, market will be left in dark without any certainty and clear direction.

Two lessons can be drawn from Qatar. First, without proper corporate governance, customers cannot be sure whether the [Islamic financial] service they get from various institutions complies with the principles of Shari’ah. Since there was commingling of funds from conventional and Islamic operations by the aforementioned conventional banks, customers are left in doubt as to whether their financial transactions were in line with Shari’ah law.

Second, after the QCB’s decision, it is highly unlikely that financial institutions will embark on providing services which are compliant with Shari’ah if there is a great deal of uncertainty involved, i.e. if the rules of the game can change without any warnings. Since, the QCB’s proclamation came as a total surprise to the market, the banks will now be extremely cautious if not reluctant to provide Islamic financial services in places where rules are not clear and ambiguous.

When viewed from the institutions’ as well as investors’ point of view, embarking upon an industry where one person’s opinion (fatwa) can change the entire rules of the game within the industry is a very risky venture.

The best example of this is Taqi Uthmani’s criticism of sukuk structures which lead to a great percentage of sukuk in the market to be deemed as Shari’ah non-compliant. Shaikh Qardawi’s fatwa regarding the situation in Qatar is another example of how great an impact a sudden change of rules can have upon the market. Hence proper corporate governance is a vital step towards establishing a stable industry where customers, investors and institutions can rely on a set of rules to guide their actions.

Table 1: Key elements of sound corporate governance
The key elements of sound corporate governance in a bank include:

  1. A well-articulated corporate strategy against which the overall success and the contribution of individuals can be measured.
  2. Assigning and enforcing responsibilities, decision-making authority, and accountabilities that are appropriate for the bank’s risk profile.
  3. A strong financial risk management function (independent of business lines), adequate internal control systems (including internal and external audit functions), and functional process design with the necessary checks and balances.
  4. Adequate corporate values, codes of conduct and other standards of appropriate behavior, and effective systems used to ensure compliance. This is includes special monitoring of a bank’s risk exposures where conflicts of interest are expected to appear (for example, in relationships with affiliated parties).
  5. Financial and managerial incentives to act in an appropriate manner offered to the board, management, and employees, including compensation, promotion, and penalties. (That is, compensation should be consistent with the bank’s objectives, performance, and ethical values).
Source: Greuning, H. v., & Iqbal, Z. (2007). Banking and the Risk Environment. In R. A. A. Karim & S. Archer (Eds.), Islamic Finance: The Regulatory Challenge (pp. 11-39). Singapore: John Wiley & Sons (Asia), p. 24.


However, such market disturbances – like in case of Qatar – are not likely to occur in Malaysia because Bank Negara Malaysia (BNM) stipulated clear rules of governance for Islamic finance operations which require conventional banks to set up Islamic subsidiaries if they decide to run Islamic finance operations. The rules of BNM prescribe that Shari’ah compliant products on liability side can only be used with Shari’ah compliant products on the asset side. Hence, the issue of commingling of the funds does not apply to Malaysia.

Currently there are three Shari’ah governance models. Firstly, there is centralized Shari’ah governance which is run by government. Such system is in place in Malaysia, Pakistan, Indonesia and Sudan. Second model is a laissez-faire model under which institutions have a luxury to choose their position in relation to a certain fatwa. The weakness of this model is that it gives rise to issues such as “fatwa shopping.” The third model is a hybrid between the two previously mentioned models. Under the hybrid model, institutions have a certain degree of freedom of action as long as it is in line with centralized guidelines which apply to the broad market.


When viewed from the plane of the seriousness of the issue (commingling of funds which occurred in Qatar), the intention behind QCB’s abrupt move is justified and welcomed. However, since Islamic finance industry is still in its infant stages of development, a great deal of vigilance is required when navigating future decisions which have a significant impact on providers of Islamic financial services. Putting in place sound Shari’ah governance rules will ensure that the industry enjoys stability, transparency and some degree of certainty, i.e. the players will have a clear picture of the rules and regulations which govern the appropriateness of their actions. Otherwise, the industry may be tapping in the dark without a clear vision and far from reaching its potentials.