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INDEPENDENT AUTHORITY

Kuwait wants legal entity for sharia supervision

Kuwait, February 11, 2014

An independent legal entity should oversee the way in which Islamic financial institutions certify they are following sharia principles, Kuwait's central bank governor Mohammad al-Hashel said in a speech to industry scholars.

The comments by Kuwait's central bank chief could reignite debate over the role of sharia scholars, as regulators around the world begin to take a more active role in monitoring the gatekeepers of Islamic finance.

Boards of sharia scholars at financial institutions rule on whether activities and products follow religious principles such as bans on interest payments and pure monetary speculation. They are also involved in audits that determine whether the institutions are operating in a compliant manner.

At the same time, the scholars are on the payroll of the Islamic banks which they vet, an arrangement contrary to good governance, Hashel said in his speech, delivered at a December conference and recently published on the central bank's website.

"Usually, the responsibility for fatwa (religious rulings) and subsequent sharia audit is assigned to the sharia supervisory authority maintained by most Islamic financial institutions. This practice is by no means in line with the sharia supervision governance fundamentals."

Traditionally, scholars have mostly practiced self-regulation, leaving the process open to accusations of conflicts of interest. The growing role of Islamic finance in some national economies is now prompting government watchdogs to pay more attention to the sector.

Last year, for example, Malaysia overhauled its Islamic finance rules, giving it greater oversight over banks and scholars, who are now legally accountable for the financial products they approve and liable to fines and prison time for wrongdoing.

Bahrain's central bank will release a new regulatory framework for Islamic insurance this quarter, in a review of standards which the regulator hopes will improve governance as well as profitability. Pakistan's central bank is revising rules on sharia governance and liquidity management for Islamic banks.

Hashel said there should be clear and specific professional frameworks for the duties and responsibilities of sharia authorities and their audit function.

"We can consider the idea of establishing an independent legal entity that will take the responsibility for the regulation and development of the work of sharia audit and supervision," he said.

Hashel did not elaborate on how such a body might operate in Kuwait, or say whether Kuwait was likely to establish one. But his proposal may strike a chord in the Islamic finance community, because loose regulation of scholars is acknowledged by many people in the industry to be an obstacle to growth.

The creation of an independent legal body could see scholars independently reviewing the work of their peers, a format pioneered by Malaysia but mostly absent in the Gulf.

Establishing the body would involve challenges but it could take its cues from the conventional financial auditing profession, said Hashel, who replaced veteran policymaker Sheikh Salem Abdul-Aziz al-Sabah as central bank head in March 2012.

"In this context, we can refer to the history of development of the audit profession to be considered as a role model and to benefit from conventional guidelines regarding this matter."

He did not elaborate, but accounting scandals at companies such as Enron have prompted regulators in some countries to require rotation of companies' auditors after a certain period of time. Companies have also been encouraged to use separate firms for their audit and advisory work.

By contrast, appointments of scholars to sharia boards in the Gulf are often considered long-term or even permanent, and the scholars become involved in the design and sometimes even the marketing of Islamic financial products.

This is beginning to change, however. Oman introduced term limits for sharia scholars as part of an extensive Islamic banking rulebook introduced in December 2012. Its rules require scholars to be appointed for three-year terms and serve a maximum of two consecutive terms, effectively requiring banks to hire new scholars periodically.

Further progress would require input from industry bodies, said Hashel, a member of the technical committee of the Malaysia-based Islamic Financial Services Board (IFSB), a top governing body for the industry.

"This should be undertaken in cooperation with competent regional and international authorities which will save much effort and time."

Such efforts could actually strengthen the independence of scholars by limiting interference in their work by financial institutions, he added.

"This will enhance confidence of stakeholders and clients in the soundness of transactions from a sharia perspective."

However, governing bodies such as the IFSB have focused on prudential rules such as liquidity and stress-testing of Islamic banks, rather than addressing the role of sharia scholars.

The Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), a body which gathers the industry's most prominent scholars, has focused on guidance for financial instruments such as sukuk, or Islamic bonds.

AAOIFI's standards do recognise that lengthy scholar appointments "could lead to a close relationship which could be perceived to be a threat to independence and objectivity", but it does not prescribe term limits.

It recommends that institutions rotate at least one sharia board member every five years, but such guidelines are not enforceable in most countries and don't address the broader self-auditing issue raised by Hashel.-Reuters




Tags: Kuwait | Sharia |

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