azerbaijan: emerging market islamic banking and finance

ACADEMIC ARTICLE
NEWHORIZON October–December 2008
jurisprudence. The IFSB emphasises the
need for these scholars to address both ex
ante and ex post aspects of financial
transactions, thus ensuring an effective
review process.
Furthermore, it is recommended that IFIs
conduct an internal Shari’ah review of all
activities, executed by a dedicated internal
division/department or as part of the
internal audit department, depending on
the size of the institution. According to
AAOIFI, the main purpose of this function,
referred to as the internal Shari’ah
compliance unit, will be to ensure the
management of an IFI discharges its
responsibilities in relation to implementing
rulings made by the supervisory board. The
compliance unit is therefore an internal and
independent function that assists the
Shari’ah supervisory board and contributes
to ensuring the IFI’s Shari’ah compliance.
Investment account holders
As previously discussed, the investment
account holder is considered a stakeholder
in an IFI. As a result, IFSB has argued for
the creation of a separate governance
committee, to implement governance policy
frameworks that will protect the interests
of the investment account holder. Such a
committee will be established by the board
of directors and comprise three members:
a member of the audit committee, a nonexecutive
director (selected based upon
experience and the ability to contribute)
and a Shari’ah scholar (possibly from
the supervisory board). IFSB argues that
of particular concern to the governance
committee will be the commingling of funds
(relating to unrestricted investment
accounts) from investors with differing risk
expectations. Investment account holders
are generally perceived as requiring
protection of their funds, whereas
shareholders, who have provided equity,
will expect high returns – the result, for
commingled funds, is a conflict of interests,
with investment account holders restricted
in their control over investment strategy.
The investment account holder is therefore
exposed to the same risk as the shareholder,
but is not expected to receive proportionate
rewards.
This problem is then further exacerbated by
the arguably controversial practice of
utilising a PER, which effectively obscures
the actual return on investments and
prevents the unrestricted investment account
holder from properly assessing the
implications of the IFI’s investment strategy.
Moreover, the PER is subject to what IFSB
refers to as inter-generational problem, in
that a build-up of reserves during periods
of above average profits may leave
unrestricted investment account holders
with forgone and unrealised benefits if they
withdraw their investment before such a
time when reserves are utilised. It is this
ambiguity, surrounding the rights of the
investment account holder, which the
governance committee will seek to address.
The committee will provide the board of
directors with reports and recommendations,
closely liaise with the management,
the audit committee, and the supervisory
board, and ensure disclosure and the
proper implementation of investment
contracts.
In light of the requirements and suggestions
outlined above, an indicative corporate
governance structure for an IFI should
include the following (Figure 3):
Figure 3 Corporate governance in IFIs
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