Corporate governance refers to the method by which a corporation is directed, administered or controlled. It includes the laws and customs affecting that direction, as well as the goals for which it is governed. Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection. Corporate governance is also viewed as a process of monitoring performance by applying appropriate counter-measures and dealing with concepts such as transparency, integrity and accountability.
Corporate governance requires corporations to exercise immense accountability to shareholders and the public, and also monitors the ...view middle of the document...
Even within the conventional system, corporate governance became a thornier issue with respect to banks. This is because banks have certain unique characteristics. Three main characteristics that lead to an independent discussion of the governance of banks are: first, banks are generally more opaque than other financial institutions, which intensifies the agency problem. Secondly, banks are exposed to extreme regulations; and thirdly, government ownership of banks makes the governance of banks different from other types of organisation.
When banks face sound governance mechanisms, they will efficiently mobilise and allocate funds, this lowers the cost of capital to firms, boosts capital formation and stimulates productivity growth. Thus, weak governance of banks reverberates throughout the economy with negative ramifications for economic development.
Islam and Corporate Governance
Strong corporate and bank governance are essential ingredients for the development of a vibrant and sound Islamic finance industry.
Corporate governance is not new to Islam. The Islamic concept of corporate governance stresses the three main areas of accountability, transparency and trustworthiness.
The need to strictly follow these corporate governance requirements is given greater weight, more so for god-fearing persons, by linking the practices to God. One commandment for Muslims is the concept of tawhid, which promotes the need to submit fully to God. It highlights the unique and distinguished relationship between man and Allah. This relationship also prevents man from behaving in any manner that is harmful to other living things. By enforcing full submission to the Creator and by insisting that the Creator expects trustworthiness, transparency and responsibility in all dealings, corporate governance is given a spiritual backing.
Elements of Corporate Governance in Islamic Banking
The statutory corporate governance in Islam witnesses Islamic financial institutions abiding to a set of rules called the Islamic law or Shariah. The Shariah governs the bank’s operations and transactions in accordance with Islamic principles derived from the Quran and Hadith. It needs to be reiterated here that Shariah in Islamic banking has a crucial role not only in governing bank transactions and operations, but also in monitoring and supervising the roles of all players within the banking system.
Shariah is a blueprint for Islamic banks to operate in accordance with the laws outlined, for instance eliminating riba (interest) in all its forms, and ensuring that banking procedures do not exploit nor do injustice to the bank’s shareholders.
To ensure that Islamic banks comply with the appropriate Shariah rulings, the services of religious boards known as Shariah boards are employed. These boards comprise of Shariah scholars or a committee of religious scholars. The Shariah board plays the dual role of supervision and consultation.
Islamic banks must...