Independence of the Shari'ah Supervisory Board
A small Islamic bank has a three-member Shari'ah Supervisory Board (SSB). One member, Sheikh A, also sits on the board of a company that is the bank's largest murabaha customer and receives a consulting fee from that customer. A second member, Dr B, is paid a performance bonus by the bank linked to the growth of its tawarruq book. The third member, Dr C, is independent. The SSB approved a new tawarruq product last quarter by a 2–1 vote, with Dr C dissenting on the ground that the commodity sequence was not properly documented. The bank's board has decided to proceed and to record the approval as 'unanimous' in the annual report. The bank's governance manual says SSB members are appointed by the shareholders' assembly on the board's recommendation and serve three-year renewable terms.
1. Identify the independence and conflict-of-interest problems and state the governance consequences.
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Three problems.
1. Sheikh A - external conflict. He sits on the board of the bank's largest customer and takes a consulting fee from it. His judgement on any matter touching that customer (including murabaha approvals, restructuring, or waivers) is compromised. He should recuse from all related decisions, and the relationship must be disclosed. Depending on the governance standard, an ongoing fee from a counterparty may disqualify him from voting on that counterparty's transactions.
2. Dr B - incentive conflict. A bonus tied to tawarruq volume makes him financially interested in approving more tawarruq. That is precisely the pressure an SSB exists to resist. Variable pay linked to business volume is incompatible with the monitoring role; it should be replaced with a fixed fee.
3. Misrecording the vote. Reporting a 2–1 decision as 'unanimous' is a misstatement to shareholders. The dissent and its reason (undocumented commodity sequence) must be recorded and disclosed. Concealing a dissent also weakens the audit trail if the product is later challenged.
Consequences: the approval is procedurally tainted; the product should be re-reviewed by a properly constituted, conflict-free SSB before further sales; the annual report must be corrected; and the appointment/remuneration framework needs revision.
2. The board argues that SSB members are 'advisers, not directors', so independence rules for directors do not apply. Assess.
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The argument confuses legal form with function. The SSB's function is to certify compliance - a gatekeeping, monitoring role. Independence rules exist because monitoring is worthless if the monitor benefits from the outcome. That logic applies regardless of whether the member is called an adviser.
Practical points:
- The SSB's fatwa is relied on by shareholders and depositors; a conflicted fatwa misleads them.
- Governance standards require SSB members to be free of relationships that could bias them, and require disclosure of any relationships.
- 'Adviser' status does not cure a fee from a customer or a volume-linked bonus; if anything, an adviser with a volume bonus has more incentive to please management than a director.
So the board's position is untenable. The fix is structural: fixed remuneration, recusal rules, disclosure, and a genuinely independent chair.
3. Recommend concrete governance changes to the appointment and operation of the SSB.
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- Appointment: shareholders' assembly appoints on nomination by an independent nomination committee, not solely the board; publish the nominees' other interests; fixed three-year terms with a cap on consecutive renewals to prevent entrenchment.
- Remuneration: fixed fees only; no bonus linked to business volume; disclose aggregate SSB remuneration.
- Conflicts: annual written conflict declarations; mandatory recusal from any matter involving a related party; a register of interests available to audit.
- Decision records: minutes must record votes, dissents and reasons; the annual report must report the true vote; no 'unanimous' label unless it is.
- Access: SSB must have direct access to internal audit and to the board risk committee, and the right to require documentation (e.g. the tawarruq commodity sequence) before approval.
- Review: the product should be re-submitted to a reconstituted SSB before further sales; suspend new sales pending that review.