Sharī`ah non-compliance risk is a unique aspect of Islamic finance that deserves specific focus. Research and studies should be dedicated to this topic in order to further expand its scope and depth, as it is still at its early stage and there is not much written about it. This book tries to lay down the first pillars and foundation in this emerging area of Islamic finance. Sharī`ah non-compliance risk means that the terms, conditions, and other related aspects agreed on in the contract do not effectively comply with the Sharī`ah rules and principles. In other words, the terms and conditions in the financial contract do not fulfill the Sharī`ah requirement, hence making the existing contract concluded invalid, or in need of rectification. It is very important to note that the risk management cycle and process should start from this point, because Sharī`ah non-compliance risk might be challenged at any point of the Islamic banking business activities, which may lead to legal conflicts, disputes, or litigations. Sharī`ah non-compliance risk may increase the risk portfolio of the Islamic Finance Industry (henceforth IFI), which may result in financial losses and reputational damages. In the context of this scenario, the present book tries to address this issue by discussing a few aspects related to the subject of Sharī`ah non-compliance risk management, which include but are not limited to the examination of legal documentations used in Islamic finance to make sure that they represent the Sharī`ah in its form, substance, and spirit. The Sharī`ah non-compliance risk and the methodology used within its process will identify the gaps between theory and practice.
The main concern of this book is Sharī`ah non-compliance risk; it addresses the issues for the following questions:
This book aims to achieve the following objectives:
This research will use the following methodology:
This book tries to identify the area of Sharī`ah non-compliance in Islamic finance, by introducing the Sharī`ah non-compliance risk management framework particularly in legal documents/contracts and practices of Islamic banks in various banking applications.
In order to achieve the objectives mentioned, the study has adopted the following approach.
This platform is demonstrated in a discussion on the concept of Sharī`ah non-compliance risk, followed by the nature of Sharī`ah non-compliance risk in Islamic banking and finance, along with the Islamic tools and instruments to identify incongruence in Sharī`ah non-compliance. In addition, there are some major elements of Sharī`ah non-compliance risk in Islamic banking and finance that have been observed, such as gharar (uncertainty), ghubn (inequality), and others. There are also other factors that can cause Sharī`ah non-compliance risk, such as human error, concept of risk, features of Sharī`ah non-compliance risk, Sharī`ah non-compliance risk events, and the Sharī`ah basis for Sharī`ah compliance.
The fundamental blocks represent the major pillars of the research; they form the Sharī`ah fundamental requirements in contracts and the legal framework of the Islamic finance facility. These blocks are as follows:
Sharī`ah rules are the first building block in this research; Sharī`ah rules govern the fundamental Islamic principles and requirements in contracts and legal documentation in the Islamic finance facilities in the bank. The major elements of the contract are sighah of the contract (offer and acceptance), the contracting parties (seller and buyer), and the subject matter of a contract (goods and price). This Sharī`ah building block enables the bank to structure the Islamic finance facility in a Sharī`ah-compliant manner.
The legal framework is the second building block, which is based on the incorporation of Sharī`ah requirements into the legal documentations. It includes the functions of the legal documentations, determining the specific prohibitions that should be avoided in the terms and conditions of the legal documentation, and so forth. The purpose of incorporating Sharī`ah requirements in legal documentation is to ensure Sharī`ah compliance and monitor the Sharī`ah non-compliance risk in the Islamic facilities. The critical areas in legal documentation are the terms and conditions (T&C) that affect the rights and liabilities of the parties in the Islamic financial contract. In addition to that, the T&C govern the Islamic finance facility and represent a point of reference in case of dispute and litigation. The T&C include clauses such as right to recall, cross default, consolidation and set-off, prepayment clause, and others.
The tools include accounting, financial statements, and cash flow. The techniques include observation, sampling, interviewing, and testing. The tools and techniques are both important to identify Sharī`ah non-compliance risk.
This is related to the process and management of Sharī`ah non-compliance risk, when the lines of defence have been used to screen Sharī`ah non-compliance risk. The lines of defence, in order, are:
These lines of defence play a crucial role in preserving the interest of Sharī`ah in Islamic finance.
The Islamic finance application taken into consideration in this book represents various Islamic banking facilities in deposit and financing and other banking products and services.