IFIs need to bump up risk governance, position of risk chiefs

The area where Islamic banks are most in need of improvement is risk governance, says joint report by CIBAFI and World Bank


Risk governance and chief risk officers (CROs) status in Islamic financial institutions (IFIs) globally requires some serious recalibration. The role of independent directors at IFIs also needs fortifying in some jurisdictions.

These were among the findings of a joint study by the General Council for Islamic Banks and Financial Institutions (CIBAFI) and the World Bank.

“The area where Islamic banks are most in need of improvement is risk governance,” according to the report entitled “Corporate Governance (CG) Practices in Islamic Banks”.

The 57-page report, based on the results of a research conducted on 77 Islamic banks in 22 countries, also looked at Shariah governance, position of independent directors, transparency and disclosure quality.

Slightly more than one third of the banks involved in the research, or 28 to be exact, are based in the Gulf Cooperation Council (GCC). The rest were from non-GCC Middle East and North Africa (MENA) (13), South Asia (12), East Asia and the Pacific (10), Sub-Saharan Africa (8) and Europe (6).

In essence, the study aimed to identify the extent to which IFIs in the banking sector are complying with standards for good CG.

It also intended to identify some policy priorities which, if implemented, will enhance the quality of governance within IFIs, according to details in the final report.

Looking at the scores by region, the report said banks in the East Asia and the Pacific region scored higher than any other region, with South Asian banks second.

The lowest scoring regions were MENA excluding the GCC and Sub-Saharan Africa.

Risk Governance

Risk governance emerged as the weakest theme in a CG index (CGI) tabulated based on the results of the research.

Within the risk governance theme, the report noted that the strongest item concerned risk appetite.

“This is understandable since it is only in the last few years that the importance of risk governance has been fully recognised.

“Very few of the banks said that their CROs were members of their executive management committee, implying that the CRO lacks high status within the bank,” according to the report.

Independent Directors

A more detailed analysis of the thematic scores of the study also underlined some potential issues with the independent directors on board IFIs.

One “recurring pattern” that emerged was an apparent lack of independent board directors, and of involvement by independents in key areas such as the audit committee and risk committee.

“It is necessary to have independent members on the risk committee in order to have an unbiased and objective overview of the overall risk management framework and culture in the bank,” it said.

The risk committee should not only have a majority of independent members, but should also have an independent chair, the report added.

In addition, it also highlighted that boards and board committees, including Shariah boards, are not meeting as frequently as might be expected given the responsibilities they should be carrying.

“There thus seems to be a weakness in the level of challenge offered to banks’ executive teams,” it said.

Shariah governance was another area that received low scores on the CGI.

“Here, the big issues are the lack of diverse experience of the members on the Shariah board and the infrequency of Shariah board meetings,” it said.

Policy Recommendations

The report recommended work to implement international CG standards, including those that have been published by the Islamic Financial Services Board (IFSB).

The IFSB is an international standard-setting organisation that works to promote and enhance the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles for the industry, broadly defined to include banking, capital markets and insurance sectors.

It also recommended the development of a new or revised standard for CG in Islamic banks — bringing together the thinking that has been done in the post-crisis period by the Basel Committee on Banking Supervision, the IFSB and others — into a single standard which can be directly implemented by Islamic banks or incorporated within national regulatory frameworks.

To enhance the board independence and competencies, the report suggested that it might well require regulatory action to require a minimum number or proportion of independent directors, who should have appropriate knowledge and expertise, including expertise in Islamic banking.

It also called for the possibility of having more female directors.