Governance and Management Structure of Islamic Finance Essay

A series of global financial crisis and economic recession for the past three decades have encourage economists world-wide to consider for an alternative financial solution. Globally this has attracted attention to focus on Islamic banking and finance as an alternative model. However, according to Chapra and Ahmed (2002) the primary of the new architecture that has received maximum emphasis so far at international forums, is improved corporate governance reinforced by prudential regulation and supervision. While these will certainly help in enhancing the soundness and stability of the financial system, they will not be sufficient.

The increased globalization of financial and Islamic products markets has raised the interest of both market participants and regulators in the quality of financial reporting worldwide. As a result, Islamic financial institutions are required to increase the corporate governance (CG) and disclosing such actions in their annual reports because it may reduce the information irregularities between the management of the Islamic banks and the shareholders. According to Kothari (2000), reduced information asymmetry has desirable effects on the cost of capital and the volatility of security prices. These benefits motivate regulators around the world to strive for high quality.

In addition, with more governance related disclosure aids reflected in the financial reports would foster more transparent and accuracy in the present and future performance of the respective Islamic banks. Disclosure aids in the financial reports will assist all stakeholders to monitor the Islamic banks performance and to avoid existing problems remain unnoticed and which could lead to financial failure in the future.

1.1 Problem Statement

Issues of corporate governance especially on the principal/agent conflict of interest with a view to promote the interests of all the stakeholders as well as the soundness and stability of the Islamic Financial System. This problem has been an inherent weakness in most conventional and Islamic banks since the advent of the financial system in Malaysia. Thus, this has eroded the credibility of the Malaysian Financial Institutions during the past financial crisis. According to McLennan (2007), good governance enables efficient and effective service delivery, and it also ensures high levels of accountability and transparency. These challenges can be classified as the top of list problem areas in the Malaysian Financial Institutions, and the main cause is problems around corporate governance.

1.2 Significance of the Research

Due to the greater push Internationally by Accounting and Audit Organization of Islamic Financial Institutions (AAOIFI), the Islamic Financial Services Board (IFSB) and local regulatory such as the Central Bank of Malaysia (BNM) and the Securities Commission Malaysia (SC) to improve the corporate governance reinforced by prudential regulation and supervision. This study examines the seriousness of Malaysian Islamic Financial Institutions and Foreign Islamic Financial Institutions complying with these guidelines. In particular, this research will examine the CG disclosures reported in their financial reports in Malaysia together with the current Malaysian Code on Corporate Governance 2012 (MCCG 2012) issued by SC focuses on strengthening board structure and composition recognizing the role of directors as active and responsible fiduciaries. According to Malaysia Code of Corporate Governance (2012), they have a duty to be effective stewards and guardians of the company, not just in setting strategic direction and overseeing the conduct of business, but also in ensuring that the company conducts itself in compliance with laws and ethical values, and maintains an effective governance structure to ensure the appropriate management of risks and level of internal controls.

Furthermore, this study is intended to contribute to the relevant literature aspects in future. This includes by institutionalizing the best practices from the Islamic financial institution and operational matters across all financial institution under the government linked companies (GLCs) in Malaysia in tandem with the Finance Ministry of Malaysia to have the GLCs to sustain in their performance and meet the transformation programme objectives by 2015. (Please refer to Figure 1)

Figure 1: Transformation Objective by 2015

Source: GLC transformation programme. Yellow Book âA¢”šA¬" Continuous Business Process Improvements GII âA¢”šA¬A…“InnovationâA¢”šA¬A Circle Meeting 2. 2012

2.1 Main Research Questions

The corporate governance guidelines issued by the respective responsible bodies as mentioned above may improve the governance practices of IFIs and hence enhance its transparency and accuracy reported in the financial reports. This study attempts to examine the extension of Malaysian Islamic Financial Institutions and Foreign Islamic Financial Institutions complying with these guidelines. Specifically, the following research questions will be developed for study:

1. Were there sufficient information related to corporate governance available in the financial reports disclosure aids to safeguard the interest of all stakeholders?

2. Was there any standard tools available for the making the Board and the Management more effective and accountable for Malaysian Islamic Financial Institutions and Foreign Islamic Financial Institutions?

3. Were there sufficient information related to the performance available to all the stakeholders reflected in the financial reports disclosure for Malaysian Islamic Financial Institutions and Foreign Islamic Financial Institutions?

2.2 The Objective of the Research

The main aim of this study is to examine the contributing factors by both board of directors and management for Malaysian and Foreign Islamic Financial Institutions of the Islamic financial institutions Thus, the objectives of this study are:

To examine the Board of Directors and Management principles, duties, responsibilities and policies Malaysian Islamic Financial Institutions and Foreign Islamic Financial Institutions complying BNM and SC new corporate governance guidelines.

To examine the performance measures for board of directors and management for both Malaysian and Foreign Islamic Financial Institutions.

ii) To examine the organization structure and functions for both Malaysian and Foreign Islamic Financial Institutions.

The study seeks to understand the disclosure of corporate governance and management decision making reflected in the financial reports between Malaysian and Foreign Islamic Financial Institutions.

3.0 Theoretical Framework

The potential theoretical framework of this study will merely concentrate on the quality of the CG information disclosure in the financial reports for Malaysian Islamic Financial Institutions and Foreign Islamic Financial Institutions. The study will focus on the examining the extension of CG information disclose by IFIs and the difference of CG disclosure quality between local and foreign owned IFIs in terms of their preference to prioritize on whether specific or general kind of governance information in their annual report in year 2012. More specifically, the primary objective of this study is thus to examine the quality of CG disclosure provided by IFIs in Malaysia in their annual report.

After conducting interviews, completing literature review and defining problems, the actual theoretical framework can be develop. However, the researcher may identify potential theoretical framework related to this research. The stewardship theory may be chosen as a framework for this study on account of the contextual characteristics of IFIs. (Please refer to Figure 2)

Figure 2: Exhibits the Potential Research Framework

4.0 Methodology

For this study the primary data and secondary data will be used. The secondary data will be collected from the central bank annual report, articles from journals and news papers and economic review. The above are the main research questions that framed the semi-structured interviews, documents analysis and discussions during data collection. In addition, this research intended to examine CG disclosure practices of IFIs in Malaysian and Foreign Islamic Financial Institutions using two stages. The first stage is the development of comprehensive CG index. Consistent with prior studies, the index acts as a proxy for disclosure quality. The comprehensive corporate governance disclosure (CGD) index used in this study based on governance guidelines and codes disseminate by AAOIFI, BNM and SC. This CG index developed is then used to assess the quality of CG of Malaysian Islamic Financial Institutions and Foreign Islamic Financial Institutions. This will constitute the second stage of the study which will focus of this paper. According to Walter and Kenneth (1986), the association between the compounded index which captures both the importance of information and extends of disclosure, and possible determinants of disclosure is compared with using simple disclosure index.

4.1 Limitations

The researcher may encounter obstacles while conducting this study. The obstacles come in many forms. The first potential obstacle would be on the data gathering during interview, where all bankers are required to abide by the rules and regulations spelled out in the Banking and Financial Institution Act (BAFIA) 1989 which prevents the interviewee from revealing certain details to a third party even for the benefit of this research. However, to be as confidential as possible and to avoid any doubts or dispute as to the authenticity of the data, respective parties within the University may have verified the details and analysis computed. In addition, the researcher also faced some constraints as some the employees of the Malaysian and Foreign Islamic Financial Institutions may not want their names to expose in the research report based on the interviews conducted by the researcher.

5.0 Findings and Conclusions

By having the studied the research problems and issues mentioned above by the researcher, it is proposed to provide the findings and to recommend suggestions to the respective parties such as regulatory body in Malaysia. With jointly and cooperative affords from all the parties to build up Malaysian Islamic financial institutions a world class for Islamic banks by managing well in their asset quality and to increase the flow of income.

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