1.

0 ABSTRACT

There is substantial evidence in the rising of Islamic Financial Institution around the globe

when the number of Islamic banking activities is increasing on daily basis. It is also surprising to

note that even the non-Muslim communities are interested to involve in this industry which

indicates that people are becoming more aware on the advantage of implementing Islam in the

banking activities. Besides, it also might be due to the fact that these opportunists do not want to

miss out the chance of being a part of a promising evolution.

Hence, good corporate governance is needed in order to control the Islamic banks activities

such as the adherence to shariah principle as well as non-existence of unethical behaviour in the

management which can result in a high confidence of the investors and encourage people

especially the Muslims to engage in Islamic banks rather than conventional banks.

Consequently, Islamic banks that have a good corporate governance also illustrated that

the management have no ethical issues which could sustain the institutions in a long run because

it is known that some corporate companies failed miserably due to bad corporate governance and

involve in unethical activities, as example the famous issue on Enron. On top of that, corporate

governance is an essential element in order to manage the organization and to ensure good

corporate performance.

2.0 INTRODUCTION

Corporate Governance is a process and structure used to direct and manage business

affairs of the company towards enhancing business prosperity and corporate accountability with

the ultimate objective of realizing long-term shareholder value, whilst taking account the interest

of other stakeholders. Usually, the shareholders will appoint directors and the auditors to satisfy

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themselves that an appropriate governance and controlled are placed in their company.

Meanwhile, the board of directors’ responsibilities are to govern the company by practicing

prudent management. In other words, corporate governance is about what the board of a

company do and how it sets the values for that respective company.

Good corporate governance is about high quality disclosure or transparency and

accountability practices that exist within a system. Good corporate governance will ensure that the

business environment is fair and transparent and that companies can be held accountable for their

actions. Besides that, transparency or disclosure communicate to the public about the company’s

activities, policies, ethical standards or even about social and environmental concern of a company.

In contrary, weak corporate governance will lead to waste, mismanagement and corruption. It can

also cause excessive risk-taking in terms of no control in business affairs.

Basically, this study was conducted to discuss on the implementation of corporate

governance in Islamic Banks. The first objective is to examine the corporate governance disclosure

quality on the 16 annual reports of Islamic Banks by using Corporate Governance Disclosure Index

(CGDi). Next, the second objective is to analyze if there is any increment of disclosing corporate

governance items in 2016. The last objective is to know whether it is sufficient to rely only on

corporate governance without shariah governance.

To meet the objective and answer of this paper, first reviews of the existing corporate

governance literature is prepared. Then research method applied in this paper is provided followed

by the findings and discussion of the research. Lastly, the conclusion of the findings and the

recommendation of the direction for future research.

3.0 LITERATURE REVIEW

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 The guidelines or standards used in the disclosure of a corporate governance is MFRS 7

which provides two main disclosures that cater the need to disclose the qualitative and quantitative

information on the exposure of risk faced by the entities in their financial statements (as cited in

Syaima’ Adznan and Sherliza Puat Nelson, 2014). Besides that, in Malaysia, the companies can

refer to Malaysian Code of Corporate Governance (MCCG) in order to enhance the quality of

information to disclose in their reports. However, MCCG allows the companies to be flexible and

develop their own approaches to corporate governance (as cited in OECD, pg 50, 2011).

The Securities and Exchange Commission (SEC) had released a new code of corporate

governance for public listed companies. This new code is to further strengthening the basic

principles of fairness, transparency and accountability in a company (Business World Online,

2017). With the new code of corporate governance, the listed companies need to disclose in their

annual reports their compliance with the provisions code.

In a study by Zulkifli Hasan emphasized that Islamic Financial Institutions are more

concerned with formal adherence to Islamic law instead of promoting Islamic ethical values which

led to several IFIs has weak corporate governance and resulted in corporate difficulties. Thus, it is

suggested to take ethics into account. According to Al-Qurtubi (1966), Islamic ethical principles

is derived from Al-Quran and Al-Sunnah which provides clear guidelines of ethics that is relevant

to corporate governance particularly in setting the standard code of behaviour of all stakeholders

and guiding the daily and business activities of the firm. This refers to the principle of adl (justice),

amanah (trust) and ihsan (benevolence).

In addition, a study by Zaleha Othman, Rashidah Abdul Rahman, and Faridahwati Mohd.

Shamsudin have shown that the role of ethics in the context of corporate governance is interpreted

from three perspectives which are corporate governance as a code of ethics, ethical inclusivity in

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governance and ethics as an affiliate of corporate governance. The writer urged that complying

with corporate governance requirement is an act of ethics and it is supported by two experts,

Sulivan and Shkolnikov (2007) which said that ethics is the heart of corporate governance.

In every organization, there is a need for a dispute management in case there are issues

arise in corporate governance. According to Umar A. Oseni, Abdul Haseeb Ansari and Hunud

Abia Kadouf, muhtasib is responsible to solve the dispute in the management in an organization

mainly Islamic Financial Institutions. The muhtasib act as a neutral, and independent body who is

able to execute a confidential investigation into such allegation and recommend appropriate steps

to the Board of Directors or General Meeting of shareholders.

On the other hand, Corporate Governance Disclosure Index (CGDi) is used to evaluate the

quality of Corporate Governance (CG) disclosure of IFIs (Norakma Abd Majid, Maliah Sulaiman,

Noraini Mohd Ariffin, 2009) and it will be used as well in this paper as a measurement. The CGDi

is derived from Central Bank of Malaysia (BNM), Islamic Financial Services Board (IFSB) and

Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). Firstly, BNM

issued GP1-i which is the “Guidelines on Corporate Governance for Licensed Islamic Banks” in

2007. Secondly, IFSB issued IFSB-3 which is the “Guiding Principles on Corporate Governance

for Institutions Offering Only Islamic Financial Services (Excluding Takaful and Islamic Mutual

Funds)” in 2006. Thirdly, AAOIFI issued GSIFI nos. 1 to 6 which is the “Governance Standard

for Islamic Financial Institutions” in 2008. Note that the first one is the main reference source to

form the checklist of governance disclosure, meanwhile the second and third sources form the

basis for identifying governance items that are not covered and overlap with the items in the first

one.

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 These 3 guidelines are used in developing the index on the basis of stewardship theory

where the managers are persons of trust that they will act in the best of interest of the principal

(Mills and Keast, 2009). The index is summarized into 14 dimensions with 123 sub-items and

divided into 2 themes which are general-governance related information (10 dimensions) and

specific-governance related information (4 dimensions). It laid down the minimum components of

CG disclosure which consists eleven dimensions namely, Board structure and functioning,

Nominating Committee, Remuneration Committee, Risk Management Committee, Audit

Committee, Shariah Committee, Risk Management, Internal Audit and Control Activities, Related

Party Transactions, Management Reports and Non-Adherence to Guidelines.

4.0 METHODOLOGY

4.1 CONTENT ANALYSIS

In this paper, the annual reports of Islamic banks were analyzed. All the sixteen

annual report of Islamic banks in Malaysia both local and foreign were analyzed which

categorized in three types named, full-fledged Islamic banks, Islamic subsidiary and

foreign Islamic banks. In addition, an interview was conducted with one of the shariah

board committee of Development Bank of Malaysia as well as the academician from

International Islamic University Malaysia, Dr Hamdino Hamdan who is also an expert in

this field and has a broad knowledge regarding corporate governance.

The analyses were carried out on the 14 dimensions adapted from the guidelines.

CGDi was applied to measure the quality of the disclosure of the CG score for each bank

under each theme, using the following equation:

Total score of the Individual Bank

CGDI = 𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑃𝑜𝑠𝑠𝑖𝑏𝑙𝑒 𝑂𝑏𝑡𝑎𝑖𝑛𝑎𝑏𝑙𝑒 𝑏𝑦 𝑡ℎ𝑒 𝐵𝑎𝑛𝑘 𝑥 100

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 A score of “1” was given if a particular items was reported and a score of “0” was

given if the items was not included.

5.0 ANALYSIS AND FINDINGS

5.1 Corporate Governance Disclosure

The first objective is to examine the corporate governance disclosure quality by

using Corporate Governance Disclosure Index (CGDi) as a base of measuring the

disclosure quality. After analyzing all the 16 annual reports (refer to Appendix 1),

undeniably, even after 8 years, all of the banks still cannot disclose all the 123 items in

CGD Index. Looking at the first dimension which is board structure and functioning, banks

such as RHB Islamic bank, CIMB Islamic bank, Bank Muamalat and Bank Islam did not

disclose shareholdings of directors and its restriction. The possible reasons of not

disclosing such items was maybe they want to make it private to public to protect the

directors. Most of the banks did not disclose the performance of assessment of board as a

whole, individual directors and CEO. They just mentioned that the method in assessing the

performance like Key Performance Indicators (Kpi). Besides that, most of the banks did

not include the criteria of appointment of Shariah advisors in their annual reports. The

annual reports just cover the criteria of appointment on the board. Also, most of the annual

reports only disclose the remuneration policies for BODs and ignore the remuneration

policies for directors and management.

As for the second dimension which is Nominating Committee, it is agreed that there

is no note indicates the assessment done by NC in relation to the mix of skills and

experience of directors. Only some bank like Standard Chartered Saadiq, Al-Rajhi

Investment Bank and HSBC Amanah, disclose such information in their annual reports.

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Moving on to the third, fourth and five dimensions which are Remuneration Committee,

Risk Management Committee and Audit Committee. Most of the banks can score full

marks on this dimensions but due to the reasons of not disclosing remuneration policies set

for management and Shariah Committee and no notes on risk management, charter for

internal and external auditor, they cannot score full marks. Proceed to Shariah Committee,

it is agreed that all of the banks did not disclose the endorsement of IFIs’ activities, policies

and procedures of the appointment and dismissal as well as the policy on rotation and

fatwas and rulings during the year. The reason of not disclosing such items are still

questionable. The other issue on this dimension is not disclosing issue report by Shariah

Committee, only certain banks such as Bank Islam and RHB Bank include the report by

Shariah Committee in their annual reports. Besides that, most of the bank also did not

include items like remuneration scheme and Shariah review performance. Surprisingly,

after analyzing all the 16 annual reports, Standard Chartered Saaddiq and CIMB did not

disclose the frequency and quorum for meeting for Shariah Committee.

As for the Internal audit and control dimension, all of the Islamic banks did not

disclose remuneration policy for internal auditor, performance of internal Shariah review

by Internal auditor and charter for ISR in bank. Plus, not many banks disclose area of focus

during the performance review and the changes of internal control policies and procedures.

Thus, it is agreed that, more than half scoreless in this dimension. For the related parties

transactions and management reports, most of the banks also cannot score full marks on

these dimension as they do not disclose either one item for each dimension. Next, all of the

banks score zero on non-adherence to guidelines and governance committee dimension

because they do not disclose any breach of guidelines and the alternatives to measures the

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breach. The possible reason of not disclosing such items is all of the banks did not breach

any guidelines. As for the governance committee, maybe there is no initiative from banks

to introduce and establish a group called governance committee.

Next, looking at the investment account holders section, most of the banks fail to

score half under this dimension. The common information they disclose under this

dimension is on profit calculation method, the application of IAH’s fund, its investment

strategies and Shariah consideration on the basis of profit allocation. However, it is true

that most of the banks did not disclose the rights of unrestricted IAHs upon Mudharib’s

failure to perform since it will expose them to greater risk. However, by not disclosing the

items, they are not being honest towards the customers as not all the customers are aware

of their rights when Mudharib fails to perform their duties. The banks also did not disclose

information on smoothing returns. The possible reason is maybe they did not practice

smoothing as one of their transaction or service. Last but not least, most of the banks score

full marks on Shariah Compliance dimensions except for Standard Chartered Saadiq and

HSBC Amanah which they did not disclose any items on this dimension in their annual

reports. As to conclude, even all of the banks cannot score full marks on the CGD Index,

their disclosure quality is still high since most of them provided more information on

corporate governance in the 2016 annual reports compared to 2009 annual reports.

5.2 Comparison of Corporate Governance Disclosure Index (CGDi)

The second objective of this paper is to analyze the performance of the Islamic

banks in disclosing the corporate governance in the annual report. In order to measure the

compliance of the Islamic banks in this matter, a comparison had been made between a

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previous study by Maliah Sulaiman, Norakma Abd Majid and Noraini Mohd Ariffin in

2009 and a study conducted on the annual reports of the Islamic banks for the year 2016.

Previously, the local Islamic banks were seen as more transparent as compare to

the foreign-owned Islamic banks because the CGDi of the local Islamic banks showed a

higher number. It also means the local Islamic banks were able to comply with the BNM

guidelines and disclose more on the corporate governance as contrast to foreign-owned

Islamic banks that had the lowest number of CGDi.

Subsequently, according to Appendix 2, it can be seen that the patent of the

changes are not uniform but instead there are quite a range of increases and decreases in

the number of scores of CGDi. Specifically, there are more than half showing an increase,

around 9 Islamic banks showing a positive changes while another 5 showing a decrease in

the score (refer to Appendix 3).

Alliance Islamic is highlighted as experiencing the most reduction in the score from

76 in 2009 to 72 in 2016 approximately 5.26 percent of downturn. This is due to the non-

disclosure items especially the related party transaction, management report, non-

adherence to the guidelines and customer/ IAH. They did not to disclose those items might

be because they see it as something confidential and significant that could affect their

performance if it were to be revealed which leads to lack of confidence of the customers

because the Islamic banks should disclose items related to the customers. Apart from that,

surprisingly the bank did a very good job in disclosing Governance Committee as it is very

uncommon to find Islamic banks to have this committee.

In contrast, OCBC Al-Amin had appeared to be the most successful Islamic banks

in complying with the guidelines as it showing a significant increase of 50 percent from 52

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to 78 in 2009 to 2016. The main contribution to the score is the fact that the bank disclosed

all 18 out of 24 items in the board structure and functioning. Plus, they also disclosed 11

out of 12 items in the audit committee/ audit & governance committee which is very

important to acknowledge the members in the audit committee as non-executive and have

no interest in the bank as it will threaten the independence of the auditors. Besides that,

OCBC Al-Amin also managed to prepare an organized and almost complete statement of

corporate governance.

Overall, the CGDi in 2016 had indicated an increment in disclosing corporate

governance items. It is agreed that most of the Islamic banks were able to comply to the

BNM guidelines and the banks are showing efforts in following the guidelines based on

the slight increase. In addition, it is proven when the scores in board structure and

functioning, nominating committee, remuneration, risk management, audit committee and

shariah committee illustrated the most disclosed items in the index which also explain that

the Islamic banks have a good understanding in the function of the board member and the

importance of these committee to ensure the directors are competent and accountable to

manage and direct the institutions.

Despites of a decrease in the score for few Islamic banks, there must have reasons

behind it. For example there could have been changes in the procedure or the system that

they could not disclose yet, but they could notify the users by showing it in the notes. After

all, the changes made gradually can result in big impact to the banks as it will directly or

indirectly help to assist the Islamic banks to have a good corporate governance in order to

monitor, control and direct the company to the best of their interest especially to the

shareholders and the investment account holders.

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 Therefore, the fact that the least likely item to be disclosed is Governance

Committee, it is the main factor that many of the Islamic banks scored low in the CGDi.

Thus, BNM has to create awareness on the importance to have this committee and to

enforce all Islamic banks to establish Governance Committee as it will help to ease and

enhance the governance of the banks.

5.3 Needs of Shariah Governance

The third objective is to know whether it is sufficient to rely only on corporate

governance without shariah governance. Corporate governance is important in the aspect

of conventional as well as shariah. However, there is a challenges for corporate governance

if the boards are lack of knowledge in Shariah perspectives. It is good if all parties in

Islamic bank are able to understand shariah especially the board of directors itself. This is

because the boards are the one who lead the Islamic bank and it will be easier for them to

give their decision when it comes to shariah issues. In conventional governance, boards

usually focus more on the profit related items without having knowledge on the shariah

issues.

However, shariah governance only depends on AAOIFI which is not enough

because the standards has not been revised for quite some time and they don’t have

international body that can check the quality and performance of the standards. The

standard is not harmonize in every country which means that different country may use

different standards. Unlike conventional, they usually use IFRS in terms of disclosure. It

shows that there is a need of harmonization in standard so that the standard is comparable

to different countries.

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 On the other hand, it is compulsory to rely on shariah governance since corporate

governance only is not enough in governing the Islamic banks. Even though governance

that follows shariah, is still in infant stage, it will still be helpful in conventional bank when

it comes to shariah related matters. There are many things need to be done to improve the

standards, but the existence of Shariah Committee, internal and external auditor as well as

good management will lead to good corporate governance provided that standard, rules and

regulations be revised regularly to cater the need of Islamic institutions.

6.0 CONCLUSIONS

As was discussed in this paper, most of Islamic banks in Malaysia are still not

consistent and committed in providing information on corporate governance. It is because

there is various increase and decline in the number of scores of CGDi between the previous

study in 2009 and the current study conducted. Thus, it can be concluded that there is a

need to raise the awareness regarding the importance of having high disclosure and good

corporate governance in an institution. The practice of good corporate governance can lead

to better performance of the bank because it provides guidelines and principles for the bank

to follow. Besides, corporate governance also acts as a paradigm to improve

competitiveness, enhance efficiency and build the shareholders confidence.

However, despite having all the codes and standards, all related parties need to be

involved in the process of improving and implementing good corporate governance

structure. It is the responsibility of the board of directors to make a right decision by

fulfilling the interest of all stakeholders and not make a decision based on self-interest. On

the other hand, the shareholders of the bank must play an active role by having good

communications with the bank. This is to ensure that the bank meets the mandatory

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 disclosure requirements and voluntary best practices. As the investor of the bank, high

disclosure on corporate governance is helpful for them to determine the performance of the

financial institution. As for the banks, they should initiate more seminars and workshops

in order to highlight the relevance of corporate governance. Lastly, it is also a must for the

bank to have a Board Committees with diverse skills, shariah knowledge and experience

in order to ensure great emphasized is made on the implementation of shariah governance

in the islamic financial institutions.

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8.0 APPENDIX

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 Appendix 1

Islamic Banks 2009 2016

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Bank Islam Malaysia Berhad (inc 8.06%) 62 67

Bank Muamalat Malaysia Berhad (dec 1.51%) 66 65

Affin Islamic Bank (inc 1.89%) 53 54

Alliance Islamic Bank (dec 5.26%) 76 72

Ambank Islamic Bank - 82

CIMB Islamic Bank (inc 2.9%) 69 71

Maybank Islamic Bank (inc 8.77%) 57 62

Public Islamic Bank (inc 3.03%) 66 68

RHB Islamic Bank (dec 2.38%) 84 82

Hong Leong Islamic Bank (inc 4.55%) 66 69

Al Rajhi Banking Investment Corporation 63 61

(Malaysia) Berhad (dec 3.17%)

HSBC Amanah Malaysia Berhad (inc 2.99%) 67 69

Asian Finance Bank Berhad (dec 4.23%) 71 68

Kuwait Finance House (Malaysia Berhad) (inc 54 75

38.89)

Standard Chartered Saadiq Berhad (inc 25%) 52 65

OCBC Al-Amin Bank Berhad (inc 50%) 52 78

Appendix 2

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Appendix 3

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