The impact of the board of directors and the Shariah board on the financial soundness of Islamic banks

Abstract

Purpose The purpose of the study is to examine the relationship between the board of directors (BODs) and the Shariah board (SB) and assess its impact on the financial soundness of Islamic banks (IBs). Design/methodology/approach The authors use a regression model to test the effects of the relationship between the BOD and the SB on the financial soundness of IBs by applying a panel data set of 61 IBs, covering 18 countries from 2008 to 2014. The dependent variable is the Z-score indicator. To test the robustness of the results, the authors use dependent variables other than the Z-score [A rating of Capital adequacy (C), Asset quality (A), Management (M), Earnings (E), Liquidity (L), and Sensitivity (S) (CAMELS)] for 2018. Findings The results show that meetings between directors and SB members significantly reduce the financial soundness of IBs. The relationship between the BOD and the SB increases conflicts of interest and agency costs. However, a representation of the SB at the BOD meetings and vice versa does not affect financial soundness. The Accounting and Auditing Organization for Islamic Financial Institutions and the Islamic Financial Services Board corporate governance standards do not require the presence of the SB representative at the BOD meetings or vice versa, which justifies the results. Practical implications This study attempts to fill gaps in the literature by investigating the impact of meetings between the SB and the BOD on the financial soundness of IBs across the world. The results suggest that the BOD’s frequent interference in the affairs of the SB can have adverse effects on IBs and should be avoided. Originality/value The authors depart from the previous literature by using three new characteristics that link the BOD to the SB. Methodologically, the authors use three new measures to evaluate this relationship and its effect on the financial soundness of IBs. This study is unique because it explores the comparative impacts of the presence of a SB representative at the BOD meetings and a director at the SB meetings and meetings between the two governing boards of IBs.

The influence of national and individual Islamic governance on Islamic banks’ social performance

“…Perhaps this is not surprising as social and moral expectations never come from the centres of power; hence, it applied for Shariah boards. Essentially, this result is similar to the result of Khalil (2021), who found that the Sharia board reduces the financial soundness of Islamic banks.…”

Islamic Social Reporting (ISR), Sharia Supervisory Board (SSB), and Financial Performance: Empirical Evidence on Islamic Banks in the GCC Region

“…If the SSB holds more meetings, SSB coordination can be further improved and sharia-based supervision can be more effective. SSB can also provide regular input to management regarding the distribution of ISR funds or input on ISR disclosures to increase transparency [11]. The formation of SSB is an effort by the government so that Islamic banks can gain trust and convince the public in their function to apply sharia principles consistently.…”

“…SSB as an independent party that the role of SSB involves providing fatwa, conducting Sharia audits, calculating zakat, and distribution of non-sharia income and guiding the bank in its wider social role [10]. Furthermore, the presence of the SSB can serve as an additional advantage for Islamic banks, as it fosters heightened customer confidence in their banking operations [11].The results of research by Nomran et al, (2020) and Neifar et al, (2020) which reveal that SSB has an effect on the financial performance of Islamic banks is supported by the findings of Alam et al, (2021) in Bangladeshi Islamic banking where SSB can affect financial performance. This is because SSB carries out and functions in monitoring and reviewing banking activities as a whole.…”

Effect of The Board of Director's Characteristic On Islamic Bank's Financial Soundness

“…Proponents of agency theory suggest that having a high number of independent non-executive directors in the board allows a better activities control and reduces the manager opportunism (Jensen and Meckling, 1976;Fama and Jensen 1983). Moreover, the independent non-executive director support the Shariah Board in order to check the compliance of financial products with shariah principles (Quttainah et al, 2013;Khalil 2021). While, the presence of independent non-executive directors guarantees the independence of the Board of Directors (Amine, 2018;Ramly et al, 2018).…”

“…Institutional directors have the expertise and a better knowledge of the of the sector issues compared to other directors (Hakimi et al, 2018;Khalil, 2020). Institutional investors are also more independent to control managers (Jensen, 1993).…”