Corporate governance in Islamic financialinstitutions: the issues surroundingunrestricted investment account holders

Rodrigo Magalhaes and Shereen Al-Saad

Abstract

Purpose – It has been observed that the practices of corporate governance in Islamic financialinstitutions (IFIs) do not sufficiently address the rights of unrestricted investment account holders(UIAHs). Given that such account holders are generally the ones who bear the risk of the performance ofthe investment pool, the purpose of this paper is to investigate the relationship between corporategovernance practice and the safeguarding of the interests of UIAHs as major stakeholders.

Design/methodology/approach – A qualitative research methodology is applied to a sample of 16managers from 12 Islamic financial institutions from Kuwait, Bahrain, UAE and Malaysia. A theoreticalmodel built around the GC principles featured in the King report underpins the research design.

Findings – The findings reveal that the current practices implemented by IFIs in protecting the rightsof UIAHs are not effective enough, in the light of standard corporate governance principles. It was alsofound that lack of responsibility, accountability and independence in decision making, as corporategovernance principles, is contributing to the ineffectiveness of current practices in the investigatedIFIs.

Research limitations/implications – The major limitation of the research is the small size of the sampleused. Hence, the work reported here must be considered as exploratory and a further study employing alarger sample is recommended as future research.

Practical implications – A number of recommendations for corporate governance practice in IFIsaimed at the unique relationship between IFIs and UIAHs are put forward.

Originality/value – The originality and the value of this paper rest on its topic which, to the best of theresearchers’ knowledge, has not been investigated empirically before. Hence, the authors believe it willbe of value not only to academics but mostly to practitioners in IFIs.

Keywords Kuwait, Bahrain, United Arab Emirates, Malaysia, Financial institutions, Islam,Corporate governance, Investments, Islamic financial institutions, Effectiveness, Protecting, Maximizing

Paper type Research paper

1. Introduction

The initial wave of oil revenues in the early 1970s and the growth of petrodollars gave

momentum to the growth of Islamic finance and many reputable Islamic banks were

established, including Nasser Social Bank Cairo in 1972, the Dubai Islamic Bank in 1975,

Kuwait Finance House in 1977, Faisal Islamic Bank of Sudan in 1977 and Dar Al-Maal

Al-Islami in 1980 (Van Greuning and Iqbal, 2008). In the beginning of 1980s, three Muslim

countries – Iran, Pakistan and Sudan – transformed their entire financial sector to be

completely Islamized. The step was considered as of great importance to the global

developments of Islamic banking (Bhatti and Khan, 2008).

Currently, Islamic Finance is one of the fastest growing industries with double-digit annual

growth rates for the past 30 years. There are more than 250 financial institutions in over 45

countries, in an industry which has been growing at a rate of more than 15 per cent per

annum for the past five years, with estimated annual earnings of $350 billion, compared with

a mere $5 billion in 1985 (Van Greuning and Iqbal, 2008). There are more than 284 Islamic

DOI 10.1108/14720701311302404 VOL. 13 NO. 1 2013, pp. 39-57, Q Emerald Group Publishing Limited, ISSN 1472-0701 j CORPORATE GOVERNANCE j PAGE 39

Rodrigo Magalhaes and

Shereen Al-Saad are based

at Kuwait-Maastricht

Business School, Salmiya,

Kuwait.

Received August 2010Accepted February 2011

Financial Institutions operating in 38 countries, and this does not include conventional banks

offering Islamic financial products and services (Dusuki, 2008). The success of the Islamic

financial system can be measured by the number of conventional banks that have

established their own ‘‘Islamic windows’’ not only in countries dominated by Muslim

populations, but also in rest of the world. A number of conventional Western financial

institutions went beyond the ‘‘Islamic windows’’, and opened whole Islamic subsidiaries.

El-Gamal (2005) suggests that the activities of Islamic financial institutions affect the welfare

of more than 20 per cent of the world’s population and for this reason the governance of such

institutions is becoming highly visible. Thus, the credibility of their CG practices is becoming

crucial for their effective growth, development, and social acceptance. However, it has been

observed that such practices do not sufficiently address the rights of investment account

holders and specifically the unrestricted investment account holders (UIAHs) in view of the

fact that it is the investor alone who bears the financial risks of his or her investments (Archer

et al. 2010). There seems to be a deficiency in the protection of investment account holders

as equity holders, in terms of board representation but also as depositors, in terms of

principal-guarantee (El-Gamal, 2005).

This paper reports on an investigation into the effectiveness of current corporate governance

practices of a sample of Islamic financial institutions with increasing international

representation. The primary foci of the research project are the IFIs’ corporate

governance practices and their effectiveness (or lack of it) in safeguarding the interests of

the UIAHs. Given the UIAHs’ central role in bearing the risk of the performance of the IFI’s

investment pool, they are arguably the major stakeholders of the Islamic financial industry.

2. Corporate governance from an Islamic perspective

Islam is a faith that relates to all aspects of life, and it includes a value-based system that

gives high priority to the recognition of justice and fairness to all humans. The main

characteristic of the Islamic economy is its aim to create a just, honest, fair and balanced

society as envisioned by Islamic ethical value. Islamic law (Shariah) states that Islamic

businesses must be conducted and founded on ethical norms and social obligations, and

also must be grounded on the moral framework of the Shariah (Ahmad, 2000). The holy

Quran and Hadith and the teachings of the Prophet Mohammed (PBUH) have extensively

stated and supported all the fundamentals behind corporate governance, by stressing the

importance of values, ethics, and morals for the welfare of a society ‘‘Each one of you is a

guardian, and each guardian is accountable to everything under his care’’ (Prophet

Mohammed, PBUH).

The beliefs of Muslims regarding the accountability of their actions in this world and beyond

have strong implications on how the application corporate governance is perceived,

especially in financial services. The main challenges that has faced the Islamic financial

industry from its inception was how to transform conventional financial products and

instruments into Islamically friendly ones, taking into account the prohibition of any payment

of interest ‘‘Riba’’. Also, there has been a need to adapt CG principles to Shariah

requirements, and to the teachings of the holy Quran and Sunnah. The Islamic Financial

Services Board (IFSB) and the Accounting and Auditing Organization for Islamic Financial

Institutions (AAOIFI) have stepped in and issued well-known CG guiding principles for

Islamic financial institutions.

Shariah law, prohibits Riba (interest), Gharar (speculations) and the trading of money.

Hence, in order to ensure that the operations and activities of Islamic Financial Institutions

are in compliance with Shariah rules and principles, a Shariah Supervisory Board (SSB) must

be in existence in all IFIs. This Board has the task of reviewing and evaluating newly

introduced products and services in order to ensure compliance with Shariah. In this

manner, Shariah endorses a stakeholder-oriented model of corporate governance, in the

light of Islamic principles (Van Greuning and Iqbal, 2008). However, Islamic finance does

introduce distinctive challenges for CG, one of the key challenge being the need of

stakeholders (in our case account holders) to be confident that the Islamic financial

PAGE 40 jCORPORATE GOVERNANCEj VOL. 13 NO. 1 2013

institutions are in fact efficient, stable, and trustworthy providers of financial services (Bhatti

and Bhatti, 2010).

2.1 Principles of corporate governance

According to the OECD (2004), there is no single model of good corporate governance

given that CG practices vary widely from nation to nation and from company to company.

The differences arise from predominantly dissimilar social values, various ownership

structures, and different business circumstances and competitive conditions (Gregory,

2000). Additionally, corporate governance frameworks depend on the development of legal

systems, and regulatory and institutional environment. Several reports from different

countries have approached corporate governance from the perspective of safeguarding

shareholder interests. Examples are the Cadbury Report (1992), the Combined Code

(1998), the Combined Code on Corporate Governance (2003, 2006), the Greenbury Report

(1995) and the Higgs Report (2003).

Originally published in 1994, the King Report 2002 advocates an integrated approach to

good governance in the interests of a broad range of stakeholders. This report takes a very

comprehensive approach establishing fundamental principles of good financial, social,

ethical and environmental practice (Mallin, 2007). In emphasising the concept of triple

bottom line (i.e. economical, environmental and social aspects), the King Report

re-emphasises the notion that generating profits for the shareholders is not the only

concern of a company’s purpose (du Plessis. et al., 2005). It highlights seven core principles

of corporate governance, namely:

1. discipline;

2. accountability;

3. fairness;

4. independence;

5. responsibility;

6. transparency; and

7. social responsibility.

Given its strong stakeholder orientation, this report presented a very appropriate model for

studying CG practices and their impact on UIAHs, in our sample of Islamic Financial

Institutions.

2.2 Basic Islamic financial instruments

Islamic banking is essentially based on the idea of interest (Riba) prohibition, while allowing

at the same time, trade and profit-loss-sharing arrangements. It is mainly ‘‘an equity-based

system featuring zero-interest, share economy, equity participation, joint ventures, mutual

funds, leasing, innovation with profit and loss sharing (PLS) and interest-free intermediation’’

(Bhatti and Khan, 2008, p. 42). The Riba prohibition has led to extensive discussions about

creating substitutes to the contemporary interest-based products of financial intermediation.

The main two profit and loss sharing instruments, which are mentioned frequently in the

literature on Islamic finance, are the Mudharabah and the Musharaka contracts. They are

considered central pillars of the current Islamic banking framework.

The focus of this paper is mainly on the Mudharabah contracts, which can be summarised as

a contract between the capital provider ‘‘Rab-al-Mal’’ and a skilled entrepreneur ‘‘Mudharib’’

who manages the business. Profit generated by such a business or activity is shared in

accordance to pre-agreed ratios, while losses, if any, are to be borne solely by the provider

of capital unless caused by the Mudharib’s negligence or violation of the terms of the

agreement (IFSB, 2007). (El-Hawary et al., 2004) states that the Mudharabah contract forms

the basis of mobilisation of funds from depositors, with the IFI as the Mudharib and the

depositor as the Rab-al-Mal. It also forms the basis of employment and investment of these

funds with the IFI now as the Rab-al-Mal and the entrepreneur as the Mudharib. The

VOL. 13 NO. 1 2013 jCORPORATE GOVERNANCEj PAGE 41

difference between the profit-share received from the entrepreneur (Mudharib) under the

first contract and the profit-share paid to the depositors (Rab-al-Mal) under the second

contract constitute the source of profits for the Islamic Financial Institution. Figure 1

illustrates the Mudharabah contract process.

2.3 Key stakeholders of Islamic financial institutions

According to Ghayad (2008, p. 209) CG can be defined as the ‘‘set of relationships between

a company’s management, its Board, its shareholders and other stakeholder’’. That author

also emphasises the importance of attaining and ensuring justice and equality to all

stakeholders through transparency and accountability. Resolving the conflict of interest

among all stakeholders is one of the most important issues of Islamic corporate governance.

In order to understand how corporate governance practices in Islamic financial institutions

are fulfilling their obligations toward their stakeholders, first we have to identify the key

stakeholders.

Van Greuning and Iqbal (2008) have grouped the stakeholders of Islamic finance industry

into three different categories; the internal stakeholders, the different interest groups, and

the institutions created to regulate and monitor the activities of Islamic financial institutions.

For the purpose of our research, we will be concentrating on the first category which is the

‘‘internal stakeholders’’. Table I describes such internal stakeholders.

The most important stakeholder that every Islamic financial institution should take into

account is Islam itself (Chapra and Ahmad, 2002). Therefore, Islamic financial institutions

have a huge responsibility to perform well, in order to protect the image of Islam in the eye of

the public. Depositors constitute a very significant group of the stakeholders given that, in

reality, they provide the largest portion of the banks’ operating (Archer et al. 2010)..There are

three main categories of deposit accounts offered by almost every Islamic financial

institution:

1. Current sccounts.

2. Restricted investment accounts.

3. Unrestricted investment accounts.

Figure 1 The Mudharabah contract process

PAGE 42 jCORPORATE GOVERNANCEj VOL. 13 NO. 1 2013

Each category raises different corporate governance issues, but those of unrestricted

investment account holders (UIAHs) are perhaps the most challenging. For the purpose of

this research we will concentrate only on the unrestricted account holders.

The unrestricted investment account holders enter into a Mudharabah contract with the

Islamic financial institution under which the financial institution manages the UIAHs’ funds

and shares with them returns, according to a predetermined ratio. The funds paid in are

placed in investment pools and the profits on investments, if any, are distributed at maturity

according to the profit and loss sharing (PLS) ratio specified in the contract. Under this

agreement, the UIAHs are the only ones who bear the risk of the performance of the

investment pool, except for gross misconduct on the part of the institution (Grais and

Pellegrini, 2006a, b, c, d).

2.4 The issues surrounding unrestricted investment account holders (UIAHs)

The key issue concerning UIAHs is the fact that holders of such accounts lack the power to

control the bank’s involvement in certain types of investment activity. The management of the

IFIs has the complete freedom in commingling depositors’ funds with shareholders’ funds for

investment in the same pool, in spite of the different risk tolerances and appetites among the

different providers of funds. The management then reports these investments and their

outcomes in IFI’s balance sheets and income statements. The result is the elimination of

operational transparency, and the creation of possible conflicts of interest with respect to the

potential deviation of risk appetite between the two types of capital providers (El-Hawary

et al., 2004).

Another issue relating to the UIAHs is the practice by most IFIs to smooth profits over time.

This smoothing of profit is done through a special reserve called a Profit Equalisation

Reserve (PER), which acts as a mean for hedging against unexpected future low income

distributions (Archer et al. 2010). The Islamic financial institution appropriates funds to PER

from the profit distributable to UIAHs and to shareholders, before the distribution of profits

among the financial institutions’ depositors and investors (Schoon, 2009). PER is used at the

IFI’s discretion to pay a return to UIAHs in years when income is low and is a tool for

maintaining a competitive return among its rivals.

Table I IFI’s key stakeholders

Internal stakeholder Roles and responsibilities

Bank regulators and supervisors The facilitators in the process of risk management and theresponsible of creating and maintain a healthy and soundenvironment through a solid risk management framework

Board of directors They are the steering wheel of the institutions throughsetting the strategic direction and establishing theoperational policies

Executive management Those are appointed by the Board of Directors andresponsible for putting into practice Board’s policies

Audit committee and internal auditors They are responsible of the execution of Board’s riskmanagement function

External auditors They have a crucial role in assessing the risk taken by thefinancial institution based on the financial informationprovided

Shariah boards Their responsibilities are vital when it comes to protectingstakeholders’ rights and to make sure that the financialinstitution’ activities are compliant with Shariah principles

Public and depositors Who are accountable for their decision of investment and todo so they require the financial institutions to be moretransparent in disclosing their financial information

Shareholders They are the owners of the financial institutions and they arethe one who appoints the people that would take care of theCorporate Governance process

Source: Van Greuning and Iqbal (2008)

VOL. 13 NO. 1 2013 jCORPORATE GOVERNANCEj PAGE 43

Such practices impede the transparency and reliability of financial information, and severely

constrain the investors from evaluating the bank’s actual performance. Moreover, such

arrangements are sometimes reported as equity; while at other times are reported as

liabilities. Others report them as off-balance sheet item, which allows them to hide any

negative information related to investment accounts, such as losses because of misconduct

or negligence (Abdel Karim, 2001). The only way for any financial organisation to protect the

interests of its stakeholders is to have a reliable governance structure. The interests of

stakeholders are not merely limited to the financial benefits, but consist also of other ethical

and religious principles that represent a significant value to the stakeholders. The same

applies to IFIs, where stakeholders are very much expecting their relationships with those

financial institutions to be framed and structured in compliance with the law Shariaha law

(Grais and Pellegrini, 2006a, b, c, d).

3. Research design

3.1 Research question

The research question which has guided our work was as follows:

RQ. How effective are the current practices of corporate governance in Islamic financial

institutions in protecting and maximizing the interest of unrestricted investment

account holders as a major stakeholder?

3.2 Theoretical framework

In order to approach the research question we have created a research model (Figure 2)

primarily based on the King report (du Plessis et al., 2005). All seven principles of this report

have been used, with the exception of the principle of ‘‘social responsibility’’. This principle

was dropped in view of the fact that our research focuses on contractual stakeholders

(i.e. UIAHs) as opposed to community stakeholders. According to the King Report, the

Figure 2 Theoretical framework showing corporate governance principles being applied to

the basic Islamic finance business model

PAGE 44 jCORPORATE GOVERNANCEj VOL. 13 NO. 1 2013

principle of social responsibility deals with the awareness and the responsiveness of

companies towards social issues, ensuring that they act in a non-discriminatory,

non-exploitative and responsible manner with regard to environmental and human rights

issues (du Plessis. et al., 2005). Thus, given its contents it was thought that this principle

lacked relevance within the scope of our research aims.

The model features the basic business model of all IFIs, with the Mudharaba contract linking

the UIAHs and the IFIs on one side, and the IFI’s shareholders on the other side. Around the

business model, the six key corporate governance responsibilities of IFIs are represented.

Describing now the variables in the model, the first is ‘‘Fairness’’, one of the main pillars of

Islamic finance. Fairness is all about acknowledging and respecting the rights of the

stakeholders equally. In our model we are aiming at evaluating how fair the managers of IFIs

are in acknowledging the rights and interests of UIAHs, in relation to the best practices

issued by AAOIFI (2009) as well as to IFSB standards and principals (IFSB, 2007). From our

interpretation of the recommended standards, we have identified two main factors that

influence fairness. They are:

1. protecting shareholder and stakeholder rights; and

2. the empowerment of UIAHs.

‘‘Responsibility’’. This element is about the responsible behaviour of the management of IFIs

in its relationship not only with the shareholders whom they are accountable to, but with all

stakeholders of the IFI including the UIAHs. It is also about how the management will put in

place all the means and resources required to guarantee the success of the financial

institution and welfare of all its stakeholders. In order to approach this factor, the level of

management responsibility in addressing the rights of UIAHs and dealing with the agency

responsibility that lies on their shoulders was examined.

‘‘Accountability’’. An element that is recognised by almost every CGmodel, accountability is

about ensuring the ethical content of the practices carried out by the management of IFIs.

While the element of responsibility is geared more toward the behaviour of individuals

involved in the management, accountability is about the mechanisms and business

processes that have been set to makemanagers accountable for their decisions and actions

taken in managing the company and its resources. The existing mechanisms and business

processes that allow the investors to query and assess the actions of the Board and its

committees is one factor which creates a culture of accountability. This works by exerting

pressure on the Board and its committees to ensure that the strategies and objectives they

set for management will work accordingly to the interest of UIAHs. Another important factor

related to accountability is management efficiency, which is the heart of our research

problem. Management efficiency means the balancing between the returns and the risks

associated with shareholders’ and stakeholders’ investments, considering that different

group have different risk appetites and different investment strategies.

‘‘Discipline’’ is the fourth element of the model. It emphasises the commitment and

adherence of the company and its management to ensuring that the universally recognised

CG principles and practices are being carried out in a correct and proper manner. In our

research, in addition to assessing the extent to which practices are adhering to good

governance and international standards, we are also evaluating the extent to which the

management of IFIs are ensuring compliance with Islamic laws and regulations.

Another element which almost every CG framework recommends is ‘‘Transparency’’. By

disclosing the necessary information and presenting the true state of the company, IFIs are

granting to the stakeholders (in our case the UIAHs) a clear picture which enables them to

make informed decisions about their investment. Customer awareness, timely disclosure of

adequate information and the ease with which potential customers can make meaningful

analysis of a company’s actions, are all categories which allowed us to determine the level of

transparency the IFIs in our sample.

The last element in our model is ‘‘Independence’’. This element is concerned with the

prevention of any possible conflict of interests that may arise from the excessive influence of

VOL. 13 NO. 1 2013 jCORPORATE GOVERNANCEj PAGE 45

a party over the management of the company when trying to serve their own interests and

benefits. From here the need arises to appoint external parties to the Board, as well as to

create Board committees, in order to ensure neutrality. We believe this is a major factor in

assessing a financial institution’s practices in dealing with UIAHs. This can be achieved by

examining the practices for minimizing or avoiding potential conflicts of interest, as well as

the mechanism the institution is applying to ensure the objectivity and independence of

decision making in issues affecting UIAHs.

3.3 Sampling, data collection and data analysis

The target population of our research were the top management of Islamic financial

institutions, such as chief executive officers (CEO), general managers, or any executives

responsible for coordinating and integrating the implementation of the governance policy

framework in the IFI. From this population, a sample was selected using a non-probability

sampling approach. A purposive or judgmental sample selection technique is most suited

when the topic requires the use of very small samples and the subjects are best selected

according to the judgement of the researchers. (Saunders et al., 2007). The key criterion for

selecting the sample of 16 managers was homogeneity in terms of functional

responsibilities. Hence, the sampling focussed mainly on decision makers and the

executives who are responsible for implementing CG processes in IFIs in Kuwait, Bahrain,

UAE and Malaysia.

The main data collection methods used for this research were participant observation and

semi-structured interviews. The participant observation part consisted of a number of visits

to four IFIs by one of the authors, aimed at observing directly the interactions between clients

and front-line staff. This was achieved through direct questions to the front-line staff by taking

on the role of a potential customer. The objective of this part of the research was to enquire

and to gain first-hand knowledge about the current processes and procedures used by the

IFIs in question in promoting and explaining unrestricted investment accounts (UIA) as a

product to their clients.

Semi-structured interviews were used since our data collection categories were known in

advance. The interview questions were conceived in a way as to cover the six CG principles

shown in the researchmodel (see the Appendix, Table AI). Open-ended questions were also

included in the interviews, thus allowing as much information as possible to be collected

regarding the relationship between IFIs and UIAHs.

As a first step in requesting the interviews, the chief executive officers and general

managers of the selected institutions were contacted through e-mail, explaining the aims of

the project and requesting face-to-face interviews with the relevant managers within the area

of CG. A total of 50 requests were sent to 12 Islamic banks in Kuwait, Bahrain, UAE and

Malaysia. After extensive follow-up, only seven successful face-to-face meetings and nine

e-mail responses were achieved. The low rate of response can be attributed to the sensitivity

of the topic as well as the difficulty in approaching the executives in charge.

Data analysis was carried out through categorisation and unitizing of data (Saunders et al.,

2007). The categories were established a priori from a detailed analysis of the main CG

principles as shown in Figure 2. Every interview was broken down into units (unitizing) and

each unit was then attached to its relevant category. The data in the next section is presented

in accordance with the analytic categories shown in Table II.

4. Findings

4.1 Direct observation exercise

The key findings based on the direct observations of four Islamic banks were as follows:

B The responses from the IFIs varied from encouraging and knowledgeable to

disappointing and unsophisticated, sometimes lacking in sufficient know-how about

Islamic products and their unique features.

PAGE 46 jCORPORATE GOVERNANCEj VOL. 13 NO. 1 2013

B Most of the observed banks emphasised the uncertainty of the exact rate of return but did

not provide enough information about the associated risk for the client, within the

Mudharabah contract.

B Most of the banks provided a written opening account agreement with all the terms and

conditions that govern the Mudharabah agreement. Yet, the account officers did not take

any time to explain verbally the detail of the ambiguous features of this agreement.

B All of the observed banks stated that only the quarterly published audited financial

information was available for the UIAHs as a mean to evaluate the performance of the

investment pool.

4.2 Structured interviews

Results are presented in accordance with the data analysis categories in Table II.

Transparency. 4.2.1.1 Customer awareness. In relation to the customer awareness aspect,

almost all of the banks within our sample confirmed advising the UIAHs about their

contractual rights and risks before signing for an UIA with the bank. They confirmed doing it

either through their employees or through their written terms and conditions. However, some

of the respondents did not seem to place much emphasis on ensuring that the clients

actually understood what they were signing. The following comment from one of

respondents illustrates this point:

At the end of the day we receive a form signed by the client. Whether he understood it or not that’s

difficult to know.

The interviews showed that the majority of respondents believed that information about

asset allocation, and the mechanics of smoothing returns should be publicly available,

especially if the company is shareholding and listed. But, on the other hand, many were

reluctant to consider profit calculations and investment strategies as public information and

they preferred to keep it confidential since it reflects the internal strategies of the bank. Some

respondents believed that because the bank is entrusted to manage the funds in a wise

manner, and to ensure keeping investors satisfied, there is no need to disclose this

information. Moreover, two interviewees stated that the detail of the bank’s investment

strategies should remain confidential especially in order to avoid it falling into the hands of

the competition. One respondent stated that such information could be revealed to

depositors on request.

In relation to the adoption of the practice of ‘‘smoothing the returns’’, the interviews revealed

that more than half of the banks use the ‘‘Special Equalisation Reserve’’ (PER) technique to

smooth the returns for their UIAHs. One of the respondents admitted that the practice is

unfair if one thinks of those UIAHs who have liquidated their accounts before getting back

Table II ‘‘Data analysis categories’’

CG principles Date analysis categories

Transparency Customer awareness Timely disclosure and adequateinformation

Ease of access to information andanalysis for potential customers

Fairness UIAHs empowerment Shareholders and stakeholders rightsprotection

Discipline Adherence to good governance andinternational standards

Compliance with Islamic laws andregulations

Accountability The existence of the mechanisms thatallow the investors to query andassess the actions of the Board and itscommittees

The efficiency of management inbalancing between return and riskassociated with shareholders andstakeholders investments

Independence Minimize or avoid potential conflict ofinterest

Appointments of committees andexternal parties

Mechanism which ensures theobjectivity and independence ofdecisions making

Responsibility Agency responsibility Responsible behaviour

VOL. 13 NO. 1 2013 jCORPORATE GOVERNANCEj PAGE 47

their distributions under the PER. However, after weighing the costs and the benefits, the

latter are much higher, and for this reason his bank considers PER to be an acceptable

practice. According to another respondent, the main reasons behind the creation of such a

reserve is to allow Islamic banks to compete with conventional banks, there being no conflict

between such reserves and the ethical principles of Islamic banking.

Six of the interviewees were totally against the practice of smoothing the returns. They

believe that it is an unfair practice, stating that returns should be distributed as fairly as

possible, and based on earnings. The following quote confirm this idea:

The bank is not using PER because that is not in compliance with the international accounting

standards and because, basically, you are manipulating your profits and this is not allowed (. . .)

There is a serious conflict between the IFRS standards and the Islamic standards and I am

personally not supporting it (PER).

4.2.1.2 Timely disclosure. With this part of the interviews we were trying to understand what

kind of information our respondents thought should be revealed and provided to UIAHs. The

results demonstrate that the majority of respondents believed that the quarterly audited

financial reports with detailed explanations of each item were sufficient information for

UIAHs. Only one respondent stated that the banks should explain to UIAHs the way of

calculating profit rates, Mudarabah fees, as well as the ways in which assets are allocated. In

contrast, another respondent stated that the bank should only present what AAOIFI, IFSB

and the Shariah Supervisory Board mandate.

In order to understand if the banks recognise the rights of UIAHs and put them on an equal

footing with collective investment schemes’ participants, the respondents were asked to

state the main similarities and differences between collective investment schemes (CIS) and

unrestricted investment accounts as regards the process of monitoring the performance of

participants’ investments. According to the majority of respondents, there are more

differences than similarities. The two are totally different types of products and should be

treated differently, regarding either contractual or accounting aspects. The differences were

attributed mainly to the high level of risk CIS customers were taking in comparison with

UIAHs. Some respondents said that the key difference is that CIS participants have better

access to their investments.

Some of the respondents related the differences mainly to the governance issues, since

CISs and UIAs are governed by different authorities – CIS are governed by the Securities

Commission while IAH are governed by the Central Bank. Most of the respondents

concurred that the published quarterly audited financial information is more than enough in

terms of reporting for the UIAHs.

4.2.1.3 Ease of access to information and analysis. Our inquiry into the accessibility to

information as a means of giving potential customers the possibility of evaluating the

performance of IFIs revealed that almost all of the respondents believed that sufficient and

adequate information is available either through their bank’s web site, financial statements or

through published reports by rating agencies. One of the respondents declared:

The bank’s website is a rich database for potential investors. They can access and assess the

bank’s financial position through its periodic and Annual Reports. Also, the website contains

statements by management which give an idea about the investment strategies, risk

management and many other related information.

4.2.2 Fairness. 4.2.2.1 UIAHs empowerment. Almost all of the interviewees acknowledged

the power of unrestricted investment account holders in their relationship with Islamic

financial institutions, although recognizing that this power is limited to withdrawals or moving

of funds to where they expect to get higher returns and receive better services. One of the

respondents said:

Every customer has power, if they are not happy with the services and the financial returns they

are getting they can withdraw their money and that would badly affect the bank (...) The days are

gone where you can make a fool out of a customer.

PAGE 48 jCORPORATE GOVERNANCEj VOL. 13 NO. 1 2013

;On this topic, the majority of our respondents were against the notion of granting UIAHs the

power of representation on the Board. The justification given by nearly all of the respondents

was related to administrative difficulties, specifically on the issues of nomination and

selection. They also emphasized strongly the dangers of interference of UIAHs in the banks’

management or strategic decision making. Only three respondents out of 16 agreed and

encouraged the idea of empowering UIAHs with the right of representation on the Board,

however, it was also emphasized that although this might be good in theory it will be difficult

to implement in practice. For some, agreement to the right of representation on the Board

was based on the condition that the appointment should be done through the central bank,

in order to avoid the hassles of nomination, selection and competency. One respondent

stated:

The issue is how to appoint the representative. If the central bank will take care of the appointment

it will be fine, otherwise it would be more of a hassle in getting a representative on the BOD,

especially finding out if the elected representative is competent enough to be on BOD. This is a

very heavy job.

4.2.2.2 Rights protection and appointment of committees. On this point, the majority of

respondents said that they do not have established governance committees and more than

half stated that they are handling the issues of governance via risk and audit committees.

The rest asserted that such issues are handled through the Board of Directors. As an

example, one of the respondents stated that:

No, and I don’t think it’s necessary to create such a [governance] committee if you have the right

structure. We have the audit and the risk management committees working independently, so

why create yet another committee? By doing so we are creating an unnecessary layer, while it is

the responsibility of the regulator. The Boardmembers are too busy because they are members of

so many companies. I don’t think this is going to be practical.

Only one of the banks in our sample had an established governance committee responsible

for channeling of all governance matters to the Board of Directors.

4.2.3 Discipline. 4.2.3.1 Good governance. The part of the investigation about corporate

governance standards revealed that all of the banks in the sample are complying with IFRS

and BASEL II standards. The reason behind this compliance is that central banks have

made it compulsory for all banks to do so. A good number of banks comply with IFSB and

AAOIFI Standards in order to ensure compliance with Shariah requirements, whereas only

three banks declared their compliance with all the four of them; namely OECD, IFRS and

BASELII, AAOIFI and IFSB.

4.2.3.2 Compliance. Almost all of the respondents named the existence of Shariah

Supervisory Board within the corporate governance framework as the key differentiator

between the structures of corporate governance in conventional banks and those of Islamic

banks. The majority stated that the current Islamic corporate governance is structured in

parallel to conventional ones with some slight differences. The following quotation from one

of the interviewees illustrates the idea:

The only difference is the existence of the Shariah Supervisory Board (SSB) to ensure that all

products and activities are fully compliant with Islamic Shariah rules.

Only five out of the respondents have named the position of the investment account holders,

whether restricted or unrestricted, as another difference in corporate governance in

conventional banks as compared to those of Islamic banks, besides the existence of SSB.

Accountability. 4.2.4.1 Query and assess. The majority of respondents expressed negative

views regarding the right of UIAHs to query and assess the actions of the Board and its

committees, mainly based on the premise that they are not shareholders. If they are not

shareholders they are not entitled to be present at the annual general meetings. Moreover, it

also was affirmed that there are financial or non-financial performance measures available to

UIAHs investors, which would enable them to assess the business of the bank. Such

measures are available through annual audited financial reports. One of the few

VOL. 13 NO. 1 2013 jCORPORATE GOVERNANCEj PAGE 49

respondents who acknowledged the right of UIAH to question the management and

escalate the complaints to the central bank in the event of unsatisfactory resolution, said:

UIAH may raise any queries to the management, and grievances can also be forwarded to the

Central Bank in the event of unsatisfactory resolution.

Balancing between return and risk and conflict of interest. Through this particular category

we were trying to understand if Islamic financial institutions are aware of the rising conflict of

interest between depositors and shareholders; and how this issue is being tackled. Only four

of our respondents acknowledged that a conflict of interest does exist between the Islamic

financial institution and the UIAHs due to the nature of the agreement governing the

relationship. For instance, an interviewee said:

There is kind of conflict of interest, as a matter of fact there is partnership relation with depositors

(...) investment account holders are not liabilities and neither are they fully recognized as equity,

they are hanging in-between.

On the other hand, the majority of respondents claimed that there are different interests

between UIAHs, who seek a low-risk investment with steady returns and shareholders, who

prefer a more aggressive and robust investment strategy offering higher returns with more

risk. According to such respondents, this does not have to be seen as a conflict of interest,

but rather as a difference in investment strategies. A respondent said:

Both investment account holders and shareholders seek maximum profit. Through well outlined

strategic programs and better executive management, legitimate interest and rights of both

parties could be fairly maintained.

Objectivity and independence. The interviews revealed that only three in our sample of

banks employ a range of mechanisms to ensure objectivity and independence of decisions

making in relation to the investments of UIAHs. The majority of the respondent banks used

general statements such ‘‘the adequate protection of the UIAHs investments’’ or ‘‘the

disclosure of relevant and material information to the UIAHs’’ without any specific

mechanisms to back them up. Four banks ensure objectivity and independence by forming

an investment committee for collective decision making. The rest of the banks follow different

approaches, namely credit committees, risk committees or the one pool approach.

Interestingly, one of our respondents stated that his/her central bank has a significant role in

protecting the funds of UIAHs by restricting Islamic banks to investing the funds of UIAHs in

the safest possible ways, but in doing so the central bank is assuming the same role as in

conventional banking. This respondent stated:

The central bank puts high restrictions on dealing with UIAHs funds. Thus, we have to go with very

low risks in investing their funds (such as giving loans and making placements with other banks)

and this is the way of conventional banking.

Agency responsibility. Nearly all of the respondents confirmed that the management of the

Islamic banks are completely conscious of their agency responsibility. However, one of the

respondents made an interesting comment regarding the type of awareness, as being

based more on theoretical knowledge rather than on actual practical experience:

They do understand this responsibility and looking it from a theory angle all Board members and

the senior management have been given enormous training in Shariah principles and in their

roles and responsibilities towards shareholders, investment account holders or other depositors

(...) Most of the senior management and Board members understand the responsibility but most

of them have a theoretical rather than a practical knowledge of these issues.

Responsible behavior. The findings reveal that the majority of respondents do not recognise

the right of UIAHs to monitor the performance of their investments. It was stated by several

that UIAHs are not in a position to impose monitoring procedures on the management since

they willingly entered into unrestricted Mudharabah agreements with the bank. However,

some respondents did state that UIAHs do have the right to monitor the performance of their

PAGE 50 jCORPORATE GOVERNANCEj VOL. 13 NO. 1 2013

funds because this is an issue of ownership of funds. Even though such mechanisms for

monitoring performance do not exist in most banks, one respondent thought it would be

harmless to grant them this right:

Currently we don’t have such a mechanism within the bank. (. . .) But it is a suggestion to be

considered for the future and there is no harm in providing them with whatever information is

needed.

Other respondents acknowledged the right of UIAHs to monitor funds, but limiting such right

to the available information through periodic audited financial statements.

5. Conclusions

Despite its rapid growth, Islamic finance as an industry is still in its infancy stage. This is

clearly reflected in our results. IFIs are still trapped in an international financial system that is

mainly tailored to supporting conventional financial institutions. Looking at Islamic financial

products and services, we can easily say they are replicas of their conventional versions, but

with some changes, so as to make them Islamically acceptable.

5.1 Corporate governance principles

Regarding the corporate governance principles identified in the research model in Figure 2,

we can draw the following conclusions:

B One of the most important objectives of CG is to ensure ‘‘fairness’’ to all stakeholders. This

is also true for Islamic finance, where the notion of fairness is envisioned and deeply

inscribed in Shariah rules and principles. However, in our research it was demonstrated

that IFIs are lacking in the fairness principle, in their relationship with UIAHs. They are not

recognising the right of UIAHs to be treated as equity holders. On the other hand, our

research has revealed that although the managements of IFIs are fully aware of their

agency’s responsibility toward UIAHs in managing their funds, their behaviour in practice

is not ‘‘responsible’’ enough in acknowledging the rights of UIAHs.

B According to good CG practices, IFIs should ensure ‘‘accountability’’ toward both

shareholders and stakeholders through all the tools and mechanisms to at their disposal.

Our results reveal that although the rights of UIAHs to monitor funds are already being

protected by the central banks of some Gulf countries (for example in Bahrain) we have

found that the managements of IFIs are biased in their accountability towards equity

holders to the detriment of UIAHs. Moreover, the means that are being deployed to avoid

conflicts of interest are not effective enough. The literature on the topic clearly indicates

that conflicts of interest exist between equity holders and UIAHs. This makes

‘‘independence’’ in decision making a vital principle in the governance of IFIs. Our

findings, however, reveal that the investment strategies of IFIs are focused on the interest

of equity holders and do not properly take into account the interest of UIAHs.

B Most of the CG recommended practices highlight the importance of ‘‘transparency’’ in

presenting the true state of the institution. Our investigation demonstrates that in general,

the IFIs in our sample are transparent when it comes to the basic requirements imposed

by regulators. Similarly, IFIs have to adhere to international standards as well as to Islamic

recognised standards, in order to ensure the ‘‘discipline’’ aspect of good CG. In our

investigation we have found, however, that when it comes to acknowledging the rights of

UIAHs, discipline seems to break down.

5.2 The issues surrounding UIAHs

On the issues surrounding the UIAHs, the main topic of this paper, our conclusions are

centred on the Mudharabah contract. The agreement between UIAHs and IFIs grants the

former the role of investors, with the condition that any profits will be shared with the IFI while

any risks will be borne solely by the UIAH. In spite of such a condition, the behaviour of

management of IFIs is not in appreciation of the notion that the UIAH is an investor. Rather, it

is clear that for many IFIs that those account holders are still under the definition of

‘‘conventional depositors’’.

VOL. 13 NO. 1 2013 jCORPORATE GOVERNANCEj PAGE 51

Iqbal and Llewellyn (2002, p. 57) concur that ‘‘The Mudharabah contract seems to be

inherently characterized by agency problems’’. Such contracts are phrased in a way as to

protect the IFI and take most responsibilities regarding UIAHs off their shoulders. Thus, any

losses arising from investments and businesses under the Mudharabah contract will be

borne solely by the UIAH, unless such losses are due to the gross mismanagement of funds.

But how to prove a mismanagement of funds if the UIAHs have no right to query or assess

the management of IFI or how to prove the low performance of the investment pool if the

management is smoothing returns through profit equalisation reserves? Shariah Supervisory

Boards are more concerned with the implementation of broad Shariah principles, rather than

ensuring the eligibility of the investments underlying UIAs. On the other hand, the main terms

and principles governing Unrestricted Investment Accounts provide basic assurance to the

investor. Hence, we believe that the problem starts with the Mudharabah contract itself since

it misses out important governance aspects aimed at protecting the rights of UIAHs.

Unsurprisingly, the outcome of our investigation is that the current practices adopted by our

sample of IFIs are not effective enough in protecting the rights of UIAHs, in the light of

standard CG principles. If the same practices were geared toward conventional depositors,

their interests would be effectively protected and maximized. However, aligning UIAHs with

their conventional equivalent and treating them in the same manner is inappropriate and

even conflicts with some basic CG principles. As shown in our results, the main contributors

to the ineffectiveness of the current practices by IFIs are the lack of responsibility,

accountability, and independence in decision making which, in turn, are causing

shortcomings in the application of other principles which should govern the relationships

between the IFIs and the UIAHs.

5.3 Limitations and further research

The work reported in this paper must be considered as exploratory in nature, the sample

being too small to allow any kind of generalisation of the findings to wider populations.

However, the authors feel that they have given an important contribution to the literature on

corporate governance in Islamic finance by moving the discussion forward on this topic

through field work and analysis of empirical data. Our findings may be regarded as a pilot to

serve as the basis for further research employing a larger sample and possibly using a

quantitative methodology. Another suggestion for further research would be to carry out an

in-depth study of UIAHs, in order to find more about their motivations and especially why

they choose to stay with an IFI which does not seem to be effective enough in protecting their

rights and their investments.

6. Recommendations

Based on our findings we offer a number of recommendations which we believe would

improve the unique relationship between IFIs and UIAHs.

Given the distinctive issues concerning CG for IFIs, the establishment of dedicated

corporate governance committees with the task of monitoring and overseeing the

implementation of the governance framework, including looking after the interests of the

stakeholders, seems to be a must. Such committees would undertake the protection of the

right of UIAHs, and would guarantee their fair treatment, especially if they are non-executive

members. Another recommendation concerns the Mudharabah contract. As discussed

earlier, this agreement lacks the elements that empower UIAHs to query the management of

IFIs about the performance of their investments. Such an important piece of governance

needs to be revised and amended according to the best CG practice, of course without

violating the underlying Shariah principles.

Islamic financial institutions are haunted by the fear of displaced commercial risks caused

by their depositors withdrawing their funds and investing them elsewhere. This fear forces

IFIs to adopt the practice of smoothing the returns through the establishment of profit

equalisation reserves (PER). The utilisation of PER appears to be a significant obstacle to

transparency and fairness. Therefore, it would seemwise to cease such a practice given that

PAGE 52 jCORPORATE GOVERNANCEj VOL. 13 NO. 1 2013

it misleads UIAHs about the true performance of IFIs. As a replacement, IFIs might

reimburse UIAHs with grants from the IFIs’ own returns, a practice already being

implemented by some IFIs. If the IFI opts to use PER, then it should allow the holders of

unrestricted investment accounts to redeem their contributions prior to leaving the financial

institution.

The role of regulators. We believe that regulators should play a more significant role in

protecting the right of UIAHs and in minimizing conflicts of interest. Central banks and

monitoring agencies should establish specialized laws and Islamic regulatory divisions as

well as their own Shariah Supervisory Board to look after issues mainly concerning IFIs. They

should also make Islamic CG standards issued by IFSB and AAOIFI mandatory for IFIs.

Regulatory bodies should impose a governance structure apt at protecting the rights of

UIAHs and if such a structure is implemented correctly, it might substitute the need for

representation of UIAHs on the Board. In order to mitigate the problem of conflicts of interest

between the UIAHs and equity holders, it is crucial that IFIs stop commingling the funds of

shareholders and UIAHs in the practice of one pool. Avoiding such practice would enhance

the element of transparency as well as of independence in CG.

Finally, we recommend that IFIs concentrate on the education of Directors (executives and

non executives) regarding their responsibilities toward stakeholders. The issue of successful

Islamic CG does not depend only on the governance structure but also on the competency

of the people within the structure. They should be knowledgeable enough about the nature

of Islamic finance and its products, which in turn would enhance current managerial

attitudes towards UIAHs.

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Economics, No. 9, pp. 57-82.

Archer, S., Karim, A.A.R. and Sundararajan, V. (2010), ‘‘Supervisory, regulatory, and capital adequacy

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perspectives’’, International Journal of Islamic and Middle Eastern Finance and Management, Vol. 1

No. 2, pp. 132-48.

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regulated’’, World Bank Policy Research Working Paper 3227, World Bank.

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Grais, W. and Pellegrini, M. (2006a), ‘‘Corporate governance and Shariah compliance in institutions

offering Islamic financial services’’, World Bank Policy Research Working Paper 4054, World Bank.

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World Bank.

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New York, NY.

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Sage, Newbury Park, CA.

PAGE 54 jCORPORATE GOVERNANCEj VOL. 13 NO. 1 2013

Appendix

Table AI Data collection instrument

Main CGprinciples Effective factors Interview questions

Transparency Customer awareness 14. Does the bank advise the UIAHs of their contractual rights and risksbefore opening an investment account with the bank? And does thatinclude profit distribution and allocation policies?

16. Do you think the following should be public or internal pieces ofinformation in relation to Investment Accounts? And why?

Investment accounts profit calculationAsset allocationInvestment strategiesMechanics of smoothing returns (if any)

12. Does the bank adopt the practice of ‘‘smoothing the returns’’ for theirUIAHs and shareholders by using a special type of reserves such as ‘‘Profitequalization reserve’’? Do you think this is an acceptable practice?

‘‘Smoothing the returns’’: IIFS generally put in place reserve funds with thestated objectives of providing a cushion of resources that can be used toweather adverse developments in the investment portfolio (Grais andPellegrini, 2006)‘‘Profit equalization reserve (PER)’’: PER is the amount appropriated by theIIFS out of the Mudharabah income, before allocating the Mudharib’sshare, in order to maintain a certain level of return on investment for IAHand to increase owner’s equity (IFSB, 2006)

Timely disclosure and adequateinformation

15. What kind of information you think should be disclosed to IAHs abouttheir investments? And how often?

11. If we compare between the participants in Collective InvestmentSchemes and IAHs in the process of monitoring the performance oftheir investment, what are the similarities or differences, according tothe practice of this bank?

‘‘Collective investment scheme’’: an open end collective investmentscheme that issues redeemable units and invests primarily in transferablesecurities or money market instruments. For the purposes of thesePrinciples, it excludes schemes investing in property/real estate,mortgages or venture capital (OECD, 2004)

Ease of access to information andanalysis for potential customers

13. What is the information the bank makes available to potential investorsfor them to rely their investment decisions on? And how accessible isthat information?

Fairness UIAHs empowerment 9. What is the power of UIAHs in their relationship with Islamic Banks? Forexample, ‘‘Displaced Commercial risk’’ which is the threat ofdepositor’s fund withdrawal, that drives Islamic banks to use their profitequalization reserve to smooth rates of return paid to investmentaccount holders, ensuring their competitiveness against rates paid byother Islamic and conventional banks (El-Gamal, 2005)

10. Do you think IAHs should be given the power of representation on theBOD? Please explain.

Shareholders’ and stakeholders’ rightsprotection

The BOD of each IIFS, as the ultimate internal policy-maker, shall beresponsible for steering the establishment of governance policyframework. The BOD shall set up a Governance Committee,compromising at least three members, to coordinate and integrate theimplementation of the governance policy framework by working togetherwith the management, the Audit Committee and the Shariah SupervisoryBoard; and to provide the BOD with reports and recommendations basedon its findings in the exercise of its functions (IFSB, 2006)3. Is there a Governance committee among the committees of the BOD?

If yes, what its main roles and responsibilities? And who does itconsists of?If no, who is coordinating and integrating the implementation of thegovernance policy framework in the bank?

(Continued)

VOL. 13 NO. 1 2013 jCORPORATE GOVERNANCEj PAGE 55

Table AI

Main CGprinciples Effective factors Interview questions

Discipline Adherence to good governance andinternational standards

2. What are the corporate governance standards the bank is following?For example:

OECD (Organization for Economic Co-Operation andDevelopment)BASEL II (A set of banking regulations put forth by the BaselCommittee on Bank Supervision)IFSB (The Islamic Financial Services Board)AAOIFI (The Accounting and Auditing Organization for IslamicFinancial Institutions)

Compliance with Islamic laws andregulations

Corporate Governance refers generally to the legal and organizationalframework within which, and the principles and processes by which,corporations are governed (du Plessis et al., 2005). It is a defined set ofrelationships between a company’s management, its Board of Directors,its shareholders and other stakeholders (IFSB, 2006)1. How do the corporate governance frameworks for Islamic banks differ

from the conventional banks?Accountability The existence of the mechanisms that

allow the investors to query and assessthe actions of the Board and itscommittees

7. Are there any existing mechanisms that allow the investors to queryand assess the actions of the Board and its committees?

The efficiency of management inbalancing between return and riskassociated with shareholders andstakeholders investments

UIAHs are generally seeking a low-risk investment with stable returns(employing a ‘‘defensive’’ investment strategy), whereas shareholdersmay favour a more aggressive and robust investment strategy offeringhigher returns with more risk. This may lead to a conflict of interest whenIAH funds and shareholders’ funds are commingled. (IFSB, 2006)8. What do you think of this statement? And how would the bank avoid the

conflict of interests in this case?Independence Minimize or avoid potential conflict of ‘‘already dealt with under (Accountability)’’

interest 8. What do you think of this statement? And how would the bank avoid theconflict of interests in this case?

Appointments of committees and ‘‘already dealt with under (Fairness)’’external parties. 3. Is there a Governance committee among the committees of the BOD?

If yes, what are its main roles and responsibilities? And who does itconsists of?If no, who is coordinating and integrating the implementation of thegovernance policy framework in the bank?

Mechanism which ensures the objectivityand independence of decision making

6. Which mechanism is the bank employing to ensure the objectivity andindependence of decisions making in relation to issues affecting IAHs?‘‘e.g. an internal guideline that sets out:

The eligibility of the IIFS employees who are responsible formanaging investment accounts operated by the IIFS;The adequate protection of the UIAHs investments, including thecase where the UIAHs’ funds are commingled with shareholders’funds;Thedisclosureofrelevantandmaterial informationtotheUIAHs;andA proper and disclosed basis for profit allocation and investmentpolicies to be based on the risk expectations of the IAH. (IFSB,2006)‘‘

Responsibility Agency responsibility ‘‘Agency responsibility’’: The Islamic contracts ‘‘Mudaraba’’ and‘‘Mucharaka’’ used by the Islamic banks represent an agency relation, in theone hand, between the depositors and the Islamic bank and in the otherhand,betweentheIslamicbankandthecompaniesinthecaseofMucharakacontract. It is involving a complex agency problem, the bank’s managementactsasan agent for theshareholders,while thebankasaMudaribactsasanagent for the investment account holders (Ghayad, 2008)4. Are the management of the bank and its BOD aware of their agency

responsibility? And how that affects their investments’ strategies anddecisions, in its dealing with UIAHs?

Responsible behaviour 5. Does the bank recognize the rights of IAHs to monitor the performanceof their investments?

PAGE 56 jCORPORATE GOVERNANCEj VOL. 13 NO. 1 2013

About the authors

Rodrigo Magalhaes is currently Professor of Information Systems and Organization at theKuwait-Maastricht Business School in Kuwait, where he has also held the post of AcademicDirector. KMBS is a private graduate school associated to the Maastricht School ofManagement in The Netherlands. He was formerly with the School of Management andEconomics at Catholic University of Portugal, for about 15 years. He holds a PhD(Information Systems) from The London School of Economics, an MBA from SheffieldUniversity, an MA (Information Science) from Leeds Metropolitan University, UK and a BA(Psychology) from the University of Natal, South Africa. He has published extensively in theareas of information systems management, organizational change, knowledgemanagement, organization learning, business process management, e-HRM ande-learning. Rodrigo Magalhaes is the corresponding author and can be contacted at:rodrigo@kmbs.edu.kw

Shereen Al-Saad received her Bachelor degree in Management Information Systems fromthe University of Bahrain. She has nearly ten years’ experience in various national andmultinational companies including AlAqeela Investment, EDS, Standard Chartered Bank,and Bahrain Telecom Company ‘‘Batelco’’. She recently received her MBA degree withdistinction in Strategic Management from Maastricht School of Management, TheNetherlands. She is currently in the investment field, working on restructuring andrescuing a defaulted Investment company. She has also developed an interest in theimprovement and development of Islamic finance.

VOL. 13 NO. 1 2013 jCORPORATE GOVERNANCEj PAGE 57

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