Internal Control, Risk and Sharīʿah Non-Compliant Income in Islamic Financial Institutions

ISRA International Journal of Islamic Finance, 12(3), 401-417, 2020

17 Pages Posted: 19 May 2021

See all articles by Mustafa Hanefah

Mustafa Hanefah

Universiti Sains Islam Malaysia (USIM) - Faculty of Economics and Muamalat

Muhammad Iqmal Hisham Kamaruddin

Universiti Sains Islam Malaysia (USIM)

Supiah Salleh

Supiah Salleh

Zurina Shafii

Universiti Sains Malaysia (USM)

nurazalia zakaria

affiliation not provided to SSRN

Date Written: 2020

Abstract

Purpose – The existence of internal control for Sharīʿah-compliance promotes reasonable assurance that the Islamic financial institution’s (IFI’s) objectives are achieved in the following categories, namely, the effectiveness and efficiency of operations, the reliability of financial reporting and the level of compliance with applicable laws and regulations, as well as accounting and auditing standards. Sharīʿah non-compliant income (SNCI) is an important issue in IFIs’ operations. Thus, the purpose of this paper is to identify issues related to governance and internal control of SNCI in selected IFIs in Malaysia.

Design/methodology/approach – This research uses a case study approach to gather data on the measures of governance and risk management in relation to the internal control for SNCI in IFIs. Interviews were conducted with officers of the Sharīʿah and internal audit departments on internal control practices regarding SNCI.

Findings – Regulator’s guidelines on SNCI are simple and brief, lacking rigour in terms of governance, risk management and audit procedures. The section on SNCI is only a brief statement within the Bank Negara Malaysia’s Guidelines on Financial Reporting for Islamic Banking Institutions and also in the Operational Risk Integrated Online Network system operated by IFIs. Most of the respondents in the interviews suggested that there should be a proper guideline in determining the classification of SNCI. Second, although IFIs have established the purification account to manage SNCI, the real practice varies from one IFI to another. Third, although there are supposedly documented procedures established in relation to management and administration of SNCI, the following events still occur in practice, namely, no authorisation from the Sharīʿah Committee (SC) on various types of income channelled to the SNCI account; unauthorised use of SNCI for other purposes; SNCI not being reported in the annual financial reports; and distribution of SNCI prior to obtaining the SC’s consent. Fourth, there is an absence of Sharīʿah risk assessment conducted on operational risk by IFIs to identify any potential Sharīʿah noncompliant event.

Research limitations/implications – This research contributes to the importance of Islamic corporate governance theory and Sharīʿah risk management, as well as strengthening the case for reporting SNCI to shareholders. It also contributes to the body of knowledge on the capability of the management in managing the internal control system of IFIs’ SNCI.

Originality/value – A new internal control assessment matrix is proposed for Sharīʿah-compliance in IFIs.

Keywords: Internal control, Islamic financial institutions (IFIs), Sharīʿah governance, Sharīʿah risk, Sharīʿah audit, Sharīʿah non-compliant income

Suggested Citation

Hanefah, Mustafa and Kamaruddin, Muhammad Iqmal Hisham and Salleh, Supiah and Shafii, Zurina and zakaria, nurazalia, Internal Control, Risk and Sharīʿah Non-Compliant Income in Islamic Financial Institutions (2020). ISRA International Journal of Islamic Finance, 12(3), 401-417, 2020, Available at SSRN: https://ssrn.com/abstract=3848249

Mustafa Hanefah

Universiti Sains Islam Malaysia (USIM) - Faculty of Economics and Muamalat

N.Sembilan
Malaysia

Muhammad Iqmal Hisham Kamaruddin (Contact Author)

Universiti Sains Islam Malaysia (USIM) ( email )

Bandar Baru Nilai
Nilai, 71800
Malaysia

Supiah Salleh

Supiah Salleh ( email )

Bandar Baru Nilai
Nilai, 71800
Malaysia

Zurina Shafii

Universiti Sains Malaysia (USM) ( email )

Jalan Sungai Dua
Minden, Penang 11800
Malaysia

Nurazalia Zakaria

affiliation not provided to SSRN

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