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Financial Accounting Issues - Conventional Banks Venturing into Islamic Finance Market

Principles of Islamic Finance -Australian bank
Principles of Islamic Finance -Australian bank

The Order on Financial accounting issues looks at how conventional banks can venture into Islamic finance market. the question that this Response provides is for the question highlighted on Principles of Islamic Finance

Table of Contents

1.0. Introduction. 3

1.1. Purpose of the Report 3

Purpose. 3

Research Method. 3

2.0. Literature Review.. 3

2.1. Corporate Governance Models. 4

Stakeholder Theory. 4

The Shareholder theory. 4

2.2. Islamic Corporate Governance and the role of the Sharia Committee. 5

3.0. Discussion and Analysis. 6

3.1. Islamic Corporate Governance in Australia. 6

3.2. Islamic Finance Product in Australia. 7

4.0. Conclusion and Recommendations. 8

Conclusion. 8

Recommendations. 8

References. 10

1.0. Introduction

The Islamic finance market serves as an alternative way that business around the world can navigate, to tap into an estimated USD 2.6 trillion potential by the year 2017 (Bm & Uddin, 2016; PwC, 2013). Given the high potential of this market, companies are finding ways of transforming their ability to venture into it. Henry (2016) suggested that one way in which companies achieve this is by restructuring their corporate governance in line with the Muslim Sharia laws.

1.1. Purpose of the Report

Purpose

This outline serves the purpose of examining the possibility of conventional banks venturing into Islamic finance market. The outline presents an analysis of the existing corporate governance models that will help to determine whether the conventional financial institutions are likely to venture into the Islamic finance market and optimize their wealth by serving the Muslim population.

Research Method

[blur] This study uses the qualitative research approach. In essence, it evaluates the existing literature of models. The conclusion is drawn from the evaluation of the specific corporate models, which are congruent to the requirements of target doctrines of the Islamic banking. [/blur]

2.0. Literature Review

[blur] As the Islamic Financial Services, (2006) board notes, corporate governance is often defined in reference to the type of relationship which occurs whenever an organizations and all of its stakeholders such as the shareholders, the management and other stakeholders such as the suppliers and employee. This relationship leads to rise in objectives, which gives obligations to the different parties noting the ways in which the services should be delivered. [/blur]

2.1. Corporate Governance Models

[blur] In explaining this relationship, corporate governance gives references to various models such as the stakeholder and the shareholder theories, which are founded on reviewing how different parts of a firm interact. These aspects are also similar to institutions such as Citigroup. [/blur]

Stakeholder Theory

[blur] As early as 1995, ten years after the inception of the stakeholder theory, Donaldson & Preston were able to identify that the relationship between the firm and its stakeholders is guided by various attributes. The first aspect of the attribute would be the action of the stakeholders since they are the parties that directly interact with the organization. The second aspect would be the task the firm has to play in reference to its stakeholders needs. Other attributes which support the stakeholder theory as Laplume, Sonpar, & Litz, (2008) comment are the obligations of the firm to the stakeholders and the respective needs that require address. In other articles by individuals such as Brower & Mahajan (2013). Stakeholders are viewed to be the community, the suppliers, employees, shareholders or the owners and the customers. [/blur]

In the modern world as Bridoux & Stoelhorst (2014) comments, the stakeholder theory has gained a lot of popularity since organizations are realizing the importance of complying to the interests of all the parties just as enshrined in the stakeholder theory.

The Shareholder theory

            [blur] The Shareholder theory is also another popular theory, which firms, have often relied on to determine their obligations. The theory is guided by the premise that the role of every organization is to maximize on profits. In this quest, the business or the shareholders hire the management who act as their agent to handle all their business interest. The relationship between the parties is thus viewed as one of an employer and employee. The employee always has the obligation to undertake any decisions, which is within their mandate and within the confines of the law. Any adjustments must comply with the guidelines of one’s country. This is why the quest by an organization such as Citigroup focuses on adopting products that will serve the larger market share of Islam while still complying with the laws in the country. [/blur]

2.2. Islamic Corporate Governance and the role of the Sharia Committee

[blur] The system of Islamic corporate governance is inclined to the stakeholder theory. The stakeholder model of corporate governance owes a duty of good faith to all the parties involved in the organization. This is where both the stakeholders and shareholders are treated with caution (Abdullah & Muhammed, 2012). According to Bhatti & Bhatti (2010) the corporate governance model for Islamic business institutions is correlated to the codes that regulate individuals’ rights, the rights of the state and the laws that regulate the ownership of property. Protection of rights in the Islam Shariah is wide and accommodates both humans and non-humans. Such includes the environment, social groups and other forms of associations. According to Paino et al (2011), the corporate governance system adopted by the Islamic institutions differs with the shareholder model due to its selfish nature. The shareholder model owes a fiduciary duty to shareholders only. Some Islamic institutions have however adopted a tailored shareholder approach in their corporate governance system known as the Tawhid. Under this model, the organization treats all parties as equals. [/blur]

            [blur] The general shareholder theory focuses on protection of the rights of shareholders only contrary to Shariah which advocates for protection of every party’s rights. Islamic organizations have instituted Shariah Committees whose role is to advice Islamic banking institutions on various financial obligations (Al-Suhaibani & Naifar, 2014).  The chief function of the Shariah Committees is to ensure that all financial practices by Islamic financial institutions are performed within the Islam religion standards. The committee seeks to guarantee that all financial services and transactions adhere to Shariah law presumptions of trading. The Shariah Committee limits Islamic institutions from adopting the shareholder model due to constrain with the Shariah guidelines hence advocates for the stakeholder model (Besar et al, 2009). [/blur]

3.0. Discussion and Analysis

            3.1. Islamic Corporate Governance in Australia

[blur] The corporate governance system in Australia is based on the theory of the shareholder. The system therefore tends to advocate prioritize satisfaction of the shareholders rights. This contradicts the Islamic corporate governance model which is guided by the stakeholder theory. Under this model, the firm seeks to protect the stakeholders’ rights which have been made vulnerable by the practices of the organization. There would be difficulties in adopting for Islamic institutions operating under the Islamic corporate governance system to practice in the Australian business environment due to corporate governance structure mismatch. The present corporate governance structure in Australia is not in line with the Shariah guidelines hence limiting performance of Islamic institutions (Mollah & Zaman, 2015). [/blur]

            [blur] The main challenge of Islamic banking organization performing in the Australian corporate environment would be adherence in different corporate governance models hence making inter organizational transactions complex. There would be difficulties for Islamic financial institutions to transact with conventional banks due to difference in regulation standards. For example, the Shariah guidelines do not allow interest on loans while this is a major feature in Australian conventional banks. This would hence limit relations among Islamic and conventional banking institutions. Further, business practices such as mergers and acquisitions between Islamic and non-Islamic institutions would be hectic due a difference in corporate governance structures (Islam, Cooper & Haque, 2013). For the Islamic financial and business institutions to effective operate in Australia, there needs specific modifications in the current corporate governance structure. A tailored shareholder model such as the Tawhid model would allow Islamic institutions to operate in the Australian corporate environment (Mollah & Zaman, 2015). [/blur]

3.2. Islamic Finance Product in Australia

            Despite the challenges that arise from the nature of the shariah laws and the Muslim doctrines as Soltani &Maupetit (2015) comments, which are viewed to be strict, there are still opportunities that Citigroup focus on. Prior to taking advantage of those opportunities, Citigroup will have to restructure its internal systems to accommodate the Islamic banking and corporate governance doctrines. Some of the products they will have to develop are the confirmation of the letters of credit by allowing the bank to incorporate Kafal, which will be in reference to the debtors and in situations where chattels are involved (Mollah & Zaman, 2015). [/blur]

            [blur] The second category of product would be in the restructuring of the interaction between the conventional banks and the Islamic institutions. This may mean creating a platform where the banks might facilitate customers to take interest free loans, which are without Riba. In reference to the interaction, there also needs to the creation of a platform where products such as commodity based dealings and discounted bills are facilitated to allow a Muslim customer to interact with other individuals who may be relying on the conventional banking system (Hasan, 2009). So far MCCA Islamic Finance and Investment has managed to adopt these practices in their products, allowing them to gain market entry and develop a similar product portfolio to their customers (MCCA Islamic Finance and Investment, 2016). [/blur]

4.0. Conclusion and Recommendations

Conclusion

[blur] This study successfully analyzed the likelihood of Institutions that offer Islamic finance service to perform in the current Australian market under existing corporate governance structure. The study revealed that while the Islamic Financial Services institutions function under shareholder’s model guidelines, the conventional firms in Australia stick to the shareholders’ corporate governance model. This indicates that there exist incompatibility between the Islamic Financial Institutions and the existing corporate governance framework in Australia. The regulators of the Islamic business oversee the way in which Islamic financial Institutions functions under existing Australian corporate governance framework. The regulators test the compliance of the Islamic financial institutions to the existing Islamic religious teaching and practices. Some of these regulators include the Sharia Committee that may not permit any Islamic financial Institution to function in a business environment that is characterized by shareholder-oriented corporate governance. The research shows that Citigroup may still concentrate on tapping into the Islamic market by restructuring and possibly using the model that would factor in the Islamic principles of operations. [/blur]

Recommendations

[blur] For a financial institution to fully comply with existing fundamental elements of Sharia Laws, some recommendations need to be adopted. First of, it is essential to create completely autonomous banking sectors with a full funds segregation. This would realign the business with the market needs and make its activities unique. Secondly, there should be an adoption of the Sharia Supervisory Committee or Board that offer legal advice given the sharia law. These two recommendations would ensure that Islamic banking complies with the standards given by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). [/blur]

Other recommendations that ought to be considered include making sure that the there is a commitment from the management to safeguard the set Muslim investors’ funds. Managerial commitment is paramount as it will ensure laws and regulations are observed to the letter (because this is partly the component of sharia law) while safeguarding the funds of the investor to prevent any circumstance that can perpetuate fraud. This may exist in the form of such stipulations as mudarib.

References

Abdullah Saif Alnasser, S., & Muhammed, J. (2012). Introduction to corporate governance from Islamic perspective. Humanomics, 28(3), 220-231.

Al-Suhaibani, M., & Naifar, N. (2014). Islamic Corporate Governance: Risk-Sharing and Islamic Preferred Shares. Journal of Business Ethics, 124(4), 623-632.

Besar, M. H. A., Sukor, M. E. A., Muthalib, N. A., & Gunawa, A. Y. (2009). The practice of Shariah review as undertaken by Islamic banking sector in Malaysia. International Review of Business Research Papers, 5(1), 294-306.

Bhatti, M., & Bhatti, M. I. (2010). Toward understanding Islamic corporate governance issues in Islamic finance. Asian Politics & Policy, 2(1), 25-38.

Bm, H., & Uddin, M. A. (2016). Does Islamic bank financing lead to economic growth: An empirical analysis for Malaysia.

Bridoux, F., & Stoelhorst, J. W. (2014). Microfoundations for stakeholder theory: Managing stakeholders with heterogeneous motives. Strategic Management Journal, 35(1), 107-125.

Brower, J., & Mahajan, V. (2013). Driven to be good: A stakeholder theory perspective on the drivers of corporate social performance. Journal of business ethics, 117(2), 313-331.

Donaldson, T., & Preston, L. E. (1995). The stakeholder theory of the corporation: Concepts, evidence, and implications. Academy of management Review, 20(1), 65-91.

Hasan, Z. (2009). Corporate governance: Western and Islamic perspectives. International Review of Business Research Papers, 5(1), 277-293.

Henry, C. M. (2016). Islamic Finance in Movement.

Islam, M. A., Cooper, B., & Haque, S. (2013). The corporate governance environment and anti-bribery disclosure: evidence from Australia. In Accounting and Finance Association of Australia and New Zealand (AFAANZ) Conference, July.

MCCA Islamic Finance and Investment (2016). How We Invest. Retrieved from http://www.mcca.com.au/super-how-we-invest

Mollah, S., & Zaman, M. (2015). Shari’ah supervision, corporate governance and performance: Conventional vs. Islamic banks. Journal of Banking & Finance, 58, 418-435.

Mollah, S., & Zaman, M. (2015). Shari’ah supervision, corporate governance and performance: Conventional vs. Islamic banks. Journal of Banking & Finance, 58, 418-435.

Paino, H., Bahari, A. B., & Bakar, R. A. (2011). Shariah, social responsibilities and corporate governance of the Islamic banks in Malaysia. European Journal of Social Sciences, 23(3), 382-391.

PwC. (2013). Islamic finance: Creating value. London: PricewaterhouseCoopers International Limited.

Soltani, B., &Maupetit, C. (2015).Importance of core values of ethics, integrity and accountability in the European corporate governance codes.Journal of Management & Governance,19(2), 259-284. 

Financial Accounting Issues - Conventional Banks Venturing into Islamic Finance Market

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