The Shariah Compliance Report (Part 2 of 3) 

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The Shariah Compliance Report (part 2 of 3)

Ethica sits down with Shariah department experts to identify industry best practices for Shariah compliance at the bank


(continued from the previous week)


Shariah Audit is a periodic activity. It must be designed as a formal, structured process based on standard operating procedures and programs. It should involve a review of documents which entails going over a checklist to see whether or not documents are genuine and their entries are correct. The aim of the Shariah Audit is not to penalize for mistakes but in fact to ensure mistakes are learned from and improvements made accordingly.

The Shariah Audit must also include an evaluation of the bank’s environment, customer reading material and staff dress-code to see if it all complies with the Shariah. It entails staff interviews, particularly the branch and operation manager’s to determine their knowledge and understanding of Islamic banking. It must include a check on the methods of profit distribution and assigning weightages. At a financing branch the audit must determine the degree of Shariah compliance of financing transactions. At a deposit branch the audit should focus on branch environment and staff awareness. The audit team must also visit clients to determine whether or not proper procedures are in place.

Errors if any should be presented in the Shariah Advisor’s Report. Errors must also be reported to the Product Development, Research and Shariah Compliance team which directs them to review post product approval process flows. If the Product Development team is not a part of the Shariah Department, then it is likely that the problem never may get communicated.

Once reported the error serves as a precedent to help avoid similar mistakes in the future and likewise informs other branches of the latest findings and measures to prevent them from repeating the same errors.

This is the synergy between the different teams within the department that enables the Islamic bank to function effectively as a whole — its perspective, objectives and activities directed to one goal — ensuring 100% Shariah compliance and ultimately 100% customer satisfaction.

As an industry best practice and as guideline given by top scholars in the field, it is strongly recommended that every year a Shariah Audit must be conducted for all the financing units, department or branches in a bank. Transactions within each unit must be checked via sampling. It is also recommended that a Shariah review is conducted at the time when the financing limits are renewed annually.

The Product Development and Shariah Compliance unit must also check sample transactions for each client to determine their conformity to Shariah rulings. This process of refinement exists to avoid mistakes that would otherwise show up in an audit.

Post Audit Corrective Measures

If the Shariah Audit discloses a serious error, the transaction should be stopped or put on hold and put before the Shariah Advisor and Product Development team. The transaction may be allowed to continue but only after the correction of error or with a revised process flow.

The cause of the error must be investigated to determine the appropriate course of action — was it the bank officer’s mistake? Was the financing mode prescribed inappropriate?

If the transaction is impermissible, the corresponding income should be transferred to the charity account. Disciplinary measures must be prescribed if the mistake is intentional. In case the error is the client’s, it should be investigated whether it occurred out of a lack of awareness or the client’s indifference to Shariah prescriptions.

Disclosures & Annual Shariah Report

All the major activities of the bank’s Shariah department and the results of the Shariah audit must be disclosed in the Shariah Board’s or Shariah Advisor’s report published within the bank’s Annual Report.

The Shariah Report must state the number of branches audited and the resultant findings. It should mention the amounts transferred to the charity account owed to flawed transactions and where the charity is distributed. Major errors too must be disclosed along with the actions recommended to rectify them. The Shariah Advisor should follow up on his recommendations in the subsequent year’s report.

The report must also disclose the research undertaken, the new products developed, the number of employee and client training sessions conducted. It should disclose the scope of the audit; the transactions covered. It must include an overall branch assessment and a review of how profit was distributed and the employees’ level of Islamic banking knowledge.

All these disclosures offer transparency and keep the bank’s clients and shareholders informed of the bank’s activities and the measures it takes to ensure continued Shariah-compliance.

Refer: Pages 75-79 and 83 of Meezan Bank Annual Report 2012 (Section: Report of the Board Audit Committee; Shariah Advisor's Report – 2012; Statement of Sources and Uses of Charity Fund)


As part of the industry best practice an Islamic bank must have two rating processes Shariah Audit rating and employee rating.

Shariah Audit Rating

The bank’s branches/departments/functions must be rated after Shariah Audits using an efficient rating system, like a five tier rating system (e.g. Excellent, Above Average, Good, Below Average, Poor) and the result of the Shariah audits should be linked to the annual appraisal of the branch and concerned staff.

For instance if a unit is rated “Poor” it affects its appraisal, promotions and increments and if a unit is rated “Excellent” it earns some type of reward or other performance enhancement incentive.

A unit rated “Poor” is also given extra support to bring it up-to-date with the latest training and performance improving activities.

Employee Rating

Starting from the CEO to the cashier at the front desk, ensuring Shariah-compliance is everyone’s job. And it is strongly suggested that in the employees’ annual appraisals due weightage must be given to the Shariah compliance mindset, knowledge and commitment to Shariah compliance.

Institutionalizing a penalty and reward system is a must to ensure good performance at both the branch and employee level.

To be continued...

The Shariah Compliance Report (Part 1 of 3)

© Ethica Institute of Islamic Finance

In Collaboration with Meezan Bank

Acknowledgements: Ethica Institute of Islamic Finance wishes to extend a special thanks to Ahmed Ali Siddiqui and his colleagues at Meezan Bank for generously sharing their time and expertise to make this Shariah Compliance Report possible.

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