9.1 Corporate Governance in Islamic Financial Institutions
Key Takeaways
Corporate governance is the system of relationships among a company's board, management, shareholders and other stakeholders that sets objectives and holds decision-makers to account. IFIs add Shariah compliance and investment account holders to this picture.
BNM's Corporate Governance policy document (3 August 2016) requires a majority of independent directors and a non-executive chairman who has not been CEO in the past five years. It allows at most one executive director without BNM approval.
Banks and takaful operators must have board nominations, remuneration, risk management and audit committees. Each committee needs at least three directors, a majority of them independent, and the board chairman may not chair any of them.
BNM expects independent directors' tenure generally not to exceed nine years, and requires a code of ethics supported by a whistleblowing policy.
IFSB guidance highlights the governance gap for investment account holders, who bear investment risk without shareholders' voting rights, and recommends specific protections for them.
Corporate Governance in Islamic Financial Institutions
Quick Answer: Corporate governance is how a company is directed and controlled: who sets its objectives, who monitors management, and how decision-makers are held accountable. Malaysian Islamic banks and takaful operators follow BNM's Corporate Governance policy document (3 August 2016), with its independent-majority boards and four core board committees. They add Shariah governance on top (sections 9.2–9.4), and must protect stakeholders, such as investment account holders, who do not exist in conventional banks.
1. What Is Corporate Governance?
The OECD describes corporate governance as the set of relationships between a company's management, its board, its shareholders and other stakeholders, which provides the structure for setting objectives, attaining them, and monitoring performance. Good governance rests on four ideas:
- Accountability: directors and managers answer for their decisions.
- Transparency: timely, accurate disclosure.
- Fairness: equitable treatment of shareholders and stakeholders.
- Responsibility: compliance with law and regard for society.
An Islamic perspective. These ideas match Islamic principles closely:
- amanah: office and wealth are trusts;
- shura: consultation in decision-making;
- 'adl: justice to all stakeholders;
- hisbah: oversight of conduct;
- ultimate accountability to Allah.
Islamic governance thinking therefore leans towards a stakeholder model: the firm serves shareholders, depositors, investment account holders, employees, customers and society, all within Shariah.
2. Why Islamic Financial Institutions Need More Than Ordinary Governance
| Special feature | Governance consequence |
|---|---|
| Shariah compliance is part of the product | A Shariah committee and control functions are needed, and a Shariah failure is a legal, financial and reputational event (IFSA s.28) |
| Investment account holders (IAHs) | IAHs bear investment risk like shareholders but have no vote. The institution must protect them through disclosure, fair profit allocation, and reserve policies |
| Depositors under qard | Principal is guaranteed, and the bank must manage liquidity prudently |
| Takaful participants | Their risk fund belongs to them, not to shareholders, so the operator must keep funds segregated and act as a fiduciary |
| Displaced commercial risk | Management may be tempted to smooth returns at shareholders' or IAHs' expense, which needs board-level policy |
3. BNM's Corporate Governance Policy Document (2016)
BNM's Corporate Governance policy document, issued on 3 August 2016, applies to licensed banks, Islamic banks, insurers and takaful operators. Its key requirements:
3.1 Board Composition
- The board must have a majority of independent directors at all times.
- The chairman must not be an executive, and must not have served as CEO of the institution in the past five years.
- The board may have no more than one executive director, unless BNM approves otherwise.
- An independent director must not have been an executive in the past two years, or have a significant business relationship with the institution.
- BNM expects tenure limits for independent directors generally not to exceed nine years.
3.2 Board Committees
Every institution must establish:
- a board nominations committee;
- a board remuneration committee (it may be combined with the nominations committee);
- a board risk management committee; and
- a board audit committee.
Each committee must have at least three directors, with a majority of independent directors. To keep deliberations robust, the chairman of the board must not chair any board committee.
3.3 Culture, Ethics and Remuneration
- Institutions must adopt a code of ethics that promotes ethical, prudent and professional behaviour, supported by a transparent whistleblowing policy.
- Remuneration must promote a sound risk culture and prudent risk-taking.
- Boards must approve and maintain credible recovery and resolution plans for conditions of stress.
3.4 Where Shariah Governance Fits
BNM's Shariah Governance policy document (SGPD 2019) makes the board accountable for Shariah governance as part of overall governance. It requires every director to keep developing knowledge of Islamic finance, and encourages the board to appoint a Shariah committee member as a director (sections 9.2–9.3). The Shariah committee therefore works alongside the board committees: for example, Shariah audit reports go to both the audit committee and the Shariah committee.
4. Listed Islamic Banking Groups
Islamic banks owned by listed groups, such as a holding company on Bursa Malaysia, are also influenced by the Malaysian Code on Corporate Governance (MCCG 2021), issued by the Securities Commission. It promotes board independence and diversity, effective audit and risk committees, and transparent reporting, on a comply-or-explain basis.
5. International Guidance
- IFSB: IFSB-3 (2006) was the first set of Guiding Principles on Corporate Governance for institutions offering only Islamic financial services. It grouped its principles around an overall governance framework, the rights of investment account holders, Shariah compliance, and transparent reporting on investment accounts. It suggested a board-level governance committee to look after IAHs. The IFSB has since issued IFSB-30, a revised standard on corporate governance for the banking segment.
- AAOIFI: AAOIFI's governance standards cover the Shari'ah supervisory board, Shari'ah review, and an audit and governance committee for Islamic financial institutions.
6. Common Governance Weaknesses to Recognise
| Weakness | Example | Safeguard |
|---|---|---|
| Dominant CEO or executive board | Chairman and CEO roles combined | Non-executive chair; independent majority |
| Weak oversight of risk | Rapid financing growth without challenge | Board risk management committee |
| Misaligned pay | Bonuses tied only to sales volume | Remuneration committee; risk-adjusted pay |
| Ignoring IAHs | Moving bad assets into investment account pools | IAH protection policies, disclosure, fair allocation |
| Shariah treated as a formality | Products launched before Shariah sign-off | Board accountability under SGPD; Shariah committee endorsement |
The IFSB's 2026 stability report notes that governance gaps, especially in frontier markets, remain a key vulnerability for Islamic banks.
Under BNM's Corporate Governance policy document, which person would NOT be eligible to be chairman of a Malaysian Islamic bank's board?
An independent non-executive director with banking experience
A non-executive director nominated by the controlling shareholder, who has never been an employee
A former central banker who has never worked for the bank
The bank's chief executive officer, who stepped down two years ago
Why do international standards such as IFSB-3 single out investment account holders (IAHs) for governance protection?
Because IAHs bear investment risk without shareholders' voting rights, so they need specific protection
Because IAHs are guaranteed their principal by the bank and therefore appoint a majority of the board
Because IAHs are always government agencies
Because IAHs are covered by deposit insurance up to RM250,000 and therefore need no further protection
Which set of board committees must every Malaysian licensed Islamic bank establish under BNM's Corporate Governance policy document?
Shariah, marketing, IT and zakat committees
Nominations, remuneration, risk management and audit committees
Credit, treasury, branch operations and human resource committees, each chaired by the CEO
A single executive committee chaired by the board chairman
Sections you finish are checked off in the contents.