THE UNIQUENESS AND NEDD FOR ISLAMIC BANK CORPORATE GOVERNANCE REGULATION

2. THE UNIQUENESS AND NEDD FOR ISLAMIC BANK CORPORATE GOVERNANCE REGULATION

A number of preliminary research and literature conclude that Islamic banks’ corporate governance is quite different compared to conventional banks (Algaoud and Lewis, 1999;

Fatima and Pramono, 2007). As Algaoud and Lewis (1999) underline that the Islamic bank should comply with Islamic principles in running its operation. Hence, the shariah compliance in Islamic banks and the existing of the Shari’ah Supervisory Board (SSB) will lead to differences in governance mechanisms in Islamic banks.

Besides that, another unique characteristic of the Islamic bank is about its system of saving and financing activities. Since Islamic bank does not apply interest-bearing deposits, as an alternative, profit and loss sharing (PLS) investment accounts, based on mudaraba and musyaraka contracts, are available (Archer and Karim, 1997; Ariffin et. al., 2003). The depositors will get a return based on the profit/loss sharing ratio applied to the investment outcome.

In the other hand, in relation to information asymmetry, Nienhaus (2003) and Li (2003) assert that Islamic banks face adverse selection and moral hazard problems as the bank’s

operation is applying the PLS system. In this sense, Ariffin, Archer and Karim (2003) argue that Islamic bank stipulates more

transparency in disclosure its performance due to greater information required by Investment Account Holders (IAH) in monitoring their investment in PLS contracts. Also, they argue that increased transparency will also enhance market discipline in Islamic bank business environment.

Chapra and Ahmed (2002) insist that practicing PLS contracts will give a potential advantage of the Islamic bank to make an enhanced market discipline. As its risks sharing

characteristics in Islamic bank operation between the bank and the IAH, this condition will encourage prudential behaviour and higher transparency in dealing relation between the bank and the stakeholders especially the IAH.

Furthermore, some academic literatures have shed light on corporate governance issues with emphasizing on specific topic as can be summarized in Table 1 below:

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Table 1: Some Literatures on Islamic Corporate Governance Issues with Emphasizing on Specific Topic

Algaoud and Lewis (1999);

Islamic corporate

Chapra and Ahmed (2002),

governance conceptual

Nienhaus (2003); AAOIFI

framework

(2002); IFSB (2005); Hasan (2009)

Algaoud and Lewis (1999);

Shariah governance

AAOIFI (2002); IFSB (2005); Dodik (2012);

Archer and Karim (1997); AAOIFI (2002); Li (2003);

Corporate governance

Nienhaus (2003); IFSB

structure and mechanism

(2005); Dusuki (2006); Ariffin et al. (2003)

Issues on regulations and Corporate governance

Chapra and Ahmed (2002);

standards on Islamic bank regulation

AAOIFI (2002); IFSB

(2005); Abu-Tapanjaeh

corporate governance

practices

Empirical results on the Corporate governance

Pramono (2005); Fatima

and Pramono (2007); Dodik disclosure of corporate disclosure and practice

(2012); Prasojoharto (2012); governance practices in Darmadi (2013)

Islamic banks

In the other hand, it is noticeable that the landscape for financial services and banking industry has transformed considerably as a consequence changing of liberalization, deregulation,

and advanced information technology nowadays. This shifting in bank business environment caused changing in bank operations in the sense of competitive strategy, product and innovations

development and internal risk management (Boot and Marinc, 2008). According to Boot and Marinc (2008, p. 1177), banking sector is perceived as ‘highly

regulated industry’, though currently banking business environment has changed from a very rigid structure to be very diverse and dynamic, but because of the problems of financial stability,

regulation still play a crucial role in maintaining the sound financial and banking sectors in the economy.

Also, Suzuki (2011, pp. 16-18) in perceiving the process of institutional change and monitoring framework of financial institution, he admits that the regulators and their regulatory

capacities are in particularly important aspect in banking landscape. He argues that the relationship of two elements of monitoring activities, namely monitoring of project financing by the banks and supervising the bank’s business by the regulators, is the crucial element in order to create healthy banking system.

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Therefore, taking into account that banking is highly regulated industry and the potential for systemic risk. Claessens (2006) argued that Islamic banks face more risks of non-compliance and weak institutional environments of emerging markets in its banking landscape.

Therefore, specific regulation essentially required in Islamic banking operation related to the structure and mechanism of good corporate governance for Islamic bank (Algaoud and

Lewis, 1999; Chapra and Ahmed, 2002; Nienhaus, 2003; Fatima and Pramono, 2007). Nevertheless, as point out by Archer and Karim (2007, p. 333), in general central bank/

financial services authority regulates Islamic bank with the minimum concern of the specificities of Islamic bank’s operation in their regulatory and supervisory guidelines. This unfavorable condition apparently can raise the contradiction impact for the bank or the stakeholders as a

whole. Thus, this situation calls for the regulators to come up with a set of corporate governance regulation which can accommodate the unique characteristic of Islamic banks.