Does Shari'ah Compliance a Matter for Financial Performance? A Study on Islamic Banks of Bangladesh

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1. Book Chapter Does Shari ’ah Compliance a Matter for Financial Performance? A Study on Islamic Banks of Bangladesh Mr. Md. Harunur Rashid Lecturer, International Islamic University Chittagong Bangladesh Dr. Md Hafij Ullah Lecturer in Accounting, Coventry University, United Kingdom Mr. Faruk Bhuiyan Assistant Professor, International Islamic University Chittagong Bangladesh How to Cite this Chapter: Rashid, M. H., Ullah, M. H., and Bhuiyan, F., (2019), Does Shari’ah Compliance a Matter for Financial Performance? A Study on Islamic Banks of Bangladesh, in Handbook of Research on Theory and Practice of Global Islamic Finance, IGI Global, USA. 1
2. Does Shari ’ah Compliance a Matter for Financial Performance? A Study on Islamic Banks of Bangladesh ABSTRACT Islamic banks have to comply with the Shari’ah rulings fully as it is the foundation of Islamic banks. However, the level of Shari’ah compliance is not the same among the Islamic banks. Similarly, despite performing well, the financial performances of Islamic banks differ from each other. Therefore, the study aims to explore the association between financial performance and Shari’ah compliance. The chapter used both the primary and secondary data. The primary data were collected through surveying 300 bank executives from six full-fledged Islamic banks operated in Bangladesh with a structured questionnaire on Shari’ah compliance, whereas information on financial performance were extracted from the annual reports of the sample banks. Descriptive statistics along with regression analysis were used to analyze the data and conclude the findings. The findings show that Shari’ah compliance has a positive and significant impact on the financial performance with respect to the total liabilities and total assets. The study concludes that higher the level of Shari’ah compliance better financial performance. Along with other factors, the Shari’ah board, Shari’ah review, and Audit and governance committee have a significant impact on the financial performance of Islamic banks. a. Keywords- Shari’ah compliance, Financial performance, Islamic banks, and Bangladesh. b. JEL Classification Codes: G21, L25 c. KAUJIE Classification Codes: J32, L2 1. INTRODUCTION This paper is the response to the call of Ullah and Khanam (2018) for a quantitative analysis exploring the relationship between financial performance and Shari`ah compliance efficiency of the Islamic banks. The study of Ullah and Khanam (2018), based on interviews, proved that Shari’ah compliance is the fundamental instinct for the financial performance of the Islamic banks in Bangladesh where financial performance and Shari’ah compliance of the Islamic banks differ significantly. Among others, Shari’ah compliance is the most important factor for influencing the financial performance of the Islamic banks, and Shari’ah compliance is impacted due to lack of government rules, lack of Shari’ah knowledge of the employees, lack of proper Shari’ah board, and lack of sufficient research and development (Ahmad & Haron, 2002; Archer & Karim, 2002; Metawa & Almossawi, 1998; Naser et al., 1999; Rashid et al., 2009). The word ‘Shari’ah’ has been derived from the Arabic word ‘Shari’ah meaning ‘divine law,’ ‘Islamic law,’ or the ‘Law of God.' There are four sources of Islamic Shari’ah: (a) interpretations of the Qur’an, that is, the guidance provided by God to humanity through the last messenger Muhammad (pbuh); (b) 2
3. interpretations of the Hadith , that is, the sayings and lifestyle of the Prophet; (c) Ijma, agreement amongst Muslim scholars or jurists or collective reasoning; and (d) Qiyas/Ijtihad, that is, the individual reasoning (Ullah, 2014, p. 184). Islam is a complete code of life (Al-Qur’an, 5:3) since Allah (SWT) and Allah’s messenger Prophet Mohammad (SAW) gave guidelines regarding every aspect of human life to be dealt with (Ather & Ullah 2009). Therefore, Muslims are required to follow Islamic guidelines while dealing with banking transactions. Shari’ah as the foundation of all types of Islamic banks and Islamic organizations because no bank or organization can be considered as ‘Islamic’ without following the Shari’ah (Ullah, 2014). The verse of the Holy Qur’an “But Allah (SWT) has permitted trade and has forbidden interest” (AlQur’an, 2:275) is the main principle of accepting Shari’ah laws in the banking business. In addition, Islamic banks are not to involve in Gharar (excessive risky projects), Maisir (projects of which outcome depend on luck or chance), Haram (Islamically prohibited) or harmful products like tobacco, alcohol, short-selling, pornography (Ullah, et al., 2018). This Shari’ah law introduces the Halal ways of doing business which eliminates all kinds of injustice from the financial system ensuring socio-economic development (Imam & Kpodar, 2010; Jalil & Rahman, 2010; Rahman, 2007; Ullah, 2014). Since the growing rate of Islamic banking is about 20%-30% per annum which is almost three times than conventional banks during the last decade (Srairi, 2015), Kabir Hassan et al. (2010) mentioned that the Islamic financial market has become the fastest-growing part of the overall financial system (Farooq, 2014). Since the demand for Shari’ah-compliant products and services among customers are increasing; the number of Islamic banks is proliferating compared to the conventional one (Benaissa et al., 2005). However, despite the consumers' adoption of Islamic banks due to Shari’ah compliance, the main objective of Islamic bank owners as well as the depositors is to earn greater profit through attaining a higher return on investment. For this purpose, based on profit and loss share (PLS), the owners and depositors invest their capital to their banks which would ultimately benefit them through the better financial performance (Masood & Ashraf, 2012). Islamic banking in Bangladesh has been started through the establishment of Islami Bank Bangladesh Limited in 1983. As Bangladesh is the Muslim majority country and people of the country is highly interested in Islamic banking, following the footsteps of Islami Bank Bangladesh Limited, other Islamic banks and traditional banks have been practicing Shari’ah based banking through Islamic banking branches and windows (Hassan et al., 2017). The other Islamic banks operating in Bangladesh are ICB Islamic Bank Limited (1987), Al-Arafah Islami Bank Limited (1995); Social Islami Bank Limited (1995); Shahjalal Islami Bank Limited (2001); Export-Import Bank of Bangladesh Limited (1999); and First Security Islami Bank Limited (1999) and Union Bank Limited (March 7, 2013) (Kabir et al., 2012). As mentioned, eight conventional banks have 19 Islamic banking branches, and seven traditional banks 3
4. have 25 Islamic banking windows (Hassan et al., 2017). For effective Shari’ah governance, improvements and more supports to individual Shari’ah Supervisory Board of each Islamic bank, Central Shari`ah Board for Islamic Banks of Bangladesh was established in 2002. Ullah and Khanam (2018) mentioned that the level of Shari’ah compliance of Islamic banks differs from their financial performance. The level of Shari’ah compliance among Islamic banks is not similar; even though they are operating their activities within the same regulatory environment (Ullah, 2014). According to Shari`ah compliance score of the four sample banks of Bangladesh are Islami Bank Bangladesh Limited, Al-Arafah Islami Bank Limited, Export-Import Bank of Bangladesh Limited, and then Shahjalal Islami Bank Limited (Ullah, 2014). Similarly, the financial performance of all banks differs from each other (Chowdhury & Ahmed, 2009; Ullah & Khanam, 2018). Therefore, the question arises whether the level of Shari`ah compliance affects the financial performance of the Islamic banks in Bangladesh (Abduh & Idrees, 2013; Hassan & Bashir, 2003; Masood & Ashraf, 2012). Therefore, this study has been conducted to examine the relationship between Shari’ah compliance and financial performance of Islamic banks. Besides, the study examines whether the Shari’ah compliance has impacts on the financial performance of the Islamic banks. Moreover, the study tries to develop the existing literature in the following ways. First, surveying primary data, the study demonstrates the overall Shari’ah compliance scenario of the sample banks of Bangladesh empirically. Second, using the data relating to financial performance, the paper explores the financial positions of the banks. Third, the study runs regression to examine the impact of Shari’ah compliance on the financial performance of the Islamic banks. Finally, the study explores a comparative analysis among the Islamic banks to show whether the Shari’ah compliance a matter for financial performance. 2. LITERATURE REVIEW a. Importance of Shari’ah in Islamic Banks Since Islamic banking has been performing well, achieving significant growth compared to the traditional banks, and contributing to the country’s economy, the present study aimed at investigating the impact of Shari’ah compliance on financial performance of Islamic banks on the basis of previous studies on Bangladesh (Ullah & Khanam, 2018), Malaysia (Ahmad & Ahmad, 2004; Idris et al., 2011), Indonesia (Asutay & Izhar, 2007), MENA countries including Bahrain, Saudi Arabia, Egypt and Sudan (Al-Jarrah & Molyneuxa, 2003; Farooq & Alahkam, 2016). Islamic banks perform operations according to the guidelines of Shari’ah which are considered as the foundation for guiding all operations (Ahmad, 2000; Akbar et al., 2012; Khan & Mirakhor, 1986; Siddiqi, 1983; Siddiqui, 2001). Shari’ah compliance is considered as the single most important factor to introduce products of the banks by ensuring the trustworthiness of the banks and increasing the 4
5. confidence of the bank owners and other stakeholders (Ahmad & Haron, 2002; Archer & Karim, 2002; Ghayad, 2008; Laldin, 2008; Naser et al., 1999; Rammal, 2006; Rashid et al., 2009; Tomkins & Karim, 1987). Besides, the studies of Imam and Kpodar (2010), Jalil and Rahman (2010) and Rahman (2007) noted that the removal of all types of injustice and malice caused by Riba (interest) is possible by developing Islamic financial system, that is, complying with Shari`ah tenets in banking operations. In addition, Dawood (2008) emphasized initiating more and more Shari’ah compliant businesses for meeting the growing demands of Muslims for Islamic products and services. Furthermore, Shari’ah compliance is also an urgent necessity for businesses to purify their incomes and expenses. b. Shari’ah compliance scenario Though Shari`ah compliance is the basic foundation of Islamic banks, many literatures including Asutay and Harningtyas (2015), Beck et al., (2013), Malik et al. (2011), Khan, (2010), Meera and Larbani (2009) observed and questioned on the Shari`ah compliance status of Islamic banks. More specifically, Khan, (2010) titled a paper on “How ‘Islamic’ is Islamic banking?” and Malik et al. (2011) on “Controversies that make Islamic banking controversial." Ullah (2014) proved that Islamic banks in Bangladesh also violate Shari`ah and the most Shari`ah non-compliance area is investment activities. Other studies including Malik et al. (2011) and Khan (2010) and also found that there is significant divergence between the Islamic Shari`ah principles and the actual practices of the Islamic banks. Moreover, Islamic banks copy the products and services from conventional banks without substantial Shari`ah compliance (Beck et al., 2013; Meera & Larbani, 2009) and, therefore, the products of the Islamic banks remain similar to interest-based conventional products which violate Shari`ah principles. As per the survey of Islamic financial Services Board, Shari’ah compliance rate of Islamic banks in Malaysia is 40% and both in UAE and Bangladesh is only 20% (Alhabshi & Bakar, 2008). Moreover, Ullah (2014) observed that Shari’ah compliance in a vulnerable condition in the Islamic banks of Bangladesh which indicates that context of Islamic banks influences Shari`ah compliance as well. Based on context, Bitar et al. (2017) and Mohamad et al. (2016) found that Islamic banks comply with Shari`ah more than their counterparts in politically democratic states with the fair public interest. Other interesting findings depicted by Jaballah et al. (2018) that Shari`ah compliance positively impacts on companies' performance in the Islamic countries and negatively impact in the USA because of being a non-Muslim country having a negative perception about Islam. Despite having many benefits, all of the Islamic banks are not in a position of complying with the Shari’ah completely. Actually, the Maqasid of Shari`ah is to create and provide welfare banking services to society, but because of various weaknesses (mostly unavoidable), Islamic banks fail to achieve the Maqasid of Shari`ah (Asutay & Harningtyas, 2015). As Islamic banks are required to operate in the conventional economic and regulatory conditions, among others, “government rules and regulations, Bangladesh Bank’s rules and regulations and interest-based economy of Bangladesh are 5
6. impediments to Shari ’ah compliance by the Islamic banks in Bangladesh” (Ullah, 2014, p. 188). Among others, poor devotion of Shari’ah audit and review committee, weak Shari’ah regulatory board and lack of Shari’ah research are responsible for weak Shari’ah compliance (Ullah, 2014). Iqbal and Molyneux (2016) argued that lack of similarity of the Islamic principles among the Muslim countries and lack of a worldwide well-accepted Islamic regulatory body, the Islamic banks independently establish Shari’ah Supervisory Board (SSB) who follow different ways to recognize new products. Therefore, the explanation of Shari’ah regarding a new product varies among the different school of scholars, that is, a financial instrument accepted by one school is rejected by another. Also, the Shari’ah scholars and authority of the Islamic banks are divergent in achieving the institutional objectives, which creates incongruence in Shari’ah compliance (Ullah et al., 2018). Besides, both the practitioners and academicians observed that most of the Islamic products are theoretically under profit and loss sharing, but they resemble very much to the products of the conventional banks (Chong & Liu, 2009; Meera & Larbani, 2009). Islamic banking literature also focused on the role of SSB as a dominant factor influencing the level of Shari`ah compliance. For example, Hassan and Fahmi (2012) showed that the Shari’ah reviews are not implemented by the SSB appropriately and Haridan et al. (2018) expressed concern regarding the level of proficiency of the SSB members on modern technologies and conventional finance and banking. On the other hand, Hassan et al. (2017) and Mollah and Zaman (2015) stated that Shari`ah compliance of the Islamic banks depends on the role of SSB whether they are performing the supervisory or advisory role. They argued that the advisory role of SSB deteriorates the Shari`ah compliance status of the Islamic banks. Moreover, Ahmed and Khatun (2013) found that the level of compliance with the standards of appointment also influences the Shari`ah compliance. Grais and Pellegrini (2006) and Malik et al. (2011) also observed that Islamic banks have been facing the crises of the qualified professional jurists and financial experts to resolve the Shari’ah compatible challenges faced by the banks. However, Ullah, et al. (2018) found that Islamic banking authority and SSB are trying hard for upkeeping the Shari`ah compliance of the Islamic banks throughout the globe, but the constraint is that SSB and bank authority cannot control everything. c. Financial performance and Shari`ah Compliance A thorough literature review of Hassan and Aliyu (2018) stated that, among others, recent researches on Islamic finance and banking focus on Shari`ah compliance and financial performance. With the growth of the Islamic financial market, Narayan and Phan (2017) counted a dozen of mixed evidence of performance measurement of Islamic banking from several perspectives. Studying the financial characteristics of both Islamic and conventional banks of 124 countries, Bitar et al. (2017) found the 6
7. Islamic banks invest more capital , keep greater liquidity and achieve more profit with unstable earnings than conventional banks. The researchers also measured the financial performance of Islamic banks with specific determinants including different ratios such as return on assets (ROA), return on equity (ROE), assets quality, liquidity, operating efficiency, and gearing ratio, asset size, asset management, capital adequacy, and macro determinants included economic growth rate and inflation (Hadriche, 2015; Masood & Ashraf, 2012). The study of Farooq and Alahkam (2016), Masood and Ashraf (2012) and Idris et al. (2011) identified that the more the size and efficiency of the management the greater the profitability of the Islamic banks. Meslier et al. (2017) the market power of Islamic banks influence and improve financial stability and Shari`ah compliance. Some other contemporary studies also found similar findings. For example, Hussien et al. (2019) found that the financial performance of Islamic banks operating in GCC was significantly impacted by bank size, capital adequacy, inflation rate, credit risk, financial risk, and liquidity. Similarly, Samail et al. (2018) found a significant relationship between asset quality and liquidity management towards the performance of Islamic Banking in Malaysia. In addition, in terms of the question of whether the Shari’ah compliance leads the banks to the better financial performance, Ullah and Khanam (2018) found that 75 percent of respondents consider that the Shari’ah compliance is the crucial factor for earning a more financial profit of the Islamic banks in Bangladesh. Since, among different factors, Shari’ah compliance is considered as the dominant one, which influences the banks’ financial performance, this study examined the impact of Shari’ah compliance on financial performance. Ullah and Khanam (2018) showed that superior Shari’ah compliance is playing the dominant role to keep the bank in the leading position. Finally, their study concluded that the bank follows higher Shari’ah compliance makes better financial performance. Pepis and Jong (2019) found that Shari`ah compliance positively affects the long term financial performance of Islamic banks. Hence the more the Islamic banks comply with Shari’ah, the higher the banks achieve growth (Ahmed & Khatun, 2013). On the other hand, there is an adverse effect on the profitability of non- Shari’ah compliant banks because of donating their unlawful income (Kasim, 2012). The adverse findings provided by Ashraf and Khawaja (2016) who proved that Shari`ah screening standards are insignificant in their effect on financial performance and hence they argued for increasing the consistency in implementing the approaches of Shari`ah evaluation. From the above discussion, it is evident that Shari’ah compliance is the single most important factor that influences the financial performance of Islamic banks; however, Islamic banks do not comply with the Shari’ah guidelines completely (Ullah & Khanam, 2018; Ullah, 2014 ). It seems to be a dilemma, does Shari`ah actually impact on the financial performance of the Islamic banks in Bangladesh. To deal with the paradoxical situation, it is essential to examine the impact of Shari’ah compliance on financial performance. Though Ullah and Khanam (2018) studied this based on interview data, a very limited quantitative study has been conducted on this issue. Thus, this study examines the impact of Shari’ah 7
8. compliance on the financial performance of the Islamic banks in Bangladesh following the methods stated below . 3. METHODS a. Sampling and data collection procedures The study conducted a mail survey with a structured questionnaire on 450 mid to high-level employees, who were selected purposively, across six (75%) out of a total of eight full-fledged Islamic banks operated in Bangladesh in order to get responses on the Shari’ah compliance aspects. A total of 300 respondents (66.67%) provided their feedback (see Table 1). In addition, the study gathered secondary data on the determinants of financial performance from banks' annual reports for the period of the last four years from 2014 to 2017". Table 1: The list of respondents. SL. Respondents Respondents Surveyed Replied Name of Bank 1. Islami Bank Bangladesh Limited (IBBL) 150 92 2. Al-Arafah Islami Bank Limited (AIBL), 75 39 3. Export-Import Bank of Bangladesh Limited (EXIM) 75 65 4. Shahjalal Islami Bank Limited (SJIBL) 50 23 5. Social Islami Bank Limited (SIBL) 50 31 6. First Security Islami Bank Limited (FSIBL) 50 50 450 300 (100%) (66.67%) Total = b. Measurements of variable In respect to the Shari’ah compliance, a fifteen-item measure (see Appendix for all items) relating to the supervisory board (four items), Shari’ah review (7 items) and audit and governance committee (4 items) was developed based on a review of the literature (Alim, 2014; Maali et al., 2006; Ullah, 2014). The respondents were provided a structured questionnaire in the form of 6 point-Likert scales which ranges from 0 (not occurred) to 5 (very highly occurred) (Likert, 1972). The Cronbach Alpha scores of the three measures of Shari’ah compliance were between 0.741 to 0.772: supervisory board 0.772, Shari’ah review 0.772 and Audit and Government 0.741, and hence met the minimum cut off of 0.70 (Nunnally and Bernstein, 1994). Accordingly, the study used the average values of the items of each measure to determine the extent to which each bank was compliant with Shari’ah. 8
9. Financial performance was measured in terms of 3 indicators : operating income to total asset ratio, operating expense to total asset ratio, and total liabilities and total assets ratio taken from a review of the literature (Abduh & Idrees, 2013; Masood & Ashraf, 2012) (see Table 2). 9
10. Table 2 : Financial performance measures. Variable Measure Notation Management Operating efficiency Operating income/total assets OITA Operating expense/total assets OETA Total liabilities/total assets TLA Financial Risk c. Data analysis tools The collected data were analyzed in two steps. First, the data were analyzed with descriptive statistics, including mean and Standard Deviation (SD). Secondly, the regression models were run in between the Shari’ah compliance and the three different indicators of financial performance to find out whether Shari’ah compliances have an impact on the financial performance of the banks. 4. RESULTS AND DISCUSSION a. Descriptive statistics The descriptive statistics are shown in Table 2 with mean scores and SD. The study used three constructs relating to Shari’ah compliance issues to explore at which level the banks were complying with Shari’ah regulations. In respect to the audit and governance committee, IBBL secured the highest mean score 5.72, while the mean scores of EXIM, SIBL, AIBL, and FSIBL were 5.50, 5.44, 5.39 and 5.00 respectively. However, SJIBL scored 2.77 only. The scores indicate that all banks except SJIBL had a high level1 of Shari’ah compliance with respect to the audit and governance committee (see Table 2). In regard to the supervisory board, all banks were highly compliant, while SJIB had a medium level of compliance. Banks had a high level of compliance with respect to the Shari’ah review. In respect to the overall scores, it showed that all the sampled banks had a high level of Shari’ah compliance. 1 Mean score less than 3 considered as low, 3-4 as medium and above 4 as high 10
11. Table 2 : Descriptive Statistics Supervisory Board Shari’ah Review Audit and Governance Frequency Overall score IBBL EXIM AIBL SJIBL SIBL FSIBL Mean SD Mean SD Mean SD Mean SD Mean SD Mean SD 6.00 0.00 5.67 0.48 4.95 0.91 3.02 0.10 5.47 0.12 5.05 0.61 5.75 0.26 5.24 0.68 4.89 0.13 4.01 0.06 5.46 0.43 5.30 0.55 5.72 0.45 5.50 0.72 5.39 0.45 2.77 0.09 5.44 0.25 5.00 0.00 92 39 65 23 31 50 5.58 4.92 5.05 4.25 4.56 5.38 Table 3. Financial performance (Average score of last four years from 2014 to 2017) Indicators IBBL EXIM AIBL SJIBL SIBL FSIBL OITA 4.01 3.88 3.96 3.64 3.30 2.66 OETA 2.00 1.69 1.52 1.91 1.38 1.47 TLA 93.71 90.82 90.86 91.95 72.67 96.18 11
12. b . The relationships between Shari’ah compliance and financial performance i. Total liabilities/total assets (TLA) The study examined the impact of Shari’ah compliance on the TLA measure of financial performance. Multiple regression analysis was conducted (see Table 4 (a) and 4 (b). The model was accepted as the adjusted R-square value was 0.904. The results indicated ‘F’ value (16.729) was significant at 10% and hence provided the evidence of a significant relationship between the Shari’ah compliance and TLA. Thus, the regulatory body of the banks should be conscious of the appointment of the members of the supervisory board and audit and government committee. In addition to the expertise of the Shari’ah board members and audit and governance committee, they would be independent so that they have rights and powers to get access into all relevant documents for review purposes. Moreover, the Shari’ah review committee is to be formed in such a way so that they can provide their opinions on Shari’ah compliance in order to meet clients’ Shari’ah requirements, and thereby proliferate banks’ financial performance. Since the banks’ financial performance relating to LTA depends on the SB, AGC, and SR, the regulatory framework of the banks should be designed in such a way so as it ensures the knowledge and skills of the Shari’ah reviewers. Table 4(a): Model Summaryb Model 1 R .981a R Square .962 Adj. R Square .904 Std. Error .60511 Durbin-Watson 2.573 a. Predictors: AGC, SR, SB b. DV: TLA Table 4(b): ANOVAa Sum of Model Squares (SS) 1 Regression 18.376 Residual .732 Total 19.109 a. Dependent Variable (DV): TLA b. Predictors: AGC, SR, SB ii. df 3 2 5 Mean Square (MS) 6.125 .366 F 16.729 Sig. .057b Operating income/total assets (OITA) Table 5 (a) provided evidence of a poor model fit to the dataset with the adjusted R square 0.253. Accordingly, the study is restricted to conclude the association between Shari’ah compliance and OITA. 12
13. Table 5 (a): Model Summaryb Model R R Square Adj. R Square Std. Error a 2 .837 .701 .253 .40879 a. Predictors: SB, SR, AGC b. DV: OITA Model SS 2 Regression .785 Residual .334 Total 1.119 a. DV: OITA b. Predictors: SB, SR, AG iii. Table 5(b): ANOVAa df MS 3 .262 2 .167 5 Durbin-Watson 2.216 F 1.565 Sig. .413b Operating expense/total assets (OETA) Table 6 (a) provides evidence of a good model fit to the dataset with adjusted R square value 0.822. While F-value (8.688) is insignificant at the confidence level of 10%. Hence, the results exhibited no significant relationship between Shari’ah compliance and OETA. Table 6(a) Model Summaryb Model R R Square Adj. R Square Std. Error a 3 .964 .929 .822 .19620 a. Predictors: SB, SR, AGC b. DV: OETA Model SS 3 Regression 1.003 Residual .077 Total 1.080 a. DV: OETA b. Predictors: SB, SR, AGC Table 6(b): ANOVAa df MS 3 .334 2 .038 5 Durbin-Watson 2.494 F 8.688 Sig. .105b As Shari’ah compliance in terms of SB, SR, AGC is significantly related with organizational financial performance in terms of TLA; it can be said that the higher the Shari’ah compliance in respect to TLA, the better is the financial performance. Also, it can be said that Shari’ah compliance plays a significant role in the TLA ratio. 5. CONCLUSION Shari’ah compliance in the absence of a statutory regulatory body may hinder to the progress of Islamic banks. Though Shari’ah governance is considered as the prerequisite for the Shari’ah compliance in Islamic banks and already eight full-fledged Islamic banks have been established in Bangladesh, the separate act for regulating the banks is absent. As a result, Islamic banks are facing numerous challenges 13
14. with the regulatory principles of conventional banks . Furthermore, the problems which are created because of the lack of congruence among the different Shari’ah boards of Islamic banks may influence the Islamic financial institutions. Besides, the different decisions of Shari’ah boards may be dissimilar to the international standards like AAOIFI, which ultimately affects financial performance. Despite the fact that the unfavorable regulatory situations existed in Bangladesh, the financial performance of the Islamic banks are better than that of the conventional one. Though the directors and CEO of the Islamic banks formed Central Shari`ah Board for Islamic Banks of Bangladesh (CSBIBB), Bangladesh Bank (BB), the central bank of Bangladesh, has not established any uniform regulatory body to examine the Shari’ah compliance. Thus, it is advised to set common standards to measure the Shari’ah compliance properly, which help to determine at what extent the Shari’ah compliance affects the financial performance of Islamic banks in Bangladesh. As a Muslim-majority country, the people of Bangladesh would like to lead their livelihood in the Islamic way. The Islamic banks are playing a crucial role to lead the financial sector by paving the way for the Islamic code of life. Therefore, this paper aimed to evaluate the Shari’ah compliance scenario and to measure at what extent the Shari’ah compliance influence the financial performance of the sample banks. The results of this study provide evidence of the positive impact of Shari’ah compliance on financial performance in respect to total liabilities and total assets. Ullah (2014) found that IBBL is the most Shari’ah-compliant bank, and its financial performance is better than most of other Islamic and conventional banks. The results of the study are also parallel with the findings of Ullah and Khanam (2018) and Mollah and Zaman (2015), where they observed that Shari’ah compliance stimulates the bank dominantly in attaining financial stability. Though there are some other important factors for better financial performance; Shari’ah compliance is the unique reason behind the better performance of Islamic banks as the high level of Shari’ah compliance attracts new customers and hence expands their business. These study findings are consistent with the findings of Ullah and Khanam (2018) in the scenes that IBBL complies Shari’ah more than any other Islamic banks of Bangladesh which provides more benefits to the banks resulting in a better position. The findings represent that the Shari’ah board plays an important role in Shari’ah compliance. However, researcher (Ullah (2014) pointed out that 26.64% of the employees have no sufficient knowledge of Shari’ah and Islamic finance and surprisingly the higher authorities of the banks do not take initiatives to arrange sufficient training programs to provide knowledge in Shari’ah to their employees. The policymakers should emphasize on the independent Shari’ah board of each bank that will have rights and powers to review whether employees are complying Shari’ah during the period of transactions and documentation. The authorities and board of directors of the banks should be careful of the appointment and composition of skilled, competent and knowledgeable members of Shari’ah board and Audit and governance committee who will be specialized in fiqh-muamalat and Islamic finance. 14
15. The findings provide the Islamic banks , their regulatory bodies, and even conventional banks invaluable insights into the impact of Shari’ah compliance on the success of Islamic banks. The research provides a valuable insight into the policymakers and regulators formulating strategies on how to increase the level of Shari’ah compliance in their banking performance. The employees of the banks can gain understanding to exercise Shari’ah principles during the period of transaction, charging profit or rent on goods and services, delivering the goods and recording in cash memos and other documents. The study provides customers a realization to choose their banks as the most Shari’ah compliance and better financial performance. The regulatory bodies can also draw some lessons from the study and plan and implement uniform guidelines to monitor and regulate all types of Islamic financial institutions. Besides, they pay attention to the factors that motivate the management and BOD in Shari’ah compliance properly. Moreover, full-fledged conventional banks and the banks having Islamic window can also be motivated to introduce more Shari’ah based windows, since the study shows higher the Shari’ah compliance better the financial performance. The study was based on the survey from the employees of six Islamic banks of Bangladesh. Hence, further study may extend the scope of generalization into the subject matters. Both the customers and executives of other conventional banks can also be considered in order to get further insights into the subject matters. Also, the study has been conducted within traditional regulatory context; further research may be conducted considering countries which have separate Shari’ah banking laws and principles to generalize the findings. REFERENCES Abduh, M. & Idrees, Y. (2013). Determinants of Islamic banking profitability in Malaysia. Australian Journal of Basic and Applied Sciences, 7 (2), 204-210. Ahmad, K. (2000). Islamic finance and banking: the challenge and prospects, Review of Islamic Economics, 9 (1), 57-82. Ahmad, N. & Haron, S. (2002). Perceptions of Malaysian corporate customers towards Islamic banking products and services. International Journal of Islamic Financial Services, 3 (4), 13-29. Ahmad, N. H. & Ahmad, S. N. (2004). Key factors influencing credit risk of Islamic bank: A Malaysian case. The Journal of Muamalat and Islamic Finance Research, 1 (1), 65-80. Ahmed, M. & Khatun, M. (2013). The compliance with Shariah Governance system of AAOIFI: A study on Islamic Banks Bangladesh. Journal of Islamic Economics, Banking and Finance, 9 (3), 1-15. Akbar, S., Zulfiqar Ali Shah, S. & Kalmadi, S. (2012). An investigation of user perceptions of Islamic banking practices in the United Kingdom. International Journal of Islamic and Middle Eastern Finance and Management, 5 (4), 353-370. Al-Jarrah, I. & Molyneuxa, P. (2003). Cost efficiency, scale elasticity and scale economies in Arabian banking. In: Hussein, K. A. and Omran, M. F. (Eds.), Financial Development in Arab Countries (pp. 25-78). Jeddah, Saudi Arabia: Islamic Research and Training Institute. Alhabshi, S. M. & Bakar, M. D. (2008). Survey on Shari’ah board of institutions offering Islamic financial services across jurisdictions. In: IFSB (Ed.), Islamic finance: Surveys on global legal issues and challenges (pp. 167–206). Malaysia: Islamic Financial Services Board. 15
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19. APPENDIX 1 : QUESTIONNAIRE ITEMS Items Constructs and questions Supervisory Board: appointment, composition, and Report SB1 The Shari’ah board performs its duty as an independent body; SB2 Board members are specialized in the arena of Islamic finance; SB3 Board members guide, review and oversee the activities of IFIs; SB4 Neither the directors nor the shareholders our bank can be selected as Shari’ah board members even though they are competent Shari’ah review SR5 The Shari’ah board authority has the rights to access all relevant documents for review purposes; SR6 The Shari’ah board is the only body responsible for commenting on Shari’ah compliance; SR7 There is a separate department to review the internal Shari’ah compliance SR8 The bank management and board of directors provide necessary assistances continuously to the Shari’ah reviewers; SR9 The head of the Shari’ah department has accountability to the BOD; SR10 The Shari’ah reviewers are expert and have proper knowledge and training SR11 During the period of arguments between management and Shari’ah reviewers, the issue is referred to the Shari’ah board for resolve. Audit and governance committee (AGC) AG12 There is an AGC at the board level; AG13 The AGC is knowledgeable regarding the activities of the banks, regulations and laws including Shari’ah rules and principles; AG14 The employees involved in AGC of the IFI cannot be a member of the Shari’ah board; AG15 The AGC continuously assesses the activities of their IFIs and tries to solve all issues independently. 19 View publication stats