Corporate governance

Corporate governance

Corporate governance especially relevant to Islamic financial institutions

Why is corporate governance especially relevant to Islamic financial institutions and what advantages does it give them?


Ans.: Corporate governance especially relevant to Islamic financial institutions because it involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. It provides a structure through which the objectives of the company are set and the means through which these objectives are obtained and performance can be monitored. Such a framework sees corporate governance as a dynamic interplay of internal and external incentives, which affect the performance of a firm.

 The internal incentives are the firm’s organizational arrangements that allow owners to direct managers to pursue goals set by the shareholders, while the external incentives on regulatory structures, voluntary standards accepted and followed by the firm and competitive market forces all exert discipline on the performance of owners and managers from the outside. By adhering both to internal and external incentives, a company can reduce its cost of capital, thereby increasing its profits.

Islamic financial institutes have some characteristics that require special care in designing their corporate governance mechanisms.

A} Stakeholders include a large number of depositors whose deposits are not guaranteed.

B} Islamic financial institutions operate on the basis of universal banking, which is close to deregulated banking environment. Financial activities cover wider spectrum than is customary in traditional finance, including equity holding, leasing and credit purchase finance on a mark-up basis.

C} Equity-holding by Islamic financial institutions would enable them to sit on the Board of directors of firms and thereby influence the corporate governance mechanisms of the latter.

D} Entry of Islamic finance market is restricted by the authorities in most countries, which provide Islamic financial institutions with a higher degree of monopoly than in conventional finance.

E} Islamic financial institutions operate predominantly in developing economies, where questions of governance in general are new and attract less attention.