KARACHI: The State Bank of Pakistan (SBP) has directed Islamic Banking Institutions (IBIs) to ensure Shariah Non-Compliance Risk (SNCR) management as a part of overall risk management framework in line with the size, complexity of their business activities and operations. The SBP on Monday issued exclusive instructions on SNCR management, aimed at enhancing the stability and soundness of Islamic banking. Senior management will ensure implementation of the SNCR management framework.
Risk Management Guidelines for Islamic Banking Institutions (IBIs) provides a set of principles of best practices for establishing and implementing effective risk management in IBIs. At present, it has been noted that there is a lack of uniform practices across the Islamic banking industry regarding management of SNCR.
On the other hand, increasing size of the industry, nature of its operations, and diversified portfolio of products & services necessitate that IBIs should broaden their focus on management of SNCR. Therefore, with a view to reinforcing the best SNCR management practices, the SBP has emphasized that SNCR management must be an essential element of an IBIs overall risk management framework.
The foundation of Islamic Banking lies in compliance with Shariah rules and principles in all its business activities and operations. SNCR is a unique risk faced by Islamic Banking Institutions (IBIs) and must be managed proactively. The increasing size of the industry in terms of assets and deposits, diversified operations, products and services make focused management of SNCR a necessity. In addition, the adoption of uniform practices will help in maintaining consistency over time and across IBIs.
To improve SNCR management, instructions issued by SBP require the Board of Directors (BoD) and senior management of IBIs to approve and ensure implementation of SNCR as a part of overall risk management framework in line with the size and complexity of their business.
The SNCR management framework will be developed using SBP’s instructions on Shariah principles and decisions in conjunction with rulings and Fatwa of the Shariah Board of the IBI as key reference points. These will allow for the identification of risks and controls in different products, services and business activities. As per SBP’s instructions, IBIs should take necessary steps to ensure that relevant members of BoD and senior management possess requisite knowledge and understanding of the risk management of SNCR.
The SBP’s instructions require IBIs to have an appropriate reporting mechanism, including frequency and thresholds for reporting of SNCR events to the BoD or its sub-committee. IBIs will also be required to maintain proper record of Shariah non-compliant events or transactions and furnish to the SBP, on a quarterly basis, the details of actual losses incurred.
The SBP believed that issuance of current instructions coupled with existing comprehensive Shariah Governance Framework will help to achieve targets laid down in the third strategic plan for Islamic banking recently issued by the SBP.
According to circular sent to IBIs, BoD or any of its designated sub-committee, responsible for risk management will also be responsible for monitoring of SNCR in order to keep an eye on risk profile at the enterprise level. Further, the senior management or its existing risk management committee will also be responsible for close monitoring of SNCR at operational/management level. Necessary steps should be taken to ensure that relevant members of BoD/senior management should possess requisite knowledge and understanding of the risk management of SNCR. IBIs will delineate the appropriate reporting mechanism, including frequency, thresholds/limits for reporting of SNCR events and transactions to the BoD or its sub-committee and risk management committee of senior management.
Copyright Business Recorder, 2021