Corporate Governance and Ethics Compliance in Islamic Financial Institutions - Legal Perspectives

Abstract

Corporate governance systems are continuously converging and inherently presuppose the predominance of law. Strong emphasis is put on checks and balances and monitoring systems. However, despite convergence tendencies there are also differences in corporate governance systems that often stem from different commercial and legal cultures, the prevailing political and economic conditions and the development of the macroeconomic model. Religious traditions and moral aspects also come into play. Islamic financial institutions are significantly subject to multi-level governance systems. They are not only required to comply with applicable laws but also with Sharia and ethical principles. If legality is insufficient to frame governance policies or where the law is silent, ethical norms can have a supplementary regulative effect.

After inquiring the relationship between law and morals the paper will argue that the two distinct spheres of law and morals can sometimes conflict with each other. The paper will then go on to discuss the content and regulative character of codes of conduct applied in the Islamic finance sector. In this context, the ethics standards of the AAOIFI and the IFSB will be presented and critically reflected upon.

Because markets and individuals do not always sufficiently guarantee adherence to ethical norms, ethical codes of conduct as instruments of self-regulation need to be implemented and “reinforced” effectively. This article attempts to create a nexus between corporate governance systems and ethics compliance taking into account the distinctive features of Islamic financial institutions. It suggests integrated legal mechanisms for applying ethical norms within the corporate governance framework of an Islamic financial institution. Formal organisational systems that create incentives for ethical behaviour and ultimately enhance ethics compliance will be discussed. The paper also shows the legal limits of implementing ethical norms and sanctioning misconduct, particularly in European legal and regulatory settings.

Keywords: Islamic Finance, Law and Morals, Regulation, Corporate Governance, Ethics Compliance, Code of Conduct, Sharia Compliance, Corporate Social Responsibility

JEL Classification: K22, K23, G30, G34, G15, G21