- This forms the second chapter of the guide titled ‘A guide for Islamic trade finance’.
- The definitive guide has been produced by Trade Finance Global (TFG), in collaboration with FCI and the International Islamic Trade Finance Corporation (ITFC), a member of the Islamic Development Bank (IsDB) Group.
- Governance in Islamic financial institutions is critical because it combines conventional financial oversight with Shariah compliance – through boards, management, and independent Shariah supervision
Governance is vital to the stability, integrity, and sustainability of any financial institution. In the context of Islamic banks and Islamic financial institutions (IFIs), the role of governance is twofold: in addition to general financial industry requirements, IFIs must also comply with Shariah rules and principles.
Effective governance is essential, as it safeguards stakeholders’ interests and market confidence, maintains Shariah integrity, and supports the growth of Islamic finance globally.
This is particularly important for international Islamic trade financing, which often involves several different jurisdictions, legal requirements, and counterparties. Governance in IFIs refers to the framework by which these entities are directed and controlled in accordance with the principles of Shariah.
Unlike conventional banking, IFIs are governed by both a board of directors and senior management, and by an independent Shariah supervisory board (SSB). This additional layer ensures that products, contracts, and operations are compliant with Shariah principles.
The importance of good governance
Proper governance in Islamic banks and IFIs is crucial primarily because it ensures Shariah compliance: deviation from Shariah can severely damage the reputation and credibility of the institution.
A good governance framework contains clear roles, functions, responsibilities, and authorities, reducing the risk of non-compliance incidents. This is important given that Shariah interpretations are applied differently across regions; effective governance helps manage these differences in a structured and transparent manner.
Governance also promotes transparency and accountability. IFIs have been entrusted with the funds of all depositors and investors, and they have the duty to manage those funds ethically and fairly. Internal controls, risk management systems, Shariah audits, and disclosure requirements are all components of governance mechanisms that ensure management acts in the best interest of stakeholders.
Additionally, sound governance can support financial stability as it reduces systemic risks. Islamic finance contracts such as murabaha (cost-plus sale), mudarabah (profit-sharing partnership), musharakah (joint-partnership model), and ijarah (Islamic leasing) have different risk profiles than customary interest-based financing.
Effective governance ensures all risks are properly identified, monitored, and managed, so risk-taking matches the strategic objectives of the institution and Shariah principles; thereby preventing potential financial distress resulting from excessive or uncalculated risks.
Finally, good governance improves market confidence and reputation. Having a strong governance framework inspires confidence and helps attract depositors, investors, and business partners. This is especially important in the increasingly competitive global financial market, where IFIs are competing with other financial institutions, including conventional banks.
Compliance with Shariah
Another important benefit is compliance with relevant Shariah standards. Most jurisdictions have specific governance standards, the most famous of which are the directives of the Islamic Financial Services Board (IFSB) and the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). Strong governance enables institutions to stay compliant with regulatory standards, avoid penalties, and streamline operations efficiently.
Governance also facilitates achieving sustainability and innovation in the long term through alignment with Shariah principles and sound risk management. This is done by creating a culture that enables IFIs to develop Shariah-compliant financial products by striking the right balance between innovation and regulatory compliance – a balance that is critical for the Islamic finance industry’s growth.
Governance in Islamic trade finance
The necessity of an effective governance framework is even greater in the context of international Islamic trade financing transactions. Islamic trade finance products, such as murabaha for trade, salam (forward sale contracts), istisna‘ (manufacturing), and wakala (agency), must be structured to comply with both Shariah principles and international trade requirements at the same time, which is no easy feat.
Governance provides a framework to reduce cross-border Shariah and legal risks in international trade finance, especially when countries have different Shariah standards, adaptations, or interpretations.
A well-governed structure, involving qualified Shariah scholars and legal counsels, ensures that Islamic trade finance contracts are acceptable across jurisdictions, thereby reducing dispute risks and improving the enforceability of contracts in foreign jurisdictions.
Finally, good governance allows IFIs to effectively improve international trade and economic development, making the most of the ethical exponential benefits which Islamic trade finance can bring.
Case study: Standard Chartered’s financial institution trade financing product, a facility to a bank
Author: Wasiq Ali, Standard Chartered
Through its Islamic financial institutions (FIs) trade finance facility, Standard Chartered (SC) partners with various entities in the Islamic finance ecosystem, including banks and multilaterals, to deliver Islamic trade finance solutions globally.
Under this structure, the partner FI selects and identifies relevant Islamic trade transactions for financing. SC also completes its due diligence to ensure that the transaction complies with all relevant international compliance and applicable rules and regulations.
Subject to satisfactory due diligence, SC finances the partner FI against these Islamic trade finance transactions using a commodity murabaha structure.
Types of transactions supported
The facility supports a wide range of Islamic trade finance transactions, including:
- Letter of credit (LC) refinancing
- Trade advances (non-LC)
- Pre-export financing
- Post-shipment financing (under LC)
- Post-shipment financing (under collections)
- Refinancing under reimbursements
This diverse product suite allows partner FIs to propose transactions for funding across various stages of the trade cycle.
Ease of execution, documentation, and tenor structures
The facility has been specifically structured to ensure straightforward execution and minimal documentation requirements. This approach streamlines the process, facilitating an efficient and user-friendly experience. Unlike facilities that demand extensive paperwork and master documentation, this facility eliminates the need for signing any comprehensive master agreement.
All necessary documentation for availing the facility is managed through simple transactional notices, which are efficiently transmitted using the SWIFT network. This method further reduces administrative
burden and expedites the overall process.
The facility can also be structured in multiple currencies and for various tenors, including tenors longer than the underlying trade transaction. This characteristic provides partner FIs greater flexibility in identifying and selecting Islamic trade transactions for funding, and allows them to better tailor funding solutions to their clients’ needs.
Islamic solutions, global reach
SC has partnered with FIs across the globe, from the Middle East and Europe to South Asia, to deliver Islamic trade solutions via this arrangement.
This approach enables SC to extend the footprint of its Islamic trade finance even in markets where it lacks a direct presence, effectively multiplying the availability of competitive Islamic trade finance solutions globally.
The Islamic finance facility is mutually beneficial for the Islamic finance industry, enabling the delivery of flexible, Shariah-compliant trade finance solutions to clients worldwide, supporting transactions throughout the trade cycle in various currencies and tenors.
Case study: Digital Islamic supply chain finance through SAB’s platform, a facility to a corporate
Author: Ahmed Al-Nowaibgi, SAB
SAB have successfully executed one of the first off-balance sheet end-to-end digital Islamic supply chain finance structures in Saudi Arabia for a large pharmacy chain. This structure enabled automated, discounted early payments for many of the client’s strategic suppliers.
SAB’s supply chain platform was enhanced to support Islamic transactions. Leveraging the new Shariah-compliant capability, the client uploaded their payment file and took advantage of fully automated processes, including:
- Recording and approval
- Sales contract generation that is Shariah-compliant
- Linking the transaction with its underlying commodity being traded
- Sales acceptance advice
This market-leading solution now allows for straight-through processing, reducing processing times from hours to minutes compared to the older, manual methods. The innovative solution yielded significant benefits to our client, including:
- Improved efficiency and control in supplier invoice processing and payment
- Minimised client operations and associated operational risks
- Strengthened supplier relationships through Shariah-compliant early payments
- Optimised working capital management with win-win extended payment terms to the buyer; here, non-recourse early discounting leverages the buyer’s creditworthiness and makes for more favourable pricing
- This Islamic platform enhancement and first transaction demonstrate the benefits of digitisation and the enormous potential of Islamic structured trade solutions in Saudi Arabia.
SAB’s supply chain platform can now provide digital automated discounting to both Islamic and conventional transactions, as well as hybrid conventional/ Islamic pairings where buyer and supplier needs differ.
