External Auditing of Sharia Compliance to Likely Strengthen Governance in Islamic Finance

External Auditing of Sharia Compliance to Likely Strengthen Governance in Islamic Finance

"We consider that the recent publication of auditing standard No. 6 by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) will reinforce governance and enhance market discipline,“ said S&P Global Ratings' Head of Islamic Finance, Mohamed Damak. "The key aspects of market discipline, in this context, are greater consistency in adhering to Sharia principles and a culture of rapid remedial action by non-compliant institutions.“ The standard specifies AAOIFI's criteria for external audit of Sharia compliance at Islamic financial institutions (IFIs). Given the lack of standardisation that the Islamic finance industry has been facing, the first problem AAOIFI faced was, which standards should an audit exercise be performed against? In its No. 6 standard, AAOIFI addresses this by creating a hierarchy of the existing standards and regulations. If opinions from these sources are ambiguous, the standard prioritises the approvals and clarifications of the entity's specific Sharia board. This is the obvious choice, given that these approvals and clarifications underpin an IFI management team's decisions and the institution's functioning. In our view, internal Sharia audits have not meaningfully supported enhanced transparency. Enforcing external, independent audits, however, could change the game, especially if the detailed results were published, or at least