An analysis of the effectiveness of the internal shariah audit function in Malaysian Islamic financial institutions

Abstract

An effective internal Shariah audit function in Islamic Financial Institutions (IFIs) is imperative to ensure better management of the Shariah non-compliance risks through a more robust Shariah audit practices. The accountabilities of the Board and Shariah Committee members are also vital to provide effective oversight on the internal Shariah audit function. The primary objective of this research is to evaluate the extent of the effectiveness of the internal Shariah audit function in IFIs in Malaysia. By using contingency theory, the study also examines the antecedents of an effective internal Shariah audit function. Consequently, the impacts of an effective internal Shariah audit function on the extent of Shariah governance and Shariah compliance disclosure in the Statements by Directors and Shariah Committee Report are examined based on the accountability theory. The study adopts a quantitative research method using a survey questionnaire and content analysis of the annual reports of IFIs in Malaysia. The total population of 47 IFIs during the period of data collection, i.e. the year 2016, were observed as the unit of analysis and the targeted sample. Survey questionnaires were distributed to the Heads of Shariah audit who are the key representatives of the internal Shariah audit function in IFIs in Malaysia. The findings indicate that the majority of IFIs have established an effective level of internal Shariah audit function. The internal control system is found to be the dominant contingent factor to contribute positive and significant effects to the effective internal Shariah audit function. There are positive but not significant effects between the Shariah risk management function, management support, and the function of Shariah Committee members on the effective internal Shariah audit function. The study also found that an effective internal Shariah audit function has a positive effect on the Shariah governance and Shariah compliance disclosures in the Statements by Directors and Shariah Committee Report. However, the effects are also not significant. The majority of IFIs have disclosed a minimum level of Shariah governance and Shariah compliance information in the Statements by Directors and the Shariah Committee Report. In conclusion, an effective internal Shariah audit function indicates the robustness of the Shariah audit practices and better management of Shariah non-compliance in the IFIs. The findings contribute to the need of rigorous monitoring and more attention by Bank Negara Malaysia as the regulator on the effectiveness of the internal Shariah audit function performed by the Takaful operators and Islamic windows in commercial and investment banks. This further emphasises the crucial need for a holistic Shariah compliance culture in IFIs to enhance the effective internal Shariah audit function and ultimately, enhance the integrity and accountability of IFIs.