M. Kabir Hassan
University of New Orleans
Sabur Mollah
Stockholm University


The distinctions between CBs and IBs are utilized in this study to examine:

Firstly, whether the multi-layer governance provided via the SSB acts as an independent control mechanism in restraining the board of directors or other governance agents from engaging in excessive risk taking.
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Secondly, the distinction between the two-types of banking systems is utilized to test whether IBs supposed adherence to ethical conduct resulted in shielding them from the devastating effects of the financial crisis and create shareholder value and hence, perform better during crisis.
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We conclude that the corporate governance index (CGI) and financial disclosure and transparency index (FDTI) emerged as the key driving force for risk-taking behavior of IBs during financial turbulence.

 Akhigbe and Martin (2008) and Pathan (2009): Highlight disclosure and governance practices and risk-taking behavior of
US Banks around Sarbanes-Oxley Act 2002, but nothing is done on the IBs governance and risk-taking.
 Sierra et al. (2006), Adams and Mehran (2012), Anders and
Valledado (2008), Wintoki et al. (2012), Francis et al. (2012) and
Pathan and Faff (2013): Investigate governance mechanism and firm performance/value, but nothing on the IBs.
 This study adds value in the existing literature by producing empirical evidence between governance and firm performance/value for the IBs during financial crisis.

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Hypothesis 1: There is no relationship between governance structure of IBs and risk-taking.
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Hypothesis 2: There is no relationship between governance structure of IBs and firm performance.

Hypothesis 3 : There is no relation between Shari’ah
Supervisoty Board (SSB) and the risk-taking of IBs.

Hypothesis 4 : There is no relation between Shari’ah
Supervisoty Board (SSB) and the firm performance of IBs.


BankScope database: 147 Islamic Banks listed in the BankScope database, but a large number of IBs do not fully involve into the Shari’ah compliant products.

Hand collected data from the Islamic Banks, which fully provide Shari’ah compliant products. We include 59 Islamic Banks in the sample.
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In addition, we collected the corporate governance data from the annual reports of these banks.

The data consists of 84 banks (59 Islamic and 25 Conventional) from Bangladesh,
Bahrain, Malaysia, Pakistan, Saudi Arabia, The United Arab Emirates, and The
United Kingdom over the period of 2006-2009.

In addition, we have conducted an extended questionnaire survey over the
Shari’ah board members from the sample Islamic banks.

We sent 47 questionnaires to the Shari’ah scholars during April-July, 2012 to
Bangladesh, Bahrain, Malaysia, Pakistan and the UK. The Shari’ah governance data from the survey has been included in the analysis to test hypotheses 3 and 4.


Risk-taking variable is defined as investment in risky assets and securities to total loans.

Firm performance is measured using return on equity (ROE) and return on assets (ROA).

The ROE is calculated as net income divided by total equity and ROA is calculated as net income divided by total assets.

The similar proxies are implemented by Hutchinson and Gul (2004) and
Gani and Jermias (2006).

The paper uses Tobin’s Q as a market-based measure of firm value.
Tobin’s Q is calculated as the Market-to-Book-Value of the equity ratio.

The similar proxy for firm value is also implemented by Yermack (1996),
Weir et al. (2002), and Haat et al. (2008).


To capture the corporate governance structure, we construct four indices:
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Board structure index (BSI), financial disclosure and transparency index (FDTI), risk disclosure index (RDI) and corporate governance index (CGI).
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BSI, FDTI, and RDI are the sub-indices; therefore, CGI constitutes all the three indices.

BSI constitutes sixteen different aspects of board and CEO structure.

FDTI contents eleven components of the audit firm/committee, risk committee, and
Shari’ah committee.
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In addition, the RDI contents the disclosure of the five key risk parameters.

Furthermore, the CGI consists of all thirty-two characteristics, which contents the
BSI, FDTI, and RDI. Finally, the SSB (Shari’ah Supervisory Board) is introduced as a dummy variable in the model.


The results of the model for both Islamic and conventional banks are presented in
Table 4.

The F-statistics for all models are highly significant, which indicate the OLS pooled regression is the right choice.

The results show that the CGI and FDTI are highly significant, which indicate that the corporate governance mechanism as a whole and financial disclosure and transparency in particular emerged as the key driving force for risk taking for Islamic banks.
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Similarly, the full-sample finds positive (significant) results for CGI and FDTI.

However, board size influences risk-taking for the full-sample.
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In addition, size and financial leverage play significant roles in protecting Islamic banks from high, but none of them matter for Conventional banks.

Nevertheless, the SSB appear as a significant parameter for the risk-taking for the IBs.


In Panel A, we find that board structure variables (board size and independence) are positively significant with ROA, which indicate that these variables are the key driving forces for the Islamic banking profitability.
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Conversely, the coefficients of FDTI and CGI indices are negatively significant with performance variables, which indicate that these indices destruct Islamic banks profitability.
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The similar results are reported in the full-sample (Panel C).

However, risk-taking behaviour, religion and financial leverage help Islamic banks making short-term profits (ROA and ROE).
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On the other hand, the risk disclosure index (RDI) and FDTI play key roles in conventional banks profit and value destruction (Panel B).

Nevertheless, financial leverage positively influences conventional banks profitability.

Nevertheless, religion and SSB played a leading role in profit making mechanism for the fullsample (Panel C).

These results indicate that governance mechanisms provide a weak explanation to changes in shareholders’ value measured by Tobin’s Q for Islamic banks.


The average size of the Shari’ah board is 3 and all members are male.

The Shari’ah boards consist of Shari’ah scholars and economists, but no lawyers.

Shari’ah board members do not work for the bank as employees.

55% of the respondents have said that they are accountable to the
Board, but 45% said, they are accountable to the shareholders.

However, 91% of the respondents have agreed that the shareholders have the power to appoint and dismiss the Shari’ah Board and the
Shari’ah board reports to the board of directors.


Despite the fact that all the respondents have agreed that banks review the qualifications and expertise of Shari’ah members, the responses are mixed when asked about Shari’ah members’ training and their understanding for the internal control and risk management process.
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All respondents, however, have agreed that the bank never evaluated their performance.

However, 63% has said that they meet quarterly, and 34% said, they meet monthly and they never experienced quorum problems. The decisions are made based on consensus.
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Moreover, 45% has said that the internal Shari’ah officer, who are bank employees, are responsible for Shari’ah board meeting, but 55% said that the company secretary is responsible for it.
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Interestingly, all Shari’ah scholars serve the bank on a part-time basis, and Shari’ah scholars sit in different boards but, in some cases, the Central bank permits one to sit in max 2 boards.


There are a few issues raised in this section regarding disclosure and transparency.

The Shari’ah governance system is monitored either by national Shari’ah council or Shari’ah authority of the central bank.

82% of respondents have agreed that the bank has an independent Shari’ah board.

The internal Shari’ah review is conducted by internal Shari’ah committee
(73%)7. Fourth, the Shari’ah resolutions are publicly available (82%).

There are questions about role of Shari’ah board and Shari’ah ruling, 55%of the respondents believe that Shari’ah board plays an advisory role, and they validate the documentation, but 45% of the respondents noted that the Shari’ah board plays a supervisory role, and the board members perform Shari’ah audit.

However, 73% of the respondents believe that the banks consider Shari’ah board ruling as the binding but 27% thinks that it is simply advisory.


Finally, the survey results cast doubt on the independent role of Shari’ah board, which was considered as the key driving force for the IBs governance system in restraining IBs in excessive risk-taking and hence, perform better during crisis.

The results fail to reject H3-H4, which help identify SSB as the weak parameter in IBs governance system.

In addition, the regression results identify corporate governance index (CGI) and financial disclosure and transparency index (FDTI) as the major variables for risk taking in IBs, but board structure of the IBs has profit motive.
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In our opinion, the monitoring ability of the Shari’ah board is minimum.

The SSB performs Shari’ah audits and validate the products and services.

The Shari’ah board members, however, perform the advisory role, and they work as an additional checkpoint, which adds some value to the bank, but Shari’ah board cannot play any supervisory role.


CGI and FDTI emerged as the key driving force for risk taking for Islamic banks, but board structure of the Islamic banks are driven by short-term profitability.

However, governance mechanisms provide a weak explanation for the changes in shareholders’ value measured by Tobin’s Q for Islamic banks.

Our findings cast doubt on the independence of Shari’ah Boards.
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In addition, Shari’ah board member tend not to undertake a monitoring role, limiting their role to giving opinions on Shari’ah compliance of the products and services offered by IBs.
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The findings of this research will be a valuable source of knowledge for policy makers and regulators, particularly in the financial services sectors, in devising strategies to deal with future financial crises.