Sharia Compliance Committee

In Islamic Financial Institutions — Structure, Mandate, and Sharia Governance

First: Introduction

In Islamic financial institutions, Sharia compliance is not an optional feature — it is the very foundation of the business. An Islamic bank that engages in interest-based transactions is no longer Islamic. An Islamic insurance company that violates Sharia principles loses its identity. The Sharia compliance system, with its various committees, is what distinguishes Islamic financial institutions from conventional ones and gives them their reason for existence.

In the Kingdom of Saudi Arabia, home to the largest Islamic financial industry in the world, the Sharia governance system has evolved significantly. The Saudi Central Bank (SAMA) issued the Sharia Governance Framework for banks practicing Islamic activities, detailing requirements for Sharia committees at multiple levels. This article reviews the Sharia compliance system: the Sharia Supervisory Committee, the internal Sharia Compliance Committee, Sharia audit, their relationships, and best practices.

💡  Key Insight Sharia governance differs fundamentally from conventional governance: it is not only about protecting shareholders and stakeholders’ interests but also about ensuring compliance with divine principles. This adds a layer of responsibility that goes beyond regulatory compliance — it touches the very identity and legitimacy of the institution. Sharia governance failures cause damage to reputation and legitimacy far exceeding any financial impact.

Second: Sharia Governance Structure

1. Sharia Governance Levels

Comprehensive Sharia governance includes:

1.1 Sharia Supervisory Committee (SSC)

Highest Sharia authority in the institution:

• External independent Sharia scholars.
• Issues fatwas on transactions and products.
• Annual Sharia audit.
• Reports to general assembly.

1.2 Sharia Compliance Committee

Internal committee at board level:

• Board members.
• Oversees Sharia governance system.
• Coordinates with SSC.
• Reports to board.

1.3 Sharia Compliance Department

Executive department:

• Internal Sharia officers.
• Daily Sharia compliance monitoring.
• Sharia training.
• Pre-launch product review.

1.4 Internal Sharia Audit

Independent function:

• Sharia audit of transactions.
• Reports to SSC.
• Separate from compliance department.
• Provides independent assurance.

2. Standards and Frameworks

2.1 AAOIFI

Accounting and Auditing Organization for Islamic Financial Institutions:

• Sharia standards.
• Sharia governance standards.
• Accounting standards for Islamic transactions.
• Globally adopted reference.

2.2 IFSB

Islamic Financial Services Board:

• Prudential standards for Islamic finance.
• Sharia governance guidelines.
• Risk management for Islamic institutions.

2.3 SAMA Sharia Governance Framework

• Specifically Saudi requirements.
• For banks practicing Islamic activities.
• Mandatory implementation.

Third: Sharia Supervisory Committee (SSC)

1. Definition and Role

The SSC is the highest Sharia authority in the institution. It consists of external Islamic scholars specialized in Islamic financial transactions, appointed by the general assembly. Its function is to ensure that all institution activities, products, and transactions comply with Sharia principles.

2. Composition

• Number: 3-5 scholars typically.
• All external (not employees).
• Recognized expertise in Islamic transactions jurisprudence.
• Academic degrees in Sharia.
• Practical experience in Islamic financial institutions.

3. Required Qualifications

• Degree in Sharia or Islamic studies.
• Specialization in jurisprudence of transactions (fiqh al-muamalat).
• Knowledge of modern Islamic financial products.
• Understanding of accounting and financial principles.
• Integrity and reputation.

4. Appointment and Term

• Appointed by general assembly.
• Membership term: typically 3 years renewable.
• Multiple memberships: limited to avoid conflicts.
• Compensation: determined by assembly.

5. Main Responsibilities

5.1 Issuing Fatwas

• On new products before launch.
• On complex transactions.
• On strategic operations.
• Fatwas binding on the institution.

5.2 Sharia Approvals

• Approving product structures.
• Approving contracts and documents.
• Approving advertising and marketing.
• Pre-launch approval mandatory.

5.3 Sharia Audit

• Annual transaction audit.
• Identifying any violations.
• Recommending purification (where applicable).
• Issuing annual Sharia report.

5.4 Annual Report

• In annual report to assembly.
• Opinion on Sharia compliance.
• Material issues.
• Purification recommendations.
• Suggestions for improvement.

6. Working Procedures

• Regular meetings: at least quarterly.
• Documenting fatwas and decisions.
• Internal voting mechanism.
• Reporting to assembly.
• Communication with internal Sharia department.

📌  Note The Sharia Supervisory Committee occupies a unique position — independent from management like the audit committee, but with a different mandate. Its decisions are not recommendations to the board but binding fatwas. Understanding this distinction is essential for proper Sharia governance.

Fourth: Sharia Compliance Committee (Board Level)

1. Definition and Role

Internal committee at board level (different from SSC). Composed of board members and is the operational link between the board, executive management, and SSC. It oversees the Sharia governance system internally.

2. Composition

• 3-5 board members.
• Independent majority preferred.
• Optimally, includes a member with Sharia knowledge.
• CEO may attend without being a member.

3. Main Responsibilities

3.1 Sharia Governance System Oversight

• Reviewing Sharia governance policies.
• Ensuring SAMA framework implementation.
• Reviewing Sharia compliance reports.
• Resource allocation.

3.2 SSC Liaison

• Communication channel between SSC and board.
• Following up SSC recommendations.
• Coordination on policies and procedures.
• Ensuring SSC has needed resources.

3.3 Internal Sharia Department Oversight

• Approving department structure.
• Reviewing performance.
• Ensuring independence.
• Department head appointment recommendation.

3.4 Sharia Audit

• Reviewing Sharia audit reports.
• Following up violation handling.
• Approving purification when applicable.
• Ensuring corrective measures.

3.5 Sharia Training

• Approving training programs.
• Ensuring Sharia awareness coverage.
• Training board members.

Fifth: Internal Sharia Compliance Department

1. Department Role

Executive department responsible for daily implementation of Sharia governance:

• Monitoring Sharia compliance daily.
• Reviewing transactions before execution.
• Supporting employees on Sharia matters.
• Internal Sharia training.
• Coordination with SSC.

2. Structure

2.1 Department Head

• Sharia expert.
• Practical financial experience.
• Functional reporting to SSC or Sharia compliance committee.
• Administrative reporting to senior management.

2.2 Sharia Officers

• Specialists in Sharia.
• Distributed across business units.
• Independent in their opinions.
• Continuously trained.

3. Main Responsibilities

3.1 Pre-execution Review

• Reviewing new contracts.
• Reviewing exceptional transactions.
• Sharia opinions to business units.
• Pre-launch product approval.

3.2 Continuous Compliance Monitoring

• Periodic transaction sampling.
• Identifying violations.
• Corrective actions.
• Reports to SSC.

3.3 Training and Awareness

• New employee training.
• Continuous training for existing.
• Awareness materials.
• Workshops and seminars.

3.4 Inquiry Response

• Internal employee inquiries.
• Customer inquiries.
• Detailed Sharia opinions.
• Documenting answers.

Sixth: Internal Sharia Audit

1. Function Concept

Function independent of compliance department, providing independent assurance on Sharia compliance system effectiveness:

• Reports to SSC (functionally).
• Reports to audit committee (administratively).
• Independent from Sharia compliance department.
• Sharia equivalent of internal audit.

2. Function Responsibilities

2.1 Sharia Audit

• Risk-based audit of operations.
• Sample testing.
• Verifying compliance with fatwas.
• Detecting violations.

2.2 System Evaluation

• Sharia compliance system effectiveness.
• Sharia governance evaluation.
• Control gaps.
• Improvement recommendations.

2.3 Reports

• Periodic reports to SSC.
• Reports on specific cases.
• Annual report.
• Follow-up on findings.

Seventh: New Product Process

1. Process Steps

Comprehensive Sharia process for new products:

1.1 Initial Concept

• Business unit proposes idea.
• Consultation with internal Sharia department.
• Initial Sharia assessment.

1.2 Structuring

• Sharia structure design.
• Drafting contracts and documents.
• Detailed review by internal department.

1.3 SSC Approval

• Submitting full file to SSC.
• SSC discussion and review.
• Required modifications.
• Final approval (or rejection).

1.4 Implementation

• Employee training.
• System adjustments.
• Marketing approved by SSC.
• Product launch.

1.5 Continuous Monitoring

• Following actual application.
• Identifying deviations.
• Re-consultation when needed.

Eighth: Sharia Violations and Purification

1. Discovering Violations

Violations may be discovered through:

• Annual Sharia audit.
• Internal review.
• Customer complaints.
• Employee reporting.
• External regulatory review.

2. Handling Violations

• Documenting the violation.
• Stopping the violating activity.
• Investigating causes.
• Corrective measures.
• Preventing recurrence.

3. Purification

In some cases, profits from violations must be purified:

• Calculating impure profits.
• Allocating to charitable purposes.
• Approval by SSC.
• Disclosure in annual report.

⚠️  Caution Concealing Sharia violations is more serious than the violation itself. The institution’s credibility before the Islamic financial community depends on its transparency in dealing with violations. SSCs and supervisory authorities deal severely with concealment, while they appreciate proactive disclosure of violations with appropriate corrective measures.

Ninth: Coordination Between Bodies

1. SSC and Compliance Committee

• Periodic joint meetings.
• Information exchange.
• Coordination on strategic issues.
• Mutual respect for roles.

2. SSC and Internal Department

• Department implements SSC fatwas.
• Continuous communication.
• Department reports to SSC.
• Department supports SSC operationally.

3. SSC and Internal Sharia Audit

• Audit functionally reports to SSC.
• Coordination on audit plan.
• Reviewing findings.
• Following up corrective measures.

4. SSC and External Auditor

• Cooperation on financial-Sharia matters.
• Information exchange (within independence).
• Coordination on annual reports.

Tenth: Common Challenges

1. Sharia Scholar Scarcity

Limited number of qualified scholars:

• Difficulty finding new scholars.
• Some scholars serve on multiple SSCs.
• Conflict of interest issues.

Treatment:

• Investing in younger Sharia scholar development.
• Membership limits.
• Comprehensive disclosure of memberships.
• Conflict management policies.

2. Difference in Fatwas

Scholars may differ on certain issues:

• Differences between madhabs (schools).
• Differences in interpreting modern transactions.
• Differences between SSCs of different institutions.

Treatment:

• Adopting recognized standards (AAOIFI).
• Comprehensive disclosure of approaches.
• Justifying choices.
• Respecting differences.

3. Sharia Versus Profitability Pressures

Tension may arise between Sharia and commercial profit:

• Some Sharia-compliant products less competitive.
• Higher costs of structuring.
• Pressure to relax controls.

Treatment:

• Strict commitment to Sharia.
• Innovation in Sharia-compliant products.
• Educating market on Islamic finance value.
• Patience in building competitive advantage.

4. Technology and Innovation

New financial technologies pose Sharia challenges:

• Smart contracts.
• Decentralized finance.
• Tokenized assets.

Treatment:

• Continuous research and study.
• Consultation between scholars.
• Specialized AAOIFI standards.
• Caution in adopting new technologies.

Eleventh: Disclosure and Transparency

1. Annual Sharia Report

Issued by SSC in annual report:

• Opinion on Sharia compliance.
• Audit work performed.
• Identified violations.

2. SSC Composition Disclosure

• Scholar names.
• Qualifications and experience.
• Memberships in other SSCs.
• Annual compensation.

3. Sharia Methodology

• Adopted madhabs and standards.
• Followed AAOIFI standards.
• Differences from market practices.

4. Products and Operations

• Adopted Islamic products.
• Approved Sharia structures.
• Strategic transactions.

Twelfth: Best Practices

1. At Sharia Governance Level

• Multi-layer Sharia governance: SSC, committee, department, audit.
• Clear charter: For each level.
• Adopted standards: AAOIFI, IFSB.
• Strict compliance with SAMA framework.

2. At SSC Level

• Distinguished competencies.
• Real independence.
• Sufficient time for work.
• Direct communication with executive management.
• Engaging in major decisions.

3. At Internal Department Level

• Competent team.
• Functional independence.
• Sufficient resources.
• Continuous training.
• Modern systems.

4. At Culture Level

• Top-level commitment.
• Sharia as identity not constraint.
• Sharia innovation.
• Transparency in violations.
• Continuous learning.

Conclusion

The Sharia compliance system is not an additional layer of governance but the very identity of Islamic financial institutions. It’s the difference between an Islamic bank and a conventional one, between Islamic insurance and conventional insurance, between Islamic investment funds and conventional ones. Failure in this system means losing institutional identity, regardless of financial performance.

Saudi Arabia, with the world’s largest Islamic financial industry, has built advanced Sharia governance models that have become global references. The SAMA framework, AAOIFI standards, and accumulated experience of major institutions form a strong foundation. The continuing challenge is keeping pace with continuous developments — new technologies, new products, new business models — while preserving Sharia integrity. Investing in strong Sharia compliance is investing in the long-term identity and sustainability of the institution. The Sharia committees that perform their role with excellence build credibility extending across generations.

🎯  Essential Points to Remember (1) Sharia governance is the identity of Islamic financial institutions, not an additional feature. (2) Multi-layer structure: SSC, compliance committee, internal department, internal Sharia audit. (3) SSC is the highest Sharia authority — independent external scholars. (4) Sharia compliance committee at board level coordinates between levels. (5) Internal Sharia department implements daily compliance. (6) Internal Sharia audit provides independent assurance. (7) AAOIFI and IFSB standards are global references. (8) SAMA Sharia governance framework mandatory for Saudi banks. (9) Sharia violations require purification and full disclosure. (10) Best practices: distinguished competencies, real independence, sufficient resources, transparency, continuous learning.

Frequently Asked Questions

What is the sharia governance structure in Saudi Islamic financial institutions and what role does SAMA play?

Sharia governance in Saudi Islamic financial institutions operates through four integrated levels. The Sharia Supervisory Committee (SSC) is the highest Sharia authority — composed of three to five external independent Islamic scholars appointed by the general assembly, with binding fatwa authority over all transactions and products, conducting annual Sharia audits, and issuing the annual Sharia report to the assembly. The Sharia Compliance Committee at board level is the operational link between the board, executive management, and SSC — composed of board members with an independent majority, overseeing the Sharia governance system and coordinating with the SSC. The Internal Sharia Compliance Department is the executive arm responsible for daily compliance monitoring, pre-execution transaction review, employee training, and supporting business units on Sharia matters. The Internal Sharia Audit function provides independent assurance on the Sharia compliance system, reports functionally to the SSC, and is separate from the compliance department. SAMA's Sharia Governance Framework for banks practicing Islamic activities is mandatory and sets detailed requirements for each governance level. International standards complement this: AAOIFI standards are the global reference for Sharia standards and Sharia governance standards, while IFSB provides prudential standards and risk management guidelines specifically for Islamic financial services.

What are the main responsibilities of the Sharia Supervisory Committee and how does it handle new products?

The SSC holds four core responsibilities. Issuing fatwas on new products before launch, complex transactions, and strategic operations — these fatwas are binding on the institution rather than advisory. Sharia approvals covering product structures, contracts and documents, and advertising and marketing, with mandatory pre-launch approval for every new product. Annual Sharia audit by reviewing transaction samples, identifying any violations, recommending purification where applicable, and issuing the annual Sharia opinion. Annual report issued to the general assembly covering the compliance opinion, material issues discovered, purification recommendations, and improvement suggestions. The new product process follows five stages. Initial concept review by the internal Sharia department with a preliminary Sharia assessment. Detailed structuring where the Sharia-compliant structure is designed and contracts drafted. SSC approval through submitting the full file for scholar discussion with required modifications before final approval or rejection. Implementation including employee training, system adjustments, and SSC-approved marketing. Continuous monitoring of actual application after launch with re-consultation when deviations emerge. The fundamental distinction in this system is that SSC decisions are binding fatwas rather than board recommendations — a distinction essential for proper Sharia governance that differs fundamentally from all other committee types.

How are Sharia violations handled and what are the key challenges in Sharia governance?

When a Sharia violation is discovered through annual audit, internal review, customer complaint, or employee reporting, the institution must document the violation, immediately stop the violating activity, investigate root causes, implement corrective measures, and prevent recurrence. In cases where profits have been generated from impermissible activities, purification is required — calculating the impure profit amount, allocating it to charitable purposes with SSC approval, and disclosing the amount in the annual report. Concealing violations is treated more seriously than the violations themselves, as institutional credibility depends on transparent handling — supervisory authorities deal severely with concealment while appreciating proactive disclosure with appropriate corrective action. Four major challenges recur across Saudi Islamic institutions. Sharia scholar scarcity given the limited pool of qualified scholars with some serving on multiple SSCs, addressed through investing in younger scholar development and strict membership limit policies. Divergence in fatwas across madhabs and interpretations, addressed by adopting recognized AAOIFI standards with comprehensive disclosure of chosen approaches. Sharia versus profitability tension where some Sharia-compliant structures cost more, requiring strict commitment and innovation in compliant products rather than relaxing controls. Technology and innovation challenges from cryptocurrencies, smart contracts, and tokenized assets that pose new Sharia questions with limited precedent, requiring continuous research and caution.

References and Sources

• Saudi Central Bank (SAMA) Sharia Governance Framework.
• AAOIFI Sharia Standards.
• AAOIFI Sharia Governance Standards.
• IFSB Sharia Governance Guidelines.
• Saudi Companies Law (Royal Decree M/132).
• CMA Regulations — Islamic Investment Funds.
• International Islamic Financial Market (IIFM).
• Islamic Development Bank — Islamic Finance Standards.
• Studies on Sharia Governance in Saudi Arabia.
• Comparative Studies — Sharia Governance in GCC Countries.