Dual board governance structure and multi-bank performance: a comparative analysis between Islamic banks in Southeast Asia and GCC countries

• DOI: https://doi.org/10.1108/CG-10-2018-0329
• Pages: 1377-1402
• Published date: 27 August 2019
• Date: 27 August 2019
• Author: Naji Mansour Nomran,Razali Haron
• Subject Matter: Corporate governance,Strategy

Dual board governance structure and

multi-bank performance: a comparative

analysis between Islamic banks in

Southeast Asia and GCC countries

Naji Mansour Nomran and Razali Haron

Abstract

Purpose –This paper aims to examine the effect of dual board governance structure, i.e. Shari’ah

supervisory board (SSB) and board of directors (BoD), on the performance of Islamic banks (IBs) in

SoutheastAsia region versus banks in the GulfCooperation Council (GCC) region.

Design/methodology/approach –This studyuses a sample of 45 IBs over seven countriescovering the

period of 2007-2015based on the GMM estimator –First Difference(2-step).

Findings –The findings revealthat SSB and BoD for IBs in both regions are segmented in termsof ROA

(negative interaction)and integrated in terms of Zakat ratio (Zakat on equity[ZOE]) (positive interaction)

only for Southeast Asiaregion. Furthermore, SSBs positively affect multi-bankperformance in Southeast

Asia while its effect is absent for GCC. This suggests that Shari’ah governance practices for IBs in

Southeast Asia are stronger compared to GCC IBs. Finally, BoD has a significant association with low

ZOE for IBs in both the regions.

Research limitations/implications –The implications of this research is that the unique agency

theory depicted in this study can be inferred when analyzing how dual board structure affects IBs’

performance.

Practical implications –For regulators in bothregions, SSBs must be given real power to monitor BoD.

They should also balance the number of SSB scholars with experience in Shari’ah,aswellasinlaw,

accounting and finance.It is also important that such a balance of scholars with PhD in these areasbe

required for Southeast AsiaIBs. For the GCC’s regulators, CG practices need to be improved by giving

due importanceto SSB characteristics and BoD structure.

Originality/value –Though the effectsof dual board structure on IBs’performancehas been previously

examined in the literature, only SSB size has been used as a single proxy of SSB governance.

Furthermore, no empirical evidence is recorded to date on this issue in Southeast Asia and the GCC

regions. One of the innovations of this paper is the use of multi-bankperformance measures in the IBs

performanceand corporate governance.

Keywords Islamic banks, Dual board governance, Islamic performance measurement,

Shari’ah supervisory board

Paper type Research paper

1. Introduction

Islamic finance industry has grown rapidly in recent years where its assets increased from

US$1.4tn in 2014 to US$1.5tn in 2015 (Farag et al., 2017). Islamic banks (IBs) operate

based on Islamic principles that prohibit (riba)[1], (gharar),and(maysir) and encourage

sharing of profits, losses, and risks (Abdelsalam et al.,2016). These principles are derived

from the Holy Quran and the practices of Allah’s Messenger, the Prophet Muhammad

(PBUH). The Islamic principles also include imposing Zakat payment on Muslims and

Naji Mansour Nomran is

based at the Department of

Finance and Banking,

Faculty of Administrative

Sciences, Thamar

University, Thamar, Yemen.

Razali Haron is based at

the IIUM Institute of Islamic

Banking and Finance,

Kuala Lumpur, Malaysia.

Received 15 October 2018

Revised 9 January 2019

1 July 2019

Accepted 8 July 2019

DOI 10.1108/CG-10-2018-0329 VOL. 19 NO. 6 2019, pp. 1377-1402, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 1377

encouraging rich people to give (qard al-hasan) to poor people. As such, IBs must pay

Zakat annually as approved by the Shari’ah supervisory board (SSB) (Mohammed and

Muhammed, 2017). Basically, a key important goal of Islam is to achieve social justice,

therefore the Prophet (PBUH) was sent to eradicate all forms of injustice which were

prominent during pre-Islamicperiod (Zainuldin et al.,2018).

IBs differ from conventional banks (CBs) in their functions, structure, and objectives

(Mohammed and Muhammed, 2017). Accordingly, IBs have unique agency issues which

give rise to different agency conflicts that might exist in IBs as compared to CBs (Farag

et al., 2017). Besides the common agency problems that occur between managers and

shareholders, IBs are also likely to encounter additional agency problem, e.g. in any case

managers deviate from their duty to ensure Shari’ahimplementation (Zainuldin et al.,2018).

For that, IBs have “multi-layer” governance structure, i.e. SSBs besides board of directors

(BoD) (Safiullah and Shamsuddin, 2018), in which SSB acts as additional monitoring

mechanism that mitigates agency problems (Abdelsalam et al.,2016). This second layer of

governance i.e. the SSB comprises scholars specializing in Islamic law and jurisprudence

with a background of economicsand finance (Nawaz, 2017).

Shari’ah law, prohibits riba,gharar and the trading of money, therefore SSB must be in

existence in all Islamic financial institutions (IFIs) in order to ensure that their operations and

activities are in compliance with Shari’ah rules (Magalha

˜es and Al-Saad, 2013). The role of

SSBs is to monitor the religious, behavioral, moral and ethical aspects of corporate

management (Almutairi and Quttainah,2017). However, the concern is about to what extent

SSBs are able to monitor IBs. Mollah and Zaman (2015) assert thatSSB monitoring role may

include restraining BoD and the management from engaging in major risk-taking activities.

However, SSBs do not seem to have any monitoring role beyond opining on the Shari’ah

compliance of IBs products and services. Furthermore, Almutairi and Quttainah (2017)

indicate that not all SSBs monitoring act on the management is equal to or as well as the

best monitoring practices. It all depends on the distribution of decision-making power,

litigation and government regulation in which the IBs operate that will eventually affect the

corporate governance.

However, empirical studies that examine both the unique agency relationships and the

unique dual board structure in IBs vis-a

`-vis their performance is still scarce (Farag et al.,

2017).

1.1 Why conducting this study is necessary

Few empirical studies investigate the impact of dual board structure either on the IBs

performance (Mollah and Zaman, 2015;Farag et al., 2017;Ajili and Bouri, 2018)oronthe

IBs risk-taking (Safiullah and Shamsuddin, 2018). Among these studies, only Mollah and

Zaman (2015) examine the interactive effects of SSB and BoD on IBs’ performance while

Safiullah and Shamsuddin (2018)examine the same effect but on IBs risk-taking.

Nevertheless, with respect to the context of dual board and IBs performance, the study of

Mollah and Zaman (2015) suffers from some limitations. First, they used SSB size as a

single proxy of SSB governance and neglected many important SSB characteristics such

as education, cross-membership, reputation and expertise that may affect performances.

Many researchers assert thatusing only individual CG items may not reflect the total impact

of governance (see, e.g. Brown et al.,2011). To overcome this limitation, this study uses a

SSB score following Farook et al. (2011) and Rahman and Bukair (2013), as it takes into

consideration the impact of otherimportant SSB characteristics.

Second, conventional measurements (e.g. ROA, ROE) are commonly used in measuring

IBs performance. However, Ghayad (2008) argues that it is inaccurate to measure IBs

performance using the same measurements used for CBs as there are many differences

between IBs and CBs in their operational features, objectives and functions. The

PAGE 1378 jCORPORATE GOVERNANCE jVOL. 19 NO. 6 2019