336 AN INTRODUCTION TO ISLAMIC FINANCE
where confl icts of interest are expected to appear (for example, rela-
tionships with affi liated parties).■ (^) Financial and managerial incentives for the board, management and
employees to act in an appropriate manner. (That is, compensation
should be consistent with the bank’s objectives, performance and ethi-
cal values).
Given the fi duciary nature of the fi nancial industry and the scope of
asymmetry in access to information, corporate governance arrangements may
matter more for fi nancial businesses than for other fi rms. In its essence, a
fi nancial business organization is a fi duciary trustee that is entrusted with the
intangible assets of another party, specifi cally depositors and other investors.
Therefore, it carries a special obligation to act in the best interests of that
other party when holding, investing, or otherwise using the principal’s prop-
erty. This is crucial in the context of banking, where informational asym-
metries are likely to be higher than in other fi rms.
The distinct nature of fi nancial intermediation conducted by IFIs raises
certain governance issues that require further discussion:
Financial interests of account holders Investors or depositors are among the
most important stakeholders and protecting their fi nancial interests is
critical. In the case of current accounts, IFIs obtain an explicit or implicit
authorization to use the deposit money for whatever purpose permitted
by Shari’ah, but pay no return or profi t to the depositors. Any negligence
or misconduct on the part of IFIs can result in fi nancial losses to current
account holders. There should be proper procedures to ensure that the IFI’s
management does not go for risky investments or excessive use of these
funds to enhance the performance of overall investments to benefi t other
unrestricted investment - account holders.
In the case of restricted investment accounts (RIA), the bank acts only as
fund manager — agent or non - participating mudarib — and is not authorized
to mix its own funds with those of the investors without their prior permis-
sion. It is in the interests of RIAH that they are provided with all relevant
information about the returns and risks. In addition, it is the responsibility of
the management of IFIs to ensure that investments funded by RIAH are ring -
fenced from the rest of the investments and there is full transparency in the
identifi cation and distribution of profi ts and losses. Similarly, unrestricted
investment accounts, which constitute the majority of deposits, pose specifi c
corporate - governance problems. It is a common practice of IFIs to place
shareholders’ and investment funds in common pools, without any mecha-
nism to separate the two. Consequently, there is the concern that shareholder -
controlled management and boards may favor and protect shareholders’
investments at the expense of those of investment - account holders.
IAHs as stakeholders Investment account holders (IAHs) are like quasi - equity
holders, but without any participation in the governance of the fi nancial