Criteria of Potential Shariah Non-Compliance Events: Analysis of Cases in a Full-Fledged Islamic Bank in Malaysia

Islamic banking is distinguished from conventional banking by its adherence to the principles of Shariah. It is perceived as a Shariah compliant financial intermediary that represent the image of Islam in providing the financial solution to the public, particularly to Muslim. Compared to its conventional counterpart, Islamic banking is exposed to an additional risk unique to its operations—Shariah non-compliance (SNC) risk. Therefore, the proper management of SNC risk is vital, as its impact may affect not only the financial stability of the institution but also the reputation it upholds. A recent regulatory amendment by Bank Negara Malaysia (BNM) in the 2023 Operational Risk Reporting (ORR) policy document has raised new challenges in this regard. Specifically, BNM replaced the requirement for Potential SNC events to be confirmed by a “qualified Shariah officer” with the broader term “officer within the Shariah control function,” which may include individuals without a Shariah educational background. This change raises concerns about the capability of such officers to accurately identify and confirm Potential SNC incidents. This study aims to identify SNC events from both Shariah and regulatory perspectives, examine the current practices in determining Potential SNC events within an Islamic bank, and determine key criteria for recognizing such events. Adopting a qualitative approach, the research employs a comparative content analysis methodology focusing on a full-fledged Islamic bank in Malaysia. The analysis centers on the Shariah Committee’s decisions regarding Actual SNC events disclosed in the bank’s annual reports, serving as a basis to derive the criteria for Potential SNC identification. The findings reveal that Potential SNC events may arise in both Shariah contractual and non-contractual activities of the bank. The study further identifies key criteria that characterize these events, reflecting how deviations from Shariah requirements can occur across different operational contexts. The study offers several important implications. For officers within the Shariah control function, particularly those without formal Shariah study, the identified criteria provide practical guidance for consistent and accurate assessment of Potential SNC incidents. From a governance perspective, the precedent-based criteria derived from Shariah Committee decisions enhance understanding of the scope of SNC risk and reduce misclassification of non-SNC cases. For regulators, the findings contribute to developing standardized frameworks that promote uniformity in Shariah governance practices across Islamic financial institutions.