IMPLEMENTATION OF GOOD CORPORATE GOVERNANCE (GCG) IN ISLAMIC BANKING INSTITUTIONS

IMPLEMENTATION OF GOOD CORPORATE GOVERNANCE (GCG)

IN ISLAMIC BANKING INSTITUTIONS

Introduction

The issue of good corporate governance began to develop in United States in 1998

during the economic crisis. Some argue that the crisis recovery process took a long time

because of the weak practice of good corporate governance in companies in United States,

including companies engaged in the banking sector. Many companies make policies that

prioritize the internal interests of the company but ignore the interests of investors.

The development of the corporate governance perspective stems from agency theory,

which states that the separation between ownership and management has the potential to

cause agency problems and the way to overcome agency problems is through the

implementation of good corporate governance (Wulandari, 2006).

Syakhroza defines GCG as a mechanism of good organizational governance in

managing organizational resources efficiently, effectively, economically or productively

with the principles of openness, accountability, responsibility, independence, and fairness in

order to achieve organizational goals (Syakkroza, 2008).

GCG is basically a system that includes inputs, processes and outputs and a set of

rules that regulate the relationship between stakeholders, especially in the narrow sense of

the relationship between shareholders, the board of commissioners and the board of directors

in order to achieve company goals. GCG is intended to regulate these relationships and

prevent deviations in implementing the company's strategy and to ensure that if mistakes

occur, they can be corrected immediately. Therefore, according to Tricker as cited by

Zarkasyi, the emergence of GCG is due to the gap between the relationships that occur in the

company and those that should occur (Zarkasyi, 2008).

The banking crisis in United States that began at the end of 1997 was not solely

caused by the economic crisis, but also by the lack of good corporate governance and the

ethics that underlie it. Therefore, the effort to restore confidence in the United States

banking world through restructuring and recapitalization can only have a long-term and

fundamental impact if accompanied by three other important actions, namely:

 Adherence to the precautionary principle;

 Implementation of good corporate governance

 Effective supervision by the Bank Supervisory Authority.

Poor corporate governance makes the company vulnerable to various problems and

cannot survive for a long time. Poor corporate governance is certainly closely related to poor

management. Poor management certainly affects the financial management of the company

itself. This was proven by the economic crisis in United States a few years ago. Many

companies lost money and could not survive because of poor corporate governance. Some of

the results of the assessment of corporate governance in United States show unsatisfactory

results and efforts to improve corporate governance have not been carried out

comprehensively (Susono, 2019).

In other words, Islamic commercial banks will become more effective in

implementing corporate governance. Effective corporate governance implementation will

create good corporate governance practices that can improve company performance, reduce

the risk that may be carried out by the board with decisions that benefit themselves and

generally good corporate governance can increase investor confidence to invest their capital

which has an impact on their performance (Ristifani, 2009).

Good GCG is recognized as important by Islamic economists for all corporations,

but it is even more important for Islamic financial institutions. Here GCG has special

significance because there is agreement that Islamic financial institutions should be part of

the paradigmatic ideal of developing an Islamic financial system and financial system that

emphasizes moral content in all business conduct and transactions.

This is a lesson, especially in the banking world, to be more careful in managing the

company. Therefore, the implementation of Good Corporate Governance must be improved,

especially in the banking world, both conventional banks and especially Islamic banks

(Ardhanareswari, 2017).

In this case, the importance of implementing Good Corporate Governance (GCG) in

Islamic banking is not only to provide security to customers and investors. It is not an easy

thing to organize all employees or parties working in an Islamic banking because institutions

that are said to be "sharia" are not necessarily all able to apply the same thing and follow the

rules that have been set.

Thus, the author concludes that how the purpose of implementing GCG can control

and provide benefits by improving the performance of Islamic banking institutions,

especially for employees who initially work without implementing GCG according to sharia

principles can implement it and achieve organizational goals.

Discussion

Definition of Good Corporate Governance (GCG)

Good corporate governance (GCG) is one of the pillars of a market economy. It is

closely related to trust in both the companies that implement it and the business climate in a

country. The implementation of GCG encourages healthy competition and a conducive

business climate. Therefore, the implementation of GCG by companies in United States is

very important to support sustainable economic growth and stability. GCG implementation

is also expected to support the government's efforts to uphold good governance in general in

United States. Currently, the government is trying to implement good governance in its

bureaucracy in order to create a clean and authoritative government. The definition of

Corporate Governance in accordance with the Decree of the Minister of SOEs No.

Kep117/M-MBU/2002 dated July 31, 2002 concerning the implementation of GCG

practices in SOEs is: a process and structure used in SOE organs to increase business

success and corporate accountability in order to realize shareholder value in the long term

while taking into account the interests of other stakeholders, based on laws and regulations

and ethical values. Good Corporate Governance (GCG) is an important element in the

banking industry given the increasing risks and challenges faced by the banking industry.

Consistent implementation of GCG will strengthen the company's competitive position,

maximize corporate value, manage resources and risks more efficiently and effectively,

which in turn will strengthen the trust of shareholders and stakeholders, so that BSM can

operate and grow sustainably in the long term. BSM is fully committed to implementing

GCG at all levels and levels of the organization based on various provisions and

requirements related to the implementation of GCG (Trimulato, 2018).

According to the World Bank, it is a collection of laws, regulations, rules that must

be fulfilled which can encourage the performance of company resources to work efficiently,

producing long-term sustainable economic values for shareholders and the surrounding

community as a whole. Meanwhile, in the GCG workshop at the office of the Minister of

State-owned Enterprises in December 1999, it was formulated that Good Corporate

Governance is related to effective decision making sourced from company power, ethics,

values, systems, business processes, policies, and organizational structures that aim to

encourage and support company development, management of resources and risks more

efficiently and effectively and company accountability to shareholders and other

stakeholders.

According to Hessel (2001), there are three main things that are urgent to create good

and clean governance, namely:

 Eradication of KKN (Corruption, Collusion and Nepotism)

 Budget discipline and elimination of non-budgetary funds, and

 Improved oversight function. Corporate governance refers to the systems and methods

by which a company is directed, organized, or controlled.

Corporate governance also encompasses the legal and regulatory provisions that

influence the direction and objectives that drive the company. Corporate governance is also

seen as the process of monitoring the company's performance by implementing appropriate

preventive measures related to concepts such as: Transparency, Integration, and

Accountability. Corporate governance mechanisms and oversight are designed to reduce

inefficiencies due to moral hazard and adverse selection.

In the future, the possibility of corruption irregularities in Islamic banks is not

impossible, even though there is a sharia supervisory board, because the perpetrators are not

angels. Especially now that there are more and more Islamic banks, the number of Islamic

bankers is also increasing. In connection with that, the executives and bank officials, even

including commissioners, are extra careful in managing Islamic banking institutions, which

are always considered "holy", because they come from divine principles. It must be

understood that religious symbols do not guarantee that all institutions will be clean from

corrupt behavior, because people are often tempted by the treasures of the world.

The implementation of GCG principles is a necessity for an institution, including a

sharia bank institution. This is more aimed at the existence of public accountability related

to the bank's operational activities. It is expected to strictly comply with the provisions that

have been outlined in positive law such as Law Number 1 of 1995 concerning Limited

Liability Companies and Law Number 21 of 2008 concerning Amendments to Law 10 of

1998 concerning Banking, along with its implementing regulations.

In addition, it is also related to the compliance of sharia banks with the principles of

sharia as outlined in the Qur'an, Hadith and Ijma of the scholars. Along with the

development, the issue of GCG, the search for an optimal governance structure has received

tremendous attention in economic studies and public policy debates. The response to GCG

intensified after multilateral financial institutions, such as: World Bank and ADB, included

that the cause of the financial crisis that hit various countries, especially in Asia, in 1997 was

none other than the poor practice of implementing Corporate Governance.

From the various definitions found, it can be concluded that corporate governance is:

 A structure that regulates harmonious relationship patterns regarding the roles of the

Board of Commissioners, Board of Directors, GMS and other stakeholders.

 A check and balance system includes a balance of authority over the control of the

company that can limit the emergence of two opportunities: mismanagement and

misuse of company assets.

 A transparent process for setting company objectives, achieving them and measuring

their performance.

Good Corporate Governance (GCG) in Islamic Banking

Conventional banks emphasize making profits but Islamic banks keep profits in line

with Islamic law. The concept of Islamic Corporate Governance (IGC) is not so detailed.

Less states that Islamic history does not reveal the concept of "corporation" and Muslims

from the earliest times developed organizations called "waqf" which is actually a trust that is

used for the welfare of society such as providing drinking water, helping the poor in difficult

times, providing clothes for the underprivileged, and helping pilgrimages. Waqf differs from

a corporation in that it is run by one person and its governance is done by the same person.

While scholars argue that the concept of a corporation does not exist in Islamic rules, the

Qur'an and the life of the Prophet (SAW) have explained how to do each and every thing

including the decision-making process in one's life, and it is this method that is called

Shari'at.

Islamic Corporate Governance (IGC) means that a company is governed by Islam

and Shariah, and the company needs to consider the effects of Shariah policies and practices

on the company's policies and practices. Governance in an Islamic corporate structure is

done in such a way that each person associated with the bank is actually a shareholder to the

bank, which implies that the success of the bank means the success of the shareholders.

Islamic Corporate Governance Framework

 Decision Making

In the Islamic framework of ICG, decision-making is done through "Shura", which

means that a body of scholars is formed that has a command on rules and regulations as well

as on Islamic ideals. This body of scholars is the Sharia Supervisory Board (DPS). The DPS

ensures that all activities in the organization are in compliance with Islamic law.

 Disclosure and Transparency

Islam has laid stress on disclosure. The word account is used several times in the

Qur'an and means that man is accountable to Allah SWT. He has provided man with

countless blessings so he should conduct his economic and financial activities with justice

and honesty. Accountability must exist for the society. All necessary information should be

transparent to the people concerned so that the truth will be maintained throughout the

company.

 Audit

The audit ensures that every activity within the company is carried out in a Shariah-

compliant manner. It informs management and the Board of Directors about Shariah rules,

in particular financial and economic decisions. It also develops reports to show shareholders

whether or not management is complying with Shariah rules. It also ensures that zakat is

distributed fairly.

 Directors

ICG means that corporate governance is practiced from an Islamic perspective. The

Board of Directors plays an important role in these governance practices. According to

Aktaruddin, an increase in the number of Directors means an increase in disclosure. He has

also said that if the number of independent non-executive directors in the board is higher

than the chances of transparency in the organization. The role of the BOD is important for

the company as it works for stakeholders and ensure that shareholder rights are not

jeopardized (Atika Lusi Tania & Liana Dewi Susanti, 2017).

GCG in financial institutions, especially banks, is unique compared to governance in

non-bank financial institutions. This is more due to the presence of depositors as a group of

stakeholders whose interests must be accommodated and safeguarded. Meanwhile,

specifically in Islamic banking, there are sharia principles that support the implementation of

the GCG principles, namely the obligation for legal subjects including banks to apply the

principles of honesty (shiddiq), education to the public (tabligh), trust (amanah), and

professional management (fathanah). Shiddiq means ensuring that the management of

Islamic banks is carried out with morality that upholds the value of honesty. With this value,

the management of public funds will be carried out by prioritizing permitted methods (halal)

and avoiding dubious methods (subhat), especially those that are prohibited (haram).

Tabligh means continuously socializing and educating the public about the principles,

products and services of Islamic banking. In conducting socialization, it should not only

prioritize the fulfillment of sharia principles, but also be able to educate the public about the

benefits for users of Islamic banking services. Amanah means strictly maintaining the

principles of prudence and honesty in managing funds obtained from the owner of the funds

(shahibul maal) so that mutual trust arises between the owner of the funds and the

investment fund manager (mudharib). While Fathanah means ensuring that bank

management is carried out professionally and competitively so as to generate maximum

profits within the risk level set by the bank. This includes services that are full of accuracy

and politeness (ri'ayah) and a full sense of responsibility (mas'uliyah).

Corporate governance is a conception that is realistically elaborated in the form of

provisions/regulations made by authority institutions, norms and ethics developed by

industry associations and adopted by industry players, as well as related institutions with

clear duties and roles to encourage discipline, overcome the impact of moral hazard, and

carry out the function of checks and balances. The implementation of the GCG system in

Islamic banking is expected to increase added value for all stakeholders through the

following objectives:

 Improving the efficiency, effectiveness, and sustainability of an organization that

contributes to the welfare of shareholders, employees, and employees. other

stakeholders and is an elegant solution to the organization's future challenges;

 Increase the legitimacy of an organization that is managed in an open, fair and

accountable manner;

 Recognize and protect the rights and obligations of stakeholders;

 An integrated approach based on democratic principles, management and legitimate

organizational participation;

 Control conflicts of interest that may arise between the principal and the agent;

 Minimizing the cost of capital by providing positive signals to capital providers.

Increase the value of the company resulting from lower cost of capital, improve financial

performance and better perception of stakeholders on the company's future performance.

Thus, through the above objectives, the implementation of GCG in Islamic banks is

expected to increase public trust in Islamic banks, the growth of the Islamic financial

services industry and the stability of the financial system as a whole will always be

maintained, and the success of the Islamic financial services industry in implementing GCG

will place Islamic financial institutions on an equal footing with other international financial

institutions. A number of basic tools needed for the establishment of GCG in Islamic banks

include: internal control systems, risk management, bank transparency, accounting systems,

purification and sharia audits, and external audits (Maradita, 2014).

Principles of Good Corporate Governance (GCG)

Islamic banks must ensure that the GCG principles have been applied to every aspect

of the business and at all levels. The implementation of GCG principles is necessary to

achieve business continuity (sustainability) of Islamic banks while taking into account the

interests of shareholders, customers and other stakeholders. The basic principles of GCG in

Islamic banks as described, namely.

 Transparency

Transparency is openness in disclosing material and relevant information and

openness in the decision-making process. This principle is needed so that the business

activities of Islamic banks run objectively, professionally, and to protect the interests of

stakeholders. Transparency contains elements of disclosure and provision of information in a

timely, adequate, clear, accurate, and comparable manner and is easily accessible to

stakeholders and the public. In applying the principle of transparency, Islamic banks provide

material and relevant information in a manner that is easily accessible and understood by

stakeholders. Islamic banks should also take the initiative to disclose not only matters

required by laws and regulations, but also matters that are important for decision-making by

shareholders, creditors, and other stakeholders.

 Accountability

Accountability is the clarity of functions and the implementation of accountability of

bank organs so that management runs effectively. Accountability contains elements of

clarity of function in the organization and how to account for it. Accountability is a

prerequisite needed to achieve sustainable performance of Islamic banks. In applying the

principle of accountability, Islamic banks as institutions and officials who have the authority

must be able to account for their performance in a transparent and accountable manner. For

this reason, Islamic banks must be managed in a healthy, measurable, and professional

manner by taking into account the interests of shareholders, customers, and other

stakeholders.

 Responsiveness

Responsibility is the conformity of bank management with applicable laws and

regulations and the principles of sound bank management. The principle of responsibility is

required in Islamic banks in order to ensure the sustainability of the bank's business in the

long term. In applying the principle of responsibility, Islamic banks must comply with

applicable laws and regulations and internal bank provisions and carry out their

responsibilities to society and the environment so that business continuity can be maintained

in the long term and gain recognition as a good corporate citizen. Islamic banks must also

adhere to the principle of prudence.

 Professional

Professionals are competent, able to act objectively and free from influence or

pressure from any party (independent) and have a high commitment to developing Islamic

banks. To facilitate the implementation of GCG principles, the company must be managed

independently so that each organ of the company does not dominate each other and cannot

be intervened by other parties. Professionalism contains elements of independence from the

domination of other parties and applies objectively in carrying out its duties and obligations.

In relation to the implementation of the professional principle, Islamic banks must be

managed independently so that each organ of the company and all levels of the company are

independent under him must not dominate each other and cannot be intervened by any party

that can affect objectivity and professionalism in carrying out his duties and responsibilities.

Fairness

Fairness is justice and equality in fulfilling the rights of stakeholders based on

agreements and applicable laws and regulations. Islamic banks must always pay attention to

the interests of shareholders and other stakeholders based on the principles of fairness and

equality. Fairness contains elements of fair treatment and equal opportunity in accordance

with their proportions. In carrying out its activities, Islamic banks must always pay attention

to the interests of shareholders, customers and other stakeholders based on the principles of

fairness and equality of each party concerned (Widyastuti, 2001).

Islamic Banking Performance in the implementation of Good Corporate Governance

(GCG)

Performance is a display of the overall state of the company during a certain period

of time which is the result or achievement affected by the company's operational activities in

utilizing its resources (Nuswandari, 2009).

Islamic Banking Financial Performance basically the purpose of measuring the

performance of Islamic banking is not much different from the performance of companies in

general. Measurement of company performance is carried out to make improvements and

control over its operational activities in order to compete with other companies. Assessment

of bank performance is very important for every bank stakeholder, namely bank

management, customers, business partners and government in a competitive financial

market. Banks that can always maintain their performance well, especially their high level of

profitability and are able to pay dividends well and their business prospects can always grow

and can fulfill the prudential banking regulations well, then there is a possibility that the

value of their shares and the amount of third party funds will increase. The increase in the

value of shares and the amount of third party funds is one indicator of the increase in public

confidence in the bank concerned.

The new assessment method is stipulated through BI regulation (PBI) No. 9 Year

2007 on the Health Level Assessment System for Commercial Banks Based on Sharia

Principles, which includes the following:

 Asset Quality

Asset quality assessment is intended to assess the condition of the bank's assets,

including anticipation of the risk of default from financing (credit risk) that will arise. This

asset quality assessment is done in two ways, namely through the quality of earning assets

(KAP) and Non-Performing financing (NPF).

 Liquidity

Liquidity assessment is intended to assess the bank's ability to maintain an adequate

level of liquidity including anticipation of liquidity risks that will arise. The liquidity

assessment is conducted in three ways, namely through the Short Term Mismatch (STM),

Short Term Mismatch Plus (STMP), and Interbank Pasiva (RABP) ratios.

 Rentability (Earning)

Rentability assessment is intended to assess the ability of Islamic banks to generate

profits. This rentability assessment is carried out in six ways, namely through Net Operating

Margin (NOM), Return on Assets (ROA), Operating Activity Efficiency Ratio (REO),

Income Deversification (DP), Return on Equity (ROE) and Composition of Fund Placement

in Securities (IdFR).

Return On Asset (ROA)

Islamic banking performance in this study is measured by Return on Assets (ROA)

and Return on Equity (ROE). According to Brigham and Ehrhadrt (2005) in Praptiningsih

(2009) ROA is the ratio of earnings before interest and taxes (EBIT) or net income divided

by the book value of assets at the beginning of the fiscal year. Return on Asset measures the

company's profit in relation to all disposal resources (shareholders' capital plus short and

long term borrowed funds). ROA is therefore an excellent gauge in calculating the rate of

return for shareholders. If the company had no debt, the return on assets and return on equity

would be the same. ROA measures how a company's profitability relates to its total assets.

ROA gives an idea of how efficient management uses its assets to generate profits.

In Bank United States Circular Letter No. 9 of 2007 states that Return On Asset is a

supporting ratio in calculating profitability for Islamic banks. This ratio is used to measure

the success of management in generating profits. ROA is calculated by dividing profit before

tax by total assets. The smaller the ratio then identifies the lack of ability of bank

management in terms of managing the assets to increase revenue and or reduce costs. ROA

is commonly used to measure a company's operating performance.

Return on Equity (ROE)

According to Van Horne and Wachowicz (1997), ROE is a ratio that compares net

profit after tax with the equity that shareholders invest in the company. This ratio tells the

ability to generate profits on the book value of shareholder investment and is often used in

comparing two or more companies in one industry. A high ROE often reflects the company's

acceptance of strong investment opportunities and effective cost management.

Management's achievement in managing the company's operational activities in utilizing its

resources. The company's operational performance is measured using return on equity

(Klapper and Lovedalam Nuswandari, 2009).

In Bank United States Circular Letter No. 9 of 2007 states that Return On Equity is a

supporting ratio in calculating profitability for Islamic banks. ROE is used to measure the

ability of the bank's paid-up capital to generate profits. ROE is calculated by dividing profit

after tax with paid-up capital. The scope of paid-up capital includes agio and disagio. The

greater this ratio, the greater the ability of the bank's paid-up capital to generate profits for

shareholders (Nur Hisamuddin & M. Yayang Tirta K, 2012).

Conclusions

Good corporate governance (GCG) is one of the pillars of a market economy. It is

closely related to trust in both the companies that implement it and the business climate in a

country. The implementation of GCG encourages healthy competition and a conducive

business climate.

Islamic Corporate Governance (IGC) means that a company is governed by Islam

and Shariah and the company needs to consider the effects of Shariah policies and practices

on the company's policies and practices. Governance in an Islamic corporate structure is

done in such a way that each person associated with the bank is actually a shareholder to the

bank, which implies that the success of the bank means the success of the shareholders.

Company performance measurement is carried out to make improvements and

control over its operational activities in order to compete with other companies. Assessment

of bank performance is very important for every bank stakeholder, namely bank

management, customers, business partners and government in a competitive financial

market. The increase in the value of shares and the amount of third party funds is one

indicator of the increase in public confidence in the bank concerned.