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HUM
29,1 Corporate governance disclosure
in the annual report
An exploratory study
4 on Indonesian Islamic banks
Salim Darmadi
Indonesian Capital Market and
Financial Institution Supervisory Agency (Bapepem-LK),
Jakarta, Indonesia and
Indonesian College of State Accountancy (STAN),
Tangerang Selatan, Indonesia

Abstract
Purpose – The purpose of this paper is to explore disclosure on corporate governance mechanisms in
annual reports of Islamic commercial banks in Indonesia.
Design/methodology/approach – Employing a sample comprising seven Islamic commercial
banks in Indonesia, the present study constructs the so-called Corporate Governance Disclosure Index
(CGDI) to score the banks’ disclosure level. Corporate governance mechanisms addressed in this study
include Shariah Supervisory Board, the Board of Commissioners, the Board of Directors, board
committees, internal control and external audit, and risk management.
Findings – It is revealed that Bank Muamalat and Bank Syariah Mandiri, the county’s two largest
and oldest Islamic commercial banks, score higher than their peers. Disclosure of the sample banks on
some dimensions, such as board members and risk management, is found to be strong. On the other
hand, disclosure on internal control and board committees tends to be weak.
Practical implications – This study shows that the average disclosure level among the sample
banks is relatively low. Hence, this result has important implications for the enhancement of corporate
governance disclosure of Islamic banks, thereby wider acceptance and enhanced reputation could
be gained.
Originality/value – This paper is believed to be among the first to explore the practice of disclosure
on corporate governance mechanisms among Islamic commercial banks. Additionally, it focuses
on Indonesia, the largest Muslim country that has a different institutional setting from that in other
Muslim countries.
Keywords Corporate governance, Disclosure, Indonesia, Islamic banks, Banks
Paper type Research paper

1. Introduction
Being the largest Muslim country in the world, Indonesia experiences rapid growth in
its Islamic banking industry. Even though the market share of Islamic banks in the
country is still below 4 percent, the total value of Islamic banks’ assets in 2010 had
been 50 times larger than that in 2000. As of 31 December 2010, there were 11 Islamic
Humanomics
Vol. 29 No. 1, 2013 The views expressed in this paper are those of the author and do not necessarily reflect the views of
pp. 4-23 Bapepam-LK. The author gratefully acknowledges helpful comments by Amir Shaharuddin and
q Emerald Group Publishing Limited
0828-8666
participants at the 2011 Islamic Seminar and Conference on Islamic Economics at Universitas
DOI 10.1108/08288661311299295 Negeri Jakarta, Indonesia. All errors and omissions remain the author’s responsibility.
commercial banks and 23 Islamic banking units, as well as 150 Islamic rural banks, in Corporate
the country[1]. The Islamic Banking Law, as the legal foundation for the Islamic governance
banking development, was also enacted in 2008[2]. It is expected that the Indonesian
Islamic banking industry continues to grow, following increased awareness of the disclosure
Indonesian Muslims, growing well-educated population, and increasingly widespread
branches throughout the country.
Since modern commercial banks are generally run as corporations, agency 5
problems (as theorized by Jensen and Meckling, 1976) may arise due to differences of
interests between shareholders and management. In firms with a higher level of
ownership concentration, such problems may occur between the controlling
shareholder and minority shareholders (Shleifer and Vishny, 1997). Hence, various
corporate governance mechanisms are intended to minimize this conflict. In the
banking industry, corporate governance has a higher level of significance since banks
mobilize public saving, depend on public trust, and have more diverse stakeholders.
Weak governance in banks has resulted in the collapse of banks during crises, as well
as financial scandals involving the owner and management, which could have
systemic impacts on the economy. In Islamic banking, greater attention should be
placed since Islamic banks are exposed to more non-compliance risks, as well as
weaker institutional environments of emerging markets in which they mostly operate
(Claessens, 2006). Further, in Islamic banks, investment depositors appear to be part of
the agency conflicts since they participate in the profit and loss like shareholders,
making good governance mechanisms highly required to protect their interest and to
maintain their confidence. Due to the banks’ diverse stakeholders, such governance
mechanisms need to be disseminated and disclosed in corporate reports.
The present study explores the practice of disclosure on corporate governance
mechanisms in annual reports of Indonesian Islamic banks. It contributes to
the knowledge in at least two important ways. First, this study is conducted in the
Indonesian context. Even though studies using data across different countries, such as
those conducted by Haniffa and Hudaib (2007) and Hassan and Harahap (2010), may
provide more powerful insights, studies in the context of one single economy is still
important since one particular economy has its unique national characteristics.
Indonesia has a relatively different institutional environment from other Muslim
countries. For instance, the country adopts two-tier board structure, where corporations
shall have a supervisory board (called “board of commissioners” – BOC) and a
management board (called “board of directors” – BOD). The Islamic banking industry in
the country, which emerged in early 1990s, was initiated by the Muslim society instead
of the government. Further, the country’s fully pledged Islamic banks are generally the
results of conversion from conventional banks or spinoffs from their conventional-bank
parents. Second, exploratory studies on corporate governance of Islamic banks, based on
information disclosed in corporate annual reports, are relatively scarce in the literature.
Such exploratory studies have addressed corporate social responsibility (Maali et al.,
2006; Hassan and Harahap, 2010) and ethical identity (Haniffa and Hudaib, 2007).
The sample of this study consists of seven banks whose 2010 annual reports are
available on their web sites; namely Bank Muamalat, Bank Syariah Mandiri, Bank
Mega Syariah, Bank Syariah Bukopin, Bank Victoria Syariah, BCA Syariah, and BJB
Syariah. The so-called Corporate Governance Disclosure Index (CGDI) is constructed
for each bank to measure the extent of governance disclosure. The corporate
HUM governance mechanisms addressed include the Shariah Supervisory Board (SSB), the
29,1 BOC, the BOD, board committees, internal control and external audit, and risk
management[3]. The result reveals that Bank Muamalat and Bank Syariah Mandiri
show higher CGDI scores than their peers. Some other banks show low levels of
disclosure. Three areas requiring much improvement are internal control and external
audit, board committees, and corporate governance implementation reporting.
6 The remainder of the present paper is structured in the following manner. Section 2
reviews prior theoretical and empirical work on corporate governance of Islamic banks
and corporate governance disclosure. This is followed by Section 3, which briefly
discusses the characteristics of the sample banks, as well as the methodology to score
the disclosure level. In Section 4, the results of CGDI scoring are presented and further
discussed. Finally, Section 5 concludes the paper.

2. Literature review
2.1 The importance of corporate governance in Islamic banks
In the banking industry, corporate governance practices are unique compared with
those in other sectors where governance mechanisms are “simply” intended to align the
interests of shareholders and managers ( Jensen and Meckling, 1976), or in the cases of
firms with more concentrated ownership structure, of the controlling shareholder and
minority shareholders (Shleifer and Vishny, 1997). The uniqueness is due to the duty of
managers to manage and safeguard the funds provided by various parties, including
depositors. Economic behavior of the banks can also affect economic outcomes, where
in some countries banks act as a major source of external financing for firms. Further,
banks have more diverse stakeholders and thus monitoring costs tend to be high,
leading to the importance of corporate governance mechanisms. Banks’ business is
also risky due to highly leveraged nature of its capital structure, where banks face
many short-term claims and are relatively dependent on depositors’ confidence.
In Islamic banking, greater attention needs to be placed on corporate governance for
at least three reasons. First, Islamic banks need to comply with shariah law, in addition
to adherence to banking regulations (Archer et al., 1998). Chapra and Ahmed (2002)
state that most depositors and investors of Islamic banks are highly concerned that
their funds are managed in accordance with shariah rules. Hence, such banks are more
exposed to non-compliance risks. Chapra and Ahmed’s survey also shows that most
depositors of Islamic banks are prepared to withdraw their funds if those banks fail to
operate in accordance with shariah rules. Safieddine (2009) explains that:
[. . .] while agency problems in conventional companies arise when managers deviate from
their duty to maximize shareholders’ wealth, any divergence by managers of Islamic financial
institutions from placing all supplied funds in Sharia-compliant investments creates an
additional source of agency problems (p. 144).
Second, Islamic banks have unrestricted investment account holders (IAHs). These
account holders appear to be part of the agency conflicts since they participate in the
profit and loss like shareholders (Chapra and Ahmed, 2002; Nienhaus, 2007). Even
though their deposits are generally higher than shareholders’ equity, they have no
voice in shareholders’ meetings. However, allowing depositors to have voting rights in
shareholders’ meetings is unlikely to do since IAHs are much greater in number and
more poorly organized compared to shareholders. As contended by Chapra and
Ahmed, all precautions need to be taken to maintain confidence of depositors in Islamic Corporate
banks. The tools may include sufficient regulation, proper supervision, sound risk governance
management, and good corporate governance (GCG). Again, when an Islamic bank
fails to protect the depositors’ interests, depositors are likely to protect their own rights disclosure
by withdrawing their deposits in the bank.
Third, most Islamic banks operate in emerging markets, where the institutional
environment tends to be weaker (Claessens, 2006). In such markets, where high levels 7
of ownership concentration and family control are more prevalent, applicable
regulations tend to be less protective for minority shareholders (as well as IAHs) from
asset expropriation committed by the controlling shareholder. Additionally,
transparency and disclosure practices are also weaker in these markets compared
with those in more developed economies, making monitoring costs and information
asymmetry higher. Alternatively, lack of market discipline appears to be another issue
in less developed markets (Claessens, 2006). These conditions, hence, stress the
importance of GCG in Islamic banks.

2.2 Corporate governance disclosure in the annual report

In the framework of agency theory, agency costs arise due to information asymmetry
that exists between shareholders and managers, or between the controlling shareholder
and minority shareholders. Increased corporate disclosure is viewed as one way to
mitigate the information asymmetry. Managers, who are more inclined to have detailed
knowledge on the firm’s operation, provide shareholders and other user groups with
particular information that may influence their economic decision (Cooke, 1989;
Narayanan et al., 2000). Financial reporting regulations generally require minimum
disclosure requirements, thus other information to be disclosed is considered voluntary.
Voluntary disclosure is managers’ discretion, and as contended by Verrecchia (1983),
managers will disclose voluntary information when the benefits outweigh the associated
costs. Healy and Palepu (2001) identify five forces that motivate managers to disclose
additional information, namely the hypotheses of capital market transactions, corporate
control losses, stock compensation, litigation costs, and proprietary costs.
There are a number of techniques that can be used by firms to distribute corporate
information to external stakeholders (O’Sullivan et al., 2008). However, as argued by
Botosan (1997), the corporate annual report is viewed as the principal medium to
convey financial and non-financial information in a detailed manner. The annual report
is considered important because of its effectiveness in conveying a certain corporate
image or message (Preston et al., 1996), managing external impressions, and
possessing a certain degree of credibility (Neu et al., 1998). As argued by O’Sullivan et al.
(2008), even though the annual report is not the only way to disseminate information,
firms with high-quality disclosure will ensure that important information is
incorporated in their annual reports.
Further, it is also argued that information on corporate governance is important to be
disclosed by the firm. Bushman and Smith (2003) define corporate transparency as “the
widespread availability of relevant, reliable information about the periodic performance,
financial position, investment opportunities, governance, value and risk of publicly
traded firms” (p. 76). Bhat et al. (2006) contend that knowledge on a firm’s governance
structure will be useful to assess the credibility of financial information, as well as to
accurately set expectation and to reduce uncertainty concerning the firm’s performance.
HUM Such disclosure also reveals who are responsible for governing the firm, how their
29,1 compensation is structured, and how and where they invest financial resources
(Bushman et al., 2004). Additionally, disclosure on the features of corporate governance
can enhance monitoring and internal control, improve firm performance (Labelle, 2002),
and drive improvements to the internal structure and process (Association of Chartered
Certified Accountants, 2009). If the governance mechanisms are not disclosed, the firm’s
8 stakeholders may not be able to access such information. In the banking sector, due to its
opaque and highly regulated characteristics, corporate governance is subject to the
regulation of banking authority. Hence, disclosure on governance mechanisms may play
a more important role compared with that in other sectors.
Islamic banks appear to be financial institutions with a religion-based identity;
hence, they are expected to adhere to the Islamic ethical values in their operation, in
addition to applicable regulations. Islam itself encourages good governance within a
firm. In Islam, corporate governance is aimed to protect the interests of all stakeholders
with adherence to shariah principles (Hasan, 2009). The Islamic concept of corporate
governance stresses the important areas of accountability and trustworthiness. Haniffa
and Hudaib (2004) suggest that:
[. . .] one of the avenues to demonstrate their accountability and commitments in serving the
needs of the Muslim community and society in general is via disclosure of relevant and
reliable information in their annual reports (p. 5).
With respect to the spirit of transparency and accountability, Islamic banks are
expected to disclose the features of their corporate governance to their stakeholders,
enabling the stakeholders to assess how the bank is governed and how their
investments is managed in shariah-compliant and prudential manners.

2.3 Corporate governance mechanisms in Indonesian Islamic banks

Based on previous studies (Chapra and Ahmed, 2002; Haniffa and Hudaib, 2007;
Safieddine, 2009), the present study addresses a number of corporate governance
mechanisms and tools that need to be disclosed by Indonesian Islamic banks. These
mechanisms include SSB, the BOC, the BOD, board committees, internal control
and external audit, risk management, and corporate governance implementation
reporting.
Shariah Supervisory Board. It is important to note that various parties have stressed
the importance of a SSB, which can ensure that the activities of an Islamic bank are in
line with shariah law (Safieddine, 2009). Hence, the SSB plays an important role as an
internal control mechanism (Haniffa and Hudaib, 2007), with the duties of reviewing
and supervising the activities of an Islamic bank in order to ensure that they are in
accordance with shariah principles. The SSB is an independent body within an Islamic
bank and, therefore, it is not subject to instructions and influences by management, the
BOD, or shareholders (Nienhaus, 2007).
In Indonesia, as regulated by the Islamic Banking Law, Islamic banks are required
to have an SSB, whose members are appointed by the shareholders’ general meeting
based on recommendations provided by the Indonesian Council of Ulamas (Majelis
Ulama Indonesia). Bank Indonesia requires the SSB of Islamic banks to have board
meetings of at least once a month and to submit periodic supervisory reports to Bank
Indonesia[4].
 Boards of commissioners and directors. The BOD is viewed as one of the important Corporate
determinants of effective corporate governance, since it plays an important role to governance
mitigate conflicts between shareholders and managers (Klein, 1998). The characteristics
of the board, including board size and board independence, have been widely addressed disclosure
in either theoretical or empirical research. Even though there are persisting debates on
whether firms should have large or small size of the board, some studies suggest that
firms with more complex operations need to have a greater number of people serving on 9
the board (Klein, 1998; Coles et al., 2008). Further, it is believed that that a larger
proportion of independent directors on the board will be advantageous to the firms since
it would lead to better monitoring, as well as wider perspectives and expertise (Hermalin
and Weisbach, 1998; Pearce and Zahra, 1992). The presence of independent board
members is also intended to protect the right of minority shareholders.
Concerning the legal form of the firm, Indonesia’s Islamic Banking Law determines
that an Islamic bank should be a corporation. This means that Islamic banks must
adhere to the Corporation Law[5]. Indonesia inherits some aspects of the Dutch law,
including its two-tier board system. According to the Corporation Law, Indonesian
firms shall have two boards in their organizational structure, namely the BOC and the
BOD. The members of these two boards are elected or appointed by shareholders in the
shareholders’ general meeting. The BOC represents shareholders and conducts
advising and monitoring roles on the firm’s management. Hence, the role of the
BOC is entirely non-executive, and its members consist of the representatives of
shareholders and/or independent commissioners (from outside the firm). Further, the
BOD conducts the day-to-day management of the firm, and is responsible to both
the BOC and shareholders[6].
In Indonesia, all of BOC and BOD members are subject to the fit-and-proper tests
conducted by Bank Indonesia. Such tests are aimed to assure that board members of
Islamic banks possess adequate levels of competence, credibility, and integrity, as well
as the commitment to enforce GCG. Different from the regulation for conventional
banks, Bank Indonesia requires Islamic banks to have at least one independent
commissioner on the BOC, without determining the number of BOC members should
be employed by the bank. The BOD is fully responsible in conducting management of
the bank based on shariah and prudential principles.
Board committees. The BOC can conduct its duties by itself or delegate its authority
to standing committees responsible to the board (Klein, 1998). The establishment of a
board committee can be mandatory for firms to a particular extent, for example for
listed firms or banks. Klein (1998) contends that due to the need of expert-provided
information about the firm’s activities, certain committees are set up to assist in
decision making process. Further, board committees are expected to conduct
independent monitoring on the firm. For example, the audit committee helps alleviate
agency problems by ensuring that accurate and unbiased accounting information is
released in a timely manner to shareholders, creditors, and other stakeholders. The
importance of board committees attracts more interests following financial scandals
involving high-profile companies.
In Indonesia, the Code of GCG, the latest version of which was issued in 2006, states
that the BOC can establish board committees to support its function. Alternatively,
Bank Indonesia has determined that it is compulsory for conventional and Islamic
banks to form at least three committees: the audit committee, the risk-monitoring
HUM committee, and the remuneration and nomination committee, where a committee is led
29,1 by an independent commissioner. The audit committee evaluates the bank’s internal
audit function and recommends a public accounting firm to be hired.
The risk-monitoring committee evaluates the bank’s policy on risk management.
The remuneration and nomination committee has responsibilities in evaluating the
compensation policy, as well as providing recommendations on suitable candidates to
10 serve on the BOC, BOD, and SSB.
Internal control and external audit. The existence of an effective internal control
system is highly important in Islamic financial institutions, in ongoing efforts to ensure
management oversight and to develop a healthy culture within the organization
(Chapra and Ahmed, 2002). Banking supervisory authorities also need to ensure that
internal control systems in all banks are in line with the nature of their risks. One of the
important parts of internal controls is the internal audit system. Chapra and Ahmed
(2002) suggest that the internal audit function should be strong and independent and
should report directly to the board and senior management. In addition, financial
audits conducted by an independent auditor appear to one of the important external
mechanisms of corporate governance. An audit provides independent checks on the
information provided by managers, and therefore plays a crucial role in maintaining
confidence in financial reporting as well as reducing agency costs (Jensen and
Meckling, 1976; Imhoff, 2003).
Through the regulation of Bank Indonesia, Indonesian Islamic banks are required to
have an effective and independent internal audit function, which is conducted by
competent personnel. Further, with respect to the independent audit on financial
statements, Islamic banks shall appoint a particular public accounting firm that are
registered in Bank Indonesia.
Risk management. A number of risks are inherent in banking business, including in
Islamic banking. Banks need to be highly cautious for their exposure to all risks. As
stated by Chapra and Ahmed (2002), board members and senior management should
be aware of the risks and develop sound risk management within the bank. Banks’
failure to manage such risks can lead to declining confidence of depositors, as well as
systemic impacts on the economy. To support this, banking supervisory authorities
will need to promote effective risk management. In Basel II, a number of risks have
been incorporated to ensure that banks have adequate capital to deal with those risks
and mitigate their impacts, namely market risks, credit risks, operational risks, and
other risks.
Bank Indonesia has issued a regulation that guides banks in managing their
risks[7]. The regulation requires Islamic commercial banks to implement risk
management for at least four risks, namely market risks, credit risks, liquidity risks,
and operational risks. Further, an Islamic bank with a higher degree of business
complexity should also manage other four risks, including legal risks, compliance
risks, strategic risks, and reputation risks. The BOD shall establish a risk management
division that is independent from other units.
Corporate governance implementation reporting. In line with the Code of GCG, Bank
Indonesia determines that Islamic banks shall prepare a report on the implementation
of GCG at the end of a financial year. The report should disclose such items as board
equity ownership, remuneration policy, board meetings, internal fraud, and the
distribution of charity funds. Such a report is also generally incorporated as part of the
banks’ annual reports. Further, Islamic banks are required to conduct self-assessments Corporate
on the implementation of GCG at least once a year. The self-assessments include a governance
number of elements, such as the implementation of the boards’ duties and
responsibilities, the implementation of internal and external audits, and financial disclosure
and non-financial transparency.

3. Sample and methodology 11

3.1 Characteristics of the sample banks
As previously mentioned, there were 11 Islamic commercial banks at the end of 2010.
The sample of the present study consists of seven banks whose 2010 annual reports are
available on their web sites, namely Bank Muamalat, Bank Syariah Mandiri, Bank
Mega Syariah, Bank Syariah Bukopin, Bank Victoria Syariah, BCA Syariah, and BJB
Syariah[8]. This subsection highlights the characteristics of the seven banks, which
include firm-level characteristics and ownership structure.
Table I shows firm-level characteristics of the sample banks. I include a number of
financial figures and indicators, namely total assets, financing, third-party funds,
return on assets (ROA), and return on equity (ROE). In these variables, generally Bank
Muamalat and Bank Syariah Mandiri lead their peers. Further, even though its shares
are not publicly traded on the stock exchange, Bank Muamalat is a publicly held
corporation, while other banks are privately held[9]. The sample banks have not yet
issued shares on the stock exchange, and the Bank Muamalat is the only bank issuing
sukuk on the Indonesia Stock Exchange (IDX).
Table II reports the controlling shareholder of each sample bank. I also indicate the
ownership type of each bank, whether it is controlled by a foreign institution, a family,
the government, or other types of institution. The ownership type is indicated by
tracing the ultimate controlling shareholder (the parent of its parent company). For
example, even though BJB Syariah is controlled by Bank Jabar Banten, its ownership
type is “government-controlled” since Bank Jabar Banten is controlled by a regional
government. Except for Bank Muamalat, the ownership structure of the Indonesian

Bank Bank Bank Bank

Bank Syariah Mega Syariah Victoria BCA BJB
Muamalat Mandiri Syariah Bukopin Syariah Syariah Syariah

Total assetsa 21,401 32,482 4,638 2,194 337 875 1,930

Financinga 15,918 23,958 3,154 1,612 28 417 1,603
Third-party fundsa 17,393 28,998 4,041 1,622 167 557 1,322
Return on assets (%) 1.36 2.21 1.90 0.74 1.09 1.04 0.72
Return on equity (%) 17.78 63.58 26.81 9.65 2.41 1.67 1.62
Year operation starts 1992 1999 2004 2008 2010 2010 2010
Number of branches 368 507 394 41 8 15 21
Public/private Public Private Private Private Private Private Private
Issuing stocks in No No No No No No No
capital market
Issuing sukuk in Yes No No No No No No
capital market
Table I.
Note: aStated in billion Indonesian Rupiah (IDR) Firm-level characteristics
Source: 2010 annual reports and financial statements of the sample banks of the sample banks
HUM
Ownership
29,1 Bank type Shares ownership of the controlling shareholder

Bank Muamalat Foreign 32.82% Islamic Development Bank

Bank Syariah Mandiri Government 99.99% Bank Mandiri, one of the largest banks, a listed
bank, 66.68 per cent of shares being held by the
12 Indonesian government
Bank Mega Syariah Family 99.99% Mega Corpora (a privately held, domestic
company)
Bank Syariah Cooperative 65.44% Bank Bukopin, a listed bank, 39.54 per cent of
Bukopin shares being held by Kopelindo (a cooperative)
Bank Victoria Syariah Family 99.98% Bank Victoria International, a listed bank,
38.01 per cent of shares being held by Victoria
Sekuritas (a privately held, domestic company)
BCA Syariah Family 99.99% Bank Central Asia, a listed bank, 47.15 per cent of
shares being held by an Indonesian family through
a Mauritius-based company
BJB Syariah Government 99.00% Bank Jabar Banten, a listed bank, 45.36 per cent of
shares being held by the regional government of
Table II. West Java
Ownership structure
of the sample banks Source: 2010 annual reports and financial statements of the sample banks

Islamic banks generally shows a high level of ownership concentration. Family control
also appears to be the most common type of ownership.

3.2 Methodology
In the present study, I construct the so-called CGDI by employing a comprehensive
checklist, comprising items related to the SSB, the BOC, the BOD, board committees,
internal control and external audit, risk management, and corporate governance
implementation reporting (see Appendix). In order validity to be enhanced, items
are carefully developed from a number of studies and guidelines[10]. Scoring of the
index for each bank is conducted through a content analysis, where the entire annual
report is read before making any judgment (Cooke, 1996). Similar to Haniffa and
Cooke (2002), in scoring items, the approach is essentially dichotomous, where an
item scores 1 if disclosed and 0 if it is not, without any penalty for each undisclosed
item. All items are equally weighted. The index is calculated using the following
formula:
Pnj
t¼1 X ij
CGDI ¼
nj

where nj is the number of items expected to be disclosed by jth Islamic bank;

Xij equals 1 if ith item is disclosed and 0 if ith item is not disclosed. Hence, the CGDI
would have the minimum value of 0.00 and the maximum value of 1.00.
The sample banks are then ranked based on their CGDI. The higher the index, the
more transparent the bank is in disseminating information on its corporate governance
mechanisms in the annual report.
4. Results and discussions Corporate
4.1 Corporate governance disclosure index governance
Table III reports the CGDI for the sample banks addressed in this study. For each bank,
I calculate the overall index, as well as the index for each of the seven dimensions. It disclosure
seems that a wide variation exists in disclosure practices among the seven Indonesian
Islamic banks. I rank the banks based on their overall CGDI. It is revealed that Bank
Muamalat and Bank Syariah Mandiri show the highest CGDIs, scoring 0.89 and 0.83, 13
respectively. This means that two banks disclose 89 and 85 percent, respectively, of
72 items constructed in the checklist. On the other hand, BJB Syariah and Bank Syariah
Bukopin appear to have the lowest CGDIs, scoring 0.32 and 0.49, respectively.
The last column in Table III also reports the average index, for either the overall
index or the index for each dimension. The items on the BOD dimension are the most
frequently disclosed constructs, with the average of 0.73. Other dimensions showing
relatively high indices are the BOC and risk management, with the dimensional indices
of 0.70 and 0.69, respectively. Alternatively, the aspect of internal control and external
audit is found to be the category with the lowest level of disclosure, with the average
dimensional index of 0.38. Given the average overall index of 0.60, it can be seen that
there are only two banks possessing above-average disclosure levels, namely Bank
Muamalat and Bank Syariah Mandiri.
It can be concluded that Bank Muamalat and Bank Syariah Mandiri show higher
levels of corporate transparency, particularly in terms of corporate governance
disclosure, compared to their peers. The two banks also achieve the highest possible
index for a number of dimensions. Bank Muamalat achieves perfect dimensional
indices (1.00) for the BOC and BOD, while Bank Syariah Mandiri is excellent at
disclosure on the BOD and corporate governance implementation.
Shariah Supervisory Board. Disclosure on the profile of the SSB would provide
assurance that the bank is conducted in accordance with shariah law (Haniffa and
Hudaib, 2004). Islamic banks are expected to disclose a set of aspects on their SSB,
including the description of board members (name, position, picture, and profile),

Bank Bank Bank Bank

Bank Syariah Mega Syariah Victoria BCA BJB
Muamalat Mandiri Syariah Bukopin Syariah Syariah Syariah Average

Shariah
Supervisory Board 0.75 0.92 0.50 0.67 0.58 0.42 0.42 0.61
Board of
commissioners 1.00 0.92 0.62 0.69 0.69 0.69 0.31 0.70
Board of directors 1.00 1.00 0.67 0.67 0.67 0.67 0.44 0.73
Board committees 0.87 0.80 0.67 0.40 0.47 0.53 0.00 0.53
Internal control
and external audit 0.88 0.50 0.38 0.25 0.25 0.38 0.00 0.38
Risk management 0.90 0.80 0.70 0.20 0.70 0.70 0.80 0.69
Corporate
governance
implementation
reporting 0.80 0.80 0.40 0.40 0.20 0.60 0.40 0.54 Table III.
Overall index 0.89 0.83 0.51 0.49 0.54 0.57 0.32 0.60 CGDI of the
Overall rank 1 2 5 6 4 3 7 sample banks
HUM duties and responsibilities, board meetings, meeting attendance, and remuneration for
29,1 board members. In addition, they need to communicate the board’s opinion whether
products, services, and profits/losses have been in accordance with shariah principles.
For this dimension, with the average index of 0.61, Bank Syariah Mandiri scores the
highest, followed by Bank Muamalat, and the lowest being BCA Syariah and BJB
Syariah.
14 It is found that most banks in the sample do not disclose any information regarding
board meetings, meeting attendance, board remuneration, and the compliance of
profits/losses with shariah principles. Further, it is only Bank Muamalat and Bank
Syariah Mandiri that disclose the board’s procedure – though not comprehensive – in
conducting assessments on the banks’ products, services, and profits, as found in the
following statements:
Activities of the SSB in 2010 included [. . .] methods and techniques to be employed in
[shariah] audit sampling (Bank Syariah Mandiri Annual Report 2010, p. 15 – translated by
the author).

To assist the Shariah Supervisory Board in executing its duties at Bank Muamalat a special
unit was formed, namely the Shariah Compliance Unit (ShCU) that acts as Liason Officer
between the Shariah Supervisory Board and the divisions/business units in Bank Muamalat
(Bank Muamalat Annual Report 2010, p. 58).
Additionally, three banks, namely Bank Syariah Mandiri, Bank Mega Syariah, and
Bank Syariah Bukopin, disclose in their annual reports the SSB’s recommendations to
management. The following statement indicates recommendation of the board for
improvements to be carried out by management in the future:
The Shariah Supervisory Board advised Bank Mega Syariah not to focus on business profits
only, but the bank also needs to adhere to prudential principles in performing banking
business based on shariah rules (Bank Mega Syariah Annual Report 2010, p. 13 – translated
by the author).
Board of commissioners. It is expected that Indonesian Islamic banks communicate a set
of important matters with respect to the BOC, namely the description of board members
(name, position, independence, picture, profile, and multiple commissionership), duties
and responsibilities, board meetings, meeting attendance, shareholding, and
remuneration for board members. For this dimension, the average index is 0.70. This
suggests that, on average, the sample banks have disclosed most constructs developed
in this dimension. Information on the BOC disclosed in annual reports is expected to
provide assurance to stakeholders that the BOC has effectively conducted monitoring
and advising roles on the BOD.
Bank Mandiri gains a perfect score (1.00) by disclosing all items for this dimension,
followed by Bank Syariah Mandiri. In their annual reports, these two banks also
communicate recommendations provided by the BOC to management, as in the
following statement:
The advice from Commissioners for Board of Directors of Bank Muamalat about the
finalization of Bank Muamalat’s business plan in the year 2010 is about improving
Management Information System so that it can be more accurate and comprehensive for
compiling customer data among all branches all over Indonesia (Bank Muamalat Annual
Report 2010, p. 143).
Board of directors. The BOD of Islamic banks is entrusted with resources to be Corporate
managed to maximize shareholders’, as well as depositors’, wealth. Thus, as suggested governance
by Haniffa and Hudaib (2004), stakeholders may need to assess the profile of those
managing the business. This implies that information regarding top management team disclosure
is important. For this dimension, most items that are important to disclose are similar
to those in the BOC dimension.
The dimensional index for the BOD is the highest among seven dimensions 15
included in this study’s checklist. Nevertheless, it is only Bank Muamalat and Bank
Syariah Mandiri scores above average, where both banks share the highest possible
score (1.00). While description of the board members are generally disclosed by the
sample banks, remuneration for board members is only communicated by three banks
in their annual reports, namely Bank Muamalat, Bank Syariah Mandiri, and BCA
Syariah. For instance, in addition to information on the compensation level for each
individual board member, BCA Syariah briefly communicates its compensation policy
in its 2010 annual report:
The distribution of remuneration and other facilities to the Board of Commissioners, the
Shariah Supervisory Board, and the Board of Directors referred to shareholders’ decision, as
determined in the shareholders’ general meeting, taking into account the advice provided by
the Remuneration and Nomination Committee. In general, the basic components of
remuneration include: (1) basic salary; (2) allowance, comprising health allowance, retirement
allowance, official vehicles, and Eid-ul-Fitr allowance of once a year (BCA Syariah Annual
Report 2010, p. 50 – translated by the author).
The detailed disclosure on the compensation level is a best practice adopted
internationally. However, such a practice in developing countries is relatively weak.
The disclosure on board remuneration would enable stakeholders to assess whether
the pay level is appropriate and has represented the performance of board members.
Board committees. Board committees are established to assist the BOC in decision
making process, as well as in conducting supervising and monitoring roles on
management. The members of the board committees are expected to possess particular
expertise or experiences that would support the effectiveness of such committees.
Therefore, information on those serving on the committees is also considered
important. Most items for this dimension are relatively similar to those for BOC and
BOD dimensions. The items include the description of committee members, committee
meetings, meeting attendance, remuneration for committee members, and the
performance report.
In terms of the performance report, Bank Muamalat and Bank Syariah Mandiri have
included such a report from board committees in their annual reports. For instance, the
following is taken from the performance report of the Remuneration and Nomination
Committee of Bank Syariah Mandiri:
The Remuneration and Nomination Committee held a meeting if it is considered urgent
according to the Remuneration and Nomination Committee Charter. During 2010, the
committee held three meetings with the following agendas: (1) discussing the remuneration
and nomination of the bank’s board members; (2) reviewing the remuneration of the bank’s
employees compared to other banks; (3) nominating the chairman candidate of the bank’s
Shariah Supervisory Board (Bank Syariah Mandiri Annual Report 2010, p. 102 – translated
by the author).
HUM The average index for this dimension among the sample banks is relatively low at 0.53,
29,1 the second lowest after the dimension of internal control and external audit. Again,
Bank Muamalat and Bank Syariah Mandiri outweigh their peers in this dimension’s
index. BJB Syariah, one of the newly established Islamic commercial banks in
Indonesia as at 31 December 2010, even does not disclose anything in terms of their
board committees. Further, it is important to note that none of the sample banks
16 discloses the remuneration scheme for committee members.
Additionally, none of the sample banks has established a Corporate Governance
Committee. Even though not required by Bank Indonesia, such a committee is expected
to provide commissioners or directors with independent recommendations related to
corporate governance matters. The establishment of this committee is recommended in
the Code of GCG, which was issued by the National Committee on Governance Policy
(Komite Nasional Kebijakan Governance) in 2006.
Internal control and external audit. Disclosure on internal control systems in the
annual report will enable stakeholders to examine that management is adequately
overseen, so that the interests of shareholders, depositors, creditors, and other
stakeholders are secure. It is expected that Islamic banks disclose a set of important
factors, such as internal control framework, duties and responsibilities of the internal
audit division, and internal audit certification held by employees. Further,
the bank’s external auditor also plays an important role as abovementioned. Hence,
this study expects that Islamic banks communicate their policies regarding the
appointment of external auditor.
Unfortunately, the disclosure practice of the Indonesian Islamic banks on this
dimension is relatively insufficient. The average dimensional index is 0.38, the lowest
among the seven categories. Bank Muamalat still leads with the score being 0.88,
followed by Bank Syariah Mandiri that scores 0.50. The scores of other five banks range
from 0.00 to 0.38. A separate internal audit report is also found in the annual reports of
Bank Muamalat and Bank Syariah Mandiri. Accordingly, internal audit frameworks
and the performance report on the internal audit are also found in the two banks only.
None of the sample banks discloses internal audit certifications held by employees. Even
though not disclosing does not mean that the bank has no certified internal auditors, the
disclosure of this specific skill will assure that the bank’s internal control system is
supported by highly skilled human resources. Bank Muamalat appears to be the only
bank disclosing its policy on the appointment of the external auditor.
Risk management. Sound risk management will assure stakeholders that a bank has
been prepared for uncertainties in the future, and that the bank has enough capital to
mitigate the risks. Hence, it is in the best interests of stakeholders that the risks faced
by a business are disclosed in a timely manner, including in its annual report
(Amran et al., 2009). In addition to the existence of a risk management unit and a risk
management framework, Islamic banks are expected to disclose how they manage four
risks as required by Basel II and Bank Indonesia, namely market risks, credit risks,
liquidity risks, and operational risks. Further, the banks need to disclose risk profile
and risk management certification held by their employees.
For the dimension, the index is 0.69 on average, which indicates that the sample
banks already have relatively sufficient awareness to communicate their risk
management. Bank Muamalat again leads with the index of 0.90. Interestingly, BJB
Syariah, which tend to have the lowest index in previous dimensions, share the second
rank with Bank Syariah Mandiri, having the index of 0.80. BJB Syariah stresses its Corporate
attention to sound risk management in its annual report, which can be seen in the governance
following:
disclosure
Bank undertook the implementation of integrated risk management through the
improvement of risk management infrastructure and implementation of adequate and
sustainable risk management processes based on the prudential banking principle
(BJB Syariah Annual Report 2010, p. 30). 17
Different from that in the internal audit, risk management certification held by
employees is disclosed in annual reports of four banks, namely Bank Mandiri, Bank
Syariah Mandiri, Bank Mega Syariah, and Bank Bukopin Syariah. However, it is found
that only Bank Syariah Mandiri and Bank Syariah Bukopin disclose their risk profile
in the risk management report.
Corporate governance implementation reporting. All Islamic banks included in the
sample have a separate Corporate Governance Implementation Report in their annual
reports. Even though the disclosure level varies among the banks, it indicates to a
particular extent their awareness in communicating the features of corporate
governance to stakeholders. Bank Syariah Bukopin states the following:
Transparency, accountability, responsibility, independence and fairness become the
foundation for the Company in implementing GCG. The Board of Commissioners, Directors,
Sharia Supervisory Board and all employees of the Company are committed in implementing
the GCG principles and practices (Bank Bukopin Syariah Annual Report 2010, p. 57).
Again, Bank Muamalat and Bank Syariah Mandiri outweigh their competitors in this
dimension. These two banks, being the most well-established Islamic banks in
Indonesia, also disclose the code of conduct in their annual report, as stated in the
following statement:
Since 2002, BSM has had the Code of Conduct that refers to the akhlaqul karimah
(good conduct). The Code is intended to provide guidance in behavioral aspects in line with
the expected values and culture, namely being Islamic, professional, and responsible in the
interactions with all parties, including colleagues, internal groups, customers, vendors, and
the regulator (Bank Syariah Mandiri Annual Report 2010, p. 109).
Bank Indonesia has required Islamic banks to carry out self-assessments on their GCG
practices. In fact, this is only disclosed by three banks, namely Bank Muamalat, Bank
Syariah Mandiri, and BCA Syariah. In order to convince stakeholders that the bank has
been conducted what has been required by the regulator, this aspect needs to be taken
into account for disclosure in the future. However, it is found that none of the sample
banks have an external party assess their GCG practices.

5. Concluding remarks
This paper examines the practice of disclosure on corporate governance mechanisms
among Indonesian Islamic banks. Islamic banks provide an interesting setting in
corporate governance studies due to several unique features, such as adherence to
shariah principles in operations and unrestricted IAHs. Indonesia, which has a
different institutional environment from other Muslim countries, provides another
interesting viewpoint. Corporate governance mechanisms are intended to align the
interests of various stakeholders. Hence, the disclosure on such mechanisms is argued
HUM to be advantageous in assuring stakeholders with respect to how an Islamic bank is
29,1 governed, which could influence the way resources entrusted to them are managed.
Employing a sample consisting of seven Islamic commercial banks in Indonesia,
this study examines the extent of corporate governance disclosure in seven areas,
namely the SSB, the BOC, the BOD, board committees, internal control and external
audit, risk management, and corporate governance implementation reporting. Using
18 content analyses on the banks’ annual reports, the CGDI is constructed for each bank,
either for the overall index or the dimensional index. A checklist as the research
instrument is employed using a comprehensive set of constructs. It is revealed that for
the financial year 2010, Bank Muamalat and Bank Syariah Mandiri show higher scores
compared to other banks. Given this result, these two banks may be referred to as the
benchmark in terms of corporate governance disclosure. The dimensions of BOC and
BOD appear to be the most frequently disclosed by the sample banks. This partly
indicates that the banks put much attention to displaying the profile of their board
members. Further, the lowest index goes to internal control and external audit. This
seems to imply that there is lack of awareness among the banks’ managers to
communicate such issues in the annual report.
This research is subject to some limitations. The content analysis may be biased to
a particular extent, and the research instrument employed here may not represent all
aspects of corporate governance disclosure. The small number of observations, despite
its significant proportion to population, is another issue. Given a sufficient number of
observations, future research is suggested to employ a more rigorous statistical
approach in examining the determinants of corporate governance disclosure.
The results of this study may bring some practical implications. Given the average
overall CGDI of the Indonesian Islamic banks that is relatively low (0.60), this study
then calls for the improvement of such disclosure in the banks’ annual report. The
enhancement of information being disclosed in annual reports is expected to benefit the
banks in several aspects. First, by disclosing the features of corporate governance in a
comprehensive manner, the banks can expect to gain wider acceptance in the banking
industry. This may leverage their reputation, so that the banks can attract more savvy
depositors and, in their capacity as issuers in the capital market, good investors.
Second, such disclosure can represent to a particular extent the banks’ effort in
enforcing GCG within their institutions, which will be a good starting point when the
banks consider seeking other financing alternatives, such as by issuing sukuk or shares
in the capital market. To date, among the Indonesian Islamic banks, it is only Bank
Muamalat who has been an issuer (for sukuk) in the capital market.

Notes
1. In Indonesia, Islamic banks are called bank syariah (literally means shariah bank). This term
is also used in the Islamic Banking Law and other applicable regulations in the country.
Nevertheless, in the present study, the term “Islamic banks” is used.
2. The term “Islamic Banking Law” here refers to Law Number 21 of 2008 concerning Islamic
Banking.
3. This study addresses corporate governance mechanisms and tools as indicated in such
studies as Chapra and Ahmed (2002) and Safieddine (2009). Thus, it excludes other relatively
irrelevant variables such as financial governance and corporate social responsibility of
Islamic banks.
 4. This refers to the Regulation of Bank Indonesia Number 11/33/PBI/2009 concerning the Corporate
Implementation of GCG for Islamic Commercial Banks and Islamic Banking Units.
Previously, Islamic banks should adhere to Regulation Number 8/4/PBI/2006 concerning the governance
Implementation of GCG for Commercial Banks. disclosure
5. The term “Corporation Law” refers to Law Number 40 of 2007 concerning Corporation.
6. The BOD in the context of Indonesia’s two-tier board system is absolutely different from that
in the unitary system. The BOD in Indonesian firms is equal to top management in unitary 19
board systems.
7. This refers to the Regulation of Bank Indonesia Number 11/25/PBI/2009 concerning the
Implementation of Risk Management in Commercial Banks.
8. The 2010 annual reports of other four banks (BNI Syariah, BRI Syariah, Bank Panin Syariah,
and Maybank Syariah) are not available on either corporate web sites or the internet.
9. The Capital Market Law in Indonesia (Law Number 9 of 1995 concerning Capital Market)
differentiates between “public corporation” and “listed corporation”. A firm is a public
corporation if its shares are “widely held” according to the Law, but not listed on the stock
exchange. On the other land, a listed corporation (whose shares are publicly traded on the
stock exchange) is definitely a public corporation as well.
10. Sources that are used to develop constructs in the checklist include previous studies, such as
Haniffa and Hudaib (2004, 2007) and Kusumawati (2007), as well as Indonesian banking
regulations, Indonesia’s Code of GCG, and guidelines of the Islamic Financial Services Board
(IFSB). Other additional constructs, which are considered best practices, are also included in
the checklist.

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Appendix. Checklist of corporate governance disclosure

A. Dimension: Shariah Supervisory Board
(1) Names of members.
(2) Positions of members.
(3) Pictures of members.
(4) Profiles of members.
(5) Number of meetings held.
(6) Members’ attendance in meetings.
(7) Remuneration of members.
(8) Duties and responsibilities of the board.
(9) Compliance of products and services with shariah.
(10) Compliance of profit or loss with shariah.
(11) Examination procedures.
(12) Recommendation to management.

B. Dimension: board of commissioners

(1) Names of members.
(2) Positions of members.
(3) Pictures of members.
(4) Profiles of members.
(5) Independence of members.
(6) At least 50 percent of members being independent.
(7) Multiple commissionership/directorship held by members.
(8) Number of meetings held.
(9) Members’ attendance in meetings.
(10) Remuneration of members.
(11) Duties and responsibilities of the board.
(12) Shareholdings of members.
(13) Recommendation to management.

C. Dimension: board of directors

(1) Names of members.
(2) Positions of members.
HUM (3) Pictures of members.
29,1 (4) Profiles of members.
(5) Number of meetings held.
(6) Members’ attendance in meetings.
(7) Remuneration of members.
22 (8) Duties and responsibilities of the board.
(9) Shareholdings of members.

D. Dimension: board committees

(1) Existence of an audit committee.
(2) Existence of a remuneration and nomination committee.
(3) Existence of a risk-monitoring committee.
(4) Existence of a corporate governance committee.
(5) Duties and responsibilities of each committee.
(6) Committee reports in the annual report.
(7) Names of members.
(8) Positions of members.
(9) Pictures of members.
(10) Profiles of members.
(11) Most members being independent.
(12) Number of meetings held.
(13) Members’ attendance in meetings.
(14) Remuneration of members.
(15) Performance of each committee.

E. Dimension: internal control and external audit

(1) Internal control report in the annual report.
(2) Existence of an internal audit division.
(3) Internal audit framework.
(4) Duties and responsibilities of internal audit division.
(5) Internal audit certification held by employees.
(6) Policies on the appointment of external auditor.
(7) External auditor appointed by the bank.
(8) Performance of internal audit division.

F. Dimension: risk management

(1) Risk management report in the annual report.
(2) Existence of a risk management division.
(3) Risk management framework.
(4) Duties and responsibilities of risk management division.
 (5) Risk management certification held by employees. Corporate
(6) Market risk management. governance
(7) Credit risk management.
disclosure
(8) Liquidity risk management.
(9) Operational risk management.
(10) Risk profile. 23
G. Dimension: corporate governance implementation reporting
(1) Corporate governance implementation report in the annual report.
(2) GCG framework.
(3) Code of conduct.
(4) GCG self-assessment.
(5) GCG assessment by an external party.

About the author

Salim Darmadi is a research staff member in Bapepam-LK and a Lecturer at STAN. His research
papers are forthcoming in such journals as Corporate Ownership and Control and Corporate
Governance. Salim Darmadi can be contacted at: salim.darmadi@bapepam.go.id

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